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Ontario’s Cannabis Lottery: A ‘Golden Ticket’?

On December 13, 2018, the ramifications of a provincial news release were felt far and wide within Canada’s fledgling cannabis industry. Without notice to stakeholders, the Government of Ontario announced that a temporary cap of 25 Retail Store Authorizations (RSA) would be imposed until national cannabis supply stabilized. The province gave the Alcohol and Gaming Commission of Ontario (AGCO) the mandate to hold a lottery to determine who could apply for Retail Operator Licences (ROL). That lottery took place on January 11, 2019. On July 6, 2019, the province announced its plans for a second lottery allocation–this time for 42 RSAs.

Though these lotteries took place in 2019, and Ontario has since moved to an open market allocation of licences, only 33 of the 42 second wave lottery winners have received RSAs and 24 of the 25 first wave winners are fully licensed. Their absence in the current retail landscape raises some points for consideration around the AGCO’s licensing and approval process.

In creating the lottery allocation system, the Government of Ontario sought to establish a fair and equitable entry process. There was a fear that without certain measures in place, Ontario’s cannabis retail landscape could become irreversibly controlled by vertically integrated sector operators with access to large swaths of capital.

Partnering with Established Retailers

The phenomenon that occurred in its place, however, saw many lottery winners enter into partnership agreements with established cannabis retail entities. Prior to the open market allocation of licences, lottery winners were oft-said to have ‘won a golden ticket,’ in reference to Roald Dahl’s classic novel, “Willy Wonka and the Chocolate Factory.” At the time of both lottery selections, the ‘green rush’ was in full effect. Between the sky-high market valuations and the break-neck speed with which large-scale transactions took place, it seemed like there was no stopping the momentum of the sector. The public discourse surrounding the cannabis market’s opportunity is likely what led to over 17,000 applications to be submitted for the first lottery. While some chose to stay the course and operate the locations themselves, reality sunk in for others. Operating a retail store in a highly-regulated environment is no easy feat.

Partnering with established retail entities afforded these winners access to industry and retail expertise, in-house regulatory and legal counsel, as well as the use of market-tested branding and conceived retail concepts. The hitch however, was the due diligence mandated by the AGCO to process and approve the complex franchise and licencing agreements required to operationalize these partnerships.

Due Diligence Takes Time

Matt Maurer is a partner at Torkin Manes LLP and the the Co-Chair of the firm’s Cannabis Law Group. Renowned in the Canadian cannabis community for his retail-specific expertise, Matt has worked with many lottery winners and open-market applicants. According to Matt, the level of due diligence required for a sole proprietor cannabis ROL application versus one with multiple entities involved varies greatly. In the former, the due diligence phase of the review concentrates solely on the applicants–who they are, whether they have any criminal charges, and where they received their funding from. When a partner or partners are involved, the AGCO then must undergo additional due diligence on them–who their shareholders are, their own corporate structure, etc. The greater the amount of paperwork, the longer it takes to review.

Comprehensive Reviews Disqualified Lottery Winners

In the lottery context, when the regulations around store ownership were more stringent than in today’s environment, the AGCO was keen to conduct comprehensive reviews to determine whether or not the winner had conceded control of the store to a third-party. In Matt’s experience, there were pending agreements that, in normal commercial transactions, would not equate a change in control. The AGCO, however, took the view that, following a holistic review of the application and the parties involved, that a declaration of a change in ownership was warranted. In some cases, lottery winners were disqualified by the AGCO for contravention of the Expression of Interest Lottery Rules. What followed in these cases is that those who were next on the lottery region’s waitlist were moved to the selected list, and the application process started from scratch.

Red Tape Reduction Required

Beginning the application process with new parties from square one, evaluating complex partnership agreements, liaising between the regulator and the applicant for missing and incorrect information, and conducting these activities remotely in the midst of a global pandemic are all very valid reasons why these remaining 10 lottery winners may find their licences delayed. It goes without saying that it is certainly within the purview of the AGCO to ensure that ROL and RSA holders are compliant and reliable retail partners. The cannabis sector is one with many risks–both perceived and real. In an industry sanctioned by the government, it is they who will bear the blame if anything goes wrong. However, one of the primary objectives of the legalization of adult-use cannabis was the elimination of the illicit market, and one of the chief ways this can be achieved is by ensuring wide-spread access through authorized storefronts. If there is one lesson to be learned from the lottery experience and what followed, it is that Ontario must seek to strike a balance between comprehensive due diligence and red tape reduction to ensure the timely and well-paced growth of the provincial sector. Otherwise, it is the illicit operators who are proven the winners.

Alanna Sokic is a Senior Consultant at Global Public Affairs.