2016 LEGISLATIVE UPDATES: Part IV

In this final installment in our legislative updates series, we turn to medical marijuana (medical cannabis or MMJ) in 2016.  Hopefully you’ve stuck with us, because we’ve reached the end… or is it just the beginning?

OPTIONAL PAIRING: Medical Marijuana

In a move that’s been anticipated with bated breath by the medical marijuana/cannabis industry since 1996’s Compassionate Use Act, the California legislature finally adopted laws to regulate medical cannabis with the Medical Marijuana Regulation and Safety Act (“MMRSA”).  This is only the authorizing act to lay the groundwork for further statutes and regulations that will make up the larger code eventually governing the cannabis industry – but it is a big step forward to getting a murky area of the law codified.

For those not following medical and recreational cannabis developments closely, the medical cannabis industry has remained relatively unregulated in California since the voters enacted the groundbreaking Prop 215 initiative in 1996, which prescribed limited protocols for patients, cooperatives and collectives, leaving the cultivators, manufacturers, testing facilities and modern-day dispensaries without much guidance or legal protection.  The limited state-wide regulations have resulted in two compliance trends that have plagued this industry: strong local control over the operations of these businesses and inconsistent federal enforcement actions, with a lot of court cases interpreting these permitting and enforcement actions.  Many hope that MMRSA will protect businesses producing and selling medical cannabis from local interference and federal prosecution by giving businesses clear state-wide laws and regulations to follow, and by providing the strong and effective regulatory and enforcement systems required by the Department of Justice (“DOJ”) to minimize the threat to federal enforcement priorities per the Cole Memoranda (available here and here).  

Early on in the legislative process, it was rumored that ABC might be called upon to regulate medical marijuana, a move that the alcohol industry leaders generally seemed wary of (and in some cases loudly opposed) out of fear it would divert resources from regulating the alcohol industry. The ABC already faces significant employee turnover and enforcement challenges.  We generally supported the ABC regulation of medical cannabis because we believe ABC understands how to regulate another controlled substance in a way that generally meets similar enforcement priorities as identified by the DOJ memos.  Instead, MMRSA goes in a different direction by giving oversight to numerous agencies and creating a new agency under the Department of Consumer Affairs, the Bureau of Medical Marijuana Regulation, to draft and enforce law and regulation in compliance with MMRSA.  Here are the most interesting parts of the MMRSA licensing scheme from our perspective:

• License Types: There are seventeen different license types. Ten of them are cultivation licenses, dividing into size (specialty small, small, medium and nursery) and type of light (outdoor sun, indoor lighting or mixed lighting).  Two licenses are manufacturing licenses (which includes edible manufacturers who mix cannabis with food ingredients).  Two licenses are for dispensaries (one limits ownership to three retail locations), and one each is for testing, distribution and transportation.  While there are overall more licenses in alcohol (because of importing licenses, various types of on- and off-premises licenses and different alcohol categories), this licensing scheme starts off with a lot of different license types for cultivation, without clear guidance about what to expect for taxing and permitting distinctions between the license types.  We note also that there are no licenses yet for on-premises MMJ consumption.

• Mandatory Distribution and Testing: The licensing scheme features a mandatory distribution tier, just like the original three-tier system in alcohol, which over the years since the end of Prohibition has been affected by a slew of state-by-state exceptions for small producers and specific venues, creating an intricate alcohol beverage attorney right to work act.  In addition to the product quality assurance and sales that alcohol distributors are responsible for, MMJ distributors are also responsible for getting every batch randomly tested by a licensed testing lab.  This process obviously favors larger operations that can make larger batches and differs significantly from the alcohol industry’s testing standards.  The TTB, the federal alcohol agency, only tests imported products, products submitted by manufacturers themselves to receive a tax credit, products receiving consumer complaints and post-market products tested as part of an ongoing audit of the marketplace.

• “Tied House”: The licensing scheme features a tied house provision (for lack of a cannabis-specific term), as in alcohol to prevent vertical and horizontal integration, with some key exceptions.  First, the limited dispensary license with three or fewer retail locations may have manufacturing and/or cultivation interests.  This exception provides allowances for smaller dispensaries to create and sell private/control label products, which will likely be an important advantage in the competitive regulated market.  Second, small cultivators may also have small manufacturing licenses, which will allow them to create edibles, oils and other manufactured goods in addition to producing flower cannabis.  These are important exceptions, and we expect more to come as the industry and regulations develop.

