California Court Enforces Arbitration Clause in Cannabis Contract
An October 2019 decision in the U.S. District Court for the Northern District of California confirmed that cannabis companies can form contracts even if the purpose of the contract is for an illegal purpose and that arbitration clauses in such contracts can be severed from the contract and enforceability determined under the Federal Arbitration Act (the “FAA”).
In Williams v. Eaze Sols., Inc., the plaintiff sought to avoid enforcement of an arbitration clause with Eaze, a company which operates an app and website to facilitate consumers’ cannabis purchases from dispensaries. The app’s terms of service contain an arbitration clause. The plaintiff argued that although she did consent to the terms of service, no contract was formed because the contract was for an illegal purpose, and thus the arbitration clause was invalid.
The court rejected her argument and dismissed the plaintiff’s case, finding that under either California or Federal law, a contract had been formed and once a contract had been formed, the court could enforce the arbitration clause under the FAA. The court declined to decide whether California or federal law determines the effect of a contract’s illegality and left that determination to the arbitrator.
Many articles on this case have stated that the U.S. federal district court enforced the agreement, which would be a development in the law with far-reaching implications for many cannabis companies. However, on a closer read, this case was much narrower, only determining that a contract was formed and that an arbitration clause could be severed from the contract to determine enforcement of that clause only. The court expressly left to the arbitrator to determine whether to enforce the contract as a whole. The arbitrator remains free to decline to enforce the contract due to federal illegality. We further note that in at least two instances, federal judges in the U.S. District Court for the Western District of Washington have indicated that contracts involving state-licensed cannabis businesses may be unenforceable due to illegality under federal law.
We continue to advise our clients not to assume that a federal court will enforce contracts involving cannabis. Depending on the context, including an arbitration clause may be a good strategy for cannabis companies looking to enforce contracts. As an alternative to arbitration, we also recommend a choice of venue clause that provides for exclusive venue in state court and expressly excludes removal to federal court.