Illinois Cannabis Legislation: The cracks in the artwork

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Illinois recently came out with the first draft of legalized cannabis legislation. The bill is loaded with social equity provisions which include a program to provide low-interest loans for “social equity applicants”.

Like any first draft nothing is final and everything is a work in progress. When looking at the bill, I noticed that there are some provisions that may not conform with federal legal standards, some provisions that could bring legal challenges and some provisions that may lack consistency with other parts of the proposed legislation.

Cannabis Business Development Fund

Under Section 7-10 of the proposed legislation, Illinois creates a cannabis business development fund. This fund, a state treasury fund, which is separate and apart from all other state moneys, is utilized for social equity purposes. One of the main purposes of the fund is to provide low-interest loans to Social Equity Applicants to “pay for ordinary and necessary expenses to start and operate a cannabis business establishment”.

Although this idea is well intentioned, it may run afoul of federal law which does not provide the green light to fund or loan money to cannabis organizations. At the federal level cannabis is illegal under the Controlled Substance Act and is classified the same way as heroin. The major banks will not get involved in funding cannabis, holding money for cannabis companies, or providing loans to cannabis companies.

With the prohibition on lending to cannabis related businesses, one must ask the question: is the state creating a fund that runs afoul of the federal law? Further, the law denotes that the fund is a “special fund”, which means the money is set aside for the program. But this begs another question, how will the money be held when banks do not want to hold cannabis money. A bank will not likely risk its federal charter by potentially violating the Controlled Substance Act.

With a provision that seems on its face to run afoul of federal banking provisions, the State may have created an entity that does not conform to federal standards. And further, the State may be participating in activity that is illegal from a federal level.

To be fair, the state may have a different funding mechanism in mind or they are anticipating the federal law changing for financial institutions pursuant to cannabis.

Nevertheless, the law on its face seems to violate federal law and allows the state to perform activities which a bank is banned from performing.

Finally, under Section 55-65, financial institutions are exempt from criminal law in Illinois if they provide financial services to cannabis related business authorized under state law.  But again, this provision does not embolden financial institutions since lending to cannabis companies can put their federal charter at risk.

Favorability to Residents

Illinois will grade applications based on a scoring system with points assigned for meeting certain criteria. Under Section 15-30, an applicant is awarded bonus points for obtaining a conditional license if 51% or more of the company is owned or controlled by Illinois residents.

As the average liquor person can tell you, criteria based on residency may not be constitutionally sound. In many liquor cases, discriminating based on residency leads to Commerce Clause violations and the law being held unconstitutional. We saw this in the Granholm case from the United States Supreme Court and may see it in the Tennessee Wine case from the United States Supreme Court.

This provision holds the potential to flirt with constitutional violations and subject the state to a legal challenge. Now I will caveat it and indicate that this challenge is harder to prove than a flat-out denial based on residency. However, if an out-of-state company finds out that its points are narrowly short of the finish line, which a state resident could have put them over the top, then a constitutional challenge could be in the offering.

Of Value and Incubator Program

Piggybacking off the liquor world, the legislation creates an “of value” provision which makes it unlawful “for any person having a cultivation center license or any officer, associate, member, representative, or agent of such licensee to offer or deliver money, or anything else of value, directly or indirectly to any person having an Early Applicant Adult Use Dispensing Organization License, an Adult Use Dispensing Organization License.” Section 20-30(o)

Yet in another section of the bill, 20-10, to obtain Early Approval of Adult Use Cultivation Center License, a license holder can agree to “participate as a host in a cannabis business incubator program approved by the Department of Commerce and Economic Opportunity, and in which an Early Approval Adult Use Cultivation Center License holder agrees to provide a loan of at least $100,000 and mentorship to incubate a licensee that qualifies as a Social Equity Applicant for at least a year.”

It seems there may be some inconsistencies between these two sections. On the one hand, someone awarded the privilege of an early license has one of many options to fulfill their duties to the state. One which of course is to provide a low interest loan to a business. On the other hand, there is an “of value” provision which does not allow one to provide funds to another business.

We are assuming that the “of value” provision is based off the liquor provisions, where the goal of the law is not to allow a major supplier or wholesaler to provide cash or credit to a retail to run their business. The reasoning is if we allow cash or credit to become extended between businesses, one business will majorly influence the other. The “of value” provision maintains independence between businesses and ensures that one doesn’t become a major influencer of another business.

By allowing a business to provide a loan and act as a mentor for an incubator, doesn’t it sacrifice the independence that the “of value” provision seeks to maintain?

On another note, I guess I am puzzled by the “of value” provision. In the liquor world “of value” is based on avoiding a tied house and from a retailer obtaining free items, such as branded glassware, furniture etc. I am not sure what items can be provided to create a tied house under this scenario. Would providing branded pipes and bowls be considered “of value” items? I guess these are issues that can become worked out in the rules process.

Limits on licenses

Under Section 15-30(k) there is a limit that a person or entity can’t own more than 10 licenses. We have seen Total Wine and More win at the South Carolina Supreme Court challenging the limit on retail licenses for a business.

However, this is a different situation. There will be strict limits on the number of cannabis licenses, unlike liquor licenses, and the state could probably come up with a sound reason for limiting the number of licenses. In other words, a judge would probably not find that economic protectionism is the purpose for store limits.

But as time goes on and the maximum number of licenses increase, this provision could be looked at with scrutiny.

Electronic Funds

Under 20 ILCS 2505 (b) the state allows and may even mandate that a tax liability be paid by electronic funds transfer. Again, this may run afoul of federal rules on banking. One would presume that the electronic payments may need to be made through a financial institution or bank. As mentioned earlier, based on its classification as a Controlled Substance, akin to heroin, most financial institutions won’t touch cannabis funds. So, the state’s provisions on electronic funds may not be feasible at this moment.

Fee Waivers

Another interesting provision of this legislation is that under Section 7-20 for Social Equity Applicant’s the state “shall waive 50% of any nonrefundable license application fees”.

Could an entity that is required to pay full freight legally challenge this provision based on the disparate treatment? Clearly, the state is not treating all applicants uniformly.

Conclusion

This legislation is a work in progress and we will see where it goes. And when it is done then the State will draft rules interpreting it all.

The bill may go through clean up and different reiterations, but the bill in its present state leaves some questions that need to be answered.

Only time will tell how it will all shape out and whether the federal government opines on some of its provisions.

Stay tuned, it is never a boring time in Illinois!

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