This site has an excellent patient and caregiver Frequently Asked Questions. Check it out.
Question: Does a medical marijuana dispensary that is legal under state law have anything to fear from the Internal Revenue Service?
Answer: Yes. In 2007 the United States Tax Court issued its opinion in the case of Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner of Internal Revenue. The issue in this case was what business expenses could a California medical marijuana dispensary deduct on its federal income tax return in light of Internal Revenue Code Section 280E, which states:
No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.
In the CHAMPS case, the IRS conceded that the taxpayer could deduct its cost of goods sold, which included $575,317 for marijuana. Based on news reports about recent IRS audits of big California medical marijuana collectives, it appears that the IRS wants to revisit Section 280E and how it applies to medical marijuana dispensaries.
Warning to All Would-Be and Existing Medical Marijuana Dispensaries about Federal Income Taxes
The IRS is auditing a number of high dollar revenue medical marijuana dispensaries in California. See for example “IRS tells California Medical Marijuana Dispensary it Owes Millions in Unpaid Taxes” and “Millions at Stake in IRS Audit of Oakland Medical Marijuana Dispensary.” I believe that the ultimate goal of the IRS is to change the result in the CHAMPS case, which will have the practical affect of putting almost all state legal medical marijuana dispensaries out of business. If a dispensary spends $1,000,000 to grow its marijuana in 2011 and none of that expense is deductible because of Section 280E, then the dispensary will pay federal income taxes of $340,000 that it would not pay if the expense were deductible. This means it actually will cost the dispensary $1,340,000 to grow $1,000,000 of marijuana.
I do not know why the IRS conceded in CHAMPS that the taxpayer could deduct the cost of goods sold. COGS was the taxpayer’s biggest expense. I believe the IRS regrets conceding in CHAMPS that the COGS was deductible. I predict the IRS will disallow the COGS of the medical marijuana dispensaries it audits. I believe the IRS wants to litigate this issue in federal district court rather than in Tax Court with the ultimate goal of having the 9th Circuit Court of Appeals rule that COGS is not deductible by a state legal medical marijuana dispensary. If the IRS can get one or more appellate courts to agree that the COGS is not deductible, the practical result may be to kill the medical marijuana industry in every state that has legalized it.
Tax Court vs. Federal District Court & Circuit Courts of Appeal
The CHAMPS case was a U.S. Tax Court case that had a good result for the medical marijuana dispensaries in states that have legalized the growing and sale of medical marijuana. Neither federal district courts nor Circuit Courts of Appeal are required to follow the decisions of the Tax Court. That is why the IRS wants to relitigate Section 280E in the federal district courts and then the appropriate Circuit Court of Appeals. The IRS wants to reverse the CHAMPS case by winning at the Circuit Court of Appeals level.
When the IRS conducts an audit and demands more taxes from a taxpayer, the taxpayer who wants to dispute the results of the audit has two choices:
- Pay the entire amount of taxes in dispute and ask the U.S. Tax Court to determine how much additional taxes, if any, the taxpayer owes, or
- Pay none or less than all of the amount of taxes demanded by the IRS and ask the U.S. district court to determine how much additional taxes, if any, the taxpayer owes.
Tax court decisions cannot be appealed. Federal district court decisions can be appealed by the losing party to the appropriate Circuit Court of Appeals, which is the 9th Circuit for California and Arizona. district courts. Any legal medical marijuana dispensary that is assessed additional taxes by the IRS will want to pay the additional taxes and have the Tax Court rule on the dispute. The practical problem with this tactic, however, is that most dispensary taxpayers will not have the cash to pay the amount of taxes in dispute and will be forced to litigate in the federal district court.
The choice of venue to litigate the dispute is significant. Dispensaries will want to pay the tax and go to the Tax Court where they expect the Court to apply the holdings of the CHAMPS case. Clearly the IRS does not want these medical marijuana dispensary Section 280E cases to go to the Tax Court where the CHAMPS case is bad precedent for the IRS. What the IRS is doing is going after dispensaries that have high income and expenses so that when it demands more taxes, the dispensaries most likely will not have the money to pay the amount in dispute and must then go to the U.S. district court. Because the amount of tax dollars in dispute will be so big, the loser in the district court will appeal to the 9th Circuit Court of Appeals where the IRS hopes it will get a favorable Section 280E ruling that will effectively allow it to tax legal medical marijuana dispensaries out of existence.
The Marin Alliance for Medical Marijuana is being audited by the IRS. When asked how much the IRS is demanding in back federal income taxes, Lynnette Shaw, the owner of this dispensary, would not disclose the amount, but she said, “It’s a staggering sum, millions and millions.” I’m guessing this dispensary does not have a few spare millions of dollars lying around to pay the IRS so it can litigate the dispute in tax court.
- “IRS targets medical marijuana businesses“
- “Things don’t look good for medical marijuana dispensaries fighting IRS, says NORML director“
- “Medical Marijuana Tax Problems?“
- “Could medical marijuana get the Al Capone treatment?“
Although I have a masters degree in income tax law from New York University Law School, I am no longer a practicing tax lawyer. I recommend that every dispensary hire a good experienced tax CPA or tax lawyer to advise the dispensary on the federal and state income tax issues arising from the operation of a medical marijuana dispensary.
Circular 230 Notice: Pursuant to recently-enacted U.S. Treasury Department regulations, I am required to advise you that, unless otherwise expressly indicated, any federal tax advice contained in this communication, including websites linked to, is not intended or written to be used, and may not be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.
Must My Dispensary Obtain a Conditional Use Permit from the City before it can File an Application for an Arizona Medical Marijuana Dispensary License?
Question: When my nonprofit entity files its application for a dispensary registration certificate, must it have a conditional use permit from the city in which the dispensary will be located?
Answer: Maybe. Arizona Department of Health Services Rule R9-17-304 states:
To apply for a dispensary registration certificate, an entity shall submit to the Department the following
6. Documentation from the local jurisdiction where the dispensary’s proposed physical address is located that:
a. There are no local zoning restrictions for the dispensary’s location, or
b. The dispensary’s location is in compliance with any local zoning restrictions;
The rule does not specifically state that a Certificate of Occupancy must accompany the application for a dispensary registration certificate, but the local zoning authority may require the dispensary to get a CO as a condition to getting the documentation required by Rule R9-17-304.
Bottom line: Every would-be dispensary owner needs to consult with a good zoning attorney about this issue and for advice and assistance if making sure that the dispensary’s desired location complies with local zoning requirements. See “Prospective Dispensary’s Single Most Important Task Before April 30, 2012.”
Question: Are there any special clauses my dispensary should include in its contract with its medical director?
Answer: Yes. The contract should be an independent contractor agreement, not an employment agreement. The contract should contain the standard clauses found in a good lawyer drafted independent contractor agreement plus the following clauses unique to this agreement:
- The medical director will provide the specific duties of the medical director set forth in the rules.
