Social Equity Leave Many Angelenos Dazed and Confused

Posted by Margolin & Lawrence on July 25, 2019

Undue Concentration and Social Equity Leave Many Angelenos Dazed and Confused

Los Angeles should take steps to promote fairness and reduce the perception of corruption.

The City of LA is moving along with “Phase 3” of its commercial cannabis licensing, the first opportunity for new cannabis businesses to obtain licenses.  Verifications from the Department of Cannabis Licensing for Social Equity status, required to apply for one of the upcoming 250 retail storefront licenses, are beginning to roll in.  Applicants are seeking to lock down properties in one of the allowed zones and outside 700-foot buffers surrounding schools, parks, existing licensed dispensaries, and other sensitive uses before the September 3 opening of the initial round of 100 dispensary licenses.

While much of the licensing process is straightforward, certain features of LA’s cannabis procedures have left some scratching their heads, and wondering whether the process of awarding the licenses can possibly be fair.  One topic causing angst and confusion is the City’s methods for allowing applicants in areas of “undue concentration” to bypass the normal process for obtaining licenses by obtaining special approval from the City Council.

In some parts of LA that have not yet reached “undue concentration,” defined as more than one dispensary per 10,000 people, there is an objective process in place, with clear standards, for applying for and obtaining a cannabis license.  But in areas of the City that have already reached undue concentration (including downtown), applicants may obtain a license only by obtaining a finding from the City Council that their existence “would serve public convenience or necessity.”  This is done by securing approval from their local councilmember. Without such approval, there is no way to apply for the license. Unfortunately, the City has so far provided no guidance or objective standards as to how anyone is supposed to judge whether a particular proposed dispensary “would serve public convenience or necessity.”  It is an inherently vague and ambiguous standard, left totally to the councilmembers’ discretion. Without any transparent regulation in how approvals or denials should be determined, applicants are left out of the process and easily denied the opportunity to a fair and unambiguous chance. 

Given the undue concentration rules, some have speculated that councilmembers could threaten to withhold approval of proposed projects unless applicants donated money to funds selected by the councilmember, or could base the approval on any number of any other inappropriate factors.  Even if nothing illegal is done, this process will end up favoring large corporations and rich people over small businesses, as the deeper pockets with more capital and access to those in power will take steps to sway City officials in ways that benefit them.  

Such a situation could certainly create the appearance of corruption, and is not ideal for a City government already saddled by an FBI investigation.  It could also lead to costly litigation from parties who claim to be treated unfairly. In order to address this problem, we would suggest the City drop the entire concept of “undue concentration.”  It is difficult to understand why it is inherently bad for dispensaries to be located in areas with other dispensaries. It makes sense that they would be more prevalent downtown, which has many visitors and workers  in addition to its residents, or in existing entertainment or shopping districts, or even brand new cannabis-focused districts. The undue concentration laws prevent the most sensible distributions of dispensaries around the City, which would be based on supply and demand, and instead bases the distribution on potentially arbitrary or corrupt decisions of local politicians.  Studies have shown that dispensaries increase both safety and property values in a neighborhood. Such new businesses also create jobs and tax revenues. In any event, any concerns regarding over-saturation of licensed dispensaries, to the extent anyone even has such concerns, could be dealt with during the public hearings that are already required for each new dispensary.

Another area that has engendered confusion is the Social Equity program.  LA has an ambitious Social Equity program intended to provide special benefits to applicants most likely to have been harmed by the pre-2016 marijuana prohibition.  As part of this program, every applicant for one of the next 250 dispensary licenses needs to demonstrate that at least ½ (for Tier 1) or ⅓ (for Tier 2) of it is owned by someone who qualifies as a social equity applicant, based on the right combination of having a prior cannabis arrest or conviction, low-income status, and/or residency for a minimum period in one of certain LA zip codes where the most marijuana arrests have occurred.  Beyond this requirement, there is no legal restriction on the relation between investor and social equity applicant, 

75 of the first 100 dispensary applications are reserved for applicants owned 51% or more by a Tier 1 social equity applicant, who is required to be both low income (under $45,644 per year) and either (a) have a prior cannabis arrest or conviction, or (b) have lived in specified zip codes with the most cannabis arrests for at least 5 years.  Many questions, however, have arisen regarding what it means for the low-income social equity applicant to have the majority equity interest, and how this arrangement will work in practice, given that someone else will have typically invested a lot of money toward startup expenses of the business. The DCR has informed applicants that investors loaning money to a cannabis business for startup expenses may get their loans back with interest before profits are distributed.  In addition, dispensaries are allowed to have management agreements whereby the managers of the storefront receive compensation including bonuses based on the performance of the business.  

Some have expressed concerns that social equity applicants may end up as mere figureheads, with no substantial financial benefits from the companies, as investors structure contracts so that profits are never distributed to the social equity applicants.  This could be done, for example, by entering into a management agreement where the investors are the managers and receive, as performance-based compensation, all of the revenues that exceed the company’s expenses. Under this arrangement, the company would appear to break even every year and never distribute profits, even with large amounts of money distributed to the managers as compensation.  Some are also concerned that investors could enter into unpublished “side deals” with social equity applicants, essentially committing a fraud on the City by claiming the social equity applicants are majority owners when in fact they are not. The City’s laws already prevent such arrangements, requiring disclosure of all financial arrangements, but many are concerned regarding whether or how this will be enforced, and whether people trying to follow the law will be able to fairly compete with those who flout the law.

The City could add some minimum standards to the social equity program that would ensure social equity applicants receive tangible benefits, as the program was intended.  One workable standard could be a requirement that the social equity applicant either be provided a job at the new business making at least a minimum income (say, $70,000), or if no such job is provided or available, that the social equity applicant is entitled to receive at least a specified portion of revenues before they are distributed to lenders or managers.

We hope the City continues to take steps to ensure everyone is treated fairly, to avoid the appearance of corruption, and to promote the laudable goals of the social equity program.  A good start would be to eliminate the ill-advised undue concentration policy, and to publish minimum objective standards for the social equity program so that everyone is playing by the same clear rules.

Update on Delivery Applications in LA County, Ventura County, San Diego County and Santa Barbara County

Posted by Margolin & Lawrence on July 23, 2019




This blog is not intended as legal advice and should not be taken as such. The possession, use, and/or sale of marijuana is illegal under federal law.