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The S&A Insider

Welcome to our new blog - the S&A Insider. From time to time we will be sharing information about different topics relevant to our practice and our clients, which we hope you find interesting. Chris drafted our inaugural blog post - it is on a topic you likely have come across scrolling past ads on your Facebook account.

If you have any suggestions for a blog post topic, please feel free to e-mail Chris at clm@sacounsel.com

I Supported a Bankrupt Crowdfunding Campaign; Now What?

by Chris Muniz
October 23, 2017

Most of us have seen crowdfunding efforts of emerging companies on sites like Kickstarter. Heck, I’ve even contributed to a few myself: I now own a travel jacket with more pockets than a mob of kangaroos, while my wife drinks her coffee out of something that looks like it belongs on Hyperloop One1. And while my biggest complaints about crowdfunding have been poor communication and overly optimistic production dates, I have luckily avoided those businesses that failed without providing their backers with any product whatsoever.

Unfortunately, the same cannot be said for those who contributed to the Skully motorcycle helmet campaign on Indiegogo, a popular crowdfunding site. In October, 2016, Skully, Inc. filed a chapter 7 bankruptcy petition in the United States Bankruptcy Court for the Northern District of California2 . Among the creditors listed on Skully’s bankruptcy schedules were 1,297 individuals who contributed anywhere from $499 to $2,649 to Skully’s Indiegogo campaign in exchange for a promised “augmented reality” motorcycle helmet. The question that arises is: what type of claim might these individuals have against Skully?

Section 507(a)(7) of the United States Bankruptcy Code (the “Code”), 11 U.S.C. §507(a)(7), allows a priority status for “unsecured claims of individuals, to the extent of $2,850 for each such individual, arising from the deposit, before the commencement of the case, of money in connection with the purchase, lease, or rental of property, or the purchase of services, for the personal, family, or household use of such individuals, that were not delivered or provided.” As set forth within the legislative history of this Code provision, “[t]he purpose of this priority is to protect consumers who leave a deposit or lay merchandise away, and who do not receive the merchandise from the retailer who files a petition.” H.R. Rep. No. 595, 95th Cong., 1st Sess. 188 (1977).

While it is unimaginable that the drafters of this Code section contemplated the crowdfunding phenomenon, let alone the internet, 40 years ago (and how many people under the age of 20 even know what layaway is!), their intent – to protect consumers who make a deposit but do not receive their goods or services before the filing of a bankruptcy petition – remains significant to this day.

How is this relevant? Claims in bankruptcy are paid pursuant to what is called a priority scheme. Generally speaking, the priority scheme provides that holders of secured claims (creditors holding liens against property of the estate) get paid first. Next in line are holders of one of ten descending categories of priority claims3 . Lastly, non-priority, unsecured creditors get the remainder of estate proceeds, if any.

By way of example, a window replacement company files for bankruptcy after accepting a $5,000 deposit from an individual customer but before providing the goods (windows) and services (replacement). In the event there is money remaining for creditors following payment in full of all secured claims and the first six categories of priority claims, the window company’s customer4 may receive up to $2,850 of the deposit paid as a priority claim, with the remaining $2,150 paid as a non-priority claim.

Unlike the window company customer, section 507(a)(7) is of no benefit to the Skully crowdfunders5. “The two limitations imposed on those seeking priority distribution under section 507(a)(7) are (1) that the claim arise from the deposit of money and (2) that the services or goods remained undelivered.” Marshack v. Hammond (In re Four Star Fin. Servs., LLC), 469 B.R. 30, 32 (C.D. Cal. 2012). While there is no doubt Skully did not deliver helmets, the claims of its crowdfunders do not arise from the deposit of money. That is because the Skully crowdfunders made what are considered to be reward-based contributions; they did not actually purchase goods, but rather were offered a reward in exchange for a donation. This is confirmed within the fine print of Indiegogo’s Terms of Use, which provides that “Indiegogo is an online crowdfunding venue for people and entities seeking to raise funds for their own Campaigns and to contribute to the Campaigns of others. Campaign Owners can offer gifts or rewards in the form of tangible items or intangible services (collectively, "Perks") to Contributors. Perks are not offered for sale.” 6

While this might not be a distinction the Skully enthusiasts cared about at the time of their contribution, they certainly did once their “reward” failed to arrive. And it is this distinction – a contribution rather than a deposit for a good or service – that renders section 507(a)(7) inapplicable to crowdfunding creditors. At best those creditors can assert a non-priority, unsecured claim.

Postscript:
While it is unlikely that Skully, Inc.’s unsecured creditors will receive a dividend in that bankruptcy case, a new entity by the name of Skully Technologies appears interested in reviving the motorcycle helmet production. On October 16, 2017, Skully Technologies began collecting information towards its stated goal “to make it right with those of you who contributed toward an original SKULLY helmet and never received one.”7

What is your best or worst crowdfunding story?


1A futuristic mode of cargo and passenger transport renamed Virgin Hyperloop One as of October 12, 2017.
2Case No. 16-31113.
3Deposit claims are seventh in the order of priority claims; see 11 U.S.C. §507(a).
4Assuming the customer filed a proof of claim of course.
5Interestingly, Skully offered its helmets direct to consumer upon the completion of its Indiegogo campaign. As a result, Skully lists those 1,895 creditors as holding priority claims, presumably pursuant to section 507(a)(7) (as no subsection is specified on Skully’s schedules) in a total sum exceeding $3,000,000.
6https://www.indiegogo.com/about/terms
7http://skullytechnologies.com/vip/makeitrightcampaign/#