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Pot Shop Deals Up in Smoke?

As federal authorities seize properties where medical marijuana dispensaries operate, they’ve found a new ally: banks.

Over the past year and a half, several banks have been pulled into property seizure proceedings because they hold mortgage notes on local commercial properties where pot shops operate. That’s driving some banks to cut their ties to such properties pre-emptively.

In the most recent example, Wells Fargo & Co. is suing an L.A. borrower for breach of contract, saying the borrower is violating federal law – and therefore his loan agreements – by leasing local storefronts to two medical marijuana dispensaries.

The dispensaries, in Sherman Oaks and Woodland Hills, haven’t been targeted by federal authorities, but Wells Fargo spokesman Gary Kishner said the bank wanted to act now to avoid the threat of losing properties to the feds.

“We let the property owner know they need to stop this or we’re required to end our relationship and notify the authorities,” he said. “The owner should understand they have to follow all laws.”

Such cases of pre-emptive action are rare but could become more common as the U.S. Attorney’s Office in Los Angeles continues to target pot shops, which are legal under California law but not under federal law.

Wells Fargo’s caution is understandable. The U.S. Attorney’s Office has already threatened to seize Riverside and Marin county dispensary properties on which the bank holds mortgage notes. That means the bank could be a big loser.


Riverside precedent

In the Riverside case, the bank and federal officials reached an agreement that calls for Wells Fargo to foreclose on the building’s owner, pay $8,000 in fines and make sure no illegal activity takes place at the property while under bank ownership.

That case was cited by Wells Fargo as a reason for filing a suit last month against Jeff Katofsky, the San Fernando Valley landlord who leased space to the Woodland Hills and Sherman Oaks dispensaries. Katofsky, an attorney and real estate developer, said in an email that Wells Fargo’s action is retaliation for a suit he filed against the bank for alleged breaches of contract.

The bank denies his allegation. It says two property owners, limited liability companies controlled by Katofsky, are in technical default on their loans because they permitted illegal activity to take place on their premises. The bank wants the companies to kick out their dispensary tenants or to pay the $5.3 million still owed on the properties. If not, Kishner said the bank would foreclose on the property and remove the dispensary tenants itself.

“This is the first time Wells Fargo has decided to take a proactive approach,” said Jennifer Crastz, an attorney with Encino law firm Hemar Rousso & Heald LLP who is representing Wells Fargo in its case against Katofsky. “They’re tired of the U.S. government threatening to take their collateral.”

J. Greg Parham, the assistant U.S. attorney in Los Angeles leading the federal crackdown on local marijuana stores, said his office doesn’t require banks to take action. But he expects banks will begin to crack down on landlords in order to protect their interest.

“There’s been no such notification to financial lenders at this point,” he said. “When banks are engaged in litigation with us, they usually start working in-house to make sure they have no other problems with the U.S. government.”

Parham’s office has threatened to seize properties across Southern California, including Santa Barbara, San Bernardino and Orange counties. The mortgage notes in those cases are held by First Credit Bank of Los Angeles, Preferred Bank in downtown Los Angeles and Pacific Western Bank in Century City. California Bank & Trust in San Diego is involved in a similar matter for a property in West Hollywood.

Anthony Napolitano, an attorney with downtown L.A. law firm Buchalter Nemer who is representing California Bank & Trust in its case, said asset seizure laws protect banks in these cases. But to quality for that protection, banks have to show they either were unaware illegal activity was taking place or tried to stop illegal activity from continuing.

“They need to take all reasonable action to terminate the illegal use of the space,” he said. “If the bank somehow has knowledge, you can’t just wait until the forfeiture proceedings start. If you see a situation, pursue it.”

That’s what Wells Fargo is doing. In the case of the two Valley properties, Wells Fargo spokesman Kishner said the bank learned of dispensary operations at the properties during routine reappraisals last year. The bank sent letters asking the landlord to remove the dispensary operations and notified federal authorities about the dispensaries.

“We’re not going out and searching out pot dispensaries,” Kishner said. “But when something comes to our attention and we confirm it’s true, then we notify the authorities. We have agreed to notify authorities as soon as we find out the federal law is being broken.”

Attorneys not involved in these specific cases said Wells Fargo and other banks are wise to cut ties with landlords who continue to lease space to dispensaries. A bank might not be expected to know every tenant in every commercial building it has financed. But once a bank knows, it has to take action, said Hal Reichwald, a partner at West L.A. law firm Manatt Phelps & Phillips LLP.

“Having knowledge of it, to sit on its hands and do nothing would probably invite liability,” Reichwald said. “The bank is looking to protect whatever collateral it has.”

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