Hello and welcome you are listening to Patrick Boyle on
Finance, a podcast exploring ideas from quantitative finance,
examining events occurring in markets right now and financial
history to see what lessons can be taken away, including
interviews with some of the most interesting people in the world
of finance. To learn more about the podcast,
visit on finance.org. Elon Musk filed a lawsuit last
week against Open AI and its CEO Sam Altman, alleging the
company's deal with Microsoft compromised the startup's
original mission. Musk is seeking disgorgement,
additional unspecified damages, and specific performance.
The lawsuit is quite interesting for a number of reasons, most of
which relate to the unusual corporate structure of Open AI,
which was founded as a tax exempt non profit, later
establishing a holding company that allowed it to take money
from investors in a capped profit subsidiary.
The investors in the capped profit subsidiary are not
entitled to board seats as they would be in a normal
corporation, and the profits returned to investors are capped
at 100 times the amount investors initially put in,
which many would view as a decent return on investment.
But it is still a capped return. Investors in the for profit
subsidiary were amusingly warned when investing it would be wise
to view any investment in Open AI Global LLC in the spirit of a
donation, with the understanding that it may be difficult to know
what role money will play in a post AGI world.
This is quite unusual. In essence, this is a breach of
contract lawsuit, but surprisingly, no actual contract
appears to exist, which can make things complicated.
The fact that the lawsuit was filed in California is also
surprising as it names 8 Delaware registered corporate
entities as defendants, and so you would expect the suit to be
filed in Delaware. The fact that it's not probably
relates to Musk's anger with the Delaware court system.
Musk's lawsuit asks the court for judicial determination that
Open A is GPT 4 software constitutes artificial general
intelligence, or AGI. There is, of course, no legal
definition for artificial general intelligence, which
might make this difficult. The suit requests trial by jury,
which means that a jury would be expected to decide on this topic
if it went trial. The lawsuit accuses Open AI of
breach of fiduciary duty to mask as a donor, but then in other
parts of the lawsuit says that the board's sole fiduciary duty
is to humanity. I guess in mathematical terms,
Set A is humanity and Set B is Elon Musk, and Set B is a very
clear subset of Set A, so maybe they do owe him a fiduciary duty
as part of humanity. I'm happy to send this diagram
to Musk's lawyers and to appear as an expert witness if needed
for a small fee. There is a section accusing Open
AI of unfair business practices and unfair competition which
doesn't describe any business practices or competitive
behaviour, but which concludes that the plaintiff is entitled
to restitution and or disgorgement of any or all
monies received by the defendants while Open AI engaged
in such practices. The lawsuit does however make a
very interesting point relating to tax policy and corporate
structure. It argues that if a company can
launch as a nonprofit working for the public benefit and can
collect pre tax donations later, transferring the IP into a for
profit venture once it's become useful, Every startup will do
this going forward. The lawsuit points out that for
every dollar that an investor invests by contributing to a non
profit, that investor gets approximately $0.50 back from
the state and federal governments in the form of
reduced income taxes. So the net cost to investors of
each $1.00 of investment is only $0.50.
That is an attractive way to invest if it is allowed.
The complaint argues that if the court validates open AI's
conduct, every startup will follow this playbook to the
detriment of legitimate nonprofits, the government's tax
coffers, and ultimately, the people of California and beyond.
So humanity, I guess. So let's go through these claims
1 by 1, see what legal experts have been saying about the case.
And we'll also discuss the Open AI memo saying that the claims
in this lawsuit stem from Elon's regrets about not being involved
in the company today, and the emails they released showing
Musk initially supported the plan to create a for profit
entity and wanted a merger that would make Tesla its cash cow.
Let's start with the breach of contract claims.
One of the biggest problems with the breach of contract claims in
this lawsuit is that no actual contract exists.
The lawsuit mentions the founding agreement 32 times, but
no founding agreement actually exists.
Instead, the lawsuit tells us that the founding agreement must
be inferred from various emails and conversations between the
founders text from the website of Open AI and the Delaware
Certificate of Incorporation. The Delaware Certificate of
Incorporation is even included as Exhibit One and is referenced
in the lawsuit as being part of the founding agreement.
A Certificate of incorporation is unfortunately not a contract.
It's a document that you file with a state in order to
incorporate a corporation. Musk didn't sign this
certificate and it gave him no rights as a shareholder.
