Citing Dormant Commerce Clause, Federal Court Enjoins Issuance of Certain New York Cannabis Licenses

The U.S. District Court for the Northern District of New York (the “Northern District”) late last week prohibited the issuance of Conditional Adult-Use Retail Dispensary (“CAURD”) cannabis licenses in five “geographic areas” of New York state. In ruling in favor of an out-of-state applicant who would not qualify for a New York license because of the applicant’s lack of ties to the Empire State, the court joined the chorus of federal courts calling state cannabis licensing schemes that favor in-state applicants over out-of-state applicants unconstitutional.

In Variscite NY One, Inc. v. State of New York, No. 1:22-cv-1013 (GLS/DJS) (N.D.N.Y. Nov. 10, 2022), U.S. Senior District Judge Gary L. Sharpe found that New York state’s law and regulations governing the CAURD licenses and application process likely violate the U.S. Constitution’s dormant Commerce Clause. In his Memorandum-Decision and Order, Judge Sharpe enjoined the state “from issuing any cannabis licenses under the CAURD application program held from August 25, 2022 to September 26, 2022, for the following geographic areas: Finger Lakes; Central New York; Western New York; Mid-Hudson; and Brooklyn during the pendency of this action or until otherwise ordered by the court.”

In its ruling, the Northern District weighed in on one of the most important issues affecting the cannabis industry today – the application of the U.S. Constitution’s dormant Commerce Clause. Once seemingly relegated to discussion only in law-school classrooms (and then seldom considered in practice), this doctrine – the “roots” of which the U.S. Supreme Court has traced backed to 1824 – is now one of the hottest topics in the cannabis industry.

The Dormant Commerce Clause

Article I, Section VIII of the Constitution states that “Congress shall have [p]ower … [t]o regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes.”

“‘Although the Clause is framed as a positive grant of power to Congress,’” the Supreme Court explained in Tennessee Wine & Spirits Retailers Association v. Thomas, 139 S. Ct. 2449 (2019), “we have long held that this Clause also prohibits state laws that unduly restrict interstate commerce” (citations omitted). “This interpretation,” the Court stated, is “generally known as the ‘dormant Commerce Clause.’”

Writing for the majority in Tennessee Wine & Spirits, Justice Samuel A. Alito, Jr. explained: “This ‘negative’ aspect of the Commerce Clause prevents the States from adopting protectionist measures and thus preserves a national market for goods and services.”

Justice Alito continued: “Under our dormant Commerce Clause cases, if a state law discriminates against out-of-state goods or nonresident economic actors, the law can be sustained only on a showing that it is narrowly tailored to advanc[e] a legitimate local purpose” (internal quotation omitted).

New York CAURD Licensing Scheme

In its recent Variscite decision, the Northern District of New York summarized the state’s CAURD legal and regulatory scheme, demonstrating how it favored New Yorkers:

Here, the challenged law and regulations require the CAURD applicant to demonstrate “a significant presence in New York State,” a showing that can be met by demonstrating “a majority of the ownership of the applicant are residents of New York State.” Applicants may also meet the “significant presence” criteria by demonstrating that it is “incorporated or otherwise organized under the laws of New York State,” or by providing documentation demonstrating: (1) “Proof of the individual with sole control’s residency in New York State”; (2) “Checking, savings, retirement, or brokerage statements showing assets in New York State”; (3) “Tax filings showing assets, accounts, or property in New York State”; (4) “Deeds, titles, mortgage documents, or homeowner warranties showing property ownership in New York State,” or; (5) “Any other proof of New York State presence as determined by [the New York State Office of Cannabis Management (‘OCM’)].” Additionally, and independent from the “significant presence” requirement, an applicant must be “[a]t least [51] [percent] or more … owned, in the aggregate, by” justice involved individuals, meaning, “convicted of a marihuana-related offense in New York State.” Finally, the applicant must provide proof of the justice involved individual’s residence at the time of his or her arrest or conviction, and the application evaluation criteria includes whether the justice involved individual lived-in housing provided by New York Public Housing Authority (citations omitted) (emphasis omitted).

