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Using International Arbitration To Settle Cannabis Industry Disputes

By Ramsey Schultz
April 13, 2023

Using International Arbitration To Settle Cannabis Industry Disputes

By Ramsey Schultz
April 13, 2023

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As continued legalization of cannabis across jurisdictions in the U.S. and foreign countries causes the industry to become increasingly lucrative, determining proper avenues for dispute resolution controlling underlying agreements and investments has become a critical consideration for business owners and foreign investors alike.

Foreign investment in businesses involving cannabis is subject to a complex web of oversight that could include any combination of local and foreign laws, agreements, regulations and practices.

Many foreign investors in the cannabis industry have turned to international arbitration as a method for navigating these complexities and resolving disputes that may arise from such investments and business relationships.

This analysis explores high-level considerations for foreign investors in the cannabis industry when assessing the viability of arbitration as a means for dispute resolution.

A preliminary consideration for investors contemplating foreign investment into the cannabis industry is whether such investments are governed by any applicable international investment agreements that may grant foreign investors certain protections, benefits and forms of recourse through investor-state dispute settlement.

One such investment agreement involving the U.S. is the North American Free Trade Agreement. NAFTA was replaced by the United States-Mexico-Canada Agreement on July 1, 2020, providing a three-year sunset period during which North American investors can still obtain certain investment protections.

Beginning July 1, 2023, investors in these locations seeking to bring claims forward under international investment agreement terms will need to comply with the terms of the USMCA, which may significantly affect available recourse for investors through substantive and procedural limitations that did not exist under NAFTA.

For example, investment arbitration will no longer be available under the USMCA for claims involving Canada, aggrieved investors will need to exhaust local remedies in the national court of the host state before resorting to international arbitration, and certain substantive claims for items such as indirect expropriation may no longer be arbitrated under the USMCA.

Notably, many of these limitations do not apply to investors with a covered government contract. Investors intending to bring future claims forward under international investment agreements — whether it be the USMCA or any other applicable agreement — and investor-state dispute settlement, will need to carefully consider the rights, limitations and available forms of recourse set out in the specific language of each agreement.

Where arbitration is not included, or is specifically excluded as an available form of recourse under an international investment agreement, investors may consider structuring investments to provide contractual or other remedies.

For private investments between business owners and investors that are not governed by international investment agreements, dispute resolution may be primarily governed by the terms of any applicable agreement between the parties.

This gives investors the opportunity to choose the form of dispute resolution, deciding parties, applicable law and other factors by way of the agreement.

For effective implementation of these dispute resolution provisions in the case of foreign investments, business owners and investors should carefully craft each of these provisions to fully cover the terms of any potential disputes that may arise. The importance of including a carefully-crafted dispute resolution provision in foreign investment agreements is especially significant for investments involving cannabis-related industries.

Cannabis litigation is often dismissed without proper resolution due to the complexities of determining the forum and choice of law governing these claims, and the inability of many judges to issue and enforce binding decisions involving conduct with questionable legality.

While some states in the U.S. — including California — are working toward the possibility of interstate cannabis agreements that could facilitate certain investments, issues of competing cannabis laws in different states and countries continue to create barriers to effective litigation.

For example, in Sensoria LLC v. Kaweske, in 2022, the U.S. District Court for the District of Colorado refused to enforce a contract formed pursuant to Colorado state law for a cannabis business, holding that "the Court may not vindicate equity in or award profits from a business that grows, processes, and sells marijuana" due to proposed relief that would endorse violating the Controlled Substances Act.

While some courts across Colorado, California, Arizona and Texas appear to have enforced cannabis-related contracts despite illegality arguments, the risks of enforcement of a contract being precluded by illegality concerns are high in U.S.-based cannabis litigation. Similar risks may exist under the applicable laws governing cannabis in foreign countries.

Arbitration, by contrast, offers business owners and investors the opportunity to privately resolve disputes and to choose the law that will govern such claims.

Where an enforceable arbitration clause governing an investment agreement exists, an arbitrator or arbitration panel will serve to issue decisions on any claims that arise thereunder. Parties are free to select the applicable laws governing the arbitration of such claims, meaning that parties can intentionally avoid thorny precedent from jurisdictions that are unfriendly to the cannabis industry by being deliberate in their selection of the applicable jurisdiction's laws that will apply.

Arbitrators can thus issue decisions based on the terms that have been agreed upon by the parties making the investments, instead of on competing laws from different jurisdictions a claim might otherwise be subject to.

