A Cautionary Tale from Colorado’s Cannabis Industry: The Perils of Hidden Ownership
March 14, 2025
In the rapidly evolving landscape of cannabis law, regulatory compliance is not merely advisable—it’s essential, even in a civil dispute not involving regulators. A recent Colorado Court of Appeals case, HMLL LLC v. MJM Holds. Ltd., 2024 COA 85 (2024), provides a stark reminder of what can happen when participants attempt to circumvent regulatory requirements, regardless of their intentions, and regardless of whether regulators are involved.
The Background: Hidden Ownership—A Persistent Challenge for Colorado Regulators
The issue of hidden or undisclosed ownership has been a persistent challenge for Colorado’s cannabis industry since legalization. These arrangements—sometimes called “strawman” or “proxy” ownership structures—attempt to undermine the ability of the Colorado Marijuana Enforcement Division (the “MED”) to vet and monitor industry participants. Regulatory officials have consistently expressed concern that such structures could potentially allow bad actors, including those with criminal backgrounds who would otherwise be disqualified from licensure, to secretly control cannabis operations. Beyond the legal complications illustrated in this case, hidden ownership arrangements can trigger investigations, result in license revocations, and lead to significant civil penalties.
The issue was pervasive in the early years of legalization when only Colorado residents could own licensed cannabis businesses. While non-residents of Colorado can now own licensed businesses, the issue persists as various industry participants, for their own reasons, prefer not to take direct ownership stakes in licensed businesses.
The Case: A Failed Workaround Goes to Court
The dispute centered around Florida-based HMLL LLC’s attempts to invest in Colorado’s cannabis industry despite not meeting residency requirements. Rather than following the proper channels for non-resident investment, HMLL devised a “resident owner” scheme whereby Colorado residents would serve as proxies, appearing on paper as the owners while HMLL provided funding and maintained operational control.
When HMLL’s relationship with its second resident owner, Avniel Wellner, deteriorated, HMLL sued for specific performance of its oral agreement and payment on a $350,000 promissory note. Wellner asserted various counterclaims of his own.
The Opinion: “Unclean Hands” Applies to All
Following a bench trial, the court denied relief to all parties, finding that everyone involved had “violated Colorado’s regulatory scheme for approving and licensing those seeking to invest in and obtain an ownership interest in a marijuana business.” The court invoked the doctrine of “unclean hands,” which prevents parties from seeking equitable relief when they themselves have acted improperly in relation to the matter at issue.
On appeal, the Colorado Court of Appeals affirmed the trial court’s decision, leaving HMLL with substantial financial losses and Wellner with what the court acknowledged was “a substantial windfall.”
Key Takeaways for Cannabis Businesses and Investors
1. Regulatory Compliance Is Non-Negotiable
The court found that the MED had clear processes for non-residents to legitimately invest in cannabis businesses through a permitted economic interest and indirect beneficial interest owner structures (both of which have since been modified by statute). HMLL’s failure to utilize these legitimate pathways proved fatal to its claims.
2. “Advice of Counsel” Is Not a Blanket Defense
HMLL argued that it had relied on attorney advice, but the court noted that it attorney had actually warned it of the risks and subsequently withdrew from representation. Proceeding despite counsel’s warnings undermined any potential advice of counsel defense.
3. Substance Prevails Over Form
Despite HMLL’s characterization of itself as merely an “unsecured creditor,” the court looked to the substance of the arrangement—including HMLL’s day-to-day control over operations and testimony from participants who understood HMLL to be the true owner—to determine that HMLL functioned as the de facto owner, which could not be properly licensed.
4. Courts Will “Leave Parties Where They Find Them”
Where all parties engaged in regulatory evasion, the court refused to intervene even when this created a significant windfall for one wrongdoer at another’s expense. As the court noted, this approach is “not for the sake of the defendant, but because [the court] will not aid such a plaintiff.”
5. Agreements That Violate Regulatory Schemes Are Void
The court affirmed that HMLL’s promissory note was void as against public policy because it was integral to perpetuating the illegal regulatory evasion scheme.
Looking Forward: The Importance of Regulatory Compliance
As cannabis laws continue to evolve across jurisdictions, this case serves as a powerful reminder that courts will not rescue parties from the consequences of their own regulatory evasion, regardless of industry norms or how common certain workarounds might be.
For cannabis businesses and investors, the message is clear: there is no substitute for proper regulatory compliance. When contemplating cannabis investments:
- Engage counsel with specific expertise in cannabis regulatory frameworks
- Follow established regulatory pathways for investment and ownership
- Ensure all interests and relationships are properly disclosed and documented
- Document agreements in compliance with applicable regulations
- Consider the risk that improper arrangements may be entirely unenforceable
In highly regulated industries like cannabis, cutting corners on compliance can ultimately lead to substantial, unrecoverable losses. As this case demonstrates, courts will not hesitate to leave parties to bear the consequences of their attempts to circumvent regulatory requirements.