Cannabis businesses run a higher risk of facing a “D&O claim,” or a lawsuit aimed directly at the directors and officers of the company rather than at the company itself.
While directors and officers of cannabis-touching companies may no longer have to worry about losing their freedom for choosing to work in the industry, they still have to worry about losing their personal assets through civil litigation. That’s right—their personal assets!
Cannabis businesses run a higher risk of facing a “D&O claim” or a lawsuit aimed directly at the directors and officers of the company rather than at the company itself. In some cases, fighting a D&O claim is so expensive it can bankrupt both a company and its owners. D&O claims in all industries have been steadily increasing for the last two decades and unsurprisingly, more and more of these claims are now popping up in cannabis. It is essential for any business taking the risks of working in the industry to plan ahead and protect themselves from this sort of expensive and damaging litigation.
Fortunately, cannabis businesses have the ability to safeguard their business with specialized D&O insurance coverage. D&O insurance coverage provides broad balance sheet protection for the organization in addition to asset protection for the directors and officers who may be held personally liable for their actions. Lawsuits can be filed by a variety of stakeholders, which is why potential claims can arise from various scenarios. Some common D&O risk scenarios include:
● Shareholder actions or derivative claims
● Reporting errors
● Misrepresentation of prospectus
● Failure to comply with regulations or laws
● Creditor claims
● Competitor claims
Why D&O Coverage is Essential for Cannabis Companies
Any business has the potential to be sued by its employees, competitors, or shareholders. In the cannabis industry it is even more perilous for directors and officers who must also navigate constantly evolving regulations and limited banking resources.
Due to federal law, state-legal companies operate in a grey area, making it difficult to access capital, use banking services, obtain adequate insurance coverage, and access other services that make traditional businesses competitive. Most insurance carriers will exclude claims that fall within federal jurisdiction, so it is important for any cannabis business to seek out coverage that is catered to the industry by people who understand and support it.
While D&O claim insurance is still rare in this emerging sector, it is available—and essential—for cannabis companies. D&O liability insurance protects the personal assets of directors, officers, and their spouses if a suit is ever filed. Most policies cover defense costs, legal fees, and settlements.
Traditional business financing is not available in the cannabis industry, which forces businesses to seek out capital from outside investors, private equity sources and/or venture capital. If an investor feels they were misguided, deceived, or wronged, they may decide to file suit directly against the company’s directors and officers. Any time a business takes on a new investor, they increase the pool of people who could file a D&O claim against them.
All of these factors contribute to a vulnerable industry with steadily increasing D&O class action lawsuits. Here are just a few of the industry’s most notable cases so far:
● Canadian LP CannTrust’s CEO Peter Aceto violated regulations by growing cannabis in unlicensed rooms. His actions led to an 85% decline in the stock’s price, a class action lawsuit, and a personal loss of $8 million in the form of stock options.
● Canadian LP Aphria’s executives were accused of overvaluing Latin American assets. The stock lost over 60% of its value, the company’s co-founders and CEO resigned, and a class action lawsuit was launched.
● American cannabis company MedMen’s executives are facing a $20 million lawsuit over accusations that include a lack of transparency as well as the directors and officers enriching themselves at the expense of shareholders.
● Cronos Group shareholders filed a securities class action lawsuit against the company as well as CEO Michael Gorenstein. The complaint alleges that Cronos’s statements regarding the size of its distribution agreements were intentionally omitted due to their relatively small size in comparison to the premium investors were paying for the stock.
Cannabis Exclusions and Why They Matter
It is necessary to work with an insurance brokerage that specializes in cannabis to reduce risks. Most cannabis companies still operate as startups, and exclusionary clauses put their personal assets at risk. Many policies contain specific cannabis exclusions, so businesses need to seek out policies that cater to the industry. Cannabis insurance brokerages are trained to spot exclusions in policies which leave directors and officers personally liable for damages.
