Lawyers Karsten Lee and Robert Eisenberg talk about how cannabis is the new "big thing" in retail. They provide a detailed breakdown of the various challenges that cannabis leasing can present in the Canadian context. This is part two of a two-part series.
Narrator: You're listening to WeirTalking Leasing, an eight-episode podcast series from WeirFoulds LLP Commercial Leasing Group, educating landlords, tenants, and property managers on today's commercial leasing landscape in Ontario. Our legal specialists will be discussing everything new and interesting from lease terminations, office sharing, unattractive properties, cannabis, and so much more. This is part two of two episodes on cannabis and leasing.
Karsten: Turning back into leasing issues within cannabis, so a few stores have actually opened, and a lot of deals have been done. So a lot of the landlords can now see exactly what's going on. Going back to your initial story about long lineups and possible security issues, how have landlords taken the view of actually leasing for actual cannabis uses? Are they really as unique and scary as people had originally thought?
Robert: There are specific issues that should be thought about. They're not necessarily unique issues, but they're issues that we talk about in leasing, but that you need to think about in a slightly different way when you're dealing with cannabis. So one of these is use clauses. This is much less of an issue in Ontario than we originally thought it would be. When we first started doing the deals, people were really concerned about limiting the type of cannabis that can be sold. Can you ingest it on premises, out of premises? What can they sell? Can they sell a Bob Marley t-shirts in the store as well?
Robert: People were concerned about these things turning into head shops that also sell cannabis. But the statutory framework in Ontario has really limited what can be sold in stores. So in Ontario, by law, cannabis stores can only sell three things, cannabis, cannabis accessories, so rolling papers, bongs, things like that, and shopping bags. However, this is going to be a much bigger issue once edibles become legalized. Because when the federal government legalized cannabis last year, it was only for dried cannabis and some oils.
Karsten: So in-store consumption of cannabis, the ability to have smoking lounges for example, is that legal?
Robert: Well, that would depend on the
provincial legislation. So in Ontario, we have the Smoke Free
Ontario Act, which restricts where smoking can be. And again, it
would be treated the same as smoking cigarettes.
Because right now, the only way to legally purchase and consume cannabis, unless you're baking it yourself, which is still technically illegal, is to buy dried cannabis or oils and ingest that or smoke it. So for the most part, what we're seeing is people are taking their cannabis and they're smoking it, which you could only do in the same places that smoking cigarettes is legal right now. So if you go to a park or something like that, but you can't go into a restaurant or bar and light up a joint.
Karsten: Going back to the lease, we've already spoken about the use clauses. What other clauses and issues should we be thinking about when we're entering into a lease?
Robert: Another thing to think about is waste disposal, which is not something you usually think about. Usually if you have a little plaza or a building, you take your garbage and throw it out in the dumpster behind the building or in a common garbage room. You can't do that with cannabis. It's similar to alcohol. If there's damaged bottles, you can't just throw them in the bin because someone can come along and take it. And you have to be able to control who it's being sold or provided to.
Robert: So one of the things that I'm doing is when I'm putting together a lease for a landlord for a cannabis use, we're being very clear that the tenant is solely responsible for disposing of any cannabis or cannabis-containing products in accordance with all laws at its own cost. So I don't want anything to do with it. Don't put it in my common garbage room. Don't put it in my dumpsters. It's your problem to take care of it.
Karsten: So how about smells? I know that smells has been a very large concern that some landlords have had.
Robert: Yeah, it's probably one of the biggest concerns apart from the unsavory characters that everyone has been telling horror stories about. But the smell is a big thing, because obviously the smell of cannabis, it's very strong. It's pungent. A lot of people are morally offended by it. So landlords especially are very concerned that when they put in a cannabis store, the smell is going to seep out into common areas. It's going to seep into neighbouring spaces. Other tenants are going to get unhappy. Patrons of the the plaza, the shopping centre are going to get unhappy.
Robert: I think it's a little bit overblown, especially in Ontario's context. Because by law, cannabis has to be sold in sealed packages, which means there's going to be less of a smell. However, what we are seeing and what is permitted is these boxes called sensory display containers. And that's where you can go into a store and there's a little box and they take the lid off and you can see the cannabis. You can smell it to really get a sense of what you're buying.
Robert: So obviously, there may be some smells in the store. I don't think this requires any drastic change in how we approach leases. Maybe think of it in the same way you think about restaurants or anything else where there's a strong smell. Consider the nuisance provisions in your lease. Consider whether there's any specific HVAC or ventilation requirements. Who's responsible for that? If there's a concern, the landlord can put an obligation on the tenant if other tenants complain or if I require you, you have to change the ventilation or you have to install your own HVAC unit.
Robert: And then obviously you can put in strong landlord rights if there is an issue. If there's a smell issue, the landlord can go in and create new HVAC or even terminate if it becomes necessary. If the smell is just bothering so many other tenants and you say it's not worth the problem, the landlord can put in the termination right. Depending on which tenant you're dealing with, right now it's a little bit harder to get those provisions just because the tenants have a little bit more leeway because there's only 25 of them operating. But once it becomes a free market, you can say you don't want this space. There's 10 other people in line who want it.
