SELLER FINANCE: Risks and Rewards When Cannabis is Involved

By Steve Beede, Founder/Counsel

In 2016, we published a series of Articles on the challenges of leasing real property when the occupant may be using, cultivating, or distributing medical marijuana (“Cannabis”). However, since then California has passed a law legalizing recreational marijuana which has greatly expanded both the potential use as well as the business opportunities for potential cultivators and distributors. Although such entrepreneurs still face a process of state and local regulations and licensing requirements that are still being developed, the opportunities have already started driving up the prices of agricultural land, particularly when its prior use had been for growing crops.

cannabis

For Sellers of such land there are new challenges and opportunities that did not exist before… but the real question will be whether the rewards are worth the possible risks. Here are what we see as the key considerations:

1. Federal Illegality – Despite California’s legalization, marijuana is still considered a Class One Narcotic under Federal law. Only a few years ago, property owners who grew or allowed tenants to grow marijuana on their property were at risk of Seizure and Sale of their land as well as other Federal liabilities, including jail. Under President Obama, such actions were stopped under a Policy decision called the “Cole Memorandum” which was issued by the Dept. of Justice in 2013 and which set forth 8 conditions under which the Feds would not intervene. But this is Policy only and can be stopped by new President Trump without any Congressional approval. To date, he has not indicated his intentions. However, the U.S. Attorney General – head of Federal enforcement – has stated that he is opposed to marijuana legalization. So until this is clarified, marijuana growth on real property will remain at risk of Federal action.

2. Lack of Institutional Finance – Because the use of land for cannabis production remains illegal under Federal law, it is virtually impossible for any Buyer to obtain institutional financing for their purchase, ie: no loans from Wells Fargo, or any other major lender, particularly any that are national or connected to use of federal funds. While in time it is possible that smaller, local banks might be willing to take on this risk with sufficient protections, that is not the case at this time. As with any market, there are “hard money lenders” who will take on almost any risk if the rewards are high enough… but the costs of such finance can take all the profit out of the business.

3. Demand for Seller Finance – Because of the lack of institutional financing and the high cost of hard money financing, many (if not all) prospective Buyers are seeking to obtain Seller financing for a portion or even all of the purchase price.Seller Financing has been used in real estate and other transactions for thousands of years and still possesses the dual capacity to provide unique investment opportunities with equally unique risks for all parties.

What are the pros about Seller Financing?

1. No Lender Required – When institutional lenders tighten-up credit and loans become harder to get, Sellers with equity in their property can get their property sold by providing some or all of the purchase financing, also called “carrying back paper”.
2. Better Pricing – Unlike institutional lenders that must package sales commissions and other funding costs into the financing, Seller Financing generally avoids these added costs and can offer lower cost financing for which Buyers will pay more.
3. Better Return on Investment – When a Seller carries back financing, they are acting in the place of an institutional lender by converting the cash that they would normally receive in sale proceeds (liquid assets) and converting it into a secured cash stream (hard assets). Cash in a bank today is earning less than 1% interest. Interest on loans is typically earning from 3-6%.
4. Security – Seller Financing is generally secured by the real estate, preferably as the first (Senior) loan. If the Buyer/Borrower doesn’t pay, the Seller can foreclose and either get paid or take the property back to rent or resell.

What are the dangers with Seller Financing?

1. Seller is the Lender – Normal loans are hard to get because lenders examine credit, and jobs, and income stability, and financial capacity. Seller financiers often lack the sophistication and access to provide the same level of “due diligence” as to the borrower’s credit-worthiness. So Seller Financing may carry a higher risk of default.
2. Loss of other investment opportunities – Because a Seller’s sale proceeds are being loaned to the Borrower, those funds are not available to the Seller to make other investments which may be more lucrative.
3. Income is at risk – If the Borrower defaults in repaying the Seller Financing, the Seller’s income stream is cut-off and will stay cut-off until the Seller either forecloses or reaches some other agreement with the borrower. Foreclosure could take more than a year. Buyers sometimes seek to avoid paying Seller Finance by claiming that the Seller failed to disclose some defect that has allegedly cost the Buyer property value… often equal to the amount of the Seller Financing.
4. Limited Recourse – If the Borrower fails to pay, the Seller must foreclose. In many States including California, Seller Financers are barred from suing the Borrower if they are not paid back in full. If the real property pledged as security has deteriorated or market conditions have fallen, the foreclosing Seller Financer may suffer the loss of their investment.

What are the added dangers of Seller Finance of cannabis property?

1. Seizure of Real Property – As referenced above, the growing, cultivation, and distribution of marijuana remains a Federal crime regardless of what State or local law may allow. Carrying back Seller finance on a Property sale in which it can be proven that the Seller knew the Buyer’s intended use and profited from a higher selling price could arguably allow Federal enforcement officers to obtain an Order seizing the real property and selling it to pay the costs of the legal prosecution. This risk was stopped by the adoption of the Cole Memorandum by the Justice Department but at this point it is unknown if President Trump will stop the Attorney General from Federal enforcement.
2. Criminal Liability – A Federal enforcement action against a person who is using their Property for cannabis business would potentially expose a Seller Financer to criminal liability for aiding and abetting the criminal action. Such liability could result in monetary fines and even imprisonment.

BOTTOM LINE:

There is no way that we or anyone else can provide any assurance to a prospective Seller financer that the above stated dangers are unlikely to occur. For a Seller making no money on a piece of land that they have been unable to sell or develop for years, the prospect of a sale to a cannabis producer may be worth the risk or at least a thorough evaluation of the options. Anyone considering such a sale with or without Seller financing should get legal counsel to review any of the sale and finance agreements and add language wherein the Buyer/debtor represents that they will not perform any actions on the Property that constitutes a legal violation. While such language cannot fully mitigate the risks, it might reduce the dangers of a claim that the Seller was a knowing participant.

For over 20 years, the attorneys of BPE Law Group, P.C. have been assisting our clients with their real estate, business, and other legal needs. We’re currently assisting a number of parties that are pursuing or developing cannabis operations in California. If you have questions concerning real estate, business, or any other legal matter, give us a call at (916) 966-2260 to schedule a Consultation with one of our experienced attorneys or email Keith at kbdunnagan@bpelaw.com.

This article is not intended to be legal advice, lending advice, or a specific recommendation of any particular lender or company, and should not be taken as such advice.