[The following post is contributed by Nikunj Agarwal, a 3rd year, B.A. LL.B. (Hons.) student at RML National Law University, and Arjun Agarwal, a 2nd year, B.A. LL.B. (Hons.) at W.B. National University of Juridical Sciences. They may be contacted at email@example.com
This post discusses the first legal proceeding by the Federal Trade Commission of United States with reference to crowdfunding. The case concerns breach of representations and promises by the campaigner and an alternate application of crowdfunding.]
In a first of its kind, the Federal Trade Commission (FTC) has initiated proceedings against the “creator” of a crowdfunding campaign for failure to “keep promises”. However, the FTC information does not discuss the liability of the crowdfunding portal in this case. The information on the FTC website quotes the standard that “consumers should be able to trust their money will actually be spent on the project they funded.”
In its complaint, the FTC charged Erik Chevalier, the Defendant, of activities with a crowdfunding campaign charging consumers for a product which was not delivered. The FTC applied to the District Court for Oregon to obtain “permanent injunctive relief, rescission or reformation of contracts, restitution, the refund of monies paid, disgorgement of ill-gotten monies, and other equitable relief” for the Defendant’s acts or practices in violation of Section 5(a) of FTC Act. Section 5(a) of FTC Act prohibits “unfair or deceptive acts or practices in or affecting commerce.”
The substance of the case is primarily that the Campaigner-Defendant launched a crowdfunding campaign on the popular crowdfunding portal Kickstarter and offered to launch a game. He represented that if certain threshold funding amount was collected, the contributors (or “backers”) would receive certain rewards in return of their funding. The project received more than thrice the reserved threshold amount, and therefore the contributors expected a reward in return.
However, after 14 months, the Campaigner-Defendant announced that he was canceling the project and represented to refund the contributors’ money. However, as noted in paragraph 26 of the complaint, the Defendant never returned the money. Further, investigations revealed that the funds were used for purposes other than the gaming project.
Thus, this case involves an important litmus test for campaigner’s liability to its contributors. The case also brings to the surface the longstanding concerns to ensure accountability of the campaigners towards its contributors to use the funds only for the represented purposes.
But this case does not provide all the answers. In the case at hand, reward-based crowdfunding was used. What would be the outcome of a case where, under similar facts, ‘donation based crowdfunding’ is used? Can we still apply the legal standard that “consumers should be able to trust their money will actually be spent on the project they funded”?
It is submitted that the contributors in a reward based system and in a donation based system of crowdfunding should be given similar, if not same, protection. The object of the law is not limited to enforcing promises but in the larger context to protecting the interest of the participants and to eliminating fraudulent activities. Not providing sufficient legal empowerment to contributors in a donation based system of crowdfunding can encourage fraudulent pooling of money through this means. Further, such a regulatory gap can even be detrimental to the object of the law in providing protection to contributors in a reward based system of crowdfunding, which is not restricted to providing contributors the promised rewards but also to discouraging and punishing any wrongful deviation from the representations made.
Apart from ethical considerations, there are also legal compulsions in providing similar protection to donors. The facts of the present case involve a “reward”, which acts as a form of consideration. But, when such consideration is absent, such as in a donation based crowdfunding, there is no incentive left to the contributor, except that the purported object of donation is achieved and funds applied towards it. Therefore, the law must deem an agreement between the donor-contributor and the campaigner that the proceeds from the campaign shall be applied only towards the represented purposes.
For providing protection, under the standard set out by FTC, to the contributors in a donation based system, the first issue to arise would be about definition of a “consumer”. Can we say that “donors” are consumers for the purposes of this standard? If yes, then the rule can be extended to cover representations made to the contributor in a donation based crowdfunding. But, it is submitted that this would import unnecessary artificiality into the law. The laws must be as simple as they can be.
Another way of providing necessary protection to a contributor in a donation based crowdfunding is to read the legal standard as nothing else but the “doctrine of legitimate expectation”. On first principles, when a campaigner represents that the donated money would be used towards certain specific purposes, he must, in law be bound to use the money towards that very purpose only and none other. Use of money for any other purposes is in breach of the contributor’s expectations and beliefs about the venture she is funding.
Further, the law must restrain the liberty of the campaigner to use the contributed funds in any manner that is not towards the represented project. Since public money has been channelized, there must be an onerous responsibility towards the contributors. The issue raises concerns familiar to the jurisprudence of corporate governance and typical self-interest problems. It could be argued that the campaigner owed fiduciary duties to the contributors and therefore must not act in self interest in breach of these fiduciary duties.
“Crowdfund governance” is yet to consolidate into identifiable set of principles but, the established legal principles can sufficiently fill the regulatory vacuum. The doctrine of legitimate expectation can be made applicable to such circumstances to create positive duties of the fund campaigners and to provide ground rules for crowdfund governance.
The dispute fails to elaborate upon the duties of the crowdfunding portal. The information update on the FTC website briefly discusses “Best Practices” followed by certain portals and responsibility of prospective campaigners. But, no word has been said about the duties of the portals and the degree of their liability and the circumstances in which it can arise. An important question that needs to be answered: whether listing of best practices codes on its website can provide sufficient indemnity to the portal from any liability? It is submitted that crowdfunding portals are an integral part of the crowdfunding process and any norm or regulation for governance of crowdfunding is incomplete without clearly elaborating the responsibilities and the role of such portals.
(The case is Federal Trade Commission v Erik Chevalier: Case 3:15-cv-01029-AC: District Court for Oregon: Date: June 11, 2015)
- Nikunj Agarwal and Arjun Agarwal