Because there are no shareholders in a nonprofit
organization. It actually states that on the
certificate. Exhibit 2 of the lawsuit is an
e-mail exchange between Altman and Musk with five bullet
points, which include questions like will you be involved
somehow in addition to just governance?
And ideally you'd come by and talk to them about progress once
a month or whatever. There's no mention of money
anywhere in the exchange, Musk replied to Altman's e-mail with.
Agree on all It's unlikely that a court would see this as being
a contract, and even if they did, it's not obvious how it
supports Musk's claims. I should add in, for the sake of
completeness, that on page seven of the complaint it says that in
2023 the defendants set the founding agreement aflame.
Which is most likely a metaphor, but who knows?
Maybe the reason Musk has not presented anything that looks
like a contract is that it was set aflame last year.
I feel that the Lord should aim to write with greater clarity
than that with regard to the lawsuit being filed in
California rather than Delaware. Anne Lipton of Tulane University
writes in her Business law Blog that must claims that he has a
contract formed under California law that allows him to dictate
the governance choices of a Delaware organized non stock
corporation and further that a California court should order
this Delaware corporation to conduct itself in accordance
with his contract. She goes on to explain that Open
AI as a nonprofit is subject to jurisdiction not only of the
Attorney General of the state of its organization, but also the
Attorneys General of the state where it operates.
Musk is not an Attorney General and thus can't bring charges
that a nonprofit violated the legal rules governing nonprofits
in California. Possibly for this reason, he's
instead claiming A contractual right to dictate the governance
of a Delaware organized non-stop corporation.
Lipton argues that if Open AI wanted to take this as a serious
threat, it could file a declaratory judgement action in
Delaware to the effect that these contracts, if they even
exist, are in fact contracts concerning internal affairs
matters governed by Delaware law.
And under Delaware law, at least at the corporate level, they are
illegal intrusions into the board's authority.
Jeremy Tellman from Oklahoma City University School of Law
highlights on his blog that with respect to these claims, Mr.
Musk seeks unspecified damages but also specific performance of
the alleged contractual or non contractual promises.
While Open AI and Microsoft could refund Musk's investment
and pay any damages claimed, specific performance is a big
ask. According to Tellman.
Specific performance means the court requiring Open AI to
fulfill their contractual obligations, Telman writes.
I don't see a court ordering a company to work for the
betterment of humanity. To quote the lawsuit, in
addition to discouragement and damages, Musk seeks specific
performance in the form of. One, an order requiring that
defendants continue to follow Open AIS, long standing practice
of making AI research and technology developed at Open AI
available to the public. And two, an order prohibiting
defendants from utilizing Open AI, Inc or its assets for the
financial benefit of the individual defendants,
Microsoft, or any other particular person or entity.
So if this was granted, Open AI would be required to release all
of their work to the public and continue working without any
financial benefit. In a rather funny article on The
Verge, Nilay Patel dismisses the entire complaint as a nuisance
lawsuit that's likely to be dismissed by the court.
He writes that Musk's lawyers have figured out that letting
the world's richest man rack up billable hours filing
nonsensical lawsuits is more lucrative than fitting the facts
to the law or whatever it is that regular lawyers do.
He writes that the breach of contract claim admits that the
founding agreement is basically a vibe everyone caught in some
emails moving on from the breach of contract claims.
The breach of fiduciary duty claim doesn't hold much water
either. The Supreme Court clarified in
Atherton versus FDIC that under the internal affairs doctrine,
the law of the state of incorporation of the
organization is the applicable law regarding the fiduciary
duties of corporate directors and officers.
So this part of the case would need to be litigated in
Delaware, not in California. Under Delaware case law,
directors are charged with an unyielding fiduciary duty to
protect the interests of the corporation and to act in the
best interests of its members. As I mentioned earlier, there
are no members or shareholders in a Delaware nonprofit
corporation and thus the board has no fiduciary duty to mask.
The Financial Times wrote in an article on Thursday that the
lawsuit reads like a mash up between a science fiction film
script and a letter from a jilted lover.
The section on unfair business practices is confusing.
It doesn't describe any business practices or competitive
behaviours, but it does say that the practices deceived Musk and
are likely to deceive other members of the public.
The most interesting part of the lawsuit, as I mentioned earlier,
is the section on how availing of tax breaks by launching as a
non profit before transferring the IP into a for profit venture
once the technology has been proved if allowed, would mean
that all startups would follow this path.
