5 Things to Confirm When Signing a Cannabis Facility Construction Agreement

As the cannabis industry continues to grow in the United States, with a majority of U.S. citizens now living in a jurisdiction that has legalized adult-use cannabis, so too has the need for new or renovated cultivation, processing, and retail facilities. Whether the facility is leased and requires a buildout, or the facility will be ground-up construction, the additional complexities of a cannabis construction project can sometimes be overlooked. As legal cannabis programs continue to expand, e.g., Ohio’s recent passage of Issue 2, legalizing adult-use cannabis, construction of new cannabis facilities or remodeling existing cannabis facilities is of constant concern. Here are five potential cannabis construction issue points you should be aware of before entering into any agreement to build your facility regardless of which state you operate in.

1. Agreement Type. Construction agreements come in distinct types and will change how costs for the project are handled. There are five typical construction agreements: (a) cost-plus agreements, (b) lump-sum agreements; (c) time-and-materials agreements; (d) unit-price agreements; and (e) guaranteed-maximum agreements. The American Institute of Architects (AIA) has form agreements for each of these.

• Cost-plus agreements structure compensation for contractors based on the cost of the project – materials, labor, etc… - plus an agreed-upon profit margin. These contracts typically prioritize quality. Although, generally, total costs are unknown and will fluctuate with price changes.
• In lump-sum agreements, the parties agree to a fixed price for the project. This limits the possibility for changing costs, but because costs are predetermined, contractors could be incentivized to perform under budget to maximize their profit.
• Under a time-and-materials agreement, contractors bill for costs of materials as well as an hourly rate for labor. These types of agreements allow for quick starts to the project with less due diligence required on the front end. They also require transparency from contractors for all aspects of the construction. On the other hand, costs can increase quickly, and the owner will be responsible for them.
• In unit-cost agreements, project costs are divided into fixed cost units and contractors are billed separately per unit. Such agreements allow for flexibility when the scope of work cannot be fully determined upfront. Additionally, they limit additional costs. Unit prices, however, can be difficult to determine, and prices may fluctuate significantly during the project.
• The final type of construction agreement is a guaranteed-maximum agreement, where parties agree to a maximum cost. Contractors are responsible for any additional costs over that amount. These agreements require well-defined pre-construction plans to reduce the chance for needed changes. While owners may appreciate that the cost of a project is capped under a guaranteed-maximum agreement, these contracts typically result in more disputes between owners and contractors.

Owners should consider the type of contract that would benefit the project the most. Generally, lump-sum agreements are the most owner friendly as the costs are known ahead of time and controlled. However, if your project is not well-defined at the outset, you may require a more flexible agreement.

2. Financing. One of the larger issues that continues to plague the cannabis industry is the lack of standard financing options; banks avoid lending because of the current federal ban on the substance. While recent news that the Drug Enforcement Administration supports rescheduling cannabis from Schedule I to Schedule III has resulted in industry optimism that capital will be more readily available, that rescheduling change has not yet happened. For now, limited financing options require owners to search for creative, alternative financing or even embark on self-financing. As money becomes more expensive with higher rates or directly out of your pocket, adhering to your budget becomes even more important. As a best practice, owners should keep ownership of their real property and ownership of their business in separate entities to insulate distinct assets from potential financial issues with other assets.

3. Scope of Work. The scope of work for your project is something that must be explicitly drawn out in your agreement. Lengthy delays, errors in the positioning of water lines, improper ventilation, or installing the wrong lights can cause irreparable harm to your business. For example, your design or cultivation technique might require LED lights, not high-pressure sodium (HPS) lights. It is important to ensure that the deliverables, milestones of the project, and end results are clearly defined in written agreements. Owners should create clear timelines that outline when each portion of the project should be completed. Specific milestones of the work product should be given dates to ensure that the project maintains its schedule. Designs and specifications must be as thorough as possible; leaving room for builders’ interpretation or discretion should be avoided whenever possible.

4. Bonds and Warranties. Surety bonds and warranties are quite common in construction projects and protect you from failures by other parties to meet the obligations of the contract during and after the construction. As with the several types of construction agreements, there exists different forms of warranties and bonds that provide different protections. Common bonds and warranties every owner should be aware of are:

1. Performance bonds: These guarantee that a contractor will perform the work according to the requirements of the construction agreement.
2. Payment bonds: These guarantee that the policy holder (typically the general contractor) pays subcontractors.
3. Bid bonds: These guarantee that the project will be completed based on the bid they have submitted for the project.
4. Material and equipment warranty: These provide protection against faulty materials and equipment used on the project.
5. Design-build warranty: These provide protection against professional services such as architecture and engineering services.
6. Vendor warranty: These are provided directly from the manufacturer to seller of the product. They usually cover items such as fixtures and roofing.

Requests for bonds and warranties on your project should be comprehensive and specific. Each type of bond and warranty provides a specific protection that might be more or less useful to your project, and you may need multiple layers of bonds or warranties.

5. Compliance. While all construction projects are subject to certain requirements from the local, state, and federal governments, cannabis facilities attract greater scrutiny and are subject to increased regulation. With greater scrutiny comes greater risk to your project. Having experienced contractors and counsel to ensure that the project is compliant with not only the local zoning ordinances for cannabis facilities but also whether the facility grow room meets the size standards for your level of cannabis permit is essential.

The ever-growing and always-changing cannabis industry compels cannabis business owners to undertake their construction projects as any other industry would. Vetting general contractors, taking multiple bids, utilizing appropriate contracts and bonds, being active in the oversight of the project are all steps business owners should take when undergoing any construction project, including owners of cannabis companies.

Tom Haren is partner at Frantz Ward and Chair of the firm's Cannabis Law Group. Tom has represented cannabis clients since 2016, helping them with innumerable legal issues, including public policy, regulatory compliance, corporate governance, contract negotiations, risk management, litigation and other day-to-day business issues. Tom has led some of the largest M&A transactions in Ohio’s cannabis market, representing both selling license holders and acquiring entities. In addition to his policy and legal work, Tom serves as the chair of Frantz Ward’s Cannabis Law and Policy practice and he was also named to the firm’s Management Committee in January 2024.

Keenan Jones, partner at Frantz Ward, represents businesses of all sizes in litigation matters, corporate formation, business development, and protection of intellectual property rights. Since 2017, he has focused his practice on assisting companies operating in the regulated cannabis space, including hemp, marijuana, and ancillary endeavors.

Before joining Frantz Ward, Keenan co-founded Foster & Jones and worked at the Hoban Law Group. In both roles, he guided businesses in the emerging cannabis industry. Keenan also teaches political science courses at Heidelberg University as an adjunct professor and serves as counsel and an ex-officio member of the board of directors of Model United Nations of the Far West.

Michael Gibbons, associate at Frantz Ward, is focused on all areas of corporate law. His experience includes commercial real estate transactions on both buy and sell side, mergers and acquisitions, as well as business formation and corporate structure. Michael has also assisted in advising clients operating in the cannabis and transportation/logistics industries. Michael received his J.D. from Case Western Reserve University School of Law as well as his Masters in Business Administration from the Weatherhead School of Management.