Article by: Janet Jackim

In this article, we report not only on the expected implications from cannabis’ rescheduling but also on numerous surprises to the cannabis industry as a result of the expected reclassification of cannabis as a Schedule III drug, which was announced to the public on April 30, 2024 and the proposed rescheduling regulation was submitted for publication on May 16, 2024.

Because the US Drug Enforcement Agency (DEA) has yet to receive public comments and hold hearings on the rescheduling we do not have answers to all of your questions, and our interpretations may be proven wrong if the DEA or US Food and Drug Administration (FDA) develop a Schedule III cannabis system that differs – mildly or comprehensively – from its policies and rules in place today that are applicable to other Schedule III drugs.

Stay tuned for updates as they happen at the Federal and State levels.

General Questions Common to Plant and Non-Plant Touching Businesses:

1. What is the difference between cannabis as a Schedule I drug and cannabis reclassified as a Schedule III drug?

As a Schedule I drug, the Federal government determined that all cannabis (other than hemp with a tetrahydrocannabinol (THC) level of <0.3% by dry weight) has no currently accepted medical use and has a high potential for abuse.  Examples of Schedule I drugs other than cannabis include heroin, LSD and ecstasy.  Societal stigma against Schedule I drugs is considerable.

A Schedule III drug has a currently accepted medical treatment use in the U.S., but abuse may lead to moderate or low physical dependence or high psychological dependence. As a Schedule III drug, cannabis would be similarly treated by Federal agencies as drugs in the nature of anabolic steroids, aspirin with codeine, vicodin, ketamine, and testosterone. Societal stigma against Schedule III drugs is minimal, particularly for the bona fide treatment of, for example, stubborn inflammations and pain, depression, and mood, energy and diminished sex-drive conditions. Federal enforcement actions against persons convicted of trafficking in a Schedule I or Schedule III drug involve substantial financial penalties and imprisonment of not less than 10 years or more or life.[1]

2. Is a prescription to buy cannabis as a Schedule III drug required before I may purchase it for myself? Or for my dispensary?

Yes, it does appear so, assuming you are an individual person. Doctors, pharmacies and persons would be obligated to follow Federal requirements including the issuance of prescriptions from a DEA-licensed medical doctor and fulfillment of the prescription by a DEA-licensed pharmacy to a cannabis user, strict storage requirements and other expensive production requirements (but see footnote #2 below).

Does a retailer need a prescription for products to be sold at the dispensary? Will a cannabis retailer evolve into a pharmacy? Until we know more from these Federal agencies, the answer is probably not, but unknown.

3. Does the federal government regulate a Schedule III drug?

Yes, see questions #2 above and 5 and 6 below.

4. Will all marijuana-convicted inmates be released from prison? What about expungements?

No, we do not expect all such inmates to be released from prison, at least not presently. However, a number of States have established, either by legislation or executive pronouncement, marijuana conviction expungement rules and regulations. Numerous State  and national judicial and justice organizations, as well as retailers and service providers, are participating in clinics to assist ex-inmates in expunging their marijuana charges and convictions. These efforts are so necessary and life-changing to the petitioners!

Specific Questions Common to Plant-Touching Retailers, Cultivators, Extractors and Manufacturers:

5. Is DEA approval of my cannabis plants or cannabis products as a Schedule III drug required before I grow, extract, manufacture or sell to the public? If so, what is that process, how much will it cost, and how long will approval take?

The answers to these questions are rooted in the connection between a Schedule III drug’s ‘currently accepted medical use’ and the FDA’s oversight of drugs prescribed for medical conditions requiring such drug. It would appear that by rescheduling cannabis to a Schedule III drug the DEA and FDA will consider all cannabis use to be medical use – but we know that that’s not the real world and as of publication of this article we don’t know whether rescheduling as a Schedule III drug will apply only to medical marijuana or to any/all cannabis.

At present, a Schedule III drug is required to be vetted by the FDA before its public sale/use.  Prior to the FDA’s vetting, the sponsor of the drug must prove, through a variety of tests, that the drug is safe and effective for its intended use. That approval comes at great cost. A team of FDA physicians, statisticians, chemists, pharmacologists, and other scientists reviews the sponsor’s data and proposed labeling. If this independent and unbiased review establishes that a drug’s health benefits outweigh its known risks, the drug is approved for sale.  Before a drug can be tested on humans, the sponsor performs laboratory and animal tests to discover how the drug works and whether it’s likely to be safe and work well in humans. Next, a series of tests on people determines whether the drug is safe when used to treat a disease and whether it provides a real health benefit.[2]

The standard review process generally takes 10 months. Trials, testing and researching a new drug for application to the FDA can cost millions of dollars.

One of the substantial benefits of rescheduling is interstate commerce could open up, thus permitting the nationwide distribution of cannabis.

6. What about those laws, rules and regulations already in place in California, Colorado, Missouri or New York (and more than 37 other States with medical and/or adult use cannabis programs) – we already comply with those at great cost, but do we have to comply with new federal regulations resulting from rescheduling? If so, what can we expect?

This is a complex question. Rescheduling would not legalize access to cannabis through State-approved legal cannabis programs, whether medical or adult use (aka recreational) (but see footnotes #2 through 5). Rescheduling would permit research on and development of drugs derived from cannabis as long as there is compliance with the CSA and FDA’s current framework applicable to other Schedule III drugs.

We think the analysis goes as follows:  Absent State legislation otherwise, figure that your State’s legal cannabis programs stay in place, as is. However, rescheduling by the DEA would impose another set of rules and regulations superior to the State program(s).[3]

We see the results of that additional set of rules and regulations in the following discussion.[4]  With rescheduling, pharmaceutical and cannabis companies desiring to compile, cultivate, produce, manufacture and extract cannabis would  be subject to FDA research and development regulations, including vigorous testing, manufacturer licensing and registration, and compliance with good manufacturing practices (GMP) concerning composition and labeling requirements, as well as strict advertising rules that may not be reflected in the State program(s).

