Can claiming you broke the law get you out of a contract?
Illegality And Unforceability
MedMen – a Canadian corporation, and one of the best-known names in marijuana – recently made headlines for pulling an old trick: attempting to avoid making nearly $1,000,000 of lease payments based on marijuana’s illegal status under federal law. This illegality defense, also known as “Ex turpi causa,” is a centuries-old legal doctrine which prohibits a plaintiff from pursuing legal relief if the relief sought is in connection with illegal conduct. It is most often used to avoid liability in breach of contract lawsuits.
MedMen’s filings do not dispute that it has not paid rent on its 15-year lease (since August 2021). Instead, its complaint filed in the U.S. District Court for the Southern District of New York asks the court to prohibit MedMen’s landlord, Thor Equities, from obtaining legal relief – the nearly $1,000,000 in unpaid rent and additional damages – against them. MedMen’s central argument is that its entire business is illegal under federal law, and thus its contract with Thor is unenforceable.
While MedMen’s attempt to avoid liability is a tale as old as time, both pre- and post-marijuana legalization, industry insiders were unsettled by MedMen’s filing, fearing that the court could breathe new life into the applicability of the illegality doctrine in the cannabis industry, which most believed had been put to rest by years of well-advised contract provisions. (Thor, the landlord, responds that its lease with MedMen specifically prohibits the marijuana company from using the federal illegality of its business as a defense to any claim arising out of the lease.)
Three Routes of Relief: Abstention, Federalism, and Discretionary Stays
For MedMen to obtain relief in federal court, it will have to first overcome Thor’s motion to dismiss. The motion requests that the court dismiss MedMen’s federal lawsuit, or at least stay – that is, not proceed with the action – until Thor’s California lawsuit against MedMen for breach of contract is resolved by the state court.
Thor’s argument is based on three grounds. First, Thor argues that the federal court should abstain from deciding the case because federal review in this case, or similar cases, could disrupt state efforts to establish a coherent policy with respect to a matter of substantial public concern: the regulated commercial cannabis industry.1 To date, at least three federal district courts have relied on this abstention principle in declining to exercise jurisdiction over disputes about contracts and regulations governing the sales and distribution of cannabis.2 Thus, Thor’s first argument must convince the court that “[t]heir reasoning is persuasive: state courts have a greater interest in the interpretation of state laws that create regulatory channels for cannabis cultivation, licensing, sales, and distribution, especially when those laws conflict with the [Controlled Substances Act].”3 However, the court is not required to abstain under such circumstances, but “may abstain.”4 Thus, even if Thor is successful in persuading the court of their reasoning, the court may still decide to hear the case.
Second, Thor argues that, based on “bedrock federalism principles,” the Anti-Injunction Act (AIA), 28 U.S.C. § 2283, precludes not only express injunctions staying state-court cases, but also federal court orders or judgments which have the effect of preventing state courts from fully and independently deciding an action. In this case, if MedMen was successful in its effort to get the federal court to declare the lease agreement illegal in federal court and thus unenforceable, MedMen would have to take the federal court’s judgment to the California court – where Thor filed its breach of contract claim against MedMen – and argue that the California state court must dismiss Thor’s lawsuit based on the federal decision. As summarized by the landlord’s counsel, “that manner of proceeding violates the AIA.” Instead, Thor argues, Medmen is required to present its defense in state court – and let the state court decide – not in a separate federal action. Unlike the first and third arguments set forth in the brief, if the court finds the AIA prohibits it from entering a decision because it would prevent the California state court from appropriately and fully deciding the case, the court would be compelled to dismiss MedMen’s federal action.
Third, Thor relies on the discretion of the court, reframing its request to dismiss or stay MedMen’s federal lawsuit as “an opportunity, rather than a duty” for the court to take particular action.5 The court’s power to take such voluntary action, and decline to hear a declaratory judgment action, “may be at its highest where an alternative remedy may be achieved through a specific and comprehensive regulatory scheme or where a pending state court action will substantially resolve the issues subject to the request for declaratory relief”; both considerations are applicable in this case.6 Further, the court always has inherent power to stay an action pending the resolution of the state court action, to obviate wasteful duplication of judicial resources and obtain the benefit of the state court’s views on state law and the purported illegality defense. Thus, even if the court does not find Thor’s abstention or federalism arguments persuasive, it could nevertheless exercise its discretion and choose to stay the case until the California court has the opportunity to rule on the legal issues.
Additional Considerations Under the CSA
Although Thor did not raise the argument in its motion, federal courts have held that the illegality doctrine does not prevent them from enforcing a contract when the remedy sought would not compel a party to violate the Controlled Substances Act.7 (In one case cited below, courts decided that simply awarding damages would not violate federal law. In another case, plaintiffs sought a remedy for theft of confidential business information, which did not seek a remedy that would compel either party to violate the Controlled Substances Act and, therefore, the court retained jurisdiction. In a third, the court ruled that just because a contract related to the marijuana industry, it did not excuse a party’s obligation to make payment, stating that “relevant case law ‘demonstrates that even where contracts concern illegal objects, where it is possible for a court to enforce a contract in a way that does not require illegal conduct, the court is not barred from according such relief.’”)
