Canada: Cannabis In Canada: A Changing Legal Landscape

The anticipated legalization of recreational cannabis in Canada by July 2018 is multi-faceted. Several areas of law will come into play, potentially impacting many types of businesses. We delve into some of these areas below.

CORPORATE FINANCE & CAPITAL MARKETS

Canadian Capital Markets

As changes in the regulatory regime open up significant opportunities in the cannabis sector, industry players will be seeking access to capital to fund growth, and investors will be looking for a means by which to participate in this emerging market. While cannabis industry participants in the United States face challenges to obtaining public listings on the U.S. stock exchanges due to the lack of harmonization between the U.S. federal and state regimes, Canada has already seen 37 successful cannabis industry listings, with potential for more on the horizon. Canada has three stock exchanges: the Toronto Stock Exchange, the largest exchange; the TSX Venture Exchange, an exchange generally composed of more junior issuers; and the Canadian Securities Exchange, which was formed as a competitor to the TSXV, which markets to entrepreneurs. The TSX currently has approximately 1,500 listed companies, with a quoted market value of more than C$2.2-trillion. The TSXV's approximately 1,800 issuers have a quoted market value of more than C$23-billion. Currently there are 300 listed companies on the CSE, with a quoted market value of approximately C$4.3-billion. Of the 37 cannabis industry participants listed in Canada, 26 have listed on the CSE, eight on the TSXV and three issuers on the TSX. Eight of these industry participants are licensed producers under the Access to Cannabis for Medical Purposes Regulations and 22 are headquartered in British Columbia.

Obtaining a Listing in Canada

One consideration for cannabis issuers and investors looking to cash in on their rising sector is proper positioning to take a company public, which includes operating in a manner that complies with rules and policies of the applicable exchange. Issuers can obtain a listing through a traditional initial public offering, or a more common avenue for emerging companies in the cannabis industry — a reverse take-over of an existing listed issuer. A reverse take-over often involves an amalgamation or issuance of securities of a listed shell company in exchange for assets or securities of the private company, resulting in the private company effectively "going public." Whereas a traditional public offering can raise timing issues and uncertainty depending on market movements, a reverse take-over may provide a more practical means of providing its initial investors with desired liquidity. At the right valuation, the reverse take-over can be an efficient alternative where a conventional prospectus financing is unfeasible or impractical, and for newly emerging companies provides the benefits of a public listing, secondary market liquidity and access to the capital markets.

Access to Capital in Canada and U.S.

Cannabis industry participants on each of the Canadian exchanges have already found success accessing capital through the Canadian markets conducting public offerings and private placements under the Canadian regime. As these issuers become more financially robust, we expect to see more graduations up to the larger exchanges with Canada poised to becoming the capital market of choice for issuers and investors. Once a company obtains a TSX listing, it could take advantage of the multi-jurisdictional disclosure system (MJDS) to access capital in the United States. The MJDS regime is a system adopted by the U.S. Securities and Exchange Commission (SEC) and the Canadian Securities Administrators to facilitate cross-border public offerings of securities. MJDS allows Canadian-listed issuers on the TSX that meet certain eligibility requirements to satisfy disclosure rules in the United States through compliance with the Canadian regime. The reverse is true for U.S. issuers raising money in Canada. The regime is particularly beneficial to companies listed in Canada who are looking to access U.S. capital as they are permitted to use Canadian style disclosure, comply with Canadian corporate governance practices and work with their local regulator on all requisite approvals as opposed to the SEC.

EMPLOYMENT & LABOUR

The pending legalization of non-medical cannabis raises a host of issues for employers. Upon passage of the new legislation, employers can expect to encounter difficult decisions relating to the appropriateness of drug testing (including suitability of any current drug-testing programs), dealing with drug-related employee misconduct and claims of discrimination, and the ever delicate balance between the obligation to accommodate an employee with a disability (including an addiction) under human rights legislation and the duty under occupational health and safety legislation to provide employees with a safe workplace.

In addition to reviewing and amending workplace policies and procedures in light of the new legislation, we recommend that our clients seek legal advice when dealing with those workplace issues that will inevitably arise with the legalization of recreational cannabis.

FINANCIAL SERVICES

Bank Act

The Bank Act gives scheduled banks the right to take security interests in farm assets, crops and other agricultural products in exchange for the extension of credit. When a borrower makes a grant of security under the Bank Act, title to the pledged asset is deemed to transfer to the lender. As a result, unique issues arise where Bank Act security is taken in respect of an agriculture product that is also a controlled substance, such as cannabis. Accepting a security interest in cannabis may result in the lender holding title to a controlled substance and may increase the risk of exposure to possible regulatory or criminal liability. That being said, the decision as to whether or not to take Bank Act security will involve a balancing of the limitations of existing Personal Property Security Act (PPSA) security as against the legal and reputational risk of taking a grant of Bank Act security. Where cannabis may constitute all or part of the collateral securing a loan, it is important for lenders to consult counsel in order to design an appropriate security package to limit exposure and maximize coverage.

