The cannabis industry has traditionally relied on handshake agreements in favor of written agreements. The reason for this is that the advice from criminal defense attorneys, prior to legalization, was to avoid paperwork which could assist law enforcement in prosecutions.
Times have changed with a majority of state allowing some form of cannabis and every third state permitting recreational sales of cannabis to adults.
The following are some of the more compelling reasons why cannabis companies need to adopt an everything in writing mindset.
IRS audits
As recent MJ Biz Daily reporting has shown, the IRS is targeting the cannabis industry for audits because it is very profitable for them to do so. The IRS has playbooks developed to extract as much useful information from cannabis owners before they have hired an attorney to represent them.
Moreover, many of the recent tax court cases have shown that cannabis companies that lack evidence or supporting documentation for their tax returns will get severely punished.
In addition to financial documentation, cannabis companies should have clear written agreements with industry partners and vendors. These agreements should include detailed cost breakdowns that can be used to defend the information provided to the IRS on a tax return.
Regulatory inspections
Most state and local regulatory agencies have the right to inspect a licensed entities’ premises and request copies of relevant agreements.
Knowing that a regulatory inspection is an inevitability should, but often does not, motivate companies to document their industry relationships in writing.
Companies need to have the agreement in writing with all of the key terms laid out either in the body of the agreement, or as an exhibit. The agreement should make clear who is handling the money, how profits are divided, and who has control over various operational functions.
As a side benefit, these written agreements will be central to the diligence information provided to a potential buyer upon a sale of the business.
Disputes: internal and external
Recent headlines and our client experiences have shown us that there are a large number of disputes within the cannabis industry both between owners and with industry partners.
Many of these disputes could have been mitigated or reduced if the parties had taken the time to use a clear and detailed agreement.
Internal disputes often center on the value of the contribution that one partner was supposed to make to the entity in question. If the actual value of the contribution is materially different from what was “agreed to” then there is a good chance of a dispute arising.
Disputes with industry partners are frequently based on the alleged responsibilities of one or both of the parties. The disputes are the result of miscommunication between the two sides.
Most of these situations could have been avoided by taking the time to prepare a clear written agreement that specifies what each party must do under the contract.