The legal cannabis industry is one of the fastest-growing sectors in the United States. Worth over $10 billion in annual sales, the economic impact of cannabis could reach as high as $77 billion by the end of 2022.[1] With industry growth comes job creation. According to Glassdoor Economic Research, the number of job openings within the cannabis industry in 2018 (an increase of 76% in one year) and Forbes reported a job creation rate of 110% from 2017-2020.

From an underwriting perspective, the cannabis sector is more complicated than other business sectors due to regulatory issues and legal questions surrounding the industry. Cannabis remains illegal at the federal level; however:

• Twenty-three states have legalized cannabis products completely, permitting adults to have access to both recreational and medicinal cannabis products with Minnesota being the most recent in May 2023.
• Thirty-eight states allow for medicinal marijuana use.

Given this expediential growth, the professionals involved in the “touching” and ancillary “non-touching” of the industry need to assess their risk and need for professional line coverage. This article will layout various insurance policies available in the market, highlight areas and types of risk and provides best practice tips.

1. SAFE Act, the CLAIM Act, and the STATES Act.

Cannabis operations face regulatory issues common to all businesses, including federal securities violations, false and misleading advertising under the Federal Lanham Act, or state-level violations, including unfair and deceptive trade practices violations or personal injury claims.
Given the rapid expansion of the regulatory market for cannabis operations, there are three laws being considered by Congress that would significantly impact the space. These are SAFE Act, the CLAIM Act, and the STATES Act.

1. SAFE Act (Secure & Fair Enforcement Banking Act)

This Act would protect financial institutions that want to offer basic banking services to marijuana businesses in cannabis-legal states. Cannabis operations would change from being cash-only through the Act’s establishment of guidance for credit unions and banks to service cannabis businesses. The Act has passed the House on multiple occasions but continues to be stalled by the Senate.
 

2. CLAIM Act (Clarifying Law Around Insurance Marijuana)

This Act would protect insurers and insurance agents from federal prosecution when doing business with the cannabis industry. To draw an analogy, it is the insurance equivalent of the SAFE Act for banking, and as with the SAFE Act, similarly, the CLAIM Act has passed the House and is awaiting Senate action.

3. STATES Act (Strengthening the Tenth Amendment Through Entrusting States)

This bill would amend the Controlled Substances Act of 1970 to remove the classification of cannabis as a Schedule 1 drug. Our prediction is that the STATES Act is the least likely to pass the Senate in the near future.
 

2. Professional Liability Insurance
   1. Directors and Officers Liability Insurance (D&O)[2]

D&O is intended to cover directors’ and officers’ personal liability for corporate decisions. One potential benefit of D&O insurance is providing protections and help attract top-level individuals. D&O coverage is currently available with limited markets and comes with a hefty premium. Regulatory exclusions in D&O policies are problematic and can go far beyond just a regulatory investigation. It is important to evaluate the policy, look for stock drop and bankruptcy exclusions. Additionally, D&O protection will not eliminate the potential risk to directors and shareholders of potential federal RICO criminal and/or civil claims.

2. Errors and Omissions (E&O) (Medical)

Many states, such as Arizona, who have legalized medical marijuana are beginning to require medical professional coverage by statute. Others, such as Missouri, require the capability to purchase Professional Liability coverage as part of their licensing application process. Testing labs and medical marijuana dispensaries are the most obvious operations with E&O exposure.

Many insurance carriers do not extend coverage for the prescription or recommendation of non-FDA approved drugs, including medical marijuana; therefore, coverage must be tailored to include cannabis.

A recent poll by the Marijuana Policy Project showed the medical marijuana card holders tend to rely upon their budtenders over their doctor when it comes to selecting a product at the dispensary. Budtenders E&O provides protection to employed dispensary clerks who provide consumers with advice or recommendations on specific products.

3. Lawyers Professional Liability Insurance

The ability to obtain LPL insurance is compromised by the federal government's illegality position. Only a handful of markets will consider writing LPL insurance for law firms with clients in any aspect of the cannabis industry. Several LPL underwriters acknowledge a “Don’t Ask, Don’t Tell” policy when it comes to the cannabis space, and most LPL applications do not specifically inquire if a firm has clients in the industry.[3] The majority of LPL carriers are looking at the chasm between the positions of the states and the Feds and treading lightly – especially considering that the little movement we have seen has been mostly moving away from the space since the 2016 election and stepping closer since 2020. The lack of case law is also a concern for actuarial evaluation. For an industry whose very foundation is determining risk, some feel there’s just not enough to go on yet.

