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Victory for Hemp

Victory for Hemp

Hemp Ban Overturned

Hemp is completely legal to grow in Illinois with the proper state license.

Illinois Hemp Ban Overturned in Rural Oakland

The City of Oakland tried to ban hemp farming inside its city limits by claiming authority under the Illinois Municipal Code section regarding Urban Agricultural Areas. Collateral Base represented the prejudiced farmer and had the municipal ordinance tossed by an Illinois Court. Because the City of Oakland is not a home rule community Dillion’s Rule in Illinois barred the City from banning hemp due to its lack of authority. 

Let’s touch on what is a “home rule” or “non-home rule” municipality in Illinois. 39 States follow “Dillion’s Rule” – including Illinois – and it allows municipalities to allow themselves to govern their community with greater detail than the state law applies, but first they must become a “home rule” unit of government.

Q: What is “home rule,” why would a community want to become a home rule unit, and how?

A: In Illinois, home rule is the State constitutional authority of local governments to override the state and self-govern provided the General Assembly did not explicitly limit that power or maintain the exclusive exercise of authority in a specific area, for example the CRTA limited home rule communities from banning home grow cannabis for medical marijuana patients.

Home rule municipalities explicitly have police powers.  Article 7 of the Illinois Constitution regarding home rule provides that they “may exercise any power and perform any function pertaining to its government and affairs including, but not limited to, the power to regulate for the protection of the public health, safety, morals and welfare; to license; to tax; and to incur debt” without specific statutory authority.

 

Hemp Questions?

How home rule is different than non-home rule

Non-home rule basically bows to the state laws, unless the municipality has a statute or enumerated constitutional powers that enable it to create new ordinances. However, a home rule municipality can go beyond state regulations unless expressly pre-empted by statute and can rely on its police powers.  Here we will examine the differences between the language from the Illinois Constitution on home rule units. 

The City of Oakland went beyond its non-home rule powers when making its hemp farming ban.

Ill. Const. Art. 7, § 7 for Non-home Rule Municipalities

  1. to make local improvements by special assessment and to exercise this power jointly with other counties and municipalities, and other classes of units of local government having that power on the effective date of this Constitution unless that power is subsequently denied by law to any such other units of local government;
  2.  by referendum, to adopt, alter or repeal their forms of government provided by law;
  3.  in the case of municipalities, to provide by referendum for their officers, manner of selection and terms of office;
  4.  in the case of counties, to provide for their officers, manner of selection and terms of office as provided in Section 4 of this Article;
  5.  to incur debt except as limited by law and except that debt payable from ad valorem property tax receipts shall mature within 40 years from the time it is incurred; and
  6. to levy or impose additional taxes upon areas within their boundaries in the manner provided by law for the provision of special services to those areas and for the payment of debt incurred in order to provide those special services.

These are the only powers a non-home rule municipality in Illinois may have – so the City of Oakland had to try and find another statute that enabled them to ban hemp farming throughout its city limits.  We will get to that soon, but we note that the City of Oakland then argued that the statutory authority did not matter because they could ban hemp under its police powers – but non-home rule municipalities do NOT have police powers.  As you can see from the powers of the Home Rule Units under Section 6 of  Article 7 of the Illinois Constitution below.

SECTION 6. POWERS OF HOME RULE UNITS

(a) A County which has a chief executive officer elected by the electors of the county and any municipality which has a population of more than 25,000 are home rule units. Other municipalities may elect by referendum to become home rule units. Except as limited by this Section, a home rule unit may exercise any power and perform any function pertaining to its government and affairs including, but not limited to, the power to regulate for the protection of the public health, safety, morals and welfare; to license; to tax; and to incur debt.

We put the police powers in bold.

What are Police Powers in Illinois?

They are: the power to regulate for the protection of the public health, safety, morals and welfare; to license; to tax; and to incur debt.

Urban Agricultural Areas in Illinois

The City of Oakland went to the Illinois Municipal Code and found a restriction against urban agricultural areas that a city can regulate if it bears a direct relationship with the public health, safety or welfare.

