History of Marijuana Treatment in the United States

By: Sarah Siegel and Danika Johnson

Marijuana use in the United States has been a topic of debate for decades. From being accepted to highly regulated and criminalized, marijuana use has gained significant importance and credibility in the modern age.

While the cannabis plant can be used for various reasons, for example, hemp for fabrics, the use of marijuana for the body dates to the 1850s. In the 1850s, marijuana was available in pharmacies for the medical treatment of nausea, pain, and other ailments. Marijuana was a popular ingredient used in medicines and tinctures. At the turn of the 19th century, government regulation of marijuana began. The Pure Food and Drug Act in 1906 made the labeling of any cannabis in over-the-counter remedies a requirement.

Only a few years after the passage of the Pure Food and Drug Act and as a result of the Mexican Revolution of 1910, the United States saw an influx of Mexican immigrants into the U.S. Mexican immigrants brought with them the marijuana plant and introduced recreational use, and by the 1930s, it became popular throughout the U.S. In 1913, California was the first state to outlaw cannabis, followed by Utah in 1914. Following the Alcohol Prohibition Era, marijuana was seen as the readily available and inexpensive alternative to alcohol, making it even more popular in America.

Since marijuana was used mostly in the Mexican and Black communities, marijuana became the next target for xenophobic fears. Massive unemployment increased public resentment and fear of Mexican immigrants. Journalists, newspapers, and the media all contributed to the negative treatment of marijuana in American culture at the time. By 1931, 29 states outlawed marijuana. The Federal Bureau of Narcotics Commissioner then started a propaganda campaign throughout the U.S. claiming that marijuana caused insanity, reckless and criminal behavior, and death. This effort was made to encourage the remaining states to adopt the Uniform State Narcotic Drug Act.

The adoption of the Uniform State Narcotic Drug Act was not enough. A national propaganda campaign against the “evil weed” pushed for the growing concern Americans had about marijuana. An example includes Reefer Madness, a 1936 film renamed “Tell Your Children,” which showcases a group of students committing crimes after smoking marijuana. The FBN Commissioner published in the American magazine, Marijuana, Assassin of Youth, to continue lobby efforts for the adoption of federal legislation. In 1937, the Marijuana Tax Act was passed by Congress, imposing federal taxes on transfers of the drug and requiring persons dealing in marijuana register their names and places of business with the IRS.

Not everyone in the United States gave in to the national propaganda campaigns. The New York Academy of Medicine issued the LaGuardia Committee Report in 1944, laying out the results of a five-year comprehensive study. They found that marijuana did not lead to the use of morphine, heroin, or cocaine, was not the determining factor in the commission of crime, and the overall publicity regarding its catastrophic effects was unfounded. By the 1950s through the 1960s and 1970s, attitudes towards cannabis use began to shift, increasing marijuana uses acceptance, especially among youth.

While American culture began to shift to acceptance, the federal government continued to criminalize marijuana. In 1970, the Controlled Substances Act was passed, labeling marijuana a Schedule I substance. This imposed many restrictions, some of which are still prevalent today. While states have moved towards legalizing or decriminalizing marijuana, and many individuals have created new businesses, federal legislation prevents those businesses from fully participating in the financial industry.

As states to continue to pass measures to legalize or decriminalize and remove harsh restrictions on marijuana, the hope is that the federal government will follow suit.  Significant campaigns throughout the nation and general acceptance for its use will encourage federal legislation to decriminalize marijuana and allow this industry to expand and develop further.

lock graphic printed on wood blocks

California Opts In for Comprehensive Privacy Protections

By: Lauren Mack and Matthew Basilotto

As our world becomes increasingly digital, concerns over the security and privacy of personal and other sensitive information have grown with the rapid adoption of new data collection and tracking technologies. Unlike the European Union with its General Data Protection Regulation, the United States has dragged its feet on taking action to create comprehensive data privacy rights for its citizens, leaving the responsibility to each state to determine how to protect the personal information of its residents. California has been a leader in enacting online privacy laws, and with the enactment of the California Consumer Privacy Protection Act (CCPA), has established the most protective privacy protection regime in the United States for the personal information of its residents.

What Businesses Must Comply with the CCPA?

The CCPA governs the collection and use of “information that identifies, relates to, describes, is reasonably capable of being associated with, or could reasonably be linked, directly or indirectly, with a particular consumer or household” who is a California resident. Information that is lawfully publicly available in federal, state, or local government records, is de-identified, or is in the aggregate is expressly excluded from the CCPA’s definition of “personal information”.

Those businesses that must comply with the CCPA are for-profit businesses that do business within the state of California and:

  • Have annual gross revenues in excess of $25,000,000;
  • Alone or in combination, annually buy, receive for commercial purposes, sell, or share for commercial purposes, alone or in combination, the personal information of 50,000 or more California resident consumers, households, or devices;
  • Derive 50% or more of its annual revenues from selling California residents’ personal information; or
  • Control or are controlled by any business that falls into one of the above categories and shares common branding with the business.

The above criteria applies to both online businesses and brick-and-mortar businesses doing business in California.

What Rights do Consumers have Under the CCPA?