- The medical director must obtain and maintain at all times a dispensary agent registration from the Arizona Department of Health Services. See R9-17-309.A.4.b., which states:
“A dispensary shall . . . Not allow an individual who does not possess a dispensary agent registry identification card issued under the dispensary registration certificate to: . . . Serve as the medical director for the dispensary“
- The medical director will comply with the applicable laws contained in Arizona Revised Statutes Section 36-2801 et.seq (Arizona’s medical marijuana statutes), and all applicable DHS rules in effect as of the date of the agreement and during the term of the agreement.
- The doctor represents and warrants that he or she satisfies all of DHS’ requirements to be a medical director not later than April 1, 2012.
- The doctor will obtain a license from Arizona Department of Health Services to be a medical director not later than April 1, 2012.
- If at any time the medical director ceases to be eligible to be a dispensary agent or if he or she cannot perform his or her duties for any reason, the contract must terminate without prior notice to the medical director.
- The contract terminates if the dispensary loses its dispensary registration certificate or ceases to operate.
- The medical director must grant a license to the dispensary to copy and use the copyrighted content the medical director gives to the dispensary as required under the rules.
- The medical director must represent and warrant that all content he or she gives to the dispensary does not infringe on anybody’s copyrights.
- The medical director must maintain at all times the types of insurance appropriate for the position in amounts not less than $500,000 or what is recommended by the medical director’s insurance agent.
- The medical director must give to the dispensary proof of insurance satisfactory to the dispensary.
- The medical director’s insurance company must be instructed to notify the dispensary of any change to or cancellation of any insurance policy.
- The compensation payable to the medical director will be reduced by X percent for every additional dispensary the doctor acts as the medical director, but the compensation will not ever be less than Y percent of the compensation payable if the doctor is a medical director for only the dispensary. If I’m representing a dispensary, I’ll try to put this clause in because the duties of the medical director are nonexistent once he or she does the initial set up so why should a doctor who is a medical director for multiple dispensaries get paid the same as a doctor who is the medical director for a single dispensary?
Question: I know my Arizona medical marijuana dispensary must be operated on a not for profit basis, but does not have to be an Arizona nonprofit corporation. Why would I want to form an Arizona nonprofit corporation that is also a tax-exempt organization under the Internal Revenue Code?
Answer: Neither the Arizona medical marijuana law nor the Arizona Department of Health Services proposed rules require that an Arizona medical marijuana dispensary be a nonprofit corporation. My recommendation is that all Arizona medical marijuana dispensaries be an Arizona limited liability company. See “Must an Arizona Medical Marijuana Dispensary be a Nonprofit Corporation?“
One of the best ways to help satisfy the requirement that the dispensary be operated on a not for profit basis is for the dispensary to make substantial donations of profits to a tax-exempt charitable organization such as the American Red Cross, the Arizona Humane Society or any one or more of the many tax-exempt charities that have purposes consistent with those of the dispensary’s owners. Donations to local tax-exempt charities that give to the local community are especially good choices. The dispensary should have a regular policy of publicizing its charitable donations such as handouts given away at the dispensary or signs on the walls of the dispensary.
Dispensary owners should also consider creating an Arizona nonprofit corporation that applies for and becomes an IRS approved tax-exempt charitable organization. One or more of the owners could be on the board of directors of the charity. The charity’s purpose would not involve the growing, possession or sale of marijuana. Instead, the charity’s purpose could be picked by the founders of the nonprofit corporation. I recommend its purpose be to engage in charitable activities in which the dispensary owners have an interest and that the money donated to the charity be spent in the local community. The tax-exempt organization must not have a purpose that is related to marijuana, including medical marijuana.
Here are some potential charitable purposes for a tax-exempt organization founded by an Arizona medical marijuana dispensary:
- Provide monetary assistance to people who are in a terminal condition or who cannot afford medical treatment
- Pay the cost for low income people to live in a care home
- Pay for nursing care for low income people
- Pay for legal drugs for low income people
The tax-exempt organization cannot be a subsidiary of the dispensary entity. It must be a separate stand-alone corporation governed by its board of directors.
Caveat: The dispensary owners and insiders cannot control the tax-exempt organization. The IRS will not grant tax-exempt status to a nonprofit corporation that is controlled by a person or a group of people. The board of directors of the tax-exempt organization can have one or more owners or insiders of the dispensary on its board of directors as long as the board of directors has enough independent members who could out vote the dispensary’s owners and insiders.
I would love to form your Arizona nonprofit corporation that you intend to become a federal tax-exempt organization. To learn more about forming an Arizona nonprofit corporation read “How to Form an Arizona Nonprofit Corporation” and “Arizona Nonprofit Corporation Formation Service.”
Question: My landlord wants the owners of my Arizona medical marijuana dispensary nonprofit entity to sign a Personal Guaranty. What is it and should the owners sign the guaranty?
Answer: A Personal Guaranty is a promise by the guarantor to pay the debt of a third party or to satisfy an obligation of a third party. If an entity such as a corporation or a limited liability company signs a lease for real property, the general rule of Arizona law is that the owners of the entity are not liable for the debts or obligations of the entity, including the rent. Landlords understand the law so a prudent landlord will require the owners of the entity to sign a Personal Guaranty by which the signer becomes legally obligated to pay to the landlord any amounts due under the lease that are not paid by the tenant and to satisfy any obligations of the tenant under the lease that are not satisfied. The landlord usually wants all of the owners of the tenant entity to sign a Personal Guaranty.
Personal Guarantees of leases are not required by Arizona law. Whether or not the owners give a personal guaranty is negotiable with the landlord. In economic times that favor landlords, they almost always require the owners of the tenant entity to sign a Personal Guaranty unless the entity has a satisfactory financial statement. During economic times that favor tenants, i.e., now, the owners of the entity may refuse to sign a Personal Guaranty and a desperate landlord may nevertheless enter into the lease without any Personal Guarantees because the landlord needs the rental income.
Personal Guaranty Negotiating Advice
Here are some negotiating tips for owners of an entity that may reduce their liability for the entity’s defaults under the lease when the landlord insists that the owners sign a Personal Guaranty:
- Reduce the term of the Personal Guaranty. Just because the lease is for five years does not mean the Personal Guaranty must last the same period of time. Try to shorten the term of the Personal Guaranty to some period less than the full term of the lease.
- Don’t guaranty extensions of the lease. If the original term of the lease expires and the entity exercises an option to extend the term of the lease, include language in the Personal Guaranty that it does not apply with respect to any extensions of the lease.
- Limit the maximum dollar amount of the signer’s liability. State in the Personal Guaranty that the maximum amount for which the signer is liable is $50,000 or $100,000 or whatever is the lowest number the landlord will agree to. If the landlord spends the landlord’s money for tenant improvements or for other items required of the landlord, the landlord will almost always want the landlord’s total out-of-pocket expenses to be the signer’s minimum liability.
