Cannabis real estate remains a complex area of law, and this case demonstrates one reason why. This blog will analyze Judge Alison Tucher’s unpublished opinion in Johnston v. Novelo, filed March 27, 2020, which reversed the lower court’s decision to dismiss Holda Novelo and Landmark Real Estate Management. The messy lawsuit, which stems from the Apothecarium’s attempts to open a Berkeley location, remains ongoing in Alameda County Superior Court.
These days, discussions around unclean hands involve why we should be washing for 20 seconds with soap and water. But this discussion of unclean hands has nothing to do with COVID-19. Recently, Judge Tucher sustained Stuart Johnson’s appeal from the trial court’s decision which granted Novelo’s demurrer and dismissed Novelo from the lawsuit. This lawsuit has many moving parts, but the judge’s opinion highlighted several important lessons.
A Brief History
Back in 2016, Berkeley’s cannabis market was booming. Previously, the city had only allowed 3 dispensaries under Measure JJ, passed by the voters in 2008. In 2016, that number went up to 4, and then quickly to 6. One of the eager applicants was The Apothecary, owned by its parent company BTHHM Berkeley, LLC. They had the means to apply for the license, and the cash to see the process through. But they needed a property, as Berkeley required applicants to declare their planned location and prove that they could open a shop there.
Stuart Johnson had such a property. He owned, and continues to own the address of 2578 Shattuck Ave, within the correctly zoned district. He entered into discussions with BTHHM through his property manager Holda Novelo. The exact details of who said what remain a secret, but a letter of intent was entered into by the landlord, through his property manager, to lease the property to BTHHM the property for use as a dispensary. Rent was paid at a premium, and BTHHM was able to use the letter to apply for their license. THe city council granted them a license, but the landlord then refused to enter into a lease agreement. He stated that he did not want a dispensary on his property, and that he never intended to go through with the lease.
BTHHM, which had spent over $400,000 in the last 2 years, including $140,000 in rent payments, filed suit. They alleged breach of contract, breach of contract to negotiate in good faith, breach of the covenant of good faith and fair dealing, promissory fraud and unjust enrichment. This kind of cannabis real estate dispute is unfortunately too common largely because of the complicated licensing framework that exists in California and elsewhere.
The landlord responded to the lawsuit in several ways, including pointing fingers at Novelo and her company, claiming that the landlord believed that his property was only going to be used for the licensing application, and that the Apothecary would never open its doors on his land. He further stated that he was duped by his manager, who didn’t tell him about the letter of intent that required him to enter a lease once the license was secured.
The manager responded to the lawsuit by saying, among other things, that claims against her were barred by the doctrine of “in pari delicto” an latin phrase meaning “in equal fault”. This doctrine, similar to the concept of “unclean hands”, says that when one participant in illegal conduct tries to sue another participant in that conduct, the court will refuse to get involved. For example, imagine if two bank robbers agreed to split the cash, but then one dupes his partner and takes it all. The partner’s attempts to sue for his fair share will not go well in court.
Here, the logic was that the landlord and the manager had worked together to defraud the city of Berkeley. They created a scheme, profitable for both, where they would profit from premium rent payments made while the license application process played out. It was clear that the landlord knew about this scheme, because he signed off to have his location used in the process without planning on going through with the lease. According to the lower court, once the landlord had “unclean hands” he could not sue the manager for assisting with the fraudulent scheme. As such, the lower court granted the manager’s motion, and dismissed them from the lawsuit.
The landlord appealed, and the appeals court agreed to reverse the decision. In a lengthy opinion, the appeals court explained that not all “in pari delicto” cases are created equal. There can be circumstances where the parties are equally at fault, and circumstances where most of the blame can lie with one party. If there is an unequal relationship between the parties, such as where one is a fiduciary to the other, the court might refuse to grant the dismissal. It would not be fair for a party to avoid litigation entirely when they are largely to blame for the wrongdoing.
Here, said the court, the manager was the one who prepared the letter of intent, allegedly without telling the landlord. It was also the manager who falsely told the city of Berkeley that a lease allowing the property to be a dispensary had been executed. The landlord had also claimed that the manager refused to show him all the documents she had signed related to the premises. Ultimately the court said that it appeared that the manager had quite the central role in this scheme, and seems to have neglected her fiduciary duties to the landlord. The appeals court reversed the previous dismissal, and sent the manager back to court. The litigation is ongoing.
There are a few important lessons to take from this case. First, don’t lie on a licensing application. Don’t lie to the city, the county, or the state. Cannabis real estate may be hard to come by, but regulators are looking for any reason to deny applications. Cutting corners might work for the short term, but it doesn’t pay off in the long run. Second, courts do not take bad faith actors lightly. By denying the manager’s attempts to get out of the lawsuit, the court made it abundantly clear that it disapproved of her actions over the course of the case. This occurs often in litigation. Having a good track record, or demonstrably acting in a fair and reasonable manner can go a long way in court. Judges understand that humans are imperfect, and will often look to reasonable actions by the parties when making decisions. This decisions could be as big as who wins the case, but I’m also referring to decisions as small as minor discovery rulings, waivers of deadlines, or extensions of courtesy. Never underestimate the value of positioning in litigation.
Third, litigation is almost always really costly. The parties have probably spent tens of thousands of dollars on attorneys fees. This is on top of the amount expended by the plaintiff in rent and licensing costs. The case is also far from over, as none of the central issues in the case have been decided yet. The case is likely to get delayed even further by the COVID-19 crisis, as courts are functionally closed to all but the most essential of cases. As the case drags on, more money will be spent by all sides on keeping the case going. Even the most entitled of litigants sometimes have to pay thousands of dollars, and wait many years before they see relief from the courts. All members of the cannabis industry need to do everything they can to avoid litigation at all costs. Read our blog about another reason to avoid litigation here.
Lastly, and this is a running theme that we mention to our clients on a regular basis, PROCEED WITH CAUTION. It is too idealistic to think that everyone in the industry is acting for the right reasons. Not all of us are driven by the desire to legitimize a harmless substance and bring medicine to the people. Some industry members are in it to capitalize on a new and upcoming market, and they will not hesitate to trample others in an attempt to do so. When engaging in business, be sure you know and trust who you are dealing with. If a deal seems too good to be true, it probably is.
It is important to remember the quote often attributed to Otto von Bismarck: “Only a fool learns from his own mistakes. The wise man learns from the mistakes of others.” In this industry, don’t be the fool who learns only after you make a mistake. Read about what others have gone through, and adapt to avoid those mistakes. Or speak to an attorney who has already done the research.