The only problem was – this law did not exist until 2019 and Oakland had no urban agricultural area. The City of Oakland tried to find any method they could to ban the hemp farming inside its city limits.  The City argued that its zoning laws from 1968 qualified as an urban agricultural area.  This is not how law works, as statutes do not operate retroactively.

Division 15.4 of the Illinois Municipal Code, titled Municipal Urban Agricultural Areas

The cited statute, 65 ILCS 5/11.4-30(a,) provides in full:

(a) A municipality may not exercise any of its powers to enact ordinances within an urban agricultural area in a manner that would unreasonably restrict or regulate farming practices in contravention of the purposes of this Act unless the restrictions or regulations bear a direct relationship to public health or safety. (Emphasis Added).

The City of Oakland skipped over all the regulatory hurdles to get to its objective of banning hemp.  Illinois amended the Illinois Municipal Code in 2019 to provide for urban agriculture and provided protections and procedures for farmers to establish an “urban agricultural area.” We must review Article 11, Division 15.4 of the Code regarding Municipal Urban Agricultural Areas. The City looked straight past the controlling provisions of the Code in search of its desired ends – banning hemp farming in its City limits. The City skipped right over numerous Sections of the Code that requires prior to adopting an ordinance designating an urban agricultural area, the municipality must:

  1.  receive an application for establishing an urban agricultural area [65 ILCS 5/11-15.4-15(a)]; 
  2. establish an urban agricultural area committee after receiving an application to so establish one [65 ILCS 5/11-15.4-10(a); 
  3. elect a chair for that committee [65 ILCS 5/11-15.4-10(b)]; 
  4. fix a time and place for a public hearing and notify each taxing unit of local government [65 ILCS 5/11-15.4-20]; 
  5. publish notice of this hearing in a newspaper of general circulation for days before such hearing [65 ILCS 5/11-15.4-20]; and 
  6. hold the public hearing; allow any interested person – like the Plaintiffs in this case – to appear and voice objections and comments with respect to the hearing [65 ILCS 5/11-15.4-20].
  7. Only after such public hearing, and in compliance with the procedures as provided in the Code, may the municipality adopt an ordinance establishing and designating an urban agricultural area [65 ILCS 5/11-15.4-20].

The City of Oakland did none of these things in banning hemp farming from its City limits. Instead, it just said that it did, which the court pointed out that it clearly did not and had no ‘urban agricultural area’ to regulate. Therefore, the City’s ban on hemp failed under judicial review.  The City of Oakland may try to appeal the decision, but that won’t fix the problems with its hemp ban. 

Illinois hemp bans may not be possible in home rule municipalities either because of the State’s comprehensive hemp licensing program, but that issue remains for another day.  

Thomas Howard

Thomas Howard

Cannabis Lawyer

Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
R. Martindale

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Agriculture Bankruptcy & Marshalling of Assets

Agriculture Bankruptcy & Marshalling of Assets

marshaling equitable doctrine

General marshaling principles.

The equitable doctrine of marshaling rests upon the principle that a creditor having two funds to satisfy his debt should not be permitted to arbitrarily prejudice a junior creditor who may resort to only one of the funds. Meyer v. U.S., 375 U.S. 233, 236, 84 S.Ct. 318, 11 L.Ed.2d 293 (1963)

Bankruptcy and Ag Financing Issues

The greatest challenge to any secured transaction arises when a borrower files a proceeding under the Bankruptcy Code. Originally enacted in 1986, Chapter 12 of the Bankruptcy Code provides a procedure by which family farmers, as defined by the Code (see 11 U.S.C. §101(18)), can restructure debt. A permanent extension of Chapter 12 was enacted as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), Pub.L. No. 109-8, 119 Stat. 23. See Terrell Lee Sharp and Bentley J. Bender, Ch. 7, Chapter 12 Bankruptcy Tips and Procedures, CONSUMER BANKRUPTCY PRACTICE (IICLE®, 2011, Supp. 2013).  In 2019, the Family Farmer Relief Act (H.R. 2336) raised the debt limits on Chapter 12 to dramatically expand its application for farmers with debts totally $10 million, up from the previous $4.4 million.