Karsten: And how about security issues?
Robert: Again, I think it's similar to alcohol. These stores have requirements on them imposed by law about checking IDs, preventing loitering, anything like that. But beyond that, you can always put into your lease if there's extra loitering. If I require extra security because of your use, I can do it as the landlord and charge it back to you and you've got to pay for it. So there are pretty simple ways to cover off any concern about that. But for the most part, we haven't really seen that being an issue.
Karsten: And any other clauses or issues in the lease that we should be thinking about while we're negotiating it.
Robert: The other big one I can think about is access. Usually in leases, especially on the landlord's form where there's a power imbalance in favour of the landlord, the landlord often has the right to enter the premises whenever it wants on brief notice to check them out, to do repairs, et cetera. From a tenant's perspective, and also from a landlord's perspective, they should think about modifying those provisions a little bit because there are restrictions on who can access areas where the cannabis is being kept.
Robert: So if you're a landlord, you might want to say, "Well, it's my store. I can go in whenever I want. It's my property." You might want to have a representative of the tenant there. You might want to make sure you're not alone in the store with the cannabis just because it can put you offside of some laws. And the other thing to think about is distress. Often landlords like to maintain the remedy of distress where if the tenant defaults, doesn't pay their rent, you can go in and take their stuff and sell it.
Karsten: That sounds like a really good remedy to me if I was the landlord.
Robert: Yeah. The problem is you can't do that because you don't have the license to possess or to sell cannabis. So, be very careful not to do that or you're opening yourself up to not only civil penalties, but it could be criminal as well.
Karsten: Now in my own practice, I've come across some pretty interesting termination rights in cannabis leases, both from a landlord's point of view and from a tenant's point of view. What do you think about those termination clauses?
Robert: Well, we talked about it a little bit earlier. But I think it's worth mentioning again is what we are seeing in these cannabis deals are more termination rights than you're used to, both in favour of the landlord and in favour of the tenant. On the landlord side, and again, it depends on the negotiating position, but we're seeing some termination rights, a variety of them actually. One of them would be if the tenant doesn't get their license by a set date, then the landlord may decide they want to recover their space. They don't want a dark storefront for an indefinite period, especially where that hurts their business.
Robert: Other landlords might not care. They might say, "Well, the tenant's paying me rent. I don't care if it's a dark storefront. I don't want to terminate." So they might give that up or they might not exercise. More common are termination rights if the tenant's license to sell cannabis is revoked, suspended, or expires. And in that situation, the landlord's going to say, "Well, you're clearly not a responsible operator. I want you gone."
Karsten: So we'll need to think about adding that as an event of default. If we're acting for landlords.
Robert: You can put it in as an event of default or you can put it in as a separate termination right. There's different ways to think about it. The danger with putting it in as an event of default is you're more limited by the default remedies and cure periods and notice periods. Whereas if you put it as a termination right, we've seen is, "Tough luck. You lose it, you're done. I can kick you out on two days notice whatever it is."
Karsten: No, that's a great practice tip and a different way to think about termination rights and default and how they interplay with each other.
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Karsten: Now we've spoken a lot about the retail side just because that's what's on the forefront of the media and a lot of the deals that have been popping up. However, before it gets sold to the retail...on the retail side, it actually needs to be grown. So that would be more on the industrial sector of leasing. What have you seen as some of the major issues?
Robert: Well, you're absolutely right. Contrary to popular belief, cannabis doesn't just grow on trees.
Karsten: It grows in a pot.
Robert: It does. We're not looking at people growing a couple of plants in their backyard or anything, which people are allowed to do now. But we're really talking on an industrial scale, really big operations. Honestly, it's a much bigger industry right now than the retail is in Ontario especially. These industrial sites are huge. Millions of dollars in equipment goes in. They consume enormous amounts of power. These are just a couple of the things to think about when doing an industrial cannabis lease. Like I said, the utilities is a big thing. There's going to be huge power and water consumption to grow cannabis.
Robert: So if you're a tenant and you're going into, especially in a multi-tenant site, you're going to be concerned about utilities. "Am I going to have enough capacity to do what I want?" If you're a landlord and you don't have separate meters, you're going to want to make sure that you have the ability to either charge this specific tenant based on their actual consumption or to adjust their share on an equitable basis. You don't want to end up with a multi-tenant site where you have to charge utilities on a proportion share, but you've got this cannabis tenant then using 90% of your power, but only paying 50%. That's not going to go well for you with your other tenants.
Robert: Some other things to think about, alterations and security. With industrial space, usually landlords are a little bit more willing to let tenants customize the space. But again, they might have to make significant alterations to the building in order to comply with the requirements of Health Canada. There's some very big security requirements they have to make.
Robert: In terms of access, we're looking at similar to what we talked about on the retail side. Landlords aren't able to just waltz in. You can't go in and just take the product if they don't pay their rent. But one of the most interesting, and I think more unique things, that I've been seeing on the industrial cannabis side is tenants are really pushing for options to purchase, or rights of first refusal, in the building.
