Cannabis and Leasing – Part 1
Narrator: You’re listening to WeirTalking Leasing, an eight-episode podcast series from WeirFoulds LLP’s commercial leasing group, educating landlords, tenants, and property managers on today’s commercial leasing landscape in Ontario. Our legal specialists will be discussing everything new and interesting from lease terminations, office sharing, unattractive properties, cannabis, and so much more. This is part one of two episodes on cannabis and leasing.
Karsten: Thank you for joining me. I am Karsten Lee, and I’m a commercial leasing lawyer here at WeirFoulds, and joining me today is Robert Eisenberg, my colleague here at WeirFoulds.
Robert: Hi, Karsten. Nice to be here.
Karsten: Yeah. Thank you for joining. And today’s topic is one of Rob’s specialties, leasing to cannabis retailers here in Canada. So since cannabis has been in a lot of the news stories over the past few months, we’ll be diving into a lot of the issues that surround entering into leases with cannabis retailers over the next few minutes today. Now, Robert, what have you been seeing in terms of how cannabis retail stores have emerged in Canada?
Robert: Well, first, I want to say thanks for having me here. You know, you’re absolutely right, Karsten, that cannabis retail, specifically in Ontario, it’s really an emerging issue, and people seem to be very fascinated by it. There’s a lot of concern about: “How is this industry different? What do we need to do differently?” I’m really excited that we’re going to get to talk about that today. But let me give you an example, first, of the potential for some of the unique issues that we’re seeing.
Robert: You know my wife Hannah. She’s American, and we were in the States recently, in Boston, where she’s from. And Massachusetts recently legalized recreational cannabis, as well. So I wanted to go see one of the stores and, you know, see how they’re doing it. And we go by and there’s a massive line and can’t get in, and we go to stand in line, and they say, “No, no, no. You have to go to the waiting area,” which is actually a 10-minute walk away, in a parking lot down the road. So there’s a shuttle bus to take you between.
Robert: So we get on the bus, we got to the parking lot. We get there, and there’s this big, long lineup you’ve got to get into, and there’s employees of the store. They’re organizing people into queues. There’s some uniformed police there. So these are just some interesting things that we wouldn’t have necessarily thought about like lineups are going to be quite so long. We look at stores that have big lineups, but something like this is crazy. So, with all this demand, do we need to start thinking about things like that? I think it’s a little bit of an extreme example and had more to do with this specific location. But I think it’s an interesting story just in how it’s not necessarily new things that we need to think about, but maybe think existing issues and a little bit of a different way.
Karsten: So that’s an interesting snapshot of a particular American city, or at least of a particular location within Boston. Now, how exactly has that translated in the Canadian context?
Robert: So there’s actually an overlay of two regulatory regimes right now. So from the federal perspective, and this applies all across Canada, we have the Federal Cannabis Act, and that was passed last October. And what that does is that legalized recreational cannabis, and it also put in some labeling requirements and restrictions on what you can grow at home. But what it didn’t do is say how recreational cannabis is going to be sold. That was left to each individual province and territory to come up with their own system for what retail sales were going to look like.
Karsten: So how has each of these provinces… And you don’t have to get into what each province does, but from a high-level view, what are some of the options that some of the provinces have adopted?
Robert: Well, what we’ve seen is really three baskets of choice. There’s a public model, and that’s where you have the government operating the stores, itself. We’ve seen that mostly in the Maritimes, something like a province like Nova Scotia where they already, the government, run liquor stores. Now, there’s government-run cannabis stores. The opposite to that is a private model, and Alberta was the leader in this regard, and that’s just anyone who wants to open up a cannabis store, come apply for a license, we’ll license you, you can go run a store. Again, similar to the way Alberta treats liquor. And then third is, is a mix between the two. It’s a hybrid option where there’s some combination of public stores and private stores.
Robert: And then, on top of that, we’re in the 21st century here, is online sales. So far, all the provinces except for Saskatchewan have decided, “This is a really big market. We want to control this. We don’t necessarily trust private retailers or we want to get a piece of the action here.” So online sales are being run by the governments in the vast majority of provinces. And the federal government, not wanting to feel left out, has created a federal online system that would fill in the gaps if any province didn’t set up their own system. So far, that hasn’t needed to come into play because the provinces all set up their own systems.
