In 2013, the Obama administration issued the Cole Memorandum, which called a truce between federal prosecutors and marijuana businesses operating legitimately under state law.  After regime change in Washington, however, it may come as no surprise that Jeff Sessions—the Attorney General who once opined that “good people don’t smoke marijuana”—rescinded the Obama-era guidance.  The only real surprise is that it took him a whole year to do it.

Since at least 2013, marijuana-related businesses have generally been operating on predictable, albeit legally shaky, ground.  Dispensaries have expanded dramatically.  Though details vary wildly, nine states currently allow recreational use and medicinal use is currently permitted under the laws of all but four states.

As a result, commercial real estate lenders have to grapple with the increasingly common problem of the dispensary tenant, and a number of lenders are dipping their toes into lending in expectation of securitizing loans secured in part by dispensaries.  But given the January 2018 announcement that the Cole memo is no longer in effect, the question everyone’s asking is: are things really that different?  The answer, we think, is no—but with an asterisk.

A few points of clarification are necessary.  First: not all financial institutions are created equal.  Banks are subject to direct federal oversight by the FDIC, the OCC, the Federal Reserve and an alphabet soup of other federal agencies.  It’s for this reason that dispensaries haven’t even been able to open accounts with banks.  Even the legal marijuana business is still a cash-only industry (and it looks like that’s not changing anytime soon).  Non-banks are not subject to the same degree of scrutiny, and it’s easier for a non-bank lender to get comfortable with the risks of extending credit to borrowers that accept money from dispensaries. We are not aware of an instance in which a prudentially regulated bank has originated a mortgage loan on a property which includes a dispensary.  The result is that non-bank lenders have a distinct edge in the dispensary space.

Not all tenants are created equal, either.  For example, the risks of lending on a dispensary—where there will be plants and other cannabis products on site—are different from the risks that accompany lending on a property with a tenant that works on the back end (for example, the corporate offices) of a marijuana-related business.  Additionally, some businesses, notwithstanding the fact that they sell products derived from the cannabis plant, may be operating legally even under federal law.  For example, certain synthetic cannabinoids, like dronabinol, are classified as a Schedule III substance (unlike “marihuana,” which is classified as a Schedule I substance).  Additionally, possession and sale of the stalk of the cannabis plant—which is used to produce hemp fibers—is legal under federal law so long as the product has a THC concentration of less than 0.3%.  Businesses which deal in synthetic cannabanoids or “exempt cannabis plant material” within the meaning of the Controlled Substances Act have substantially diminished exposure to enforcement risk.

It should also be noted that, when it comes to dispensaries, enforcement is not the only risk at play.  Loan sellers, issuers and servicers should consider whether there could be reputational risk from lending on a dispensary.  In our experience, the parties have been keenly aware of this risk.  There are also certain risks inherent in lending on a property that derives revenue in part from a cash-only business, which can give rise to auditing difficulties and may require certain unique security considerations.  Additionally, there’s the risk that rent would not be collectible in the event that the tenant or the borrower declares bankruptcy.  Bankruptcy courts have closed their doors to debtors involved in the business of marijuana, and there’s a possibility that a borrower deriving revenues in part from a marijuana-related business could face the same problem.  In fact, in an article published by the American Bankruptcy Institute, the United States Trustee Program expressly took the position that trustees were prohibited from “[collecting] rent from a marijuana business tenant” or otherwise “[seeking] to collect the profits of a marijuana investment.”

If a lender decides the rewards outweigh the risks, it might insist on certain protections.  These have been varied, but have generally included, at the very least, a non-recourse carveout for losses attributable to enforcement actions, as well as covenants that the borrower will comply with any marijuana-related enforcement action.  Particularly risk averse lenders might also consider including a soft or springing lockbox for dispensary loans, thereby minimizing the lender’s exposure to the potentially problematic revenues (though it’s certainly debatable whether this would make any significant difference in terms of enforcement risk).  The lender may also require a covenant that the borrower will not permit an increase in the percentage of the mortgaged real property used as a dispensary, which would preclude the dispensary tenant from expanding both its profile at the property and its share of the property revenue.

