The cannabis industry is booming across many U.S. states, but it continues to operate under a complicated legal framework due to its federal illegality. As a result, cannabis companies face unique challenges when drafting and enforcing contracts. While most businesses rely on traditional contract law to protect their interests, cannabis companies must tread more carefully. The intersection between state legality and federal prohibition creates legal gray areas that can render contracts unenforceable—or even void from the outset.
Understanding how to properly structure cannabis contracts is essential to minimize risk and avoid the potentially devastating consequences of contract breaches.
The Legal Dilemma: State-Legal, Federally Illegal
Under the Controlled Substances Act (CSA), cannabis is still classified as a Schedule I substance, meaning it’s federally illegal to cultivate, distribute, or possess it. This poses a major hurdle for cannabis companies trying to enforce agreements in federal court, where judges may decline to enforce contracts that involve an illegal product.
Even when contracts are legal under state law, federal courts may view them as unenforceable due to the doctrine of illegality. In some cases, simply referencing cannabis in the contract could lead a court to rule that the agreement is void because it involves an illegal activity at the federal level.
Cannabis Contract Disputes: 3 Real-World Cases
Here are three real-world examples that illustrate how these legal conflicts can play out in court:
J. Lilly, LLC v. Clearspan Fabric Structures (2019, Oregon)
J. Lilly, a cannabis grower, hired Clearspan to build greenhouses but claimed the structures were defective and sued for breach of contract. Clearspan attempted to move the case to federal court, which then questioned whether it had jurisdiction, given that enforcing the contract could be seen as supporting federally illegal cannabis operations.
Outcome: The court dismissed parts of the complaint under federal law, showing how cannabis-related businesses can be denied legal recourse due to the federal status of the plant.
Green Earth Wellness Center v. Atain Specialty Insurance Co. (2016, Colorado)
Green Earth, a cannabis dispensary, sued its insurer after a theft and a fire damaged its cannabis inventory. The insurer denied the claim, citing federal illegality as justification.
Outcome: The federal court sided with the insurer, noting that because cannabis is illegal federally, the insurance contract—though legal under Colorado law—was problematic at the federal level.
Hammer v. Today’s Health Care II (2018, Arizona)
A former investor sued a cannabis company for failing to repay a loan. The company argued that the contract was unenforceable due to the subject matter—cannabis—being illegal under federal law.
Outcome: The court refused to enforce the contract, stating that the agreement would involve aiding and abetting an illegal act under the CSA.
How Cannabis Companies Should Write Contracts
To protect themselves, cannabis companies must draft contracts with clear, compliant, and protective language. Here’s how to do that:
1nclude State Law Provisions
Clearly state that the contract is subject to and governed by the laws of the state in which the business operates. This won’t guarantee federal enforceability, but it helps establish legal standing in state courts, where judges are more inclined to uphold contracts between licensed cannabis entities.
Example clause:
“This Agreement shall be interpreted and enforced under the laws of the State of [Insert State], without regard to federal law concerning the legality of cannabis.”
Avoid Federal Jurisdiction Triggers
Do not include language that might trigger federal court jurisdiction, such as references to interstate commerce or transactions involving out-of-state entities unless you’re confident your legal team can handle it. Even choosing arbitration or mediation over litigation may reduce exposure to federal scrutiny.
Use Severability and Savings Clauses
A severability clause can prevent the entire contract from being voided if one part is found to be illegal. This is especially important when dealing with cannabis-related clauses.
Example clause:
“If any provision of this Agreement is held to be invalid or unenforceable under applicable law, the remaining provisions shall continue in full force and effect.”
Avoid Explicit Illegal Conduct
Use neutral or generalized terms where possible. For example, instead of explicitly referring to “cannabis distribution,” consider using “regulated business activities” or “products permitted under state law.”
Additional Protections for Cannabis Companies
Beyond the language of the contract itself, there are other precautions cannabis businesses should take:
Work With Cannabis-Savvy Legal Counsel
Work with attorneys experienced in cannabis law. This includes not just contract law, but also regulatory compliance. They’ll help draft contracts that anticipate potential issues and reflect the fast-changing legal environment.
Utilize State Court Jurisdiction
Structure contracts to resolve disputes in state courts where cannabis is legal and courts are more willing to enforce such contracts. Including a forum selection clause can help.
Arbitration and Mediation
Alternative dispute resolution (ADR) mechanisms like arbitration and mediation offer private and more cannabis-friendly forums for dispute resolution. These methods can bypass some of the issues faced in federal courts.
Licensing and Regulatory Compliance
Always ensure your company and any contract counterparties are properly licensed and compliant with local laws. Contracts involving unlicensed operators are more likely to be deemed unenforceable—even in state courts.
Final Thoughts
Writing cannabis contracts is more complex than it is for most other industries. Because of the unique legal risks posed by the plant’s federal status, cannabis businesses need to be extra cautious when formalizing agreements. Understanding how to mitigate federal illegality risks, choosing the right legal language, and seeking expert legal counsel are essential steps to ensure your business contracts are enforceable and protective. In the fast-growing but legally precarious cannabis space, a well-drafted contract isn’t just a best practice—it’s a vital defense.
