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Clearing the Haze

Cannabis insurance comes of age as federal uncertainty persists

August 15, 2022 Photo

The legal marijuana industry continues to thrive despite the federal government’s lack of clarity. Given that the cannabis industry is now worth tens of billions of dollars and has created hundreds of thousands of jobs across 37 of our 50 states, it is clear that an abrupt reversal of policy by the federal government would be utterly chaotic and disruptive.

Indeed, any perceived erosion of the status quo by federal law enforcement would certainly be met with a vigorous response and action in the courts led by state and local authorities, civil rights organizations, and members of Congress, all supported by the cannabis industry and the many thousands of ancillary businesses that serve it. To put it bluntly, even if there was a desire to do so, it is simply not feasible for the federal government to materially change its marijuana enforcement to a more aggressive posture against state-legal commercial cannabis entities and their ancillary service providers.

Relative to the insurance industry in particular, no reported federal action has been taken to date against any insurance-related entity that works with state-compliant marijuana businesses. This is notable when one considers the active and growing commercial insurance market that services the industry. It is difficult to imagine that the federal government would suddenly turn on entities that provide important insurance-related services to legitimate marijuana businesses operating in compliance with state law.

There are more than 30 insurance companies and managing general underwriters that write many lines of coverage for the cannabis industry, primarily on a surplus lines basis. The market capacity for property, commercial general liability, and product liability coverage has expanded to the extent that it is now relatively easy for most licensed cannabis operators to find multiple options for good coverage.

Those policies nevertheless remain more expensive than similar policies purchased by companies in other markets. Locating adequate excess insurance limits continues to be problematic for larger cannabis verticals, though this is also steadily improving. Specialty lines coverage remains fragmented and expensive despite multiple new options for D&O and other management liability policies. Most large commercial insurance carriers remain hesitant to enter the cannabis insurance space primarily due to Schedule 1 and related banking concerns. Reputational risk is a secondary and fading consideration.

Federal Marijuana Reform

The U.S. cannabis industry saw legal cannabis sales grow from $12.1 billion in 2019 to $17.5 billion in 2020 to nearly $25 billion in 2021. Forecasts vary, but all predict that the U.S. cannabis industry will continue to see robust growth over the next five years, with a compound annual growth rate of at least 15% and likely higher.

At the federal level, however, marijuana can exist legally in the United States only if it is reclassified or removed entirely from the Controlled Substances Act (CSA). Multiple petitions have been filed over the past 50 years seeking reclassification or removal of marijuana and THC within the CSA. The Drug Enforcement Administration (DEA) has consistently rejected those petitions, most recently in 2016, by devaluing or ignoring evidence of medical use for marijuana and its safety under the supervision of a physician, and by relying on U.S. obligations under international drug control treaties. In addition, a number of bills have been introduced in Congress without success.

Private lawsuits have, to date, unsuccessfully sought assistance by the courts to mandate that the DEA reschedule or completely remove marijuana under the CSA. Several cases have sought review up to the U.S. Supreme Court but have not received certiorari for review.

In June 2021, however, U.S. Supreme Court Justice Clarence Thomas issued an unexpected statement questioning whether the federal government’s continuing prohibition on marijuana is necessary or proper. His statement was made accompanying the denial of a writ of certiorari in the matter of Standing Akimbo LLC v. United States, which asked the court to address whether a medical marijuana dispensary could properly deduct ordinary business expenses in violation of section 280E of the Internal Revenue Code.

In his statement, Justice Thomas bluntly acknowledged that the reasoning behind the U.S. Supreme Court’s 2005 decision in Gonzales v. Raich (the last time the Supreme Court ruled on federal marijuana policy), which held that the power of Congress to regulate interstate commerce authorized it to prohibit the local cultivation and use of marijuana, has been “greatly undermined” by federal policies of the past 17 years. He characterized the federal government’s current approach as a contradictory and unstable “half-in, half-out regime” that “strains basic principles of federalism and conceals traps for the unwary.” Justice Thomas warned that by allowing states to act as laboratories that try novel social and economic experiments, the federal government may no longer have authority to intrude on the states’ core police powers, and that “a prohibition on intrastate use or cultivation of marijuana may no longer be necessary or proper to support the federal government’s piecemeal approach.”