- If the landlord will agree to limit the signer’s liability to a stated amount, provide in the Personal Guaranty that the amount of the liability goes down each month. For example, if the signer’s maximum liability is $120,000 and the term of the Personal Guaranty is two years, provide in the Personal Guaranty that the signer’s liability goes down $5,000 every month.
- State in the Personal Guaranty that the signer’s obligations terminate as of the date the entity loses its license to operate an Arizona medical marijuana dispensary.
- State in the Personal Guaranty that the signer’s liability terminates if the signer were to die.
- State in the Personal Guaranty that the signer’s total liability is equal to the total liability thereunder divided by the number of other owners who sign a Personal Guaranty. For example, if the entity has four owners who will sign guarantees, state that the signer’s total liability under the Personal Guaranty equals 25% of the total liability.
- State in the Personal Guaranty that if the Arizona Cardinals with the Superbowl, the Personal Guaranty will terminate. A knowledgeable landlord should not have a problem with this because the landlord knows there is almost no chance this will ever happen.
Important Fact About Personal Guarantees & Arizona Community Property
Arizona law provides that a Personal Guaranty signed only by one spouse is not effect against the assets of the non-signer spouse. If the landlord requires that both spouses sign the Personal Guaranty, try telling the landlord that the spouse who is not active in the business refuses to sign a guaranty.
Question: I own real property that is zoned for an Arizona medical marijuana dispensary or cultivation site. How can I increase the chances of obtaining a tenant that will actually obtain a dispensary registration certificate and become a long term paying tenant?
Answer: Easy. Lease your property to more than one prospective dispensary owner. Consider the following two scenarios:
Scenario 1: You lease to prospective dispensary owner number 1. The prospective tenant includes a clause in the lease that allows the tenant to terminate the lease if the tenant does not obtain a dispensary license. The tenant does not obtain a license. Long term rental income = $0.
Scenario 2: You lease the same site to 20 prospective dispensary owners. Each prospective tenant includes a clause in the lease that allows the tenant to terminate the lease if the tenant does not obtain a dispensary license. One of the 20 prospective tenants obtains a license to operate an Arizona medical marijuana dispensary. Nineteen prospective tenants leases are canceled. Long term rental income = big $$. Of course, each lease should have appropriate language in the lease that notifies each prospective tenant that its lease only becomes effective if the tenant actually obtains the dispensary registration certificate.
Update: A visitor to this website sent me the following message:
“I thought of this a couple of weeks ago and checked with the AZ Department of Health Services. The first person I spoke with was an employee of the department. She told me that multiple license applications with the same address would all be rejected. I then spoke with Laura Oxley the head of the department. She said it was a good idea, but I should speak with Tom Salow the department attorney for medical marijuana. Tom said that what I was proposing was currently acceptable under the guidelines, but he expected the guidelines to change making it unacceptable in the next revision.”
If Tom Salow’s statement about is true, why would the Arizona Department of Health Services reject multiple applications for the same location? It would not make any sense. The only purpose behind such a rule would be to make it more difficult for prospective dispensaries to find a suitably zoned location and to cause a lot of landlords to waste time entering into leases with tenants that will never get a dispensary registration certificate. If DHS changes the rules to reject applications for the same location, it would be another instance of the Arizona Department of Health Services bureaucrats/desk jockeys being the problem, not part of the solution.
Question: My attorney put language in the Articles of Incorporation for my Arizona medical marijuana nonprofit corporation that say it will be operated as a 501(c)(3) charitable organization and that no part of the earnings of the corporation can go to insiders. Is that a problem?
Answer: Yes. Big time! If you want to operate a pure charity then the language is appropriate. Here is some common language I have seen in Articles of Incorporation of Arizona nonprofit corporations:
“This corporation is organized exclusively for charitable purposes such as religious, educational, literary and scientific purposes, including, for such purposes, the making of distributions to organizations that qualify as exempt organizations under section 501(c)(3) of the Internal Revenue Code, as amended, or the corresponding section of any future federal tax code (the “Code”).
“The Corporation is not organized and shall not be operated for pecuniary gain or profits. No part of the net earnings of the Corporation shall inure to the benefit of or be distributable to its directors, officers, members, or any other private person; provided that the Corporation shall be authorized and empowered to pay reasonable compensation for services rendered and to make payments and distributions in furtherance of the purposes set forth herein.”
You definitely do not want the above language in the Articles of Incorporation for a corporation that intends to own and operate an Arizona medical marijuana dispensary. The first problem with the above language is that it is used in Articles of Incorporation of nonprofit corporation. You should not be using a nonprofit corporation to own your dispensary because Arizona nonprofit corporations do not have owners/shareholders. See “Is It a Mistake to Form an Arizona Nonprofit Corporation to Operate an Arizona Medical Marijuana Dispensary?“
The second problem is the above language is appropriate in the Articles of Incorporation of an Arizona nonprofit corporation only if the corporation intended to become a tax-exempt organization under the Internal Revenue Code. If you intend for your nonprofit corporation that will own a medical marijuana dispensary to file an IRS Form 1023 or 1024 and apply for tax-exempt organization status with the IRS you should know that:
- Arizona Revised Statutes Section 36-2806.A states: “A registered nonprofit medical marijuana dispensary need not be recognized as tax-exempt by the internal revenue service”
- The IRS will not grant an organization an exemption from federal income taxes if the activities of the organization involve the violation of federal criminal law.
The third big problem arises from the language in the second paragraph quoted above. The language is used in the Articles of Incorporation of nonprofit corporations that want to become tax-exempt organizations because it is required by the IRS. Tax-exempt organizations are prohibited by the Internal Revenue Code from paying excess benefits to insiders such as officers, directors and members. Violations of the excess benefit rules are taxed at the rate of 100% of the excess amount for every year the excess is not repaid to the organization.
If the insiders of an Arizona nonprofit corporation that intends to own an Arizona medical marijuana dispensary want to be able to be paid more than reasonable compensation and most do, then the corporation’s basic governing document, its Articles of Incorporation, should not limit the insiders compensation to reasonable amounts. Consider the insider who provides no services, but receives $5,000 a month from the corporation. The payment is a violation of the corporation’s Articles of Incorporation and makes the directors and officers who are responsible for the payment liable to the corporation for exceeding their authority.
Bottom line: Neither Proposition 203 nor the Arizona Department of Health Services rules require dispensaries to be nonprofit corporations. The rules say that the entity must be operated on a not-for-profit basis, but do not require any specific type of entity. Dispensaries may be a for profit corporation (I don’t recommend this type of entity), a nonprofit corporation (ditto), a general partnership (the worst type of entity to form), a limited partnership (ok, but now obsolete in Arizona), a sole proprietorship (bad choice) or a limited liability company (yes – this is the one!). See “Must an Arizona Medical Marijuana Dispensary be a Nonprofit Corporation?” If you formed any type of entity other than an Arizona limited liability company to own an Arizona medical marijuana dispensary, you need to dump it and switch to an Arizona limited liability company.
Is It a Mistake to Form an Arizona Nonprofit Corporation to Operate an Arizona Medical Marijuana Dispensary?
