Duty of a Crowdfund Campaigner towards Contributors

[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 protected].
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.”
I
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.
II
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.
III
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.
IV
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

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

2 comments

  • “But consumers should be able to trust their money will actually be spent on the project they funded.”

    Sporadic: Is this not nothing different from what has been happening all around, all the time; but thanks to the gullibility or imbecility or wanton ignorance , on the part of most of the customers, – not barring government departments- due to which the irregularity /illegality has come to stay as a part of the game, hence happens to be over sighted and not objected to any seriously? To readily think of an instance, in our own country, promoters of any building or other private or public projects , soon after signing a contract agreement, are, as agreed but unwittingly as a matter of routine, given a sumptuous / disproportionately large amounts , as ‘advance’. But, there is invariably no check or control, or monitoring, over the actual utilisation of the collections in advance by the contractor for the particular project for which the monies are advanced. This is an ongoing practice for decades in the notorious realty sector. It is only lately that in the specially designed regulatory enactment for realty sector , -mooted but with no known development or noticeable progress ,- that the mechanism of ‘escrow account’ is sought to be brought in. Of course, the success or otherwise thereof, if and when enacted, as is anybody’s guess, in turn is again going to wholly upon vigilant and sincere monitoring.

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