• Transportation and Delivery: There are additional transporter licenses required for all delivery between licensees.  Transporter licensees may have distribution licenses, but distributors must have transporter licenses. There is a grandfather clause for existing businesses that are vertically integrated and that comply with local permitting restrictions, and a requirement that delivery companies must be dispensaries or dispensaries must do their own delivery.  For now, at least, it appears that the intention is to not allow an unlicensed tier for third party providers like many of the alcohol delivery companies, who deliver on behalf of licensees as their agents.

• No Alcohol Retailer Cross-Ownership: Alcohol retailers cannot also hold dispensary licenses, a restriction intended to prevent liquor stores, bars and restaurants from being able to sell medical cannabis in combination with alcohol.  Noticeably, the MMRSA is silent about any restrictions on other types of alcohol licensees, such as alcohol distributor and supplier licensees, many of whom we know are closely following the licensing scheme and preparing to enter the market.

• Local Licensing: In addition to state licenses, there is a requirement for local permits, a system that differs greatly from the alcohol regulation scheme in California. In alcohol, all licenses are issued by the state, but local cities, counties and districts must approve and often condition licenses and can implement their own restrictions or moratoriums on certain types of licenses. The ABC makes the final decision about whether a license issues. In the medical cannabis industry, on the other hand, businesses will need to get separate licenses from their local government, which could have its own system of requirements in order to operate in its community. This gives substantial control to local governments, many of which have been instituting outright bans of cannabis businesses with a tight deadline from MMRSA. A legislative fix is promised, but otherwise, it looks like the required local licensing scheme is already producing more limited patient access to medical cannabis.  

With our experience, it’s hard not to compare this time in the history of cannabis with the end of alcohol prohibition, especially with recreational legalization slated for the California ballot in 2016. Whereas with alcohol there was an established network of black market bootleggers and understaffed enforcement, in the pre-prohibition cannabis industry, we see strong local governments grabbing for more control over an industry that has been plagued by raids, lack of banking and incarceration. We also see many industry newcomers who may benefit from the kind of code that requires capital and counsel to navigate. The big difference between these two eras may be public perception and acceptance of the product: teetotalers did not have quite the same hold on the public imagination as the drug warriors have had.  

2016 LEGISLATIVE UPDATES: Part III

By Rebecca Stamey-White and Erin Kelleher

It’s round three in our legislative updates for 2016.  Part three gets into the meat of licensing, qualification and tied-house ownership, our favorite issues!

THIRD COURSE: LICENSING, QUALIFICATION & TIED-HOUSE OWNERSHIP ISSUES

ABC qualification relief, but no tied-house changes, for private equity investors  (SB 796: 23405.4)

Investors (and not just private equity investors) have struggled in California to legally make investments in licensed businesses largely for two reasons. First, upper tier investors are loathe to provide personal information and qualify with ABC, largely due to privacy concerns. Second, generally speaking, there is no de minimus exception to the California tied-house laws. Thus, an investor might have a passive investment in a fund which holds retail interests, which could prevent them from making another passive investment in a fund which holds supplier interests. ABC has struggled with these issues, out of a legitimate desire to know the ultimate owners of a licensee. The limited partners in a fund, which might technically be the ultimate "owners" of a license, however, generally do not have an active role in the management of the fund or the licensee. Further, they might not even know what investments the fund makes at all. So why qualify them or prevent them from making an investment in a licensee?

SB 796 attempts to address the first problem regarding qualification, but does not address the second and larger problem regarding the tied-house laws. Specifically, the statute will not require qualification (but still requires compliance with the tied-house laws--an important distinction of which to be mindful) of an investor in a private equity fund, provided:

• The fund's interest is passive (no involvement with the licensee's business);
• The fund's advisors are registered under the Investment Advisors Act of 1940 and are subject to federal reporting requirements;
• The investor holds less than 10% of the fund (not the licensee); and
• The investor has no control in the investment decisions of the fund.

SB 796 does not apply to hedge funds, liquidity funds, REITS, securitized asset funds or VC funds. Why not? Good question--though it is consistent with other legislative changes to the code governing alcoholic beverage licensees; that is, hyper-specific and very limited.

ABC may require the manager of the fund to execute an affidavit confirming compliance with the conditions above and affirming that the investors not being qualified do not have interests that would violate the tied-house laws. Importantly, if the manager does not have direct knowledge of any facts necessary to execute the affidavit, the statute requires them to make a direct inquiry of investors, and requires notification if any of the attested-to facts change. Ostensibly, this creates an ongoing investigation and reporting obligation of the fund.

