OUR BLOG

In Part 3 of this series, I discussed the residency rules for Ballot Measure 91 businesses that the Oregon Liquor Control Commission (“OLCC”) distributed to members of the Rules Advisory Committee on August 14. The OLCC has not yet made any changes to those rules. However, there is some news to report.

On September 3, Amy Margolis and I met with Steve Marks (Executive Director) and Jesse Sweet from the OLCC to discuss the residency rules. The purpose of the meeting was not to debate the merits of the OLCC’s policy decisions regarding residency. Rather, we were there to: (1) find out what the OLCC’s policy was in the first place; and (2) discuss ways in which: (a) the language in the rules could be clarified; and (b) certain common business organization structures could be specifically addressed. Our firm’s only goal was to attempt to assist the OLCC in making the rules as clear as is reasonably possible, so that license applicants will have some relative certainty (before they file their applications!) that their business organization structures are permissible under the rules. We informed the OLCC that our firm does not support residency requirements and that, in fact, we were reserving the right to assist one or more of our clients in challenging the residency rules.

OLCC’s Current Policy

We were informed that the OLCC’s policy is as follows:

1. Ownership – 51% of the ownership interests must be owned by two-year Oregon residents.
2. Management – 100% of the individuals who are directly involved in the operation or management of the business must be two-year Oregon residents.

In Part 3 of this series, I expressed skepticism that the OLCC meant what it was actually saying in the August 14 version of the rules. Either my skepticism was valid or my analysis was partially incorrect, because my interpretation of the OLCC’s August 14 rules concerning management that I stated in Part 3 is not consistent with the OLCC’s management policy stated above. No matter. I now am suggesting that everyone should ignore my management conclusion from Part 3 and consider the above management policy to be the OLCC’s current position, even if the current version of the rules doesn’t exactly say that.

Clarifications / Safe Harbors

At the meeting and in subsequent correspondence, I proposed several clarifications and safe harbors to the OLCC.

On the ownership side of things, I proposed clarifications and safe harbors for: (1) options to purchase ownership interests; (2) convertible promissory notes; (3) preferential distribution rights based on return of capital contributions; and (4) security interests.

On the management side of things, clarifications and safe harbors are particularly important because the numerical threshold (100%) is so high and the substantive threshold (“direct involvement in the operation or management of the business”) is so vague. Of utmost importance, is what exactly does “direct involvement” mean? In Part 2 of this series, I noted that the term “direct involvement “ is not a phrase that is typically used by businesses or business law attorneys. Without clarification, there is simply no understanding what it means. I proposed limiting its definition to participation in the control of day-to-day ordinary course of business matters. There is statutory precedence for such line-drawing. Under the Oregon Business Corporation Act, the Oregon Limited Liability Company Act, and the Oregon Limited Partnership Act, certain major decisions are “kicked up” to the ownership level, while day-to-day ordinary course of business matters are dealt with at the management level. For example, the Oregon Limited Liability Company provides that in a manager-managed LLC, all decisions are made by the managers, except for certain major decisions (which are specified in the statute) that require the consent of the members. See ORS 63.130(2-4). For the OLCC’s residency requirements, it would be beneficial to know that the right to vote on certain decisions that are outside the ordinary course of business does not constitute “direct involvement” in the operation or management of the business.

Legal and Political Pressure

All of our clients should assume that the OLCC’s current policy will, in fact, end up being the policy in the final version of the rules. However, there is always a chance that the OLCC could be affected by certain legal and political pressures.

1. Legislative Counsel Committee Legal Memorandum – At the request of Representative Ann Lininger, Oregon’s Legislative Counsel Committee issued a memorandum that concluded that Oregon House Bill 3400 does not permit the OLCC to impose residency requirements on mere owners of a business. The memorandum was written by Deputy Legislative Counsel Mark Mayer and is dated July 28, 2015 (although it was just recently delivered to us). The memorandum’s legal conclusion is as follows: “For purposes of [Ballot Measure 91 and Oregon House Bill 3400], an “applicant” is a person that participates in the management of the business, owns the business outright or otherwise has the power to control the operations of the business. An “applicant” is not a person that merely has an ownership interest in the business.” The OLCC’s current 51% ownership policy directly conflicts with this legal opinion, and so it will be interesting to see if the OLCC agrees or disagrees with the memorandum.

