(This story has been updated to correct the fact that Brent Cox is not a former board member of MedMen Enterprises. He is a former board member of MMMG, a MedMen entity.)

Cannabis industry retail giant MedMen Enterprises and its top executives face a $19.8 million lawsuit by an early investor group who charge that senior execs enriched themselves at the expense of shareholders and breached their fiduciary duties.

A spokesman for California-based MedMen called the allegations contained in the suit “frivolous.”

The lawsuit could be a precursor of things to come in the emerging legal cannabis industry as more companies go public and become subject to greater disclosure requirements about their business dealings and the impact on shareholders.

The suit, filed Jan. 8 in California Superior Court in Los Angeles County, in part alleges that MedMen CEO Adam Bierman and President Andrew Modlin paid themselves millions of dollars through unlawful, “brazen self-dealing.”

“Beneath the MedMen veneer is a complex web of interconnected subsidiary entities, virtually all of which are directly managed, directed, controlled and owned by Bierman and Modlin, and all of which always pursue the best interests of Bierman and Modlin, rather than the best interests of any stakeholder or entity,” the suit charges.

The suit was filed by Inception Companies founders Brent Cox and Omar Mangalji through their investment entity MMMG-MC , which owns about 10% of a predecessor MedMen company.

The suit asks for $18 million in damages, plus another $1.8 million for Cox, who owned 1.3% of the same MedMen entity.

‘Backed into a corner’

“We have a long history with MedMen – as one of the largest and original shareholders of the company,” said Cox, who served on the board of the MedMen entity involved in the suit from March 2016 to March 2018. “Sadly, we are backed into a corner here and compelled to take action on behalf of all stakeholders of the company.”

Daniel Yi, MedMen’s senior vice president of corporate communications, in a statement called the claims “frivolous” and said the court on Wednesday denied the plaintiffs’ request for a temporary restraining order and preliminary injunction.

“Mr. Mangalji and Mr. Cox have already received cash distributions representing a complete return of their capital plus a substantial gain … This is clearly and egregiously an attempt to devalue the shares of the enterprise for their own personal gain at the expense of all other stakeholders.

“MedMen remains focused on building one of the leading cannabis companies in the world, and we feel confident we will prevail on that mission and against this meritless complaint.”

Proper disclosure considered key

California cannabis attorney Katy Young said the lawsuit “addresses a very significant issue for the still-nascent cannabis industry.”

“The existing concerns about self-dealing that exist whenever a company has a multi-entity structure (as MedMen and many other MJ companies do) are exacerbated by going public,” Young said.

There has to be proper disclosure, she added, and the decisions have to be reasonable and benefit shareholders.

MedMen went public in Canada in May 2018 through a reverse takeover.

Robert Mikos, a law professor and marijuana law expert at Vanderbilt University, noted that investor suits such as this are common in other industries.

“This lawsuit is probably just another sign that marijuana businesses are becoming more ‘mainstream’, which means they’re facing all the usual legal battles that businesses in other industries face,” Mikos said.

“It’s possible the number of such suits will increase, as outside investing becomes more common. But there’s no reason to suspect that such suits will become more prevalent in this industry than in others.”

Here are key points from the complaint, which follows a potential class action suit filed against MedMen in December by former employees:

Cox alleged that an initial critical event leading to the current situation occurred on March 17, 2017, when he tried to exercise a contractual right to acquire additional MedMen equity at an “advantageous price.” Bierman got angry, Cox claimed in the suit, and threatened to “do everything in his power” to make the MedMen entity that the plaintiffs had a stake in the least valuable part of the company.

And that’s exactly what’s happened since, the suit alleged. The plaintiffs claim they’ve been treated worse than other investors, both before MedMen went public and after. The suit alleges that Bierman and Modlin have locked up the plaintiffs’ shares in MedMen until November 2019 while allowing other investors to partially cash out their investments. (MedMen said in its statement that some investor groups negotiated separate lockup periods – a common practice when companies go public – but added that two other funds now are under certain lockup provisions until November 2019.)

Bierman and Modlin paid themselves multimillion-dollar bonuses and salaries, the lawsuit alleges, while MedMen burned through cash and reported “breathtaking” losses that totaled $145 million over six months. For example, the suit claims that Bierman and Modlin inflated MedMen’s enterprise value in the fall of 2018 in connection with equity financing deals and a $682 million acquisition of PharmaCann in order to trigger $4 million cash bonuses.

MedMen sought equity financing in September and October 2018, allegedly to address “acute liquidity challenges.” That included selling 13.6 million shares to Eight Capital for 75 million Canadian dollars ($56.7 million) and agreeing to a loan of CA$99.9 million ($75 million) from Hankey Capital at a 7.5% annual interest rate.

MedMen is traded on the Canadian Securities Exchange as MMEN and on the U.S. over-the-counter market as MMNFF.

Jeff Smith can be reached at t [email protected]