A Pain In The Bud: Restructuring A (California) Medical Marijuana Non-Profit
Cannabis businesses operating in California as a non-profit now should keep close watch on the situation and keep their options open as California unveils its new systems in the coming months.
![Hilary Bricken](https://abovethelaw.com/wp-content/uploads/Hilary-Bricken-bio-photo-300x171.jpg)
Hilary Bricken
Most medical marijuana entities in California are organized as state non-profit mutual benefit corporations (NBMCs) or statutory cooperatives. This is because under current California law there is no strong argument that marijuana sales by for-profit companies are legal and Senate Bill 420 specifically states that it does not authorize “any individual or group to cultivate or distribute marijuana for profit.” This is true in many other states, too — cannabis possession by medical patients may have been legalized, but “businesses” were not, so different forms of nonprofit cannabis clubs developed as a result.
It is important to note that though many medical marijuana entities are formed as non-profits under state law, they are not similarly tax exempt at the federal and state levels. So though these non-profits technically cannot earn profits, they still must pay federal taxes on any revenue generated minus expenses (though not all business expenses are eligible under section 280E), and California’s Board of Equalization absolutely collects sales tax against medical marijuana entities.
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As states like California legalize cannabis and implement comprehensive regulations (in California, the Medical Marijuana Regulation and Safety Act (MMRSA) is the first step towards robust regulation), for both medical and recreational use, many businesses started under an older legal regime will want to transition into whatever new licensing system is in place. In addition to getting licensed to operate in the new system, the directors and officers of these non-profits will often want to restructure into for-profit corporations and LLCs, if such transitions are feasible. This is doubly true when medical businesses get priority in new licensing regimes, as those with priority will likely be the first targets for purchase or investment by newcomers to the industry.
But can a non-profit restructure in that way?
Not all non-profits are the same, and not all state non-profit laws are the same. Most states have a basic entity called a “non-profit corporation,” and the limits on those entities are pretty strict. A non-profit corporation has no owners, but it does have officers and directors. No one has the right to receive distributions of cash or property from the non-profit. On dissolution and liquidation of the non-profit, any remaining assets are distributed as the articles of incorporation may govern, but generally officers, directors, and other insiders are not able to receive any types of asset distributions.
California’s non-profit mutual benefit corporations, though, aren’t quite as limited as some other states’ general non-profit corporations. Similar to other types of non-profits, distributions of corporate assets are not allowed during the life of the corporation. If a non-profit member, director, or officer wants to get money out of the non-profit while it exists, they have to receive that money as either salary or as repayment of debt. Mutual benefit corporations diverge from some other types of non-profits here. On dissolution — when the business shuts down — it can freely distribute its assets to its members. And these corporations can admit any individual to membership. This means that the directors and officers can also be members, and they can draft corporate bylaws to allow full asset distribution to members on dissolution.
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But distributions on dissolution only get you so far. What if you want to keep the entity alive, so that it can rely on its business track record and reputation to receive a new marijuana business license, but then you simply want to restructure it afterward? Again, most general state non-profits don’t really allow that type of transition, but mutual benefit corporations may be able to, using a merger. Indeed, California allows mutual benefit corporations to merge with for-profit corporations. So, if you want to restructure your California non-profit mutual benefit corporation into a regular for-profit corporation so that it can issue stock to new investors, you could form a new for-profit corporation, execute a merger with the mutual benefit corporation, and then walk away with the new for-profit company as the surviving entity. It’s a little more complicated than that, but it’s possible. And I fully expect that lots of California NBMCs will make the transition once MMRSA licensing is ready to go.
A non-profit mutual benefit corporation in California can also convert to a for-profit entity by amending its articles of incorporation and filing the amendment with the Secretary of State. The amendment will require approval from the state and may also require approval by its members.
That doesn’t mean that current California MMJ operators will necessarily be able to take advantage of this merger or conversion ability, however. First, we don’t really know what types of limitations the State of California will put on medical marijuana businesses under the MMRSA. Even if it doesn’t, the state may give itself approval power over any merger or conversion involving a licensed cannabis business. Cannabis businesses operating in California as a non-profit now should keep close watch on the situation and keep their options open as California unveils its new systems in the coming months.
Hilary Bricken is an attorney at Harris Moure, PLLC in Seattle and she chairs the firm’s Canna Law Group. Her practice consists of representing marijuana businesses of all sizes in multiple states on matters relating to licensing, corporate formation and contracts, commercial litigation, and intellectual property. Named one of the 100 most influential people in the cannabis industry in 2014, Hilary is also lead editor of the Canna Law Blog. You can reach her by email at [email protected].
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