Let the litigation begin.  The Arizona Department of Health Services had 120 days to create the rules to implement Arizona’s medical marijuana law.  During that time DHS produced FOUR versions of its rules, but it saved its three  improvised explosive devices until the 120th day.  When the smoke clears from the DHS final rule bombs and allows would-be dispensaries to check their damage, many will find that they are too crippled to continue the race to the dispensary license finish line.

Today, the DHS submitted its final rules to the Arizona Secretary of State, but not without making three new rules that will prevent many would-be dispensaries from actually filing an application for a dispensary license.  Here’s what DHS did:

The Zoning Comfort Letter Bomb

The first bomb is contained in new rule R9-17-304(D)(6), which reads: “To apply for a dispensary registration certificate, an entity shall submit to the Department the following . . . . Documentation from the local jurisdiction where the dispensary’s proposed physical address is located that:

a. There are no local zoning restrictions for the dispensary’s location, or

b. The dispensary’s location is in compliance with any local zoning restrictions

DHS issued the following FAQ on this issue:

“Do I need a certificate of occupancy from my city in order to apply? No, applicants do not need to submit a certificate of occupancy in the initial application. They must attest to meeting zoning requirements and provide documentation from the local government saying either there are no local zoning requirements or the location meets the requirements. However, if chosen as the dispensary for a specific CHAA, a copy of a certificate of occupancy or other documentation issued by the local jurisdiction will be necessary when requesting approval to operate the dispensary.”

The legal significance of this new rule is that the decision on which entity will get a dispensary license will be determined at the city or local zoning level.   The rule does not give any guidance on what it means to be “in compliance with any local zoning restrictions.”  Each local zoning authority will decide the conditions on which it will give its zoning comfort letter.  The zoning authorities are  able to give one comfort letter per CHAA if they so desire.  Any would-be dispensary that fails to get a zoning comfort letter by June 30, 2011, is precluded from filing an application to get a dispensary license.   Each local zoning authority is now free to determine who will get its zoning comfort letter.  This new rule is an abrogation of DHS’ duty to select the qualified dispensaries and a shameful dereliction of its duty.

For a an actual example of how the cities are now able to select who will own a medical marijuana dispensary within their jurisdictions, see “Fountain Hills Faces Medical-marijuana Challenge.”  Fountain Hills has only accepted one zoning application so no other would-be dispensaries will be able to operate in Fountain Hills.  Result:  Fountain Hills will determine who owns the dispensary in Fountain Hills, not DHS.

The Landlord Comfort Letter Bomb

New rule R9-17-304(D)(7 ) reads: “To apply for a dispensary registration certificate, an entity shall submit to the Department the following . . . . Documentation of:

a. Ownership of the physical address of the proposed dispensary, or

b. Permission from the owner of the physical address of the proposed dispensary for the entity applying for a dispensary registration certificate to operate a dispensary at the physical address;

DHS went backwards.  The second draft of the rules created a nightmarish situation for prospective dispensaries because a large number of prospective tenants were all trying to enter into leases for a very small number of possible sites.  The law of supply and demand made it impossible for most prospective dispensaries to find a properly zoned site and tie it up with a lease.  This caused rents to soar way above market because the laws of economics applies to medical marijuana dispensaries and available rental space like it does to every other commodity.  It was because of this hellish situation that I wrote an article on February 8, 2011, called “Prospective Dispensary’s Single Most Important Task Before May 30, 2011.”

Once again would be dispensaries will be engaged in a mad scramble to get a comfort letter from a landlord.  Many will not be successful or will be successful only at great expense in time and money.  Most landlords will demand real money to get a letter.  Few will give away comfort letters.  A commercial real estate broker who has been successful in getting leases for would-be dispensaries told me today that some landlords are demanding $5,000 to give a tenant a comfort letter for the purpose of getting local zoning approval.  He also said that he has seen rents for dispensaries as high as $27 a foot, which is more than the going rate for class A office space in the Camelback corridor.

