For those of us involved in day to day D&O insurance transactions, it is a recognized fact that cannabis-related companies represent a tough class of insurance business. Different insurers take different approaches to the business, but at best it is a risk class that most carriers approach warily. There are reasons for the caution, mostly having to do with questions relating to legality across and between jurisdictions. The question of potential claims is a little less certain, as there arguably are relatively few claims examples. However, a recent securities class action lawsuit involving a Canadian-based cannabis business may provide some insight into the kinds of claims in which these kinds of companies may become involved – at least those that are publicly traded.
Cronos Group is a Canadian-based company organized to produce and distribute cannabis products with the requirements of Health Canada’s Access to Cannabis for Medical Purposes Regulations. (Cannabis products are to be legal in Canada, subject to applicable regulations, on October 17, 2018.) Cronos’s common shares trade on NASDAQ under the symbol “CRON.”
On August 21, 2018, Cronos issued a press release announcing its initial supply agreements for retail distribution, both government-operated and private, across various Canadian provinces for the launch of the Canadian recreational market in October 2018.
On August 30, 2018, short-seller Citron Research issued an article entitled “Cronos: The Dark Side of the Cannabis Space,” as discussed here. Among other things, the article claims that Cronos was “all talk” and was omitting key details about the size of its distribution agreements. The article also reportedly claimed that Cronos “appears to have been deceiving the investing public by purposely not disclosing the size of its distribution agreements with provinces — unlike every other major cannabis player.” The report also stated that “Our sources have informed us that it’s because the agreements are so small they could never justify the premium investors are paying for the stock.” In reaction to the release of the Citron Report, Cronos’s share price dropped more than 28%.
The Securities Lawsuits
On September 4, 2018, a Cronos shareholder filed a securities class action lawsuit in the Southern District of New York against the company and its CEO, Michael Gorenstein. The complaint purports to be filed on behalf of Cronos investors who purchased the company’s shares between August 21, 2018 and August 30, 2018. According to the plaintiff’s attorneys’ September 4, 2018 press release (here), the complaint (a copy of which can be found here) alleges that the defendants “failed to disclose: (1) that the size of Cronos’ distribution agreements with the provinces was relatively small; and (2) that, as a result of the foregoing, Defendants’ positive statements about Cronos’ business, operations, and prospects were materially false and/or misleading, and/or lacked a reasonable basis.” The complaint alleges that the defendants’ statement violated the federal securities laws and seeks to recover alleged damages on behalf of the purported class of investors.
On September 14, 2018, a second Cronos shareholder filed a complaint in the Southern District of New York against the company and against Gorenstein. A copy of the second complaint can be found here. The allegations in the second complaint are substantially similar to the allegations in the first-filed complaint. The September 14, 2018 press release of the plaintiff’s attorneys who filed the second of the two complaints can be found here.
A number of Cannabis businesses have launched offerings in recent months, seeking to take advantage of the end of Cannabis prohibition in Canada, as well as the expanding legality in a number of U.S. states. While there clearly will be successful businesses in this space, the market sector is still developing and a number of competitors have emerged.
Beyond competition questions, the businesses still face legal uncertainties. Even after recreational marijuana use becomes legal in Canada in October, the substance will still face legal prohibitions at the federal level in the U.S., as well as in most of the individual U.S. states. The legal uncertainty continues to make many U.S.-based D&O insurers cautious about companies in the cannabis space.
Interestingly, it is not the legal uncertainties per se that are behind the new lawsuits against Cronos. Rather, the lawsuit arises out of the kind of questions that might arise in connection with any new venture in any developing business space. Here questions about the distribution arrangements into which Cronos claims to have entered and based upon which it hopes to conduct businesses within the Canadian provinces affected the company’s share price. The lawsuits and the underlying circumstances are a reminder that beyond questions surrounding the cannabis businesses’ product there are the more basic operational and financial questions that pertain to any new business venture.
In any event, the new lawsuits against Cronos provide examples of the kinds of claims that can arise in connection with cannabis-related businesses. As the industry develops and evolves, there undoubtedly will be further questions and further claims. The emergence of these issues and claims should help underwriters as the developing guidelines to try to underwriting these kinds of risks. The claims should also help the companies’ insurance advisors as the companies attempt to manage and transfer their risks.