Cannabis Leases: Important Considerations for Commercial Property Owners, Landlords and Tenants

As Connecticut awards provisional licenses to various types of cannabis establishments throughout the state, cannabis business owners, commercial real estate owners and prospective commercial real estate investors must consider several factors unique to this highly regulated industry. The following are some of the key considerations for negotiating a cannabis establishment lease.

• Understand the local zoning regulations. Although cannabis is now legal in Connecticut, local towns and cities have implemented a wide range of differing zoning regulations, restrictions and, in some cases, bans. Under Connecticut General Statutes § 21a-422f, any municipality may, by amendment to its zoning regulations or by local ordinance, (1) prohibit the establishment of a cannabis establishment, (2) establish reasonable restrictions regarding hours and signage, or (3) establish restrictions on the proximity of cannabis establishments to other establishments. Consequently, owners and investors should consider whether the local jurisdiction in which the subject property sits has set space, distance, or other operational requirements for cannabis establishments in order to determine whether the subject premises is suitable for a cannabis tenant. If so, stakeholders should consider any restrictions or regulations pertaining to signage, hours, security and the like in order to ensure that these terms are reflected in any potential lease. Additionally, consider the type of local zoning approval that will be required to operate the cannabis business, along with the time and expense required for such approval. For more information on zoning considerations related to cannabis establishments in Connecticut, please consider this article authored by Shipman lawyers, Chelsea McCallum, Sarah Westby and Joe Williams.
• Understand cannabis laws and regulations in relation to your property (or prospective property). Even if the subject property is located in a cannabis-friendly municipality and complies with zoning regulations, keep in mind that cannabis establishments require enhanced security systems, ventilation systems, screening or fencing and other cannabis-property specific enhancements. In addition, cannabis cultivation operations in particular have high energy demands and cultivation facilities often require remediation. In order to defray costs, landlords and property owners may consider a requirement that the tenant build out the space, either as a wholesale requirement to the lease or through a tenant improvement allowance. In contrast, investors may find vacant properties with existing infrastructure to attract tenants seeking to reduce build-out costs or ramp up operations quickly to meet provisional license deadlines. In Florida, for example, investors have purchased buildings that previously housed banks and converted them into cannabis establishments given the already-secure structure, advanced security systems, existing parking, preferential location and street visibility.
• Understand your financing documents. It is important to understand that most financing documents will either expressly prohibit use of the subject property as a cannabis establishment or will require compliance with applicable local, state and federal laws. Cannabis is still classified as a controlled substance under federal law, and therefore, allowing the property to be used for the purpose of its sale, distribution or otherwise could trigger a default under existing financing documents or prevent one from obtaining future financing; particularly if you are an investor seeking to finance the purchase of a property for this use. Consequently, be sure to consult with your lender and legal counsel and consider any restrictions on the use of the property prior to entering into negotiations. Regardless of whether you need, or currently have, financing, owners and investors will want to consult with their banks to confirm that the bank will accept rent checks from a cannabis establishment. Though there are a handful of banks and credit unions doing business with cannabis establishments in the state, most will not accept accounts for cannabis-related establishments given that cannabis remains federally illegal.
• Understand the tax implications. Landlords, real estate owners and prospective investors must also be mindful that under Section 280E of the Internal Revenue Service’s Tax Code (“280E”), federal tax deductions and credits cannot be taken on gross income derived from a cannabis business. While many experts do not expect 280E to apply to landlords and property owners, it remains a factor to be monitored. Owners and landlords are best advised to mitigate the risks of 280E through tax planning and corporate structuring.

Considerations for Landlords

• Compliance with Applicable Laws and Financing Documents: Consider the inclusion of specific federal law carve-outs and expressly require the tenant to comply with all applicable state and local cannabis laws and regulations. Landlords should take extra care to ensure that cannabis use does not run afoul of their financing documents.

• Use: Confirm whether the applicable municipality permits the use that the tenant is proposing and, if so, identify in the lease those regulations that apply to the particular use (e.g., hours of operation, signage, security requirements). Note that a special permit or other affirmative zoning approval is required for any retailer or micro-cultivator. Additionally, landlords should expressly prohibit on-site consumption in accordance with state law.