      Whenever a dispute arises in a bankruptcy case as to the lien rights of a lender, an adversary proceeding will be filed to determine the validity, priority, or extent of a lien under Rule 7001(2) of the Federal Rules of Bankruptcy Procedure. Regardless of whether the adversary proceeding is brought by the lender, the debtor, or the trustee, the adversary proceeding provides the vehicle by which all legal and equitable theories may be tested. See, e.g., Illini Bank v. Clark (In re Snyder), 436 B.R. 81 (Bankr. C.D.Ill. 2010).

Problem Ag Loan

the equitable doctrine of marshaling

At issue in Illini Bank was whether the equitable doctrine of marshaling should be applied to the benefit of Tri Ag, Inc., the holder of a junior lien against certain crop proceeds held by the Chapter 12 trustee. Illini Bank, as the assignee of the senior lienholder, wanted the funds for itself and opposed marshaling. In the debtors’ Chapter 12 petition and schedules, Mr. Snyder listed himself as a farmer and Mrs. Snyder listed herself as retired. However, the schedules for real property and personal property listed them as jointly owned.

      Tri Ag’s debt of $123,342 was the oldest. In February 2006, only Mr. Snyder signed a security agreement covering all crops grown on real estate farmers in bankruptcylocated in Logan and Mason Counties. To perfect that security interest, a UCC financing statement naming him as the sole debtor was filed on April 7, 2006.

      Unfortunately for Tri Ag, AG-LAND loaned money to the debtors and, on February 27, 2006, filed a UCC financing statement naming both as debtors. AG-LAND was owed $130,897.05. Thus, AG-LAND had the prior security interest in all growing and harvested crops. In 2007, both debtors borrowed money from Illini Bank and granted it a security interest in crops, machinery, and equipment, among other property. After the bankruptcy case was filed, Illini Bank purchased AG-LAND’s position and thereby leapfrogged from third to first priority on the crop lien. Tri Ag and Illini Bank filed cross-motions for summary judgment on the issue of marshaling an application of the total crop proceeds of $100,520.88.

      The first issue the court decided was that the direct and circumstantial evidence supported the conclusion that Mrs. Snyder owned half of the crop proceeds. Consequently, because she failed to sign the Tri Ag security agreement, Tri Ag acquired and held a lien on only one half of the proceeds.

      Next, the court rejected Illini Bank’s argument that the doctrine of marshaling should fail. Instead, the court held that marshaling could be applied to protect the one-half interest held by Tri Ag. The court noted that if AG-LAND had not sold its claim to the bank, AG-LAND, because it held a first priority lien on crop proceeds and on machinery equipment, would have been substantially oversecured. As a result, Illini Bank took the assigned claims subject to the marshaling rights of Tri-Ag.

Thomas Howard

Thomas Howard

Real Estate Lawyer

Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
R. Martindale

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LLC Operating Agreements

LLC Operating Agreements

LLC Operating Agreements

LLC Operating Agreements in Illinois

What to Put Your Illinois Company’s Operating Agreement

LLC Operating AgreementAn Operating Agreement is the contract of your Illinois company’s life – which it really does not have. However, your company is a legal fiction of a person that has a beginning, called articles of organization for LLCs, and even an end, called a dissolution. The Operating Agreement is a long contract that explains how your company is managed, how new owners come into the business, how existing owners leave the business, and more.  Here’s an article all about operating agreements for your cannabis company.

Illinois Company Operating Agreements are Flexible

We have done scores of operating agreements, many for Illinois companies.  Illinois companies often require additional care in drafting their operating agreements because of the amount of money and free cash flows that they kick out during their operations. Therefore, it is very important to review and understand your cannabis company’s operating agreement.  Please read yours with a lawyer or advisor that is experienced in them and ask questions until you understand everything about how your cannabis company operates – hence the term Operating Agreement.

