The Federal Cannabis Act and Cannabis Regulations, which regulate production, distribution, and sale of cannabis in Canada, have created unique risks for directors and officers of cannabis companies. In the event of non-compliance, they may face significant criminal fines or administrative monetary penalties (“AMPs”) in addition to civil liability. Health Canada’s suspension of licences of CannTrust Holdings Inc. (“CannTrust”) to produce and sell cannabis and severe consequences for its management and board exemplify these unique exposures. D&O liability insurers should know about these risks when underwriting or excluding them from coverage.

The Federal Cannabis Act and Regulations: a broad and strict regulatory framework

The Cannabis Act and Cannabis Regulations, the purpose of which are to protect public health and safety, have strict requirements regarding promotion, packaging and labeling, production, sale and distribution, and licensing. Set out below are requirements relevant to the CannTrust matter, as well as exposures faced by directors and officers.

Licences must be obtained from the federal government minister responsible for the Cannabis Act (“Minister”) for production, cultivation, processing, and sale of cannabis.

Licences must set out the following:

  • sites where activities are authorized;
  • buildings within the sites; and
  • the authorized activities.

Licence holders must do the following:

  • only conduct authorized activities at the sites and buildings within the sites set out in the licences;
  • apply to amend their licences if they propose to change authorized activities at licenced sites or buildings within the sites;
  • if proposing to change site plans requiring physical security measures (ie. storage and operations areas), obtain the Minister’s approval beforehand; and
  • retain documents demonstrating that cannabis and other ingredients were produced, packaged, labelled, distributed, stored, sampled and tested in accordance with good production practices to permit timely audit.

Holders of licences for processing have to ensure that cannabis and other ingredients are produced, packaged, labelled, distributed, stored, sampled and tested using procedures approved by trained, experienced, and knowledgeable quality assurance persons.

The Minister has powers to do the following:

  • suspend and revoke licences – the Minister may suspend licences if it has reasonable grounds to believe suspension is necessary to protect public health or safety;
  • require disclosure of information necessary to address public health or safety issues or verify compliance;
  • designate inspectors who may enter places where regulated activities occur to verify compliance or prevent non-compliance; and
  • take measures necessary to address public health or safety issues or prevent non-compliance.

Offences and violations include:

  • contravening provisions requiring compliance with license conditions;
  • making false or misleading statements to inspectors; and
  • making, or participating in, assenting to, or acquiescing in, the making of false or misleading statements in any record.

Directors and officers who direct, authorize, assent to, acquiesce or participate in the commission of offences or violations are deemed parties to them and are liable for violations.

Punishment for an indictable offence is a fine of up to $5,000,000, or imprisonment, or both. Punishment for a summary conviction offence is a fine of up to $250,000, or imprisonment, or both, for the first offence and a fine of up to $500,000, or imprisonment, or both, for any subsequent offence.

An AMP for a violation is up to $1,000,000 or a maximum amount fixed by the regulations.

CannTrust: severe consequences for management and board following non-compliance

 

This year, CannTrust, based in Ontario, disclosed Health Canada determined non-compliance. More specifically:

  • CannTrust had grown cannabis in unlicensed rooms in a greenhouse facility and CannTrust employees had provided inaccurate information;
  • CannTrust had converted rooms in a manufacturing facility from operational to storage and constructed new areas, including one to store cannabis, without prior approval; and
  • at the manufacturing facility, there were
    • insufficient security controls,
    • inadequate quality assurance investigations and controls,
    • standard operating procedures that did not meet regulatory requirements, and
    • documents that were not retained in a manner to enable completion of an audit in a timely manner.

Health Canada’s actions were as follows:

  • it suspended CannTrust’s licences to produce, process, and sell cannabis, without affecting its ability to continue cultivating and harvesting cannabis;
  • it placed a hold on impacted inventory;
  • it identified the following remedial measures to be taken:
    • measures to ensure cannabis would be produced and distributed only as authorized,
    • measures to recover cannabis that was not authorized by CannTrust’s licence,
    • measures to improve key personnel’s knowledge of and compliance with federal legislation; and
    • measures for improving record-keeping.

CannTrust did not challenge the suspension. It placed a hold on the sale of cannabis products. CannTrust also destroyed biological assets and inventory that was not authorized by its licence, worth about $77,000,000 in total.

 

Other consequences for CannTrust and its board and management included:

  • the CEO was terminated and the board chair resigned following media reports indicating they knew about non-compliance;
  • the Ontario Securities Commission is investigating matters and parties related to CannTrust; and
  • proposed class actions were filed alleging that CannTrust and certain of its officers and directors made misrepresentations that CannTrust was in compliance and failed to make timely disclosure of non-compliance, as a result of which the price of CannTrust securities dropped significantly.

Conclusion

Under a broad and strict federal regulatory framework, directors and officers of cannabis companies face a range of exposures in the event of non-compliance, including significant criminal fines or AMPs, potential sanctions by securities regulators if their companies are public, and civil liability.

D&O liability insurers should consider these unique risks when underwriting D&O coverage. Insurers would be well advised to examine what procedures are in place to ensure compliance, directors and officers’ level of experience, and their training in and knowledge of compliance requirements and risks arising from this regulatory framework.

Samantha Wu‘s civil litigation practice includes insurance defence under specialty line coverages.

A version of this blog post was published on the D&O Diary.