• Landlord’s Access: Ensure the landlord’s right to inspect at any time consistent with applicable local cannabis laws. Note, security requirements are far stricter for cannabis tenants than for most other types of tenants, which will result in more limited access rights for landlords and their agents.

• Reformation: Consider allowing for automatic reformation of the subject lease as may be required by any governmental authority or for changes in laws, regulations, or conditions of licensure to allow for flexibility in an uncertain future.
• Environmental Impact: Most leases provide for an expansive definition of “hazardous materials.” Such a broad definition results in the prohibition of many substances commonly used in the operation of a cannabis business (e.g., cannabis waste, byproducts, fertilizer, pesticides, etc.). Clearly outline the types of waste which may be disposed of (which will depend on the type of cannabis business) and provide that the tenant’s business will comply with all applicable disposal procedures under all federal, state, and local environmental regulations.
• Co-Tenancy Issues: In multi-tenanted properties such as shopping centers, be aware of the terms and conditions of all other leases affecting the subject property and their requirements which outright prohibit cannabis establishments or could lead to claims by other tenants of nuisance, for breach of the covenant of quiet enjoyment, rent reduction, or otherwise, particularly due to odors associated with cannabis cultivation and processing.

Considerations for Tenants

• Lease Term: Consider the time and expense necessary to prepare the premises for the tenant’s operations. Additionally, consider the relevant timeline to obtain all licenses and permits. For example, if necessary licenses or permits remain outstanding, the provision regarding the commencement of the lease term should be drafted in a way that acknowledges the realities of the procedural timelines and accounts for these operational prerequisites and potential delays. Consider particular dates related to the commencement of occupancy and/or rent in relation to which building, zoning or other approvals may be outstanding.
• Use: Consider current and future uses which the tenant desires to have permitted at the premises. Each tenant should expressly state the particular type of business it intends to operate at the premises (e.g., retail) and any related uses, and reserve the right to change such use if there is an understanding between the landlord and the tenant as to future expansion.

• Title and Zoning: Take extra care in performing due diligence on the subject property, including performing a title search on the subject property and thoroughly reviewing any and all diligence to ensure no future surprises will disrupt the tenant’s operations. Tenants should take extra care to ensure that cannabis use is in keeping with local zoning regulations.

• Utilities: Consider whether existing utilities are sufficient to meet the energy demands specific to the tenant’s operation and the added cost of those utilities.

• Operating Requirements: Consider the operational realties of the tenant’s cannabis business as opposed to other types of businesses. Tenants may need to revise traditional operational provisions with respect to hours of operation, signage and avoidance of nuisance to conform to the realities of operating a cannabis business, as well as state and local laws. Consider HVAC and ventilation issues that may arise from the operational realities of the cannabis business, particularly if the subject property contains multiple tenants.
• Alterations and Improvements: Consider (i) what structural and non-structural alterations and/or improvements need to be made to the premises to permit and accommodate the planned cannabis use, and (ii) whether future plans will require additional alterations and/or improvements (e.g., if a tenant’s retail use will later expand into cultivation at the same location). Tenants should outline processes for how alterations and/or improvements will be paid for and completed, and how additional alterations and/or improvements may be approved.
• Landlord Access: Consider landlord access rights in the context of applicable security requirements, whether required by state or local law or otherwise. Tenants should clearly specify landlord’s access rights, and establish policies with respect to entry that fully comply with all applicable local and state regulations.

• Insurance: Landlords may require tenants with cannabis-related businesses to maintain levels of insurance that are higher than non-cannabis-related businesses. Prior to execution, tenants should consult with their insurance providers to ensure compliance with all insurance requirements. Additionally, tenants should ensure that their insurance provider is fully aware that insurance is being issued for a cannabis-related business to avoid the possibility of the insurer denying a future claim based on federal illegality.

The provisions pertinent to each cannabis lease will vary due to the different types of establishments, array of local regulations, suitability of the property itself and a collection of other factors unique to each tenant and each landlord or owner’s goals. Commercial real estate owners, investors and landlords considering a cannabis tenant, or seeking information on how to attract cannabis tenants, should contact our Cannabis Team.