First class action filed in the world of crowdfunding

An investor in the crowdfunding campaign of a company that developed a digital pen claimed in a motion for class action certification that the company had not supplied the pen as it had promised – and it should therefore return the money and compensate the group  The company argued that this was not a consumer transaction  In light of the court’s recommendation, the plaintiff withdrew his motion

20.09.18 | Efrat Neuman

The idea behind crowdfunding on the Internet is a simple one: Many private individuals each give a small amount of money and together the funding helps in the financing of ventures, businesses and organizations. Crowdfunding platforms have been used in recent years as an important financing tool for startups and young small businesses. In order to increase the chances of success of the round, the entrepreneur can offer investors “something” – this may be the product in its first version, a signed letter of thanks, or even participation in a film for which the money had been raised.

The innovative field also brings some interesting questions. One of them concerns the status of these small investors. For if they are promised a return for their investment, can it be said that there is a consumer transaction? Can an investor in a crowdfunding project file a motion for class action certification against the company raising the money, claiming that it did not fulfil its obligation to him?

This precedential question recently reached the courts. Although there was no was no ruling, or even a decision regarding certification of the motion for class action certification, the Judge, Hadas Ovadia, expressed her preliminary position that no consumer relationship exists with the crowdfunding participants. Following this, the plaintiff withdrew the application.

Participation of 188 dollars in the crowdfunding

In November 2017, Ziv Melamed filed a motion for class action certification against OTM Technologies, which raised funds through a crowdfunding campaign to develop Phree, a technological pen. This is a smart pen, which can be used to write on any surface and synchronize what is written with other technological products, such as PCs and tablets.

In mid-2015, the company raised its fundraising campaign on the Kickstarter website, raising about one million dollars in one and a half months. Kickstarter is one of the largest and most popular crowdfunding platforms in the world, providing a platform to many technology projects (but not only in this field), enabling them to raise money for development and production with the support of the public.

One of the entrepreneurs behind the company, Gilad Lederer, said in an interview he gave after the funding that 5,000 people had on average given the company 200 dollars each and that the crowdfunding campaign run by the company on the Internet was at that time one of the world’s most successful ever in the field of technology.

Melamed also participated in the crowdfunding and paid 188 dollars, an amount that includes the price of the pen plus delivery to Israel. In his motion for class action certification, he claimed that as part of the preliminary sale, the company committed to adapting the technological pen for mass production by February 2016, and to begin supplying the technological pen to members of the class action group in March-April 2016. But, in practice, it breached the undertaking and did not supply the product in that timeframe.

Until the day the suit was filed, the motion alleges, the company had still not completed adaptation of the pen, had not supplied it, and had even refused to refund to group members the money it had raised.

Melamed claimed that this was a contract to all intents and purposes, made between the group of payers and the company. Since it was breached, and since the company did not meet its obligations in a reasonable timeframe, and since there is no expected date for provision of the product, instruction should be given for the contract to be annulled, for the paid monies to be returned, and compensation made to group members.

There is no promise to supply the completed product

In the response filed by the company in April 2018, it emphasized that the matter was a precedential one, and wrote that the lawsuit deals with a relatively new field, which had only started to grow in recent years. It further stated that this field is not regulated by legislation, and that no lawsuit or motion for class action certification had been filed in a similar area.

The company claimed, first and foremost, that this is not a consumer transaction, and that in fact in the company’s books, the supporters’ money was entered as “participation in research and development expenses” and not as sales amounts.

“A person who participates in crowdfunding is someone who contributes to a project he wishes to support, and he does so without expectation of any return or, alternatively, out of expectation of a non-monetary return. Alongside the expectation of a return, there is also a risk that the expectation would not materialize and that the venture would not be implemented, or that delays, or even significant delays in its completion would occur. There is nothing in the financial support of a project that guarantees its success or that any consideration at all will be received, and certainly not with regard to the timing of completion of the venture or receipt of the return. Even when investing in the shares of a company, there is no guarantee that the company will distribute dividends to shareholders, and there is certainly no commitment regarding the date of any distribution. The matter is dependent on various factors that cannot possibly be foreseen,” it states.

The response also states that the petitioner, like the rest of the members of the group of contributors, supports a venture of the company that has not yet been completed and they are not consumers. “The supporters can be likened to donors. In return for their support they did not win shares in the respondent or any ownership whatsoever, but some of them are eligible to receive a ‘reward’ – meaning they are eligible to receive the product being developed by the respondent – if and when its development and its production are completed”.

In the hearing held in July before Judge Ovadia of the Central District Court, Attorney Menachem Abramowitz, of law firm Hamburger Evron & Co., who represented OTM Technologies, said that the technological pen is an innovative product that requires time for completion of the development process and that so far has no substitute in the market. According to him, the company is in negotiation with several large companies in an attempt to make the transition to mass production, and that the prototype exists and works. “It’s true that time has passed”, he added, “The people who are here continue to finance the company through owner loans. They wholeheartedly believe they will ultimately succeed – after 20 years – in getting this endeavor properly on track. The fact that a motion for class action certification has been served against the company is a priori a red flag to potential investors, and allegations such as fraud, non-disclosure and investor fraud do not help find the investor who will want to accompany the company and turn production into mass production”.

The company’s main shareholders also attended the discussion. One of them, Ofer Kinnorot, said that three months earlier the company had provided its most recent report to supporters on Kickstarter, in which it said that the entrepreneurs were holding discussions on production of the pen with various companies. It is a long process, and by their very nature, such talks are confidential.

During the discussion, the Judge expressed her preliminary position, whereby she is inclined to accept the company’s claims that this is not a case of a consumer relationship which would allow for a class action motion, but only support in a crowdfunding campaign. She said that it was more reasonable to say there is no promise on the part of the company to supply the finished product, but only a request for a financial donation that would help in its development – which sometimes succeeds, and sometimes does not. Based on her recommendation, the petitioner decided to withdraw the motion, and the Judge approved this, without laying costs on either of the parties.

When buying shares, the story changes

Abramowitz says that it may be that the fact that the company’s owners proved that they had made exceptional efforts to try to develop the product helped in the Judge’s decision. “All the shareholders have invested millions of shekels, and they still hope to complete the development. This is not fraud, but a company trying to meet its obligations. The pen already exists, and it works. Perhaps later on a crowdfunding motion will be made to the courts in which the conduct of the fundraising company is more problematic, and so more stringent rules may be created. In legal terms, this should not change anything, but we have already seen that there are differences in approaches between judges”.

The case of the digital pen relates to the classical model of crowdfunding. At the beginning of the year, crowdfunding in Israel received a significant boost, when the Securities Authority approved regulations allowing companies to raise money online from an unlimited number of investors, without the recruiting companies being obligated to publish a prospectus. This is crowdfunding for shares, also for those who are not qualified investors. Recruitment of funds will be carried out through crowdfunding platforms that meet the criteria set out in the provisions.

This raises the question as to whether in such a case it would also not be possible to file a motion for class action certification. Adv. Shaked Nissan-Cohen of law firm Hamburger Evron & Co., who represented the company together with Adv. Abramowitz, notes that in the case of the purchase of securities, the picture is different, since the moment one purchases shares, the Securities Law is applicable, and it, subject to meeting conditions, allows motions for class actions.

She said, “With the exception of purchasing securities, it is difficult to envisage cases where it will be possible to file a crowdfunding class action, because there are no relations between business and consumer”.