What are the elements of an Illinois LLC Operating Agreement

Operating agreements, for any company – not just Illinois businesses – have different sections, or articles. Like chapters in a book, articles in an operating agreement break down the contract into logical subgroups where specific things are discussed.  The common sections, or articles, in operating agreements that we use include:

  1. Recitals
  2. Formation of Company
  3. Members & Units
  4. Management of the Company
  5. Rights & Obligations of Members
  6. Actions of Members
  7. Contributions to the Company and Capital Accounts
  8. Allocations, tax and distributions
  9. transferability
  10. Issuance of Membership Interests
  11. Dissolution and Termination
  12. Books and Records
  13. Miscellaneous Provisions

 

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Illinois Company Operating Agreements Basics

You may not know it, but your business is just a ball of contracts with all the rights of a person, from owning property, to entering into contracts, and even suing in court, but does not include the right to vote in public elections, but you can spend money on supporting the people running for office.  Don’t be so upset, America itself is basically a large corporation – most municipalities are actually corporations. See these useful informational tidbits? – everything you’ve come to expect from…

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learn all the differences between corporations and LLCs that may have huge impacts on your business if it raíces money, or just its day-to-day operations. 

This is another of our Fundraising.  If you are getting into the Illinois industry and you are under a million dollars for your dispensary team, or under 4 million for your craft or micro grower team – then this is the content for you,

You may not know it, but if you are in an LLC for your Illinois company, or on its application, then this is how your company as a legally fictional person literally operates.  It is the owners’ manual for your company – which basically means it is like the one for your car – in the glove box and probably not really read too closely. 

That is a mistake – corporate entities – whether LLCs or corps – can only do what their contracts say they can do. So it is not only quite crucial – but expletive deleted important to know how your company runs its operations and distribution’s of profits – to raising capital – to diluting your shares. 

 

Want a Custom Operating Agreement

Why are LLCs so popular now instead of corporations?

Because LLCs are flexible – you can have an operating agreement between the owners, called members of the LLC, that literally governs the whole life trajectory of the business.  We are going to discuss several different permutations of operating agreements depending on the goals of your business venture. 

Remember that LLCs are flexible? What does that mean? 

 from reading you Illinois company’s operating agreement I can tell:

  1. If it was set up to be sold to the highest bidder
  2. If it was to be a family business for generations
  3. If it was to operate a real estate business
  4. If it was to operate a big one time deal and then have parties part ways
  5. If the parties did not care what the other owners did
  6. If the the parties wanted specific duties to the business
  7. If it was to hold control in very specific ways – this could be a social equity operating agreement.
  8. If it was to be taxed as the business owner, an s-corp or a c-corp. 
  9. If the profits interest went to different things despite the ownership percentages
  10. How it would die – dissolution
  11. How the owners get in or out
  12. And that’s more than enough points to tell you about how flexible this contract is.

Isn’t that amazing one contract can be set up in almost any number of ways for your unique business situation – so please get your tax guy involved immediately and your corporate consultant and lawyer and discuss it to suit your company’s needs.  We can talk about your company’s needs to see what your objectives are – what your exit is – a big check list of things that if you want to get. LLCs are great because not only do they have the flexibility to do whatever your business really needs, they also have relaxed formalities and greater restrictions on transferability of ownership interests. 

You probably know that corporation’s ownership is referred to as “shares” in the company while LLCs have “units” of membership in the company. 

So why are these LLCs so popular – because about 50 years ago some business people in Wyoming asked, “Wouldn’t it be great if you can get all the protections of the corporate shield but not have to follow all the rules?”  Heck Yeah – it would. Only in America.

In an LLC you can set it up so that owners, shareholders in corporate speak, or members in LLC jargon, have no duty to one another.  Just be like – I did this – deal with it. That could be a part of the business. We have an operating agreement that we like to call the fugghetaboutit – because not only does it allow you to have the least amount of duties to your partners as a matter of law, but the freedom to leave the business on a moment’s notice, dissolve the business and leave it in the past. It’s the LLC for the deal when you got just one little thing to do.

Then you got the protect yah neck, son – that’s just a single member LLC – The operating agreement basically gives the liability shield and very little else.  I have seen these be just a few pages, but you get more people involved and watch the operating agreement grow into the dozens of pages, maybe over 100 depending on the exhibits attached. 

Then we have another operating agreement that I like to call the flip – this company is basically on a mission to be sold – the LLC comes with an exit so you are almost for sale from the day you go into business on the terms set by the operating agreement. In this format, we use the tag-along-drag-along clause as a term of the operating agreement to provide protections to the minority owner of the company the “tag along” to be “dragged along” in the full sale of the company, or substantially all of its assets. So you can see, both the minority owner and the majority owner are in agreement as to what will happen when the offer to buy comes along.