These cases strongly suggest that, because Thor is not requesting that the court direct MedMen to violate the Controlled Substances Act, but only seeking an award of damages, the MedMen court might be even less likely to retain jurisdiction or grant MedMen’s requested relief.
Should MedMen successfully overcome Thor’s Motion to Dismiss or Stay, the court’s decision in this case could have far-reaching, unpredictable, and potentially devastating impacts throughout the country. As recognized by one federal court, “if a defendant could assert an illegality defense in federal court, a contract party might attempt to skirt or avoid state laws and regulations by creating contracts that would be enforceable in federal court.”8
Further, permitting an illegality defense in cannabis-related disputes could result in “forum-shopping;” that is, searching for the most favorable court in which to file a lawsuit.9 Indeed, such a decision by a federal court “could signal to those involved in the cannabis industry ‘that federal jurisdiction operates as an absolute defense to private contract claims.’”10
Still, while at least three federal courts have found these considerations persuasive, concluding that the “‘exercise of federal review . . . would be disruptive of state efforts” to responsibly regulate the commercial cannabis industry in their state, the outcome could be different in this case.11
And while not necessarily relevant to the court’s legal analysis, the optics of the court’s potential decision to hear and decide this case are unique: MedMen is a Canadian company asking a U.S. federal court to allow it to skip out on a fair-and-square business contract into which MedMen voluntarily entered – in other words, to “get [a U.S. company’s] property for nothing when they purport to be buying it.”12 A successful result in this case would thus essentially allow a Canadian marijuana company (and potentially any company), which has benefitted from marijuana laws in the United States for years, to escape all responsibility by aggressively insisting its own conduct violates U.S. law.
The Importance of Strategic Contracting
That parties will continue to raise the illegality defense to such contracts is inevitable while marijuana remains illegal under federal law, but businesses in all industries are not defenseless. Well-advised businesses entering into any agreement with a marijuana-company or with marijuana-related business activity should ensure key contract provisions protecting against this type of illegality defense are included in their agreements, such as: waivers of the defense of illegality; waivers of the use of, or removal to, federal courts to resolve any disputes; state-court-only forum selections provisions; and informed choice of law provisions, among others.
McGlinchey’s Cannabis group will continue to keep its finger on the pulse of this ongoing litigation, and welcomes the opportunity to review agreements and prospective agreements to ensure clients are protected from an unscrupulous business asserting this illegality defense in the case of breach of contract or related legal claims.
[1] Burford v. Sun Oil Co, 319 U.S. 315, 316-17 (1943).
[2] See Gopal v. Luther, 2:21-cv-00735-KJM-CKD, 6 (E.D. Cal. Feb. 18, 2022); MediGrow, LLC v. Natalie M. LaPrade Med. Cannabis Comm’n, 487 F.Supp.3d 364, 376 (D. Md. 2020); Left Coast Ventures Inc. v. Bill’s Nursery Inc., No. 19-1297, 2019 WL 6683518, at *2 (W.D. Wash. Dec. 6, 2019).
[3] See Medigrow, 487 F.Supp.3d at 376. Gopal v. Luther, 2:21-cv-00735-KJM-CKD, 6 (E.D. Cal. Feb. 18, 2022).
[4] Gopal v. Luther, 2:21-cv-00735-KJM-CKD, 6 (E.D. Cal. Feb. 18, 2022).
[5] Wilton v. Seven Falls Co., 515 U.S. 277, 288 (1995).
[6]H & R Convention & Catering Corp. v. Somerstein, No. 12-CV-1425, 2013 WL 1911335, at *10 (E.D.N.Y. May 8, 2013).
[7] See Indian Hills Holdings, LLC v. Frye, No. 3:20-cv-00461-BEN-AHG, 2021 WL 5994036 (S.D. Cal. Dec. 17, 2021); Siva Enterprises v. Ott, No. 2:18-cv-06881-CAS(GJSx), 2018 WL 6844714 (C.D. Cal. Nov. 5, 2018); J. Lilly, LLC v. Clearspan Fabric Structures International, Inc., No. 3:18-cv-01104-HZ, 2020 WL 18551990 (D. Colo. April 13, 2020), citing Mann v. Gullickson, No. 15-cv-03630-MEJ, 2016 WL 6473215 (N.D. Cal. Nov. 2, 2016).
[8] Gopal v. Luther, 2:21-cv-00735-KJM-CKD, 6 (E.D. Cal. Feb. 18, 2022), citing Left Coast Ventures Inc. v. Bill’s Nursery Inc., No. 19-1297, 2019 WL 6683518, at *2 (W.D. Wash. Dec. 6, 2019).”
[9] Gopal, at *4.
[10] Left Coast Ventures v. Bill’s Nursery Inc., CASE NO. C19-1297 MJP, 5 (W.D. Wash. Dec. 6, 2019).
[11] Gopal, at *4 (internal citations omitted).
[12] Kelly v. Kosuga, 358 U.S. 516, 520-521, 79 S.Ct. 429, 3 L.Ed.2d 475 (1959).