by Dennis Baranowski Geraci Law Firm

by Paul Sievers Geraci Law Firm

Headlines publicizing the Federal Government’s recent crack-down on criminals illegally cultivating cannabis in residential properties in California sent reverberations among non-conventional lenders – temporarily heightening fear about the risks of cannabis lending in the Trump era. A closer look, however, reveals the risks associated with cannabis lending have not increased, but some may argue that they have ebbed. The bigger story is the impact of the crack-down on the non-conventional lenders that were blindsided upon receiving notice that their collateral had been seized by the Department of Justice and is subject to forfeiture.

Earlier this year, hundreds of federal agents swarmed the Sacramento area in a raid on illegal marijuana operations. The agents involved executed search warrants on 74 homes and two businesses suspected of engaging in illegal, both under Federal and California law, marijuana cultivation. The Justice Department simultaneously filed forfeiture actions against more than 100 homes in several Northern California counties.

The investigation, apparently begun in 2014, culminated in a two-day sweep on April 3, which included both federal agents and local police. The raids focused solely on residential homes and businesses operating illegal marijuana-grow farms. The FBI estimates that the value of the properties identified in the forfeiture actions to be around $10 million.

The raids, however, fall well short of the sea change in Federal cannabis policy heralded by many observers. Upon closer examination, the April raid simply reflects a consistent Federal policy targeting only those cannabis businesses operating outside the sanction of state law. Legal cannabis businesses – and borrowers – in regulated states should remain unaffected.

The Department of Justice under Jeff Sessions initially took a tough approach towards enforcement of Federal marijuana laws. In January, the DOJ formally ended an Obama-era policy instructing U.S. Attorneys to not prosecute Federal marijuana crimes in states permitting legal use and where robust regulations were in place. The January announcement appeared to some to signal a change in Federal cannabis policy, opening the door for the criminal prosecution of businesses that operate outside long-standing Federal law. Others felt that the rescission of the Cole Memo was a political tactic aimed at chilling cannabis business investment based on the announcement coming as California began issuing temporary licenses for adult use (commonly known as “recreational use”) cannabis businesses and the lack of a mandate to regional DOJ offices to begin prosecuting cannabis businesses operating legally in states that have passed some level of cannabis reform.

In a move that shocked many, and that was made without consulting Attorney General Sessions, President Trump provided assurances to Senator Cory Gardner (R-CO) that he would promote a new law that would give states the authority to make their own rules regarding cannabis sales and distribution. During the same conversation, which the White House has confirmed, President Trump assured Senator Gardner that the rescission of the Cole Memo “would not impact Colorado’s legal cannabis industry.”

In a statement that was confirmed by the White House, Senator Gardner represented that “President Trump has assured me that he will support a federalism-based legislative solution to fix this states’ rights issue once and for all.
In addition to the apparently favorable stance from President Trump, there have been multiple pieces of legislation introduced in both the House of Representatives and Senate which would limit the amount of Federal interference in states that have legalized cannabis.

As part of the Federal spending bill enacted in March of this year, Congress renewed the Rohrabacher-Blumenauer Amendment, which prohibits the use of Federal funds to prevent states from implementing medical marijuana laws, until September 2018. The Amendment has been attached to the current spending bill being considered by Congress and has wide support across both sides of the aisle.

Finally, a bipartisan group of senators, including Senator Gardner and Elizabeth Warren (D., Mass.) introduced a bill this month called the Marijuana STATES Act that would amend the Federal Controlled Substances Act, which classifies marijuana as a Schedule I narcotic with drugs like heroin, to only apply to marijuana when state law makes the action criminal. Proponents of the STATES Act assert that it will also open up banking to the cannabis industry by clarifying money-laundering statutes.

Given these policy pronouncements at the Federal level, the April raids simply represent the enforcement of Federal drug laws against criminals that are also violating state cannabis laws. Federal law enforcement will respect the various states’ individual decisions concerning the cultivation, distribution and use of marijuana, provided those states regulate what for the present remains a Federal Class I drug and ensure that it does not move beyond the borders of the individual state.

States such as California, have put in place stringent regulations to oversee the cultivation, distribution, and sale of marijuana and related products. However, some businesses have chosen to continue operating in the “gray area,” along with criminal enterprises attempting to capitalize on a growing black market for cheap marijuana.

