Despite being considered “essential” businesses, cannabis distributors are experiencing a rollercoaster of retail activity that’s anything but stable.

At the onset of shelter-in-place orders in March, cannabis sales were flying high. But, by April 20, or 4/20, the annual “Black Friday” for cannabis retailers, sales had leveled off and continue to do so. Americans have less discretionary money to spend and for more, cannabis is another “extra.”

This drop in sales leaves cannabis businesses vulnerable. Start-up, fledgling cannabis operations across the country are experiencing dramatic valuation reductions, missing earning goals and seeing a steep decline in their ability to raise the capital necessary to move their businesses forward post-COVID-19.

Chapter 11 and Receivership

Businesses in this situation typically have the option to file for Chapter 11 bankruptcy protection, allowing them time to reorganize while keeping creditors at bay. Because cannabis is not legal federally, plant touching operators are prohibited from filing for bankruptcy. Instead, many are looking at collateralized credit and debt offerings and other privatized options.

Some states wrote Receiverships into their cannabis licensing agreements. While a Receivership allows businesses to slowly transition ownership of assets to pay off creditors, it doesn’t offer protection against lawsuits and claims nor does it allow cannabis companies the ability to come out of the bankruptcy intact. A Receivership essentially helps businesses resolve debts before closing their doors. For cannabis businesses that have operations in Canada and across states with different laws, navigating these issues will be a major challenge.

Ample D&O coverage will indemnify Directors and Officers

Insolvent businesses without Chapter 11 protection will face another challenge - shareholder lawsuits against their directors and officers. These lawsuits will claim that the directors and officers didn’t do enough to prevent the insolvency and or that they mismanaged assets that led to the insolvency. Without Directors and Officers (D&O) insurance, these lawsuits can threaten the personal assets of the cannabis business’ directors and officers.

Directors and Officers (D&O) policies protect the personal assets of directors or officers by indemnifying them in lawsuits. As more and more cannabis businesses experience a fluctuation in sales and some even insolvency, D&O insurance will be critical. Here are four tips to optimizing your D&O protection.

  1. Determine how to indemnify the directors and officers in the event of insolvency. It’s not uncommon for cannabis D&O insurance to contain an insolvency exclusion. Because there is no standard coverage form, each policy is written for the individual business and must be tailored to that specific cannabis operation. This is when having the right broker to negotiate coverage terms is important. If your cannabis business doesn’t employ D&O yet, consider adding it now. As D&O insurance costs and cannabis businesses remain in flux, it will be harder to come by with optimal limits and minimal exclusions.
  2. Review and revise your policies at renewal. Cannabis D&O policies are mainly written on non-admitted insurance contract paper and have the ability to change from year to year. Pay attention to your policy language at renewal time. Don’t just assume the new policy is the same as last year — the potential for it to change this year is significant. Double check the exclusions and make sure there isn’t one for insolvency.
  3. Communicate with shareholders. The ability to articulate a long-term plan in the face of short-term adversity is key. Be transparent with shareholders. Let them know the current challenges facing the business and what they should be prepared for.
  4. Operate with a think-ahead mentality. Get out in front of issues. Forecast and communicate and then determine next steps. Some cannabis businesses were able to pivot to online sales, fewer to a delivery-based models and appointment-only sales.

Contact your HUB Cannabis Expert for more information on indemnifying your directors and officers with adequate D&O coverage.