Then I have one called the generational wealth – where you have the business being able to have rights of first refusal to retain ownership – often inside a family owned business. It is a sticky wicket to get into or out of – and that’s the point.

There are so many variants that we can make up a new type of operating agreement that we could make, like a ‘give it to the people’ where the company agrees to an ESOP to become an employee owned company at a certain point in time in the future.  I guess we could set that one up for you. We’d have to research it though.

Remember that your company is just a ball of contracts related to a statute – a legally fictional person that gets to generate you money – but you’re responsible for bearing the risk as the entrepreneur. 

The reason you need an operating agreement when raising capital is because it tells your prospective investors exactly what your company is legally obligated to do.

That  is the plan – the operating agreement spells out how it will all go down.  From management, to new owners, to getting out of your ownership, dissolution of the company, everything. 

can you run your LLC like a corporation?

In corporation terms, an operating agreement blends shareholder agreements and bylaws all together – but in theory, an LLC could do bylaws separately – in theory.  And as we get to the intersection of these two different type of corporate entities businesses have at their disposal, we can finally answer of the question, can an LLC be run like a corporation?

So you can see that – yes, you can structure a LLC like it is a corporation – but it will be much more expensive than the couple page single member LLC operating agreement.  The operating agreement has to blend agreements about new owners, types of owners, officers and directors, voting rights, tax consequences – so many things.  

Conclusion on LLC Operating Agreements

So why not just start with a corporation?  You can, but they have greater formality, less flexibility, and easier exchange of your shares. An LLC can become a corporation – so if your first 5 years are expected to be you and your core team operating the business before it is geared up and sold, or who knows.  Then you can start to set up the corporation as best you can, but borrower the flexibility and lack of formality that the LLC has, plus get more restrictive ownership, to keep your team together until you are ready to become a full on corporation that ends up getting sold for stock – a corporation can still buy an LLC. 

Thomas Howard

Thomas Howard

Real Estate Lawyer

Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

LLC Operating Agreements

LLC Operating Agreements

What to Put Your Illinois Company's Operating Agreement An Operating Agreement is the contract of your Illinois company’s life – which it really does not have. However, your company is a legal fiction of a person that has a beginning, called articles of organization...

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Illinois Cannabis Zoning Laws

Illinois Cannabis Zoning Laws

Illinois Cannabis Zoning Laws

Illinois Cannabis Zoning Laws

Illinois Cannabis Zoning Laws Illinois Cannabis Zoning Laws depend greatly on the local governments that are placing “reasonable” restrictions on their community’s cannabis businesses that may operated in their jurisdictional limits. Many communities require a “special use permit” for having cannabis business operations.  Then, there are certain set-backs to that limit the distance a cannabis company may be from certain sensitive businesses or schools, churches, and other things in the city that they want to keep the cannabis business away from by using their zoning authority.  Here’s a lot more on the Illinois Cannabis Zoning Laws. 

Can Your City Ban Cannabis?

At the beginning of this year, Illinois’ cannabis legalization bill, formally known as the “Cannabis Regulation and Tax Act” (the “Cannabis Act”), went into effect. The Cannabis Act creates a comprehensive licensure scheme for the cannabis industry, and allows for adult, recreational use of cannabis. Governor Pritzker kicked off the Cannabis Act by pardoning over 11,000 people convicted of marijuana crimes.

Still, plenty of local communities are approaching legalization with much more caution, and sometimes fear. Lake County, the third-most populous county after Cook and DuPage, intends to impose a one-year moratorium on cannabis in the unincorporated parts of the County. In a lengthy Report of the Recreational Cannabis Task Force, Lake County freely states that

“local government attorneys have differing interpretations of the Act on whether communities can enact separate licensing requirements. It is essential that every community consult with their own counsel prior to enacting a licensing mechanism.”

