Crowdfunding Entrepreneurs Beware; You Might Have to do Stuff

Anyone whose parent is not on the board of a bank knows that getting a small business loan is not the simplest process.  Banks owe a duty to their depositors (and to the Federal Deposit Insurance Corporation) to exercise due diligence before making a loan to perspective creditors and, as such, must evaluate the creditworthiness of those creditors.  These evaluations often involve an analysis of the creditor’s borrowing and repayment history, evidence of the business’s monthly cash flows, a balance sheet showing other outstanding loans, and may require the business owner to personally guarantee the loan on behalf of his business.  In addition to the personal fitness requirements of the borrower to repay the loan the lender may, in some cases, sue the borrower if the money being lent is not used for its intended purpose.

Contrast these requirements with money raised through a crowdfunding campaign, and you would suspect that crowdfunding entrepreneurs are merely artistic types who are displaying their creativity on crowdfunding platforms as a means of seeking compensation for being clever.  Campaigns that support this suspicion include the potato salad that raised $55 thousand, and the “Cloud Project” that raised $7 thousand  for the purpose of “[hiring] a man in a plane to write stupid things with clouds in the sky.”  Now, you may ask yourself (or you may not because, who cares) what happens if these “entrepreneurs” don’t make potato salad, or don’t “write stupid things with clouds in the sky?”  Will the backers of these noble endeavors have both the right to demand that their money be returned, and the courage to admit to the public that they donated to these projects?  The latter part of the question is up in the air, but as for the former part of the question, it’s beginning to look that way.

A default judgment issued by the King County Superior Court in Washington State will go down in the history books as the first court order requiring a crowdfunding campaigner to pay civil penalties for not honoring the promises it made to backers of the campaign.  The judgment, totaling $54,851.29 in restitution and penalties, is against Altius Management, a campaigner that promised 810 individuals who donated a total of $25,146 to the campaign that it would use those funds to develop “horror themed” playing cards.  As an added bonus, many of the backers were promised their own deck of cards upon completion of the project with an estimated delivery date of December, 2012, just in time for the holiday season.  As of July of this year (it’s 2015 by the way), not a single backer who was a party to this judgment has received any “of their promised rewards” according to the court filing.

It should be noted that in order to benefit from this judgment, you would have had to have been one of the 31 backers, of the 810 nationwide, who live in King County, Washington.  This means that we should hope to expect to hear 779 other individuals from various other parts of the country voicing their displeasure with Altius by way of a formal complaint to their respective state’s court.  But they better get in while they still can, because of the nearly $55 thousand judgment levied against Altius Management, only about $700 of it was actually restitution to be returned to the backers of the campaign.  In other words, the state of Washington is levying what amounts to a $54 thousand penalty (fines and attorney’s fees) against Altius for allegedly swindling its residents out of $700.  If other states take the same approach, Altius (assuming they even have enough to pay the fines from this judgment) will likely not be long for this world.

This judgment comes on the heels of a settlement earlier this year between the Federal Trade Commission and crowdfunding campaigner Erik Chevalier.  Mr. Chevalier was ordered to repay the approximately 1,200 backers the $122 thousand he received from them for the purpose of developing a board game (yes, it was a horror themed board game).  Though Mr. Chevalier pleaded with regulators that he sincerely tried to get this project completed, and never intended to defraud backers, the FTC didn’t see it that way.  Not surprisingly, this settlement has been suspended because of Mr. Chevalier’s inability to pay.

Does it seem unlikely to anyone else that crowdfunding has been around for approximately 10 years now and these are the first two campaigns that broke their promises to backers?  So why bring the hammer down now?  Well, this could be a bit of cleaning house before the in-laws get here.  As the highly anticipated final rules from the Securities and Exchange Commission regarding the crowdfunding portion of the JOBS Act are hopefully upon us, a bit of house cleaning may be necessary to instill confidence in investors that crowdfunding is a relatively safe and adequately regulated platform for investing.  It could also be argued that this is just a matter of regulators catching up to new technologies, and finally giving adequate weight to transactions that probably left them befuddled on first approach (I’m looking at you potato salad).  Regardless of the reason for these new developments, one thing is for sure, entrepreneurs who are interested in using crowdfunding as a means of raising capital had better keep their promises.

posted by Jon Mayhugh, Clinic Fellow