The statute clearly states that it is not intended to permit someone from making an investment through a private equity fund in a license if such investment is not otherwise permitted. Therefore, the statute does not address the larger and more difficult problem of passive investments in licensees and the tied-house laws. Thus, while qualification might be slightly easier, private equity funds will still be limited in how they can invest in licensees.

The Craft Distillers Act of 2015 (AB 1295: 23500, 23501, 23502, 23504, 23506, 23508, 23363.1, 23771 and 23772)

AB 1295 represents a big change in the industry, and could be a huge boon to folks looking to take advantage of the recent craft spirits craze that has swept the country. Historically, spirits have lagged behind wine and beer in terms of securing exceptions to the tied-house laws, which has made it more difficult for spirits products to get to the ultimate consumer without the backing of a major distributor. The new regulations not only create a new license type for small distillers, but also create tied-house exceptions that do not exist for their larger-production counterparts. These regulations do, however, amend the tasting provisions for spirits, which are applicable to large distillers as well.

• Basic License Permissions and Limitations (23500, 23501, 23502, 23504, ABC Industry Advisory) 

The new craft distiller’s license (Type 74) will allow the production of no more than 100,000 gallons (liquid volume and not proof gallons) of distilled spirits per fiscal year (July 1 – June 30), excluding brandy that it manufactures or is manufactured for the licensee with a brandy manufacturer’s license. Fees and qualification will be the same as for Type 4 spirits producers. Craft Distillers must report their production volume to ABC when applying for an annual renewal, and if they exceed the production cap their license will be renewed as a Type 4.

They can package, rectify, mix, flavor, color, label and export only their own products. They will only be able to sell to wholesalers, manufacturers (and their agents), winegrowers and rectifiers that hold a license authorizing the sale of spirits. Thus, Craft Distillers cannot make sales to retailers–-however note the limited DTC exception for consumers outlined below.

• Tastings (23363.1)

The tastings statute applicable to spirits now covers both large distillers and craft distillers. Like regular distilled spirits manufacturers, craft distillers will be able to conduct tastings and charge for them on their premises, subject to the following conditions:

• Total volume of pours cannot exceed 1.5 oz per person, per day;
• Tastings can only include products produced (or produced for) the licensee; and
• Servers have to be at least 21.

The statute has been changed to allow the service of cocktails or mixed drinks at the tastings, however, note that licensees can only use product that they make or that they have made for them. Therefore, cocktail creativity here is limited (or, encourages companies to start making their own mixers, which could be good for everyone).

Tastings can occur off licensed premises as well, provided they take place within permitted events sponsored by a nonprofit organization. No sales or solicitations are permitted at these events.

• Direct to Consumer Sales (23504)

Craft distillers can sell up to 2.25 liters of their pre-packaged product at instructional tastings that occur on the licensee’s premises pursuant to the tasting provision of 23363.1 outlined above. This represents a huge win for craft distillers attempting to get their products to market, as DTC sales of spirits to consumers have until now been barred by ABC.

• Bona Fide Public Eating Place & Private Events (23506(c) and 23508)

Like their wine and beer making counterparts, Craft Distillers may also operate a bona fide public eating public place located on, or contiguous to, their licensed premises. However, they may also serve distilled spirits, which is a big difference from wineries or breweries, who may not. Additionally, Craft Distillers may also offer beer, wine and distilled spirits, regardless of source, for sale to guests during private events. All beverages sold on the premises that are not manufactured by or for the Craft Distiller must be purchased from a wholesaler.

If the Craft Distiller loses this designation and becomes a large distiller, they may continue have events on their premises. This is a huge win for Craft Distillers who wish to market their space for events for extra revenue, something that is has become quite popular for all types of manufacturers. However, the ABC advisory indicates that if the Craft Distiller becomes a large distiller, they do not get to keep operating the bona fide public eating place under their distiller license. The bona fide public eating place on the premises would have to have a separate on-sale license, which could raise some tied-house issues.

• Tied-House (23502(b), 23771, 23772, ABC Industry Advisory) – No Interests with Large Manufacturers, Agents, Wholesalers or Rectifiers

Craft Distiller licenses cannot be held by anyone “affiliated,” directly or indirectly, with a person who manufactures (or has manufactured for them) more than 100,000 gallons of distilled spirits per year within or without California (excluding brandy it manufactures or has manufactured for it with a brandy manufacturer license). The term “affiliate” is not generally defined in the code, though it is sometimes defined within the specific section where the term is used. Not so in this case, leaving it ambiguous as to what exactly “affiliated” means in this context. Nonetheless, the main take-away here is that Craft Distillers cannot also have Type 4 licenses or Type 5 licenses (Distilled Spirits Manufacturer's Agent licenses) in California, and also that they cannot be affiliated with larger scale manufacturers of distilled spirits located outside of California.

