Struggling Cannabis Cos. Look To Force Majeure Amid Virus

By Diana Novak Jones
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Law360 (April 28, 2020, 11:37 AM EDT) -- The cannabis industry was among the earliest to see a contract suit leaning on a force majeure clause due to the coronavirus pandemic, and experts say there are almost certainly more on the way.

But the financial problems that have dogged cannabis over the last year might make it so even a pandemic isn't enough for these businesses to use the contract trapdoor meant for unforeseen catastrophes, lawyers told Law360.

Force majeure clauses excuse a party to a contract from its obligations if certain circumstances arise that make its participation impossible. That typically means some sort of act of God — something largely unexpected or unpredictable.

And as the country's economy is ravaged by virus-related closures and shutdowns, businesses in every industry are checking their contracts to see if the virus will trigger these escape hatches in the fine print. Cannabis companies, which have already been using the courts to hash out contract disputes in increasing numbers, are among them.

Those claims could fall apart if the company was struggling going into the virus crisis, which was the case for many cannabis businesses.

"Many in the cannabis industry were not thriving before the COVID-19 pandemic," said Whitt Steineker, co-chair of Bradley Arant Boult Cummings LLP's cannabis industry team. "It may be possible that an act of God is happening, but that's not the reason you couldn't perform."

Unusual Circumstances

A force majeure claim tied to the coronavirus made its first appearance in the cannabis space on March 23, when Kentucky hemp company Third Wave Farms sued to get out of a contract with Oregon CBD processor Pure Valley Solutions.

Third Wave was supposed to act as a broker for CBD oil Pure Valley made, but problems popped up with Third Wave's financing and Pure Valley's manufacturing, the suit claims. And then the coronavirus hit, the suit says.

Third Wave "requests that the court declare that the agreement is not enforceable or should be appropriately terminated and/or rescinded pursuant to Section 4.3 force majeure of the agreement in light of the spread of the coronavirus and the state of emergency declared in Kentucky by Gov. Andy Beshear's executive order ... and under similarly applicable executive order(s) by the governor in the state of Oregon," the company said in the suit.

While many of the contracts in the cannabis space started out as handshake agreements, these days most involve lawyers. So it's not unusual that a cannabis contract would have a force majeure clause, according to Lauren Rudick, a co-founder of Hiller PC's cannabis practice.

Regulations might shift after a contract is signed, making a product no longer sellable, Rudick said. Some businesses, like vape cartridge manufacturers, rely on Chinese materials, so they have to anticipate disruptions in the global supply chain, she said.

And in some parts of the country, cannabis businesses need to be conscious of the risk of fires or floods, Rudick said.

"The cannabis industry should be ready for this," she said.

Just having a force majeure clause doesn't mean someone can automatically escape from their contract. Anyone considering implicating the clause in light of the virus should be prepared for battle over whether it actually applies, according to Tracy Gallegos, a partner in Duane Morris LLP's cannabis industry group.

Many clauses use general language about a broad number of situations, which will lead to arguments over what was and was not included, and whether or not it could have been foreseen and mitigated in some way. But if it specifically mentions a pandemic, it's going to be hard to argue it doesn't apply to COVID-19, she said.

For contracts she's working on now, Gallegos said she's careful to ensure the clauses reference COVID-19 or something like it.

"For deals we're negotiating, we've revised [the force majeure clause] to say 'pandemic,'" she said. "We've also included related things [like] closures, stay-at-home orders," she said.

But it's also not clear how judges will react — in particular, whether they'll decide that the pandemic was in some way foreseeable, Steineker of Bradley Arant pointed out.

Most of the time, claims brought under a force majeure clause are frivolous, he said, so courts are pretty skeptical when they get brought up.

"I don't know that we're going to see the answer of how the law plays out for a while now," he said.

Contract Fights on the Horizon

Breach of contract suits involving cannabis business partnerships gone bad are becoming an everyday occurrence. It's part of the maturation of the industry, which has many businesses fighting each other for a chance at survival, Steineker said.

"Not everybody in the industry is doing all that well, and when people aren't doing well they tend to fight," Steineker said.

But the problems surrounding cannabis companies could mean that even if a contract's force majeure clause survives the gauntlet of caveats, it won't be a get-out-of-jail-free card.

That's because the state of the business going into the pandemic matters, attorneys said. If it was doing poorly and likely could not have met its obligations under the contract anyway, the fact a pandemic happened isn't really relevant.

"These things end up being extremely fact-intensive," he said. "What exactly happened that made it impossible for you to perform? Was there this act of God, was that the cause? Or was it one of the 30 other business considerations?"

And it's not enough to show that the pandemic has made the economic terms of the contract unfavorable, Gallegos added. A company attempting to use a force majeure clause has to show that its inability to perform is "directly attributable to the unforeseen event," and that it tried to mitigate the event's impact, she said.

If the company was failing before the virus hit, "invoking force majeure now as a result of the pandemic is likely not going to be successful," she said.

--Editing by Rebecca Flanagan and Marygrace Murphy.

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