The CCPA grants consumers three primary rights:

  • The right to know: Consumers have the right to request that businesses subject to the CCPA disclose the following:
    • The categories of information that the business has collected about that consumer
    • The specific pieces of information that the business has collected about that consumer
    • The categories of sources from which the business collected that information 
    • The reasons why the business collected that information
    • The categories of third parties with which the business shared that information
    • Whether the business has sold the consumer’s information, and if yes, the categories of information sold and if the information was sold for a business purpose
  • The right to opt-out (and for minors to opt-in): Businesses must allow consumers who are 16 and older to opt-out of the sale of their personal information by the business. The personal information of a person under the age of 16 but at least 13 years old may not be sold unless the business has obtained the explicit written consent of the person. To sell the personal information of a person under the age of 13, the business must have the explicit written permission of a parent or guardian.
  • The right to delete: A consumer may request that a business delete any personal information the business has collected about that consumer unless an exception applies. Exceptions to a business’ obligation to delete personal information include needing to maintain the information to comply with a legal obligation, to detect security incidents or fraud, or to fulfill a contract between the business and the consumer. 

Businesses are prohibited from discriminating against any consumers who exercise their rights under the CCPA. However, a business may charge a person who opts out of the sale of their personal information more than a consumer who opts in if the difference in price is “reasonably related to the value provided to the business by the consumer’s data”.

What do Businesses Need to Do to Comply?

To comply with the requirements of the CCPA, businesses will need to update their privacy policies and data processor agreements, review their security and data breach practices, and implement procedures for responding to consumers’ right to know, opt-out, and delete requests.

A CCPA-compliant privacy policy must disclose:

  • The date the privacy policy was last updated;
  • The categories of personal information collected by the business during the prior 12 months;
  • The reason why that personal information is collected;
  • The categories of personal information that the business has sold during the prior 12 months;
  • The categories of personal information that the business has disclosed for a business purpose during the prior 12 months;
  • The categories of sources from which the business received personal information during the prior 12 months;
  • The rights of California residents under the CCPA; how to submit requests to know, opt-in, or delete; and how the identity of the requester will be verified; and
  • How to contact the business if a consumer has questions about its privacy practices.

The categories of personal information collected and the reason why it is collected must be disclosed at or before the point of collection. What methods for submitting a request under the CCPA are required depend on how the business generally interacts with the consumers and whether it has a direct relationship with those consumers, but they may include an email address, a toll-free phone number, an interactive online form, or a mail-in form. Before responding to a request to know or to delete, the business must verify the identity of the requester using a method that collects as little new information about the requester as possible.

The CCPA also requires companies to maintain “reasonable” data security procedures and practices. Any business that uses a third party to store personal data of California residents should review its data processing and cloud storage agreements to ensure appropriate and industry standard security measures are implemented and, if applicable, to ensure the business will be able to respond to consumer requests within the required timeframes. Personnel handling CCPA compliance procedures must be trained on the CCPA’s requirements and how consumers may exercise their rights under it, and all employees should be trained on the business’ security practices generally. Each business subject to the requirements of the CCPA must maintain certain records on the consumer requests received and the response given for at least 24 months.

Failure to cure any noncompliance with the CCPA within 30 days may subject a business to civil penalties assessed by the Attorney General of California, which may range from $2,500 to $7,500 for each violation. The CCPA also gives consumers whose nonencrypted and nonredacted personal information is accessed or disclosed in a data breach the right to directly bring a civil claim for monetary damages or injunctive relief. 

The Path Forward

Despite the general consensus that California’s rollout of the CCPA has been bungled by delayed final regulations and confusing requirements, California’s approach to privacy is likely a harbinger of legislation to come. Other states are expected to follow suit with similar privacy laws until a comprehensive federal privacy law is passed by Congress to replace the current patchwork of state privacy laws. Until Congress decides to act, it is clear that California will continue to push the envelope when it comes to privacy protections in the United States, as the even more stringent California Privacy Rights and Enforcement Act of 2020 (CPRA) will be on the ballot for California residents to vote for or against in November.

Sync Negotiations: How Much Should You Ask for Your Music?

By: Steven Masur

Synchronization rights negotiations become relevant whenever someone wishes to use your or your client’s music in combination with visuals and moving images such as in movies, television shows, video games, or YouTube videos. Many lawyers write articles about the legal issues that you are likely to encounter in a typical sync negotiation. But the truth is, there’s no such thing as “typical” when it comes to your music. What is crucial to know are the practical considerations that will drive your discussion of the scope, length, and pricing for potential licensed uses.

In doing so, get as much information as you can about the planned uses. Some of the questions you may want to ask include:

  • Is this for film, TV, streaming VOD, or some other use?
  • What’s the revenue model, subscription, ad-driven content, or something else?
  • Is it a music-driven script?
  • What other music are they thinking of using adjacent to yours?
  • What’s the distribution strategy?  Is there an international distribution plan?
  • Theatrical release, indie arthouse?
  • If they can’t tell you their music budget, what’s the budget for the entire production?
  • If it’s for advertising, what’s the brand?
  • What’s the scale and length of the campaign?
  • Will there be influencers pushing it? Who do they have in mind?

