Street v. ACC Enters., LLC, 2018 U.S. Dist. LEXIS 167299 (D. Nev. Sept. 27, 2018)
Plaintiff Bart Street III (the “Plaintiff”), a Nebraska entity, is a money lender. Defendants ACC Enterprises, LLC, ACC Industries, Inc. (collectively, the “ACC Entities”) and Calvada Partners, LLC (collectively with the ACC Entities, the “Defendants”), all Nevada entities, allegedly own and operate a Nevada cannabis cultivation plant.
In August 2016, the Plaintiff and the Defendants executed a promissory note agreement for a loan to the Defendants of $3.5 million (the “First Promissory Note”). Shortly thereafter, the Plaintiff and the Defendants executed a second promissory note for a loan to the Defendants of $1.2 million (the “Second Promissory Note” and, together with the First Promissory Note, the “Promissory Notes”).
The First Promissory Note specified the use of the funds, including (i) $725,000 for operating capital and (ii) $2.2 million to repay a prior loan of the ACC Entities. The Second Promissory Note required the Defendants to purchase two parcels of land in Nevada. Both Promissory Notes gave the Plaintiff a right of first refusal to obtain units or shares of the ACC Entities.
The Plaintiff filed suit against the Defendants in federal district court in Nevada (the “Court”), alleging the following breaches: (i) failure to pay off the prior loan, as required by the First Promissory Note; (ii) failure to purchase the land parcels, as required by the Second Promissory Note; and (iii) giving a right of first refusal with respect to newly issued units of ACC Enterprises, and control over actions and decisions of ACC Enterprises, to another entity in breach of both Promissory Notes. The Defendants moved to dismiss the Plaintiff’s complaint on several grounds, including that the Plaintiff could not state a claim for the enforcement of the Promissory Notes because it would require the Court to enforce a contract for the “operation and expansion of a marijuana business” (which is illegal under federal law).
The Court refused to dismiss the complaint. The guiding principle is that federal courts sitting in diversity jurisdiction (plaintiff and defendant of different states) should apply applicable substantive state law so long as enforcement does not require illegal conduct under federal law. A court need only dismiss a claim if the sole remedy available would be illegal under either federal or state law.
Under Nevada law, illegal contracts may not be enforced. However, when some, but not all, portions of a contract are illegal, Nevada law allows courts to sever the illegal portions from the legal portions and enforce the legal portions. Here, the Promissory Notes contained explicit directives to use some of the loaned funds for entirely legal acts: (i) to repay prior lenders (the First Promissory Note) and (ii) purchase land (the Second Promissory Note). Because of these explicit directives, enforcing such terms would not violate the Controlled Substances Act under federal law or give the Defendants discretion to use the funds for the cultivation or possession of marijuana.
However, it was clear that the Plaintiff knew, when the parties executed the Promissory Notes, that the Defendants were engaged in the federally unlawful cannabis cultivation business. Therefore, the Court could not order any remedy that would permit the Defendants to directly use the Plaintiff’s funds for cannabis cultivation or allow the Plaintiff to gain ownership in the Defendants’ business. Therefore, the Court could not enforce the term of the First Promissory Note that provided funds for “operating capital” or the right of first refusal in both Promissory Notes.
Because, among other reasons, severance of the illegal and legal provisions was, on its face, possible in this case, the Court denied the motion to dismiss.