Question: My attorney formed an Arizona nonprofit corporation for me to own and operate an Arizona medical marijuana dispensary. Was that a mistake?
Answer: Yes because Arizona nonprofit corporations do not have owners/shareholders. Why would you invest a lot of money in an entity that you cannot own and cannot leave to your heirs if you were to die? For the reasons mentioned below, you should ask your attorney to refund the money if he or she formed your nonprofit corporation after December 17, 2010. See “Must an Arizona Medical Marijuana Dispensary be a Nonprofit Corporation?”
For profit Arizona corporations are owned by their shareholders. Arizona limited liability companies are owned by their members. Arizona partnerships are owned by their partners. Arizona nonprofit corporations do not have shareholders. If authorized in the Articles of Incorporation, an Arizona nonprofit corporation can have members and the criteria and characteristics of members can be set forth in the Articles of Incorporation or in the corporation’s bylaws. However, members are not shareholders/owners and are not treated as such by Arizona’s nonprofit corporate statutes.
Admission: Before the Arizona Department of Health Services issued its first draft of the rules on December 17, 2010, it was my opinion that Arizona medical marijuana dispensaries had to be Arizona nonprofit corporations. I formed a number of Arizona nonprofit corporations for my clients before DHS issued the first draft of the rules because the only type of nonprofit entity recognized by Arizona statutes is the nonprofit corporation.
Proposition 203 stated that a dispensary had to be a nonprofit “organization,” which I thought was a strange choice of words. Last December I asked the lawyer for the Marijuana Policy who is in charge of the model medical marijuana code on which Proposition 203 was based why Proposition 203 used the word organization instead of corporation, limited liability company and/or partnership. She said she did not know. I could tell she did not understand the significance of the fact Arizona nonprofit corporations do not have shareholders/owners.
Before December 17, 2010, I recommended to clients that they form an Arizona nonprofit corporation to own the dispensary because Proposition 203 was uncertain and because the nonprofit corporation is the only type of nonprofit entity authorized under Arizona law. I told my clients in writing of this issue.
When the first draft of the rules was issued on December 17, 2010, it clarified that a dispensary could be owned by any type of entity recognized by Arizona law. Since that date, I recommend to everybody that they form an Arizona limited liability company to own a dispensary and that the LLC be operated on a not-for-profit basis.
If you formed a nonprofit corporation to own your dispensary, it is not too late to replace it with an Arizona LLC. If your nonprofit corporation has already entered into one or more leases, get approval from your landlord to allow the tenant’s rights to be assigned by the corporation to the new LLC.
P.S. If you find a lawyer today who advises you to form a nonprofit corporation to operate your dispensary, run away as fast as you can.
Question: Must all owners, officers and members of the board of directors of an Arizona medical marijuana dispensary be a citizen of the United States?
Answer: Apparently “the principal officer” or one board member must be a U.S. citizen as of today, January 26, 2011. It appears that no other owner, officer or director must be a U.S. citizen, except for the one “principal officer” or board member selected by the insiders to give proof of U.S. citizenship to the Arizona Department of Health Services.
Although Proposition 203 does not contain U.S. citizenship or Arizona residency requirements, the first draft of the Arizona Department of Health Services rules contain both requirements. Rule R9-17-107.F.1.d.v(1) requires that after a dispensary applicant receives the written notice of preliminary approval from DHS, the applicant shall submit to DHS “a copy of the principal officer or board member’s Arizona driver’s license or identification card issued before October 1, 1996, and one of the following:
(1) Birth certificate verifying U.S. citizenship,
(2 ) U. S. Certificate of Naturalization, or
(3) U. S. Certificate of Citizenship.”
My take from reading this poorly worded rule is that only one person who is an owner, officer or board member of an Arizona medical marijuana dispensary must be a United States citizen. The term “principal officer” is used 47 times in the rules, but the term is not defined.
How Can a Non-Arizona Resident Who Wants to Own an Interest in an Arizona Medical Marijuana Dispensary Participate Before Becoming a Resident?
Question: Arizona Department of Health Services’ first draft of the medical marijuana dispensary rules requires that all officers and directors of Arizona medical marijuana dispensaries be Arizona residents for at least three years. I don’t satisfy the residency requirement so how can I be involved in a dispensary now and become an owner when I qualify?
Answer: There are several ways. If your goal is to own an interest in an Arizona medical marijuana dispensary, you must establish Arizona residency for at least three years so the sooner you move to Arizona, the sooner you will meet the residency requirement. The current DHS rules contain a three year Arizona residency requirement to be an owner, officer or director of a dispensary. Myself and others have suggested to DHS that it eliminate the residency requirement because the requirement is not contained in Proposition 203 and it is a violation of the equal protection clause of the United States Constitution. DHS could increase or decrease the residency requirement or eliminate it altogether before it issues the final rules.
A person who has not lived in Arizona for three years could become a paid employee or an unpaid volunteer of a dispensary. These positions are great learning experiences and can help to establish contacts and relationships with the dispensary owner that could lead to an ownership interest in a dispensary. However, without a legally binding written contract between you and the nonprofit entity or the owner(s) of the nonnprofit entity to acquire an ownership interest in the dispensary, you probably would never become an owner.
Make a Loan with an Option to Convert the Debt to Equity
A better way for a non-Arizona resident to acquire an ownership interest in an Arizona medical marijuana dispensary is by the non-Arizona resident loaning money to the nonprofit entity and having a written option to convert the loan to an equity (ownership) position after the non-Arizona resident establishes residency and each of the 17 other requirements of ownership currently in the DHS rules. For example, if you and another person want to own a dispensary and become equal 50/50 owners, the other person could loan or contribute $125,000 to the nonprofit entity and you could loan it $125,000. The other person would initially be the sole owner of the dispensary. Your loan documents would provide that once you satisfy all 18 requirements to be an owner of an Arizona medical marijuana dispensary, you would have the option to notify the entity and its owner that you exercise your option to purchase a fifty percent ownership interest in the entity in exchange for releasing the entity from its obligation to repay the loan. A condition to actually becoming an owner would be that DHS would have to approve you becoming an owner.
During the period of time before the lender becomes eligible to become an owner of the dispensary, the lender could be a paid employee of the nonprofit entity.
What Documents are Needed to Evidence a Debt to Equity Conversion Option
Here are the documents that must be prepared and signed by the appropriate parties do create and document a transaction where the nonprofit entity borrows money and gives the lender an option to convert the debt to equity:
- Loan Agreement: This document sets forth all of the terms and conditions of the loan and the rights and obligations of the parties with respect to the option to convert the debt to equity. For example, it would state the conditions that must be satisfied before the borrower can exercise the option such as establish residency and each of the 17 other DHS requirements for ownership, state when the option would expire, require the borrower to become a signer on the entity’s governing document [Operating Agreement for an LLC and stockholders agreement for a corporation] and on a buy-sell agreement and state the conversion ratio for converting one dollar of debt into a specified percentage of ownership of the entity.
