Can Federal Law Block a Fraud Claim in a State-Legal Cannabis Deal?
Cannabis businesses operate legally throughout Michigan, but with a catch: what state law permits, federal law still prohibits. For the hundreds of dispensaries and other cannabis businesses in the state, this matters most when a business deal goes wrong and lands in federal court, where the judge applies federal law. A recent Michigan federal court decision, 5 Guys Management, Inc. v. Redbud Roots, Inc., explains how that federal-state conflict affects a lawsuit and reveals that a company’s federal status does not erase the ordinary rules for common law fraud claims and securities fraud claims. Our firm represents the plaintiff in this case.
A court will not lend its assistance to enforcing the terms of an illegal contract. This is a long-standing principle of law. Because marijuana remains classified as illegal under the federal Controlled Substances Act even in states that have legalized it, a federal court may treat a contract related to investing in or operating a dispensary as an illegal contract. When the illegality comes from a federal statute, federal law defines how far the doctrine reaches. If a company sued purely to collect the profits you were promised from a cannabis deal, a federal court would likely turn the plaintiff away.
How Does Restitution Differ From Enforcing an Illegal Contract?
The court explained that this bar to relief applies when a judgment would force a party to carry out the illegal deal or hand over the benefit of the illegal bargain. It does not reach a claim for restitution, meaning a claim that simply returns what was taken. The court found the investor here was really asking for restitution rather than enforcement of a contract, in part because it sought its money back from alleged fraudsters who were not parties to the underlying investment contract. Here, the investors were asking the court to undo the deal rather than validate it. The court also found that the public interest in denying relief was weak: many states have legalized marijuana, and the federal government has largely tolerated and even encouraged that trend. Letting the defendants keep money obtained by fraud would reward the more culpable party and encourage others to do the same and hide behind the illegality defense.
What Happened in the Case?
The investment group put $1.5 million into a Michigan dispensary after being told the money would fund that dispensary and that all owners would share profits proportionally. According to the investors, the money instead went to the operator’s other businesses and never reached the dispensary, which then failed. When the investors sued for fraud, the defendants argued the entire deal was federally illegal, so no court could award anything to the investors. The court refused to treat that as a total defense. It dismissed the claims that depended on validating the investors’ ownership interests, but allowed the securities fraud and common law fraud claims to move forward. The deciding factor was remedy: returning a defrauded investment through restitution does not require anyone to carry out the federally illegal contract, so the claims survived.
A business in a state-legal, but federally prohibited, industry is not beyond the reach of the courts and cannot count on the venture’s federal status to excuse fraud. An investor deceived in one of those deals is not always left without a remedy, as it depends on whether you are asking the court to enforce an illegal bargain or simply to return money taken through fraud. A claim may still be enforceable in state court, even if it is not enforceable in federal court, since cannabis is legal under Michigan law.