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Cannabis Litigation Options: The Benefits of a Receivership

Thank you to everyone who joined us for the “The Top 12 Alternative Dispute Resolution Strategies” webinar last week. We received a ton of questions on a lot of really interesting topics, and we will be spending the next few weeks addressing those we couldn’t fully get to during the one-hour period. We received a…

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cannabis receivershipThank you to everyone who joined us for the “The Top 12 Alternative Dispute Resolution Strategies” webinar last week. We received a ton of questions on a lot of really interesting topics, and we will be spending the next few weeks addressing those we couldn’t fully get to during the one-hour period.

We received a few questions on the topic of cannabis receiverships. As we discussed in the webinar, we’re seeing that a good amount of cannabis litigation has to do with “partnership” (technically, LLC member) disputes. You also might have or will find yourself in trouble because you chose a business partner you’re not happy with, and you want that partner to exit. While you evaluate your options (litigation or alternative dispute resolution) and proceed whichever way makes most sense for you, who will run the day-to-day of your business while you duke it out?

The best answer for some marijuana companies is a court-appointed receiver. These receivers are neutral third-parties that will take over a business’ operations while it’s involved in legal proceedings. A receiver’s sole purpose is to preserve and protect the business during this period – and, if you take care to ensure that your receiver is well-versed in the cannabis industry, he, she or it can typically handle everything from sales to personnel to accounting.

Some clients have viewed receivership as a “last resort” option as most don’t like to relinquish control of a business they’ve grown from the bottom up. This is a valid concern, as a receiver’s powers over a business is usually extremely broad – it can manage all funds, replace a management company, hire and fire employees, obtain new legal counsel, etc. However, especially in the case of a partnership dispute, there are definite upsides. If you’re concerned that funds are being commingled, misappropriated, or flat out stolen, putting in a receiver can safeguard against those concerns for the time-being. Similarly, if you suspect that your partner is unmotivated or may be sinking the ship intentionally, a receiver can step in and make sure that the business is being run optimally. In great cases, a receiver may make the business better than ever by implementing better business practices (think: actually setting up books and records) and stopping any unnecessary bleeding (think: reducing exorbitant salaries or theft of cash and inventory).

Also consult with your attorneys about whether modified receiverships make more sense – in circumstances where a total receivership is inappropriate, the court may consider a “limited purpose receiver” to take charge of a defined aspect of a business (hold the funds, collect the accounts, take charge of the accounting functions, prosecute and settle a lawsuit), leaving you and your partner to run the rest of the business. A receivership may also be used in combination with other remedies, such as injunctions, to accomplish your desired results.

Another thing to note is that any interested party can ask the court to appoint a receiver, like a creditor. This is especially useful as cannabis businesses can’t obtain bankruptcy protection. So, even if a lender can’t go to bankruptcy court, they can go to a state court and ask for a receiver to be appointed to give a distressed cannabis business a better chance of succeeding.

Receivers typically bill hourly (like attorneys and accountants), and they take their fees from the business unless another arrangement has made. Depending on the level of control, a receiver’s total compensation can really range – obviously, another important consideration to keep in mind. Despite the cost, we anticipate that receivers will become much more common in the cannabis industry as it continues to grow.

If you find yourself in a dispute, and particularly a partnership dispute, don’t forget that a receiver might help alleviate a lot of your business concerns while your attorneys fight for your legal ones.

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Hemp & CBD

Charlotte’s Web Faces Another Class Action Lawsuit For Improperly Marketing CBD Products

The hemp-derived CBD market is a tough one right now. From uncertainty in when and how the FDA may begin regulating products, to the downturn in the stock markets as result of the coronavirus affecting the hemp industry, the problematic interim rules concerning hemp production and increasing state regulation, CBD companies face a plethora of…

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suing you

The hemp-derived CBD market is a tough one right now. From uncertainty in when and how the FDA may begin regulating products, to the downturn in the stock markets as result of the coronavirus affecting the hemp industry, the problematic interim rules concerning hemp production and increasing state regulation, CBD companies face a plethora of issues in trying to turn a profit. Add increasing consumer class action litigation to the list – something we predicted several months ago.

Recently, Charlotte’s Web Holdings, Inc. (“CWB”) was served with a second consumer class action lawsuit alleging “multiple and prominent mislabeling” of certain products that “form a pattern of unlawful and unfair business practices that harm the public.” Benson v. Charlotte’s Web Holdings, Inc., No. 1:20-cv-00418 (N.D. Ill.) (You can read about the first consumer class action lawsuit against Charlotte’s Web here). This new lawsuit, filed in the Northern District of Illinois, focuses on two products, “Soothing Scent Hemp Infused Cream” and “Unscented Hemp Infused Cream” (the “Products”).

