NYC Cannabis Landlord Accountability Law Has Limitations

By: Andrew P. Cooper, Esq., LL.M., Michael A. Curatola, Esq., Ariel S. Holzer, Esq., Dana W. Sivak, Esq., and Terran Cooper

In April, New York City Council member Lynn Schulman introduced a bill[1] that would prohibit landlords from knowingly leasing to a commercial tenant engaged in the unlicensed sale of cannabis, tobacco products, cigarettes or electronic cigarettes. Having already been approved by the Committee on Public Safety and the full council, the bill was sent to Mayor Eric Adams for review, who neither signed nor vetoed the bill by the July 22 deadline. Since Adams did not veto the bill within the deadline, it has now become law.

As per the bill, city inspectors will be dispatched to suspected unlicensed stores, which currently number in the thousands.[2] 

If an inspector determines that illegal cannabis, or cigarettes, electronic cigarettes or tobacco products, are being sold on the premises, the landlord will face a fine between $5,000 and $10,000. 

A second inspection will later take place, and if the landlord can provide proof that eviction proceedings have begun since the first inspection, the fines may be avoided. 

In addition to the state agencies currently authorized to inspect for relevant violations, the bill allows the mayor to designate any state agency to inspect for such violations. 

While the levying of fines against landlords may significantly reduce unlicensed cannabis stores, the bill only targets certain unlicensed operators, and as such, loopholes in the legislation will likely be exploited by unlicensed operators — potentially limiting the bill's impact on the unregulated market. 

As such, further legislative action may be required to address the limitations and unintended consequences of the bill, as discussed in greater depth below. 

The Existing Markets 

New York effectively has two cannabis industries: the legal market and the illegal market. 

The legal market was born by the Marijuana Regulation and Taxation Act in March 2021, and is bound by the Office of Cannabis Management's rigid regulatory framework. 

In order to be licensed to enter the legal market, operators must comply with strict regulatory requirements, apply for licensure and be issued a license by the OCM. 

In contrast, the illegal — unlicensed — market is vastly larger, older and unfettered by the restrictions placed on legitimate licensees. This allows unlicensed operators to avoid the payment of relevant taxes, forgo product testing, and disregard public safety prohibitions on operating in sensitive locations or selling to minors. 

Legal Adult-Use Market 

The rollout of the legal adult-use market has crawled sluggishly forward under the weight of bureaucracy, with the first adult-use dispensary only opening at the end of 2022 — over 20 months after legalization. 

In the six months following legalization during which he was governor, former Gov. Andrew Cuomo failed to appoint a single board member to the Cannabis Control Board, the oversight body of the wider OCM. 

While Gov. Kathy Hochul quickly appointed CCB board members upon taking office, it took additional time for the CCB and OCM to establish and approve regulations for adult-use cannabis licenses. 

The Unlicensed Market Conundrum 

In every state that launches a legal adult-use — i.e., recreational — cannabis program, despite varying adult-use programs and enforcement actions across different states, there exists an unlicensed market. 

Even in one of the states with the longest-running legal adult-use cannabis programs, California, there are up to $8 billion in illegal sales every year, generating significantly more revenue than the legal market.[3] 

The presence of a thriving unlicensed market can often hinder a state's legal cannabis industry. 

Among the many reasons for which the unlicensed market exists, access and cost stand at the forefront. Those who have difficulty accessing legal adult-use dispensaries, or those who can more easily access unlicensed cannabis, may be inclined to purchase unlicensed products. 

Due to significant regulatory requirements and additional tax burdens, including the impact of Internal Revenue Code Section 280E, which effectively disallows standard business deductions beyond the cost of goods sold, the cost of legal adult-use cannabis is typically higher — even up to double — that of unlicensed cannabis. 

This price discrepancy and significantly higher accessibility, when compared to the legal adult-use market, has allowed the unlicensed market to thrive across New York City. 

Unlicensed Operators Adapt to New Market Opportunities 

Unlicensed cannabis sales are certainly not new to New York, with cannabis sellers who have been selling illicit cannabis since before legalization commonly referred to as legacy operators. 

While many legacy operators continue to operate as they did under prohibition — with relatively loyal customer bases and under-the-radar transactions — or attempt to convert to a legal adult-use business, some have adopted a new model entirely. 

The methodologies utilized by unlicensed operators now vary significantly. 

The opportunity provided by cannabis decriminalization and the delay in creating a functional adult-use market attracted new entrants to the unlicensed market, beyond just legacy operators. 