New York’s scheme favoring in-state residents with in-state cannabis convictions ostensibly was designed to promote a stated goal of social equity. As OCM states on its website:

Social equity is central to the Cannabis Law, which seeks to begin the work of repairing decades of disproportionate enforcement and over criminalization of cannabis prohibition, especially in Black and Brown communities. Ensuring those harmed are given an equitable chance to participate and thrive in the legal New York cannabis industry is a key mandate of the Cannabis Law and a priority of the Office of Cannabis Management.

A Likely Constitutional Violation

According to the Northern District, Plaintiff Variscite NY One, Inc. (“Variscite”) “applied for a CAURD license; however, because it is ‘[fifty-one percent] owned by an individual who has a cannabis conviction under Michigan law’ and ‘has no significant connection to New York,’ Variscite is ineligible to be selected. Variscite ‘satisfies all [other] requirements’” to be eligible to apply for a CAURD license (footnote omitted) (citation omitted).

As such, Variscite commenced litigation “pursuant to 42 U.S.C. §1983, alleging a violation of the dormant Commerce Clause” and sought a preliminary injunction to prevent the state from issuing CAURD cannabis licenses in the regions of New York designated by Variscite.

After stating the relevant standard of review and determining the applicable preliminary-injunction standard, the Northern District turned to the central issue in the case, providing first a framework for its dormant Commerce Clause analysis. Thereafter, it found that “the aforementioned application requirements, especially when considered in the aggregate, will have a discriminatory effect on out-of-state residents seeking a CAURD license.”

The Northern District further found that those requirements were not “narrowly tailored to advance[e] a legitimate local purpose” (internal quotations omitted). The court stated:

[The State] did not even attempt to make the requisite “showing that [the challenged laws and regulations are] narrowly tailored to advanc[e] a legitimate local purpose.” Additionally, when directly questioned by the court as to whether the challenged laws and regulations could survive the heightened level of scrutiny …, [the State] offered no cogent response. [The State has] not met [its] burden of demonstrating that the Cannabis Law and Cannabis Regulations are sufficiently “narrowly tailored” to serve a legitimate local purpose (citations omitted).

Therefore, the Northern District found that Variscite was likely to prevail on the merits of its claim.

A Warranted Injunction

The court also found that the other prerequisites for issuance of a preliminary injunction were satisfied. First, “[b]ecause Variscite alleges harm of a constitutional nature, such harm is deemed irreparable,” the Northern District explained.

Second, the court determined that “the balance of hardships” tips in Variscite’s favor, “given that OCM has not begun issuing licenses, and will not begin issuing licenses until, at the earliest, November 21, 2022.” “Additionally,” the court continued, “all of defendants’ arguments are undercut, to some degree, by the fact that Variscite only seeks to enjoin the application process in five of the thirteen geographical regions, and defendants could proceed with the licensing process in the other eight regions (citation omitted).

Third, the court found that “[t]he final factor, whether the public interest will be served by granting the injunction, also weighs in Variscite’s favor, as ‘[n]o public interest is served by maintaining an unconstitutional policy when constitutional alternatives are available to achieve the same goal.”

Therefore, the court concluded that “Variscite had met the standard for the issuance of a preliminary injunction.”

A Growing Chorus

The Northern District is not the first federal court to find that cannabis licensing laws and regulations that are designed to favor in-state applicants violate the dormant Commerce Clause. Far from it. In mid-August 2022, for example, the U.S. Court of Appeals for the First Circuit (the “First Circuit”) affirmed a federal district court’s ruling that Maine’s residency requirements to participate in its cannabis industry violated the dormant Commerce Clause.