Insurance companies that provide D&O claim coverage to cannabis companies often exclude certain types of claims in the cannabis industry:
● Bankruptcy exclusions
● Creditor exclusions
● Major shareholder exclusions
● Class action exclusion
● Prior acts
● Fines and penalties.
D&O Coverage as a Recruiting Tool: A Must-have for Cannabis Executives
A cannabis company with specialized D&O coverage has a significant competitive advantage in the hiring process. Many experienced executives coming to cannabis from other industries have become accustomed to working with companies that ensure their personal assets are safe from litigation. Whether a company is recruiting a new CEO, president, risk manager, or CFO, the first question these individuals will ask is simple: Does your company have D&O coverage?
If the answer to this question is no, then it is likely the company has already lost the recruit. When looking for a new landing spot, no corporate executive is going to risk joining a team where they can be held personally liable for their decisions.
When a company purchases D&O insurance, they can reassure potential hires their personal assets are not at stake. The insurance policy will often provide protection against some of these common claims:
● Disputes regarding human resources and employment law
● Failure to implement a plan that follows cannabis regulations
● Fraudulent misrepresentation in corporate dealings
● Negligence while performing duties
As a company continues to grow, D&O coverage becomes increasingly more important. This is especially true for companies working towards a public listing or in the process of sourcing additional funding.
Kirk Miller is a commercial insurance, risk management, and business strategy leader with more than 20 years of cannabis consulting and insurance industry experience. Kirk is an Executive Producer at Nine Point Strategies. Follow him on LinkedIn, here.
MJ Biz Daily spoke with Purple Heart Patient Center’s CEO and Founder Keith Stephenson to discuss the state of the dispensary and industry amidst Covid-19 and following looting. Read for his insights and advice to other cannabis leaders in similar situations.
Today we’re re-sharing this important article by David Lesser, CEO of Numina.
|IS YOUR TEAM BEING STRAIGHT WITH YOU?
Workplace hostility is in the news again. Enlightened bosses want to understand what people are experiencing and often ask us to interview key members of their teams. Almost always, there is something withheld. Members of the team will tell us things about which they are not speaking up candidly in meetings or one-on-one reviews. Here are two ways you can make it safe for your people to tell you what is really going on.
Reward Blunt Candor
Unless there is some material acknowledgement of the behaviors you want to see, all the lip service in the world won’t move the cultural needle. How do we measure candor? The most potent method is to delegate the scoring to your people’s direct reports. For each person reporting to you, collect five or six “candor” scores from those he or she works with most closely. Do this each year. If your key executives are being candid with you, the people they work with will know. They will see their boss thinking about how to report hard truths to you. They will see you acting on things that they found painful.
Channel Of Personal Connection
We have clients who have instituted regular correspondence with everyone on their teams. One leader I know sends a personal letter each month, adding a handwritten note each quarter to all 200 of his employees. I have seen a leader encompass a monthly correspondence with as much as 2,000 team members. That takes help. One who receives well-written notes from 400 people says that it takes less time than you might expect. And the benefit of being attuned to people in this way are invaluable.
The key to opening such a channel of personal connection is not so much what you say to the people. It is what they say to you. When you find a way to make it safe and make it fun for people to share what it is like to work for you, great leadership moves just naturally emerge. You look like a genius, when in fact the most brilliant solutions were just sitting there all along.
We would love to hear your experience of rewarding straight talk in a corporate culture and creating channels of personal connection that enhance the team’s intelligence and deepen their sense of belonging.
Jesse Parenti, Director of Programs at Nine Point Strategies, has been featured in today’s Cannabis Insurance Broker Spotlight on InsuranceJournal.com. How did Jesse get into the cannabis space? “I have family and friends that have been cottage growers for over 20 years. Protecting and having them be able to have a legal farm was very exciting to know could happen. When we saw the opportunity that was happening in Colorado, Oregon, Washington and California, we went all in.” Read the full interview.
