# Elon Musk Vs. OpenAI - The Lawsuit

An episode of [Patrick Boyle On Finance](https://invisiblenetwork.ai/podcast/1547740313), 8 Mar 2024, 21 min.

Audio: https://anchor.fm/s/fc0914e0/podcast/play/92761846/https%3A%2F%2Fd3ctxlq1ktw2nl.cloudfront.net%2Fstaging%2F2024-9-8%2F387759609-44100-1-7f83317001aa4ba0.mp3

Send us a textElon Musk filed a lawsuit last week against OpenAI and its CEO Sam Altman, alleging the company’s deal with Microsoft compromised the start-up’s original mission. Musk is seeking disgorgement, additional unspecified damages and specific performance. Let’s go through these claims one by one, see what legal experts have been saying about the case. We will also discuss the Open AI memo saying that the claims in this lawsuit suit stem from Elon’s regrets about not being i...

## Transcript

[0:00] Hello and welcome you are listening to Patrick Boyle on
[0:03] Finance, a podcast exploring ideas from quantitative finance,
[0:08] examining events occurring in markets right now and financial
[0:11] history to see what lessons can be taken away, including
[0:15] interviews with some of the most interesting people in the world
[0:18] of finance. To learn more about the podcast,
[0:20] visit on finance.org. Elon Musk filed a lawsuit last
[0:29] week against Open AI and its CEO Sam Altman, alleging the
[0:34] company's deal with Microsoft compromised the startup's
[0:38] original mission. Musk is seeking disgorgement,
[0:41] additional unspecified damages, and specific performance.
[0:46] The lawsuit is quite interesting for a number of reasons, most of
[0:50] which relate to the unusual corporate structure of Open AI,
[0:55] which was founded as a tax exempt non profit, later
[0:59] establishing a holding company that allowed it to take money
[1:03] from investors in a capped profit subsidiary.
[1:07] The investors in the capped profit subsidiary are not
[1:11] entitled to board seats as they would be in a normal
[1:14] corporation, and the profits returned to investors are capped
[1:19] at 100 times the amount investors initially put in,
[1:23] which many would view as a decent return on investment.
[1:28] But it is still a capped return. Investors in the for profit
[1:33] subsidiary were amusingly warned when investing it would be wise
[1:38] to view any investment in Open AI Global LLC in the spirit of a
[1:43] donation, with the understanding that it may be difficult to know
[1:47] what role money will play in a post AGI world.
[1:52] This is quite unusual. In essence, this is a breach of
[1:57] contract lawsuit, but surprisingly, no actual contract
[2:01] appears to exist, which can make things complicated.
[2:05] The fact that the lawsuit was filed in California is also
[2:09] surprising as it names 8 Delaware registered corporate
[2:13] entities as defendants, and so you would expect the suit to be
[2:17] filed in Delaware. The fact that it's not probably
[2:20] relates to Musk's anger with the Delaware court system.
[2:25] Musk's lawsuit asks the court for judicial determination that
[2:30] Open A is GPT 4 software constitutes artificial general
[2:36] intelligence, or AGI. There is, of course, no legal
[2:40] definition for artificial general intelligence, which
[2:44] might make this difficult. The suit requests trial by jury,
[2:49] which means that a jury would be expected to decide on this topic
[2:53] if it went trial. The lawsuit accuses Open AI of
[2:58] breach of fiduciary duty to mask as a donor, but then in other
[3:03] parts of the lawsuit says that the board's sole fiduciary duty
[3:07] is to humanity. I guess in mathematical terms,
[3:12] Set A is humanity and Set B is Elon Musk, and Set B is a very
[3:19] clear subset of Set A, so maybe they do owe him a fiduciary duty
[3:25] as part of humanity. I'm happy to send this diagram
[3:28] to Musk's lawyers and to appear as an expert witness if needed
[3:34] for a small fee. There is a section accusing Open
[3:39] AI of unfair business practices and unfair competition which
[3:44] doesn't describe any business practices or competitive
[3:48] behaviour, but which concludes that the plaintiff is entitled
[3:53] to restitution and or disgorgement of any or all
[3:57] monies received by the defendants while Open AI engaged
[4:02] in such practices. The lawsuit does however make a
[4:06] very interesting point relating to tax policy and corporate
[4:09] structure. It argues that if a company can
[4:12] launch as a nonprofit working for the public benefit and can
[4:17] collect pre tax donations later, transferring the IP into a for
[4:22] profit venture once it's become useful, Every startup will do
[4:27] this going forward. The lawsuit points out that for
[4:30] every dollar that an investor invests by contributing to a non
[4:35] profit, that investor gets approximately $0.50 back from
[4:39] the state and federal governments in the form of
[4:42] reduced income taxes. So the net cost to investors of
[4:47] each $1.00 of investment is only $0.50.
[4:50] That is an attractive way to invest if it is allowed.
[4:55] The complaint argues that if the court validates open AI's
[4:59] conduct, every startup will follow this playbook to the
[5:03] detriment of legitimate nonprofits, the government's tax