It is important to keep asking questions about the scale of the opportunity, and how the music will be used. As that picture becomes more and more clear, you will be able to ascertain how real the opportunity is and come to a comfortable idea of the appropriate fee for your work.

Typically, the interested party will be paying a one-time flat fee for use of the song in their project. In most cases, this sync license fee can range from a few hundred dollars for a small artist in a small project to a few hundred thousand dollars for a major artist whose song is being used in a large budget production. Still, there are other payment arrangements available that may include royalty interests or some other calculation of fees.

After internalizing the intended use as well as the typical payment that similar works garner in similar projects, you should have a solid idea of how much you should be asking for your music. You ought to be skeptical of “test” deals, where entities attempt to get limited usage rights for a test to see how your music reacts against a market, or “just for social media.” As soon as your music is being exposed to actual customers for their product, it is no longer a test – it is then a use. Also, it’s unlikely they will be coming back for more.

You should also pay close attention to what the stated scope and scale of the usage of the music is and explicitly have outlined in the agreement that authorized usage by the license. Often, though the main purpose of the licensing is for use in a production like a motion picture, the licensee will plan to use the work in advertising or social media posts as noted above.

It is important to remember that having your music in circulation in any context is great promotion for future uses, or for the rest of your songs, and could even get your act touring. Still, it is easy to fall victim to receiving payment for your sync license that is well below the value of your work given the scope and scale of its use. Exposure and passive income are great but receiving an undervalued fee for your music can sometimes outweigh those benefits.

Smart Creatives Use Loan-Out Companies

By: Steve Masur and Danika Johnson

Artists, performers, celebrities, and freelancers in the know use loan-out companies. A loan-out company is a personal LLC or corporation formed to do business on your behalf. Instead of signing agreements yourself and risking getting sued personally, the loan-out company signs, and “loans out” your services. 

Advantages

As the saying goes, if you want your life to be a certain way, live as if it were.  Just like an animal developing plumage to make itself look more intimidating, a loan-out company can make you look more professional, better organized, and more important.  It is a subtle indication that you have a lot going on, that you are probably well represented by lawyers and accountants, and that you want real money for your services.  In other words, that you’re one of the real players of what you do, and that you probably won’t accept being low-balled on your fees. Also, for many well-paying gigs, the hiring companies require that you have your own company for their own liability protection, and so they can pay you as an independent contractor instead of as an employee. So for certain opportunities, you need the loan-out company to even be considered for the role.

A loan-out company also makes it contractually easier for you to delegate work to third parties.  You can engage agents, managers, lawyers, accountants, roadies, and social media managers to get more done more quickly in order to build your creative business faster.  Engaging these people allows you to focus on your core product; you and your creative output. A loan-out company allows you to take advantage of itemized tax deductions, protects your personal assets against third-party lawsuits as well as lawsuits brought against you by your own employees or agents. Finally, having a loan-out company allows you or your agents to sue others who owe you money without fear that you might be sued back, or brought in personally through counterclaims. A loan-out company can pay you a regular salary exempt from self-employment tax, which allows you to pay a regular rent or mortgage and your living expenses, and write your business expenses off against your total income, while the rest of your money is wisely invested.  

How it Works

Since the loan-out company enters into any contracts for income or services on your behalf, the loan-out company receives payment and/or gives payment to those that are due. If an issue arises with any third party, the loan-out company’s assets are on the line, but your personal assets are protected from liability.  Still, it is important to look out for inducement agreements. These provisions, strategically placed in contracts for your services, state that if anything happens to the loan-out company, you must still provide the services agreed in the contract.  But if you have enough leverage under the circumstances, you can negotiate around these provisions. 

Disadvantages

All good things come with responsibilities. There are costs required, sometimes substantial, in order to set up a well-organized loan-out company, and annual costs thereafter to keep it in good standing with the state of incorporation. You also have to file tax returns for it every year, so you might find yourself getting an accountant to do it for you. As a result, it makes sense to wait until your career is generating good money before setting up a loan-out company.  Also, after you have delegated as many of the ancillary roles for your career as you can afford, it is important for you to demand good reporting, and to maintain oversight and ultimate control over what the loan-out company does.  It is literally your career on the line, and almost everyone has heard the stories of artists who lost control of the money, and their career. But if you maintain good oversight of your agents and employees, and you are not afraid to let go of dishonest, controlling, or unreliable people, this will not happen to you.

Other Things to Keep in Mind

Recently, the New York District Court decided that loan-out companies are not authors of an artists’ work and therefore cannot exercise termination rights in accordance with Section 203 of the U.S. Copyright Act. Under Section 203, only the actual artist may terminate the rights that the artist themselves granted. Therefore, a loan-out company must take caution when determining which legal entity, whether the artist or the loan-out company, will be signing agreements granting rights to third parties. 

