Converting Mutual Benefit Corporations into For-Profit Corporations

Over the past few months, many cannabis collectives organized as non-profit mutual benefit corporations under prior law, such as the 2004 Medical Marijuana Program Act, have asked us to help them convert into for-profit general share corporations (C Corps.). This isn’t surprising because the laws have changed and because cannabis operators wanting to attract new-money investors are learning fast that mutual benefit companies (MBCs) are generally not good investment vehicles for outside investors. [For an in-depth discussion of why it is almost impossible to raise money as an MBC, see this client advisory document.]    

Fortunately, the conversion process can be handled pretty easily, requiring just an affirmative vote of the MBC’s members and the filing of amended articles of incorporation with the California Secretary of State (SOS). In fact, the SOS has, through its “cannabizfile” portal, posted web instructions so that cannabis MBCs can easily learn how to convert into other forms of legal entities such as a C Corp. or an LLC.

However, under certain circumstances, we are seeing a few important questions complicate these otherwise simple conversions. One important question to ask is whether an MBC conversion might invalidate a company’s existing conditional use permit or any other existing permit or license to engage in commercial cannabis activities. The ultimate decision on this particular question of law can have profound consequences on companies wishing to maintain their existing first-mover advantages.

Converting Mutual Benefit Corporations into For-Profit General Share Corporations
Image Source: My 420 Tours [CC BY-SA 4.0], from Wikimedia Commons

We believe that a conversion of an MBC into a C Corp. should not deprive permit holders of their property rights. A permit to operate within the state is correctly understood as an intangible asset belonging to the recipient.  See Am. Shed v. County of L.A., 66 Cal.App.4th 384, 392 (1998); see also I.R.C. § 197(d)(1)(D).  The conversion of an MBC into a C Corp. is nothing more than a change in the legal form of ownership. Even the cases that have held legal conversions operate as an “assignment by operation of law” have generally held that such a transfer should not deprive property rights so long as there is no adverse effect on any third-party interests. See, e.g., Trubowitch v. Riverbank Canning Co., 30 Cal.2d 335, 344-45 (1947). We believe to decide otherwise would elevate form over substance. [This client advisory document describes these legal principles in detail.]

While we believe this is the strongest argument for respecting existing permits and licenses through a legal conversion from an MBC into a C Corp., cannabis companies should know that not all government officials have agreed. Companies should be cautious not to undo their hard-fought and valuable head start by what seems to be nothing more than an administrative non-event.

Contact an attorney with Rogoway Law Group if you need assistance in converting an MBC while maintaining your existing permits and licenses.

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