California Regulators Target White Labeling Contracts in Proposed Rule

California Regulators Target White Labeling Contracts in Proposed Rule

Under the proposal, licensed cannabis business would not be allowed to engage in contracts with unlicensed businesses.

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November 9, 2018

California’s Bureau of Cannabis Control has been shopping around a draft of permanent rules for the industry, and one proposal in particular could have far-reaching implications for a nascent marketplace that’s still figuring out statewide norms and best practices.

(The California Department of Food and Agriculture and the California Department of Public Health, which also oversee segments of the cannabis industry, released draft rules as well.) 

Tucked into the BCC rules is a provision that would bar licensed cannabis businesses from conducting any commercial cannabis activity via “contract with any person that is not licensed under the [law].” (See Section 5032 here.)

Under this rule, commercial cannabis activity would include:

(1) Procuring or purchasing cannabis goods from a licensed cultivator or licensed manufacturer.

(2) Manufacturing cannabis goods according to the specifications of a non-licensee.

(3) Packaging and labeling cannabis goods under a non-licensee’s brand or according to the specifications of a non-licensee.

(4) Distributing cannabis goods for a non-licensee.

In short, this rule would put an end to the white labeling workaround that has brought many unlicensed, non-cannabis-specific companies into the growing California cannabis industry. While the practice is not uncommon or illegitimate on face value, this proposed BCC rule would serve to tighten the cannabis industry and further prescribe who’s in and who’s out. 

Lauren Geisser, a transactional lawyer at Russ, August & Kabat in Los Angeles, tells Cannabis Business Times that white labeling has become a point of entry for many businesses jockeying for a spot on shelves in California.

“The way that a lot of businesses have been operating in California is: Unlicensed companies will engage in a co-packing relationship with a licensed manufacturer,” she says. “Interstate commerce of cannabis is illegal, so, for even Canadian companies that want to enter the California market, [unlicensed businesses] can enter into a licensing arrangement with a manufacturer. [They] license their IP and their ideas for an edible product or a cannabis product, and the manufacturer will procure the cannabis and all the other supplies, create it [and] they’ll even package it sometimes. [In this way, they] enter into an agreement with a distributor … to get those products to market without the unlicensed company ever touching the plant.”

The BCC rule cuts that entire process out. Medical and adult-use businesses would still be permitted to engage in commercial activity together, as long as both entities are licensed by the state.

With the first year of regulated adult-use cannabis sales drawing to a close, the BCC draft rules, which encompass 152 pages, are the latest example of the state painting a clearer picture of how it wants the market to function. The “emerging crisis” that the California Growers Association warned of earlier this year, however, remains in play. The licensing regime is competitive and onerous, critics have repeated throughout the year, and this backdoor into the marketplace was certainly seen as an opportunity for those left on the outside.

“The state wants everyone in the industry to be licensed. That’s the goal."

Harris Bricken, a law office in San Francisco and Los Angeles, sent a letter to the BCC before the public comment period closed earlier this week, taking issue with the broad definitions of commercial cannabis activity that may be banned. 

“Intellectual property licensing agreements are utilized widely throughout virtually every industry,” the law office’s letter stated. “Eliminating the ability of licensees to enter into intellectual property licensing deals with non-licensees harms both licensees and consumers by restricting the number of brands and products available. It also seems that the Bureau’s goals may not be well-served by this proposed rule modification due to overbreadth of its scope.”

The letter argues that the effects of Section 5032 may have a chilling effect on cannabis product manufacturing at large. (“Just as a landlord should not have to be licensed in order to lease its property to a licensed cannabis operator in exchange for rent, an owner of a brand or a recipe should not have to be licensed in order to license its intellectual property to a licensed operator in exchange for compensation,” Harris Bricken attorneys write.)

Whether the BCC takes the firm up on its interpretation and suggested edits is not yet clear. State regulatory agencies are intending on getting these rules in place by the end of the year—to go into effect in 2019.

“The state wants everyone in the industry to be licensed. That’s the goal,” Geisser says. “We’re already seeing creative solutions like joint ventures and mergers and acquisitions in the pipeline. Until the regulations are finalized, we don’t know how companies will react, but people are definitely ramping up and preparing for what is likely to pass.”

Top photo courtesy of Adobe Stock