Why Not Just Blame the Landlord and the Mortgage Lender...?
The New York City Council has adopted a new law that imposes penalties on landlords who knowingly lease premises to unlicensed cannabis or tobacco sellers. The law imposes fines on landlords who lease property to a tenant who they know will use the premises for the unlicensed sale of cannabis or tobacco. The law imposes fines on landlords who take no action after they are notified by a law enforcement agency that an existing tenant sells cannabis without a license. Although this blog refers to unlicensed cannabis sales, the law applies not only to cannabis but also to the unlicensed sale of cannabis products, tobacco, and e-cigarettes. Everything I suggest below regarding cannabis also applies to the unlicensed sale of cannabis products, cigarettes, and e-cigarettes.
The penalties for violating the law are severe, with a fine of $5,000 for the first violation and $10,000 for subsequent violations. Although not clear from the statute, published reports suggest that each day that a violation continues is a separate penalty. A landlord can defend against the violation by showing that a proceeding to evict the unlicensed tenant has been commenced.
The law defines owners to include not only people who own the building but also mortgage lenders that take possession of the property, contract purchasers who take possession before the deed is transferred, tenants who sublease to the unlicensed seller, parties that hold assignments of rents, managing agents, and anyone else who directly or indirectly controls the premises. Since virtually every commercial mortgage includes an assignment of rents, a literal interpretation of the law imposes liability on mortgage lenders who find out that a tenant is an unlicensed cannabis seller, even if the lender does not have the authority to evict the tenant.
To limit the risks, we recommend the following for different groups of potentially liable parties.
Make sure that your leases expressly prohibit unlicensed sales. The clause in the lease that describes permitted uses of the premises should be drafted so that it cannot possibly be interpreted to permit unlicensed cannabis sales. If you expect that the tenant may be selling cannabis, require that the tenant provide a copy of a duly issued license before commencing sales and a copy of all renewals before the existing license expires. The lease should authorize you to evict an unlicensed tenant by summary proceedings and authorize you to obtain an injunction prohibiting unlicensed sales. If the lease permits the retail sale of any products, consider requiring the tenant to provide an annual affidavit that no cannabis is being sold without a license. If the lease permits subleasing, impose parallel obligations on both the sublessor and sublessee as a condition of permitting the sublease.
The lease should also include an indemnification provision for any fines imposed upon the landlord for the wrongful acts of the tenant. Indemnification against fines in some cases is considered against public policy and thus unenforceable, but whether an indemnification for these types of fines and related costs will be enforced should be left to another day. For the moment, including an indemnification clause is better than not having it. Make sure that any contract you have with a managing agent requires that the agent periodically verify the nature of the occupancy and that the agent immediately commence eviction proceedings if a tenant is engaged in the unlicensed sale of cannabis.
Commercial mortgages almost always include an assignment of rent, so the new law seems to encompass all mortgage lenders. Other statutes with similar language referencing assignments of rent have been interpreted not to cover the standard assignment of rents in which the lender has an assignment as additional collateral for the loan unless the lender takes actual control of the rents. However, no lender wants to be a test case. Therefore, the lender should include a provision in its form of mortgage expressly prohibiting the use of the premises for the unlicensed sale of cannabis and obligating the borrower to commence eviction proceedings immediately if there is any evidence of the unlicensed sale.
The failure of the borrower to pursue eviction aggressively should not only be a default under the mortgage, but the mortgage should also include a provision giving the lender the right to commence legal proceedings on behalf of the landlord if the landlord fails to act promptly. If appropriate, based upon the nature of the tenancy, the lender should obtain copies of all licenses permitting the sale of tobacco or cannabis by the tenant as part of its normal due diligence, and the tenant estoppel certificate should obligate the tenant to provide copies of all license renewals directly to the mortgage lender. If there is not already an appropriate indemnification provision in the mortgage, a provision should be added that expressly covers fines for unlicensed cannabis sales. If the lender performs periodic property inspections, as many bank mortgage lenders do, cannabis sales should be included in the inspector’s checklist.
If a managing agent is authorized to negotiate and sign leases, it should make sure that the lease provides all of the protections that I suggest above for the landlord. If the managing agent is only involved in ongoing management but not the origination of a lease, the managing agent is still liable for fines if it becomes aware of the unlicensed sale on any premises that it manages. Therefore, I recommend that managing agents conduct periodic inspections and also establish appropriate lines of communication to make sure that a notice from a law enforcement agency regarding unlicensed sales on the premises is not ignored. Instead, the notice should be reported up the line so that the landlord or the agent commences eviction proceedings immediately.
And in conclusion, having appropriate documentation in advance (such as leases, mortgages, loan policies, and managing agent agreements), coupled with proper training of your employees to know what to look for, is crucial to avoid draconian penalties. We are here to help you because an ounce of prevention is a lot less expensive than a pound of cure.