You should also consider purchasing worker’s compensation insurance and medical coverage. If something happens to you, the loan-out corporation needs to be able to cover the costs, not only of your injuries but also the costs related to unwinding any gigs to which the loan-out company contractually committed. The loan-out company must also play by the rules of any other company and pay quarterly payroll taxes, and other costs related to any employees.  As a result, if you form one, you should seek assistance from a good tax advisor.  The more successful you are, the more likely you will be audited. If the IRS believes that the loan-out company is a sham set up solely to avoid taxes, it may attempt to reallocate income between owners and those controlling the corporation, charge the higher personal tax rate, and hit you with fees and penalties related to years of nonpayment.  Luckily, you can engage a PEO (professional employer organization) like TriNet, ADP, or Paychex to manage all of this for you. 

With proper preparation and continued diligence, a loan-out company can provide you with liability protection, peace of mind, and substantial tax write-offs, as well as credibility that will strike directly to your bottom line.  If you are interested in setting one up, let us know, and we’ll help you get it done!

EARN IT Act & the Crusade Against Encryption

By: Jon Avidor, Jason Gershenson and Maria Samson

In the midst of a global pandemic, a contentious bill attacking encryption and heightening censorship seeks congressional approval. On March 5, 2020, several US. Senators sponsored the Eliminating Abusive and Rampant Neglect of Interactive Technologies Act (“EARN IT”), which claims to combat child sex abuse material (“CSAM”) online. The bill’s rhetoric depicts the internet as a 21st century wild west: a space full of criminals in need of policing. Ending CSAM is an utmost priority, and it deserves a solution much more pragmatic than EARN IT. This is the case of a federal official against warrant-proof encryption creating a slippery slope that overwhelmingly invades privacy and jeopardizes free speech by incentivizing social media platforms to censor their users on an unprecedented and alarming scale.

Encryption, the use of cryptographic techniques to safeguard privacy, ensures that digital exchanges of information remain secure from unintended third parties. In a world of cyberattacks and criminal hacking, strengthening encryption — not impairing it — is almost universally considered to be the path to protect individual privacy.  Like many decisions that weigh both public safety and individual security, the Government is charged with striking a balance between patrolling CSAM with surveillance and respecting privacy in communication. However, EARN IT’s slant toward oversight raises fundamental questions: Has the internet grown into a perversion of free speech to justify mass surveillance? If these platforms can censor conversations to detect crime, should they? If so, at what cost? Ultimately, the answers reveal EARN IT to be a potential ‘scorched-earth’ policy that avoidably dismantles the essential right of private communications.

EARN IT requires companies to “earn” immunity. 

While the bill does not outright ban the use of encryption, it has the effect of doing so. EARN IT proposes to create a commission called the National Commission on Online Child Exploitation Prevention (“the Commission”). United States Attorney General William Barr would lead the Commission alongside government officials and experts to draft a set of best practices. The heads of the Department of Homeland Security and the Federal Trade Commission, along with Attorney General Barr would later approve of best practices and make them official. The Commission’s constraints are not yet defined in the bill, which affords the Commission (and particularly Attorney General Barr) a concerning degree of latitude to unilaterally create rules that all social media platforms must comply with. Failure to comply would mean losing immunity under Section 230 of the Communications Decency Act (“Section 230”). Such loss of immunity would trigger numerous lawsuits, and incentivize platforms to excessively scan and monitor posted content. The content of the bill sounds ideal in theory because CSAM is abhorred without exception, but it unnecessarily comes at a great cost to social media user privacy rights.

Section 230 is a liability shield. 

Section 230, a product of the mid-90s Dot-Com Boom, is a liability shield that protects any interactive computer service. An interactive computer service (“ICS“) is essentially any digital platform where its users communicate with others. This Section 230 legislation significantly advanced the evolution of social media because it granted companies immunity from the consequences of illegal content posted by their users. Without such immunity, social media sites probably would not have evolved to be the interactive juggernauts they are today.

Nonetheless, social media platforms like Facebook or Reddit do provide reporting methods for removing illegal content.  They’re simply not held accountable by law if they fail to do so. One could say this was the best of both worlds. For instance, if you were to tweet illegal content, others could surely sue you — but they couldn’t sue Twitter for the content of your tweet. Section 230’s separation of the  ICS from the publisher was a decisive factor in the rise of social media platforms and websites that featured comments sections or messaging functions. EARN IT fundamentally modifies Section 230 because it requires platforms to earn their immunity by complying with yet-to-be-determined best practices. 

The rise of digital communications necessitated strong encryption. 

Within the last two decades, the rise of digital communications begot the advancement of strong encryption. Strong encryption is the fundamental type of privacy that fosters trust and encourages platform usage. In an increasingly insecure digital space, the EARN IT bill undermines the value of trust between platforms and their users by threatening privacy. The bill doesn’t define or specify best practices, giving the Commission an enormous amount of discretion. It also urges platforms to surveil and censor the content of its users, by burdensome manual review or over-invasive algorithm, to detect any criminal activity. Finally, EARN IT gives law enforcement backdoor access to encrypted communications, shattering our existing expectations of privacy in communications. Rather than create a method that determines whether a type of product, business model, or product design, or other factors related to the provision of an ICS would make a social media platform susceptible to the use and facilitation of CSAM, EARN IT  provides for a sweeping curtailment of encryption.

EARN IT could have a chilling effect on free speech.

