Whether you own a restaurant, car dealership, widget factory or any other business, soon after you begin to enjoy commercial success you will likely search for opportunities to increase the scope of your operations. By making your goods or services available in new territories, you can increase market share, create new sources of revenue and strengthen customer loyalty for your brand. Because time, money and human capital are finite resources, when evaluating how to expand your operations you should consider selling to others the rights to use your business name and other intangible assets instead of commencing operations in each new market by yourself. While there would be concerns for licensing intellectual property (IP) assets for any business, there are several unique considerations to be evaluated if your company is part of the cannabis industry.
There is currently a conflict between federal and state law with respect to the manufacture and sale of cannabis and cannabis-infused products. Under the Controlled Substances Act (“CSA”), it remains illegal under federal law to manufacture, sell, process or transport such goods across state borders. Penalties for violating the CSA include substantial civil fines and imprisonment. Although in recent years many states have enacted laws that permit the cultivation, processing, sale and/or use of cannabis-related products, such authorization is expressly limited to activities within the state’s borders. Under the 2013 memorandum commonly known as the Cole Memorandum, the United States Department of Justice directed federal prosecutors and law enforcement officials to limit their enforcement of the CSA against businesses operating in accordance with state laws to cases in which there has been a violation of one of eight enforcement priorities. One such enforcement priority is to “prevent the diversion of marijuana from states where it is legal under state law in some form to other states.” In order to avoid violating the CSA, state laws and the Cole Memorandum, it is essential that business owners do not create any licensing program that calls for transporting controlled substances across state lines.
Although there are strict limitations on transporting infused products between states, businesses may lawfully license their intellectual property to companies in other states. Legal cannabis operators allocate a tremendous amount of time, money and effort to creating and improving their product brands, formulas, cultivation techniques, extraction methodologies, operational methods and supporting documentation. These IP assets do not constitute controlled substances under the CSA, they have tremendous value and they can be both protected and monetized.
The ability for cannabis operators to license their IP assets is also limited because the United States Patent and Trademark Office has refused to register marks used for cannabis products, paraphernalia and/or certain related support services. The USPTO, through its Trademark Trial and Board has consistently held that, to be registered by the USPTO, the use of a mark must be “lawful” under federal law to qualify for federal registration. Notwithstanding this limitation, operators have been able to register marks with the USPTO in connection with consulting services, educational services and non-infused products. Operators have also registered their marks with various state registries.
Under the current circumstances, how can operators in one state properly license their IP assets to businesses or applicants in other states? While licensing deals are not to be viewed as a formulaic or “one size fits all proposition,” such arrangements often include most or all of the following components:
- A successful operator in the legal cannabis industry creates a separate IP licensing company
- No controlled substances cross state lines
- The licensee in each state remains solely responsible for all manufacturing and distribution issues within that state
- The licensor may provide training, equipment, non-infused supplies and/or operational consulting
- The parties structure payment terms to comply with the laws of both jurisdictions
The parties to the license agreement must also be careful to not create an arrangement which qualifies as an unregistered franchise system. While franchise laws vary from state to state, the Federal Trade Commission’s general definition of a franchise is a system in which: (1) the licensee obtains the right to operate a business that is identified or associated with the licensor’s mark; (2) the licensee exerts or has authority to exert a significant degree of control over the licensee’s operations; and (3) the license makes required payments as a condition to using the license. In order to avoid this potential problem, a licensor can impose conditions on the use of its mark without attempting to exert any meaningful control on the overall operations of the licensee’s business.
A licensing agreement must also be flexible enough to address what will happen if and when there is a change in the applicable laws, regulations or enforcement policies of either the federal government or any applicable state or local government. Each licensing agreement must be tailored to the specific parties, states, laws, products, services and assets in question. In particular, license agreements should include payment provisions that do not violate the state laws of either the licensor or the licensee. In some states, an out-of-state licensor receiving royalties from an in-state licensee would be treated as possessing a direct financial interest in the licensee, which would trigger an in-state residency requirement for the licensor. Some states with legal cannabis programs restrict the amount and type of payments that may be paid to out-of-state companies. Additionally, some states prohibit involvement in their cannabis industry by companies that are not licensed to trade in cannabis in the state.
Parties to a cannabis industry license should regularly revisit the contract during the term of the agreement. Both the licensor and the licensee should regularly make sure that each side is honoring its obligations and identify any changes required due to changes in the law or applicable circumstances. With proper operating procedures, the parties can make needed amendments to the agreement before a small issue becomes a substantial problem.
Jonathan Wachs is a Co-Founder of Offit Kurman’s Cannabis Law Group and is the Chair of the firm’s Intellectual Property Group. If you have any questions on licensing your cannabis related Intelectual Property, please contact Mr. Wachs by e-mail at firstname.lastname@example.org or phone at 301-575-0302.
ABOUT JONATHAN WACHS
Jonathan Wachs provides strategic counseling and operational advice to clients in the areas of intellectual property, commercial transactions and outsourced legal departments. As head of the firm’s Intellectual Property Group, Mr. Wachs works closely with clients to develop, register, analyze, enforce, and transfer intellectual property assets in a customized, cost-efficient, and highly effective manner. Additionally, he conducts intellectual property audits through which clients learn the nature and value of their intellectual property assets and the steps needed to protect such assets from misappropriation or dilution. As a business lawyer, he has successfully negotiated and completed several multimillion dollar business transactions and has served as general counsel to several small and midsize businesses and organizations in various industries and professions. He also manages a blog about intellectual property issues, Friday Factoids. Mr. Wachs co-manages New Paradigm Counsel, a service through which Offit Kurman delivers customized, comprehensive and cost-effective outsourced legal departments. Through New Paradigm Counsel, Jon served as outsourced general counsel for a government contractor, a large printing business, a payment processing company and an identity theft restoration business.
ABOUT OFFIT KURMAN
Offit Kurman is one of the fastest-growing, full-service law firms in the Mid-Atlantic region. With over 135 attorneys offering a comprehensive range of services in virtually every legal category, the firm is well positioned to meet the needs of dynamic businesses and the people who own and operate them. Our eleven offices serve individual and corporate clients in the Virginia, Washington, DC, Maryland, Delaware, Pennsylvania, New Jersey, and New York City. At Offit Kurman, we are our clients’ most trusted legal advisors, professionals who help maximize and protect business value and personal wealth. In every interaction, we consistently maintain our clients’ confidence by remaining focused on furthering their objectives and achieving their goals in an efficient manner. Trust, knowledge, confidence—in a partner, that’s perfect.
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