Will Washington Rethink Residency Rules For Marijuana Businesses?

When Colorado and Washington kicked off recreational marijuana legalization and business licensing, both states limited ownership of licensed marijuana businesses to their own state residents. Oregon’s ballot measure, passed two years later, followed suit. But Oregon’s legislature almost immediately removed that restriction.

Colorado’s legislature similarly lifted the restriction in 2016, allowing US citizens to qualify for ownership of licensed cannabis businesses. California, Nevada, and the clear majority of legal cannabis states allow at least some level of out of state ownership of licensed businesses. Washington, however, continues to maintain its strict residency requirement for ownership of marijuana businesses.

Washington’s residency requirement does not have any de minimis baseline — a 0.01 percent business owner is subject to the same restrictions as a 100 percent business owner. And the residency requirement doesn’t only apply to owners: Any person that can exert control over a business (such as a director, officer, or contract manager), anyone that has the right to receive business profits, and the spouses of all those people are all required to live in Washington.

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The restrictions even rope in things that may not be apparent on first read. For example, the state Liquor and Cannabis Board still considers royalties on branded products (e.g. a trademark license for 2% gross sales on products carrying the mark) to invoke the residency restriction.

As with all regulated industries, businesses push as much as they can at the bounds of these rules to accomplish their objectives. Out of state residents enter into business deals that include providing capital loans for a fixed interest return, which was itself restricted for the first few years of legalization. They lease or sublease real property, purchase and lease capital equipment, enter into consulting contracts, and enter into branding deals with fixed payments. The closest that they can come to a profit share or revenue share is an agreement to sell inputs at a markup to licensed cannabis businesses – be they branded packages or ingredients for edibles. The various restrictions and promises in these agreements test the boundaries of whether or not the out of state businesses exert “control” over cannabis businesses.

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Some state lawmakers and many licensed businesses cite these out of state business deals as a reason to partially lift the residency restrictions. If these types of deals are being entered into anyway, why not allow them to encourage transparency, the logic goes. It’s a similar argument to the one made about legalization in the first place.

But there are voices in Washington that support maintaining the residency restriction. Retailers, craft and cottage industry advocates, and established businesses think that the negative ramifications of more out of state money flowing into the state would outweigh any potential benefits. And for now, Washington agrees.

While the August 2013 Cole Memorandum put out by the Department of Justice did not have any language touching on state residency of cannabis business owners, the follow-up financial guidance from FinCEN did include payments to non-state residents as a red flag event for marijuana businesses.

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A quirk about marijuana businesses is that the states really don’t want them to fail. If this were any other new industry getting a lot of press buzz, you would expect to see lots of business failure in the early days. Businesses that are not adequately capitalized would have a tough time going up against competitors with large bankrolls that can afford to sell at a loss in the early days of the market.

In a regular market, that trend would course correct in a reasonable amount of time, and the market would stabilize. But with cannabis, business failure can be a scary thing for the state. A dying marijuana business is a risky candidate for black market and out of state diversion of product. And that type of diversion is precisely the type of activity that could trigger direct involvement from the DEA and DOJ, agencies that would love nothing more than to have a good reason to bust up state-legal cannabis businesses. Many business owners and legislators in Washington think that maintaining the state residency requirement contributes to current industry stability, and they prefer the status quo to the unknown possibilities of a large influx of out of state capital.

The Washington legislature goes back into session in January, now under unified Democratic Party rule. After taking on cannabis issues every year since 2014, the legislature seems ready to move on to other things, but don’t be surprised to see the state residency restriction rear its head in proposed legislation.

Robert McVay is an attorney at Harris Bricken, a law firm with lawyers in Seattle, Portland, Los Angeles, San Francisco, Barcelona, and Beijing. This story was originally published on the Canna Law Blog.