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Lottery for retail cannabis favours big players

Powered By Canadian LawyerBusiness & Legal Issues||Written By Aidan Macnab
Lottery for retail cannabis favours big players
Lou Brzezinski says the Alcohol and Gaming Commisson of Ontario's lottery system creates unrealistically fast timelines and the financial and contractual obligations imposed are so onerous that only large players can afford the risks involved.

Ontario’s cannabis retail authorization lottery guidelines place an onerous process on winners and only large, well-financed and established players will be able to handle it, say lawyers in the cannabis sector.

Applications were accepted from Jan. 7 until noon Jan. 9 and the lottery will be held Jan. 11 at which time Alcohol and Gaming Commission of Ontariowill announce the 25 selected. By Jan. 16, the winners will need to produce a $6,000 licensing fee, a $50,000 line of credit, have a property leased, have hired employees and be ready to order product and open for business by April 1. The store must be in the assigned region and in a municipality of more than 50,000 people and meet the school-distance requirements set out in the regulation.

Applicants will also have to post their proposed location, go through a public consultation where the public will have an opportunity to object to that location, after which the applicant will have to respond and request a hearing.

Failure to be up and running will cost the retailer $12,500 from their line of credit, with another penalty of $12,500 on April 15 and an additional $25,000 if they’re still not selling cannabis by April 30. The 25 winners will be the only cannabis retail operators until Dec. 13, 2019, when a new application process begins.

“But just think about who can afford that? Who can afford to get chosen on the 14th and then get a lease, get the store open, train the employees and put up all the money a month and a half?” says Lou Brzezinski, partner at Blaney McMurtry LLP’s commercial litigation group.

While the government says they want a private sector-run system so everyone is given an opportunity to be involved in the industry, the truth is only well-financed entities can afford to take the risks within this timeline, he says.

“The ADCO’s lottery system creates unrealistically fast timelines and the financial and contractual obligations imposed are so onerous that only large players can afford the risks involved,” he says.

It is a “really ambitious target date,” says Trina Fraser, co-managing partner at Brazeau Seller LLP and advisor to the Cannabis Council of Canada, the cannabis industry association.

 “Applicants who find this timeline challenging may choose to wait for further opportunities for cannabis retail in Ontario which will follow the temporary lottery process,” says Brian Gray, spokesperson at the Ministry of the Attorney General told Legal Feeds via email.

Even with the tough requirements it is expected a large number of applicants will be gunning for a winning ticket, according to Susan Newell, an associate in Osler’s health industry group.

“Everybody wants into the cannabis market,” she says. “I think people who didn't buy stocks early are now trying to find their own way into what's obviously a very booming industry.”

There are many unanswered questions arising out of this process, Fraser says. Prospective retailers do not know how the Ontario Cannabis Store — the province’s lone cannabis merchant — will allocate product between online and storefront sales. They also don’t know what the wholesale markup will be. While the government has said retailers can set their own prices, they are competing with the Ontario Cannabis Store’s monopoly on online sales and with a huge black market, Fraser says.

“Everybody who is putting their name in this hat and hoping to be one of these 25 retailers, it's just on the belief that this right to open one of the first 25 stores is going to be a very valuable one, without any understanding of what their costing or profit margins are going to be. Because you don't know,” Fraser says.

“They have said that retailers can set their own prices, but this is not an inelastic product. There is a price at which people will not buy your product.” 

Fraser says she has clients who are saying they are in no position get the operation in order by April and are skipping the lottery to wait until full application process opens up and others who say; “No, this is too big of an opportunity. If we are lucky enough to win, we'll figure it out.”

Gray says licenses are non-transferable and those who entered the lottery are not allowed to “change their applicant type, ownership and/or corporate structure in such a way that would result in a change of control of the [expression of interest] applicant or licensee during the lottery process.”

Control of the entity cannot change hands during the retail store authorization period which lasts until Dec. 13, 2019. Applicants can take on minority investors and Fraser says she expects to see licensing deals, service contracts, convertible debentures, options and other innovative ways for non-winning, well-capitalized companies to use the winners to get a foothold in the market.

The cannabis market is still dealing with a deficit in supply, which is why only 25 spots were available for retail in 2019. Fraser says Health Canada has over 600 applications outstanding, some of whom are her clients who have been trying to get licensed for four years or more.

“Health Canada promised that they're trying to streamline their processes. They've allocated more resources to processing applications. They've hired and trained more people. Hopefully, we're going to see those licenses and expansions of existing sites be approved at a more rapid rate, so that the production can ramp up quickly,” she says.

“I think it's fair to say that supply will probably be an issue for at least the next year or so.”

Also, on Oct. 17, 2019 — a year post-legalization — edibles containing cannabis will become legal, which will add to the supply problem.

“We've got literally hundreds of new product types coming onto the market this year. Until these products actually do come onto the market, we don't really know what the consumer demand for them is going to be,” Fraser says. “So it's going to have to be a period of adjustment, where we see what it is the consumers are looking to buy and figure out how to allocate the available supply to those types of products.”