Marijuana Policy Gap: Insurers' Uncertainty

The number of states that have legalized marijuana use continues to grow, as 33 states have already approved medical use, with 10 of those states having approved recreational use, as well. According to New Frontier Data, a leading cannabis market research and data analysis firm, the legal cannabis market is expected to grow to $25 billion by 2025. The industry reached $10.4 billion by 2018, with $10 billion of investments in North America, more than twice the amount of the last three years combined.​ Despite the trend toward legalization at the state level, marijuana remains a Schedule I controlled substance under federal law, thus creating the “Marijuana Policy Gap” as characterized by a March 2017 report of the Congressional Research Service, The Marijuana Policy Gap and the Path Forward. Under the Federal Controlled Substances Act (CSA), the cultivation, sale, distribution and possession of marijuana is illegal, irrespective of individual state constitutional provisions, statutes and regulations that legalize and regulate marijuana. The Marijuana Policy Gap is creating uncertainty as businesses consider whether, and in what capacity, to enter the legal marijuana industry. As with any other industry, marijuana-related businesses (MRBs) require adequate insurance coverage to protect against a wide range of risks. However, the Marijuana Policy Gap is serving to limit insurance options available to MRBs to smaller specialized insurers and the excess and surplus lines market, as larger admitted carriers remain cautious with respect to the exposure associated with underwriting marijuana-related risk. This uncertainty is due, in large part, to conflicting judicial opinions on the enforceability of insurance policies purporting to cover marijuana-related risk and the shifting approaches of the Department of Justice (DOJ) in its enforcement of the CSA. While principles of contract law generally prohibit courts from enforcing agreements that are illegal or against public policy, the current dichotomy between state and federal law creates an interesting and often confusing dynamic. See also: Legal Marijuana: An Insurance Perspective   This article will highlight this evolving dichotomy being created as courts attempt to balance the federal regulations deeming marijuana an illegal substance against those states that have determined that marijuana use provides certain benefits to their citizens. Under the Supremacy Clause of the U.S. Constitution, federal law generally preempts conflicting state law. This principle was central to a decision by the U.S. District Court for the District of Hawaii in 2012 in Tracy v. USAA Cas. Ins. Co., 2012 WL 928186, Civil No. 11-00487 LEK-KSC, March 16, 2012. In Tracy, the court held that USAA was not obligated to provide coverage under a homeowner’s policy for theft of an insured’s marijuana plants. In doing so, the court agreed with USAA’s argument that, although the insured’s possession and cultivation of marijuana for medical use was legal under Hawaii law, it was illegal under federal law and that federal law controlled based upon the Supremacy Clause. Thus, the court concluded that it was against public policy to force USAA to provide coverage for the illegal plants. The following year, the U.S. District Court of New Mexico in Hemphill v. Liberty Mut. Ins. Co., No. CIV 10-861 LH/RHS, at 4 (D.N.M. October 23. 2012), expressly adopted the court’s reasoning in Tracy, concluding that an insurer was not obligated to provide coverage for the use of medical marijuana. The court stated that it could not force an insurance company to cover medical expenses pertaining to use of a product that was illegal under federal law. However, the evolving approach of the U.S. Department of Justice (DOJ) toward lenient enforcement of the CSA in states that have legalized marijuana appears to be generating a shift in judicial philosophy on the enforceability of marijuana-related contracts and the coverage provided through insurance policies. In August 2013, a memorandum issued by then deputy-Attorney General James M. Cole stated that, as a matter of prosecutorial discretion, the DOJ would not prosecute federal marijuana offenses in states where marijuana was legal and where “strong and effective regulatory and enforcement systems” were implemented to control the cultivation and sale of marijuana. The “Cole Memorandum” noted that effective state regulation would probably address federal concerns regarding the threats that marijuana posed to public safety, thus obviating the need for federal enforcement. Against this backdrop, the U.S. District Court for the Northern District of California in Mann v. Gullickson, 2016 U.S. Dist. LEXIS 152125 (N.D. Ca. 2016) held, in a 2016 decision, that a stock purchase agreement for two companies that provided equipment and consulting services to the marijuana industry was enforceable. The court upheld the agreement notwithstanding the argument of the purchaser that the stock purchase agreement was void because it involved the sale of businesses engaged in activities that were illegal under federal law. The court further noted that, since Tracy was decided, the federal government had shifted its priorities from enforcement of the CSA in states that permit the use and cultivation of marijuana. The court observed that there had been an “erosion” of a clear and consistent federal policy toward CSA enforcement. As the federal government abandoned federal enforcement of the CSA prohibition on marijuana cultivation and sale by deferring to state enforcement, it apparently subordinated its interests in this arena to those of the states that have legalized marijuana. In another 2016 case, the U.S. District Court for the District of Colorado revisited the issue of whether a policy of insurance covering marijuana-related risk was void as against public policy and federal law. The court in Green Earth Wellness Ctr., LLC v. Atain Specialty Ins. Co., 163 F. Supp. 3d 821, United States District Court, D. Colorado (February 17, 2016), rejecting that notion and finding that the policy of insurance was enforceable, noted that the federal government had taken a “nuanced (and perhaps even erratic)” approach to enforcement of the CSA in states where marijuana was legal and regulated. In distinguishing Tracy, the court, as in Mann, emphasized the “erosion of any clear and consistent federal public policy” in the area of CSA enforcement since that case was decided. Courts continuing to look to DOJ policies and enforcement for guidance in crafting their approach regarding enforceability of marijuana-related contracts and insurance policies may continue to encounter confusion. In 2018, former Attorney General Jeff Sessions rescinded the Cole Memorandum, ostensibly signaling that more stringent enforcement of the CSA prohibition on marijuana would follow. However, Sessions resigned shortly thereafter, before any significant shift in DOJ prosecutorial practices. During his confirmation hearing, Attorney General William Barr pledged not to prosecute marijuana companies that comply with state laws. Nevertheless, Barr is not bound by that position, and he, or his eventual successors, have the prosecutorial discretion to engage in stronger enforcement of the CSA. If that happens, it could have a significant impact on insurers and their insureds, and more specifically, how courts analyze the enforceability of policies covering marijuana-related risk. See also: In the Weeds on Marijuana and WC   Clearly, the marijuana industry presents an exciting area of opportunities for both MRBs and insurers. Nevertheless, insurers considering entry into this marketplace to underwrite MRB-related risk should continue to monitor DOJ policies and their potential impact on the enforceability and coverages provided under marijuana-related insurance policies. The Marijuana Policy Gap will remain a source of confusion for businesses and insurers operating in this space. By remaining informed and educated on DOJ policies and judicial decisions, at both the federal and state level, those enterprises seeking to capitalize on the legal marijuana trend can more fully assess the potential risks and rewards, and will be able to arrive at the soundest business decisions.