The American Arbitration Association includes cannabis-related disputes as one of its practice areas, reporting that over 100 cannabis-related disputes were filed with the AAA within the last five years.

The AAA defines these disputes as business disputes, which can be "commercial, construction, or real estate disputes; domestic or international ones."

The AAA's self-reported caseload lists — among others — disputes involving joint venture agreements, purchase/sale agreements, breach of contract, profit-sharing agreements and shareholder settlement agreements, all of which may potentially arise in the case of foreign investment into cannabis-related businesses.

The AAA has a designated Cannabis Industry Panel for arbitrating such disputes, and stresses the importance of inserting a well-written dispute resolution clause into contracts between parties to ensure a fair, timely, cost-efficient dispute resolution process.

Other arbitration organizations, such as JAMS, have similarly provided the opportunity to arbitrate disputes arising from claims involving cannabis-related industries.

While many of the disputes arbitrated in the U.S. involve business partnerships, consulting agreements, or investing relationships that occur within the U.S., this also presents a potential forum for claims arising under agreements involving foreign investments or business relationships, subject to general considerations involving international investments.

In any instance where private arbitration is chosen as a means for dispute resolution, business owners and investors must take care to ensure that the terms of any corresponding agreement provide the language necessary to properly resolve such disputes. For investments involving cannabis-related industries, special consideration should be given to the choice of law and seat of arbitration to ensure that the law and the seat are friendly to the cannabis industry.

This is especially important for enforcement purposes in any applicable jurisdiction. The challenges of enforcing an arbitration award in the industry once it has been granted should not be understated.

Some jurisdictions take the default position that there are public policy concerns with enforcing a contract tainted with illegality, introducing a degree of uncertainty whether awards granted under arbitration proceedings will be enforceable in a jurisdiction where cannabis is deemed illegal.

This creates a balancing act of priorities that could involve myriad complicated public policy issues. In the U.S., further complexities arise due to conflicts between state and federal law where federal law may be necessary as an enforcement tool.

An example of competing priorities arising in certain U.S. jurisdictions is found under the New York Convention.

Under the New York Convention, state courts are faced with the tension between the need to ensure respect for the finality of an international arbitration award and the need to ensure respect for legitimate public policy concerns.

By contrast, in 2019's Williams v. Eaze Solutions Inc., the U.S. District Court for the Northern District of California determined that any issues of illegality involving a contract for a cannabis mobile application were to be determined by arbitrators, not the federal courts, where the parties' contract expressly provided for arbitration of the parties' disputes.

Under the Federal Arbitration Act and U.S. Supreme Court precedent, arbitration provisions in such contracts are severable from the rest of the contract. Claims that illegality preclude enforcement of the contract are thus left to the arbitrators.

Business owners and investors partaking in cannabis-related industries must therefore evaluate the applicable choice of law and seat of arbitration carefully in the jurisdiction that would be enforcing any drafted arbitration provisions. Furthermore, even where a jurisdiction is found to be cannabis industry-friendly, owners and investors should ensure that there are sufficient assets to enforce an arbitration award in that jurisdiction, so as to avoid hollow victories.

Parties drafting provisions for arbitration of claims should look to the applicable laws and practices pertaining to the enforceability of arbitration provisions in each involved jurisdiction.

Even where a claim involving foreign investments into cannabis-related industries is subject to arbitration with an enforceable judgment, there are additional considerations that business owners and investors should take into account in making investment decisions. One such consideration is the interaction between foreign investments in cannabis-related industries and applicable immigration law.

For foreign investments made in the U.S., these considerations are largely governed by the Immigration and Nationality Act.

In the U.S., cannabis remains a Schedule I controlled substance under the Controlled Substances Act. Under the Immigration and Nationality Act, a person who has been a knowing aider, abettor, or conspirator in the illicit trafficking of any controlled substance under the Controlled Substances Act is inadmissible to the U.S. and/or may be unable to naturalize as a citizen in the future.

Whether an investment into a cannabis-related industry qualifies as aiding, abetting or conspiring under the Immigration and Nationality Act may depend on whether such investment is seen as an active or passive investment.

Nonetheless, business owners and investors who may later be considering U.S. citizenship or naturalization should weigh the implications of investments involving cannabis-related industries.

Business owners and investors looking to make investments into cannabis-related industries in foreign countries should evaluate potential applicable immigration consequences in any involved jurisdictions.

Similarly, business owners and investors looking to invest in foreign cannabis-related industries should consider whether such business or investment activities may be subject to prosecution or other criminal consequences in relevant jurisdictions. The law surrounding the treatment and enforcement of federal criminal implications on the cannabis industry in the U.S. is somewhat inconclusive.