Over two years since cannabis legalization, the unlicensed marketplace has continued to proliferate at light speed, particularly when compared to the legal adult-use market, which, at the time of writing, only has 21 adult-use retail dispensaries statewide — four of which are designated temporary delivery-only locations.[4] 

Unlicensed Seller Methodologies

Gifting and Membership Models 

Following legalization, unlicensed operators began experimenting with various schemes and methodologies to allow them to profit from the sale of unlicensed cannabis products. 

Many of the earliest models were intended to appear lawful. 

The MRTA disallows the unlicensed sale of cannabis, but it does allow for the transferring, without compensation, of certain amounts of cannabis to those over 21 years of age. 

In an attempt to exploit the allowance of uncompensated cannabis transfers, some operators implemented gifting or membership models for their businesses. 

Under the gifting model, an unlicensed operator sells another good or service, often a low- value item such as a T-shirt or sticker, at a mark-up price, which includes a gift of cannabis. 

With the membership or cannabis club model, unlicensed sellers charge a fee associated with membership or entrance to a club or group, where only members are able to purchase cannabis. 

Schemes such as these were somewhat inevitable, evidenced by similar methods employed in regions with legalized cannabis possession and a lack of sufficient legal programs, such as in Washington, D.C. 

The OCM eventually caught wind of this and sent cease-and-desist letters to a number of operators suspected of unlicensed sales, including those utilizing gifting schemes.[5] 

The OCM has similarly begun enforcement action against unlicensed sellers utilizing membership or club models, having declared the sharing of cannabis in connection with the sale of a service as illegal, according to their adult-use information webpage.[6] 

While these actions clarified the OCM's position on such unlicensed methodologies, and may have even minimized the use of gifting and membership schemes, the unlicensed market as a whole was not significantly reduced. 

Transactional Model 

As these creative schemes arose, an initial lack of enforcement action seemingly emboldened further and more overt unlicensed sales of cannabis. 

Based on our observation, the most common unlicensed sellers currently operating are not those attempting to exploit a loophole in the adult-use law, but those simply unlawfully selling cannabis products for cash — i.e., the transaction model. 

Tables and pop-up stands selling unlicensed cannabis are commonplace across New York City. 

An early iteration of this simple unlicensed cannabis transaction model was the use of trucks to sell cannabis products across the city's five boroughs. 

Their rapid proliferation and eye-catching style attracted much attention from both the public and law enforcement, which resulted in fines, parking tickets and towing — significantly reducing such unlicensed truck sellers. 

An expansion of the transaction model, which is the primary target of the recent bill, is the unlicensed brick-and-mortar retail store. Operators quickly realized the financial opportunity in such storefronts, and these unlicensed stores have become commonplace across New York City. 

Although enforcement action against such stores has already begun, the significant profits generated by many such stores have left them undeterred by the threat of relevant fines. 

This type of unlicensed retail operation poses a significant risk to the legal adult-use market, and thus has drawn significant scrutiny. 

The success of these stores jeopardize competing legal adult-use retail dispensaries, in that they operate under significantly less financial and regulatory burdens, often sell unregulated products at prices below what adult-use stores can afford and confuse consumers as to their legality. 

Existing-Store Model 

Yet another method employed by unlicensed sellers is the existing-store scheme. 

The significant profit of unlicensed sellers, particularly the brick-and-mortar retail stores, led many existing businesses to partake in unlicensed cannabis sales. 

Through this method, a bodega, smoke shop, convenience store or other existing, legitimate retail store simply sells unlicensed cannabis products along with their other products. 

This allows an otherwise legally operating business to make additional profit, potentially tax-free, through the sale of unlicensed cannabis. 

This type of unlicensed operator may not be directly affected by the bill. 

Landlord Accountability Aims to Limit Business Opportunities for Illegal Operators 

While actions against illicit businesses have increased with the OCM's expanded enforcement powers as per the state's fiscal year 2024 budget,[7] it is clear that additional actions will be necessary to fully address the unlicensed market. 

In a further effort to combat the booming illicit market in New York, politicians at every level of state government have proposed some sort of landlord accountability as a deterrent against would-be illegal operators. 

This proposal presumes that, if landlords are discouraged from or punished for entering into or maintaining leases with illegal operators, these businesses will be unable to secure the necessary space, or, in the event that they already secured a lease, will face eviction. 

It is against this backdrop that the New York City Council passed Schulman's bill, which provides, among other things, that landlords will be unable to continually plead ignorance to avoid fines. 

Initially, it was understood that, per OCM guidelines, a landlord would not be able to lease space directly to a conditional adult-use retail dispensary, or CAURD, license holder, but rather would be required to enter into a lease with the Dormitory Authority of the State of New York, which would then sublease the space to the CAURD licensee. 

