Legal/Regulatory Update

Patrick J. McNamara, Esq., Scarinci & Hollenbeck

The article contains excerpts from a presentation on legal and regulatory issues given by NAFFS General Counsel Patrick McNamara.

SODA TAX

The ongoing battle continues in various states over whether to impose, repeal or modify what are popularly called a “soda tax” on sugary beverages of various types in nature. So far, the states of Arizona and Michigan have voted to prohibit or preempt the municipal soda taxes, menu labeling and food marketing restrictions. Several states, including Pennsylvania, Oregon and Washington have such legislation under consideration. In California, the state legislature voted to bar the imposition of additional local municipal taxes on sugary drinks. On an international level, in Australia the Australian Beverage Council announced last June that the industry would cut sugar content by 10 percent by the year 2020 and another 10 percent by the year 2025 in an attempt to mollify critics who favor the imposition of the sugar tax, such as the Australian Medical Association. France introduced its targeted sugar tax nationally in 2012. The results have generally been mixed in terms of cutting into consumption of various drinks using sugar or artificial sweeteners. Ireland introduced a soda tax on May 1 of this year. Drinks containing more than 8 grams of sugar per 100ml will be subject to a 30-cent-per-liter tax. Studies in Mexico continue to support the imposition of a sugar tax. These studies have reported increases in purchases of water and non-taxed beverages compared to those that fall under how the Mexican government defines its sugary drinks. The Philippines introduced a tax on sugar sweetened drinks effective at the start of this year. Last October the United Arab Emirates introduced a 50-percent tax on soft drinks and a 100-percent tax on energy drinks, as well as a 100-percent tax on cigarettes. In the United Kingdom, the version of the sugar tax, officially named “Soft Drink Industry Levy”, went into effect on April 6, 2018. Beverage manufactures are taxed according to the volume of sugar sweetened beverages they produce or import. It’s projected the measure will generate 1 billion pounds a year in tax revenue to be spent on funding sports in schools.

TARIFF WARS HAVE AN IMPACT OF THE FOOD INDUSTRY

There have been numerous ongoing exchanges between the United States, China as well as with Canada and Mexico and the European Union over the imposition of tariffs as a negotiating tactic for revision of trade deals such as NAFTA. Last summer Coca-Cola CEO James Quincy said raising tariffs may result in higher drink prices. There have also been various proposals to help the agricultural industry and farmers who may be impacted by retaliatory tariffs. At the end of June 2018, the USDA proposed a package of up to $12 billion in aid for U.S. farmers, including direct payments to farmers of soybean, corn, wheat, cotton and dairy products and to pork producers impacted by tariff retaliation.

Countries such as China and Mexico have already introduced retaliatory tariffs on various American goods including coffee, pork, soy beans and whiskey. China has targeted the U.S. pork industry, introducing a 25-percent tariff last April and another 25-percent tariff in July. Canada imposed various tariffs of 10 percent on a wide variety of consumer food products ranging from coffee and maple sugar to cucumbers, strawberry jam, ketchup and other tomato sauces, salad dressing and condiments, soups and broths and carbonated or flavored water. The European Union imposed tariffs in late June on a variety of products such as corn, kidney beans, rice, peanut butter, cranberries, whiskey and bourbon of 25 percent. There is also a potential impact from food and beverage companies that rely upon containers made from imported aluminum or steel, since they are also being subjected to new tariffs.

MEDICAL CANNABIS

A majority of states have legalized medical cannabis. As a result, flavor companies are considering selling flavorings to medical cannabis business entities in these states. In brief, engaging in commercial transactions with cannabis companies encompasses a certain degree of inherent legal and economic risk, even if the companies are located in states with legalized medical cannabis programs. Any business decisions should be made and any contracts should be drafted with great care to minimize these risks to the greatest degree possible.

A) Controlled Substances Act

The 1970 Controlled Substances Act (“CSA”) 21 U.S.C. § 801 et seq., is the statute establishing federal U.S. drug policy by which the manufacture, importation, possession, use and distribution of certain substances is regulated. The CSA created five “schedules” of such substances with varying qualifications for a substance to be included in each. Schedule I drugs are defined as drugs with “high potential for abuse, no accepted medical use, and no accepted safety for use in medically supervised treatment,” and are the most heavily regulated. Cannabis is a Schedule I drug, together with others such as heroin, LSD, and cocaine. As such, it is a federal crime to manufacture, import, possess, use or distribute cannabis.

