Washington Court of Appeals overturns LCB’s interpretation of “tied house” rule
On the one hand, Washington State strictly regulates the relationship between cannabis producers and processors and cannabis retailers. Many states allow the same person to hold a financial interest in all three types of permits. But not Washington. According to RCW 69.50.328, neither a licensed cannabis producer nor a licensed cannabis processor may have a direct or indirect financial interest in a licensed cannabis retailer. This means that Washington prohibits vertical integration from production to retail, although this is common in Oregon and other jurisdictions.
This statutory ban on cross-level financial benefits has led the Liquor Control Board (“LCB”) to adopt a rule commonly referred to as a “bundled house” rule. The Bundled House Regulations stipulates that “No industry member or licensee may sign any agreement that improperly affects other licensees or industry members.” WAC 314-55.018. Clearly exempt from the category of “undue influence” is an agreement on placing orders and accepting orders for cannabis purchases and delivery based on usual and prevailing business practices, otherwise it is legal. But in the actual everyday sense, the exact meaning of the bundled house regulations is not yet clear.
In a recent opinion, the Washington Court of Appeals was asked to explain the meaning of “improper influence” in the Bundled House Ordinance because it involved disputes between members of limited liability companies holding cannabis retail licenses. Aaron v. Conley, No. 80120-1-I (June 7, 2021).
The facts of Yaron v. Conley
As with many marijuana commercial transactions, the facts involve individuals who hold multiple entities, and these entities have overlapping relationships and transactions. In April 2014, LCB granted the defendant Conley a retail cannabis license in Kirkland, Washington, in the name of her business Mary Jane. In 2015, Conley approached AVH & BJ Holdings LLC, which owns commercial real estate in Kirkland. The owners of AVH & BJ are Joseph, Bracha, plaintiff Yaron and Auroraview Holdings, and the majority shareholder of the company is Yaron. AVH & BJ is managed by Joseph and Yaron.
AVH & BJ leases the entire property to JRM, an independent company owned by Joseph. JRM then subleases part of the property to hemp producer Dynamic Harvest. At the same time, Conley reached an agreement with Yaron, Joseph, and Bracha that they would find commercial space for Conley’s cannabis business on the condition that they become her business partner and be designated as part of the owner of the Mary Jane retail license. Later, Blanchard gave up the idea, leaving Conley, Aaron and Joseph as presumed members of Mary Jane.
Yaron and Joseph submitted a manager change application to LCB. They did not disclose their interest in JRM or AVH & BJ Holdings to LCB. But LCB later learned that Joseph, the owner of JRM, had leased the property to the producer Dynamic Holdings. LCB concluded that Joseph cannot become a retail license holder without violating the Bundled House regulations and corresponding regulations.
LCB also began investigating Yaron’s ownership interest in Mary Jane. In February 2017, LCB issued a letter stating that Yaron was barred from holding the ownership interest in Mary Jane because of his ownership in Auroraview. (Recall that Auroraview owns an interest in AVH & BJ Holdings, which owns the property and leases it to JRM, which then sublet a portion to Dynamic Holdings.) LCB believes that this relationship violates the bundling house rule.
LCB gave Mary Jane 45 days to correct Yaron’s alleged violation of the bundling house regulations or cancel his rights in Mary Jane or Auroraview. Yaron began to divest from Auroraview, but Conley removed Yaron as a member of Mary Jane.
Yaron sued Conley for breach of contract, breach of fiduciary duty, and declaratory and injunctive relief. In her answer, Conley asserted that, as a positive defense, the operating agreement is illegal because it violates public policy.
After the bench trial, the court of first instance ruled that Aaron was not good for Conley, but was good for Conley. The court of first instance concluded that Yaron’s ownership interest (via AVH and BJ) in the property leased by JRM to the cannabis producer (Dynamic Holdings) while also owning the interest in the cannabis retailer (Mary Jane) is a “cross-level regulatory violation” because The possibility of improper influence on any entity”.
Bundled House Ordinance
Yaron appealed, arguing that the court of first instance made an error in ruling on his ownership interest in ABV & BJ and that Mary Jane violated the binding house regulations.
Here is the text of the rules again: “Any industry member or licensee shall not sign any agreement that improperly affects other licensees or industry members.” WAC 314-55.018.
The Washington Court of Appeals agreed and overturned the judgment of the court of first instance. Among other things, the Court of Appeal pointed out that these provisions did not define “undue influence.” The court found that the term was ambiguous because:
Improper influence may apply to financial relationships of varying degrees. For example, it can be applied to any landlord who is interested in cannabis production, processing or retail business and rents out to different levels of cannabis business, even if the rent is not used for their cannabis business. On the other hand, it may not apply to any landlord at all. Therefore, the regulations are ambiguous regarding factors that improperly affect another industry member in this case and in general. But the regulation provides clarity because it applies specifically to licensed cannabis producers and processors, and thus points to a narrower interpretation.
Here, the court reasoned that Yaron was neither a licensed cannabis producer nor a licensed cannabis processor. On the contrary, Yaron is the manager of AVH & BH. According to the lease between the company and JRM, JRM requires his consent before subletting any property. Therefore, JRM needs Yaron’s approval to sublet the property to Dynamic Holdings. But nothing allowed Yaron to control the operations or rents of Dynamic Holdings.His control is limited to approving the lease he signed before He acquired the ownership interest in Mary Jane. (Some people want to know if he agrees, the result will be the same Rear He acquired the ownership of Mary Jane. )
Therefore, although Yaron is subject to regulations due to its interest in Mary Jane, Yaron lacks the ability to improperly influence Dynamic Harvest for Mary Jane’s benefit, and vice versa. The court ruled that this relationship was “too fragile to have undue influence” and his ownership rights did not violate the relevant housing regulations.
In this case, I found three important points. The first is that LCB’s interpretation of cannabis regulations is not always correct. (In this regard, neither is its Oregon counterpart, OLCC.) The second is LCB’s interpretation of the regulations, which has no right to be respected unless it is adopted as a policy position. Here, the court ruled that LCB’s letter to Conley and Yaron expresses its interpretation of the bundled housing regulations because they do not contain agency policies and therefore have no right to be respected. The third is that licensees and presumed licensees in Washington should carefully consider how to structure business relationships and transactions to avoid violating binding rules.It is not clear Aaron v. Conley Proof, so careful business owners have opportunities, and careless business owners have risks.