2. Legislative Days – Members of the Oregon legislature are convening for “Legislative Days” from September 28 through September 30. During Legislative Days, various committees hold informational hearings to hear updates on the implementation of past legislation and to consider potential future legislation. The OLCC’s position on residency requirements could be a topic of discussion, especially in light of the Legislative Counsel Committee’s memorandum.

3. Legal Challenge – A lawsuit could be filed challenging some or all of the residency rules. The ownership requirements could be challenged based on the reasons set forth in the Legislative Counsel Committee’s memorandum. Additionally, all of the residency requirements could be challenged on a constitutional basis. In a subsequent part of this series, I will discuss why the residency requirements probably violate the U.S. Constitution.

4. Oregonian Editorial Board – On September 5, 2015, the Oregonian Editorial Board published an editorial opposing residency requirements for owners.

What to Do

Our overall advice has not changed. If your business is seeking an investment from one or more out-of-state investors, or if your business already has one or more out-of-state owners, and if you haven’t already discussed the issue with us, contact us today to do so. Additionally, if your business is made up entirely of out-of-state owners, and if you haven’t already done so, you should begin searching for one or more Oregon residents who you might be willing to make a co-owner or a manager, director, or officer.

Continue to stay tuned to our blog, as we will post any updated residency information when we receive it.

On August 14, the Oregon Liquor Control Commission (“OLCC”) distributed to members of the Rules Advisory Committee (“RAC”) a revised draft of the rules that will affect the residency requirements for Ballot Measure 91 businesses.

There are several significant changes from the initial draft of the rules (which initial draft was discussed in Part 2 of this series).

Here are the latest versions of the most relevant provisions:

Definitions

() “Applicant” means any person or legal entity having a financial interest in the business for which licensure is sought and who is directly involved in the operation or management of the business
(a) Direct involvement in the operation or management of the business may be indicated by, but is not limited to, the following behaviors, benefits or obligations:
(i) Any person or legal entity that exercises control over, or is entitled to exercise control over, the business;
(ii) Any person or legal entity, that incurs, or is entitled to incur, debt or similar obligations on behalf of the business;
(iii) Any person or legal entity, that enters into, or is entitled to enter into, a contract or similar obligations on behalf of business [sic];
(iv) Any person or legal entity that identified [sic] as the lessee of the premises proposed to be licensed.

() “Financial interest” means having an interest in the business such that the performance of the business causes, or is capable of causing, an individual or a legal entity with which the individual is affiliated, to benefit or suffer financially, and such interests include but are not limited to:
(a) Receiving, as an employee or agent, out-of-the-ordinary compensation, either in the form of over-compensation or under compensation;
(b) Lending money, real property or personal property to an applicant or licensee for use in the business;
(c) Giving money, real property or personal property to an applicant or licensee for use in the business; or
(d) Being the spouse or domestic partner of an applicant or licensee. For purposes of this subsection, “domestic partners” includes adults who qualify for a “domestic partnership” as defined under ORS 106.310.

845-025-XXXX
Applicant and Licensee Qualifications

(1) An applicant must:
(a) Be at least 21 years of age; and
(b) Be the legitimate owner of the business proposed to be licensed; and
(c) Until January 1, 2020, have been a resident of Oregon for at least two consecutive two years [sic] prior to the date the initial or renewal application was submitted.
(2) Individuals listed as applicants on an initial or renewal application, or identified by the commission as an applicant must maintain Oregon residency while the business is licensed.

845-025-XXXX
Legitimate Ownership

In determining whether an applicant is the legitimate owner of the business proposed to be licensed or subject to license renewal the Commission:
(1) Must consider whether at least one applicant owns at least 51% of the business proposed to be licensed or whether one or more applicant [sic] in sum owns at least 51% of the business proposed to be licensed; and
(2) May consider whether an individual or legal entity other than an applicant, or an employee acting under the direction of an applicant, is directly involved in the operation or management of the business.

