Risks for New York’s New Legal Cannabis Businesses

Jonathan Isaacson


June 1, 2021

Protesters with signs advocating marijuana legalization.

On March 31, the Marijuana Regulation and Tax Act (MRTA) was officially signed into law in New York. The act legalizes recreational marijuana use for adults and ushers in a billion-dollar industry, paving the way for economic opportunities across many business sectors. From agriculture and manufacturing to retail and hospitality, the MRTA could create up to 60,000 new jobs and generate as much as $350 million in annual tax revenue in New York, according to projections from the office of Governor Andrew Cuomo.

However, there are considerable risks any new market entrants must consider and prepare to address before opening a marijuana-related business in New York. First, it is essential to ensure you understand and comply with the regulatory framework that will govern the issuance of licenses and permits to new businesses. While the MRTA legalized adult use of cannabis in a broad sense, implementation and regulation will be the responsibility of a newly formed, and yet to be determined, Cannabis Control Board (CCB). The CCB will be responsible for developing and administering a licensing and permitting approval process and will also have the authority to determine which applicants receive such licenses and permits.

As in any industry, once licenses and permits are issued and cannabis businesses are up and running, they will face a wide range of exposures depending upon their function. Two risks of particular concern are product liability exposures and theft, both by insiders like employees and outside actors like criminals or competitors.

Broadly speaking, product liability exposures include claims that products—whether plant buds, manufactured edibles, or even smoking/vaping devices—are defective and cause injury. There could also be claims that a company failed to properly warn of the risks associated with their products. Such claims can affect nearly every level of the cannabis supply chain, from cultivators and manufacturers of cannabis products to distributors and retailers. There are also risks of adverse health effects from contaminated products, and injuries caused by common vaping devices, which have been known to explode or catch fire. Such product issues can not only result in liability litigation, but also costly product recalls. In either case, the financial and reputational costs can be significant, particularly for a young start-up.

Fortunately, cannabis businesses can take steps to mitigate product liability exposure. It is important that growers and cultivators closely monitor their crops and comply with all regulatory guidance concerning pesticide use and other operational procedures. For those further down the supply chain, it is critical to vet suppliers and work with trusted and reputable sources. In a new and rapidly developing industry, this can be challenging. As a safeguard, cannabis businesses should ensure they have insurance that covers the risks of product liability claims and potential product recall exposures.

Unfortunately, this may be this may be difficult. As cannabis remains a Schedule I controlled substance under federal law, sale and consumption are federally prohibited, posing risks to entities that accept or process money related to the related to cultivation, sale or use of the substance. As a result of this legal grey zone, large insurers have been either hesitant or unable to accept the risk of underwriting business in the cannabis industry. Smaller specialized insurers and the excess surplus lines market currently fill this gap.

While this has resulted in capacity limitations for certain types of insurance, it is critical for any new cannabis company to navigate the difficult insurance market and secure the coverage necessary to protect against product liability risks. Upstream businesses within the supply chain should look to limit their exposure through risk transfer agreements with suppliers and/or distributors, while ensuring that these downstream businesses have proper insurance to cover product liability risk. By negotiating indemnity, risk transfer and/or insurance requirements into their agreements, retailers and other public-facing businesses can transfer portions of their product liability risk upstream.

Though not unique to this industry, theft of both product and funds presents a critical risk to cannabis businesses. Given the limited banking and credit options currently available to them, they often deal primarily in cash. As such, both employees and external actors are aware that cannabis businesses are likely to have large amounts of cash on hand. While brazen robberies may get more attention, employee theft of both funds and product is more likely to cause business losses.

To hedge against such risk, cannabis businesses at every level should invest in security measures to guard against both internal and external threats. They should closely monitor product inventories, and create and maintain detailed records. To the extent possible, inventory and cash should be kept in safes, vaults or secure facilities with limited employee access.

As with any business, cannabis companies should carefully vet candidates before hiring, provide employees with formal training, and set a zero-tolerance policy for anyone engaged in employee theft. They should also consult with employment counsel regarding their rights and obligations under relevant employment laws. To help manage employee conduct and avoid wrongful termination claims in the event of an incident, it is critical to create employee handbooks that clearly set forth the expected code of employee conduct and define the grounds for termination.

New York is only one of the states to recently legalize marijuana for both medical and recreational use. In the time since MRTA passed, New Mexico and Virginia also legalized cannabis use for adults. Earlier this year, New Jersey enacted a law legalizing adult-use recreational cannabis and is now in the process of setting up its regulatory structure. Previously, 15 other states and Washington, D.C., had legalized cannabis use for adults. By engaging in proper risk management when forming and opening their new businesses, cannabis companies can protect against the very real dangers of entering this new and evolving industry.

Jonathan Isaacson is partner at Kaufman Dolowich & Voluck where his practice focuses on liability litigation, insurance and cannabis matters.