Additionally, Craft Distiller licenses may not be issued to anyone “affiliated” with, directly or indirectly, a wholesaler. The same ambiguity exists here with respect to the meaning of “affiliate.” The prohibition appears to only to apply to wholesale interests in the state of California (Type 17 beer and wine wholesaler or Type 18 distilled spirits wholesaler), and not to wholesale interests in other states.

Because a Craft Distiller can package, rectify, mix, flavor, color, label and export only their own products, ABC has indicated that they cannot also hold a Rectifier’s (Type 07 or Type 24) license. Craft Distillers may however use grain-neutral spirits manufactured by another distiller in the manufacture of their product.  

• Tied-House – Interests in On-Sale Licensees (23506)

Craft distillers, or one or more of their subsidiaries of which they own at least 51% who also manufactures or produce, bottle, process, import or sell distilled spirits under a craft distiller’s license “or any other license issued pursuant this division” may hold an ownership interest in, or have a “financial or representative relationship” in up to two on-sale licensees.

Before we discuss the conditions on this important tied-house exception, we wanted to address some of the language in this statute. First, it is unclear what ABC means by the phrase “or any other license issued pursuant to this division.” This could allow Craft Distillers who have subsidiaries with other licenses to partake of this exception, where they otherwise would not have been able to do so. Second, “financial or representative relationship” is broader than the similar exception for winery interests in on-sale licensees found in 25503.15, meaning that not just ownership of the retailer is at issue for the tied-house analysis, but also the broader relationship of the Craft Distiller and the retailer.

The exception does contain a wholesaler poison pill, requiring the on-sale licensee to make all alcohol purchases (including wine and beer) from California wholesalers, except for those spirits which are made by or for the interested Craft Distiller. This could be a deal breaker for many on-sale licensees. Additionally, the number of spirits by brand offered by the off-sale licensees are limited to 15% of those produced by the interested Craft Distiller.

Importantly, this exception is not lost if the Craft Distiller eventually exceeds the production cap and becomes a regular large distiller.

Pedicabs get licenses (SB 530), no luck for beauty salons (AB 1322)

While clearly we all need to find out more about pedicabs, which can apparently carry up to 15 passengers and still qualify as pedicabs (our minds are spinning, meaning we may need to go to spin class more often), passengers may also now consume alcohol in pedicabs without requiring a license by the pedicab from the ABC. These pedicab operators must receive LEAD training from ABC and may not “sell, serve, or furnish” these beverages, but provided all the passengers are 21+, the passengers may serve themselves while enjoying the ride.

Other possible licensees or exceptions to the rule were not as lucky as the pedicab operators. A bill to provide an ABC licensing exception to beauty salons to enable them to provide alcoholic beverages incidental to the service of beauty treatments did not pass. We have a feeling the long-standing practice will not entirely go away, since it's been happening without this exception in place for many years (shhh! We ladies need our champagne!).

Larger brewers join small brewers in exception permitting on-sale retail license ownership (SB 796: 25503.28)

25503.28 used to allow only small beer manufacturers (those producing 60,000 barrels a year or less) to have an interest in up to 6 on-sale licenses, and now that privilege has been extended to large beer manufacturers in California as well.

The new privilege cannot be combined with the existing privilege under 23389(c) which allows beer manufacturers to sell their beer at 6 branch locations, 2 of which may be bona fide public eating places selling wine in addition to beer. Thus, a beer manufacturer (regardless of the number of licenses they hold alone, in common ownership with another beer manufacturer, or under common ownership with anyone operating as a on-sale retailer), may exercise on-sale retail privileges at premises where they do not manufacture beer at no more than 6 locations. Despite this, there is still no limit on the number of manufacturer locations, or the exercise of retail privileges at those locations.

Beer specifically added to non-profit temporary licenses (AB 774: 24045.6 and 25607.5)

Beer was specifically added to the statute permitting nonprofits to obtain special temporary on-sale and off-sale licenses for fundraising activities. While there are a variety of temporary off-sale licenses available for nonprofits, we most commonly see the combination of the licenses covered by 24045.1 (the on-sale general license, usually used for full bars at nonprofit fundraisers) and 24045.4 (the off-sale license that permits nonprofits to auction off bottles of wine). 24045.6 could be used by a nonprofit hosting an event featuring on-site consumption and also selling alcohol donated to it for off-sale consumption (but not using a silent or live auction to do it).  Most commonly, this privilege is used by nonprofit wine varietal or regional organizations who might conduct larger wine tastings and also sell wine donated to it by wineries participating in the event or who make special blends as a private label for the organization.  Previously, the statute was limited to wine, but now nonprofits can receive donated beer as well for their fundraising events under this section, which likely means we’ll see more beer association events structured like the wine association events.