EARN IT threatens not only privacy but also free speech. To comply, social media platforms may decide to remove any content they think is either “obscene” or that may otherwise get them in legal trouble. Due to the “I know it when I see It” nature of determining “obscenity” in the context of free speech, makes it excessively difficult to adequately train people or generate algorithms to scan user content. Likewise, if people know that platforms will watch their posts, they will be less likely to use such platforms. A moderator could silence dissenting opinions because they find them distasteful. For this reason, EARN IT could have a chilling effect on free speech.

While best practices are yet to be decided, law enforcement should engage in this risk. It appears that EARN IT only seeks to expand the scope of liability to indirectly harm privacy rights and free speech, leaving CSAM prevention as the scapegoat. Like a trojan horse, EARN IT infiltrates in disguise and under the radar.

The Ins and Outs of Qualified Small Business Stock

By: Steve Masur

In simple terms, a qualified small business stock (QSBS) is the stock or share of a qualified small business. It is defined as a domestic and active C-corporation whose gross assets do not exceed $50 million as of the date the stock was issued and immediately after issuance. Section 1202 of the Internal Revenue Code defines a qualified business as one that does not operate in the hospitality industry, financial sector, farming business, and any business that depends on the skill of one or more of its employees such as accounting, law, health, consulting, etc. The businesses that do qualify include companies in the wholesale, retail, technology, and manufacturing fields.

In order to qualify as QSBS, the following requirements must be met:

  • The issuer must be a domestic C Corporation that does not have more than $50,000,000 in aggregate gross assets, including amounts received upon issuance of the stock. Gross assets mean cash and the adjusted basis of other property.
  • The issuer must use at least 80% of its assets in the active conduct of one or more qualified trades or businesses for substantially all of the holding period of the stock. Assets used in business start-up activities and R&D are generally treated as used in an active business.
  • The issuer must not have violated certain rules against certain redemptions of its own stock.
  • The issuer must submit periodic reports to the IRS and shareholders detailing its compliance with the requirements of small business corporation status.

It is important to note that even if the stock qualifies initially as QSBS, this status may be revoked as to one or more shareholders in the future if some of the requirements are not met on an on-going basis.

A QSBS is any stock that was acquired from a qualified small business after August 10th, 1993. In order for the investor to claim the stock as qualified for tax purposes, they must have acquired the stock at its original issue (primary market) with cash or property as a payment for service. In addition, it is not enough to just purchase or acquire the stock; the investor has to have held the stock for at least five years to reap the tax benefits of a qualified small business stock.

Tax treatment for shareholders:

  • Stock acquired after September 27, 2010: If it’s held for more than five years, there is no tax on the gain. It is free from income tax, alternative minimum tax, and the 3.8% net investment income tax. If it’s held for more than one year but not more than five years, the gain is treated like any other capital gain taxed at up to 20%. If the stock is held for one year or less, the gain is a short-term capital gain that is effectively taxed as ordinary income.
  • Stock acquired between February 18, 2009, and Septemeber 27, 2010: If it’s held for more than five years, then 75% of the gain is excludable from gross income. In addition, 7% of the gain is subject to the alternative minimum tax.
  • Stock acquired before February 18, 2009: The exclusion of gain is limited to 50%, and 7% of the gain is subject to the alternative minimum tax.

Benefits of QSBS

When you sell qualified small business stock, you may be eligible for up to 100% exclusion from federal income tax. This means that when you sell your qualifying stocks, you will avoid federal tax fees on gains of up to 10 times your tax basis. Many entrepreneurs who don’t know about QSBS and its potential benefits may be missing out on possible savings in future endeavors.

Examining the SAFE Banking Act’s Potential Impact on the Cannabis Industry

By: Jon Avidor and Liam McKillop

Last September, the Secure and Fair Enforcement Banking Act of 2019 (the “SAFE Banking Act”) garnered enough votes in the House of Representatives to pass through to the Senate. This was an important first step for a bill that cannabis-related businesses are relying on to gain access to basic financial services that are currently unavailable to them. While the bill asserts that the main purpose of providing safe harbors to depository institutions that provide financial services to state-legal cannabis-related business to be an increase in public safety by reducing the amount of cash-on-hand to be held and transported, the effects of such an enactment will be much further reaching for the entire cannabis industry.

Currently, federally chartered depository institutions will not work with legitimate businesses within the cannabis industry due to the potential enforcement of severe penalties from federal banking regulators. The cash-dominant nature of the industry provides an abundance of headaches for these businesses, from the constant security needed to protect their cash on hand, to the overwhelming administrative recordkeeping required to account for every transaction, to the ability to acquire loans from banks for the financing of real estate acquisitions instead of having to use all-cash, therefore, depleting their capital on hand. This results in cannabis-related businesses being forced to seek out the services of state-chartered banks and credit unions who are willing to work with legal cannabis businesses within their jurisdiction. However, the strict reporting requirements imposed on these state-chartered banks make these services very expensive, sometimes costing around $5,000 per month in fees just to operate a checking account.