The gravamen of the complaint is that CWB markets the Products online and on the product packaging as containing a certain amount of hemp extract, but the Products actually contain an amount of hemp extract significantly less than the amounts claimed by CWB in its marketing and labeling. In particular, the Complaint alleges CWB represents that the Products contain “750 MG Hemp Extract,” but several tests of the Products—done by a third-party laboratory most likely at the behest of the Plaintiffs—reveal that amount of hemp extract in the products ranged from 177.5 MG to 347.9 MG.

The Plaintiffs allege claims for breach of express warranty, breach of the implied warranty of merchantability, unjust enrichment, and violation of several state consumer fraud acts. The Complaint claims that class damages exceed $5 million and seeks to recover monetary damages in an amount proven at trial and attorneys’ fees. (Feel free to email me for a copy of the complaint.)

If your company sells CBD products these lawsuits should concern you. Increasingly we work with clients who contract with one or more third parties for the manufacture, labeling and shipping and of CBD products. But if your company’s name is on the label or the product purchased through your website, you are at risk. Now is the time to revisit your contracts to ensure that the risk of the manufacturer failing to ensure the product contains the amount of CBD on your label falls on the manufacturer, not on you. Start with the defense and indemnity provisions in each of your contracts, and go from there!

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Business Basics

Girl Scouts Allege Misappropriation by Cannabis Edibles Company

As usual, we’ve been monitoring both brewing and active trademark disputes in the cannabis space, and the most recent example involves the institution that is the Girl Scouts. For background, here are some of the other disputes we’ve covered in the past: Kiva Lawsuit Highlights the Cannabis Industry’s Ongoing Trademark Troubles Cannabis Trademark Litigation: Web…

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girl scout cookies cannabis

As usual, we’ve been monitoring both brewing and active trademark disputes in the cannabis space, and the most recent example involves the institution that is the Girl Scouts. For background, here are some of the other disputes we’ve covered in the past:

According to a recent article in Forbes, California cannabis-edibles company Kaneh Co. was promoting its cannabis-infused cookies as similar to several of the Girl Scouts’ cookie brands. According to the article, Kaneh was comparing its “Toasted Coconut Caramels (‘flecked with vanilla and sea salt’) to the Scouts’ Samoas; its Lemon Sugar Cookies to the Scouts’ Lemonades; and its Salted Toffee Blondies (‘a brown sugar blondie swirled with toffee chips and a generous dose of sea salt’) to the Scouts’ Toffee-tastic cookies.” All of these descriptions were included in an emailed advertisement for Kaneh’s goods, and a representative from Kaneh stated that the Girl Scouts comparison would not appear in any print or online advertisements.

The Girl Scouts, however, were not amused by Kaneh’s likening of its products to the Girls Scouts’ cookies, particularly given the connection to cannabis. A statement from the Girl Scouts said, “We consider … such use of our [cookie names] trademarks to be misappropriation, which we take seriously and, when applicable, [we] will send a cease and desist request.”

This is not the first time the Girl Scouts have gone to bat against a cannabis company, previously having clamped down on the use of the strain name “Girl Scout Cookies.” See: How an LA Weed Dispensary Pissed Off the Girl Scouts.

Quite frankly, it’s understandable that a youth organization would object to the use of its intellectual property in conjunction with a Schedule I controlled substance. But what is interesting about the Girl Scouts’ current beef with Kaneh’s use of its intellectual property (IP) is that the Girl Scouts representative didn’t argue that Kaneh was infringing the Girl Scouts’ trademarks (as was the case in the disputes we’ve covered in the past and linked to above). The representative instead asserted that such use of the Girl Scouts’ cookie names was “misappropriation,” and this is an important distinction.

As we’ve covered before, a trademark is a word, phrase, symbol, and/or design that identifies and distinguishes the source of the goods of one party from those of others. And trademark infringement is the “unauthorized use of a trademark or service mark on or in connection with goods and/or services in a manner that is likely to cause confusion, deception, or mistake about the source of the goods and/or services.” In the case at hand, the Girl Scouts would be hard pressed to show that Kaneh’s use of the names of its cookies (which are protected by trademark registrations), was likely to cause consumer confusion or mistake about the source of the goods, since Kaneh was only referencing the cookies in a comparative manner, to explain to customers what its cookies tasted like. In fact, this comparative manner of use would make it very clear to customers that Kaneh’s cookies were not Girl Scout cookies.