Robert: But one of the important things to note, and we can talk about this a little bit later, is that under the Federal Cannabis Act, edibles are not yet legal. And those are only supposed to become legal a year later to give the provinces more time to set up a regulatory regime. So right now, all that we’re seeing for retail use across the country, it’s dried cannabis and it’s some oils. So no edibles. But one interesting statistic, I saw actually… This was a number put out by Scotiabank, and they said that despite legalization of cannabis and all these retail sales models, 71% of cannabis sales in Canada in 2019 will still be on the black market. So there’s a long way to go before the legal retail sales model has become the dominant sales medium for cannabis.
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Karsten: So exactly how has Ontario, specifically, just because I know a lot of our listeners do have a vested interest in Ontario… How has Ontario embraced the distribution of cannabis on a retail scale?
Robert: So Ontario is an interesting case because it’s really been a yo-yo approach with the provincial election last year sandwiched right in the middle. Originally, under the former liberal government, Kathleen Wynne, it was decided that Ontario would be a public model province, and all the retail stores were going to be owned and operated by a new Crown corporation called the Ontario Cannabis Retail Corporation, which was set up as a subsidiary of the LCBO, and they control in-person and online sales. And it looked like we were well on our way to being a public-model province.
Robert: Then the election happened, and Doug Ford and his Progressive Conservative government was elected, and Doug Ford came in and he decided he’s going to end the OCRC monopoly, and he abolished that, and he decided he was going to institute a full private-retail model. Online sales will continue to be run by the province through the OCRC, which was rebranded as the Ontario Cannabis Store. But because of the rapid about-face, October 17th came around, and Ontario was not ready to do anything. There were no retail stores, but online sales did commence through the OCS platform. But Doug Ford said, “Retail stores are going to open by April 1st, 2019.”
Karsten: And what happened on April 1st, 2019?
Robert: Well, we can’t quite jump there just yet because there’s still another twist in the story. In December of 2018, Doug Ford had another change of heart and decided that he no longer liked the idea of a complete private market where they would license whoever wanted to apply. So he said, “No. You know what? There’s a national shortage of supply of cannabis in the country.” And he said, “As a result, we can’t allow a free market of cannabis stores. So instead, we’re only going to issue 25 licenses for the entire province of Ontario for an indeterminate amount of time.” And not only was it only 25 licenses, but that was broken down by region. Of those 25 licenses, five were in the city of Toronto, and a further six were in the remainder of the GTA, excluding the city of Toronto. So that’s it. 11 stores in the GTA were going to be allowed to sell cannabis.
Karsten: So obviously, that didn’t cut it. How did people take this?
Robert: People were unhappy, especially the people who had gone and entered into binding leases when they thought it was going to be a completely open, free market.
Karsten: So why were binding leases entered into before any retail stores were actually opened?
Robert: So that was a result of people looking at what happened, mostly in Alberta, which was kind of the trailblazer on the private-model system. Once Ontario decided it was not going to be a public model system, everyone looked at Alberta and said, “Well, I assume we’re going to do it like Alberta does it.” And in Alberta, in order to apply for your license, you had to show that you had real estate. So either you owned a property or you had a binding lease or an offer to lease for some space. People also assumed that there were going to be restrictions on how close these stores could be together, how far they had to be from some sensitive uses like schools. So that really cut down on what the prime locations were, and people wanted to make sure that they got those locations, even if they didn’t yet have their licenses. So there was a big rush on deals where these potential licensees went out and were trying to snap up the choice real estate.
Karsten: So how were these deals structured?
Robert: It was great for landlords. It was a boon because not only were they getting above-market rents because a lot of these cannabis companies and potential cannabis companies were flush with cash from investors. But because there was still some taboo around the use, they were able to charge higher rents. Obviously, these stores weren’t going to be able to open until they got their licenses. So what happened was a lot of these deals… Actually, the term commenced in November or December of 2018 even though these operators knew they weren’t going to have their licenses. So they were saying, “I’m willing to start paying you rent now, months in advance, just so I can lock down my space.”
