On November 3, Judge Gary L. Sharpe of the U.S. District Court for the Northern District of New York issued a preliminary injunction, blocking cannabis regulators from issuing marijuana retail licenses for five geographic regions across the state, while a constitutional challenge to the program proceeds.

The challenger, Variscite NY One, Inc. (Variscite), applied for a retail license, but its 51% principal owner failed to meet two New York-nexus requirements. Variscite alleged these requirements are discriminatory against out-of-state applicants in a way that offends the U.S. Constitution’s dormant commerce clause. Due to the federal illegality of cannabis, the cannabis industry is one of the last places where states and localities have been able to get away with reserving business licenses for in-state residents. Such preference for in-state applicants is a clear violation of the dormant commerce clause in other contexts. We have previously written about the tenuous status of such laws here and here.

Under the New York program, a for-profit organization must, among other things, be “[a]t least 51% or more … owned, in the aggregate” by “at least one individual that satisfies” (1) a New York “significant presence” requirement and (2) a “justice involved” requirement, which asks whether the applicant (or a family member or dependent) “was convicted of a marihuana-related offense in New York State.” 9 N.Y.C.R.R. § 116.4(b)(1)(i). Even though Variscite is a corporation organized under the laws of New York (which Judge Sharpe suggested in a footnote should qualify under the requirement), the regulator found that the company did not meet the “significant presence” requirement because its principal owner did not have significant presence in New York state. In addition, although the principal owner had a prior cannabis-related conviction, the conviction occurred in Michigan, not New York.

Considering these and other aspects of the program in the aggregate, Judge Sharpe agreed with Variscite that the program “will have a discriminatory effect on out-of-state residents seeking a CAURD [cannabis retail] license,” and, therefore, he applied a heightened level of scrutiny under dormant commerce clause precedent, asking whether the laws were “narrowly tailored to advance[e] a legitimate local purpose.” He found that the state was likely to lose this point, observing that “defendants did not even attempt to make the requisite []showing,” and “when directly questioned by the court as to whether the challenged laws and regulations could survive the heightened level of scrutiny … defendants offered no cogent response.”

Judge Sharpe not only granted the preliminary injunction, but also sent a clear signal he thinks the law is patently unconstitutional. In a footnote, he wrote: “While [Variscite] need only demonstrate a likelihood of success on the merits, the court notes that [Variscite] has also demonstrated a clear likelihood of success on the merits and, thus, would satisfy the standard for a mandatory injunction for the same reasons that it has shown a likelihood of success.”

The decision marks the latest blow to residency rules in the cannabis industry. In August 2022, a First Circuit panel affirmed a lower court’s decision to strike down a Maine law that required officers or directors of a medical cannabis dispensary to be residents of the state, finding it a “patently protectionist” violation of the dormant commerce clause by placing a “substantial burden” on interstate commerce. A petition for rehearing en banc was denied on September 21, and no petition for certiorari has yet been submitted by the state to the Supreme Court.

We expect these decisions to continue to have a snowball effect. With every residency rule struck down, courts are more likely to point to the persuasiveness of earlier decisions in blocking similar requirements. States that do want their residency rules to pass constitutional muster should take note and be prepared to defend their policies under a strict scrutiny analysis. No court has yet looked explicitly at whether reserving social equity licenses for residents is “narrowly tailored” enough to serve a “legitimate local purpose,” but such laws seem more likely to hold up than general preferences for in-state residents.

The case is Variscite NY One, Inc. v. New York, No. 1:22cv1013 (N.D.N.Y. Nov. 10, 2022).

Our Cannabis Practice provides advice on issues related to applicable federal and state law. Marijuana remains an illegal controlled substance under federal law.