B) The 2013 Cole Memo

In 2013, Department of Justice Deputy Attorney General James M. Cole issued a memorandum to all U.S. attorneys in response to the enactment of numerous state laws legalizing medical and adult-use cannabis programs (the “2013 Cole Memo”). Generally, the 2013 Cole Memo states the DOJ will defer its right to enforce the federal cannabis prohibitions so long as the legalization states do not contravene eight specific federal enforcement priorities and maintain robust regulatory systems pertaining to their respective intrastate cannabis industries. To date, the federal government has not acted to shut down a state medical or adult-use cannabis facility.

C) Potential Liability Exposure Pursuant To Federal Law

Notwithstanding the continuing effect of the 2013 Cole Memo, cannabis remains a Schedule I drug pursuant to the CSA. Accordingly, flavor companies must be aware of possible violations of federal law that may result in any potential business transaction. Chief among these potential violations are aiding and abetting, conspiracy and money laundering.

D) Banking Issues

Because cannabis operations remain illegal under the CSA, banks and other financial service institutions that work with cannabis companies risk violation of the Money Laundering Control Act and other federal statutes, including the 1970 Bank Secrecy Act. These statutes can impose criminal liability for engaging in certain financial and monetary transactions with the proceeds of a “specified unlawful activity” and for failing to identify or report financial transactions that involve the proceeds of cannabis-related violations of the CSA.

After numerous states legalized this industry and following the DOJ’s issuance of the 2013 Cole Memo, Deputy Attorney General James M. Cole issued a new guidance document in 2014 to address cannabis-related banking issues (the “2014 Cole Memo”). The 2014 Cole Memo generally instructs federal prosecutors to weigh the eight federal enforcement priorities set forth in the 2013 Cole Memo in determining whether to prosecute financial service providers for violation of the CSA and indicates that prosecution may not be appropriate if the financial institution offers services to a cannabis business whose activities do not implicate any of the priorities.

The U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) simultaneously issued guidance in 2014 entitled “Bank Secrecy Act (BSA) Expectations Regarding Marijuana-Related Businesses” (the “FinCEN Guidance”). The FinCEN Guidance clarifies how financial institutions can provide services to cannabis-related businesses consistent with their BSA obligations and aligns the information provided by financial institutions in BSA reports with federal and state law enforcement priorities. Generally, the FinCEN Guidance requires financial institutions to perform extensive due diligence with respect to the cannabis businesses they intend to service. If a financial institution decides to provide services to the cannabis business, the FinCEN guidance requires it to continuously and assiduously monitor the company’s account and to file Suspicious Activity Reports with FinCEN, as such services would typically involve funds derived from activity that is illegal under federal law.

The ongoing federal illegality of such businesses and the relatively small market largely dissuaded banks from providing financial services to industry members prior to 2014. However, smaller banks and credit unions seeking new revenue streams after the 2008 recession began to service cannabis clients. Since the issuance of the 2014 Cole Memo and the FinCEN Guidance, larger banks appear to be slowly following suit as individual states continue to legalize medical cannabis and adult-use cannabis programs. Washington and Colorado have developed small but stable networks of financial institutions that service cannabis businesses. New Jersey has not reached this level of financial institution activity and information regarding the financial institutions that are providing service to industry members is sparse.

It is unclear at this time whether any flavor company would be able to use its current financial institution for banking purposes with respect to the contemplated transactions. Although a flavor company is not in the cannabis business, the proceeds of the potential transactions would clearly be flowing from cannabis operations and may implicate the financial statutes discussed above, which might cause your financial institution to decline to accept such proceeds.

Lastly, the nature of cannabis transactions requires parties outside the industry to carefully negotiate cannabis-related contracts. No general form of contract will be applicable in any given situation; industry parties to such agreements may seek to include several specific provisions in their contracts to address cannabis-specific issues.