One suggestion in an attempt to avoid professional liability issues is to make clear in writing clear to your cannabis business clients that while they may be operating legally under state law, they could still be charged with violating federal law.

Another consideration for professionals who want to get involved in the cannabis industry is the potential difficulty in enforcing contracts. Court around the country have widely varied on whether or not a plaintiff has standing to bring a breach of contract lawsuit when the alleged claim violates federal law.

            Expert retention and discovery in this budding industry may prove fairly limited given the lack of federal legitimacy, thereby leading to a fear of compromised reputation for some. The usual pool of cannabis experts that can meet Daubert standards will not be as large as it otherwise would be in non-cannabis related cases.

            As a means of counseling clients so as to avoid litigation, accurate record keeping and document retention are key (as they are in non-cannabis related cases). Further, procurement of strict adherence to company policies and the law will prove critical in minimizing claims against your client as the general trend is punishing those in the black market and/or those who are not engaged in a professional, clean conduct.
 

3. Professional Rules of Ethics for Attorneys

The immediate concern with the intersection between state-licensed marijuana and the legal profession has, thus far, centered largely on state rules of professional conduct. Under Rule 1.2(d) of the Model Rules of Professional Conduct), “[a] lawyer shall not counsel a client to engage, or assist a client, in conduct that the lawyer knows is criminal or fraudulent ....”

Individual states have taken it upon themselves to protect the legal profession if it chooses to represent cannabis clients. For example is Colorado. Recognizing that Section 841(a)(1) of the Controlled Substances Act criminalizes the growth and sale of marijuana, the Ethics Committee of the Colorado Bar Association in November 2012 issued Formal Ethics Opinion 125, concluding that federal law places strict limits on the advice that lawyers may provide to marijuana businesses. It concluded that lawyers may run afoul of Rule 1.2(d) by undertaking routine tasks, such as drafting leases or supply contracts, for licensed marijuana businesses.

            The Colorado Supreme Court--over the dissent of two justices-- added a comment to Colorado’s Rule 1.2(d) stating that a lawyer “may assist a client in conduct that the lawyer reasonably believes is permitted by ... constitutional provisions” allowing the retail sale of marijuana. Further confusing the situation is the fact that the language of Rule 1.2(d) itself remains unchanged, and that comments to the rules of professional responsibility do not change the substantive governing rules.

            Legal professionals need to consider the risks involved in entering the cannabis arena. Just a few considerations are:
• If the Department of Justice changes its enforcement policy regarding state-licensed growers and retailers, might lawyers who helped clients structure businesses that violated federal laws be liable to a client convicted for violating these laws?
• Will fee agreements between lawyers and cannabis-clients be found void against public policy or found unenforceable under the illegality clause?
• Can legal malpractice suits brought by licensed marijuana businesses ever be adjudicated in federal court?
• Might a criminal acts exclusion in a PLP leave a lawyer who assisted a licensed marijuana business without coverage against a malpractice claim?
• So far, most banks, wary of federal drug laws, have refused to deal with licensed marijuana businesses. What sort of liability does a lawyer face who accepts cash payments from marijuana clients--and then perhaps holds them in a client trust account?
           
The answers to these questions, again, vary from state to state. The trends are pointing to state governance of this issue and the federal government keeping their hands-off, at least for now.
 

4. Hospital Handling of Medical Marijuana

Hospitals that are located in states that have legalized medical marijuana must decide whether they will permit their physicians to authorize patients to obtain medical marijuana under state law, and whether they will permit patients to use medical marijuana as in patients in the hospital.
Federal law prohibits hospitals and their physicians from using or possessing medical marijuana or assisting a patient in doing so. The conflicting nature of state and federal medical marijuana laws engenders certain legal risks for hospitals, including risks related to reimbursement, federal funding, accreditation, and professional liability exposure. Another consideration is the reimbursement from federal health care program such as Medicare or Medicaid. The hospital and its employed physicians could be subject to criminal and civil penalties under federal law for permitting an employed physician to recommend medical marijuana.