Licences

There is considerable uncertainty across Canada as to whether a licensed producer can grant, and a creditor can take, a security interest in a producer's licence, as courts have not yet had the opportunity to determine whether a producer's licence is an "intangible" for the purposes of the respective provincial PPSAs. However, the uncertainty over whether a producer's licence constitutes "intangible" property for the purposes of the respective PPSA should not affect the nature of the security documentation. In a properly drafted security document, a typical grant of a security interest from a borrower will attach to all of its present and after-acquired assets, property and undertakings. It is also typically subject to the usual carve-out for restricted assets. As a result, where a producer's licence is capable of being charged, it will be. If not, then a lender should consult counsel to ensure that the security package provides for secondary or overlapping coverage.

GOVERNMENT & PUBLIC SECTOR

The new legislation will inevitably result in a flurry of discussions between the government and affected stakeholders. For our clients who are planning to engage government officials (elected or otherwise) regarding the new regime, it will be important to consider applicable laws related to communicating with public office holders, particularly with respect to lobbying registration requirements and access-to-information matters.

INTERNATIONAL TRADE

Cannabis, similar to any other commodity, is subject to Canada's customs laws respecting international trade in goods. However, in the case of cannabis, additional rules apply regarding the fact that trade in cannabis is subject to international agreements or arrangements to which Canada is a party.

In the case of importations of goods, Canada's Customs Tariff, Customs Act, and Export and Import Permits Act are the primary regulatory statutes. An importer is required to satisfy certain notification, reporting, release and accounting obligations in order to import goods into Canada. The importer must also have a business number and import account. This is in addition to any licences and/or import permits that the importer may be required to apply for/obtain from the Canada Border Services Agency (CBSA), Global Affairs Canada (GAC), Health Canada, Canadian Food Inspection Agency (CFIA) or other regulatory agencies or bodies.

In the case of exportations of goods, Canada's Customs Act and Export and Import Permits Act are the primary regulatory statutes. An exporter is required to satisfy certain export reporting requirements under the Customs Act and must ensure that any export permits necessary for the exportation of the goods are obtained from GAC or other relevant regulatory agency or body. In the case of exports, the exporter should also confirm that the goods are not being shipped or that there are no dealings with sanctioned countries, individuals or entities under Canada's Special Economic Measures Act, United Nations Act or any other sanctions-related acts and associated regulations. The exporter must also have a business number and exporter account. This is in addition to any licences and/or export permits that the exporter may be required to apply for/obtain from the CBSA, GAC, Health Canada, CFIA or other regulatory agencies or bodies. The exporter must also ensure that the cannabis being exported may lawfully be imported into the destination jurisdiction and that any approvals, licences, permits or other requirements are satisfied.

MARKETING & HEALTH REGULATORY

The extent to which the new law will restrict the advertising and branding of cannabis was, and still is, one of the key unknowns. From industry's perspective, cannabis should be regulated more like alcohol than tobacco, and the ability to brand their products (rather than sell only in plain packaging) is essential to properly compete with the black market and makes it more difficult to have counterfeit product. In contrast, many public health, law enforcement and youth experts believe strict controls are needed to minimize the risks of cannabis promotion to youth, given the challenges with partial restrictions (i.e., only prohibiting advertising that targets youth).

The Task Force on Marijuana Legalization and Regulation recommended that advertising and promotion of cannabis be strictly regulated and products only sold in plain packaging (similar to the global trend with tobacco). However, the current version of the Cannabis Act's (Act) restrictions on promotion and packaging presently fall in-between those advocated by industry and those advocated by public health and other experts.

The Act prohibits any promotion of cannabis, a cannabis accessory or a service related to cannabis, as well as any packaging, that (1) uses testimonials or endorsements; (2) depicts a person, character or animal (real or fictional); (3) constitutes lifestyle advertising (e.g., associated with a way of life involving glamour, recreation, excitement, vitality, risk or daring); or (4) is directed to young persons. Whether plain packaging will be required once regulations are introduced remains to be seen. Sponsorships are also prohibited under the Act, and promotion on the basis of price or distribution is restricted. Further, to pre-empt the use of foreign media as a loophole, the Act also explicitly prohibits the use of foreign media to promote cannabis, an accessory or service if the promotion would otherwise have been prohibited under the Act. Informational promotion or brand-preference promotion is permitted in limited circumstances (e.g., in a place where young persons are not permitted by law).

In addition to cannabis-specific restrictions, industry must remember to comply with all of the general advertising, anti-spam and privacy laws that apply to all businesses. This is especially important since a flood of class actions are expected once the private right of action comes into force on July 1, 2017, for contraventions of Canada's Anti-Spam Legislation as well as certain types of misleading advertising under the Competition Act.

