Hank Levy of the Henry Levy Group writes……

My apologies to Woody Guthrie for butchering his famous lyrics.  The debate over the best entity choice for a cannabis business has not decreased substantially  since the passing of the California Medical Marijuana Regulation and Safety Act (MMRSA) last October.  The good news is that MMRSA has somewhat clarified the entity choice; the bad news is that MMRSA is not effective for another 16 months.

In general,  the list of possible entity choices  beginning Jan. 1, 2018 will be similar to what things were like prior to the publication of the Attorney General Guidelines in 2008 and will be much more similar to the choices for every business in California.    There are two big exceptions to this, which will be discussed in future articles: (a) How Internal Revenue Code (IRC) Section 280E affects entity choice; and (b) how the dissolution and/or conversion of current non profit corporations affects entity choice.

Proposition 215, the Medical Marijuana Program Act (MMPA), also known as the California Compassionate Use Act of 1996), did not say much about what how businesses should be organized.  In these early days, businesses were often organized as sole proprietorships, LLCs, or for-profit corporations.   See http://medicalmarijuana.procon.org/sourcefiles/california-proposition-215.pdf.

The next legislation which was passed, Senate Bill 420,  effective January  1, 2004, codified at Section 11362.765(a) of the Health and Safety Code,  that “. …nor shall anything in this section authorize any individual or group to cultivate or distribute marijuana for profit.”   While various attorneys and the bills’ main author, John Vasconcellos, argued that the intention of this provision was never to prohibit profit, nevertheless a period began which created the promotion of the non-profit corporation as the entity of choice.  See Robert Raich’s article on this subject at http://www.tokeofthetown.com/2012/02/medical_marijuana_profit_is_allowed_under_californ.php.

I do not recall if SB 420 began the movement away from for-profit entries.   What I do remember is that the movement toward non-profit businesses began in earnest with the publication of the Attorney Guidelines, published in August, 2008, called “Guidelines for the Security and Non-Diversion of Marijuana Grown for Medical Use.”   See (http://medicalmarijuana.procon.org/sourcefiles/Brown_Guidelines_Aug08.pdf).  These Guidelines stated that cannabis business should either be statutory cooperatives or non-statutory collectives, which “might have to organize as some form of business to carry out its activities.”   Due to the requirement that such businesses should be operated in a “not-for profit manner,” this led to the most popular entity recommended by attorneys and CPAs, the non-profit mutual benefit corporation, commonly known as “NMBCs.”

Of course, a few attorneys  believed that statutory (consumer)  cooperatives were (and still are)  the only true prescribed type of legal entity, because it was mentioned specifically in the Guidelines, and (these attorneys thought)  the best entity choice to give their clients the utmost protection under the law.     And, it is interesting  that the City of San Diego, appears to have mandated that any cannabis license holder must be a Medical Marijuana Consumer Cooperative (MMCC) under San Diego Municipal Code Sec. 141.0614.  See    http://docs.sandiego.gov/municode/MuniCodeChapter14/Ch14Art01Division06.pdf.   Some people believe that this was not an informed decision by the San Diego City Council, but nevertheless it does appear that entities in San Diego must be a consumer cooperative.

As the NMBCs gained popularity, they became the accepted type of entity.  In an extremely convoluted legal matter involving Mr. Jovan Jackson and San Diego County (he was prosecuted three times between 2009 and 2013, the Appeals Court indicated that that organizing as a nonprofit organization (either as a corporation or cooperative) would be necessary to obtain the protection of the MMPA.    http://www.leagle.com/decision/In%20CACO%2020121024058/PEOPLE%20v.%20JACKSON

Another indication that for-profit entities are not allowed comes from anecdotal evidence that the California Secretary of State, if it is aware that an applicant for a corporate business registration is a marijuana company, will only register such a business if it is a nonprofit corporation (or presumably a cooperative as well).   Because it is not required to tell the Secretary of State the nature of a business, it would be possible to get registered as a for-profit.

Cannabis businesses are not the only type of NMBCs.   Organizations which are typically MNBCs are trade associations, labor unions, Rotary/Lions’ Clubs, and even youth sports associations.   They do not benefit the public, only their own members, and are not therefore “charities.”.  California NMBCs  are governed under Corporations Codes Sections 7110-8910.  See   http://www.leginfo.ca.gov/.html/corp_table_of_contents.html.

In general, MNBC’s seek and obtain tax-exempt status.   Cannabis NMBCs cannot get tax-exempt status because the activity is illegal under Federal law.    However, even if the activity was legal under Federal law, it is doubtful that a cannabis business could obtain tax exempt status; in fact, there is an argument why this would create serious legal problems.

The California Attorney General regulates California charitable organizations.  Because, as of now,  NMBCs are not charitable organizations, they are not regulated by the California Attorney General ‘s office.  There are marijuana attorneys, nervous that the Attorney General may be able to regulate marijuana businesses who are NMBCs, who feel that cannabis organizations should not incorporate at all, but just be “non-profit associations.”

Other types of organizational forms are being suggested by some attorneys:  A benefit (“B”) Corporation is being proposed by some as a hybrid between for-profit and non-profit.   See https://www.bcorporation.net/what-are-b-corps.     Basically, these corporations are for-profit with less obligations to make a profit for its shareholders.  The attorneys who are promoting these feel that they express the proper sentiment of the law, but will be easier to continue after MMRSA takes effect.

Finally, there are knowledge attorneys who are outright promoting for-profit LLCs and corporations  right now, even in rural areas where a sheriff or local district attorney may be inclined to prosecute for this reason alone.

So, now that we have not only MMRSA, but also new proposed legislation that appears to make it crystal clear that operating in a non profit manner won’t be required, one would think that now new cannabis businesses should feel more comfortable operating as a for-profit.    But, this is not the case.   Most new cannabis businesses are still being formed as NMBCs.   Even in counties which expressly state that a business may be formed without any restrictions whatsoever, attorneys still want to comply with what they think is state law, and which the majority still maintain hold the NMBC to be the favored entity choice.

In future articles, we will discuss the effect of IRC Section 280E on entity choice, as well as converting an NMBC into a for-profit entity.

Henry C. Levy, CPA/ABV  CFE/CFF
The Henry Levy Group, A CPA Firm
5940 College Avenue
Oakland, CA 94618
Phone:- 510-652-1000 x305
Fax:  510 225 3911