This is my best analysis of what the latest versions of the rules say:

1. Two-year Oregon residents must own at least 51% of the business. The OLCC has provided for this in a rather roundabout way by adding the “legitimate owner” requirement to the Applicant and Licensee Qualifications provision, and then by saying that the OLCC, in determining the identity of the legitimate owner, must consider who (individually or in the aggregate) owns 51% of the business. See clause (1)(b)) of Applicant and Licensee Qualifications and clause (1) of Legitimate Ownership.

2. If any single individual controls the business, or if any single individual has the unilateral authority to take certain actions on behalf of the business (such as incurring debt or entering into contracts), then that individual must be a two-year Oregon resident. The OLCC’s language is not clear here, but this appears to me to be the most likely interpretation. Under the rules, an individual is not an “applicant” unless the individual is “directly involved” in the operation or management of the business. “Direct involvement” means controlling the business or having the right to take certain actions on behalf of the business. If there is a single owner who completely controls the business, then the rule is clear and can be simply applied. However, consider a multiple-owner scenario where a business is owned only by minority investors, some of whom are residents and some of whom are non-residents. For example, assume that a business is owned by four individual shareholders (25% each) and that all four shareholders are also directors. Then assume that the shareholders/directors adopt a common “majority rules” approach, where a majority of the shareholders/directors (three out of four) make all decisions on behalf of business. Finally, assume that two of the shareholder/directors satisfy the two-year Oregon residency requirement and the other two do not. Under this common scenario, no individual person controls the business and no individual person has the unilateral ability to do anything without the majority’s approval. Who then, from the OLCC’s perspective, would be “directly involved” in the operation or management? Because the definition of “direct involvement” in the latest version of the rules does not contain the “individually or in the aggregate” concept that appears in the Legitimate Ownership provision, it stands to reason that each individual person must be analyzed on his or her own to determine whether the individual controls the business or has the right to take certain actions on behalf of the business. Consequently, under the above multiple-owner scenario, I would say that none of the individuals is directly involved in the operation or management of the business.

Some observations:

Observation #1 – If my interpretations are correct, then the revised rules appear to be a complete flip-flop from the initial draft of the rules. As was noted in Part 2 of this series, in the initial draft of the rules, the OLCC seemed much more concerned with non-resident managers than non-resident owners. However, under the revised draft of the rules, the focus seems to be primarily on making sure: (1) that 51% of the owners (individually or in the aggregate) satisfy the residency requirements; and (2) that no single individual non-resident controls the management of the business.

Observation #2 – I’m a bit reluctant to say this, but at this point I believe it has to be said. Both drafts of the OLCC’s rules regarding residency are worded so poorly, and are so vague and ambiguous, that I essentially don’t have much faith in my own analysis of what the rules actually mean. Or to be more accurate, I don’t have much faith that the OLCC’s rules say what the OLCC actually means. Or even worse, it’s entirely possible that the OLCC does not even know what it wants to say in the first place. The rules regarding “direct involvement” in management are not clear even when considering the most basic and simple organizational structures. And there are many other more complicated (but quite common) organizational structures that are not even being contemplated by the OLCC. Additionally, the OLCC’s way of drafting open-ended non-exclusive definitions (“Direct involvement . . . may be indicated by, but is not limited to . . . .”), together with the absence of any safe harbors, will make compliance a virtual guessing game in many scenarios.

Observation #3 (editorial comment) – In my opinion, it is practically unconscionable that the residency requirements have not yet been finalized. The Oregon Medical Marijuana Act never contained any residency requirements for ownership or management. Ballot Measure 91 intentionally did not contain any residency requirements for anyone. The Oregon legislature, in an unfortunate move, imposed a residency requirement on somebody, but then failed to say who. And now the OLCC is struggling with what it wants to do on this issue. From a policy perspective, residency requirements have absolutely nothing to do with public safety, with the ability of the OLCC to conduct criminal records checks, with law enforcement, with the eight Federal enforcement priorities set forth in the “Cole Memo,” with Oregon tax revenues, with local jurisdictions, or with anything else, other than good old-fashioned economic protectionism. And for that very reason, from a legal perspective, residency requirements probably violate the U.S. Constitution (which I will discuss in a subsequent part of this series). In just a bit more than four months, hundreds and hundreds of businesses will be submitting license applications to the OLCC. And a substantial number of those businesses have no idea if their current ownership and management structures will be legal under the OLCC’s rules. Organizing and capitalizing businesses takes a significant amount of time, energy, and money. Reorganizing and recapitalizing businesses so close to the opening day of applications will cause a substantial number of businesses to spend time, energy, and money that is better spent on safety, compliance, higher employee wages, and other matters. For the sake of the entire industry, this issue should be decided and finalized as soon as possible. And just as importantly, the rules must be absolutely clear on the front end. If the rules are vague, ambiguous, or too simplistic, and if the applications of businesses are denied based on some 2016 after-the-fact policy interpretation by the OLCC, there is certain to be litigation and finger-pointing.