  1. WHAT DOES THE CANNABIS ACT SAY?

The Cannabis Regulation and Tax Act can be found at 410 ILCS 705/1-5 et seq. Certain parts of the Cannabis Act directly and explicitly preempt any state and local government from regulating cannabis. Section 55-90 of the Act reads:

Except as otherwise provided in this Act, the regulation and licensing of the activities described in this Act are exclusive powers and functions of the State. Except as otherwise provided in this Act, a unit of local government, including a home rule unit, may not regulate or license the activities described in this Act. This Section is a denial and limitation of home rule powers and functions under subsection (h) of Section 6 of Article VII of the Illinois Constitution.

That is, local governments are prohibited from regulating in the area of cannabis except when the Cannabis Act specifically allows it.

Illinois Cannabis Zoning Restrictions on Municipalities 

Note the reference to “home rule powers and functions” in the Illinois Constitution. Article VII, Section 6 of the Illinois Constitution sets forth the definition and rules governing home rule units. Basically, any County which elects a chief executive officer, or any municipality with over 25,000 people constitutes a “home rule” unit. Home rule units are given a great degree of authority to govern their internal affairs. If you’re reading this in Chicago or in the Chicago suburbs, you probably live in a home rule county and probably a home rule city or village as well. And as sub-section (m) of this part of the Illinois Constitution provides, “[p]owers and functions of home rule units shall be construed liberally.”

Conversely, Article VII, Section 7 of the Illinois Constitution covers non-home rule units of government. These units are essentially limited to a few fiscal powers in the Constitution, and then anything else granted to them by other laws. See, e.g., Hawthorne v. Village of Olympia Fields, 790 N.E.2d 832 (Ill. 2003) (striking down a zoning ordinance that had the effect of prohibiting an otherwise lawful home daycare center) If you are reading this from a rural, agricultural community, there is a good chance you live in a non-home rule municipality.

Need Help With Cannabis Zoning

David Silvers

David Silvers

Chicago Business Lawyer

David Silvers practices cannabis and corporate law with litigation experience and first-hand knowledge of start up operations.

Zoning Ordinances For Cannabis In Illinois

So what is the status of zoning restrictions and moratoriums, like those out of Lake County? Section 55-25 discusses local ordinances. While Section 55-25 allows local governments to enact restrictions on the time, place, and manner of legal cannabis, they may not use zoning ordinances as a cover to effectively ban cannabis. Specifically, subsection (1) provides:

A unit of local government, including a home rule unit or any non-home rule county within the unincorporated territory of the county, may enact reasonable zoning ordinances or resolutions, not in conflict with this Act or rules adopted pursuant to this Act, regulating cannabis business establishments. No unit of local government, including a home rule unit or any non-home rule county within the unincorporated territory of the county, may prohibit home cultivation or unreasonably prohibit use of cannabis authorized by this Act.

Local governments like Lake County may be limiting cannabis under the guise of protecting the “health, safety, and welfare” of the community, or some similar phrase. Such justifications should be treated with skepticism, no matter what the issue is. But with respect to bans like Lake County’s, it’s difficult to see how they could possibly be within the bounds of the Cannabis Act.

Illinois Cities May “Reasonably” Restrict Cannabis Businesses with Zoning.

Section 55-25 limits zoning ordinances to those which don’t “unreasonably” prohibit legal uses of cannabis, and there’s nothing more unreasonable than a blanket prohibition or moratorium. For rural, non-home rule municipalities, they might totally lack the authority to enact such zoning ordinances with or without the authority granted by the Cannabis Act. See Hawthorne, supra. Municipalities that get in the way of the overwhelming public support and public demand for legal cannabis are putting themselves at a huge risk for litigation that they stand a strong chance of losing. In Lake County alone, there are roughly 700,000 residents (including your humble author), and many of them won’t be happy when they find out that the County Board is curbing their hard-won rights under the Cannabis Act.

Key Takeaways of Cannabis Zoning in Illinois

  • Illinois Zoning Changes Depending on What City Are Located
  • To find your cities zoning ordinance, Google: “(Your City) Cannabis Ordinance”
  • Illinois Cannabis Laws allow ‘reasonable’ zoning restrictions
  • Cities in Illinois cannot ban cannabis or home grow for medical cannabis patients.

How To Get Help With Your Cannabis Zoning Issues

Feel free to call our law firm with all your questions regarding cannabis zoning, there are many levels of interactions with local governments and we are experienced with assisting business clients in their real estate matters, whether related to cannabis, or not. 