In Northeast Patients Group v. United Cannabis Patients and Caregivers of Maine, 45 F. 4th 542 (1st Cir. 2022), the “defendants [did] not dispute that they cannot show that Maine’s residency requirement, if it were applied to a lawful market, would be narrowly tailored to serve a legitimate local purpose, because they agree that, as applied to such a market, the requirement would ‘basically [be] a protectionist measure,’ that would both ‘discriminate[] against’ and ‘unduly burden[] interstate commerce” (citation omitted).

However, the defendants “argue[d] that, notwithstanding these points, Maine’s residency requirement comports with the dormant Commerce Clause because federal law makes participation in the market to which the residency requirement applies illegal.” The First Circuit rejected that argument.

Additionally, as the Northern District observed in Variscite, “[n]umerous [other federal] [d]istrict [c]ourts have ruled on similar regulatory cannabis licensing schemes, and all applied the heightened level of dormant Commerce Clause scrutiny.”

For example, in Toigo v. Department of Health and Senior Services, 549 F. Supp. 3d 985 (W.D. Mo. 2021), the U.S. District Court for the Western District of Missouri considered a challenge to Missouri’s cannabis licensing scheme. That court observed:

It is not necessary to look beyond the face of the State’s durational residency requirement to determine whether it is discriminatory. A law that prevents persons from becoming majority shareholders in Missouri businesses that engage in the cultivation, manufacture, and dispensation of medical marijuana products unless they have lived in Missouri for one year and do not reside in any other state is facially discriminatory against out-of-state economic interests. A law that prevents out-of-state persons from applying for medical marijuana licenses or purchasing them from others is also facially discriminatory against out-of-state economic interests.

“To survive the resulting presumption of invalidity,” the court continued, the state “must show the law advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives. These justifications must survive strict scrutiny” (citations omitted).

According to the court, Missouri “proffer[ed] two virtually interchangeable justifications for the residency requirement: that it is required to enforce drug laws and that it is required to prevent the illicit diversion of medical marijuana for recreational or out-of-state use.” The court rejected both of them.

For example, it found that, “[a]lthough the State has a legitimate interest in enforcing laws concerning controlled substances (including those laws that prevent medical marijuana from being used recreationally or outside its borders), Supreme Court precedent makes clear that durational residency requirements are not narrowly tailored to advance that interest.

The Future

The effects of the Northern District’s recent ruling will play out over time in New York. For example, whether the state’s stated social-equity goal can be advanced while opening the market to out-of-state participants remains to be seen.

Moreover, similar Constitutional challenges are already pending or are likely to be brought elsewhere in the United States. Simply put, the dormant Commerce Clause issue is not going away anytime soon.

In fact, if and when federal legalization occurs, new dormant Commerce Clause challenges are likely to arise. At that time, state regulations and restrictions – concerning matters such as additives, packaging, and labeling – could be challenged as unconstitutionally burdening interstate commerce. And, at that time, there also may be challenges to whether a state can require that all cannabis sold in the state be grown in the state.

It is, therefore, important that participants in the cannabis industry in New York and across the United States continue to pay attention to dormant Commerce Clause-related developments in the states, the U.S. Congress, and the courts.

Phil and the other members of Leech Tishman’s Cannabis Industry Group routinely counsel plant-touching, non-plant-touching, and ancillary businesses about a variety of legal issues. Our attorneys are prepared to help cannabis-related businesses in New York and across the United States understand the implications of the dormant Commerce Clause, litigate dormant Commerce Clause issues, and/or understand judicial decisions applying the dormant Commerce Clause.

If you have any questions about this decision, the dormant Commerce Clause, or other issues affecting the cannabis industry, please contact Philip T. Simpson.

Philip T. Simpson is a Partner in Leech Tishman’s Litigation and Real Estate Practice Groups. He is also a member of the firm’s Cannabis Industry Group. Phil can be contacted at psimpson@leechtishman.com or at 212-603-6300.

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