Recommendation to the OLCC

At this point, the OLCC should seriously consider taking a more benign and objective approach to residency. The OLCC would be well within its statutory authority to require only that a single individual on the application be a two-year Oregon resident, or that some other relatively minimum threshold be satisfied. This would have the following positive effects: (a) businesses would be better capitalized overall, and would be able to spend more money on “industry best practices” instead of being forced to spend money on corporate legal fees, owner buyouts, and other reorganization matters; (b) the process of reviewing initial applications by the OLCC would be simplified; (c) the process of reviewing change forms for future changes of ownership or business structures would be simplified; (d) the likelihood of one or more lawsuits being filed against the OLCC alleging the unconstitutionality of residency requirements would be practically eliminated; and (e) the likelihood of individual lawsuits being filed against the OLCC alleging the improper denial of an application based on unclear residency requirements would be substantially reduced.

To the extent that the OLCC is dead set on promulgating rules that impose significant residency requirements, the OLCC should promptly consult with one or more experienced business law attorneys to ensure: (a) that there are no ambiguities in the rules; (b) that the rules are sophisticated enough to capture scenarios that are common in organizing and structuring businesses; and (c) that the rules contain safe harbor provisions that make clear that certain organizational and management structures will not violate the rules.

What to Do

If your business is seeking an investment from one or more out-of-state investors, or if your business already has one or more out-of-state owners, and if you haven’t already discussed the issue with us, contact us today to do so. Additionally, if your business is made up entirely of out-of-state owners, and if you haven’t already done so, you should begin searching for one or more Oregon residents who you might be willing to make a co-owner or a manager, director, or officer.

Continue to stay tuned to our blog, as we will post any updated residency information when we receive it.

On July 17, the Oregon Liquor Control Commission (“OLCC”) distributed to members of the Licensing, Compliance, and Enforcement Technical Advisory Subcommittee an initial draft of certain rules that would affect the residency requirements for Ballot Measure 91 businesses.

The most relevant provisions relating to residency are as follows:

Definitions

() “Applicant” means any individual:
(a) Having a financial interest in the business for which licensure is sought and who is directly involved in the management of the business; or
(b) Who owns 51% or greater interest in the business proposed to be licensed; or
(c) Any individual who is a managing member, partner or director or officer of a legal entity if the legal entity owns or operates the business for which licensure is sought.

() “Financial interest” means having an interest in the business such that the performance of the business causes, or is capable of causing, an individual or a legal entity with which the individual is affiliated, to benefit or suffer financially, and such interests include but are not limited to:
(a) Receiving, as an employee or agent, out-of-the-ordinary compensation, either in the form of over-compensation or under compensation;
(b) Renting or leasing real property to an applicant or licensee for use by the business;
(c) Lending money, real property or personal property to an applicant or licensee for use in the business;
(d) Giving money, real property or personal property to an applicant or licensee for use in the business; or
(e) Being the spouse or domestic partner of an applicant or licensee. For purposes of this subsection, “domestic partners” includes adults who share the same regular and permanent address and would be financially effected by the success or failure of the business as well as adults who qualify for a “domestic partnership” as defined under ORS 106.310.

845-025-XXXX
Applicant and License Qualifications

(1) An applicant must:
(a) Be at least 21 years of age; and
(b) Until January 1, 2020, have been a resident of Oregon for at least two consecutive two years [sic]prior to the date the initial or renewal application was submitted.
(2) Individuals listed as applicants on an initial or renewal application, or identified by the commission as an applicant must maintain Oregon residency while the business is licensed.