FDA ISSUES WARNING LETTER FOR SELLING E-CIGARETTES TO UNDERAGE CONSUMERS

On Sept. 12, 2018, FDA announced a series of critical and historic enforcement actions relating to the sale and marketing of e-cigarettes to children. More than 1,300 warning letters and civil money penalty complaints were issued to retailers who illegally sold these products and other e-cigarette products to minors during a nation-wide undercover blitz of both online and brick and mortar stores. FDA stated e-cigarette use among youth has hit epidemic proportions; FDA Commissioner Scott Gottlieb announced the agency will take new and significant steps to address this challenge. The vast majority of the violations issued were for the illegal sale of five e-cigarette products; Vuse, Blu, JUUL, Mark 10 XL and Logic. According to the FDA, these five brands comprised over 97 percent of the U.S. market for e-cigarettes.

FDA also issued 12 warning letters and enforcement actions to other online retailers for selling misleadingly labeled and/or advertised e-liquids resembling kid-friendly fill products such as candy and cookies. As a result of the agency action taken earlier this year, these products are not supposed to be sold anymore. However, some retailers who received these warning letters are still advertising and selling these products and were cited again for illegally selling products to minors.

Over the last several years, FDA has conducted more than 978,000 retail inspections, issued more than 77,000 warning letters to retailers for violating the law and initiated approximately 18,560 civil money penalty cases through Sept. 1, 2018. The agency has also issued more than 135 no-tobacco-sale order complaints which can result in retailers being prohibited from selling tobacco products for specified periods of time. FDA cited results of surveys that show e-cigarettes are the most commonly used tobacco products by youth. These studies indicate that more than 2 million middle school and high school students were users of e-cigarettes in 2017. “The FDA now believes that youth use of e-cigarette is reaching epidemic proportions,” FDA said in a statement. “The belief is based on not just the results of the agency’s enforcement actions but also recent sales trends, news coverage, increased concerns among children, parents and educators, as well as various field data.” Commissioner Gottlieb stated that the “five companies that I referred to earlier have also been notified by the FDA that they have 60 days to submit plans describing how they will address the wide spread youth access and use of their products.” The agency went on to state that if they fail to do so or if the plans do not appropriately address the issue, FDA will consider revisiting its policies that result in these products remaining on the market. This could mean requiring the brands to remove some or all of their flavored products that may be contributing to the rise in youth use from the market until they receive pre-market authorization and meet all of their obligations under law.

FDA also announced it is examining its compliance policy. This re-examination includes all aspects of FDA’s enforcement discretion stepping up enforcement actions with a sustained campaign to monitor, penalize and prevent e-cigarette sales at convenience stores and other retail sites. It also includes evaluating internet storefronts.

In a companion statement from FDA, Gottlieb said e-cigarettes may present “an important opportunity for adult smokers to transition off combustible tobacco products and onto nicotine delivery products that may not have the same level of risk associated with them.” He noted that a new rule-making process was under way to regulate nicotine levels in combustible cigarettes to render them minimally or non-additive. He went on to state that the agency is committed to creating a “regulatory framework for how we properly evaluate an electronic nicotine delivery product and are committed to the development of guidance and regulations, including product standards, that will better spell out the rules of the road.”

In his remarks, Gottlieb acknowledged the agency did not foresee the extent of the epidemic level of e-cigarette use among teenagers. He said it was one of the reasons why FDA launched its youth tobacco prevention plan earlier in 2018. This plan focuses on three key strategies: first is preventing youth access to tobacco products; second is curbing the marketing of tobacco products aimed at youth; and third, educating teenagers about the dangers of using any tobacco products.

Commissioner Gottlieb went on to state that the legal standard for FDA pre-market review of the tobacco product includes consideration of whether the product would be appropriate for the protection of the public health. He noted that the Agency must factor in this evaluation whether the products get children addicted to nicotine.

Patrick J. McNamara, Esq. has served since 1994 as general counsel to NAFFS. Copies of the various reports and documents referenced in his speech can be obtained from NAFFS or directly from him. Please contact him at pmcnamara@scarincihollenbeck.com or call his office at 201-896-4100. The complete version of Mr. McNamara’s presentation is available at www.naffs.org.

This presentation provides general information only and does not constitute legal advice. No attorney-client relationship has been created. If legal advice or other expert assistance is required, the services of a competent professional should be sought. We recommend that you consult with an attorney familiar with your specific situation before taking any action.

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