- Promissory Note: The Note evidences the loan terms and repayment obligation of the nonprofit entity. It could be interest only for a period of time. If principal payments are made, the lender would receive a smaller ownership interest in the entity on converting the debt to equity.
- Security Agreement: If the loan will be secured by any personal property of the entity, the lien is evidenced by a Security Agreement signed by borrower and lender.
- UCC-1 Financing Statement: If the borrower obtains a lien on the entity’s personal property, the lender must file a UCC-1 Financing Statement with the Arizona Secretary of State
- Deed of Trust on Real Property: If the nonprofit entity owns any real property, the loan could be secured by a lien on the real property.
- Lender’s Title Insurance: If the loan is secured by a lien on the entity’s real property, the lender should obtain a policy of lender’s title insurance.
- Personal Guaranty: The lender should require the other owners of the nonprofit entity to guaranty the Loan Agreement.
- Resolutions of an Action by Unanimous Consent: The governing body of the entity (board of directors of a corporation or members of an LLC) must hold a duly called and noticed meeting and adopt a resolution authorizing the entity to enter into the Loan Agreement, the Promissory Note and any other documents and designating the person who has the authority to sign the documents on behalf of the entity. In lieu of holding a meeting, the governing body can sign an Action by Unanimous Consent that adopts all of the necessary resolutions, but all members of the governing body must sign the Action by Unanimous Consent or it will not be valid and the governing body must then hold a duly called and noticed meeting.
- Employment Agreement: Needed if the lender will work for the nonprofit entity and be paid compensation before becoming an owner of the entity.
- NonDisclosure & Confidentiality Agreement: The parties should sign this document to prevent either party from disclosing anything about the loan and to keep information confidential.
Should I Loan Seed Money to My Medical Marijuana Dispensary or Should I Give it to the Entity as a Capital Contribution?
Question: I estimate that my Arizona medical marijuana dispensary will need $250,000 to open its retail store. Should I loan the money to the nonprofit entity or should I pay it to the entity as a capital contribution?
Answer: You should discuss this question with your accountant. There are significant differences in the two primary methods (debt vs. equity) of inserting money into a business. Here are some pros and cons associated with each method.
Debt: You could loan the entity $250,000. The loan should be evidenced by a Promissory Note signed by an authorized agent of the entity. The governing body of the entity (members of an LLC or directors of a corporation) should hold a meeting (or sign an action by unanimous consent) and vote to approve the terms and conditions of the loan and designate the person who has the authority to sign the Promissory Note on behalf of the entity. The loan should be commercially reasonable as to the interest rate, payment terms and maturity date. If I were representing the lender, I would recommend that the Promissory Note be secured by a Security Agreement that encumbers all of the assets of the borrower. If I were representing the borrower, I would suggest the loan be unsecured.
There are several advantages for the lender / owner who capitalizes the entity using a loan. First and foremost, the entity becomes indebted to repay the loan according to its terms. A loan creates a greater likelihood of being repaid before a capital contribution because the law of Arizona prohibits an Arizona entity from paying its owners and not paying creditors. A loan may also be a better way to capitalize a medical marijuana entity because presumably Arizona’s medical marijuana laws and the Arizona Department of Health Services rules do not consider the entity’s repayment of a loan to be inconsistent with the require of the law and rules that the entity be operated on a nonprofit basis.
One problem with debt vs. equity is that although the entity has the funds, the infusion of capital does nothing for its balance sheet. The assets of the entity increase by $250,000, but so does the entity’s debt, which means the loan does not increase the net worth of the entity.
If an owner does make a loan to the entity, it is critically important the the loan be properly documented with a good Promissory Note, Security Agreement and a UCC-1 Financing Statement filed with the Arizona Secretary of State (if the loan will be secured by a lien on personal property), and resolutions or an action by unanimous consent of the entity’s governing body. If your entity needs to document a loan, call KEYTLaw business and contracts attorney Jeana Morrissey at 602-906-4953, ext. 4.
Equity: Instead of loaning $250,000 to the entity, you could pay the money to the entity as a capital contribution. Capital contributions have a lower priority the debt on the repayment totem pole. The last people to be paid and recover their investment when a business goes bad are the owners. Some organizational documents such as an Operating Agreement may provide that the owner does not have the right to demand that capital contributions be repaid. Usually capital contributions do not accrue interest although it is possible to accrue interest if company documents provide for the accrual.
Because Arizona medical marijuana dispensaries must be operated on a nonprofit basis, it may also be more difficult to repay a capital contribution than a loan. Currently the DHS rules do not give us any guidance as to whether an entity may freely repay owners their capital contributions so we do not know if a capital contribution in year 1 followed by a total repayment in the same year would be considered an improper use of entity profits contrary to the nonprofit character of the entity required by Arizona law.
An owner could also fund the entity with debt and equity. In the above example, the owner could loan $125,000 to the entity and also make a capital contribution of $125,000.
Is it Legal for a Promoter to Ask Me to Invest $25,000 in a Syndicate that Will Seek to Own an Arizona Medical Marijuana Dispensary
Question: An Arizona business has a website on which it is offering to put together a group of people to own minority interests in an entity that will seek to obtain a license to operate a medical marijuana dispensary in Arizona. In exchange for paying $25,000 I would become a part owner with several other investors in the entity that will seek the license. Is this legal?
Answer: Maybe, but be cautious. It appears that the people who are seeking the investors are soliciting investors to purchase a security. Federal and state securities law regulate the offer and sale of securities. The general rule is that no person or entity can offer to sell or actually sell a security unless the securities are registered with the United States Securities and Exchange Commission or offered and sold as a private offering under one of the SEC’s rules that provide for exceptions to the general rule.
In the famous United States Supreme Court case of Securities & Exchange Commission v. W. J. Howey Co. the Court ruled that the sale of real estate coupled with a mandatory leaseback of the land was a type of security called an “investment contract.” The Court said that”
“an investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”
If Sure Thing Investments, Inc., solicits me to join nine other investors who will each contribute $25,000 to World Wide Widgets, LLC, and my only involvement with the company is as a silent investor, I have purchased a security, i.e., the 10% membership interest in the LLC. Sure Thing Investments, Inc., and the people who put the deal together must comply with applicable federal and state securities laws or they will be liable to me and the other investors for any loss I suffer plus be subject to sanctions by the SEC and each state where an investor resides. Complying with securities law involves many things, including a requirement that the promoter deliver to investors before purchase a written prospectus or private placement memorandum that contains all material facts concerning the investment and that does not fail to disclose a material fact.
Given that the medical marijuana industry is brand new in Arizona and that its core busi9ness involves violating federal law, it is especially important that promoters and prospective issuers of securities involving an Arizona medical marijuana dispensary provide all prospective investors with a detailed disclosure document that lists all of the many risks arising from the unusual type of business.
