An OpenAI-Inspired Nonprofit Law Story – Part Two

This post continues the story from Part One and is inspired by some of the drama involving OpenAI.

In Part One, the board of a nonprofit that also served as the manager of a joint venture (JV) with several investors was dealing with a dilemma. On one hand they wanted to pursue their original and charitable goal of producing and distributing a documentary on the dangers of vaping. On the other hand, they were dealing with pressure from the investors in the JV and the filmmaker to convert the documentary into a commercial film with a weak connection to the nonprofit’s mission.

Charitable Trust

If the documentary was housed in the nonprofit, then the nonprofit board members would need to take actions consistent with furthering the organization’s charitable mission. The mission is determined primarily by reviewing the nonprofit’s governing documents (e.g., articles of incorporation and bylaws), but its public representations on governmental filings (e.g., Form 990), website, and solicitations are also relevant. In this case, however, the documentary is not housed in the nonprofit. It’s housed in a for-profit JV in which the nonprofit may be the founder but is currently a minority owner.

Unlike the case with a charitable nonprofit, the owners of a for-profit entity, particularly a limited liability company (LLC), may be able to determine and freely change the entity’s goals and limitations. If the intellectual property (IP) related to the film was housed an a typical for-profit, the board could change direction from producing a documentary to producing a commercial film. Here, however, the JV possessed some valuable assets held in charitable trust. That is, some of the assets were produced with charitable funds and can only be used for the charitable purposes for which they were raised. This holds true even if they were contributed to the JV (unless the for-profit provided fair market value in exchange for these assets, which was not the case here).

Because key assets used to develop the intellectual property are held under charitable trust, the nonprofit should have safeguarded use of those assets, ensuring that the JV could only use those assets to further the nonprofit’s charitable purposes and only incidentally any other purposes. The nonprofit did this through:

  1. provisions in the JV’s organizing and governing documents, which were shared with all of the JV’s investors before they made their investments; and
  2. selecting the nonprofit to serve as manager of the JV, essentially making the nonprofit’s board members concurrently the fiduciaries of the JV.

Of course, the owners of the JV might be able to change its organizing and governing documents, but the nonprofit should have ensured that they could not be changed without the nonprofit’s approval, which would ultimately come from the nonprofit’s board.

The nonprofit board members might be viewed as having two legal roles: (1) serving as fiduciaries of the nonprofit in protecting the charitable assets they transferred to the JV, and (2) serving as fiduciaries of the governing body that must advance the JV’s purposes as expressed in its governing and operating documents. If the purposes are precisely aligned, that may make the board members’ duties easier. Conversely, if the purposes may be viewed as conflicting – for example, if the JV’s purposes are also to commercially distribute the film to allow it to have the biggest audience reach – then the board members may need to consider some difficult decisions. The following may be possible options, depending on the structure and provisions of the existing governing and operating documents and agreements.

Option 1

The nonprofit board could hold fast and tell the other JV owners that the JV will produce the documentary even if that precludes also producing a commercial film using some of the same footage. While such action may be consistent with the restriction impressed on the IP contributed by the nonprofit, it might also result in the loss of support from the other owners and the filmmaker. Such loss and any ancillary consequences might end up harming the nonprofit and its ability to further its mission even if the documentary is produced and distributed.

Option 2

The nonprofit board could instead sell its stake in the JV for its fair market value. Because the JV is a closely held company, a valuation might be difficult and subject to complex negotiation. But it may be possible for the nonprofit board to negotiate (1) a fixed payment, (2) points on the back end, (3) mission-related messaging with the end credits, and (4) rights to some footage to be used to produce a documentary some time after the commercial film is released. In such case, the parties would presumably replace the nonprofit or its board as the manager or fiduciaries of the JV.

Valuation of IP assets can be challenging where their value may have been increased using charitable funds. For example, the amount expended to create the IP (e.g., $2 million) may not represent its true market value if the developed IP is considered to have much higher value, which appears to be the case here. The monetary value of the developed IP if used only to produce the documentary may not be very high, but the value of the developed IP if used commercially may be much higher. In such case, the nonprofit board has a legal responsibility to get the IP’s fair market value based on whatever restrictions may or may not apply. Consequently, if the nonprofit sells its share of the JV, then the nonprofit should demand significantly more than the $2 million investment it made in the IP if the IP now has much higher value. Fair, arm’s-length negotiations would be a required part of the process for finalizing a price.

Option 3

The nonprofit board could initiate a change to the JV’s governing and operating documents to remove itself as the manager but remain an owner. In such case, it would need to ensure the appropriate restrictions remain on the IP it contributed or receive fair market value for such assets. This might include an agreement to (1) create the documentary separate from the commercial film, (2) have editing rights to all messaging in the commercial film pertaining to the use of e-cigarettes, and (3) sponsor an anti-vaping campaign. As a co-owner of the JV, the nonprofit may still be able to participate in any profit-sharing.

What About the Donor?

In our story, an individual who recently lost their child to throat cancer donated $2 million specifically to fund the production of a film on the dangers of vaping. This created a legal restriction on how the $2 million could be used. Subsequently, a documentary film was produced with the $2 million. The restriction on the $2 million became a restriction on the IP produced with such donated funds. The nonprofit board could therefore be seen as having a legal duty to ensure that such IP is used consistent with the restricted purpose.

However, assuming the restriction was no more restricted than described in the preceding paragraph, the nonprofit board may have more options, including those previously discussed. However, ultimately, the $2 million donated by the donor or any products resulting from such funds, whether the original film produced or some subsequent produced film with the proceeds of selling the IP associated with the original film, must be used to produce a documentary film on the topic originally funded.

Additional Resources

Nonprofit Joint Ventures: Basics

Private Benefit in Tandem Structures (Perlman + Perlman)

Charitable Trust Doctrine