Cannabis Clients – High Times, or Buzz Kill?

Editor’s note: This article was originally published by the Los Angeles County Bar Association and is republished here with permission.

By Neil J Wertlieb

In November 2016, California legalized marijuana for recreational use.¹ The new law created tremendous business opportunities for entrepreneurs, investors and others – including attorneys, many of whom jumped into a new practice area of advising operators, growers, distributors, dispensaries and other participants in the cannabis marketplace. 

However, while recreational and medical use is now legal in California, marijuana remains a Schedule 1 restricted drug under the Federal Controlled Substances Act,² which prohibits the production, distribution, sale, use and possession of marijuana.

So, what are the implications to all those newly minted cannabis attorneys?

High Times

Effective November 1, 2018, a comprehensive set of new Rules of Professional Conduct (the “Rules”) went into effect governing the conduct of attorneys in California. New Rule 1.2.1 (Advising or Assisting the Violation of Law) provides that “a lawyer shall not counsel a client to engage, or assist a client in conduct that the lawyer knows is criminal, fraudulent, or a violation of any law, rule, or ruling of a tribunal.”

On its face, the literal language of the Rule suggests that cannabis attorneys may be in violation of the Rule due to the status of marijuana under federal law. However, Comment [6] of the new Rule addresses this issue and makes clear that an attorney may “advise a client regarding the validity, scope and meaning of California laws that might conflict with federal or tribal law.” Even where there is such a conflict, the attorney “may assist a client in drafting or administering, or interpreting or complying with, California laws, including statutes, regulations, orders, and other state or local provisions, even if the client’s actions might violate the conflicting federal or tribal law.” Where there is such a conflict, the attorney “must inform the client about related federal or tribal law and policy and under certain circumstances may also be required to provide legal advice to the client regarding the conflict.”

The addition of new Comment [6] is not necessarily a change in how Rule 1.2.1 (or its predecessor) would be interpreted, as both LACBA’s Professional Responsibility and Ethics Committee and the San Francisco Bar Association’s Ethics Committee issued opinions supporting the same conclusion.³ But, because those are opinions of local bar associations, and not pronouncements by the California State Bar, the addition of new Comment [6] should provide a great deal of comfort for those attorneys who want to enter the cannabis space.

That’s the good news.

The Buzz Kill

Cannabis lawyers, and those attorneys interested in entering this practice area, should be mindful of the following risks:

Dazed and Confused: The wording of Comment [6] is not at all clear. What does it mean to “assist a client in drafting or administering, or interpreting or complying with, California laws”? Is this language intended as a limitation on the types of assistance an attorney can provide, and if so, what is excluded? Would this language encompass the work of an attorney, for example, in forming an entity, or working on a lease or an acquisition, on behalf of a cannabis client? Presumably so, but the awkwardness and uncertainty of the language of Comment [6] may call into question the propriety of certain legal services provided by cannabis attorneys.

Wrecked: California attorneys can still be prosecuted under federal law. While an attorney acting in compliance with Rule 1.2.1 should not be subject to discipline by the State Bar for advising cannabis clients, nor should an attorney be prosecuted under California law for recreational marijuana use, an attorney can still be subject to prosecution under federal law for, among other things, aiding and abetting the client’s violation of federal law,⁴ engaging in a federal criminal conspiracy,⁵ or even possession of marijuana for personal use.⁶

And conviction under federal law could constitute conduct involving moral turpitude, which in turn may result in State Bar discipline. Rule 8.4(b) (Misconduct) provides that a lawyer may be disciplined for “a criminal act that reflects adversely on the lawyer’s honesty, trustworthiness, or fitness as a lawyer in other respects.” California Business and Professions Code Section 6106 similarly provides that a lawyer may be disciplined for “any act involving moral turpitude, dishonesty, or corruption, whether the act is committed in the course of [the lawyer’s] relations as an attorney or otherwise.”

Prior to the legalization of marijuana in California, the State Bar had found that state law convictions for the cultivation of marijuana, and the possession of marijuana with the intent to distribute, were crimes of moral turpitude warranting suspension or disbarment.⁷ Since the legalization of marijuana and the change in the Rules, the State Bar has yet to take a formal position with respect to federal law convictions. As a result, there remains the possibility that an attorney may be disciplined, not for legal advice given (due to Comment [6]), but for conviction of a federal crime.

Cashed: Although a number of banks now accept business from the cannabis industry, many banks do not allow for the deposit of funds that are received from a business operated in violation of federal law.⁸ Under new Rule 1.15 (Safekeeping Funds and Property of Clients and Other Persons), advance fee retainers paid to an attorney must be deposited with a bank in an account identified as a trust account. For attorneys working with cannabis clients, there is no excuse for failing to comply with Rule 1.15 just because their bank won’t accept funds derived from activities that “touch the plant.” And failure to disclose the purpose of the account, when the attorney knows of the bank prohibition, may constitute conduct involving “moral turpitude, dishonesty, or corruption” in violation of Business and Professions Code Section 6106, which would be independent grounds for discipline.⁹

In addition, an attorney accepting funds derived from a cannabis business operating in violation of federal law may face possible exposure for money laundering and forfeiture. By accepting a payment of more than $10,000 that the attorney knows came from an unlawful cannabis business, the attorney may be committing a federal money laundering crime, which makes the funds subject to forfeiture.¹⁰

Up in Smoke: Standard attorney professional liability insurance policies have an exclusion for criminal acts committed by an insured attorney. The insurance carrier may deny coverage under such an exclusion if the attorney participates in a federal crime, such as those referenced above. Further, if, because of such an exclusion, the attorney knows or reasonably should know that his or her insurance coverage may not extend to matters handled for a cannabis client, the failure of the attorney to disclose such fact to the client in writing may subject the attorney to discipline pursuant to Rule 1.4.2 (Disclosure of Professional Liability Insurance).

