Legalized marijuana and the real estate finance dilemma

Colorado’s legalization of the sale and use of medical and recreational marijuana is creating more complexity in an already stressed banking community.  This now flourishing industry is sorely in need of banking services and is willing to pay well for space to lease or own. 

But while the Colorado voters made possession of marijuana legal under Colorado law, the federal government has not.  Therefore marijuana use, production and distribution in Colorado is still a federal crime.  Accordingly, Colorado banks must be vigilant to avoid doing business with marijuana-related businesses or else risk harsh penalties and even loss of charter – a vigilance that necessarily impacts real estate-related customers of those banks.  However, there may be hope on the horizon with a newly introduced bill in the U.S. Congress that could allow banks to serve these expanding, profitable and tax revenue-producing businesses.

Currently, Colorado banks cannot take deposits from, nor lend money to, marijuana-related businesses.  Virtually all banks in Colorado are regulated by federal laws that prohibit banks from providing banking services to illegal businesses.  Under federal law, marijuana is a “controlled substance,” and it is unlawful to manufacture, distribute, or dispense a controlled substance; parties that aid or abet in the business of the same, or are seen as “laundering” the proceeds of such activities, may well be held guilty of participation in the illegal activities.

In addition to such direct regulatory prohibitions, banks need to be concerned with the business risk of providing services to a marijuana-related business.  The property of a marijuana-related business is subject to seizure and forfeiture under federal law.  Therefore, any bank that loans money directly to such marijuana-related business and collateralizes that loan with a security interest in the property of that business risks losing its collateral to a federal seizure and forfeiture. 

Further, loaning money to a developer or landlord that is merely renting a portion of its space to a marijuana-related business presents similar issues for the bank; deposits or payments from the landlord could be deemed proceeds of illegal behavior, and the landlord’s property that is pledged as collateral for a loan can be lost to seizure. Banks also risk loss of their charter by providing financial services to marijuana related businesses.  Under federal law, banks must examine the nature of customers’ businesses to avoid supporting illegal activity.  Banks must report any illegal or suspicious activity to the federal government, and failure to do so not only exposes the bank to civil and criminal fines, but also threatens the loss of its banking charter. 

Many of the foregoing are concerns for landlords as well.  Leasing to a marijuana-related business poses a number of potential threats, including: putting the landlord’s property at risk of federal forfeiture,  putting the lease in immediate default of the typical “compliance with all applicable law” provisions, putting the landlord at risk of having to evict the tenant or risk losing its credit facility with the bank, putting the landlord in violation of any number of requirements under both its deposit and loan agreements, and  potentially putting the landlord at risk of being found guilty of participating in an illegal scheme by knowingly renting to such an illegal tenant. 

The situation is growing more common where commercial landlords are being advised of loan covenant violations for having marijuana-related tenants and being advised that unless the offending lease is terminated, the loan will be called.  And it may not be easy to evict the tenant upon receiving such a demand; the tenant may argue the landlord always knew of the nature of the operation and cannot now claim it constitutes an actionable default.

Aware of the ever-increasing problem of denying banking services to a growing industry within the state, U.S. Rep. Ed Perlmutter and others introduced the Marijuana Businesses Access to Banking Act of 2013 in the U.S. Congress to resolve the conflict between the state and federal laws, at least as it relates to the banking industry.

The legislation proposes a number of changes, including:  providing immunity to banks from civil and criminal prosecution or investigation for providing services to, or investing income from, a marijuana-related business;  protecting them from loss of FDIC insurance; exempting them from reporting a transaction as suspicious solely because it involves a marijuana-related business; and protecting them from forfeiture of security interest in collateral for a loan made to an owner or operator of an otherwise-lawful marijuana-related business.

Currently, however, the bill has only been proposed to the Committee on Financial Services and the Committee on the Judiciary, but has not been heard by either.  Resolution of these competing laws could be many months away, if ever, since passage by both houses of Congress and Presidential sign-off will not come easily.  And even if the bill passes, it neither addresses all marijuana-related issues for banks, nor provides similar safe harbor protections for landlords or sellers who carry back financing who lease or loan to marijuana-related businesses.  So even if the newly proposed legislation passes, banks and landlords should remain weary. 

Importantly, the supremacy of the federal illegality of marijuana over its new legality under the Colorado constitution, is a somewhat subtle point to many bank customers or tenants who may not fully appreciate the continuing restrictions on their bank or landlord.  Banks should carefully vet new accounts and provide sufficient notice to their depositors and borrowers that deposits, as well as loans and collateral, cannot relate to marijuana. 

Furthermore, the loan documentation should provide ample rights and remedies to a bank to extricate itself from a loan and related collateral if a bank learns later that the collateral is being used by a marijuana-related business.  Similarly, landlords should consider additional representations in leases relative to permissible uses, changes in use, subleases and the like, and should provide for remedies that allow for quick, permissible action in the event of a demand from a lender or from federal authorities. 

Both banks and commercial landowners should consult with counsel to confirm that their documentation sufficiently provides these protections to avoid facing federally-imposed penalties for what is otherwise lawful activity under state law.