Beer label approval no longer required by ABC, however brands must be registered with ABC prior to sale (AB 893:25200, 25201 and 25204)

Beer manufacturers and certificate of compliance holders are no longer required to furnish labels of beer containers to ABC, however every beer manufacturer, before the first sale of a brand of beer in California, must register the brand with ABC. Form 412 has been amended and is now titled the Beer Brand Registration Form. Manufacturers do not have to register brands that currently have accepted labels on file with ABC. ABC will not send a response to the brand registration form, and licensees may submit malt beverage price schedules and territorial agreements simultaneously with brand registration forms.

25200 was repealed and replaced with a provision that governs beer labels and brand registration, as well as alcohol content labeling previously included in 25204 (which has been repealed). Beer labels must meet federal malt beverage labeling regulations, and must also include:

• the brand and class or type of beer;
• the manufacturer’s name (can be a DBA) and address (if the beer is a collaborative effort, everyone must be identified);
• the bottler (if other than the manufacturer); and
• a statement of alcohol content if the beer is over 5.7% ABV.

Provisions on growlers used to be contained in 25200, but are now addressed in a separate and new section 25201. Although the citation is new, the law has not changed. 

If you're full of legislative updates, don't worry, we'll have a post next week that will help bring back your appetite! Have a great weekend!

2016 LEGISLATIVE UPDATES: Part I

By Rebecca Stamey-White and Erin Kelleher

In 2016, we’ll see a lot of changes to California’s laws regulating alcoholic beverages. As the state’s legal experts on alcohol, we’ve been answering a lot of questions from clients about how they can comply with these new laws and take advantage of the new exceptions, so we decided to compile our analysis of the legislative changes into a series of blog posts to ensure your compliance is off to a great start in the new year.

 In order to help our readers digest the information and understand the changes, we’ve grouped our legislative discussion into four courses:

• First Course: Promotional Activities

Pairing Suggestion: an H&C big bottle of wine; best served with your sweepstakes dinner prize.

• Second Course: Advertising, Events and Things of Value

Pairing Suggestion: Renwood 2014 Old Vine Zin, to be enjoyed while you check-in at our restaurant on social media.

• Third Course: Licensing, Qualification and Tied House Ownership

Pairing Suggestion: White Russian with craft coffee liqueur and locally-sourced vodka, because you can soon enjoy a cocktail when you visit your favorite craft distillery.

• Fourth Course: The Medical Marijuana Regulation and Safety Act from an alcohol industry perspective.

Pairing Suggestion: Cannabis-infused wine… as soon as we can legally get our hands on some! Rebecca will also be speaking on some of these issues at the Women Grow Bay Area chapter meeting this Thursday in Oakland if you can’t wait for this course.

If you get heartburn from any of these courses, please reach out to us for a legal remedy.  

FIRST COURSE: PROMOTIONAL ACTIVITIES

Alcohol may now be part of a prize for contests & sweepstakes (SB 796: 25600.1 & 25600.2)

In big news for a state that only rejoined the rest of the country in 2013 by even permitting alcohol supplier-sponsored sweepstakes and contests, alcohol may now also be given away as a prize in connection with a contest or sweepstakes, provided that it is an “incidental part of a prize package.”

This is a marked departure from California’s previous position of being strictly against the potentially "overly aggressive marketing" of alcoholic beverages in the form of sweepstakes and contests. The state now blazes a trail by permitting the beverages themselves to be a prize (but not without a gray area to interpret!).

What “incidental” means exactly is not clear. While it is still the case that alcohol cannot be the sole prize that is given away in a contest or sweepstakes, it is less clear how marginal the alcohol prize must be and whether it can be specifically advertised or highlighted in the official rules. In our view, while “incidental” likely includes alcohol poured in connection with trips to supplier premises or at hosted dinners that may involve pairing with the supplier’s products, it likely would not include things like prized bottles of wine or a free bottle of wine every month for a year in addition to such trips.

Bottle signing events are here to stay (SB 796: 25502.2)

The sunset provision of this statute was deleted, allowing celebrity bottle signings to occur indefinitely (click here for a link to the previous Booze Rules post on this topic, outlining the requirements).

Still hungry? Good, because there are three more courses to go…