Cannabis and Trusts

Take-Away: If an individual owns an interest in a cannabis-related business, special consideration needs to be given to holding that interest in a trust, and transfer of that interest by the trustee from the trust, so long as cannabis is treated as an illegal substance under federal law and such business is highly regulated and licensed at the state level.

Background: Cannabis is among the fastest growing markets in the U.S. Legal cannabis supported 243,700 full time equivalent jobs as of January of this year. $11 billion in consumer worth of legal cannabis was sold in 2018. It is estimated that consumers will purchase $23 billion in cannabis by 2022. In 2015 a Silicon Valley venture capital firm, Founders Fund invested $75 million in Privateer Holdings, a Seattle based private equity firm that is focused on the legal cannabis industry, and filed to go public and list that stock on the NASDAQ. Clearly cannabis is becoming big business. While cannabis might be looked upon as just another asset that is held by an individual, much like a wine collection, the big difference is that unlike wine, cannabis is still illegal under federal law.

Federal: Since 1970 cannabis has been treated by the federal government as a Schedule I substance under the Controlled Substances Act, right next to heroin, LSD and cocaine, for its cultivation, distribution or possession. Penalties for violating the Controlled Substance Act range from 5 years to life in prison. In 2018, the Drug Enforcement Agency moved prescription cannabidiol (CBD) as a Schedule V drug, which in turn caused the Food and Drug Administration (FDA) to treat the sale and marketing of CBD-infused food and dietary supplement in interstate commerce as unlawful. The federal government treats cannabis, and almost all activities related to it, as illegal, including the consumption of cannabis on federal land and on many indian reservations.

Michigan: In contrast to the federal government’s treatment of cannabis, two-thirds of the states permit the legal use of cannabis for medical reasons, and 11 states (and their number keep growing) permit the use of cannabis for recreational purposes. Michigan permits retail sales of cannabis for recreational use, pursuant to a license, but not on federal property. Only four states prohibit all use of cannabis in all forms: South Dakota, Nebraska, Kansas and Idaho. The legalization of cannabis in Michigan for recreational use has prompted a sudden growth in cannabis businesses. In a small town like Traverse City we now have at least 6 new business that have opened in the past 18 months that intend to cater to cannabis users.

Cannabis-Related Businesses: The dichotomy between federal treatment of cannabis as an illegal substance and state laws that permit limited recreational use of cannabis has created some unique dynamics and aspects for the cannabis-related business.

Bank Secrecy Act: This federal Bank Secrecy Act imposes regulations on banks and other financial institutions including the duty to file reports on large cash transactions. Under this Act a financial institution must file reports of cash deposits and withdrawals exceeding $10,000 and any suspicious activity that might indicate money laundering, or any other criminal activity, criminal being the operative word. While these regulations do not prohibit a financial institution from accepting cannabis related customers, it requires extensive and onerous paperwork from the financial institution with regard to its cannabis-related customer, including the ‘know-your-customer’ customer due diligence inquiries. Beginning in 2019, financial institutions are no longer required to file suspicious activity reports (SARs) for customers solely because the customer is engaged in the growth or cultivation of hemp or cannabis in accordance with applicable laws and regulations, but the financial institutions are still expected for follow SAR procedures and file a SAR if warranted by suspicious activity. [Financial Crimes Enforcement Network, FinCEN, Providing Financial Services to Customers Engaged in Hemp-Related Businesses, December 3, 2019.
Cryptocurrency: Many cannabis businesses are awash with cash. Accordingly, they have turned to carrying on business using cryptocurrency because federally chartered banks are prohibited from participating in illegal activities including accepting deposits of funds resulting from criminal With the inability to deposit revenues and profits in a federally regulated bank, funds were initially hidden, literally, under mattresses, and now with the ability to use various cryptocurrencies, that has become the basis for many cannabis-related businesses to transact business with suppliers and with end-users. Currently there are at least five cryptocurrencies intended specifically for the cannabis marketplace: PotCoin, CannabisCoin, DopeCoin, HempCoin, and CannaCoin. The IRS has determined that all these cryptocurrencies are capital assets.

Cannabis and Estate Planning: With many viewing the legalization of the recreational use of cannabis as a fantastic business opportunity, there is a good chance that one such cannabis-business (growth, distribution, retail sales) may become an asset of an individual’s estate, or an individual has invested in a cannabis-related security. Some thoughts on how the explosion in cannabis-related businesses may impact estate planning considerations, consider the following observations:.