Secret Stash: Attorneys are obligated to not reveal confidential information of their clients.¹¹ In addition, confidential communications between a lawyer and a client are generally subject to protection pursuant to the lawyer-client privilege.¹² The crime-fraud exception, embodied in California Evidence Code Section 956(a), provides that there is no lawyer-client privilege if the lawyer’s services are obtained to help the client to plan or to commit a crime. Evidence Code Section 956 was recently amended to address the tension between state and federal law relating to cannabis. New paragraph (b) to Section 956 provides that the crime-fraud exception “shall not apply to legal services rendered in compliance with state and local laws on medicinal cannabis or adult-use cannabis.”

However, the crime-fraud exception reflected in the Federal Rules of Evidence does not carve out advice provided to cannabis clients.¹³ Where federal law governs a claim of privilege, federal courts do not apply state law privileges.¹⁴ As a result, the federal crime-fraud exception may apply to an attorney’s communications with cannabis clients – meaning that such communications would be discoverable in a dispute involving claims governed by federal law in a federal court.

Green Out: Lawyers and law firms advising cannabis clients may be precluded from utilizing the protections afforded by federal bankruptcy law in the event their businesses become insolvent. The law is clear that businesses that grow or sell cannabis may not take advantage of federal bankruptcy law because, after filing their bankruptcy cases, such entities continue to operate in violation of federal law. 

A 2018 federal bankruptcy case extended this preclusion to debtors not directly engaged in a cannabis business. In In re Way to Grow, Inc.,¹⁵ a federal bankruptcy case in Colorado (where recreational use is legal), the debtors were businesses that did not “touch the plant,” but rather provided consulting services and sold equipment to cannabis growers and distributors for the purpose of enabling such entities to produce or distribute cannabis. The court noted that because the debtors were not growers or dispensers of marijuana, its inquiry needed to focus upon whether the debtors had a specific intent to enable their customers to engage in an activity that violated federal law. The court found that that debtors had actual knowledge that they were selling equipment used to manufacture a federally controlled substance, and that the debtors would not have a viable business without their clientele in the cannabis industry. On that basis, the court determined it was compelled to order a dismissal of the bankruptcy cases.

The same rationale may apply to lawyers and law firms that focus on advising cannabis clients that engage in businesses that violate federal law.¹⁶

The Blunt Reality

While the Rules of Professional Conduct and the crime-fraud exception in California have caught up with the legalization of recreational use of marijuana in the state, as long as marijuana remains a Schedule 1 federally-restricted drug, there are still significant risks to lawyers who work with cannabis clients. 

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1. Proposition 64, the Adult Use of Marijuana Act.
2. 21 U.S.C. § 801 et seq.
3. LACBA PREC Opinion No. 527 (August 12, 2015); San Francisco Bar Association, Ethics Committee, Opinion 2015-1 (June 2015).
4. 18 U.S.C. § 2.
5. 18 U.S.C. § 371; 21 U.S.C. § 846.
6. 21 U.S.C. § 844(a).
7. See Matter of Deierling 1991 WL 94400 (St. Bar. Rev. Dept.); In re Possino 37 Cal.3d 163 (1984).
8. See “More Banks Working With Marijuana Businesses, Despite Federal Moves,” by Tom Angell, FORBES (June 14, 2018).
9. See People v. Furtado, No. 15PDJ056 (Colo. 2015).
10. 18 U.S.C. §§ 981(a)(1)(A), 1957. (Section 1957(f)(1) does contain a safe harbor for “any transaction necessary to preserve a person’s right to representation as guaranteed by the sixth amendment to the Constitution.” Because of the reference to the Sixth Amendment, however, this safe harbor only applies to attorney fees in criminal cases.)
11. Bus. & Prof’l. Code § 6068(e)(1); Rule 1.6.
12. Evidence Code §§ 950-962.
13. Fed. Rules of Evidence Rule 501.
14. Id. (“But in a civil case, state law governs privilege regarding a claim or defense for which state law supplies the rule of decision.”).
15. In re Way to Grow, Inc., Case No. 18-14330-MER, Dkt. No. 379 (Bankr. D. Co. Dec. 14, 2018).
16. Note that the law is still developing in this area. See Garvin v. Cook Investments NW, SPNWY, LLC, 922 F.3d 1031 (9th Cir. 2019); In re Basrah Custom Design, Inc., 600 B.R. 368 (Bankr. E.D. Mich. 2019); In re CWNevada LLC, No. 19-12300-MKN, 2019 WL 2420032 (Bankr. D. Nev. June 3, 2019).