Wednesday, March 6, 2024

Musk, OpenAI, and the Internal Affairs Doctrine

Vital-sinkevich-k2iRpPpbKFY-unsplashOne thing that's particularly puzzling about Musk's suit against OpenAI is that he's bringing it in California. After all, OpenAI is incorporated under the laws of Delaware, so Delaware would seem a more apt jurisdiction to bring the suit in.

Of course, Musk has some history with Delaware courts, and may prefer to avoid them. Moreover, I suspect that he couldn't bring much of his suit in Delaware. In general, the ability to enforce nonprofit boards' fiduciary duties lies with the state Attorney General. In fact, for nonprofit corporations without member and with self-perpetuating boards of directors (such as OpenAI), generally "only the attorney general or a director has standing to sue" to enforce fiduciary duties. Delaware seems to follow this rule: the Chancery Court has acknowledged the rule that donors lack standing to enforce directors' fiduciary duties.

California might have a different rule, though. In line 134 of the complaint, Musk asserts that "[u]nder California law, Defendants owe fiduciary duties to Plaintiff, including a duty to use Plaintiff’s contributions for the purposes for which they were made." It cites to Cal. Bus. & Prof. Code § 17510.8, which provides that:

Notwithstanding any other provision of this article, there exists a fiduciary relationship between a charity or any person soliciting on behalf of a charity, and the person from whom a charitable contribution is being solicited. The acceptance of charitable contributions by a charity or any person soliciting on behalf of a charity establishes a charitable trust and a duty on the part of the charity and the person soliciting on behalf of the charity to use those charitable contributions for the declared charitable purposes for which they are sought. This section is declarative of existing trust law principles.

But, as my colleague Ann Lipton points out, the attorneys here hedged: the aren't sure that this provisions provides Musk with standing to sue. And it looks like her instinct may well be correct. Recently, a district court held that this provision didn't provide standing to sue; rather, by its terms it creates a fiduciary duty between a donor and a solicitor, but that fiduciary duty can only be enforced by "an action brought by the Attorney General or an authorized relator.”  

 And, of course, even if it gets passed this standing hurdle, it still has to deal with the internal affairs doctrine. That doctrine provides that "the management of the internal affairs of a corporation will be subject to the law of the state of incorporation." In the for-profit corporation world, it is an ineluctable part of the law. The internal affairs doctrine is mandated by constitutional principles and can only be ignored in the "rarest situations."

It's a little squishier in the nonprofit world. Some states apply the internal affairs doctrine to their nonprofits. Others haven't ruled on the question. And a handful of states, including California and New York, don't recognize the internal affairs doctrine when it comes to nonprofits. California, in fact, expressly claims oversight over foreign nonprofits that operate in the state (albeit through the Attorney General, so even if this derogation of the internal affairs doctrine is permissible, it may not help Musk). At the very least, if I were OpenAI, I would ask the Delaware courts to hold that they, not California, have exclusive jurisdiction to enforce the board's fiduciary duties.

All this to say (a) Musk may have some reasons to prefer that the litigation occur in California rather than Delaware, but (b) it's not clear that California is a good or a permissible choice for his litigation.

Samuel D. Brunson

Photo by Vital Sinkevich on Unsplash

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Big fan of the blog! Do you have a cite for the proposition that NY does not recognize the internal affairs doctrine for nonprofits?

Posted by: Rafi Stern | Apr 2, 2024 1:30:05 PM

Hi Rafi! I got the assertion from Peter Molk, Where Nonprofits Incorporate and Why It Matters, 108 Iowa L. Rev. 1781 (2023). Professor Molk refers to N.Y. Not-for-Profit Corp. Law § 1320 (McKinney), which lists at least three areas where New York will apply its own law to foreign nonprofits.

Hope that helps!

Posted by: Sam Brunson | Apr 2, 2024 2:57:16 PM

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