While more than two-thirds of the states have created a cannabis legal framework of some kind, federal law still classifies cannabis as a Schedule 1 controlled substance under the Controlled Substances Act. This article discusses how the federal illegality of cannabis affects the enforceability of cannabis-related contracts even in those states that have legalized it. This article further discusses recent case law in the Ninth Circuit addressing the enforceability of binding arbitration clauses in cannabis-related contracts.
In California, a court can declare a contract void and unenforceable if it was entered into for an illegal purpose. This principle is established by the California Supreme Court and California statutes, including California Civil Code Sections 1598 and 1608.
Because the cultivation, distribution, sale, purchase, possession, manufacture, and use of cannabis is a federal crime, cannabis-related contracts run the risk of being declared void and unenforceable. As a consequence, many cannabis companies may find themselves in the precarious position of being unable to seek damages or other remedies for breach of contract.
However, including a mandatory arbitration clause in agreements is an important tool that many cannabis businesses use to increase the likelihood that their contracts will be enforced. In addition, to reduce the risk that the entire contract is deemed void and unenforceable, many cannabis businesses choose to add severability clauses to their contracts specifically addressing the application of federal cannabis law. These severability clauses provide that any invalid, illegal, or unenforceable provisions shall be severed from the contract so as to preserve the validity of the remainder of the agreement.
Recently, these concepts were discussed by the Ninth Circuit in Williams v. Eaze Sols., Inc., 417 F. Supp. 3d 1233 (N.D. Cal. 2019), which clarified that (i) a cannabis-related contract can be formed despite the fact that it is for an unlawful purpose, and (ii) arbitration clauses in such contracts are severable and can be separately enforced from the remainder of the contract.
In Williams v. Eaze, a consumer brought a putative class action against Eaze, a company that operates a mobile app and online marketplace to facilitate the delivery of cannabis products from dispensaries to consumers. The plaintiff alleged that Eaze violated the Telephone Consumer Protection Act by sending consumers unsolicited, autodialed text messages.
The app’s terms of service contained an arbitration clause with a class-action waiver. The arbitration provision also included a delegation clause, under which the parties agreed that any challenges to the validity and scope of the contract as a whole are to be decided by the arbitrator.
The plaintiff sought to avoid enforcement of the arbitration clause, arguing that no contract was formed because the contract was for an illegal purpose, and the arbitration clause was therefore unenforceable. The court, however, rejected plaintiff’s argument, holding that under California law, a contract had been formed, and once a contract had been formed, the court could sever the arbitration clause and enforce it under the Federal Arbitration Act (the “FAA”). Thus, the court granted Eaze’s motion to compel arbitration, enabling the company to avoid a class action.
The court explained that, under California law, the consequence of an unlawful purpose is not that a contract was not formed in the first place, but rather that the contract cannot be enforced. The court then followed precedent from the US Supreme Court in Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, 445-46 (2006), which established that, under the FAA, an arbitration provision is severable from the remainder of a contract that is challenged as being void or unenforceable for illegality.
Finally, it is important to note the narrowness of the holding in Williams v. Eaze. The court merely held that a contract was formed and that its arbitration clause could be severed from the contract to determine enforcement of that clause only. The court did not determine the enforceability of the contract as a whole, and expressly left that determination to the arbitrator.
In these uncertain times, it is important to protect yourself and your business from unnecessary liability or financial missteps. Be certain to consult a competent attorney to ensure that you are preserving all your rights in your contracts.
Disclaimer: This article has been prepared and published for informational and educational purposes only and is not offered or intended, nor should it be construed, to be legal advice.