At a high level, the SAFE Banking Act would work to provide these depository institutions with protections from various federal banking regulators (i.e., the Federal Reserve, the Bureau of Consumer Financial Protection, and the Department of the Treasury) for their provision of basic financial services to legal cannabis business. Protection from federal regulators is necessary because the capital maintained by these state-legal cannabis businesses is directly tied into various cannabis-related operations that are illegal at the federal level due to the classification of cannabis as a Schedule I drug under the Controlled Substances Act (“CSA”). These financial services include things such as operating a checking account, obtaining a loan, or setting up an employee 401-k program—all things that a “normal” business would not have to think twice about obtaining as part of their standard operations—but also services that are almost entirely unavailable to legitimate cannabis-related businesses. Advocates of the bill believe that allowing basic financial services to these cannabis-related businesses will help reduce crime and fraud throughout the industry related to both the holding of large amounts of cash and the proper record-keeping procedures associated with such. Proponents also express hope that the bill will finally lead to more consistent growth within the industry, by allowing banks to funnel money into these companies and removing one of the largest concerns of potential investors.

However, as noted above, the passing of the bill through the Democratic-controlled House was simply just the first step, and the cannabis industry is anxiously awaiting a potential showdown in the Republican-controlled Senate. While there was not much doubt about the bill’s ability to pass through the House, concerns which loomed large about opponents within the Senate putting up a fight or using stall-tactics to prevent a vote have come to light. Currently, the bill is in a holding period, as it was referred to the Committee on Banking, Housing, and Urban Affairs after being received in the Senate. In December 2019, Mike Crapo (R-Idaho) the Chairman of that Committee had this to say in a statement expressing his lack of support for the SAFE Banking Act: “Significant concerns remain that the [bill] does not address the high-level potency of marijuana, marketing tactics to children, lack of research on marijuana’s effects, and the need to prevent bad actors and cartels from using the banks to disguise ill-gotten cash to launder money into the financial system.”  This statement echoes the concerns of most opponents who believe that the bill is just a partial solution and any real fix to the banking issues that plague the industry not come without a re-scheduling of the drug under the CSA.

While it seems unlikely that a final resolution for the bill will be reached in the near future, the steps taken thus far can still be viewed as a positive for the cannabis industry. The bill making it through the House was a monumental step, and even if voted down in the Senate, it has still laid the necessary groundwork for future relevant legislation. The bill has also worked to spark awareness and conversation around the extremely restrictive financial constraints which the legal cannabis industry currently faces. While actual victories are always better than moral victories, any and all forward progress is important to the long term stability sought throughout the industry

Am I More of a C-Corp or an S-Corp?

By: Steve Masur

C-Corp or S-Corp

When forming a corporation, an important decision to consider is whether to form as a default C-Corporation (“C-Corp”) or elect for the corporation to be an S-Corporation (“S-Corp”). This distinction can carry major implications for the corporation, such as the way the it will be taxed or the rights of its shareholders.  It is crucial to understand the differences as well as the similarities between the two corporate structures and which one is more beneficial for your corporation’s needs.

The C-Corp

A C-Corp is the traditional, default structure of a corporation. It is created when the incorporator files the formation documents with the governing state. In a C-Corp, the shareholders own the corporation, but the shareholder-elected board of directors carries out the management and day-to-day operations and responsibilities of the corporation. The C-Corp shareholders have limited liability protection, meaning that shareholders are typically not liable for the debts or liability of the corporation.

The S-Corp

The S-Corp derives its name from Subchapter S of the Internal Revenue Code, which provides corporations to elect its tax status. To form an S-Corp, the corporation elects a special tax status with the IRS by filing Form 2553. Similar to a C-Corp, shareholders of an S-Corp also have limited liability protection and the board of directors are responsible for all managerial decisions on behalf of the corporation.

 Taxation

Taxation is one of the biggest differences between an S-Corp and a C-Corp. C-Corps are subject to double taxation. The C-Corp is first taxed at the corporate level when the corporation files its corporate income tax return using Form 1120.  Its shareholders can then be taxed again on their personal income tax returns if the corporate income is distributed to the shareholders.

S-Corps may take advantage of pass-through taxation, meaning that the corporation’s profits are directly passed to the shareholders. The corporation’s income and losses of the business are divided among the shareholders. The shareholders report their share of the business’s income and losses on their personal tax return and thus, are only taxed at the personal income tax level and not subject to the corporate tax. 

Size and Type of Ownership

C-Corps are typically more beneficial for larger corporations, especially those with international aspirations.  In a C-Corp, there is no limit to how many shareholders the corporation may have or where the shareholders must live. By contrast, S-Corps can have no more than 100 shareholders, all of whom must be residents or citizens of the United States. Additionally, C-Corps can be owned by other business entities, such as LLCs, trusts, or other corporations, whereas S-Corps can only be owned by individuals.

Shareholder Rights

Both S-Corps and C-Corps can issue stock to its shareholders, however, C-Corps have more flexibility in issuing stock. C-Corps can issue different classes of stock, which divide up the shareholders’ voting rights. Early investors in C-Corps typically have more voting rights with their shares, affording them more voting power over other shareholders. This means that some shareholders’ votes, depending on their class of stock, are weighted more than other shareholders’ votes. S-Corps, however, may only issue one class of stock, meaning that all shareholders have the same voting power.

