Wednesday, January 15, 2014
Businesses are built on contracts. Consider a mom and pop grocer. It will have a lease agreement with its landlord, purchase agreements with the firms that supply its food, and loan agreements with the investors who provide financing for equipment, inventory, etc. We take it for granted that such contracts are enforceable. For example, if the grocer fails to make timely loan payments, we know its lenders can sue for breach. And if the court adjudicates in their favor, the state will use its coercive power to help the lenders recoup their principal and unpaid interest against the delinquent borrower.
But what if those contracts are not enforceable? That’s a very real possibility now confronting parties doing business with the marijuana industry in Colorado and elsewhere. In at least one recent decision, a state court has refused to enforce loan agreements between two investors and a retail medical marijuana shop operating in Colorado. Under the agreements, the investors provided $500,000 to finance the shop’s sale and distribution of marijuana in Colorado, for which the shop promised to pay 12% interest annually. When the shop failed to make those payments on time, the investors sued to recoup their principal and unpaid interest in an Arizona state court. But the court balked. Noting that the sale of marijuana remains illegal under federal law, and reflexively citing a contract doctrine that discourages enforcement of contracts against public policy, the court dismissed the investors’ lawsuit. It essentially allowed the marijuana shop to walk away with $500,000 of the investor’s money. Ouch. (The opinion and some analysis of the case can be found here.)
I’m no contracts scholar, but I have some doubts about the court’s rather superficial and cursory analysis of contracts doctrine (the opinion runs all of three pages). The late Allan Farnsworth’s venerable Contracts treatise suggests that contracts against public policy are not per se void, and that a court needs to engage in a more nuanced balancing of interests before refusing to enforce one. In particular, Farnsworth instructs courts to consider the strength of the public policy involved and the justified expectations of the parties. And on the basis of such factors, the Arizona court’s decision appears unsound. For one thing, it’s not clear the agreement is against a relevant public policy. After all, both Arizona and Colorado have legalized medical marijuana, and it’s not obvious to me why their policy interests should be passed over in favor of Congress’s, at least as a matter of contract law. What’s more, it seems likely all parties expected their agreement would be enforced. The only factor that suggests otherwise is the rather high rate of interest involved, which might have reflected awareness that the agreement entailed unusual risks, including perhaps the risk of non-enforcement. But at the very least, the court should have done a better job justifying its decision to let the shop walk away with someone else’s $500,000.
Even if the court erred as a matter of contract law, however, there might be a sounder basis on which to bar enforcement of these agreements: preemption. The investors in this case were asking the state to help them violate federal law. Whether or not this offends contracts principles, it likely offends the Supremacy Clause. As I mentioned in my post Monday, Congress has the constitutional authority to block all state interference with the private market, including, in a case like this, a state’s intervention in a contract dispute between two private parties. To be sure, as I’ve explained in more detail elsewhere, Congress might not want to preempt enforcement of all contracts involving the marijuana industry. But its unlikely to tolerate enforcement of at least some types of contracts. Suppose, for example, that the shop had sued its landlord for wrongful eviction. If the court ordered the landlord to reinstate the shop to its premises, it would force the landlord to violate a provision of federal law making it a crime to rent property to drug dealers.
In sum, caveat contractor.
In my next post, I’ll discuss what parties can do to adapt to this legal predicament.