Doing Business in South Dakota - Implications for the Marijuana Industry

Medical marijuana is now legal in South Dakota.  Recreational marijuana legalization, however, remains a topic of discussion.  Even if South Dakota continues down this path, people and businesses looking to get in on the “action” of this new industry need to be aware of lingering legal pitfalls and traps. 

Most of these issues arise from the fact that marijuana remains illegal under the federal Controlled Substances Act.  Congress and the Department of Justice have taken various steps to clarify that marijuana-related activities that comply with state law will generally not be investigated or prosecuted (particularly those related to medical marijuana).  But this policy of non-enforcement does not eliminate the obstacles presented by non-criminal aspects of federal law.

Tax Implications

Regardless of state legalization, businesses engaged in the sale of marijuana likely cannot deduct most business expenses, other than the “cost of goods sold” when filing their federal taxes (IRS Section 280 E).  In fact, the Tenth Circuit Court of Appeals upheld an IRS inquiry into a Colorado cannabis business’s sale of cannabis for purposes of conducting an audit regarding Section 280E compliance, upholding the federal government’s criminalization of marijuana in the process. 

Relatedly, IRS Form 8300 is to be submitted by recipients of $10,000 in cash or more in a single transaction.  This aids in combatting money laundering.  However, because marijuana businesses sometimes have difficulty obtaining conventional bank lending and account services, they are more likely to engage in cash transactions.  This use of cash increases their need to diligently comply with cash reporting requirements and the likelihood that their suppliers and vendors will need to do the same. 

Insurance

Businesses typically want liability insurance protection, and medical marijuana businesses will be no exception.  Most business liability insurance policies do not have a specific exclusion regarding cannabis services.  However, many policies have a provision stating as an exclusion “[d]ishonest, fraudulent, criminal, deliberate, intentionally wrongful, or malicious acts or omissions committed by or at the direction of, with the knowledge of, or ratified by any Insured.”  Given the continued clear illegality of marijuana under federal law, it’s not clear how these policy provisions will be interpreted.

Bankruptcy Protection

Several courts have ruled that businesses whose operations constitute federal crimes cannot take advantage of the federal bankruptcy system, which also calls into question what rights the creditors of marijuana businesses will have in the bankruptcy system.  In fact, bankruptcy courts have even dismissed cases where the debtors did not operate cannabis businesses but operated ancillary companies manufacturing or selling equipment that may be used to cultivate marijuana.  

Intellectual Property

Federal intellectual property laws also present obstacles to cannabis businesses.  The United States Patent and Trademark Office typically rejects cannabis trademark applications on multiple grounds such as the illegality of marijuana under Controlled Substances Act, coupled with the “use in commerce” requirement of federal trademark law, because “commerce” is defined in federal trademark law as “all commerce which may be lawfully regulated by Congress.”  However, obtaining a patent on cannabis and cannabis-adjacent technology is possible because there is no “use in commerce” requirement in the patent laws.  Still, no court has firmly opined whether infringement litigation related to these devices is possible, given the exclusive federal jurisdiction over patent litigation.

These are just some of the issues that remain for the unwary looking to jump in to the marijuana business or a cannabis-adjacent field, and for lenders and other businesses who are considering doing business with a cannabis-related business.

Written By: Sander J. Morehead