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Right of First Refusal

Right of First Refusal

Right of First Refusal

What is the Right of First Refusal in Real Estate Contracts

The explanation of the right of first refusal (ROFR) can be complicated sometimes, but we will discuss the term further to explain what the right of the first refusal means in the real estate business and how it applies to the holders of the right and the real estate owners.

What Is the Right of First Refusal?

The right of first refusal (ROFR) in the real estate is a contract that gives a specific right to a party to purchase a particular property. The right of first refusal must have at least three parties: the owner, the buyer, and the option holder.

The holder of the ROFR may claim the right in the case when an owner of the property sells the property on the market. If the owner sells the property to a third party without offering the holder the opportunity to purchase it first, the holder of the right has the option to sue the owner. After the process, a court can stop or reverse the sale.

One type of ROFR is essentially an option to buy a property for sale at the specific price and under specific terms. The seller and the holder may or may not agree to bind themselves to these terms. The option may end at some specific date in the future and the seller can sell the property under different terms and at a different price when the option stops to be active.

The parties can negotiate the price of the property. If the property has a value of $100,000 in the first year, the holder and the seller can agree that the price can raise each year for 3%. Under these conditions, the option price will be 3% higher, either compounded or not compounded, during each succeeding year.

Depending on the contract, the holder of the ROFR has an opportunity to suggest a sale price without worrying about competition and bidding on the market. The holder can decide to accept or refuse to buy a property. The other case allows the seller to negotiate with other buyers who are interested in the property.

When Is the Right of First Refusal Used?

The right of first refusal is used in a few situations. One of them is the situation when a property has a tenant. When a landlord (owner) decides to sell the property, he must first contact the tenant. The same applies when the tenant is interested in buying a property. An owner must consider the offer from a tenant before negotiating with other parties about the price and conditions.

Another case when the ROFR comes into use is when a family member wants to buy a property. An owner who is a relative to a potential buyer must offer the property to this party first, before offering the property to someone else.

Dealing with a homeowners association or condo board can also be the case when the right of the first refusal comes into force. Sometimes, the governing documents contain the right-of-first-refusal clause that allows the board to vet potential buyers before a seller can accept an offer. In some situations, discount sales can lower the value of the property, which is why communities use the clause to protect the value and reject the offer that is not acceptable.

How the Right of First Refusal Affects Sellers and Buyers?

If you are a seller of a property, you can benefit from the right of first refusal. In case that the market is full of similar properties that are generally low in price, you can sell the property to the holder of the right and get the price that might be higher than the price when selling it to someone else. The contract is drafted before the home hits the market and you might be able to persuade the holder of the right to buy the home at a higher price than the market value.

On the other hand, if you are a buyer, you have many possibilities to profit from the right of first refusal contract. You have the right to be informed by the owner when the owner decides to sell the property. If you are a tenant, you can prepare for the transaction before the period of actual buying of the property comes. You can have a good amount of time to save money for a down payment, or you can choose to improve your credit score. As a holder of the ROFR, you can also discuss the price before it hits the market. This gives you a significant advantage when comparing to other potential buyers.

Both parties have an interest in making a contract that declares the ROFR. The holder can pay the lower price for the property, while the owner can have cash in hand at the right time when the ROFR allows the transaction. The ROFR sets forth a future price. Both parties can have certainty about a future price, time, and other arrangements. If the holder cannot meet the terms of the ROFR in the future, the seller is free to sell the property to someone else in the future.

How Long the Right of First Refusal Is Valid?

Most contracts are made to last one or two years. This period might appear to be short, but there is a reason why both parties decide to make the contract short. The prices on the market can significantly change over a specific period of time, and the value of the property can be completely different in the long run. Both parties usually decide to set the price for a shorter period, just to ensure that the price won’t be much lower or much higher at the end of the specific period. This kind of contract duration protects both the holder of the right and the seller.

Both parties should get lawyers to make clear that each part of the right-of-the-first-refusal contract is clear and understandable. A lawyer can give the right advice to both parties about the price, conditions, and duration of the contract.

Thomas Howard

Thomas Howard

Real Estate Lawyer

Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
R. Martindale

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