To distribute and sell cannabis to the public, a State-licensed retailer’s pre-purchase process must require that a DEA-licensed medical doctor prescribe cannabis to a patient as evidenced by the ‘prescribing’ doctor’s cannabis prescription and the prescription must be fulfilled by a DEA licensed pharmacy. Strict storage, packaging and transport requirements must be continuously met, most of which are very expensive to implement and follow. Again, such requirements (or at least some of them) may not be included in the State program(s).  Absent FDA approval, only epidiolex and its counterparts may be sold to the public.

Licensed retailers and other distributors may sell only cannabis drugs to the public in specific forms that have been tested and approved by the FDA (as described above).[5]

7. Does rescheduling mean that competitors can open up dispensaries (or other cannabis facilities) next door to my operation?

Although rescheduling is likely to open new doors to entry for potential competitors, we do not anticipate that a State’s program(s) granting licenses to retailers, cultivators, extractors, transporters, services providers and other businesses will change the current status of competition unless the State also adds to or modifies its program(s). We see rescheduling as an addition to the hierarchy of governmental regulations of the cannabis industry, whereby the ‘top’ position in the hierarchy is the DEA/FDA and their desire to regulate cannabis use as ‘medicine’. However, whether these Schedule III regulations will apply to the adult use side of the cannabis industry is unknown at this time.

8. Does rescheduling give me/my cannabis operation an advantage over ‘newcomer’ operators or products to the industry?

Generally, any operating cannabis business that has survived the industry’s various challenges (e.g., high interest rates, scarcity of investment/funding dollars, low flower pricing, excess capacity, increased competition, etc.) has a leg up on its competitors.

IF (and that’s a big, bold and italicized “if”) every cannabis product (medical and/or adult use) must be approved by the FDA prior to commercial sale, the operating business first in time is likely first in line. But caveats apply here, e.g., whether FDA approval will be required for: (1) all (versus only new) cannabis products, or (2) only medical-use intended products versus all cannabis products. We don’t have enough information to answer the question.

9. Now that IRS Section 280E will no longer apply, will my lender loan my company more, based upon modified/improved financials?

Obviously, if cannabis is rescheduled to a Schedule III drug the business of cannabis companies is no longer a ‘criminal enterprise’ engaged in ‘trafficking’ Schedule I substances and the prohibition of Section 280E of the Internal Revenue Code would no longer apply.  Section 280E precludes a trafficker of Schedule I drugs from deducting ordinary and necessary business expenses from its taxes; these ordinary and necessary business expenses include office rent, advertising expenses, normal overhead expenses, wages and salaries, travel expenses, entertainment expenses and others. This difference alone could be a huge gift to cannabis companies filing their Federal returns, but State returns may have different results.

10. Do covenants in my company’s loan documents, shareholder agreements and management services agreements, that require certain compliance activities applicable to operating my company, no longer apply?

The answer to this question is “it depends”, with the actual answer tailored to you/your business and the applicable documents and agreements. They are also beyond the scope of this article, although very important to the discussion. We suggest you seek legal counsel on this question. We also suggest you speak with your lender about the likelihood that your financials will be improved as a result of rescheduling, but keep in mind that we’re still early in this game and don’t have much guidance from the IRS in regard to the tax implications or benefits of rescheduling.

11. Would federal bankruptcy protection be available to me/my business if cannabis is rescheduled to a Schedule III drug?

Yes, likely.  Rescheduling would likely provide access to the Federal courts overall, which could mean a rise in Federal bankruptcy filings by individuals and cannabis companies, as well as class actions based upon cannabis companies’ violation of Federal securities laws or employment laws including the Occupational Safety and Health Act and the Americans with Disabilities Act.

If it’s any comfort, we are all in the same position trying to figure out next steps and possible outcomes – particularly those that are strategic for ourselves and our businesses.  In general, the cannabis industry seems thrilled that the Federal government has finally taken steps to reclassifying cannabis, however many of us cannabis supporters believe that descheduling is preferable.

It appears that this rescheduling move by DEA would put medical marijuana into the class of drugs (Schedule III) with an accepted medical treatment use, but where adult use/recreational marijuana sits in the Schedule hierarchy is not certain or revealed by the DEA (yet). Does it make sense to require that every cannabis species, plant or product (medical and adult use) be registered with the DEA and/or the FDA, following lengthy and expensive testing protocols?  No, it doesn’t. Please check back as we at Zuber Lawler monitor developments!

[1] State penalties vary on a state-by-state basis.

[2]  One has to postulate whether (as described in footnote #3 below) the current intentions of the FDA and DEA will stabilize the cannabis industry in favor of major pharmaceutical companies that can afford (and are already performing) compliant testing.

[3] And by implication, rescheduling seems to relate only to State medical marijuana programs, given the involvement of the FDA testing and approval processes. Meaning that adult use would be fully legalized by exemption or exception from all scheduling? We do not know at this time.

[4] We note that, if another set of rules and regulations (this time at the Federal level) is imposed upon the cannabis industry as a result of rescheduling cannabis to Schedule III, the illegal market for cannabis will likely become exceedingly less expensive and more prevalent than heavily-regulated licensed medical marijuana. This is a worrisome outcome likely not anticipated by legal cannabis businesses or law enforcement.

[5]  Imagine the backlog of applications for FDA approval of the thousands (perhaps, hundreds of thousands) of cannabis products in the market today, if all medical and adult use cannabis and cannabis products must comply with Schedule III laws.