There are unique privacy considerations with cannabis. For example, as privacy laws for personal information versus personal health information differ, businesses will need to keep this in mind once cannabis is legal for both medical and recreational purposes. Also, for both privacy and safety/diversion reasons, there may be issues with having packaging, or even an envelope, that identifies the recipient as someone who may have cannabis. A privacy class action against the Government of Canada is pending because several years ago Health Canada sent mail to certain Canadians that inadvertently referenced "Marihuana Medical Access Program" in combination with the addressee's name on the envelope.

Even once recreational cannabis is lawful, edibles are not likely to be permitted until a later date. Once permitted, those in the edibles business will need to ensure compliance not only with cannabis-specific laws (e.g., cannot be appealing to young persons, cannot contain any substance designated as prohibited such as caffeine, potentially), but any applicable general food laws too. The task force report specifically recommended that the labelling requirements that apply to food and beverages generally also apply to edibles. At a federal level, the food industry is undergoing some of the most significant developments and consultations in decades (including the Safe Food for Canadians Act), and any business interested in edibles should ensure it is familiar with all applicable regulatory regimes (from federal to municipal). For example, notwithstanding that dispensaries are currently illegal throughout Canada (due to federal law), some municipalities have chosen to regulate these businesses and it is interesting to note the difference in treatment of edibles, even within the same province (e.g., the City of Vancouver has banned dispensaries from selling edibles, while the City of Victoria has not, despite both being in the province of British Columbia).

PRODUCT LIABILITY

The licencing, sale and use of cannabis (both medically and recreationally) is likely to result in an increased risk of product liability claims on behalf of patients and consumers, including class action risk for the industry, both at the level of the producer and throughout the chain of distribution. Historically, product liability — particularly claims involving pharmaceutical medicines — has been a focus for the plaintiffs' class action bar in Canada, and some specific focus on cannabis has already occurred and is expected to continue. In that regard, proposed class actions were recently commenced in both Ontario and Nova Scotia against a federally regulated producer in which allegations of "negligent design, development, testing, manufacturing, and distribution" have been made after alleged unapproved pesticides were found in the product and ingested. Like other products that have risks and benefits inherent to their use, producers and distributors of cannabis should carefully consider their quality and manufacturing control processes, product warnings and proactive strategies for dealing with consumer complaints, recalls and litigation risk generally.

TAX

Sales of illegal marijuana have long been subject to tax in Canada (notwithstanding the illegality of the sales), and legal sales of medical marijuana are also currently treated as taxable. From the outset, the federal government stated its intention to "legalize, tax and regulate marijuana" in a discussion paper by the Task Force on Marijuana Legalization and Regulation. While the function of tax is primarily to raise revenues for government, in the case of cannabis it has been suggested that tax may also serve certain policy-oriented ends, including:

  • Managing price and discouraging consumption, particularly among youth
  • Funding programs associated with cannabis legalization and paying for negative external costs of cannabis use to society (e.g., enforcement and dependence treatment), as discussed in a recent report by the Office of the Parliamentary Budget Officer.

The task force advised the federal government to work with provincial and territorial governments when crafting a tax regime for legal cannabis to ensure that prices are competitive with the illicit drug market. However, another explicit recommendation was that the tax scheme should be based (at least in part) on THC potency to discourage purchases of high-potency products with higher prices, as discussed in the task force's final report.

The government has several existing models of taxes to choose from to implement these tax recommendations, including (1) sales taxes at the point of sale, based on purchase price (e.g., GST/HST or PST), (2) excise taxes payable by producers, per unit or by weight/volume (similar to alcohol and tobacco), and (3) additional taxes, whether charged at point of sale or by producers, based on potency or other considerations. The federal budget published on March 22, 2017, implied that any excise tax rates imposed on cannabis will rise over time, perhaps adjusted to the Consumer Price Index, similar to the new regime that was announced for alcohol. If the government does decide to impose excise or other taxes on producers, it will also have to consider how the tax authorities will enforce the rules to ensure that producers do not under-report their production for tax purposes.

One additional point that should be addressed by the government is the distinction between medical and recreational cannabis sales. Normally, prescription drugs are zero-rated (i.e., not subject to GST/HST). Based on existing jurisprudence, which interprets the term "prescription" narrowly, medical marijuana is considered to be subject to GST/HST because it is not prescribed, but rather a physician provides a declaration of support for an individual's application for an Authorization to Possess under the Marihuana Medical Access Regulations (SOR/2001-227). Both the Tax Court of Canada and the Federal Court of Appeal have noted that the legislation "needs work."

The task force recommended that the same tax system for medical and non-medical cannabis products should be applied, while recognizing that cannabis and cannabinoid-based medicines could be developed that are prescribed as medications and zero-rated for GST/HST purposes. Meanwhile, the Canada Revenue Agency has confirmed that it will allow the costs of medical marijuana purchased from a licensed producer as a medical expense for income tax purposes.

The forthcoming legislation presents an opportunity for the government to clarify the tax treatment of medical marijuana and make any appropriate price/tax distinctions between medical and recreational products.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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