Second Retail Lottery in Ontario: Tricks and Traps for Applicants

The Alcohol and Gaming Commission of Ontario (AGCO) announced a subsequent allocation process for an additional 50 retail store authorizations (RSAs) in Ontario. Forty-two of these RSAs will be granted through a second allocation expression of interest lottery (Second Lottery) and the remaining eight RSAs have been allotted for First Nations reserves on a first-come, first-served basis.

The 42 RSAs to be allocated by lottery will be distributed to the following regions of Ontario as follows:

The East Region is comprised of Stormont, Dundas and Glengarry, Prescott and Russell, Ottawa, Leeds and Grenville, Lanark, Frontenac, Lennox and Addington, Hastings, Prince Edward, Northumberland, Peterborough, Kawartha Lakes, Simcoe, Muskoka, Haliburton, and Renfrew.

The GTA or Greater Toronto Area is comprised of Durham, York, Peel and Halton.

The West Region is comprised of Dufferin, Wellington, Hamilton, Niagara, Haldimand-Norfolk, Brant, Waterloo, Perth, Oxford, Elgin, Chatham-Kent, Essex, Lambton, Middlesex, Huron, Bruce, Grey, and Manitoulin.

The North Region is comprised of Kenora, North Bay, Sault Ste. Marie, Thunder Bay, and Timmins.

As the first expression of interest lottery (Initial Lottery) had very few requirements to apply (e.g., payment of a C$75 fee and a short application), it resulted in over 17,000 submissions. The requirements for inclusion in the Second Lottery have been significantly increased and are expected to substantially reduce the number of expected applicants. In addition to the standard acknowledgement and a C$75 application fee, the AGCO has added the following pre-qualification requirements in the Second Lottery:

• Letter of Confirmation – Cash or Cash Equivalents Capacity, from a bank found in Schedule I or Schedule II of the Bank Act (Canada), or a credit union or caisses populaire registered under the Credit Unions and Caisses Populaires Act, 1994 (each, a Qualified Financial Institution), which must confirm the applicant is in good standing and has the financial capacity necessary to obtain C$250,000 in cash or cash equivalents (Liquidity Requirement). Applicants who are applying for more than one region are permitted to use the same letter of confirmation for each regional application.
• Commitment to Provide Letter of Credit, from a Qualified Financial Institution, which must confirm the applicant has the financial capacity necessary to obtain a standby letter of credit in the amount of C$50,000 (LOC Requirement) and that such letter of credit will be provided by the Qualified Financial Institution within five business days of the applicant being notified of its selection. Applicants who are applying for more than one region are permitted to use the same letter of confirmation for each regional application.
• Secured Location, in the applicable region and provide the following information relating to such location: (a) the street address; (b) an attestation that the retail space will be available to operate a cannabis retail store as of October 2019; and (c) the name and contact information for a person with a legal interest in the retail space. The retail location may not be located less than 150 metres from a public or private school.

Application materials must be submitted between 12:01 a.m. EDT on August 7, 2019 and 8 p.m. EDT on August 9, 2019. The Second Lottery draw will be held on August 20, 2019.

Based on our experience working with winners in the Initial Lottery, the following points of interest may be important to applicants.

1. Can I Change My Organizational Structure If I Win?

The Second Lottery is open to applicants that are corporations, limited partnerships, partnerships, trusts, or sole proprietors. However, applicants are not permitted to change their type, ownership and/or corporate structure in a manner that would result in a change of control until at least July 2020 (Allocation Timeline).

This approach is consistent with the rules in the Initial Lottery and failure to comply can result in disqualification on the basis of making an unauthorized change. Although the AGCO did permit Initial Lottery winners to change their organizational type for tax reasons (due to the large number of successful sole proprietor applicants), it is unlikely to be permitted again in the Second Lottery. Accordingly, proper legal and tax planning is critical for serious applicants.

