May 9, 2023 by Jason Contant
Four-and-a-half years after recreational marijuana use was legalized in Canada, cannabis companies continue to face a number of challenges, including insolvency, consolidation and low or flat growth, according to a recent report from EY Canada.
“Established/mature markets — including Canada, Colorado, California and others — will continue to experience low or flat growth, oversupply and margin compression,” said the inaugural Global Cannabis CEO Survey 2023 from the EY Americas Cannabis Centre of Excellence. “A significant number of cannabis companies are expected to either collapse or become insolvent and resort to the Companies’ Creditors Arrangement Act, Canada’s corporate insolvency law.”
EY also expects consolidation to accelerate in these markets, with “inefficient and undercapitalized” cannabis companies likely becoming insolvent and acquired by larger, better-capitalized corporates.
What does this mean from an insurance perspective?
“If the marketplace does shrink, we expect to see more competition as we will have fewer licensed insureds to provide coverage for,” Tyson Peel, vice president and director of commercial insurance at Burns & Wilcox Canada in Toronto, told Canadian Underwriter. “We may also potentially run into capacity issues if larger companies keep expanding through M&A — this increases their portfolios and may put a strain on the capacity provided by the current insurer.”
In terms of claims, Burns & Wilcox sees a variety, with the main claim type currently being theft, fire or water damage, Peel said.
From a directors and officers (D&O) perspective, cannabis companies are vulnerable due to a lack of established standards and/or regulatory uncertainty, he said. “This leads to potential lawsuits alleging directors’ failure to properly navigate regulatory obstacles.
“Some of the main claim types are securities class actions, capital regulatory actions and shareholder actions. Cannabis companies are also vulnerable to cyberattacks that may potentially lead to losses.”
For cannabis companies with a potential for a high number of future acquisitions, Peel recommends reps and warranties (M&A) insurance.
“We oftentimes see claims that involve the sellers providing representation, which is inaccurate and can cause the buyer financial loss, or when a buyer files a lawsuit against the seller, alleging a breach in terms of the agreement,” he said. “Companies should absolutely protect themselves, as a high majority of shareholders challenge M&A deals.”
What about insolvency — is that reflected in claims?
“Potentially, as with any business that becomes insolvent there could be a claims risk,” Peel said. “It is important for companies that do become insolvent, or those heading in that direction, to maintain their insurance policies to continue to protect themselves from any potential claims that may arise.”
The EY report found more than half of cannabis company executives recognized that their companies will require funding or financing over the next six to 12 months to sustain operations and fund innovation and M&A initiatives. (Nearly 50 private and public cannabis company C-suite executives were interviewed for the study, with more than 28% from Canada). And 58% of companies underperformed relative to their board’s expectations in 2022.
“The year ahead will force many companies to either exit the industry or become exceptional operators, executing efficiently with resolve, grit and a value-oriented mindset,” said Rami El-Cheikh, EY Americas Cannabis Centre of Excellence leader, in a press release. “In this new normal, flawless operational execution and financial management should be top of mind.”
Feature image by iStock.com/stockstudioX