On April 17, 2012, Maricopa County, Arizona, Superior Court Judge Michael R. McVey signed a Judgment of Dismissal that could be the death blow to Arizona’s fledgling medical marijuana dispensary industry.  The case is Michele Rene Hammer v. Today’s Health Care II, a Colorado corporation (“THC”).  Although the judge’s decision has not yet been appealed and may not be appealed, the legal significance of the case cannot be ignored by anybody who is considering becoming involved in a prospective or actual  Arizona medical marijuana dispensary or anybody who is a party to or may become a party to a contract that involves the growing, transporting, storing, infusing, processing, selling or dealing in any way with marijuana in Arizona.

Hammer v. Today’s Health Care II involves a very common situation.  Michele Hammer and Mark Haile each loaned $250,000 to Today’s Health Care II, a Colorado corporation.  Each lender and borrower signed a loan agreement that stated:

“Borrower shall use the loan proceeds for a retail medical marijuana sales and grow center.”

THC defaulted on both loans.  Although the loan proceeds were to be used only in Colorado, a state where medical marijuana is legal, each lender sued in Maricopa County Superior Court to collect the amounts owed under the promissory notes signed by THC.  The two cases (Hammer v. THC and Mark W. Haile v. Todays Health Care II) were consolidated.  The plaintiffs and defendant filed motions for summary judgment.  On April 17, 2012, the judge signed the Judgment of Dismissal in which he ruled that THC is not obligated to repay all or any part of either loan.  Judge McVey stated:

“The explicitly stated purpose of these loan agreements was to finance the sale and distribution of marijuana. This was in clear violation of the laws of the United States. As such, this contract is void and unenforceable. This Court recognizes the harsh result of this ruling.  Although Plaintiffs did not plead any equitable right to recovery such as unjust enrichment, or restitution, this Court considered whether such relief may be available to these Plaintiffs.  Equitable relief is not available when recovery at law is forbidden because the contract is void as against public policy.”

Result:  The borrower can keep the $500,000 and it has no legal obligation to repay the loans.  The borrower does not get to keep all of the money, however, because it will be required to report $500,000 as taxable income on its 2012 federal income tax return.  Forgiveness of a debt causes “discharge of indebtedness income” that must be reported to the IRS and taxed at the taxpayer’s marginal tax rate.

There is an equitable concept in the law called unjust enrichment.  There are many cases where a court has ruled that even though the plaintiff could not prove a legal basis on which the plaintiff should be paid damages, a court of equity looking at all of the facts gave the plaintiff a judgment for money because the actions of the plaintiff caused the defendant to be unjustly enriched and it would not be fair for the defendant to keep the economic benefit bestowed on the defendant.  Judge McVey wrote that he considered ruling in favor of the lenders on the basis of unjust enrichment, but that remedy is also denied when the contract involved is void as against public policy.

Judge McVey based his decision on the fact the purpose of the loan was for a purpose that is illegal under federal law.  He did not examine whether the loans should be enforced because they were legal under state law.  After all, collection of a loan arises from legal obligations and rights created under state law, not federal criminal law.  It seems logical and lawful to me that the judge could have ruled in favor of the plaintiffs had he considered the legality of the loans under state law.

This case does not have the legal precedent of a written opinion from the Arizona Court of Appeals or the Arizona Supreme Court.  Nevertheless Hammer v. Today’s Health Care II stands for a very important principle that everybody who is contemplating becoming involved with the Arizona medical marijuana industry cannot ignore, i.e.:

Unless and until an Arizona appellate court rules that contracts involving Arizona medical marijuana are enforceable under Arizona law (as opposed to unenforceable under federal law), any contract that has a purpose related to Arizona medical marijuana may be unenforceable and not worth the paper it is written on!

What Does the Case Mean to People Considering Becoming Involved in Arizona Medical Marijuana Dispensaries?

Until an Arizona appellate court reverses the result in this case it means that people who enter into contracts that relate in any way to Arizona medical marijuana will have to hope the other side to the contract satisfies his/her/its obligations because it may not be possible to sue for breach of contract and get a judgment against the party who defaults.  This case should cause the following people to think twice or three times before getting involved:

• Landlords who lease to dispensaries.  The lease may not be enforced.  If a dispensary tenant defaults on the rent would a court evict the tenant or give the landlord a money judgment for damages for breach of the lease?

• Investors in dispensaries.  Would the investment be treated the same as a loan with no legal way to force the dispensary to repay the investment or profits?

• Lenders who loan to dispensaries.  This is the same facts as Hammer v. Today’s Health Care II.  Why would any person or entity make a loan to a dispensary when there is a good chance a court would refuse to enforce the loan?

• Medical directors of dispensaries.  What if the dispensary doesn’t pay for the doctor’s services?

• High paid employees or independent contractors.  Are you willing to work and have the dispensary refuse to pay and dare you to sue?

The above list is not complete.  If you are contemplating entering into any type of contract (oral or written) with a prospective or actual Arizona medical marijuana dispensary you are taking a risk that an Arizona court may rule that the contract is unenforceable.

You might think that the ultimate winner as a result of Hammer v. Today’s  Health Care II is the Arizona medical marijuana dispensary.  Perhaps, but I submit that dispensaries are actually the ultimate losers because this case stands for the proposition that it will be very difficult if not impossible for Arizona medical marijuana dispensaries to operate because prudent people and businesses will not want to contract with dispensaries until an Arizona appellate court rules that the contracts are enforceable under Arizona law.

Update:  Richard Keyt and Judge McVey’s ruling are discussed in the following stories:

• ABC News:  “$500,000 Medical Marijuana Loan Up In Smoke” quotes “Richard Keyt, a business attorney in Phoenix who runs a medical marijuana law web site.”

• Phoenix New Times reporter Ray Stern’s article called “Marijuana Dispensary Loan for $500,000 Doesn’t Need to be Paid Back, Judge Rules, Because Pot is Illegal Under Federal Law” in which he gives me credit for breaking this story.

• Arizona Republic story called “Arizona Medical-pot Ruling may Reverberate.”

• Fox News Chicago story called “Contracts with medical marijuana companies unenforceable, Arizona court rules.”