Conclusion

While S-Corps and C-Corps are similar in many ways, their differences can have a major impact on the way the corporation operates. C-Corps are generally more beneficial for larger companies due to the lack of restraints on the number of shareholders allowed in a C-Corp. While shareholders in a C-Corp have more flexibility with voting rights and ownership, this advantage comes at a price; C-Corp shareholders face double taxation, unlike S-Corps that utilize pass-through taxation. 

Structuring your corporation as a C-Corp or S-Corp is a big decision with big potential implications for the future of your corporation. MG+ can help you choose the best corporate structure for your corporation based on your corporation’s needs and future aspirations. Contact us at info@masur.com or (212) 209-5450.

Crypto Mom’s SEC Safe Harbor Proposal for New Token Offerings

By: Steven Masur and Cameron Ashby

During the 4th International Blockchain Congress in Chicago, Hester Pierce, Commissioner for the U.S. Securities and Exchange Commission (SEC) (aka, the “Crypto Mom”), announced the “Token Safe Harbor Proposal,” or the “Proposed Securities Act Rule 195 – Time-limited exemption for tokens,” (“Safe Harbor”). Up until now, token projects have grappled with the SEC’s stated viewpoint that most, if not all tokens are “investment contracts” and therefore, recognized as securities offerings under the Howey Test. Pierce’s Safe Harbor seeks to offer a “fix” for cryptocurrency projects that do not consider their tokens to be securities, and thus do not believe they must comply with the registration and disclosure requirements intended for the sale of securities.

Pierce aims to “fill the gap between regulation and decentralization” by giving utility token projects a three-year exemption from some federal securities laws, allowing them enough time to prove that their tokens are not securities, rather that they have developed into functional decentralized networks that have a function that falls outside the purview of the securities laws. After the grace period, the project’s development team must (1) determine whether their token transactions involve the offer or sale of a security and (2) confirm their tokens are actually in use to buy and sell the services for which they were intended.

Three-Year Grace Period from the First Sale

Currently, whether your token is intended to be a security or not, you have to comply with the relatively onerous and costly regulations intended to govern the sale of securities, for any US facing offering.  Many believe that this puts any offering seeking American customers or buyers at a disadvantage to offerings that do not have American buyers. By extension, this also means that products and services freely available to people outside the US are not available to American citizens.  The Safe Harbor is a step toward making it possible to legally launch a token offering in the US that is not intended to be a securities offering. To help achieve this, the SEC will provide network entrepreneurs the time to construct their networks before having to measure against a “decentralization yardstick.” Meaning, the SEC will allow new cryptocurrency projects to defer compliance with some federal securities laws, including the registration provisions of the Securities Act of 1933. However, the token development team must still meet certain conditions, including disclosing information about their project.  Also, the antifraud provisions of the Securities Act of 1933 will still apply.

Tokens come with a wide variety of different attributes and exist in different types of ecosystems.  Pierce clarifies the “Regulatory Catch-22,” of the offer and sale of tokens as they relate to federal securities laws, i.e. that a decentralized network that transcends the sale of securities and becomes something else can never develop if people cannot legally buy and sell the tokens.  The token transactions would not be considered securities transactions if the network has matured into a decentralized or functioning network on which the token is in active use for the exchange of goods or services. Furthermore, some tokens may look like securities at launch, but can mature to the point where they no longer have the attributes of a security.  Further, Commissioner Pierce states, “once the network cannot be controlled or unilaterally changed by a person, entity, or group of persons or entities, the token that operated on that network will not look like a security.” In other words, if the tokens are used to buy and sell actual intended services, securities laws will not apply.

Transparency

If the Safe Harbor is accepted, it would create strict disclosure requirements for cryptocurrency projects and how they could raise funds. Specifically, the project’s initial development team would need to raise funds strictly through a token sale, and put out necessary disclosures such as, public notices, code disclosures, personal disclosures, as well any necessary paperwork. These disclosures ensure that there is full transparency between the SEC and crypto projects within The Safe Harbor. Additionally, it would also require the development team to disclose the names, relevant experience, qualifications, attributes, and skills of each member. The number of tokens held by each member and any bonuses and rewards would also be presented. Investor protection will still remain a priority. Pierce says, “The safe harbor is also designed to protect token purchasers by requiring disclosures tailored to the needs of the purchasers and preserving the application of the anti-fraud provisions of the federal securities laws.” The concept is that enough information should be made available about a token so that any legitimate American buyer can make a rational purchase decision, and that any bad actor trying to use the Safe Harbor for nefarious purposes can be found and rooted out.

Life After the Safe Harbor

By the end of the three-year grace period, the project’s initial development team must have sufficiently matured the network, so that the tokens trading within it do not constitute securities. In other words, when the project’s initial development team no longer has to perform essential functions to ensure the token’s success. Unfortunately, the SEC has traditionally held the view that tokens are securities. Therefore, it is almost impossible to demonstrate the existence of a decentralized network if the token is not put into the hands of potential users either through direct issuance or secondary trading. Pierce looks to alter this by using “liquidity” and “secondary trading” as necessary tools for the success of the Safe Harbor. Pierce states,

“Admittedly, the liquidity condition may surprise observers of SEC staff positions in which attempts to facilitate secondary trading have been viewed as indicia of a securities offering. In the context of the safe harbor, by contrast, secondary trading is recognized as necessary both to get tokens into the hands of people that will use them and offer developers and people who provide services on the network a way to exchange their tokens for fiat or cryptocurrency.”