Validity of Trust: Probably the first thing the trustee must do is determine if the purposes of the trust are lawful and not contrary to public policy. A trust may be created only to the extent its purposes are lawful and not contrary to public policy. [MCL 700.7404.] The trustee has a duty not to comply with a provision of the trust that the trustee knows or should know is invalid because the provision is unlawful or contrary to public policy. [Restatement (Third) of Trusts, Section 72.] So the first question for the trustee is to determine if the trust’s purposes are permissible. This then could raise the question is whether the trust is valid if it authorizes investments in cannabis securities, and whether the trustee acts properly in making a cannabis-related business or security investment.
‘Proceeds of Unlawful Activity:’ The Controlled Substances Act makes it unlawful for any person who derives income from illegal drug activity to invest such income in any enterprise engaged in interstate commerce. [24 U.S.C. 854.] A trustee should ensure that it knows the source of the assets under it control. Federal law imposes criminal penalties on any person who conducts a financial transaction knowing that the transaction is designed in whole or in part to conceal or disguise the nature, location, source, ownership or control of the proceeds of the unlawful activity derived from the unlawful activity. Accordingly, a trustee that knowingly invests illicit drug profits could be deemed to be aiding and abetting illegal activity.
Minor Beneficiary Cannot Hold License: The beneficiary of a cannabis-related trust asset may be a minor. Many state laws prohibit a minor from possessing or owning any of these assets outright. The trust instrument should authorize the trustee to hold such an asset during the minority of the trust beneficiary, if not longer., before distributions are made.
Define ‘Illegal Drug:’ Some trusts condition distributions to beneficiaries dependent upon if the beneficiary is using illegal drugs. A trust instrument will need to specify when such a restriction applies, what law applies (federal or state), and whether cannabis is to be treated as an illegal drug for purposes of withholding distributions from the beneficiary.
Opt Out of Prudent Investor Rule?: Unclear is whether a trustee may invest in cannabis-related securities under conventional fiduciary investment standards. Cannabis-related securities are arguably illegal under federal criminal statutes. If this flexibility to invest in cannabis-related businesses or securities is desired by the trust’s settlor, then the trustee may need to be expressly relieved of having to make investments in accordance with the Prudent Investor Rule. And even if a cannabis-related security is permissible under the Prudent Investor Rule, because cannabis-securities are new and few, the trustee will need to exercise heightened due diligence to evaluate the risk of holding such securities.
Duty to Report Suspicious Activity: If the trust holds cannabis-related securities, the trustee will have to comply with the federal duty to report suspicious transactions that involve cannabis proceeds.
Required Transfer of Cannabis License: Cannabis-related businesses in Michigan all require the issuance of a state license. If there is a cannabis-related business that is held in the trust, and it is to be distributed after the settlor’s death, the settlor needs to consider business succession planning strategies in order to avoid transfers of the cannabis-related business to an individual who is not qualified to become an owner of the cannabis-related business and hold the required license. This might also entail the need for cross-purchase or buy-sell agreements if there is more than one business owner to avoid the difficult issues associated with the transfer of a cannabis license on one owner’s death. Inasmuch as most state licenses with regard to cannabis impose age, residency and criminal history requirements on license ownership, it is not clear how those conditions will be interpreted if a trust or an estate becomes the holder of the cannabis license.
Trustee Appoints Independent Fiduciary to Deal with Cannabis Asset: The trust instrument should give the trustee the authority to appoint an independent fiduciary to carry out the duties associated with the transfer of a cannabis-related business and its licenses when the trustee is not ideally suited to, or comfortable with, that task.
Transfer to Beneficiary Who Cannot Hold License: Even if the trust beneficiary is qualified to take legal ownership of the cannabis-related business or security, there could be problems with how to transfer the ownership of the business or security from the trust to the beneficiary. The laws that govern the transfer of assets by a decedent are those of the decedent’s domicile prior to his or her death. The law of the beneficiary’s domicile applies to determine whether or not he/she may take possession. What does the trustee do if the designated beneficiary is domiciled in one of the states that refuses to legalize any aspect of cannabis?
Delivery Impediments: As cannabis is a Schedule I controlled substance, the use of the U.S. Postal Service to deliver the cannabis-related business or security is a federal crime, punishable by monetary fines and imprisonment, even where its recreational or medical use is legal. [ 18 U.S.C. 1716; Sansouci v USPS, P.S. Docket No. MLB, 18-9, April 13, 2018.] In short, the traditional delivery by mail of an asset to the trust beneficiary is yet another challenge for the trustee to contend with.

Conclusion: These are just some of the many questions and concerns that a trustee will have to sort through if the trust holds a cannabis-related business or security. While cannabis may be legalized in Michigan, cannabis use, possession, production, distribution, and marketing remain illegal under federal law. Thus, cannabis users and businesses remain at risk of civil and criminal prosecution by the Department of Justice.