The cannabis industry is built on state-level licensing regimes that favor - to varying degrees - in-state residents over out of state competitors. Industry observers (hello Nerd Corner!) have been speculating for some time as to whether this residency component of the licensing process can survive scrutiny under the Dormant Commerce Clause - the constitutional provision prohibiting protectionist-style laws and regulations between the states. A recent decision by a Missouri federal court banned the State's residency rules for its medical cannabis program and provided yet another indication that the residency requirements don't pass constitutional muster. In other words, the Dormant Commerce Clause may be poised to alter the foundation of the cannabis industry as we know it.

Dormant Commerce Clause 101

As suggested by its name, the Dormant Commerce Clause is not found in the express language of the U.S. Constitution. Instead, it is (as one federal District Court recently put it) the "negative aspect" of the Commerce Clause. NPG, LLC v. Portland, 2020 WL4741913, *2 (D. Me. 2020). Found in Article I, Section 8, Clause 3, the Commerce Clause entitles Congress "to regulate commerce with foreign nations, and among the several states, and with the Indian Tribes." The Dormant Commerce Clause refers to the notion that states should not be permitted to promulgate laws or regulations that are "designed to benefit in state economic interests by burdening out-of-state competitors." Id. Simply put, the "Dormant Commerce Clause is intended to effectuate the Framers' purpose to prevent a state from retreating into economic isolation," and invalidates laws and regulations that discriminate against out of state competitors unless (i) Congress has explicitly permitted the State to restrict the flow of interstate commerce in such a manner, or (ii) the law or regulation furthers a "legitimate local objective that cannot be served by reasonable, non-discriminatory means." Id.

Residency Requirements in the Crosshairs

Residency requirements and residency-based scoring criteria have been a feature of state-level cannabis regulatory regimes since day one. While their specifics can vary across jurisdictions, residency components often play a significant role in determining who gets a license to operate, manufacture, distribute or sell medical and/or adult-use cannabis products within a particular state, and who doesn't.

For example, Montana - which is currently launching its adult-use program - will deploy one of the strictest residency requirements in the country, limiting the issuance of cannabis business licenses to Montana residents only. For a more subtle use of residency requirements, one need only look to the State of Maine, where the City of Portland awarded 5 of a possible 34 points to adult-use licensing applicants if they were "at least 51% owned by individual(s) who have been a Maine resident for at least 5 years," and additional four points to individuals that had been previously licensed for a non-cannabis related business in Maine (accounting for more than 25 percent of the total available points) NPG, LLC, 2020 WL4741913, *2 (D. Me. 2020). Of course, Maine's scoring criteria was ultimately struck down by a federal court, which cited - you guessed it - the Dormant Commerce Clause as its basis for doing so. Id.

It's easy to see how these kinds of residency requirements could raise serious constitutional issues under the Dormant Commerce Clause - whose entire reason for being is to prevent interstate commercial discrimination based on residency. While state and local governments can try and justify their residency requirements by asserting (as many have) that they advance a compelling local interest (a heavy burden under constitutional case law), the fact is that residency-based components that favor in state residents (or exclude out of state competitors all together) are disfavored under current Dormant Commerce Clause jurisprudence.

Once is an Incident; Twice is a Trend . . .

Which brings us to the recent decision by the United States District Court for the Western District of Missouri in the case of Toigo v. The Missouri DHSS (Case No. 20-cv-4243). The plaintiff in Toigo was a member of the ownership group for Organic remedies, an MSO with vertical licenses in Missouri and Pennsylvania. But because Toigo was a Pennsylvania resident, he was restricted to a minority interest in any Missouri-licensed medical cannabis entity. Toigo argued that the 51% in-state resident ownership requirement unfairly discriminated against him and other non-Missouri residents and violated the Dormant Commerce Clause.

Following the entry of a preliminary injunction in Toigo's favor and a bench trial, it took Senior District Judge Nanette K. Laughrey only 7 minutes to conclude that Toigo was right, and that Missouri's rule requiring that medical cannabis license holders be 51% owned by in-state residents ran afoul of the Dormant Commerce Clause. Judge Laughrey ruled from the bench and has indicated that a written decision is forthcoming.

Together with the decision in NPG, LLC v. Portland, the decision in Toigo could signal something of a trend. At a minimum, the decision could embolden other non-resident plaintiffs to challenge the residency requirements of other state and local governments. Before long, we could have something of a national consensus on which (if any) residency-based licensing criteria are permissible under the Dormant Commerce Clause. And if the decisions by federal courts continue trending in their current direction, the cannabis industry may soon be looking at an entirely different playing field when it comes to winning the all-important licenses they need to conduct their business.

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.