Employers in Cannabis - Legislation and the Market's Response

October 11, 2019 | PublicationClient Alert

While the Agriculture Improvement Act of 2018 (2018 Farm Bill) generally legalized the commercial production, distribution, and sale of hemp and that change in the law has correlated with the rise in consumer products containing cannabidiol (CBD) (more on that in our previous alert here), as you’re likely aware, the 2018 Farm Bill did not have an impact on the legality of products containing more than 0.3 percent tetrahydrocannabinol (THC). Outside of the now-exempted hemp, cannabis remains a Schedule I substance, as defined in the Controlled Substances Act (CSA), Title II of the Comprehensive Drug Abuse Prevention and Control Act of 1970.

With the number of states legalizing, at a state level, varying uses (medical or recreational) of CBD and THC continues to rise (with 33 states permitting some use of THC), this disconnect in treatment at the federal and state levels remains a point of complication for employers in the cannabis industry. While the federal government taking a hands-off approach to regulation, there are still some MAJOR challenges.

Consider the following hypothetical:

“Can Do Cannabis” was founded in 2018 and sells a variety of CBD and THC products throughout California. Its innovative model has been widely successful and it predicts that by the end of 2019 it will have upwards of 30 locations and 500 employees. With this expansive growth, Can Do begins to professionalize its “back office” capabilities and hires a team of three seasoned HR/benefits professionals to assist the lone HR generalist who has been handling all basic HR (including recruiting and running payroll off an archaic excel spreadsheet).

The HR trio undertakes a review of compliance to date and want to think strategically about attracting and retaining talent in this highly competitive space. First stop, state law compliance. Well, good news. California, like many states that have chosen to legalize recreational cannabis, has published resources dedicated to the Cannabis industry.

Next, the team wants to outsource payroll and calls the major payroll providers that you know by name. The response they get – “no thank you.” Why, you ask, would a payroll provider pass on this opportunity to capture this new business?

First off, it’s complicated. Section 280E of the Internal Revenue Code of 1986, as amended (the IRC) forbids businesses from deducting otherwise ordinary business expenses (like from gross income associated with the “trafficking” of Schedule I or II substances, as defined by the Controlled Substances Act). So, there’s that.

Then, there’s the interaction of payroll with a bank (perhaps the payroll organization is even related to a bank) which implicates the Federal Deposit Insurance Corporation (FDIC). The involvement of the FDIC – a federally created agency – causes banks to fear possible financial and/or criminal repercussions for aiding cannabis companies. In an oversimplified manner, this has caused many cannabis companies to be “cash only” or cash-dominated. Even IN PAYROLL!

Thus, the payroll company passes and the excel spreadsheet headache may continue – unless there is an alternative. More on that below.

Finally, our HR trio does some peer company research and finds that similar sized entities almost always offers a robust benefits package. Thus, they’re seeking to expand the benefits offering (beyond cash wages and cash bonuses) to include equity incentives and a 401(k) plan (maybe even with a match or profit share) as the next best step. Again, a call to the major benefit plan services providers is the first stop. Again, things are off to a great start – that is until the cannabis industry is disclosed. You guessed it – the financial institution connection causes hesitation to get involved with cannabis.

The answer? Well, legislation is making its way through Congress that could provide some portion of an answer. This legislation, called the Secure and Fair Enforcement (SAFE) Banking Act, overwhelming made it through the House of Representative late last month. The SAFE Act, if it is passed by the Senate would serve to protect financial institutions in states that have legalized cannabis use that want to offer basic banking services to cannabis businesses.

Unless and until the legislative answer arises, there may be other options. Smaller players in the human resources, payroll, and benefits arena saw the opening in the market – those entities rejected by the established players – and capitalized. Without a doubt, the cannabis-specific offerings may come at a premium cost and may require signature of certain service provider favorable provisions (including as it relates to violations of the CSA or federal banking laws), but may be the best current choice for cannabis employers. Careful vetting of these new players in the market, or to those new to cannabis, will be of paramount importance. Service agreements should be negotiated with precision.

So, what will Can Do do? High time we find out.

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