According to Federal officials, the Sacramento raid targeted a criminal enterprise, claiming it used foreign funds to purchase homes and set up grow operations inside the residences. The FBI stated that the down payments for the grow houses originated in Fujian province, China and that the marijuana was intended for distribution outside of California, with most destined for the East Coast.

A single realtor facilitated the purchase of 85% of the properties involved in the raid, utilizing a series of legitimate non-conventional loans to fund the acquisitions. Upon closing, the criminal enterprise converted the homes into high-tech marijuana grow factories. The months-long investigation focused on Chinese nationals, acting as “straw man” buyers for the enterprise, buying homes in seven Northern California counties. Authorities said that all the “straw men” were in the country legally, with residential addresses in states as far away as Illinois, Georgia, Ohio, Pennsylvania, and New York.

The criminals operating the illegal grow houses failed to comply with both California state and local laws, including operating without a license, growing more plants than the legal limit, and growing in areas not approved for cultivation, as well as Federal law.

The Federal Government raid presents three major take-aways for non-conventional lenders operating, or interested in operating, in the cannabis space. First, the nature and target of the raid indicates that cannabis lenders, provided they are lending to legitimate borrowers in compliance with state law, have little apparent risk from Federal authorities during the Trump era. As indicated, the raid targeted a criminal enterprise engaged in conduct clearly outside the California regulatory scheme.

Second, the criminal scheme and resulting raid highlights the importance of proper loan underwriting and origination to avoid being victimized by criminal conduct – not just illegal cannabis growing. At a recent conference, a representative of one of the major national title insurers indicated that most claims asserted against the company arise out of loan or real estate fraud. Verifying borrower information, verifying deposits and other simple safeguards reduce the risk of lending to a criminal enterprise, regardless of the nature of the criminal conduct. In this respect, cannabis lending is no different from non-cannabis lending.

Finally, and thankfully, the lenders victimized by the enterprise’s scheme are not without protection. The DOJ has adopted an expedited settlement procedure that permits innocent lenders to recover their principal, note interest and some other loan charges.

While the arrests and seizures sent shockwaves throughout the non-conventional lending community, those shockwaves should not deter prudent lenders from pursuing larger yields in what is certainly a viable and state-sanctioned industry. The specifics of the raid, however, particularly the fact that the conduct of the enterprise was criminal under both Federal and state law, should remind lenders that while the cannabis space may be relatively safe, actors in and outside the space may not be.

Dennis Baranowski is the Vice-Chair of the Banking and Finance group at Geraci LLP. He has extensive experience in helping banks, credit unions, mortgage funds, private lenders, brokers, developers, and loan servicers navigate through complex transactions, including negotiation of terms, transaction review, and drafting of documents. He developed and manages Geraci’s cannabis lending and compliance practice and has regularly presented on cannabis lending, as well as had articles on the topic published in national trade publications. Mr. Baranowski believes in dedicated, constant communication, and providing swift, custom, effective, and efficient solutions to client problems. He understands that his role is not to stand in the way of a transaction, but to be a trusted guide in all lending matters.

Paul Sievers’ diverse practice focuses on helping clients find practical and cost-effective solutions to complicated business disputes and transactions. His practice also extends to representations before the Federal and State Appellate Courts. Mr. Sievers brings to bear nearly twenty-five years of litigation, appellate and transactional experience gleaned in diverse settings, but he specializes in representing and counseling insurance policy holders, parties in commercial litigation and transactions, and real estate owners, lenders and lessees in both transactional and litigation representations. He has developed considerable experience in the coverages available under all types of insurance policies, real estate title issues, including title insurance, appellate practice, and lending secured by both real and personal property.

Mr. Sievers works with a diverse spectrum of clients, both large and small, in industries ranging from real estate development to business finance to e-commerce. His clients have included institutional lenders, landlords, developers, bankruptcy trustees, building tradesmen, financial brokers, directors and officers of corporations, and manufacturers and distributors of goods.

Mr. Sievers is a former Chairman of the Insurance Law Section of the Orange County Bar. He has spoken at continuing legal education programs on insurance, insolvency, ethics and various litigation topics.