A fundamental rule of contract law is that “illegal” contracts are not enforceable. But what constitutes an “illegal contract”? Generally speaking, an illegal contract is one where the performance of the contract results in an illegal act. Illegal contracts are considered “void and unenforceable,” meaning neither party can sue the other party for nonperformance of the contract.
What if a tenant enters into a commercial lease that contemplates illegal activities by the tenant on the property? This is the situation for many tenants who are leasing property for cannabis operations. In many cases, the activity may be properly licensed and permitted under state recreational marijuana laws, but the activity is illegal under federal law (such as the Controlled Substances Act). A recent Arizona Court of Appeals case addressed this issue directly.
In Green Cross Medical, Inc. v. Gally (April, 2017), the landlord and tenant entered into a lease agreement for the tenant to operate a medical marijuana dispensary. Less than two weeks after entering into the lease, the tenant received a letter from the landlord’s attorney stating the lease was being revoked. In response, the tenant filed a breach of contract complaint against the landlord seeking damages, and also sought injunctive relief to prevent the landlord from terminating the lease. The landlord responded by arguing the lease was illegal, and therefore unenforceable.
The court reviewed the issue of illegality under state and federal law to determine whether the lease was enforceable. The court first reviewed the Arizona Medical Marijuana Act (AMMA) and concluded that the lease of property to a medical marijuana dispensary that is in compliance with the AMMA is not illegal under Arizona law.
The court then reviewed whether the lease was illegal under federal law, specifically the Controlled Substances Act (CSA). The CSA makes it illegal to lease property knowing it will be used for the illegal production or distribution of controlled substances. The court concluded that the lease should not be void simply because it violated the CSA. The court reasoned, in part, that voiding leases relating to property used for marijuana dispensaries could lead to unjust enrichment or “an unconscionable windfall” for the person who breaches the lease:
“To allow a landlord carte blanche to void the lease simply because it might violate the CSA, even though the landlord knew the proposed use of the land when he entered into the lease, would undermine the sanctity of contracts and leave a dispensary without a remedy for any monetary losses caused by the breach. Conversely, it would allow lessees to breach leases when it suited their needs to relocate.”
While each state has its own case precedents for when a contract is considered illegal and unenforceable, marijuana operators in Arizona can take some comfort that the lease in this case was upheld.
Warning Regarding Federal Law: The possession, distribution, and manufacturing of marijuana is illegal under federal law, regardless of state law which may, in some jurisdictions, decriminalize such activity under certain circumstances. Penalties for violating federal drug laws are very serious. For example, a conviction on a charge of conspiracy to sell drugs carries a mandatory minimum prison term of five years for a first offense and, depending on the quantity of marijuana involved, the fine for such a conviction could be as high as $10 million. In addition, the federal government may seize, and seek the civil forfeiture of, the real or personal property used to facilitate the sale of marijuana as well as the money or other proceeds from the sale. Although the U.S. Department of Justice (DOJ) recently rescinded its guidance regarding prioritization of criminal prosecutions of individuals and entities operating in compliance with effective state regulatory systems, DOJ left in place long standing guidance to federal prosecutors regarding how to exercise this discretion. Individuals and companies are cautioned to consult with experienced attorneys regarding their exposure to potential criminal prosecution before establishing business operations in reliance upon the passage of state laws which may decriminalize such activity. Federal authority to prosecute violations of federal law as crimes or through seizures and forfeiture actions is not diminished by state law. Indeed, due to the federal government’s jurisdiction over interstate commerce, when businesses provide services to marijuana producers, processors or distributors located in multiple states, they potentially face a higher level of scrutiny from federal authorities than do their customers with local operations.
Since its founding in 1966, Garvey Schubert Barer has counseled clients across a broad range of industry sectors. Our attorneys have deep bench experience and significant expertise in both complex legal and business matters. We value innovation and entrepreneurship, and closely monitor industry trends. It is with these values in mind that our firm established the cannabis industry group. Read More ›