The Public Utilities Commission has proposed a requirement that all indoor cultivation operations use only LED lights by 2023. This allots a 3 year period for California’s 3.4 million square feet of indoor cultivation facilities to completely switch over. Cultivators have pushed back, expressing that this regulation would be excessive considering the standing environmental regulations they already must comply with. The push back is warranted, considering LED lights typically cost up to $90 more than traditional HPS lighting. The situation is still unfolding, but it’s clear there is a major sustainability issue, and any solution will require major buy in from all parties.
As we close out the week, we’re boosting this class action case that reinforces the urgent need for Product Liability coverage. Read this article on the Cannabis Business Times.
Nine Point Strategies featured in this great reporting by Shariq Khan and Nichola Saminather for Reuters. Cannabis operators across the nation are now having to deal with spikes in already-expensive insurance. Click here to read the full article.
A lack of consistent industry regulations surrounding vaporizers has left cannabis businesses more vulnerable than ever. As of January 2020, the Centers for Disease Control and Prevention confirmed over 2,600 cases of vaping-related illnesses in all 50 states—including 59 fatalities. The outbreak has pushed the issue of product liability to the forefront of the cannabis industry.
“In 2019, we saw a dramatic influx of product liability claims associated with exploding vaporizer batteries, vaping lung injuries, CBD and THC testing, labeling, and compliance issues,” said Jodi S. Green, partner at Nicolaides Fink Thorpe Michaelides Sullivan LLP, a law firm serving the insurance industry.
Product liability claims are especially burdensome, but fortunately cannabis businesses now have the ability to protect against the catastrophic losses associated with these lawsuits. It is important to note, however, that not all standard product liability insurance policies provide this coverage.
“Most cannabis businesses are not only unaware of what they need, but also of what they actually have after they buy it,” Phillip Skaggs, assistant counsel of the American Association of Insurance services, said. “There is definitely a tendency for wishful thinking—younger companies buying whatever policy or package is available and within budget, and then just hoping it stands up when they need it to later. This results in most businesses being underinsured, or even completely uninsured, for a potentially ruinous loss or claim for liability.”
Business owners need to understand that in regards to products sold, the legal theory of “strict liability” may apply—meaning that everyone in the chain of distribution is considered liable, and thus if named in a suit, all parties have to lawyer up and show up in court. The first step in managing this exposure is to obtain a solid policy providing the carrier’s Duty to Defend. Such a policy must also be free from exclusions that would strip out this very necessary coverage.
Not all product liability policies provide the same level of coverage, even among those marketed specifically to the cannabis industry. Let’s take a closer look at what constitutes the right coverage for this main pillar of a proactive risk management plan.
Product Liability Insurance: The Basics
Product liability insurance, offered either as part of a commercial general liability (CGL) policy or as a standalone (monoline) policy, is designed to protect a company from first-party and third-party claims of bodily injury, property damage, and other damages related to the products and services that the company sells.
First-party claims refer to any type of claim arising from an accident, injury, or loss caused by manufacturing defects, improper labeling, and failure to warn consumers about a wide variety of potential hazards ranging from inaccurate THC measurements to mold or the presence of carcinogens.
Third-party claims refer to any type of claim that could see a business held liable for damages that result from the use of a product. This may include property damage, loss of wages, DUIs, medical expenses, and bodily injury.
For cannabis companies, this can include incidences such as:
● Life-threatening illnesses allegedly caused by defective vaporizer cartridges
● Contaminated marijuana purchased from a third-party vendor and resold to retail customers.
● Selling edibles that cause food poisoning or some other type of illness due to poor food quality standards.
● Any form of harm that occurs due to false advertising or misleading claims made through a company’s marketing campaigns.
● Product recalls stemming from the use of illegal pesticides—or even approved pesticides if applied in a manner that is off-label.
Your CGL or monoline products policy should provide your company with a vigorous defense against such claims—but this isn’t always the case in the cannabis industry, in which some carriers utilize exclusionary clauses that so narrowly define coverage they effectively render a policy useless.