Robert: A lot of them are very optimistic that we're entering into this deal now, but we're going to want to control the space and customize it and be there for a long time. So I'm seeing a lot of them are really pushing for these rights. It's an open question whether the landlords want to grant these rights in the first place. But if they are willing to grant it and it's open for discussion, like always, you need to think about what triggers the option.
Robert: Is it only a right of first refusal if someone else wants to sell the building? Is it if a landlord decides they want to sell, do they get the first offer? Or you had a straight up option to purchase? And if that's the case, you need to set up what are the terms going to be, how are we going to evaluate the value of the building? All the things that you usually deal with in rights of first refusal or options to purchase, but they're really coming to the forefront in industrial cannabis deals I think in a way that is a little bit surprising.
Karsten: So what we've been talking about previously was on the retail side. The ability to sell on a retail scale has been heavily legislated. Would you say that it's the same system on the industrial side? Is it also very heavily regulated by legislation?
Robert: It is, but it's different. So like I said at the beginning, there's really two tiers operating here. There's the provincial, which is governing retail sales. But industrial production of cannabis is right now covered by the federal government. It's managed through Health Canada, so you have to apply to them for license producer status. There's various different licenses and permits you can get from them. There's production. There's wholesale. Can you sell seeds? Can you sell plants? Can you sell dried cannabis? It is all very heavily regulated. It's just regulated by the federal government.
Karsten: Can we say that landlords who are entering into these industrial deals with cannabis growers can rely, to a certain extent, on the fact that the producers are heavily regulated and that they have to act and grow these plants in a certain way that can't be completely offside and damaging to the landlord and their properties and all that?
Robert: Yeah, I think there's some comfort to be found there in the same way that if you're dealing with any regulated profession, medical or dental or anything like that where there are professional guidelines or obligations that they have to abide by. It's some comfort that you think, "Well, this person wants to run their business. They want to make money so they're going to comply with these obligations. So that's a little bit less I have to worry about." But at the same time, if there's a concern, I would say it's always better to try to address it in the lease and try to tighten up what a default is. Because let's say they fail to comply with their obligations. Well, then they're in trouble with their regulator. Maybe they can't operate. But maybe you don't have the recourse that you want to get them out of your property.
Karsten: So we need to think about possibly inserting some termination rights in the event that they're not abiding by specific laws that have to do with growing and cultivating cannabis.
Karsten: So this has been great. Now as a final question, what do you see as some of the biggest emerging issues in the cannabis leasing sector here in Canada?
Robert: I'll give you three of them. The
first is food and beverages. Like we said, edibles are coming down
the pipeline, and we need to start thinking about it now.
What's going to happen? Are we going to start
seeing a proliferation of cannabis cafés? Is it going to be over-the-counter takeaways of cannabis milkshakes and burgers or whatever it's going to be? So landlord and tenants should be very careful right now in how they word their use clauses. Landlords, obviously, you want to make them as narrow as possible: the sale at retail of dried cannabis for offsite consumption.
Robert: Tenants are going to want to make it broad. They're going to want to say cannabis in all its forms or anything like that. Obviously, the power dynamics here are going to drive this depending on whether you're dealing in a province where you're a public model, you're dealing with a crown corporation or you're in a private province where there's a little bit more leverage on the landlord side.
Robert: The second issue is the future of medicinal cannabis, which we haven't talked about. But as it stands right now, all we've talked about is recreational cannabis. The current medicinal system has remained in place so far, and that's that the only way to get legal medical cannabis is to go to your doctor, get a prescription, and then order from a licensed producer and have it delivered by mail. It's still the only way to get legal medicinal cannabis. So in terms of thinking about the future, again, when dealing with the use clause, if you're putting in a storefront, say recreational cannabis, we don't want them selling any medicinal cannabis right now. In the future, we don't know what's going to happen. So we don't want to hamstring ourselves as landlords. Also make sure to carve that out from any exclusive you've given. I've seen landlords offered a tenants, "You'll be the only cannabis retailer in my shopping centre."
Robert: I would say, "Well, hold on there. We don't know what's going to happen with medical cannabis in the future." The pharmacies are angling right now that they want to be the ones that sell medical cannabis. So, if you give them an exclusion on cannabis, you might not be able to put in a pharmacy in the future if they want to sell cannabis. So I'd say tighten it up. Recreational and medicinal, treat them as completely separate products.
Robert: And the third future issue that I think is really interesting is what are we going to do with so-called craft producers? We've got craft beer everywhere, where you go to the brewery and there's a little a bar or restaurant on site and you can sample. What are we going to do with onsite consumption in the industrial arena?
Robert: The provincial legislation did leave open the potential that licensed producers would be able to open up some shops, but it would have to be on their property. I haven't seen any of those yet, but it's something to think about. Are we going to start getting, in the same way people go to breweries, are people going to start going to cannabis production facilities? And how are we going to deal with sales there? If you're doing a lease for an industrial facility and you're a producer, you might think, "Well, I want to carve out the ability to operate a little bar or a restaurant or a café or a gift shop or something like that." So something to think about for the future.
Karsten: All very exciting issues that might come up. We're only scratching the surface of cannabis sales and cannabis consumption. I'd like to thank you for joining us today, Rob.
Robert: It's a pleasure.
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