Here is my analysis:

Observation #1 – The OLCC seems much more concerned about non-resident managers than non-resident owners. For example, it appears that a non-resident individual could own up to a 50.99% interest in a licensee, so long as the non-resident individual is not a manager, partner, director, officer, or otherwise directly involved in management. In fact, it would appear from the rules that 100% of the ownership interests of a licensee could be owned by non-residents so long as: (1) no individual non-resident owned a 51% or greater ownership interest; and (2) the owners hired an Oregon resident to be the sole manager of the business.

Observation #2 – Certain words and phrases in the rules are either ambiguous, or are not sophisticated enough to capture scenarios that are common in organizing and structuring businesses.

For example, the term “directly involved in the management” is not a phrase that is typically used by businesses or business law attorneys. The phrase may have come from Representative Ann Lininger’s oral legislative history (which was mentioned in Part 1 of this series), where she stated that the definition of applicant was intended only to include a person who “directly manages” the business. However, the line between “direct” and “indirect” involvement in the management of a business is definitely not self-evident. A more commonly-used phrase (and perhaps this is what Representative Lininger and the OLCC are trying to get at) is the term “ordinary course of business”, which is usually used to distinguish between: (1) day-to-day operational decisions that are generally made by managers or officers; and (2) more significant decisions that are generally made by members, shareholders, and directors. However, even that distinction is unclear, and what might be the ordinary course of business for one company may not be the ordinary course of business for another. Another commonly-used phrase is “control,” which usually means that one or more individuals have a majority of the voting power.

As another example, the term “51% or greater interest” could, in some circumstances, be ambiguous. Not every entity has only one class of ownership interests, and some owners may have the right to receive preferential returns for a period of time. In a typical preferential return scenario, a cash investor may have the right to receive 100% of the distributions from the entity until such time as the investor recoups the entire amount invested, and then, after receiving such amount, would have the right to receive a lesser percentage of all future distributions. Depending on the numbers and percentages before and after recoupment, it may be unclear whether an individual would be considered the owner of a “51% or greater interest.”

Observation #3 – The policy behind the rules is difficult to discern. Like most sets of line-drawing rules, there are scenarios that can be articulated that make the rules seem nonsensical. For example, a corporation having only Oregon shareholders and only Oregon directors would nevertheless be disqualified merely because it hired a single non-resident officer as an employee. On the flip side, as was noted above, an entity having no Oregon owners could obtain a license merely because it hired an Oregon resident to be the sole manager.

Observation #4 – The draft rules may be inconsistent with Sections 12, 14, 15, and 16 of HB 3400. As was mentioned in Part 1 of this series, the phrase “an applicant listed on an application” in Sections 12, 14, 15, and 16 of HB 3400 arguably indicates that only one individual listed on the OLCC application needs be an Oregon resident. Also, although the OLCC may have considered Representative Lininger’s oral legislative history when drafting clause (a) of the definition of “Applicant,” the OLCC disregarded the other portion of her legislative history where she stated that the definition of “Applicant” for residency purposes was intended only to include a person who “directly manages” the business. Therefore, clauses (b) and (c) of the definition of “Applicant” in the draft rules are inconsistent with Representative Lininger’s legislative history. (In a subsequent part of this series, I will discuss the possibility that the residency requirements for a marijuana license violate the Commerce Clause of the U.S. Constitution.)

Recommendation to the OLCC

To the extent that the OLCC is going to promulgate rules that impose residency requirements, the OLCC should consult with one or more experienced business law attorneys to ensure: (1) that there are no ambiguities in the rules; and (2) that the rules are sophisticated enough to capture scenarios that are common in organizing and structuring businesses. Additionally, and ideally, the rules should contain “safe harbor” provisions that make clear that certain business organizational structures will not violate the rules.

What to Do

If your business is seeking an investment from one or more out-of-state investors, or if your business already has one or more out-of-state owners, and if you haven’t already discussed the issue with us, contact us today. Additionally, if your business is made up entirely of out-of-state owners, and if you haven’t already done so, you should begin searching for one or more Oregon residents who you might be willing to make a co-owner or a manager, director, or officer.

Stay tuned to our blog, as we will post any updated residency information when we receive it.