Note: Federal law provides that no person or entity can be compensate or receive property of value for finding an investor who purchases a security unless the person or entity is licensed as a securities broker or licensed as a securities sales agent working for a licensed securities broker. For example, if Joe solicits investors on his website to invest $25,000 to become one of ten people who form an Arizona limited liability company that seeks to obtain a license to operate an Arizona medical marijuana dispensary and the LLC pays Joe $500 for each investor he brings to the deal, Joe must be a licensed securities broker or a licensed securities salesman working for a licensed securities broker.
Query: What if Joe finds the investors for the would be dispensary LLC, but the LLC does not pay Joe any money or property for finding investors. Instead, the LLC hires Joe for big bucks to assist the LLC in obtaining a dispensary license. Must Joe be a broker or a salesman working for a broker? I don’t know, but it is a good question to ask a securities law lawyer or the Securities Division of the Arizona Corporation Commission. You could argue that Joe must be licensed because the only reason the LLC paid Joe the money was because of Joe’s efforts that caused the investors to form the LLC for the purpose of hiring Joe. My advise to Joe is to consult with an experienced securities law lawyer and if necessary, get licensed.
Warning: Any person or business that solicits investors over the internet is by definition involved in a public offering that must be registered with the Securities and Exchange Commission. As an Arizona business lawyer I have had people come to me from time to time because they placed an ad in a newspaper soliciting investors and received a cease and desist letter from the Securities Division of the Arizona Corporation Commission. If you know of a website that is making a public offer to sell a security that has not been registered with the SEC or that is exempt from registration, contact the SEC. If you have any inquiries or complaints regarding salesmen, investment advisers or securities involving offers or sales of securities to an Arizona resident, call the Securities Division of the Arizona Corporation Commission at (602) 542-0662.
Question: I am an Arizona physician who is considering offering my services to be the medical director of an Arizona medical marijuana dispensary. Does every dispensary need a medical director? What are the duties of the medical director under the Arizona Department of Health Services rules?
Answer: The Arizona Department of Health Services rules require that every Arizona medical marijuana dispensary hire a medical director. Proposition 203 did not contain a requirement for a medical director, but DHS decided in its wisdom that every dispensary should spend a lot of money to hire a medical director who must be doctor of medicine who holds a valid and existing license to practice medicine pursuant to A.R.S. Title 32, Chapter 13 or its successor or a doctor of osteopathic medicine who holds a valid and existing license to practice osteopathic medicine pursuant to A.R.S. Title 32, Chapter 17 or its successor and who has been designated by a dispensary to provide medical oversight at the dispensary. R 9-17-312.
The Arizona Department of Health Services rules (R 9-17-312) for Arizona medical marijuana dispensaries require that every dispensary contract with a medical director who shall provide oversight for the development and dissemination of educational materials for qualifying patients and designated caregivers. Here is the text of R9-17-312:
A. A dispensary shall appoint an individual who is a physician to function as a medical director.
B. During hours of operation, a medical director or an individual who is a physician and is designated by the medical director to serve as medical director in the medical director’s absence is:
1. On-site, or
2. Able to be contacted by any means possible, such as by telephone or pager.
C. A medical director shall:
1. Develop and provide training to the dispensary’s dispensary agents at least once every 12 months from the initial date of the dispensary’s registration certificate on the following subjects:
a. Guidelines for providing information to qualifying patients related to risks, benefits, and sides effects associated with medical marijuana;
b. Guidelines for providing support to qualifying patients related to the qualifying patient’s self-assessment of the qualifying patient’s symptoms including a rating scale for pain, cachexia or wasting syndrome, nausea, seizures, muscle spasms, and agitation;
c. Recognizing signs and symptoms for substance abuse; and
d. Guidelines for refusing to provide medical marijuana to an individual who appears to be impaired or abusing medical marijuana; and
2. Assist in the development and implementation of review and improvement processes for patient education and support provided by the dispensary.
D. A medical director shall provide oversight for the development and dissemination of:
1. Educational materials for qualifying patients and designated caregivers that include:
a. Alternative medical options for the qualifying patient’s debilitating medical condition;
b. Information about possible side effects of and contraindications for medical marijuana including possible impairment with use and operation of a motor vehicle or heavy machinery, when caring for children, or of job performance;
c. Guidelines for notifying the physician who provided the written certification for medical marijuana if side effects or contraindications occur;
d. A description of the potential for differing strengths of medical marijuana strains and products;
e. Information about potential drug-drug interactions, including interactions with alcohol, prescription drugs, non-prescription drugs, and supplements;
f. Techniques for the use of medical marijuana and marijuana paraphernalia;
g. Information about different methods, forms, and routes of medical marijuana administration;
h. Signs and symptoms of substance abuse, including tolerance, dependency, and withdrawal; and
i. A listing of substance abuse programs and referral information;
2. A system for a qualifying patient or the qualifying patient’s designated caregiver to document the qualifying patient’s pain, cachexia or wasting syndrome, nausea, seizures, muscle spasms, or agitation that includes:
a. A log book, maintained by the qualifying patient and or the qualifying patient’s designated caregiver, to track the use and effects of specific medical marijuana strains and products;
b. A rating scale for pain, cachexia or wasting syndrome, nausea, seizures, muscles spasms, and agitation;
c. Guidelines for the qualifying patient’s self-assessment or, if applicable,assessment of the qualifying patient by the qualifying patient’s designated caregiver; and
d. Guidelines for reporting usage and symptoms to the physician providing the written certification for medical marijuana and any other treating physicians; and
3. Policies and procedures for refusing to provide medical marijuana to an individual who appears to be impaired or abusing medical marijuana.
E. A medical director shall not establish a physician-patient relationship with or provide a written certification for medical marijuana for a qualifying patient.
Question: Should I be the sole owner of my Arizona medical marijuana dispensary?
Answer: Probably not. Although the Arizona Department of Health Services rules allow an Arizona medical marijuana dispensary to be owned by a single person (a sole proprietor) or a company that has only one owner, I strongly recommend that no dispensary owner be the sole owner of the business. The reason every dispensary should have at least two owners is to prevent the lose of the valuable dispensary license if the sole owner were to die or to become ineligible to be an owner, officer or director of the business.
Two examples will illustrate the terrible consequences of having a sole owner dispensary business.
Example 1: Homer Simpson is the sole owner of an Arizona LLC called Bart’s Greenies, LLC. Homer invested $500,000 to get a dispensary license and open his dispensary in Scottsdale in the food court of the Fashion Square Mall and to set up his 20,000 square foot cultivation farm in Pine Top. Homer unexpectedly dies from joy and pride while attending Bart’s graduation ceremony at the Penn State University Hershey School of Medicine where Bart received his M.D. degree. Because the LLC no longer has an owner approved by the Arizona Department of Health Services to be an owner, the LLC’s dispensary license automatically evaporates and so does all of its value. There is no LLC with a dispensary license to be inherited by Homer’s family.
Example 2: Same facts as in Example 1 except Homer does not die. Instead, Homer divorces Marge and defaults on his child support payments for Maggie. Because Homer is no longer eligible to be an owner, officer or director of an Arizona medical marijuana dispensary the LLC’s dispensary license automatically evaporates and so does all of its value.