            Hospitals and physicians should review their insurance coverage to determine whether their insurance carriers deny coverage for medical marijuana-related claims. The policy may just specifically exclude the recommending of medical marijuana from coverage, or the policy may deny coverage for any illegal acts.

            Finally, hospitals that prevent their physicians from recommending medical marijuana should still make sure their physicians are educated on the use of medical marijuana and discuss it with their patients if it is a potential treatment modality. Otherwise, the physician may be subject to liability for violating informed consent requirements, acting contrary to the best interest of the patient, failing to meet the standard of care and may be accused of contributing to the ongoing opioid crisis.

Although the federal government has the ability to regulate controlled substances, it may not interfere with a physician’s First Amendment right to inform patients about the use of marijuana for medicinal purposes. Based upon the foregoing, a hospital should refrain from prohibiting its physicians from discussing medical marijuana with their patients.
 

5. Concerns for CPAs Serving Marijuana Businesses[4]

Both audit and tax services present unique challenges, such as the valuation of inventory and the disallowance of tax deductions under IRC section 280E. Prior to agreeing to render these services, CPA firms should discuss management’s plans for inventory management systems, and briefly explain the limitations of available tax deductions under IRC section 280. What is clearly deductible is the cost of goods sold, but the retail operation is not.

When assessing client acceptance and continuance, firms should determine whether the business has conducted criminal background checks of its employees and if any adverse findings will affect the firm’s ability to effectively render services. When entering into an engagement, firms should obtain a representation letter from the business principals, expressly stating that they fully understand and intend to comply with all state laws applicable to their business. Engagement letters should clearly define the scope of the services to be rendered and require client management to acknowledge its responsibility for maintaining all tax and accounting records as needed to respond to inquiries, investigations, or audits initiated by regulators and criminal or tax authorities. In addition, all communications with the client should be documented in writing.
Insurance coverage will apply, just as it would to services rendered for clients in other industries. In light of the fact that marijuana businesses remain illegal under federal law, however, claims may include allegations that the firm or individuals employed by the firm engaged in dishonest, fraudulent, or criminal acts. Coverage is typically excluded if this occurs, but the relevant policy exclusions contain important exceptions, which usually indicate that the exclusion does not apply unless there is a final judgment by a court finding that the insured party is guilty of the allegation. Additionally, the Sec. 7525 tax preparer-client privilege may not apply to cannabis clients. If the client is under investigation, the CPA may be in the awkward position of being required to testify against that client.
 

6. Professional Liability Tips to Protect Yourself and Your Business

A.Stay Current. Professionals need to stay up to date on changes in order to advise clients appropriately. Follow your state cannabis regulatory site, attend training seminars and following industry leader website such as Marijuana Policy Project, National Association of Cannabis Businesses and of course DRI.

2. Use Due Diligence.  Do your due diligence and investigate the potential client, run a background check, meet the owners/shareholders, talk with prior and current counsel/professional and put all correspondence in writing and/or a follow-up communication in writing.
3. Avoid perceived conflicts. The potential dollars involved in a successful cannabis business makes it alluring to take an ownership interest in lieu of fees, or in lieu of a portion of the fees.
4. Check for conflicts before taking new clients. Make sure you look closely at potential conflicts before agreeing to represent additional clients in the same sector of the medical marijuana business.

E.Develop a specialty. Dabbling in any industry is always a professional liability risk, but, combined with the unique considerations associated with cannabis clients and the evolving regulatory and legal landscape, the risk of dabbling is even greater.

F.Engagement letter. Obtain an annual, signed engagement letter that clearly delineates the scope of services. Include a provision that requires the client to affirm it is operating legally under applicable state law. Require a new, signed engagement letter or amendment when the scope of services changes.

G.Billing. Require a retainer at the onset of an engagement and maintain a positive balance through sound billing and collection practices. Suspend or terminate services for nonpayment.

H. Management Representation Letter. Obtain a management representation letter for all services provided to cannabis clients, including tax, accounting, and consulting, which contains the following:

• The business is operating legally under applicable state law.
• The client’s records are accurate and complete.
• Required tax filings are current.
• The client agrees to indemnify and hold harmless for knowing misrepresentations or intentional concealment of information.