By Jonathan Bench, Attorney at Harris Bricken
Many cannabis handshake deals result in the parties forming an inadvertent cannabis partnership. The words “partnership” and “joint venture” are often thrown around casually. Many early stage cannabis entrepreneurs know they want to do some type of business venture, often with a business partner, but they often do not know why or how to avoid forming an inadvertent cannabis partnership.
Why are cannabis partnerships bad?
Cannabis partnerships are undesirable because general partnerships as a legal entity are undesirable. If two people go into business together based on a handshake deal, they are, from that point forward, partners in an unregistered state general partnership, complete with all of the legal and state and federal tax obligations of a general partnership.
It may surprise you that the partnership is equally undesirable whether the partnership is a registered or unregistered partnership. This is because partners in a general partnership are saddled with both the good and bad aspects of a general partnership. Both partners can and do represent the partnership as equal partners, with equal rights to governance and profits and equal obligations regarding all partnership debts and other liabilities.
Most business partners agree that one partner is often better suited for business development, another for operations, and another for finances. Usually the business development partner negotiates the bullet points for a business deal but then hands off the deeper discussions to the operations partner. And if the cannabis partnership has junior and senior partners, then often the senior partner wants to sign contracts and checks.
Partnerships are rarely split equally down the middle between (partnerships of two) or among (partnerships of more than two) the partners. Usually partners go into business together because they bring complementary skills, assets, and connections to the partnership. They then delineate roles and responsibilities based on those contributions in a written partnership agreement. Good partnerships need to be established carefully.
Structuring cannabis partnerships as joint ventures
All cannabis partnerships should be documented, preferably with a partnership agreement (for registered partnerships), an LLC agreement (for an LLC), bylaws and a shareholder agreement (for a corporation), or a joint venture agreement. Any colloquial use of the phrase “joint venture” should be clarified by how the joint venture relationship will be structured.
Contractual joint venture cannabis partnerships
Under general U.S. business law regimes, a cannabis joint venture that is not a partnership is either a contractual JV or an entity JV. A contractual JV is a contract that tries to approximate a full entity relationship. This means that a typical cannabis joint venture contract will be quite complicated, similar to an operating agreement.
Technically from a U.S. tax perspective, a contractual JV should give rise to the establishment of a partnership by virtue of state law, with all of the attendant partnership obligations, depending on how tied together the parties are by the contract. There is no set legal standard on when a contractual JV becomes subject to U.S. partnership laws. Generally, these contractual JV arrangements are not reported as partnerships.
Virtually no contractual JVs acknowledge any potential partnership obligations to tax authorities or the other JV partner, which is why we often see language disclaiming the establishment of any partnership on purpose or otherwise in almost all U.S. business contracts.
Entity joint venture cannabis partnerships
An entity joint venture cannabis partnership means that the JV partners form a new business entity. This entity is often a corporation due to underlying cannabis tax implications for owners, but LLCs are also frequently used. In these entities, the cannabis partners are forming a new business venture together with all of its attendant tax and liability obligations and clear delineation of roles, responsibilities, and profits.
Because the LLC and corporation acts in all U.S. states treat these entities differently from general partnerships, potential cannabis partners should at minimum form a corporation or LLC from which to conduct their business together. Without an operating agreement in place, these owners will still enjoy limited liability based on statutory protections, which they will not have in an unintentional partnership relationship consummated over a drink and a handshake.
Re-published with the permission of Harris Bricken and The Canna Law Blog
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