More frequently over recent years, federal courts have wrestled with the constitutionality of a state’s requirement under its cannabis regulations that ownership of a cannabis company be majority owned (or some other prescribed percentage ownership) by a resident of such state, better known as a state’s “residency requirement.” The obvious repercussion of this regulatory requirement is the investor pool that cannabis companies can draw from is limited, especially as compared to cannabis businesses operating in states without a residency requirement. Not to mention the disappointment of entrepreneurs who want to invest in a new cannabis market, but don’t want to establish residency there.
Residency requirements have been challenged in federal district courts on the grounds that the regulation violates the Dormant Commerce Clause, a rather opaque bit of constitutional jurisprudence. The federal courts of Maine and Missouri have struck down residency requirements in those states, while just last week, a federal court in Washington upheld the residency requirement as constitutional and valid. Below is a summary of each court’s reasoning behind the decisions. No doubt, as new markets open up and states that have legalized adult use in November 2022 roll out their regulations, there will be additional states that include residency requirements and citizens eager to challenge them in federal court.
Maine and Missouri
Under Maine’s medical marijuana program, all directors, managers, shareholders, board members, partners, or other persons holding a management position or ownership interest in a cannabis business in the state were required to be residents of the state of Maine. This regulation was challenged in Northeast Patients Group, et al. v. Maine Department of Administrative and Financial Services, et al. in the United States District Court District of Maine.
Under Missouri’s medical marijuana program, each cannabis business holding a license to conduct medical marijuana business activities must be majority owned by persons who have been a resident of the state of Missouri for at least one year. This regulation was challenged in Mark Toigo v. Department of Health and Senior Services, et al. in the United States District Court Western District of Missouri.
Plaintiffs in each case alleged that the regulations at issue violate the Dormant Commerce Clause by resulting in discrimination against out-of-state commerce. The concept of the Dormant Commerce Clause could fill a law school textbook or two, but it essentially prohibits protectionist state regulations designed to benefit in-state economic interests by burdening out-of-state competitors unless such regulation is narrowly tailored to a legitimate local purpose.
And the scene is set. Plaintiffs argue that a residency requirement is unconstitutionally protectionist and not narrowly tailored to a legitimate local purpose, while the government-defendants argue the regulation is, in fact, constitutionally and narrowly tailored to a legitimate local purpose or is otherwise inapplicable.
The Maine defendants conceded that no local purpose could overcome a constitutional challenge and instead argued that the Dormant Commerce Clause’s intent is not to protect individual rights but rather to preserve a national market and prohibit state laws that interfere with that national market. Given there is no national cannabis market due to cannabis prohibition, the Dormant Commerce Clause does not apply. The judge disagreed, noting that certain nonresidents are permitted to be medical marijuana patients in Maine, making the business interstate, if only minimally. The judge found no legal authority to defend the defendants’ position.
The judge in Missouri determined at an injunctive relief hearing that the residency requirements in other industries have been deemed not sufficiently narrowly tailored to a legitimate local purpose and applied this to the cannabis context.
In both cases, the judges ultimately determined that the regulations unconstitutionally discriminated against residents of other states, thus invalidating residency requirements in each state.
Analogously, a federal court recently upheld the constitutionality of the state’s residency requirement in Brinkmeyer v. Washington State Liquor & Cannabis Board. Under Washington’s cannabis program, all members, governors, agents, managers, and shareholders of an applicant for a cannabis license must have resided in the state of Washington for at least six months prior to applying.
In Brinkmeyer, the plaintiff provided debt to a cannabis business in Washington and was approved as such by the regulators. However, he was barred from sharing in the profits of the cannabis business pursuant to the terms of the loan agreement because he did not meet the residency requirement.
Plaintiffs in this case again relied on the Dormant Commerce Clause to invalidate the residency requirement.
Unlike the federal judges in Missouri and Maine, the judge in Brinkmeyer ruled that the residency requirement does interfere with interstate commerce because there is no legal interstate commerce in marijuana, a “drug” that remains illegal under federal law (Author Note: Still can’t bring myself to call cannabis a drug, even if referencing a judicial opinion). The judge opined further that the residency requirement attempts to prevent any interstate commerce in cannabis and to prevent cannabis from Washington from moving into states where it remains illegal, which is a legitimate local purpose. Plaintiffs are currently considering an appeal of this order, given it is at odds with the decisions of other federal courts on this issue.
Prior to the Brinkmeyer decision, it seemed that courts would consistently and reliably strike these residency requirements down as unconstitutional.
What we do know, residency requirements will continue to be codified in state’s cannabis regulations and continue to be challenged by out of state entrepreneurs in federal courts.
My hope is clarity on this issue emerges in the next year or so. Cannabis companies experience an uphill battle towards success and profitability when compared to other legally operating businesses, let’s not compound those difficulties by thinning the investor pool to in-state citizens only.
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