Even when a network remains centralized, securities laws will be inapplicable where the tokens are “actually in use to buy and sell the services for which they were intended.

The Safe Harbor represents a bold proposal concerning digital asset regulation that could even the playing field between token offerings inside and outside the US.  Furthermore, Pierce herself has welcomed feedback on the draft. But, since the Safe Harbor would be subject to approval by vote of the full Commission, as well as the often time-consuming SEC rule-making process, the American public will have to wait before a concrete directive is put into place.  Nevertheless, the proposal is fair, well balanced, and a step in the right direction to allow American utility token offerings to compete on a level playing field with similar offerings from other countries.

COVID-19 and the Force Majeure Clause

By: Steve Masur and Ilana Faibish

Does COVID-19 constitute a force majeure event under my contract?

The COVID-19 crisis has resulted in significant disruptions in most industries. A great many companies are struggling to meet their obligations under their commercial contracts. Now is certainly a good time for companies to dig up their commercial agreements and assess whether the force majeure clauses contained in them might provide relief under current circumstances.  If you seek to suspend performance or have already suspended performance, you should consider whether COVID-19 qualifies as a force majeure event in your contract. If so, you should determine whether the risk of nonperformance was foreseeable and if mitigation measures were taken. Lastly, you should consider whether performance is actually impossible or commercially impracticable.

What is a force majeure clause?

A force majeure clause is a boilerplate contract provision that excuses a party’s inability to perform in the event that unforeseeable circumstances occur beyond the party’s control. Kel Kim v. Central Mkts., 70 N.Y.2d 900, 902 (1987). The clause may excuse a party’s performance if any of the force majeure events listed in the clause occur.  Force majeure events could included strike, government action, acts of God, war, terrorist attack, pandemic, epidemic, or any other uncontrollable hazard on which the parties have agreed. However, merely including a force majeure clause in your agreement, and merely mentioning words like “epidemic,” or “pandemic” may not excuse performance. Rather, the fine print of your force majeure clause will become critical in a court of law, and by extension, in any negotiation that precedes going to court.

Does COVID-19 qualify as a force majeure event in my contract?

On its face, COVID-19 should qualify as a force majeure event if the force majeure clause in your contract includes words like “pandemic” or “government action” as events that excuse performance. If such events are not listed, it is possible that a reference to “acts of God,” which is more often intended to cover natural disasters like floods, hurricanes, and earthquakes, may cover nonperformance. But courts tend to narrowly interpret force majeure clauses. As a result, the more narrowly tailored the events listed in your clause are to COVID-19, the more likely performance might be excused.  If your contract does NOT have an express contractual force majeure provision, there are other common law avenues of relief to consider, including impossibility of performance, frustration of purpose, and impracticability of performance. The doctrine of impracticability may provide relief if you can prove that “superseding events occur, the nonoccurrence of which was a basic assumption when the contract was made” and it would be unreasonable or commercially senseless to require performance in light of such events. This is a very high standard to meet and a court’s interpretation may vary depending on your respective jurisdiction.

In analyzing your situation, you should examine whether the event was foreseeable and as a result should have been contemplated upon signing the agreement. Courts will not typically apply force majeure when the parties could have expected the event to occur at the time of contracting, yet did not include the event in the clause – even with a catch-all provision. The foreseeability of a pandemic-related event is subject to debate. On one hand, the outbreak of COVID-19 may be interpreted as unpredictable and considered a classic force majeure event. On the other hand, some argue that this is not the first time in history that an epidemic or disease has affected contracts and industries, such as the 2009 flu epidemic or the 2003 SARS epidemic, and thus a foreseeable event that should have been considered in the agreement.  As a result, it is always a good idea to include in your force majeure clause words describing any event that a court might otherwise consider having been foreseeable.

In the event of nonperformance, parties should undertake reasonable efforts to mitigate the effects of a force majeure event. It is important to realize that the other party may be open to amending performance obligations, such as considering partial performance as a solution which may be possible to achieve.

Finally, consider carefully whether performance is actually impossible. It is crucial to carefully document the degree of direct causation of COVID-19 as it relates to your impossibility to perform and to note that mere increased costs or economic burden may not be sufficient to excuse performance. For example, with the cancelation of televised sporting events, advertisers are seeking to suspend their advertising spend. However, something like COVID-19 does not prevent a broadcaster from showing the ad during the specified times, even though the televised content may have changed. Therefore, it may not legally be required for broadcasters to return money to advertisers under force majeure if performance under the agreement is not actually impossible.

Conclusion

It is important that you closely monitor COVID-19 developments and comply with the guidance of your state laws and officials. There are certain implications that apply if the force majeure event lasts for an extended period of time, such as a complete termination of the contract. In addition, take special note of insurance policies you own that may be redeemable under these circumstances. If you are uncertain as to whether your force majeure clause applies, it may be beneficial to discuss intervening industry matters with the other party to mitigate damages best you can.