Robert: However they needed an out. And one of the things that I’ve seen, personally, in a lot of the cannabis deals I’ve done both on the landlord and the tenant side is tenants have an early-termination rate. Basically, what this termination right said was upfront, the tenant’s going to give the landlord a big chunk of change as a deposit. The tenant’s going to go out and apply for its permits and all of its licenses. But if the tenant doesn’t get it, despite making best efforts, reasonable commercial efforts, whatever the language was, to obtain their permits by a certain date, usually a year out, then the tenant would have the right to walk away from the deal, and the landlord would get to keep that big deposit for its troubles.
Karsten: So all these deals were being entered into by landlords and tenants, and now Mr. Ford’s government had an about-face, and now all these deals were in peril.
Robert: Right. So when they decided they were going to limit the number of licenses to 25, they decided they were going to run a lottery for who was going to be the lucky 25, and this was put under the auspices of AGCO, so the Alcohol Gaming Commission of Ontario. And AGCO decided they’re going to solicit interest, and then they’re going to run lotteries for each of the five regions in Ontario.
Karsten: So what happened with all the other deals that were signed but weren’t able to secure a license?
Robert: So it’s actually a big problem and an ongoing issue right now. The first thing that if you are one of these parties, either a landlord or a tenant, you’re wondering, “What do I do with my deal?” The first thing you should do is look and see is it a conditional deal? Is it actually binding? Is it conditional on the tenant getting their licenses? Is it conditional on the tenant getting their licenses by a certain date? Something else to think about is was there a termination payment that’s owing?
Robert: But other operators right now are taking a different tact, and there’s one dispensary owner in Toronto right now who’s suing the province for over a million dollars in damages, claiming that the change in policy to restrict the number of licenses has caused them damages to their business. And they’re also suing for the cost of their rent in securing the space, saying that but for the province’s about-face, they would have been able to operate this business and make all this money.
Karsten: So I guess it remains to be seen exactly how that case winds its way through the courts or even if it will be heard. That particular retailer wasn’t the only one who had the same thoughts about being left out in the cold by the about-face of the government. So going back to those deals that were signed before the cap on the licenses came out… So have a lot of those deals kind of gone by the wayside and the landlords just took the security deposit and terminated the deals?
Robert: From what I’ve seen, not yet because a lot of those had a termination right after a year. There were a few that were at six months, but for the most part, I’ve seen tenants have a year to get their licenses before these termination rights kick in.
Karsten: So as of now, there’s only about 25 licenses out there. Have 25 stores been opened?
Robert: Certainly, they were not open by the April 1st deadline. There were, I think, only two in Toronto that were able to open in time. But then the province decided they were going to start levying pretty heavy daily fines on these companies that had their licenses but weren’t yet open. So since then, the operators who have been issued licenses have been opening.
Karsten: Has there been any indication by the Ontario government that more licenses will be issued in the near future? And what’s the process?
Robert: So there hasn’t been a direct announcement. When the cap was put in place, it was initially said that it was going to be for an indefinite period, so we didn’t know when it was going to happen. The idea was once there’s more supply in the marketplace, then they’ll open up the number of licenses. What we saw in the recent budget that was tabled, the provincial budget, was some language that suggests that that cap is going to expire in December of this year without any further actions. So I know that the provincial legislature has been adjourned now until after the federal election, so if we see something come up in the fall where they acknowledge that the cap’s going to remain in place, then we’ll have a better sense. But barring anything to the contrary, it looks like, come December, we’re going to end up in that free-market situation where there’s no cap on the number of licenses and, as long as you satisfy AGCO’s criteria, they’ll issue you your license.
Karsten: So it’ll end up being a free-for-all, come December?
Robert: Yes, but I think that was what people expected in the first place, anyways.
Karsten: I’d like to thank you for joining us today, Rob.
Robert: It’s a pleasure.
Narrator: Thanks for joining us for this episode of WeirTalking Leasing by WeirFoulds, LLP. Be sure to tune in to part-two of this episode on cannabis and leasing. Please take a moment to rate, review, and subscribe. And if you’d like to hear from our lawyers on another topic, send us an email at email@example.com.