I don't know if a California court can judge on this, but it
does appear to be quite a tax loophole that other startups
could possibly exploit. Sometimes companies find and
exploit tax loopholes, and if a government decides not to close
them up, they go on to become the way things are done going
forward. the US government might decide that they're happy to
allow this loophole in order to incentivize investment in
startups. The four O 1K retirement plan
came about when Hughes Aircraft Company used a loophole in the
IRS Revenue Code to convert its after tax savings plan into what
we now call a Four O 1K plan. While Musk has highlighted this
issue in his lawsuit, I don't believe the California court
will decide on an issue like this.
But the press around this lawsuit may draw the attention
of the Office of Tax Policy. In the wake of the lawsuit, Open
AI Chief Strategy Officer Jason Kwan wrote an internal memo,
which has been seen by numerous press organizations, which said
we believe the claims in this suit may stem from Elon's
regrets about not being involved with the company.
Today Open AI disputes Musk's version of events and is moved
to dismiss his legal claims. In a blog post this Tuesday,
Open AI's Co founders released a number of emails sent by Elon
Musk which showed that Musk had supported Open AI's move to
create a for profit business entity and had even wanted to
fold the company into Tesla, the blog post says.
In late 2017, we and Elon decided the next step for the
mission was to create a for profit entity.
Elon wanted majority equity, initial board control and to be
CEO. In the middle of these
discussions, he withheld funding.
Reed Hoffman bridged the gap to cover salaries and operations in
one of the released emails. Musk discouraged making the
research freely available, saying if you can't seriously
compete but continue to do research in the open, you might
in fact be making things worse and helping them, meaning Google
out for free because any advances are fairly easy for
them to copy and immediately incorporate at scale in the same
2018 e-mail, he writes. A for profit pivot might create
a more sustainable revenue stream over time and would, with
the current team, likely bring in a lot of investment.
He goes on to say the most promising option I can think of,
as I mentioned earlier, would be for Open AI to attach to Tesla
as its cash cow. The Open AI founders claim that
Elon soon chose to leave Open AI, saying that our probability
of success was 0 and that he planned to build an AGI
competitor within Tesla. When he left in late February
2018, he told our team he was supportive of us finding our own
path to raising billions of dollars.
Musk's lawsuit is asking the court to return his donations,
pay him damages, and for an order forcing Open AI to release
all of their source code into the public domain and end
Microsoft's exclusive license agreement.
The court will of course be aware that Musk runs a competing
for profit artificial intelligence company called XAI,
along with other companies that claim to use artificial
intelligence like Tesla and Twitter.
Matt Levine at Bloomberg points out that Musk's protests about
Open AIS unseemly pursued of AI profit for investors looks a
little insincere since he's doing the exact same thing at
his other firms. The Centre for AI Policy wrote
in an open letter on their website that it's possible that
Musk is simply tech washing and creating chaos in the
marketplace. The unusual corporate structure
of Open AI has allowed Microsoft to put billions of dollars into
the company over the last several years.
Open AI is using Microsoft's computing resources to develop
its technology and Microsoft is integrating Open AI services
into its core products. Microsoft has been able to do
this without attracting antitrust scrutiny as they claim
to not exercise any control over the limited for profit company
controlled by a non profit organization.
That lack of control has since been called into question after
Microsoft stepped in when Sam Altman was fired late last year.
The Justice Department and the Federal Trade Commission are now
reported to be deep in discussions over which agency
can probe Microsoft's involvement with Open AI on
antitrust grounds. The relationship between the two
firms has additionally drawn scrutiny from the UK's
Competition and Markets Authority and the European
Commission. I'm not sure that Musk's lawsuit
will lead to much. Noah Feldman, a professor at
Harvard Law School, told the New York Times that the contract
Musk claims Open AI and the Altman breached contains a hole
you can drive a truck through. Open AI Certificate of
Incorporation, which Musk's lawyers claim is part of the
founding agreement, says the AI maker will seek to open its work
to the public for its benefit when applicable.
And Open AI can easily argue that it is adhering to this
term, which is vague. While the lawsuit itself may not
be awfully interesting, it does highlight the unusual structure
of Open AI, which has all sorts of tax and antitrust
implications which are of great interest in corporate finance.
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