The most popular cannabis reform proposals claim their intent is to preserve each state’s autonomy when it comes to cannabis. However, unless Congress includes language to suspend the Dormant Commerce Clause, the supposed self-determination will be overruled by a highly important but infrequently discussed legal threat with potentially massive consequences for the current operators who have invested time, energy, and resources into the booming cannabis industry.

What is the Dormant Commerce Clause?

If you look for the words “dormant commerce clause” (DCC) in the Constitution, you will not find the exact phrase. However, Article 1 does grant Congress the ability to regulate interstate commerce in what is known as the “Commerce Clause.” The DCC doctrine was born out of several Supreme Court rulings based on the Commerce Clause.

This doctrine restricts states’ action and prohibits competing and protective measures that benefit commerce in one state over another. Simply put, the DCC prevents states from putting unnecessary burdens on the flow of goods, services, and capital across state lines. In regards to cannabis, the implementation of DCC would break down many current requirements and open up traditional interstate commerce unless Congress inserts special protections.

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How might the DCC affect legal cannabis?

The current structure of the cannabis industry relies on meeting state-specific requirements and, through regulation, controls the flow of product. Once federal legalization occurs the dormant commerce clause would automatically kick in, except if Congress includes language to grant each state the right to regulate its own market. What happens when these state-specific requirements are at odds? How will businesses respond, especially the ones who made significant investments to meet requirements that may become obsolete?

With the current ambiguity and possible slash in the value of these investments, some in the industry would rather just SAFE Banking or 280E tax reform occur.

Likely the most immediate impact of the DCC would be the preemption of state prohibition on the import and export of cannabis. Once cannabis can freely cross state borders, the intricate web of a vertically integrated state markets will quickly unravel. Certain climates are much more hospitable for outdoor growing, making cannabis from those states much more affordable than cannabis that must be cultivated indoors. Producers in the Northeast, for example, would see the value of their costly indoor growing facilities drop precipitously. Like other forms of agriculture, production would likely consolidate into national hotspots for growers. 

If Congress does not address the DCC, how this clause is applied to the cannabis market will be decided piecemeal by the judicial system. These lawsuits will require a significant time and monetary investment, leaving the rest of the industry in a lurch as it awaits the ruling.

KEY AREAS OF CONCERN

Social equity programs

Most every social equity program relies upon recipients living in an area that has been identified as having been disproportionately affected by the War on Drugs. However, residency requirements will most certainly be one of the first casualties once the DCC kicks in. (They’ve been overturned before.) With the previously existing foundation of social equity programs removed, there is not currently a readily available avenue to identify who qualifies for such programs. The Supreme Court, citing the Equal Protection Clause, has already struck down one state school’s reliance on race as a key determinant when it comes to social equity programs.

And, looking into the future where the DCC immediately takes effect, these small, independent licensees will be thrown to the wolves as they are forced to compete with large, well-financed MSOs. However, legalization coupled with an explicit suspension of the DCC will dissolve the largest hurdle facing minority businesses – access to capital. Legislation that legalizes cannabis nationally while allowing (for a time) the protective measures states have in place to regulate their individual marketplaces will help minority business owners gain their financial footing and eventually begin to compete in the national marketplace.

Gaps in regulation of the industry

Unlike congressional preemption of state laws, the DCC can block state regulations even if federal regulations governing that industry do not exist. Because Congress has relied upon the Controlled Substances Act to regulate the cannabis industry since the 1970s, there will be extremely little federal oversight of the industry once cannabis is taken off the Schedule I list even as various state laws become invalid due to the DCC.

Certain regulations that apply to all similar industries (such as the Sherman Antitrust Act and the Food Drug and Cosmetic Act) would apply. However, the resulting and sizable cannabis-specific regulatory gaps will likely put consumers and businesses at risk of ambiguity at best and predatory, fraudulent actors in the worst case scenario. These gaps could have many negative consequences for the environment, business owners, consumers, and beneficial community programs currently funded by the sale of state-legal cannabis.

Race to the bottom

Once the DCC removes the states’ prohibition on importing cannabis, operators will no longer have to be located in a state in order to sell their goods in that state. Therefore, operators will be free to relocate to states with much more laissez faire policies. States will feel pressured to reduce the regulations that were crafted with the intent to best serve the residents in that state – regulations surrounding environmental, equity, fair labor, energy consumption, and job creation concerns.

With cannabis businesses free to relocate wherever they believe they are treated best, market consolidation is sure to occur. This consolidation would also bring some favorable efficiency and competition to the market. If Congress decides to mandate some federal minimum requirements for the industry, we believe it is possible to reap the benefits of market consolidation without completely sacrificing the value derived from local regulations drafted to best meet the varying needs of each state.

Significant investments made to comply with state requirements

It is estimated that the startup costs alone for a state cannabis license averages around $250,000, and once the license is granted, operators often invest multi-millions in real estate, construction, security and other costs. All of these investments were made in good faith in accordance with a state’s stipulations. The idea that entrepreneurs who played by the rules, who were burdened with some of the highest tax rates of any business entities in the country, and whose tax dollars helped fund much-needed local programs will soon be left out to dry due to bad policy sets a bad precedent.

Not only will the business community be significantly harmed by the DCC, but states themselves will be as well. Each state has established its own agency or agencies to oversee its cannabis program. These regulatory agencies are staffed by hundreds of employees whose livelihoods will be threatened when their jobs evaporate overnight. Also, the state programs funded partially or fully from cannabis sales taxes will see a drastic, if not total, loss in funding. The loss of these programs will impact education, the environment, community reinvestment, job training, and more, and the negative consequences will be felt the strongest in the most vulnerable populations and communities.

End the marketplace of ideas created by distinct state programs

Both states with current programs and states without programs would be disadvantaged for different reasons. As we mentioned earlier, states with extant industries have invested in establishing regulatory agencies and staffing these agencies; they also derive significant tax revenue from legal sales. States that have not yet legalized cannabis will likely feel they are being punished for sticking to the official law of the land because they are missing out on the first-mover advantage enjoyed by states with existing medical and adult-use programs.

The current system has effectively created dozens of laboratories where states are experimenting with the best way to regulate and support the cannabis industry. National lawmakers can learn from the successes and struggles of these various approaches.

Another thing to note – these unique models have been functioning despite cannabis operators being denied the same access to traditional financial services and payment systems as other legitimate industries. Washington DC lawmakers could glean a better-informed understanding of which policies and regulations make the most sense for a national marketplace if they wait to see how each state’s unique models react to the normalized financial access that would come with the end of prohibition.

CONCLUSION

Absent a suspension of the DCC, we fear the cannabis industry will suffer significant, avoidable damage and the many entrepreneurs, investors, and state governments that took on substantial time and financial risks to create flourishing state-legal marketplaces will see the value of their investments evaporate into nothingness. Truly, the current system will find itself out of the frying pan of prohibition and into the fire of the DCC.

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