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December 21, 2022

Cross-Border Update

Q4, 2022—"Foreign Ownership in New York's Two-Tier Cannabis Market"

New York State legalized adult-use cannabis on March 31, 2021. With New York’s legalization came the imposition of a two-tier market system. The New York State Cannabis Law (Cannabis Law) divides the market into two tiers: supply—consisting of cultivation, processing, and distribution; and retail—consisting of retail dispensaries, on-site consumption lounges, and delivery licensees. 

An applicant for an adult-use cannabis license must have a “significant presence in New York State, either individually or by having a principal corporate location in the state; is incorporated or otherwise organized under the laws of this state; or a majority of the ownership are residents of this state.”i

At first glance, to establish a “significant presence” in New York State, an applicant would only have to form a New York entity, which may have ancillary benefits in the application process. However, Section 137(1)(c) of the Cannabis Law states that a partnership or corporation is forbidden from trafficking in cannabis:

. . . unless each member of the partnership, or each of the principal officers and directors of the corporation, is a citizen of the United States or a person lawfully admitted for permanent residence in the United States . . . provided however that a corporation which otherwise conforms to the requirements of this section and chapter may be licensed if each of its principal officers and more than one-half of its directors are citizens of the United States or persons lawfully admitted for permanent residence in the United States.

Therefore, if Canadian citizens want to have an ownership interest in a New York adult-use cannabis license, it must be in the form of a corporation, and the majority corporation’s board and all the principal officers must be US citizens or permanent residents.

However, there are further restrictions beyond the composition of the ownership and leadership of the applicant. The two-tier system implemented by the Cannabis Law means that a person having an interest in the supply side of the industry cannot have an interest in the retail side. The Cannabis Law calls this a direct or indirect interest.ii In regulation, this has become known as the true party of interest (TPI) rules. Under 9 NYCRR Part 116 of the regulations, TPIs include, but are not limited to:

  • An applicant or licensee’s sole proprietor, partner (whether limited or general), member, manager, president, vice president, secretary, treasurer, officer, board member, trustee, director, or a person with equivalent title to each of the foregoing
  • A stockholder of the applicant or licensee, other than a passive investoriii 
  • Each person that makes up the ownership structure of each level of ownership for an applicant that has a multilevel ownership structure
  • A person with a right to receive some or all of the revenue, gross profit, or net profit from the licensed business during any full or partial calendar or fiscal year
  • A person with a financial interest in the applicant or licenseeiv
  • A person that has authority to or exercises control over the applicant or licensee
  • A person that has membership rights in the applicant or licensee in accordance with the provisions of any articles of incorporation, bylaws, limited liability corporation agreements, partnership agreements, or operating agreement
  • A person that assumes responsibility for the debts of the applicant or licensee
  • A spouse of any individual in the first three bullet points

Guidance that has been released subsequent to the only regulation to define TPI has expanded on the meaning of TPI and when someone crosses a threshold to become a TPI.

For example, there is a prohibition on having a direct or indirect interest in more than one cultivation license. In the context of TPI, this means that a person cannot be a TPI in more than one cultivation license. However, in the guidance, the Office of Cannabis Management (OCM) , the agency charged with administering the rules approved by the Cannabis Control Board (CCB) and regulating the industry in New York State, stated that a company that provides management services to a licensee may provide their services to multiple cultivation licensees but only if the fee is a flat rate that, in a calendar year, does not exceed the greater of (1) 10% of revenue, 50% of net profits, or $100,000. If those thresholds are violated, the management service provider is deemed a TPI and cannot have an interest in more than one cultivation license. Moreover, even if the management service provider is not considered a TPI of a cultivator or processor, they cannot provide management services for dispensaries, delivery companies, on-site consumption lounges, laboratories, or registered organizations (New York medical cannabis licensees).

On October 28, 2022, the OCM released guidance for adult-use retail dispensary licensees broadening the scope of the two-tier prohibition. Previous to that guidance, it was understood that being a TPI in a supply-side adult-use cannabis business in New York State would prohibit a person from being a TPI in a New York adult-use cannabis retail business. However, the OCM expanded the prohibition so that a person that has an interest anywhere in the supply tier is prohibited from having an interest in a New York adult-use retail license.

This new guidance has major implications for New York’s adult-use cannabis industry. Some states mandate vertical integration of cannabis companies, effectively banning industry participants in those states from having an interest in retail in New York. Most other states have no ban on vertical integration, and therefore, vertically integrated companies are common in other legal states, as it tends to be a more efficient corporate structure, particularly in regard to the effects of US tax law on cannabis companies.

Applicants for New York adult-use cannabis retail licenses who have interests in the supply tier in another jurisdiction must divest themselves of that interest. Similarly, a TPI of an applicant for a New York adult-use cannabis retail license, e.g., a passive shareholder, must be vetted by the applicant to ensure the TPI has no interest in the supply tier in the cannabis industry. This prohibition falls squarely on the licensee, as the OCM only has authority to regulate licensees. Therefore, retail licensees must be vigilant to ensure not only that their TPIs do not have an interest in the supply tier when the TPI is initially brought into to the license but also that the TPI never acquires an interest in the supply tier.

If you have any questions regarding the content of this blog, please contact Jason Klimek, Cannabis Team co-leader, at jklimek@barclaydamon.com, or another member of the firm’s Cannabis Team.
                                                           

iNew York State Cannabis Law Section 3(1).
iiNew York State Cannabis Law Article 4.
iiiA passive investor is someone who has an aggregate ownership of no more than five percent of the outstanding shares of an applicant or licensee whose shares are publicly traded, and that person does not have control over the applicant or licensee.
ivA financial interest means any actual or future right to ownership, investment, or compensation arrangement with another person, either directly or indirectly, through business, investment, parent, or child. A person with a financial interest does not include a passive investor.
 

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