The long-anticipated New York cannabis market is finally coming into shape. The New York State Office of Cannabis Management (“OCM”) has issued more than 250 Adult Use Conditional Cultivator Licenses and 25 Adult Use Conditional Processor Licenses and began processing retail license applications on August 25. There’s no doubt that New York is the cannabis industry’s next land of milk and honey. As potential investors prepare to inject capital into this promising new market, it’s important they—and their target businesses—be aware of potential regulatory pitfalls particularly as they apply to “True Parties of Interest.” Below, this blog discusses what it means to be a True Party of Interest in New York and how such designation may affect investment in New York’s Adult Use Cultivation and Processing market.
What is a True Party of Interest??
To promote more balanced competition, many states with legalized recreational cannabis have implemented restrictions and limitations on the number of licenses an individual or entity can have a direct or indirect “interest” in. In New York, individuals with such interests are identified by the OCM as “True Parties of Interest.”
The definition of “interest” and the restrictiveness of these provisions vary from state to state. They are often confusing and fraught with grey areas where it’s unclear if an economic interest qualifies as an “interest” that would be regulated. For instance, in the past, state regulatory bodies have struggled to characterize springing interests such as options or security interests such as liens on the property. Younger state regulatory agencies with less mature state markets, by virtue of having less experience regulating the industry and no precedent of past decisions, tend to struggle with these matters more. And a lack of clarity in this area can cause real issues for investors and cannabis businesses alike, resulting in the forced sale or forfeiture of investors’ interests in a company and/or loss of a business’s cannabis license.
Thankfully, the OCM has been proactive in trying to clear this matter up ahead of the complete roll-out of its regulatory program, issuing guidance in August.
So, what is a True Party of Interest in New York, and what does it mean to be one?
According to the OCM, True Parties of Interest include:
- Sole proprietors, partners, LLC members, LLC managers, shareholders of a licensed entity, or their spouses;
- Persons who exercise control over a licensee;
- Persons who hold an actual or future right to ownership or investment or are the spouse of someone who holds such a right, including by stock, convertible bond, note, warrant, option, SAFE, or equity swap agreements over a licensee.
- Leadership or control position persons, such as a manager, president, vice president, secretary, treasurer, officer, board member, trustee, director, or a person with an equivalent title or position in a licensee or are the spouse of a person who holds one of these roles or titles.
- Persons receiving aggregate payments in a calendar year, as part of a flat fee consulting agreement, management services agreement, or risk sharing agreement, that exceed the greater of:
- Ten percent (10%) of gross revenue;
- Fifty percent (50%) of the net profit of a licensee; or
- Guarantors of debts of the licensee; or
- Persons who make up, or are the spouse of a person who makes up, the ownership structure of each level of ownership of a licensee that has a multilevel ownership structure.
By including spouses and future rights to ownership such as options, New York is using a broader definition of “interest” than many other states and aiming at workarounds investors have used to maintain interests in several businesses without triggering regulatory violations. Additionally, OCM has not set forth a minimum threshold of ownership one must have to be considered a True Party of Interest, meaning even minority equity holders owning less than one percent of a licensee will be considered True Parties of Interest subject to restrictions on ownership Lenders and landlords are noticeably absent from the definition of a True Party of Interest.
So, what are the implications of being a True Party of Interest in New York’s Adult Use Cultivation and Processing market? Unfortunately for prospective New York investors, restrictions on True Parties of Interest are strict in the state. An individual can only be a True Party of Interest in one Adult Use Conditional Cultivator licensee (an “AUCC”). Furthermore, suppose a person is a True Party of Interest in an AUCC and/or an Adult Use Conditional Processing licensee (“AUCP”). In that case, such a person can neither be a True Party of Interest nor hold any other interest (such as a security interest) in any retail dispensary licensee, which means true vertical integration in New York is impossible. Unlike AUCCs, individuals can be a True Party of Interest in multiple AUCPs.
Because of the difference in AUCP and AUCC treatment, it would behoove businesses that are considering acquiring both such licenses to hold such licenses in different entities, as some investors who are restricted in investing in an AUCC, by virtue of being a True Party of Interest in another AUCC, will still be able to invest in the AUCP—so long the same entity does not hold it as the AUCC. Additionally, investors and cannabis businesses may find loans or lease relationships are more feasible and attractive avenues to invest in New York than in other states.
Investors and cannabis businesses seeking investment should consult experienced attorneys before entering capital raise transactions. Still, because the State has taken a relatively strict and broad stance on interest holder restrictions, this is even more so the case in New York. Good, experienced cannabis business attorneys, like those of us at Burns and Levinson, will help investors and cannabis businesses in structuring raises to avoid limiting future investment opportunities or capital sources.