Solution: I recommend that every Arizona medical marijuana dispensary organization have at least two owners so that if one of the owners were to die or cease to be eligible to own an interest in the business, the other owner could continue as the sole owner of the business so that the business does not automatically lose its dispensary license. Although a husband and wife who jointly own a dispensary are technically do not have a sole owner business, they should consider having another nominal owner in case the husband and wife were killed in a common accident.
Caution 1: The December 17, 2010, first draft of the proposed rules contains 18 requirements that must be satisfied for a person to become an owner, officer or director of an Arizona medical marijuana dispensary business. If any owner, officer or director ever becomes ineligible to be an owner, officer or director, the business will automatically lose its license to operate the dispensary. This risk of automatic termination is one very big reason why all entities that want to obtain a dispensary license need to purchase my Bylaws that contain provisions intended to protect against the loss of the license if an owner, officer or director ceases to be eligible to be an owner, officer or director. For more about why all dispensaries need properly drafted Bylaws see “Bylaws for Arizona Medical Marijuana Dispensaries.”
Caution 2: Whenever a business has multiple unrelated owners, the owners must enter into a buy-sell agreement that contains their exit strategy. Medical marijuana dispensaries especially need a good buy-sell agreement that covers the automatic buy-out of any owner who ceases to be eligible to be an owner.
Question: What are the various types of contracts needed by all Arizona medical marijuana dispensaries?
Answer: The following is a list of the contracts that all Arizona medical marijuana dispensaries need. Because of the unique nature of the business and the risk that an improper action by an employee, independent contract or dispensary agent could cause the loss of a dispensary’s license, it is critically important that the dispensary have very tight contracts that protect the dispensary. Each contract must be drafted by an attorney who is familiar with and takes into consideration the legal requirements imposed on dispensaries by Arizona’s medical marijuana law and the Arizona Department of Health Services’ rules. Each dispensary needs:
- Lease for the dispensary site
- Lease for the cultivation site
- Application for Employment
- Employment Agreement
- Contract with the primary medical director (see “Clauses to Include in a Contract between a Medical Director & a Dispensary)
- Contract with the alternate medical director (see “Why Every Arizona Medical Marijuana Dispensary Must Hire a Primary & an Alternate Medical Director“)
- Contract with Marijuana Grower Personnel
- Authorization to Conduct Background Check
- Dispensary Agent Agreement
- Employee & Dispensary Agent MMD Law Knowledge Test
- Employee Policy Manual
- Nondisclosure & Confidentiality Agreement
- Independent Contractor Agreement
- Premises Security Agreement for security guards
- Information Technology Agreement for computer services
- Patient Registration Form
- Patient Disclosure Form with Receipt
- Retail Sales Contract Form with disclosures
- Contract to Purchase Marijuana from another Dispensary
- Contract to Sell Marijuana to another Dispensary
- Marijuana Delivery Contract for anybody who delivers marijuana
- Buy-sell Agreement for the Owners of the Dispensary (the exit strategy)
Richard Keyt is an Arizona business lawyer and Arizona medical marijuana attorney. I’ve practiced business law in Arizona since 1980 and prepared thousands of business contracts.
Question: Must I know my Arizona medical marijuana dispensary and cultivation locations before I file my application with Arizona Department of Health Services to obtain a dispensary license?
Answer: Yes. Arizona Revised Statutes Section 36-2804 states:
“Not later than ninety days after receiving an application for a nonprofit medical marijuana dispensary, the department shall register the nonprofit medical marijuana dispensary and issue a registration certificate . . . if . . . The prospective nonprofit medical marijuana dispensary has submitted . . . an application, including:
(i) The legal name of the nonprofit medical marijuana dispensary.
(ii) The physical address of the nonprofit medical marijuana dispensary and the physical address of one additional location, if any, where marijuana will be cultivated, neither of which may be within five hundred feet of a public or private school existing before the date of the nonprofit medical marijuana dispensary application.”
Therefore, Section 36-2804 requires that the application state the name of the dispensary owner and the actual address where the dispensary will sell to patients and where it will grow its marijuana. Now is the time for all prospective dispensaries to be looking for an buying or leasing the premises where they will operate and grow. Once you find a site, if the site makes sense and if the zoning allows for the use of the site for a dispensary or cultivation site, you must tie up the site, i.e., enter into a legally binding lease for the premises or a contract to buy it.
Note: Before you find your site, you must have formed you limited liability company so that it can be the party that signs the lease or purchase contract. You do not want the personal liability that goes with being the singer on a lease or contract. If you need me to form your Arizona limited liability company, see the links near the top of the right column of this website.
Because no applicant will know if the applicant will actually receive a dispensary license, it does not make sense for the dispensary to enter into either a lease or a contract to buy unless the lease or contract contains provisions that are unique to the medical marijuana business. For example, you want a clause in your lease or purchase contract that gives you the option to terminate the lease or purchase option if you do not actually get a license or if you get a license and later lose the license and cannot get it back. You’ll want a use clause that is appropriate for the business as well as clauses that allow you to make tenant improvements and take actions inside and outside the premises that are necessary to comply with Arizona’s medical marijuana law and the ADHS rules.
Question: Can I create a business in Arizona that only grows marijuana and sells it to licensed medical marijuana dispensaries?
Answer as of 1/31/11: Yes. The January 31,2011, second draft of the rules eliminated the requirement that all dispensaries grow any portion of the marijuana. A condition to growing, however, is that the grower must have a license to operate a dispensary. It is not possible to get a license to grow without operating a dispensary.
Answer Before 1/31/11: Not unless the Arizona Department of Health Services changes its proposed rules. Proposition 203 and the December 17, 2010, first draft of the proposed rules allow only licensed dispensaries to grow and sell medical marijuana. The proposed rules contains this provision:
“R9-17-307. Administration. C. A dispensary:
1. Shall cultivate at least 70% of the medical marijuana the dispensary provides to qualifying patients or designated caregivers;
2. Shall only provide medical marijuana cultivated or acquired by the dispensary to another dispensary in Arizona, a qualifying patient, or a designated caregiver authorized by A.R.S. Title 36, Chapter 28.1 and this Chapter to acquire medical marijuana;
3. May only acquire medical marijuana from another dispensary in Arizona, a qualifying patient, or a designated caregiver;
4. May acquire up to 30% of the medical marijuana the dispensary provides to qualifying patients and designated caregivers from another dispensary in Arizona, a qualifying patient, or a designated caregiver; and
5. Shall not provide more than 30% of the medical marijuana cultivated by the dispensary to other dispensaries.”
Question: I’ve formed my nonprofit entity and want to open a bank account in the name of the entity. Will my bank refuse to open an account because the business is growing and selling medical marijuana?