While federal prosecutors in the U.S. may theoretically have grounds to prosecute such activities under, for example, money laundering laws, the U.S. government and corresponding enforcement agencies have seemed generally reluctant to prosecute such claims. These agencies have largely tended to ignore investments into cannabis-related industries where the activity is not illicit under the law of the jurisdiction in which it is occurring, whether that be a state in the U.S. or a jurisdiction abroad.

As with considerations involving the Immigration and Nationality Act, whether such activities are considered illicit under federal laws in the U.S. may center on how active or passive the foreign investment is determined to be. Business owners and investors operating in foreign countries should consider similar general practices of government and enforcement agencies in any involved jurisdictions.

Moreover, many foreign investments into cannabis-related industries are subject to strict disclosure laws that may require specific information surrounding owners, investors or other financial interest holders — even where the interest held is comparatively small — to be disclosed at the individual level.

This may subject investors in the industry to additional liabilities or criminal implications. Business owners and investors into the industry must also consider the financing of such investments, as countries such as the U.S. will not allow federally regulated and insured banks to fund the industry due to federal illegality.

The same holds true for any foreign investors who may be subject to legal regulations involving investment into cannabis-related industries under the laws of jurisdictions involved in the investment.

Business owners and investors should weigh the implications of legality — under the jurisdiction of both the location of the investor and the location where the investment will be made — when making decisions involving foreign investments into cannabis-related industries.

Finally, business owners and investors looking to make foreign investments in cannabis-related industries should consider any applicable economic, political, social and/or regulatory implications of involvement in such industries in foreign countries.

Several countries across the globe have presented examples of both the benefits and restrictions of international relationships in cannabis-related industries.

Well-known Canadian cannabis companies such as Canopy Growth Co. and Cronos Group Inc. have established operations, licenses, joint ventures and global trade models overseas following federal legalization of cannabis allowing the country to become a large source of overall investment in the industry.

The U.S., Canada, Colombia, China and parts of Europe held the highest levels of foreign investment into the industry as of reports issued as early as 2019. Jamaica's introduction of the Dangerous Drug Amendment Act in 2015 created a legal regime for the cannabis industry that opened the country to partnerships with overseas cannabis firms and pharmaceutical companies from Canada, Europe and the U.S.

Other countries across the globe have begun to legalize cannabis in various forms, introducing the possibility of global trade and investment in the market. Trade and investment is often subject to regulations heavily influenced by the socioeconomic and political implications of such activities on individual countries.

For example, as a component of legalizing forms of cannabis, countries such as Thailand and Colombia have adopted policy approaches to protect domestic actors in the industry from foreign influence.

This has taken the form of implementing prohibitions and regulations protecting small and medium scale domestic growers. Similarly, Jamaica and other countries consider factors such as the mission, brand reputation, potential export market, technical and market knowledge, and influence of particular investors in deciding whether to allow those investors into the market.

Business owners and investors seeking to make foreign investments into cannabis-related industries should thus carefully evaluate the goals of each country where an investment is set to be made and any corresponding influential factors, policy approaches, regulations and protections involved in the foreign market.

Foreign investment in the cannabis industry has grown exponentially over the past few years due to legalization in an increasing number of jurisdictions in the U.S. and abroad.

This presents lucrative opportunities for business owners and investors to capitalize on an emerging global market in the early stages of growth.

Nevertheless, these investments are subject to a combination of local and international laws, agreements, regulations, and practices that create complexities in the resolution of any resulting disputes, which may deter foreign investment into the industry as a whole.

International arbitration of foreign investment claims in the cannabis industry — under applicable international investment agreements, contractual provisions or otherwise — allows parties to resolve these disputes while mitigating the risks of such underlying complexities. Parties intending to invest in the cannabis industry overseas should thus strongly consider arbitration as a method of dispute resolution.

Where arbitration is selected as a form of dispute resolution by way of investment agreements between the parties, the language of any applicable dispute resolution provisions should be carefully crafted to ensure that the method of arbitration and selection of governing law allows for enforceable resolution of such claims under agreed-upon terms.

Parties should additionally consider the specific implications — in both the host country of any investor and the country where such investment is being made — involving the enforceability of arbitration treaties and provisions, applicable criminal or immigration consequences, and any corresponding influential factors, policy approaches, regulations, and protections specific to the involved jurisdictions.

Ramsey Schultz is an associate at Duane Morris LLP.

Reprinted with permission of Law360.