I predict that no prudent landlord will simply issue a comfort letter that satisfies the vague language in the new rule.  I am a real estate lawyer and if I were advising a landlord and asked to draft a comfort letter that said the landlord will give the dispensary permission to lease the premises for a medical marijuana dispensary, I would put in language the makes it clear that the letter does not create a legal obligation on the part of the landlord to lease the premises to the dispensary.  Without actually having a signed lease with the dispensary, every landlord should be concerned that a comfort letter does not obligate the landlord to lease the premises.  I would also advise my landlord client to charge a substantial fee to get a comfort letter.

Query:  If the landlords issue comfort letters that clearly state they are not binding on the landlord, then what is the purpose of requiring the prospective dispensaries to get the comfort letter?  Maybe I’ve missed something, but the only reason I can see for this new requirement is to reduce the number of applicants for dispensary licenses and increase the applicants’ costs of doing business.  Landlords once again have the upper hand which means the dispensaries will pay higher rents and the patients will pay more for their medicine.

See “Arizona Medical-marijuana Dispensaries Face Property Hurdles.”

The Bank Comfort Letter Bomb

Last, but not least, are new rules R9-17-302.A.5 and R9-17-304.D.1.f.ii.  This last minute bomb was triggered by a question that should never have been asked of Will Humble last week at the April 5, 2011, forum in Phoenix.  The first final rules issued by DHS on March 28, 2011, added a new requirement that said the dispensary application had to include:

“Documentation, from an in-state financial institution or an out-of-state financial institution, demonstrating that the dispensary has at least $150,000 available to begin operating was submitted with the dispensary registration certificate application.”

Unfortunately for many would-be dispensaries, a man asked Will Humble if it would be ok to deposit money in the bank, get the letter from the bank and immediately take the money out of the bank.  Mr. Humble was visibly stunned by the question as he visualized a hole a mile wide in his capital requirement plan.  Because of that question, RR9-17-304.D.1.f.ii requires the applicant for a dispensary license to submit “documentation that:

(1) Is from an in-state financial institution or an out-of-state financial institution;

(2) Is dated within 30 days before the date the dispensary registration certificate application was submitted; and

(3) Demonstrates that the entity applying for the dispensary registration certificate or a principal officer of the entity has at least $150,000 under the control of the entity or principal officer to begin operating the dispensary and has had control of the $150,000 for at least 30 days before the date the dispensary registration certificate application was submitted“

In-state financial institution” means the same as in A.R.S. § 6-101.  Out-of-state financial institution” means the same as in A.R.S. § 6-101.

A client asked me the if Charles Schwab or Merrill Lynch are “out-of-state financial institutions?  A.R.S. § 6-101 states that “Out-of-state financial institution means a state or federal bank, savings bank, savings and loan association or holding company with its home office in a state other than this state.”  I don’t believe these types of institutions are banks or S & Ls, but could they be “holding companies?”  I have no clue what the term “holding company” means.  It appears, however, that a person who has sufficient assets in Merrill Lynch or a similar financial institution could not use that type of entity as an out of state financial institution for the purposes of this new rule.

This rule is outrageous, unreasonable, unfair and just plain wrong.  Whether or not the reasoning behind the rule is good is something we could debate, but that is not my problem with the rule.  I despise this rule because it is much too late in the process to issue the rule and simply not enough time for many prospective dispensaries to be able to comply with this new rule issued on the last day of the 120 days DHS had to finalize its rules.

The last day applicants may submit applications for dispensary registration certificates is June 30, 2011.

Note carefully requirement number 3.  It could be a nuclear bomb!  Either the entity applicant or A PRINCIPAL OFFICER OF THE ENTITY (whichever one actually has the funds) must show that it/he/she has had control of the $150,000 for at least 30 days before the dispensary application is submitted to DHS.

Bottom line:  DHS may have just opened the litigation flood gates and may have cost the State of Arizona mega-millions in damages for promulgating unreasonable rules that have no basis in Proposition 203.

What do you think?  What am I missing?  Am I wrong.  Add your comments below.