Answer: Maybe. If your entity has the word “marijuana” in its name, you may be dead in the water with many banks. Unfortunately, many banks and credit unions refuse to do business with a medical marijuana business. You may have to search to find a bank that is willing to open an account for your medical marijuana business.
In a May 20, 2010, letter six members of the U.S. House of Representatives asked Treasury Secretary Geithner to help solve the problem of banks refusing to do business with state legal medical marijuana businesses. The letter states:
“dispensary operators are finding it increasingly difficult to maintain accounts with financial institutions, due to what a spokesman for Chase bank called, ‘financial operational and compliance risk.’ Thus, it seems clear that legitimate state-legal businesses are being denied access to banking services, which does not serve the public interest. Among other concerns, the effects of this denial of service include: (1) an increased risk to public safety with potential theft or robbery that any cash-only or cash-reliant business faces; (2) a decreased likelihood that medical marijuana vendors will have the ability to accurately account for tax liability; and (3) an affront to fundamental fairness. since forcing businesses to operate with cash exposes the owners to greater legal risk under the Bank Secrecy Act.
we respectfully request that your office issue formal written guidance for financial institutions assuring that Department priorities do not include targeting or pursuing institutions whose account holders are involved in a business ostensibly operating in compliance with a state medical marijuana law.”
In a July 30, 2010 letter to Congresswoman Zoe Loftgren, the Office of the Comptroller of the Currency, Office of Thrift Supervision, Office of Thrift Supervision, National Credit Union Administration responded to the May 20, 2010, letter to Secretary Geithner and politely said the equivalent of the federal government couldn’t care less. Here’s the conclusion reached in the letter:
“The decision to open, close or refuse a particular account or relationship should be made by a depository institution without involvement by its supervisor. An institution must make its own assessment of whether or not to accept an account based on its business objectives, an evaluation of the risks associated with offering particular products or services to customers or members, as well as its capacity to effectively manage those risks.”
Question: What are Bylaws & Must My Dispensary Adopt Bylaws?
Answer: Black’s law dictionary defines Bylaws as “a rule or administrative provision adopted by an organization for its internal governance and its external dealings.” Bylaws have traditionally been a set of rules adopted by the Board of Directors of a corporation to govern the internal affairs of the corporation. In fact, Arizona Revised Statutes Section 10-3206 requires all Arizona nonprofit corporations to have Bylaws.
Arizona enacted its limited liability company laws in 1992, but nothing in the Arizona LLC Act refers to Bylaws or requires Arizona LLCs to adopt Bylaws. As a result, Arizona LLCs that have Bylaws are exceptions to the general rule that Arizona LLCs do not have Bylaws. The Operating Agreement is the Arizona LLC’s governing document that replaces corporate Bylaws. Because the most commonly formed entity in Arizona today is the LLC, and because many people who seek to obtain a license to own and operate an Arizona medical marijuana dispensary may form an Arizona LLC for that purpose, the question is does an LLC that seeks a license to own and dispensary need to adopt Bylaws?
The answer to that questions is Yes! Arizona Revised Statutes Section 36-2806.A states: “The Bylaws of a registered nonprofit medical marijuana dispensary shall contain such provisions relative to the disposition of revenues and receipts to establish and maintain its nonprofit character.” The rules of the Arizona Department of Health Services also require Bylaws and that the Bylaws contain certain provisions. Therefor, the law requires the dispensary to have Bylaws so you must make sure your nonprofit entity adopts ADHS acceptable Bylaws.
Question: Must an Arizona Medical Marijuana Dispensary be a Nonprofit Corporation?
Answer: Apparently not! Although the text of Proposition 203 says that an Arizona medical marijuana dispensary must be a ““a not-for-profit entity that acquires, possesses, cultivates, manufactures, delivers, transfers, transports, supplies, sells or dispenses marijuana or related supplies and educational materials to cardholders,” and it refers to Bylaws (a corporate governing document), officers (typically associated with corporations) and directors (exclusively associated with corporations), the Arizona Department of Health Services expanded the definition of not-for-profit entity to include types of entities in addition to corporations.
The December 17, 2010, first draft of the proposed DHS rules states that an “Entity means a person as defined in A.R.S. § 1-215.” Section 1-215 says that “Person” includes a corporation, company, partnership, firm, association or society, as well as a natural person.” Since an Arizona limited liability company is a company, DHS apparently will allow LLCs to own dispensaries unless it changes the rules to eliminate LLCs. Here is an additional provision in the first draft of the rules that sanctions the use of a limited liability company:
“R9-17-301. Individuals to Act for a Dispensary Regarding Requirements. When a dispensary is required by this Article to provide information on or sign documents or ensure actions are taken, the following shall comply with the requirement on behalf of the dispensary: . . . 4. If the dispensary is a limited liability company, a manager or, if the limited liability company does not have a manager, a member of the limited liability company”
As an Arizona business and entity formation attorney who has formed over 2,800 Arizona entities, I am surprised, but very glad that DHS is not requiring that people form Arizona nonprofit corporations to own and operate medical marijuana dispensaries. The only type of entity that is specifically recognized under Arizona as a nonprofit entity is the Arizona nonprofit corporation. The big problem with an Arizona nonprofit corporation is that it does not have any owners. It simply would not be right for the government to require people to spend substantial amounts of time and invest large amounts of money into a nonprofit corporation that does not have any owners.
If you want more background and analysis of this nonprofit entity issue, read my article called “Arizona Proposition 203 – Legalization of Medical Marijuana.”
Arizona Medical Marijuana Dispensaries Should be Arizona Limited Liability Companies
My recommendation is that all entities that seek to obtain a license to operate an Arizona medical marijuana dispensary be Arizona limited liability companies. People who have already formed an Arizona nonprofit corporation with the intent to have it obtain the license should put the corporation on the shelf and form a new Arizona LLC to be the nonprofit entity that seeks and obtains the license.
I would love to form your Arizona LLC that will own and operate a medical marijuana dispensary. My fee is $1,599, which includes the all important nonprofit LLC Bylaws. See my articles called “Why Every Arizona Medical Marijuana Dispensary Must Have a Buy Sell Agreement,” “Bylaws – We Don’t Need No Stinking Bylaws or Do We?” and “Bylaws for Arizona Medical Marijuana Dispensaries.”
Question: Must My Nonprofit Arizona Medical Marijuana Dispensary Be a Federal Tax-exempt Organization?
Answer: No and thankfully no! Arizona Revised Statutes Section 36-2806.A states: “A registered nonprofit medical marijuana dispensary need not be recognized as tax-exempt by the Internal Revenue Service.” If Proposition 203 required dispensaries to become tax-exempt organizations, the IRS would deny every application because it would not allow any business engaged in violating federal law to become exempt from federal income taxes. In addition, even if it were possible for a dispensary to obtain a tax exemption, the consequences would be disastrous for most dispensaries. Tax-exempt organizations are prohibited from paying excess benefits to owners, directors, officers and insiders. If excess benefits are paid, the tax penalties are severe – 100% of the excess benefit PER YEAR since the payment until the penalty is paid in full.