These rules do not necessarily prohibit corporate, partnership or trust entities from taking on additional shareholders, partners or beneficiaries, provided there is no “change of control” and the acquisition or addition is approved by the AGCO. Applicants should consult with their legal and tax advisors prior to engaging in any transaction involving the purchase or sale of equity or convertible debt to ensure that it complies with the requirements of the AGCO and will not jeopardize their eligibility to obtain the necessary licences and authorizations.

2. If We Win, Are Branding Agreements Permitted?

Although the AGCO’s FAQ indicates that, among other things, agreements that result in a change of control are prohibited; several successful applicants in the Initial Lottery partnered with established cannabis participants to operate their stores under a banner, including those owned either directly or indirectly by federal cannabis licensees. The content of these agreements varies but may include brand licensing, offering of financial assistance and/or the provision of operational resources. The Second Lottery rules have not prohibited similar arrangements from being entered into with the new round of lottery winners.

Counterparties to material agreements with winners of the Initial Lottery were subject to due diligence by the AGCO, and the agreements themselves were also subject to AGCO review and approval. This diligence and review can take extended periods of time for complex counterparties, which can put the lottery winner’s letter of credit at risk if it causes delays to the opening of the store.

3. Do I Need A Binding Offer to Lease?

The Second Lottery rules indicate that a lottery winner must be in possession of the retail space as set out in its application by October 1, 2019. This requirement can be satisfied by, among other things, a conditional lease in each of the regions in which an applicant is applying. For applicants, it is important to negotiate an exit from each lease in case their application is unsuccessful. These are lessons learned from the Initial Lottery, as many applicants that did not win and had failed to negotiate appropriate termination rights assumed significant obligations for the balance of those lease terms.

As desirable retail locations are few, there is no rule that prohibits the same location from being listed in multiple applications. However, lottery winners must operate their store at the address provided on their application. Accordingly, if more than one lottery winner has identified the same retail space in their application, each winner will have five business days to submit a formally executed legal instrument that demonstrates the applicant’s right to possession of the retail space identified in the application. A lottery winner that cannot demonstrate this right of possession will be disqualified, unless, within five business days, they can: (a) demonstrate the right of possession to a different retail space; and (b) secure the AGCO’s approval of such address. The AGCO has indicated that its decision as to whether to permit a change of address will be made on a case-by-case basis.

As a result, it is important for both applicants and landlords to be clear on the terms of the lease conditions, especially if more than one conditional lease is being issued by a landlord for a single location. Failure to do so may inadvertently lead to disqualification for a lottery winner and litigation for a landlord.

4. How Does Financing Work?

One of the major hurdles faced by many lottery winners in the Initial Lottery was access to financing. Due to the recency of the legal retail cannabis industry in Ontario and the short timelines in the Initial Lottery, few traditional lenders were able to make credit facilities available to the first round of lottery winners.

The Second Lottery has introduced the Liquidity Requirement and mandated proof of the LOC Requirement prior to submission (rather than after the lottery selection, as was the case with the Initial Lottery). This must be evidenced by a letter of confirmation issued by a Qualified Financial Institution in the name of the applicant. The AGCO has also indicated that it may verify that each such applicant has actual access to the funds required to satisfy the Liquidity Requirement between the submission deadline and the draw date.

In addition to the letter of confirmation for the Liquidity Requirement and the LOC Requirement, it is important for an applicant to confirm with their financial institution whether they will be permitted to open a business account as a lottery winner (rather than an applicant) and/or have access to other credit products, such as an operating line.

5. Can I Sell My Store If I Win?

A lottery winner cannot currently sell their interest in the store or the regulated assets. Any change of control in a lottery winner is also prohibited during the Allocation Timeline; however, agreements with options to purchase an applicant’s interest in a store when permitted were announced after the Initial Lottery.

If a lottery winner’s plan is to eventually sell their interest in a store, it is especially important that they apply with an organizational structure that will allow them to facilitate the sale once permitted. It is recommended that applicants consult with their legal and tax advisors on how best to structure their submission.

For further information on the Second Lottery, please contact:

Kevin Rusli                   416-863-4020

or any other member of our Cannabis group.