California Cannabis and Demystifying Distribution under the MMRSA

California CannabisOn September 11, 2015, California legislators passed the Medical Marijuana Regulation and Safety Act (MMRSA). The Act went into effect as of January 1, 2016 and the state is slated to begin accepting applications for state licenses by 2018. The MMRSA is composed of three separate bills: AB 266, AB 243, and AB 643. As per usual, the bills contain a sufficient amount of “legalese,” resulting in some confusion within the California cannabis industry. There has been particular confusion surrounding the role of a “distributor” under the MMRSA, as the same term has been used in other contexts, the most common of which is the regulated alcohol industry. There is concern in the cannabis community that state regulations for marijuana will too closely mirror those for alcohol, and these concerns are not unfounded considering evidence that states are basing their marijuana models on existing alcohol regulations.

California’s alcohol market has a three-tiered system that includes producers, distributors, and retailers. The original intent of implementing this three-tiered system was to cure one of the problems that ultimately led to alcohol prohibition: producers who sold directly to retailers placed pressure on retailers to increase their sales of alcohol, thus encouraging overconsumption by consumers. By adding a distributor as a middle man between the producer and retailer, producers no longer had the power to pressure retailers and thus the system was seen as a better solution for public health. Only distributors can arrange sales with retailers and these distributors are subject to several limitations, including the requirement to offer the same price to all retailers.

Now let’s compare this with the system for marijuana distributors under California’s MMRSA. The MMRSA defines “distribution” as “the procurement, sale, and transport of medical cannabis and medical cannabis products between entities licensed pursuant to this chapter” (AB 266, 19300.5(p)), and defines a “distributor” as “a person licensed under this chapter to engage in the business of purchasing medical cannabis from a licensed cultivator, or medical cannabis products from a licensed manufacturer, for sale to a licensed dispensary” (AB 266, 19300.5(q)).

Many in the cannabis industry are unhappy about the addition of a distributor as a “middle man” under the MMRSA, as this is not a role which presently exists in the current marijuana market. However, some of this frustration may be due to the misconception that marijuana distributors will take on the same role as alcohol distributors. This is understandable considering the definition under Section 19300.5 makes it sound like only distributors will be allowed to buy marijuana products from cultivators and manufacturers to then sell to licensed retailers. However, in contrast to the alcohol distribution model, the MMRSA does not limit the ability of marijuana producers to arrange sales directly with retailers. Instead, the function of distributors is to act as the exclusive channel for transporting products from producers (cultivators and manufacturers) to testing labs for quality assurance and batch testing, as required for all medical marijuana products under the MMRSA (AB 266, 19326(b)). But after the testing is complete, distributors can either transport the tested products directly to a retail dispensary or to the same or different producers. This all depends on the contracts created by the producers. Distributors will transport the marijuana products where they are directed to under contract, and the producers themselves maintain the right to contract for sales to retailers or other licensees.

The MMRSA “does not limit the ability of licensed cultivators, manufacturers, and dispensaries to directly enter into contracts with one another indicating the price and quantity of medical cannabis or medical cannabis products to be distributed” though distributors can collect a fee for their services (AB 266, 19362(c)(3)). Thus, marijuana producers will be able to arrange for direct sales to retailers, set pricing and terms for the sale of their products, and continue to build valuable relationships with the retailers of their choice.

In fact, because the MMRSA allows for limited vertical integration, a Type 10A licensed dispensary can also have a cultivation or manufacturing license and thus be both a producer and a retailer (which is not allowed under the alcohol three-tiered system). In this case, the double license holder would produce the marijuana products, then it would contract for a distributor to provide the required quality assurance and transportation to a lab for testing, and finally the distributor would transport the product to the license holder’s own retail site. This type of transaction could never happen under the alcohol system and proves that a distributor under the MMRSA was not meant to act as the marijuana equivalent of an alcohol distributor. Though one way in which marijuana and alcohol distributors may serve the same purpose is taxes, which when applied at the distributor level ensures that all products that pass through the state system will be hit with a state-level tax.

Another interesting element of the new marijuana distributor under the MMRSA is the opportunity it creates for new businesses to step in and serve this previously unnecessary role. We’re counting the days until California begins accepting license applications in 2018 and there will be several Type 11 distribution licenses up for grabs for anyone interested in entering this untapped segment of the marijuana market.

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