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“The Legalization of Cannabis in New York State and the Need for Directors and Officers Insurance Coverage,” New York Law Journal, May 21, 2021

Jun. 04, 2021

On March 31, 2021, Governor Cuomo signed Senate Bill S854A to enact the Marijuana Regulation and Taxation Act, making New York the 16th state, along with the District of Columbia, to legalize adult-use cannabis.[1]  The potential implications of this Act on the economic and social landscape of New York state are staggering.  The legal cannabis market in New York state is expected to capture $1.2 billion in sales by 2023 and the state expects to eventually collect $350 million in annual revenue.[2]

As both the number and type of New York businesses in the legalized cannabis industry continue to grow, their need for insurance coverage will only expand.  Plus, New York, as a global financial and investment epicenter, faces unique risks in the cannabis space as deals, investments, acquisitions, and mergers become common vehicles to cash-in on the green.  These risks include claims by investors, customers, vendors, competitors and others for a variety of claims, including, mismanagement, misrepresentation, breach of fiduciary duty, misappropriation of trade secrets, and fraud.  These risks exist in both public and private companies.

Such risks have been highlighted by the rash of shareholder and securities class action lawsuits recently filed against companies in cannabis related-businesses.  Indeed, some of the biggest cannabis companies, including Medmen Enterprises, Canopy Growth, CannTrust Holdings, and Columbia Care have all already been on the receiving end of shareholder litigation.  The leaders of these companies have been accused of making false claims, failing to act in the shareholders’ bests interests and attempting to defraud shareholders.  As cannabis companies and risks grow, the companies, as well as prospective investors, board members and managers will be compelled to buy D&O insurance.

D&O insurance policies provide three separate types of coverage, Side A, Side B and Side C.  The first, Side A coverage, is liability coverage for the individual directors and officers. Under Side A coverage, the insurer agrees to indemnify the individual directors or officers for all “Loss” that those individuals become legally obligated to pay arising out of a “Wrongful Act” committed in their capacity as a director or officer.  Side A coverage only responds, however, where the policy provides insurance to pay the directors’ and officers’ personal liabilities for which the corporation either cannot or will not provide indemnification.

The second, Side B coverage, is coverage for the payments a corporation makes on behalf of its directors and officers.  Side B coverage reimburses the corporation for all payments for which the company is required to indemnify, or has legally indemnified, the directors or officers for “Loss” resulting from a claim alleging a Wrongful Act.  The third, Side C, known as “entity” coverage, reimburses the corporate insured for liability arising out of a defined group of claims filed directly against the corporation.  The scope of entity coverage for a publicly held company is often limited to securities claims.

While it is apparent that D&O insurance could be a crucial, and essential, component of a cannabis company’s success and growth, obtaining adequate D&O insurance to date has been a challenge.  The looming cannabis issues of federal legality, banking hurdles and reputational risks have largely kept admitted insurers out of the D&O market.  This has led to a dearth of available D&O coverage.  And, due to the nascent and highly regulatory nature of the cannabis industry, with limited historical claims available, the typical D&O coverage currently available has limited limits, multiple regulatory exclusions, and high premiums.

On a positive note, however, the introduction of the Secure and Fair Enforcement Banking Act (the “SAFE Act”) and Clarifying Law Around Insurance of Marijuana Act (the “CLAIM Act”) in March 2021, could pave the way for an influx of D&O insurers to enter the cannabis market.  The SAFE Act would create a safe harbor for financial institutions, including banks and credit unions, removing potential liability or forfeiture for providing financial services to a cannabis-related business.  The CLAIM Act, targeted at the insurance industry, would “create a safe harbor for insurers engaging in the business of insurance in connection with a cannabis-related legitimate business, and for other purposes.”  By creating a “safe harbor” for insurers to issue policies and insureds to transact business without fear of federal penalties, the SAFE Act and the CLAIM Act could open up the market to more competition, encourage more insurance product offerings and lower premiums.

Presently, and as more insurers enter the D&O coverage cannabis space, insureds should ensure that they are working with brokers and insurers who are well-versed in the space.  Cannabis companies, ancillary cannabis businesses, and potential investors in the cannabis space may have unique risks and challenges that require the attention of specialists.  Given that, risk management professionals and in-house counsel in this space should work with their insurance professionals to monitor legislative and regulatory developments and to obtain the appropriate coverages.

Insureds should also take steps to maximize their potential D&O coverage.  First, insureds should clearly communicate their business operations and potential exposures when shopping for a D&O policy.  Second, insureds should read their insurance policies and understand the coverage provided, conditions, exclusions, and time restraints on coverage.  In particular, given the regulatory nature of cannabis, most (if not all) D&O policies will carry some form of a regulatory exclusion.  Further, given the wide variety of policy language in these cannabis D&O policies, insureds should carefully review policies and never assume that something is excluded.  Third, given the limited D&O products available, insureds should explore alternative solutions such as captives and alterations to traditional D&O policies (e.g., purchasing Side A coverage only).   Fourth, insureds should review ALL potentially applicable insurance policies to a claim.

Article available at Law.com.

[1] https://www.governor.ny.gov/news/governor-cuomo-signs-legislation-legalizing-adult-use-cannabis

[2] https://www.forbes.com/sites/willyakowicz/2021/03/31/new-york-state-legalizes-adult-use-cannabis/?sh=3a25287395ca

Jeffrey L. Schulman
Managing Partner
Name a Northeast Trailblazer in 2021 by The American Lawyer

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