Though Justice Thomas’ statement has no formal precedential value, it nevertheless represents the most explicit statement yet from a sitting Supreme Court justice that questions the rationality of current federal marijuana policy.

This development caused many to believe the Supreme Court would agree to take the closely watched case of Musta v. Mendota Heights Dental Center, which would resolve a split among states that either allow or prohibit workers’ compensation reimbursement for the cost of medical marijuana. On June 21, 2022, however, the Supreme Court announced that it would not hear Musta. This decision to remain on the sidelines of the debate over marijuana legalization is disappointing to many who were hoping to see the high court help break the logjam in Congress.

How the Courts Have Ruled

A trend has developed providing reassurance that the courts will enforce most cannabis-related contracts, including insurance contracts. This trend demonstrates that both state and federal courts are responding to the reality of tens of thousands of plant-touching and ancillary cannabis businesses needing access to the courts to resolve the full spectrum of disputes that arise from typical business relationships.

Numerous states with commercial cannabis regulations have modified their respective state laws by exempting commercial cannabis activity as being void for illegality. These statutory changes have resolved any question as to whether cannabis-related contracts are legally enforceable under state law.

Federal courts have taken a more nuanced position with respect to enforcement of cannabis-related contracts and other rights by evaluating whether doing so would require the litigant to actively violate the CSA. For example, various federal courts have enforced cannabis-related rights pertaining to insurance, federal labor and employment statutes, certain federal intellectual property protections, and contracts around ancillary products and services. In those cases, the courts determined that enforcement of the contract or right would not result in the litigant directly profiting from the possession, cultivation, or distribution of marijuana. The core question, therefore, is whether the federal court is being asked to order a violation of the CSA. When answered in the affirmative, this question has resulted in cases being dismissed by federal courts. The rights of cannabis litigants are typically enforced when the answer is no.

Political Progress

Momentum toward cannabis reform at the federal and state levels continued after the 2020 presidential election. Since then, 10 states have passed new adult-use or medical cannabis laws and six states have passed expansions to existing medical cannabis regulations. The adult recreational use of cannabis is now legal in 18 states, the District of Columbia, and Guam. The medical use of cannabis is now legal in 37 states, the District of Columbia, Puerto Rico, Guam, and the U.S. Virgin Islands. New adult-use legislation and ballot initiatives are being pursued in numerous states.

 Progress also is observed at the federal level, though it is certainly less than was expected in the wake of the 2020 election. It is possible, but unlikely, that any cannabis legislation, including either broad legalization or more incremental reform, will be passed by Congress before the 2022 mid-term elections. The U.S. House of Representatives has twice passed the Marijuana Opportunity Reinvestment and Expungement (MORE) Act within the past 18 months. The MORE Act stands little chance of becoming law due to lack of bipartisan support and because it is eclipsed by other legislation, including the Cannabis Administration and Opportunity Act (CAOA).

Details of CAOA were initially released in July 2021 by its Senate sponsors, led by Senate Majority Leader Charles Schumer (D-N.Y.). After soliciting comment from industry stakeholders, a revised bill was formally introduced in the Senate on July 21, 2022. The draft bill is strong on social justice/equity issues but has been criticized by the cannabis industry for a proposed 25% federal excise tax on undefined “larger cannabis businesses” and lack of a coherent federal regulatory plan. The CAOA is widely assumed to have inadequate bipartisan support to pass in the Senate, but it could help pave the way for more narrow incremental reform.

A Republican-led House cannabis legalization bill was released in November 2021 that proposes a low excise tax and the preservation of states’ rights to regulate cannabis, but it has drawn criticism for being largely silent on social justice/equity issues. That bill lost momentum soon after it was released.