“In this new-product environment, standard CGL insurance coverage is not adequate to protect a cannabis policyholder,” Ian A. Stewart, Chair of Wilson Elser’s National Cannabis and Hemp Law practice, said.
Product Liability Exclusions and Cannabis
The devil truly is in the details—and it is not uncommon for cannabis companies to purchase an insurance policy with exclusions directly aimed at the types of products the insured sells. This is known as illusory coverage.
Michael Sampson, a partner in Reed Smith’s insurance recovery group and co-vice chair of the cannabis law team, explained it this way: “There can be marijuana-related exclusions in a CGL or other policies marketed and/or sold to cannabis-related businesses. As a result of such an exclusion, a cannabis-related business could be left with essentially no coverage, or at least no meaningful coverage for the specific risks it faces.”
The most common cannabis exclusions relating to product liability coverage include:
● Health Hazard Exclusion—Any products sold by a company that may cause some form of health hazard will not be covered. These hazards include any form of adverse health effects (and yes, that includes E-Cig and/or Vaporizer Associated Lung Injury, aka EVALI).
● Cannabis Exclusion—The general cannabis exclusion is designed to render an insurance policy ineffective if the insured operates within the cannabis industry. For cannabis companies, this can leave them exposed to a variety of risks associated with product liability, D&O, and regulatory claims.
● Carcinogens Exclusion—Cannabis companies that sell dried flower, vaporizers, and any form of a cannabis product that contains carcinogens or has the potential to create carcinogens will not be covered if their insurance policy contains this exclusion. The carcinogen exclusion will prohibit coverage for bodily injury, property damage, and personal and advertising injury.
● Psychotropic Drug, aka Impairment Exclusion—Any products with the potential to alter an individual’s mental state would not be covered in a product liability lawsuit if this exclusion was included in the policy. Virtually all forms of cannabis alter your mental state as many of the compounds in cannabis like THC and CBD, whether intoxicating or not, are psychoactive.
● Hardware Exclusion—Be on the lookout for this exclusion if you sell vape cartridges, batteries, or hardware that assists with consumption. Lithium ion batteries can explode, and the endcaps found on cartridges may leach heavy metals into the oil they contain. It’s important to secure coverage for the entire product, not just the cannabis component.
Exclusionary language leaves your company exposed to lawsuits that can directly impact your operations and the survival of your company. It’s vital that any policy you obtain provides the coverage necessary to be indemnified during a claim.
For these reasons, it is recommended that insureds review their policy language with a specialized insurance broker to make sure they are not exposed to exclusionary clauses.
Advantages of Working with a Specialized Cannabis Insurance Brokerage
Although the recreational market is still in its infancy, several product liability lawsuits have already been launched against cannabis companies.
Cannabis businesses need to protect themselves from these risks, as the regulatory frameworks that govern consumer products and devices within the industry are still being developed by agencies like the USDA and FDA.
“It is imperative for any cannabis-related business to carefully review the regulations in each jurisdiction in which it does business to ensure that it has obtained all required insurance,” advised Michael Sampson.
A specialized cannabis insurance brokerage will help ensure that your business is properly covered and holding the necessary limits of insurance. Product liability litigation poses an existential threat to every cannabis business, but the potentially catastrophic nature of such claims can be effectively managed by working with a brokerage knowledgeable of both the risks involved and the various available policies’ strengths and weaknesses.
Read this article by Kirk Miller in the Cannabis Business Times.
Kirk Miller is a commercial insurance, risk management, and business strategy leader with more than 20 years of cannabis consulting and insurance industry experience. Kirk is an Executive Producer at Nine Point Strategies. Follow him on LinkedIn: https://www.
Ben Curran outlines some effects of COVID-19 on the industry in this article for Forbes. The effects are far-reaching, and while we at Nine Points are staying up to date on cannabis insurance shifts, it is equally as important to stay updated on industry best practices, changes, and adaptations.