Lance Rogers of Greenspoon Marder writes……
In 1893, the United States was in a serious economic depression. Unemployment was over eleven percent. People rushed to withdraw their money from banks and caused bank runs. This period became known as the “Panic of 1893.” Against this backdrop, small family-run farms in California developed a new model for marketing their crops that fundamentally changed the way that farmers market their products in the U.S. today. The farmers realized that if they organized themselves into “cooperatives” they could increase their profits and their collective bargaining power with other businesses such as workers, packers, distributors, and retailers.
The Southern California Fruit Exchange was one such cooperative. This group of citrus farmers joined together to market California oranges and lemons. In 1908, the Exchange created the “Sunkist” brand which became the produce industry’s first ever national ad campaign. By 1990, the Sunkist cooperative brought in gross revenue of over $1 billion. To this day, Sunkist remains a not-for-profit cooperative entirely owned and operated by farmers.
Since the creation of agricultural cooperatives in the late 1800s, federal and state laws have developed to protect these entities and the farmers that join them. For example, in California state law actually provides special protection under the Food & Agricultural Code for these associations. Interference with a farmer’s right to join a cooperative bargaining association constitutes an unfair trade practice and may subject the violator to civil fines and penalties. Under federal law, Internal Revenue Code section 521 provides that certain farm cooperatives are granted tax-exempt status. This exemption is based on an economic situation that is peculiar to farmers in which a farmer may sell his products in a wholesale market but makes his purchases in a retail market. According to the IRS website, “[c]onceivably, a farmer might invest more money in his crop in the form of seed and fertilizer than he is able to obtain for it when it is harvested.” Section 521 was enacted in 1926 to address this economic disparity and has remained mostly unchanged with some minor exceptions.
Typically these groups are formed as corporations that provide services to farmer members on a nonprofit basis. Cooperatives are often categorized by the types of services that they provide to their members. For example, “marketing cooperatives” assist farmers in marketing products to a larger market than they would otherwise have access to. These cooperatives may take title to the produce and sell it to distributors or manufacturers or they may simply provide marketing services for the farmers who then sell the product themselves. So called “bargaining cooperatives” negotiate with processors and distributors on behalf of members to achieve the best price for the product. “Supply Cooperatives” procure farm supplies and equipment in bulk for farmer members. Lastly, “Service Cooperatives” render other services such as a shared labor pool for farm workers. Some cooperatives provide a combination of some or all of the services above.
Now, almost 120 years after these original cooperatives first took root in the U.S., many observers wonder if cannabis farmers will be the next wave of producers that band together to market their agricultural products to a broader market through agricultural cooperatives.
Prior to 2016, cannabis lacked any legal definition other than as illegal “contraband” under California law. This created legal ambiguities in many areas of the law that involved the crop. For example, some municipalities claimed that they could not regulate marijuana businesses at all if it was an entirely illegal activity. Fortunately for cannabis business operators and regulatory agencies, California law was clarified in January of 2016 when the state Legislature passed the Medical Marijuana Regulatory Safety Act (MMRSA). Under MMRSA, cannabis is now defined as an agricultural product under state law which is regulated at both the state and local level. As a result, this new classification allows for a new analysis of this crop in numerous areas of the law including the ability of farmers to organize as agricultural cooperatives.
Similar to the Sunkist citrus farmers in the late 1800s, California cannabis farmers may find that organizing into a cooperative and marketing their products as a group under one brand may increase their overall profits. New brands that promote the unique California climate and culture of particular cannabis growing regions have begun to appear on the shelves in dispensaries throughout the state. Cannabis farmers may also be able to leverage their group bargaining power for better terms with distributors and manufacturers rather than as individual farms. This may become increasingly important as the state moves towards a tiered licensing system in in which all cannabis must go through a licensed distributor before reaching the retailer.
Farmers may also find value in pooling their resources for trimmers and farm equipment through a Supply Cooperative. A cooperative could even purchase a central processing facility where the farmers could share space for trimming, drying, and packaging prior to transport. While IRC 521 does not currently allow these cooperatives to be tax exempt entities since cannabis remains illegal under federal law, forming these groups in accordance with established state and federal cooperative laws may allow for them to receive this preferential tax treatment when/if federal law changes.
In short, the California cannabis farm industry is undergoing fundamental changes with the enactment of MMRSA and the establishment of cannabis as an agricultural product. While many farmers fear that “Big Agra” will take over the industry, by utilizing cooperative business models similar to farmers of other legal crops small cannabis farmers may be able to not only survive but thrive in this new marketplace.
Lance Rogers – Partner
402 W. Broadway, Suite 400, San Diego, CA 92101
Phone: (619) 595-4884