Cannabis Litigation: Another Blow to the Illegality Defense (Kennedy v. Helix TCS, Inc.)

Yes, cannabis is still federally illegal. But no, that doesn’t mean cannabis businesses should act as if federal law doesn’t exist. It does, and it probably applies to any cannabis business. Nevertheless, our cannabis attorneys often hear claims that federal law doesn’t apply. In fact, two questions that I’ve heard numerous times are:

  1. If the other side breaches this cannabis contract and we sue them, will they just claim that the contract is federally illegal to get off the hook, and if so, will the judge agree?
  2. Does federal law apply to our cannabis business?

The answer to the first question is admittedly pretty tough. Our cannabis attorneys see parties put all kinds of things in contracts to try to avoid this problem—from acknowledgements of federal illegality, to waivers of the right to bring a case in federal court, to outright waivers of the illegality defense. Whether any clauses could make a difference in litigation is not clear, and depending on the jurisdiction, a court could theoretically agree that the contract is illegal and can’t be enforced, though we believe that’s unlikely to happen in any state court in a state with a commercial cannabis licensing system. After all, one would hope that a judge wouldn’t sympathize with a party who signed a contract, breached it, and then claimed the whole thing was illegal.

The answer to the second question is much easier: federal law almost certainly applies. A good rule is that if the federal government says that a business has to do something, they have to do it. On the other hand, when federal laws offer protections or benefits to normal businesses, those often don’t apply to cannabis companies (such as bankruptcy protection or certain tax deductions). Here are a series of examples:

  • The Controlled Substances Act: Even though the federal government hasn’t really enforced the CSA against state-lawful operators in a few years, it actively enforces it against allegedly unlicensed operators. Theoretically, nothing is stopping the federal government from bringing charges against every licensed dispensary in the United States (with the exception of strictly medical operators as protected by the Rohrbacher Blumenauer amendment, as extended from time to time). In reality, it doesn’t look like the federal government will abandon its current policy of non-enforcement any time soon.
  • Federal Trademark Laws: Thinking of using an established company’s trademarks on cannabis goods? Well, they might haul you into court under the federal trademark laws. A federal trademark registration offers the holder the right to seek certain remedies against unlawful users of that trademark (the “infringer”), regardless of whether the infringer was selling a legal or illegal good. Even businesses without federal trademark registrations can bring trademark actions against infringers.
  • Federal Trade Secret Laws: If a cannabis company improperly acquires information, data, methods, or any other kind of secret from any other company, the cannabis company could be sued under the federal Defend Trade Secrets Act.
  • Federal Environmental Laws: Cannabis companies that don’t comply with federal environmental laws risk being penalized or even criminally indicted.
  • Federal Tax Laws: Yes, cannabis companies need to pay federal taxes, but unfortunately, thanks to Internal Revenue Code section 280E, they cannot take regular business deductions, so they end up paying taxes on their gross receipts less their allowed cost of goods sold.
  • Federal Employment Laws: Thanks to the Tenth Circuit Court of Appeals (a federal appellate court based in Denver that is one step below the U.S. Supreme Court), we can now add compliance with the Fair Labor Standards Act (“FLSA”) to this list.

The case at issue is Kenney v. Helix TCS, Inc., which we’ve been following for about a year. As we explained previously:

Helix TCS, INC. (“Helix”) provides security services to cannabis businesses. Kenney, an employee of Helix, was classified as an exempt employee, meaning Helix did not pay him overtime pursuant to the requirements of the FLSA. Kenney brought suit against Helix claiming he was misclassified as exempt and should have been paid overtime.

Helix moved to dismiss the case, arguing that Kenney was not entitled to the protections of the FLSA because cannabis was entirely forbidden under the CSA. The district court denied the motion to dismiss but certified the ruling for immediate appeal to the Tenth Circuit Court of Appeals.

On Appeal, Helix contends that its employees are not entitled to the protections of the FLSA. Helix’s main argument is that all participants in state recreational marijuana industries assume the risk that their activities will subject them to federal criminal sanctions and therefore they are not entitled to benefits under federal law, and cannot expect federal court to aid their conduct. Essentially Helix is arguing that the federal government would be assisting employees in drug trafficking if they afforded the employees the protections of the FLSA.

On September 20, 2019, a three-judge panel of the Tenth Circuit issued a concise, 12-page opinion unanimously disagreeing with Helix and holding conclusively that the FLSA does apply to cannabis businesses. In one part of the Kenney opinion, the court noted that “case law has repeatedly confirmed that employers are not excused from complying with federal laws just because their business practices are federally prohibited.” After reviewing this law, the court held that “the FLSA is focused on regulating the activity of businesses, in part on behalf of the individual workers’ well-being, rather than regulating the legality of individual workers’ activities.” In conclusion, the court held that the FLSA does apply to cannabis companies and allowed the case to proceed.

There is an important note in the wake of the Kenney case: the case is only “binding” on jurisdictions within the Tenth Circuit, which are the District of Colorado, District of Kansas, District of New Mexico, Eastern District of Oklahoma, Northern District of Oklahoma, Western District of Oklahoma, District of Utah, and District of Wyoming. The decision will just be “persuasive” authority for federal courts elsewhere in the U.S., which means that they don’t necessarily need to be adhered to. Even though Kenney won’t be binding on federal courts outside the Tenth Circuit, we don’t see many courts departing from the Kenney rule.

You may be asking why this case is relevant to the illegality defense. The answer is simple—the court’s reasoning is broad enough to apply outside of the context of the FLSA. In other words, courts across the country could either cite the case persuasively outside the FLSA context, or just come to different conclusions based on the same reasoning. Even if federal legality doesn’t happen soon, we expect that the federal illegality defense will continue to weaken substantially over the next few years.

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