When preparing the securitization offering and transactional documents, loan sellers and their counsel should get ahead of any potential issues as soon as they become aware of a marijuana tenant.  The first hurdle is to make sure at the outset of the deal that the issuer, servicers and the B-buyer are comfortable with a marijuana-related business operating at the mortgaged property.  Historically, some issuers have been hesitant to include such loans in their deals, largely for reputational reasons.

CMBS servicers (both master and special) will largely have the same cashiering and foreclosure concerns that lenders do.  We have seen several instances in which a bank has agreed to act as master servicer for a mortgage loan secured in part by a dispensary; however, to our knowledge, no bank has agreed to act as special servicer with respect to such a loan.  One possible inference is that banks are more comfortable accepting cash from a dispensary than operating and taking title to one.

Any investor concerns would likely be voiced by B-buyers who, unlike most public investors, perform robust diligence on the assets and may take the brunt of any losses due to the presence of a marijuana-related operation.  But most B-buyers are not banks, and many invest in specialty properties anyway, in each case reducing the likelihood of any serious objection from the typical B-buyer.  We note, however, that investors with whom we’ve talked frequently caution that they may not be comfortable with a situation where a more significant percentage of revenue is derived from a marijuana-related business, as would be the case with a single-tenant dispensary property or a particularly large loan with a dispensary tenant.

As far as the deal paper goes, loan sellers and their counsel should consider how the presence of a marijuana tenant may affect both rep exceptions and offering document disclosure.  For example, CREFC model reps and warranties #26 (regarding local law compliance) generally requires loan sellers to represent that the mortgaged properties are in material compliance with laws governing the uses of such properties (and model rep #27 requires that the underlying loan documents require as much).  Similarly, model rep #27 (regarding licenses and permits) generally requires loan sellers to represent both that (a) the borrower covenants in the underlying loan documents that it possesses, and will continue to possess, all material licenses, permits, and other approvals necessary to operate the mortgaged property, and (b) all such licenses, permits, and other approvals are in fact in place.  Similar reps appear in every conduit MLPA.

When it comes to offering document disclosure, issuers, as well as the loan sellers and their counsel should ensure that the issue is appropriately disclosed if the presence of a dispensary tenant poses a material risk to the trust.  However, whether or not the presence of a marijuana tenant requires disclosure depends on a number of facts, including the precise nature and extent of the tenant’s operations, the percentage of income the borrower derives from the tenant, and the size of the mortgage loan relative to the entire pool.  As is the case with rep exceptions, the analysis must take into account many factors.

It’s not at all clear how much Sessions’ January pronouncement changed any of this calculus.  Certainly in some technical sense, the risk of lending on dispensaries increased after the policy change, but practically speaking, it seems that the industry received the news with a yawn.  In our experience, the lenders willing to lend on dispensaries under the cover of Cole have not changed their tune now that they find themselves without its protection, and we’ve seen some new entries into the space even after the Cole memo was rescinded.  Perhaps we have FinCEN to thank—after the Cole memo, FinCEN guidance provided that financial institutions were permitted to work with marijuana businesses, subject to certain diligence and filing requirements.  FinCEN has confirmed that, even after the rescinding of the memo, its guidance remains in effect.  And it’s also worth noting that the pronouncement has not deterred so-called “cannabis REITs”—some of which are listed on public exchanges—from acquiring and building portfolios of dispensaries.

There are a couple takeaways here.  First, there’s an inherent degree of risk in lending on properties with marijuana-related tenants.  This risk can be reduced but, unless federal prohibition comes to an end, there’s no way to eliminate it completely.  Enforcement risk is significantly greater for banks than for non-bank lenders, but non-bank financial institutions lending on dispensaries still face some exposure.  If you’re asking “can I do this?”, we can’t give you a straight answer.  Sorry—blame the Feds.  The only real way to answer that question is to determine the degree of your exposure to enforcement and other risks, and to decide how much of that risk you’re comfortable accepting.

Lastly, there is no singular roadmap for how to handle the origination and securitization of dispensary mortgage loans.  Depending on, among other considerations, the type of lending institution, the structure of the mortgage loan, the nature of the operations of the tenant and the opinions of the other players involved, the origination and securitization processes for dispensary loans look a lot different from one loan to the next.  Until federal marijuana prohibition is repealed, dispensaries—and the lenders which originate mortgage loans secured by them—will continue to operate in legal purgatory.