The difficulty in locating and securing compliant premises, however, has led the OCM to approve locations for CAURD licensees in premises not controlled by the Dormitory Authority. 

This change and subsequent confusion has created more opportunity for unlicensed brick- and-mortar operators to flourish. 

Under the bill, landlords who enter into non-Dormitory Authority leases directly with unlicensed tenants that conspicuously advertise THC products are at high risk of enforcement action, particularly after a city agency warning letter, which could disprove any landlord's claims of ignorance. 

If this bill proves successful in curtailing illegal operators from operating brick-and-mortar stores, these unlicensed operators will be forced to consider going entirely underground, ceasing operations, or obtaining a dispensary license and entering the legal marketplace. 

For many unlicensed operators, however, the latter legacy-to-legal option may not be realistic. 

New York was the first state in the nation to prioritize justice-involved license applicants through its CAURD license program. 

Over two years after the MRTA was passed, and with over 1,000 adult-use cannabis applications submitted, there are still only a handful of legally compliant retail dispensaries currently open for business in New York. 

Limitations and Unforeseen Consequences of the Bill 

Fining commercial landlords and mandating that they evict unlicensed cannabis tenants is a predictable step in the implementation of New York's legal cannabis market. 

Without it, legitimate license holders would continue to be at an unfair disadvantage in the wider cannabis industry, and neither consumers nor the general public will reap the benefits of a well-regulated marketplace. 

The impact of this bill is limited, however, in that it only targets commercial premises and their landlords. While brick-and-mortar retail storefronts are of significant concern to the legal adult-use market, they only represent a portion of the broader unlicensed market. 

The existing-store scheme, for example — where otherwise legally operating businesses sell unlicensed cannabis products along with their standard offerings for sale — is not fully contemplated by this bill. 

One provision of the bill, Section C.1, specifies that written notice of a violation following an inspection, and presumably any future fines, shall only be directed to a property that is used to sell illicit cannabis products and "is not occupied for any other licensed or lawful purpose." 

While the bill may still result in the imposition of fines against landlords of unlicensed cannabis stores, this provision may be interpreted to mean that if the premises are used for another lawful purpose, the landlords may not be subject to these fines. 

Since the businesses operating under the existing-store scheme are occupied for another licensed or lawful purpose, such as operating as a convenience store, they will be outside the purview of this bill. 

This carveout in the bill for unlicensed sellers occupying their premises for another lawful purpose will not only allow such sellers to continue their unlicensed sales, but may well lead more otherwise lawful store owners to engage in unlicensed cannabis sales. 

Without the fear of further enforcement action, the profitability of unlicensed cannabis sales will likely inspire other similar stores to sell cannabis, which will further proliferate the market and confuse consumers as to their legality, particularly since the store's other offerings are presumably lawful. 

Moreover, while this bill may significantly reduce the amount of operating unlicensed brick- and-mortar retail stores, unlicensed operators selling cannabis out of residential locations, mobile platforms, pop-up stands and tables, and direct delivery services will likely not face negative repercussions as a result of this bill. 

If anything, at least for a time, a curtailing of other types of illicit operations could reduce competition in the illegal market, and indirectly benefit their own businesses. 

The complexity and adaptability of the unregulated cannabis market cannot be underestimated. While this bill may address some of the significant illicit competition affecting law-abiding adult-use dispensary licensees, it falls woefully short of addressing the entire unregulated market in New York, and will leave other avenues of unlicensed retail cannabis sales unaddressed entirely. 

Frequent reassessment of enforcement action to ensure it is responsive to all of the different ways the unlicensed market functions will be necessary to ensure a flourishing New York legal adult-use cannabis industry.

This article was originally published in Law360 and is presented here for informational purposes.

[1] https://legistar.council.nyc.gov/LegislationDetail.aspx?ID=6165428&GUID=33A0F77B- 950A-4A9E-8033-F0316A346404&Options=ID%7cText%7c&Search=schulman. 

[2] https://mjbizdaily.com/1400-illegal-marijuana-sellers-proliferate-unchecked-in-new- york-city/. 

[3] https://www.politico.com/news/2021/10/23/california-legal-illicit-weed-market-516868. 

[4] https://cannabis.ny.gov/dispensary-location-verification. 

[5] https://cannabis.ny.gov/news/office-cannabis-management-announces-enforcement- action. 

[6] https://cannabis.ny.gov/adult-use-information. 

[7] https://www.governor.ny.gov/news/governor-hochul-signs-legislation-curb-illicit- cannabis-market-new-york-state-part-fy-2024. 

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