With Congress passing historic amounts of economic stimulus in response to the COVID-19 pandemic, every business in the country is asking how to obtain relief. In particular, one of the core provisions of the CARES Act is the approval of billions of dollars in federal guarantees for small business loans made under a modified and expanded Small Business Administration (SBA) 7(a) loan guaranty program. (See our full discussion of the Paycheck Protection Program here.)
These loans are not available to small businesses that engage in marijuana-related activities that are allowed under state law, even though dispensaries and other marijuana-related businesses (MRBs) are struggling in response to the COVID-19 shutdowns. As we previously discussed, Representatives Earl Blumenauer (D-OR) and Ed Perlmutter (D-CO) have introduced legislation to allow cannabis companies and related service providers in states where the use or sale of medical or recreational marijuana has been legalized at the state level to become eligible for participation in the SBA programs. However, there is still significant uncertainty as to whether any federal relief will be provided for the marijuana industry. Accordingly, for MRBs that are fighting to stay in business or maintain payroll, the only option for short-term funding will likely come from financial institutions and non-bank lenders willing to take on the risk of providing loans to companies in the marijuana industry.
But to what extent is that an option for MRBs? While most financial institutions have avoided the industry entirely, an increasing number of financial institutions have begun to serve the industry in states where the use or sale of medical or recreational marijuana has been legalized. Some of these financial institutions have been lending to MRBs or their owners or principals already, but it remains to be seen whether they will continue or expand lending to MRBs during the COVID-19 pandemic. For those that do, whether a financial institution or non-bank lender, it is important that they understand the legal and business risks of doing so.
Overview of the Federal Laws Relevant to MRB Lending
Any lending to an MRB or persons involved in the marijuana industry presents risks of violating the federal Controlled Substances Act (CSA), which continues to classify marijuana as unlawful. In addition, the facilitation of illegal transactions under the CSA, which could include providing any financial services to an MRB, may serve as the basis for the prosecution of other crimes, such as those prohibiting money laundering.
Notwithstanding the CSA prohibition, however, the federal government, including the Department of Justice, Financial Crimes Enforcement Network (FinCEN), and the banking regulators, have issued guidance on how financial institutions can provide services to MRBs in states where marijuana has been legalized, consistent with their legal and regulatory compliance obligations. These enforcement and regulatory agencies are well aware that many banks and credit unions already provide services to MRBs.
The DOJ and FinCEN guidance for serving MRBs does not distinguish among taking deposits, paying checks, and lending money, which are known as traditional banking services. Although it could be argued that lending to an MRB involves providing more direct support to marijuana-related activities than providing a deposit account, and therefore may attract more law enforcement scrutiny, we are not aware of any federal guidance or case law that draws this distinction.
Accordingly, while providing lending services to MRBs or individuals associated with the marijuana industry may increase the risk to a degree, providing such services does not appear to fall outside of the regulatory construct that the federal government (DOJ, FinCEN, and banking agencies) has developed for providing banking services to the marijuana industry. This may provide an opportunity for banks, credit unions, and non-bank lenders to extend credit to MRBs that are struggling in response to the COVID-19 pandemic—provided, of course, that the MRBs are operating in compliance with state laws.
What Are Some of the Indirect Legal and Business Risks?
Even if a financial institution or non-bank lender decides it is comfortable taking on the risk of providing loans to MRBs, the lender should understand that there are additional business risks that may impact the lender's ability to protect its loan portfolio, given the uncertain legal status of marijuana.
Specifically, the illegality of marijuana at the federal level presents challenges to a creditor looking to exercise its rights with respect to any marijuana-related assets used as collateral for a loan, particularly for a process such as bankruptcy that is governed by federal law. In this regard, the main indirect risks to a lender when dealing with MRBs are the following: (1) the federal government may seize the collateral underlying the loan, and (2) federal courts have generally held that a bankruptcy trustee cannot administer a bankruptcy estate's marijuana-related assets. These uncertainties could result in a loan to an MRB becoming unsecured (because the collateral is seized), the borrower losing the ability to repay (because it can no longer access other seized assets needed to operate its business), or a lack of an orderly bankruptcy process for the resolution of claims.
While not a perfect solution, there are steps that a lender can take to minimize these risks, including by (1) perfecting its interest in any assets pledged as collateral, (2) adding a receivership provision to its loan agreements, and/or (3) accepting different forms of collateral or over-collateralizing the loans with multiple sources of pledged assets. Even with these steps, however, there remains a greater risk that the lender will face challenges in attempting to secure collateral and protect its MRB loans.
The Importance of a Robust Compliance Program
Of course, providing lending services to MRBs in a safe and sound manner requires that the financial institution dedicate significant resources to an appropriately tailored compliance program.
The federal regulators in particular emphasize the importance of performing due diligence on potential MRB customers so that the financial institution understands potential risks and is able to tailor appropriate controls for each customer. This type of diligence should include a review of the MRB's business, corporate structure, licensing, and operations, as well as its key business relationships. Once diligence information is collected, it is prudent to perform a site visit to confirm that the information provided matches the reality of the customer's operations.
Many financial institutions classify their MRB customers into tiers, depending on the degree to which the customer engages directly or indirectly in marijuana-related activities. A Tier I borrower might include licensed dispensaries and other businesses that "touch the plant," with additional tiers designated for businesses that receive significant indirect revenue from the sale of marijuana. This type of MRB customer risk rating allows the financial institution to tailor its compliance program for the specific risks presented by each borrower.
Finally, it is important for a lender to monitor each MRB borrower's activities, including by reviewing and updating, as necessary, its diligence information on a periodic basis. This monitoring should include a focus on identifying any suspicious activity and filing suspicious activity reports (SARs) where appropriate. Any such reporting should follow the FinCEN Guidance establishing specific SAR-filing procedures for MRBs. These include the filing of a "Marijuana Limited" SAR at account opening, a "Marijuana Priority" SAR in the event an MRB implicates one of the Cole Memo priorities or violates state law, and a "Marijuana Termination" SAR filed when the financial institution terminates its relationship with the MRB.
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The COVID-19 pandemic has hit all businesses hard, including MRBs that operate in states where marijuana has been legalized. Absent congressional action, these businesses are limited to private funding and support to stay in business. Given that marijuana is still illegal at the federal level, any financial institution or non-bank lender looking to help must do so carefully, from both a business and a compliance perspective.
2020 Venable LLP. Using, distributing, possessing, and/or selling marijuana is illegal under existing federal law. Compliance with state law does not guarantee or constitute compliance with federal law. This informational overview is not intended to provide any legal advice or any guidance or assistance in violating federal law.