Although many expect that cannabis will ultimately be regulated at the federal level similar to how alcohol or tobacco is regulated, none of the broad legalization bills contain an adequately detailed regulatory plan that explains how the federal government will engage with and provide oversight to dozens of disparate state regulatory schemes that will continue to exist after federal legislation is passed. In this legislative vacuum, groups such as the Cannabis Regulators Association are increasingly focused on ways to harmonize existing state regulations through adoption of consensus standards and other best practices.

The Secure and Fair Enforcement (SAFE) Banking Act remains the legislation with the best chance of passing into law. Indeed, the SAFE Banking Act has already passed in the House six times. The legislation, as currently drafted, does have adequate Republican support to pass in the Senate, but there are several Democratic senators who have announced they will not support a cannabis bill that does not include social justice and equity provisions.

It also is important to note that the so-called Rohrabacher Blumenauer protections are again written into the federal budget for the current fiscal year. These protections limit the ability of the DOJ or DEA to spend federal monies to enforce federal law against state-legal medical marijuana commercial activity. Legislation that would expand these protections to adult-use marijuana activity has passed in the House but stands little chance in the Senate.

Anti–Money Laundering Obligations

Until federal law is changed, insurance entities should seek competent legal advice before providing insurance services to a marijuana-related business. It is important for insurance entities that operate in the marijuana space to understand requirements mandated by the Bank Secrecy Act of 1970 (BSA), which requires U.S. financial institutions—a term defined to include an insurance company—to assist U.S. government agencies in detecting and preventing money laundering.

The BSA establishes a series of record-keeping and reporting requirements for financial institutions that help monitor and police the financial system by establishing customer due diligence programs. The Financial Crimes Enforcement Network (FinCEN) is the official bureau created by the Secretary of the Treasury to enforce the provisions of the BSA. On Feb. 14, 2014, FinCEN issued a memorandum of guidance to clarify the continuing obligations of financial institutions that seek to provide services to marijuana-related businesses. The guidance memorandum is not law and does not provide an explicit safe harbor, but rather sets forth an explanation of the intent of the regulations.

FinCEN instructs financial institutions to refer to the enumerated priorities within the 2013 Cole Memorandum in determining how to work with marijuana-related businesses. The Treasury Department has clarified that the FinCEN guidelines remain in place despite DOJ’s rescission of the Cole Memorandum in January 2018. In sum, there are two primary aspects to the FinCEN guidance: a customer due diligence component and potential obligations to make Suspicious Activity Report (SAR) filings.

Despite this guidance, many financial institutions have remained reluctant to take on policing duties with respect to the legality of potential marijuana-related business clients. The guidelines do not address how rigorous an institution’s anti–money laundering program must be to achieve a level of compliance deemed acceptable to FinCEN. This ambiguity and the time and expense of SAR filings for those institutions required to file SARs are the principal barriers to entry by financial institutions into the cannabis space.

The Decision

It is reasonable to conclude that the risk-benefit calculus has adequately shifted to justify entrance into the cannabis market without an unreasonable fear of prosecution. This certainly is true for the insurance industry. Congress continues to prohibit the DOJ and DEA from spending money to prosecute conduct that complies with state medical marijuana laws, and federal law enforcement has not initiated any prosecution against a plant-touching or ancillary business involved in either adult-use cannabis or medical marijuana where the underlying marijuana business activity was compliant with state law and there was no other independent violation of law.

Despite this favorable outlook, it must be acknowledged that, without a change to the status quo, some degree of theoretical legal risk remains present for any plant-touching or ancillary business in the marijuana industry. Any decision to provide insurance-related services to the cannabis industry must be based upon a well-informed understanding of the legal risks and the very challenging operating environment for state-licensed cannabis companies.

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About The Authors
Ian A. Stewart

Ian A. Stewart is a partner at Wilson Elser. ian.stewart@wilsonelser.com

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