But are companies allowed to make these kinds of comparative statements? And what is “misappropriation” in the context of trademarks? The theory of misappropriation in a trademark context is tenuous, but there are three basic elements (J. THOMAS MCCARTHY, 2 MCCARTHY ON TRADEMARKS AND UNFAIR COMPETITION § 10.72 (4th ed. 2006)):

  1. Plaintiff has made a substantial investment of time, effort and money into creating the thing misappropriated such that the court can characterize that “thing” as a kind of property right [the creation element].
  2. Defendant had appropriated the “thing” at little or no cost, such that the court can characterize defendant’s action as “reaping where it has not sown” [the appropriation element].
  3. Defendant has injured plaintiff by the misappropriation [the injury element].

The idea here would be that Kaneh was free-riding on the goodwill that the Girl Scouts have worked to establish over the years. But there are also “fair use” exceptions to trademark infringement, including for comparative advertising. It is unclear whether such comparative advertising principles would apply in this case, since traditional girl scout cookies fall within a completely different product category from cannabis-infused cookies. Still, this is something that all cannabis business owners should be mindful of. Use of another company’s trademark in comparative advertising may be allowed under certain circumstances, but businesses must be very careful to avoid advertisements that could be deemed false and misleading.

Even if you think that your use of another’s trademark does not constitute trademark infringement, or that your use falls within a fair use exception like comparative advertising, it is important to consider claims that could be made against you like misappropriation, or false and misleading advertising, and it is important to run these types of advertisements by your IP lawyer.

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California

California Cannabis Litigation: Airing the Dirty Laundry Edition

We’ve written a good amount on how ugly litigation will be. There’s federal illegality and the possibility that a court refuse to rule on a contract dispute because cannabis is federally illegal. Companies can be sued for false advertising and have all of their profits attributable to the false advertising disgorged by competitors. Allegedly false…

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california cannabis litigation

We’ve written a good amount on how ugly litigation will be. There’s federal illegality and the possibility that a court refuse to rule on a contract dispute because cannabis is federally illegal. Companies can be sued for false advertising and have all of their profits attributable to the false advertising disgorged by competitors. Allegedly false claims can also be the subject of class-action shareholder suits. If a company is engaged in ongoing wrongs, courts can literally order them to stop via injunctions, and if they do not, people could be held in contempt and go to jail. Courts can award punitive damages just to punish companies who do very wrong things like engage in fraud. The list goes on.

One thing that many cannabis companies may not even have on their radars is the damage that can arise through pleadings and during the discovery process in court litigation. Pleadings are the complaint and answers in any case. Plaintiffs file complaints and make allegations about defendants, and defendants answer those complaints and admit or deny the allegations. All of this is public unless companies are in arbitration or a court has ordered that it not be public (and good luck getting that order).

When it comes to the discovery process, during litigation, parties can make requests for the other parties to produce documents or information and can even force certain people to sit for hours under oath and testify (this is often videotaped and almost always transcribed for later use). Discovery is not necessarily public, but outside of arbitration and without “protective orders” signed off on from the court, the information learned in discovery often winds up in the public domain.

Cannabis companies should not overlook the importance of pleadings and discovery and their potential public nature. By now, everyone is familiar with this fact pattern: allegations are made against a public cannabis company, and overnight, its stock value plummets significantly. Even for non-public companies, having allegations of things like fraud, false advertisement, breach of contract, etc. out in the ether can be problematic when trying to raise funds and get licenses. Moreover, even if a cannabis company gets a case dismissed, the complaint is still public record without a court order sealing it, and again, that’s probably not going to happen.

What makes the risk of publicity all the more problematic is the potential for rule violations to come to light. Given the fact that all state-level cannabis regulations are murky and complicated, it is understandable that some companies may not have strictly complied with the rules. That may come out in discovery. What also may come out in discovery are the internal conversations about those rule violations. Imagine an email chain where the owners of a company talked about, acknowledged, and agreed to sweep under the rug a severe rule violation. That could be part of the record in litigation.

Also problematically, cannabis regulations require licensees to keep records of just about everything, and to keep them for years. Parties to litigation will have a hard time saying that records don’t exist, and if they truly don’t exist…. well, that’s another potential rule violation that could come out.

Litigation is almost always ugly and unpleasant for the parties. But in this industry, parties will have a lot of leverage over each other given the nature of cannabis regulations and the industry as a whole. In the first quarter of 2020, our cannabis attorneys have already seen a huge uptick in disputes, and we don’t expect it to relent anytime soon. Stay tuned to the Canna Law Blog for more on the wave of disputes that are about to hit.

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