Marijuana Leases: Where There’s Smoke, There’s Damage(s)

June 2017

Over the years, a number of states have legalized the use of medical marijuana, but federal law still does not protect the possession or use of medical marijuana.  This dichotomy has led to uncertainty for people in this industry. Recently, the Arizona Court of Appeals discussed the inconsistency between federal and state law with respect to medical marijuana in the context of a commercial real estate lease.

The case of Green Cross Medical, Inc. v. Gally (2017) involved a lease under which the Tenant was applying for a license from the State of Arizona to run a medical marijuana dispensary on the leased property. Less than two weeks after entering into the lease, the Landlord notified the Tenant that the Landlord was revoking the lease. The Tenant sued for breach of contract.  The Landlord argued that the lease was illegal from the outset and therefore unenforceable; the trial court agreed, holding that the lease was void for illegality because it violated both federal and state law.

On appeal, the Arizona Court of Appeals considered whether a lease of real property to a party to operate a medical marijuana dispensary is illegal and therefore void. The court first held that, even if the operation of a dispensary violated the law, the Tenant could still recover damages for the loss of the lease because the Tenant had a right to sublease the property, which the court noted is “a valuable commercial right that existed independent of any concerns over the legality of medical marijuana.”  [Note: the court did not indicate whether the lease limited the use of the property to a medical marijuana dispensary.  Presumably, if such restriction on use existed, then any sublease right might be worthless if such use was illegal.]

The court then addressed the interplay between state and federal law. First, the court concluded that the lease was not illegal under Arizona state law for several reasons. Among these reasons was language in the Arizona Medical Marijuana Act (“AMMA”) that protects the rights of dispensaries to enter into leases so long as they are in compliance with the provisions of the AMMA [Note: California has a similar statute, Section 19317 of the Business & Professions Code]. In order to operate under the AMMA, a dispensary must certify to the Arizona Department of Health Services that it has a secured facility and that the dispensary has permission from the landowner to operate as a dispensary. Therefore, to allow a dispensary to lease premises for use compliant with the AMMA while also authorizing a court to void an AMMA-compliant lease would render the statute futile. Moreover, the court emphasized that the AMMA does not require a landlord to rent property to a dispensary. While the Landlord was free to not enter into the lease in the first place if he was uncomfortable with the proposed use of the property as a medical marijuana dispensary, the court concluded he was not free to rescind his contractual commitments after the fact without facing potential liability.

Next, the court discussed whether the lease was illegal under federal law. The court acknowledged that the sale and use of marijuana for medical purposes is illegal under the federal Controlled Substances Act (“CSA”) and that it is illegal under the CSA to lease property knowing it would be used for the illegal production or distribution of a controlled substance. However, instead of rendering the lease unenforceable under the CSA, the court balanced the federal government’s interest in enforcing the CSA with Arizona’s interest in effectuating the AMMA.  In balancing those interests, the court concluded that the action for damages brought by the Tenant was not barred simply because the lease violated the CSA.  The court reasoned, among other relevant factors, that “allowing a damage action for wrongful termination of the lease would not be requiring persons to violate the CSA.  It would only be enforcing [the Tenant’s] contract rights under the lease at least for an award of damages.”  The court further noted that the federal policy regarding medical marijuana has been “in flux for years.” Before the lease in question was signed, the United States Department of Justice had instructed United States Attorneys not to prosecute persons acting in compliance with state marijuana laws, and Congress had barred the Department of Justice from using any funding to prosecute persons using or distributing medical marijuana in compliance with state laws.  It is unclear, however, if the new administration and Congress will continue these policies.

Finally, the court found that its conclusion was supported by the Restatement (Second) of Contracts, which sets forth factors to consider when applying the common law doctrine of illegality. Such factors include the parties’ justified expectations regarding the contract and legislative and public policy interests. In applying the factors, the court concluded that voiding the lease for illegality would not only be contrary to the parties’ contemplated expectations, but it would contradict the legislative intent and public policy behind the AMMA.  The court further reasoned that there is a strong public interest in enforcing leases compliant with state law in order to deter parties from breaching medical marijuana dispensary leases.

Although Green Cross Medical, Inc. v. Gally was an Arizona case, the same reasoning could be applied by other state courts with statutes similar to the AMMA. For now, landlords should be aware that they may be subject to damages if they try to break leases for medical marijuana dispensaries. Tenants should also be careful when entering into such leases because, while they may be entitled to recover damages for breach of contract, it is unclear whether they can actually use their leased spaces for the operation of medical marijuana dispensaries. The case also seems to suggest that it is helpful for tenants to have subleasing rights in their dispensary leases—presumably for a different use.