[5:07] coffers, and ultimately, the people of California and beyond.
[5:12] So humanity, I guess. So let's go through these claims
[5:17] 1 by 1, see what legal experts have been saying about the case.
[5:22] And we'll also discuss the Open AI memo saying that the claims
[5:26] in this lawsuit stem from Elon's regrets about not being involved
[5:30] in the company today, and the emails they released showing
[5:34] Musk initially supported the plan to create a for profit
[5:38] entity and wanted a merger that would make Tesla its cash cow.
[5:43] Let's start with the breach of contract claims.
[5:46] One of the biggest problems with the breach of contract claims in
[5:49] this lawsuit is that no actual contract exists.
[5:53] The lawsuit mentions the founding agreement 32 times, but
[5:58] no founding agreement actually exists.
[6:01] Instead, the lawsuit tells us that the founding agreement must
[6:05] be inferred from various emails and conversations between the
[6:09] founders text from the website of Open AI and the Delaware
[6:14] Certificate of Incorporation. The Delaware Certificate of
[6:18] Incorporation is even included as Exhibit One and is referenced
[6:23] in the lawsuit as being part of the founding agreement.
[6:27] A Certificate of incorporation is unfortunately not a contract.
[6:32] It's a document that you file with a state in order to
[6:35] incorporate a corporation. Musk didn't sign this
[6:39] certificate and it gave him no rights as a shareholder.
[6:43] Because there are no shareholders in a nonprofit
[6:46] organization. It actually states that on the
[6:49] certificate. Exhibit 2 of the lawsuit is an
[6:53] e-mail exchange between Altman and Musk with five bullet
[6:57] points, which include questions like will you be involved
[7:01] somehow in addition to just governance?
[7:04] And ideally you'd come by and talk to them about progress once
[7:09] a month or whatever. There's no mention of money
[7:13] anywhere in the exchange, Musk replied to Altman's e-mail with.
[7:18] Agree on all It's unlikely that a court would see this as being
[7:23] a contract, and even if they did, it's not obvious how it
[7:27] supports Musk's claims. I should add in, for the sake of
[7:31] completeness, that on page seven of the complaint it says that in
[7:36] 2023 the defendants set the founding agreement aflame.
[7:41] Which is most likely a metaphor, but who knows?
[7:45] Maybe the reason Musk has not presented anything that looks
[7:48] like a contract is that it was set aflame last year.
[7:52] I feel that the Lord should aim to write with greater clarity
[7:55] than that with regard to the lawsuit being filed in
[7:59] California rather than Delaware. Anne Lipton of Tulane University
[8:05] writes in her Business law Blog that must claims that he has a
[8:09] contract formed under California law that allows him to dictate
[8:14] the governance choices of a Delaware organized non stock
[8:18] corporation and further that a California court should order
[8:23] this Delaware corporation to conduct itself in accordance
[8:27] with his contract. She goes on to explain that Open
[8:32] AI as a nonprofit is subject to jurisdiction not only of the
[8:37] Attorney General of the state of its organization, but also the
[8:41] Attorneys General of the state where it operates.
[8:45] Musk is not an Attorney General and thus can't bring charges
[8:50] that a nonprofit violated the legal rules governing nonprofits
[8:54] in California. Possibly for this reason, he's
[8:57] instead claiming A contractual right to dictate the governance
[9:02] of a Delaware organized non-stop corporation.
[9:05] Lipton argues that if Open AI wanted to take this as a serious
[9:10] threat, it could file a declaratory judgement action in
[9:14] Delaware to the effect that these contracts, if they even
[9:18] exist, are in fact contracts concerning internal affairs
[9:23] matters governed by Delaware law.
[9:26] And under Delaware law, at least at the corporate level, they are
[9:30] illegal intrusions into the board's authority.
[9:34] Jeremy Tellman from Oklahoma City University School of Law
[9:38] highlights on his blog that with respect to these claims, Mr.
[9:42] Musk seeks unspecified damages but also specific performance of
[9:48] the alleged contractual or non contractual promises.
[9:52] While Open AI and Microsoft could refund Musk's investment
[9:57] and pay any damages claimed, specific performance is a big
[10:01] ask. According to Tellman.
[10:03] Specific performance means the court requiring Open AI to
[10:08] fulfill their contractual obligations, Telman writes.
[10:12] I don't see a court ordering a company to work for the
[10:16] betterment of humanity. To quote the lawsuit, in
[10:19] addition to discouragement and damages, Musk seeks specific
[10:24] performance in the form of. One, an order requiring that
[10:28] defendants continue to follow Open AIS, long standing practice
[10:33] of making AI research and technology developed at Open AI
[10:37] available to the public. And two, an order prohibiting
[10:42] defendants from utilizing Open AI, Inc or its assets for the
[10:46] financial benefit of the individual defendants,
[10:50] Microsoft, or any other particular person or entity.
[10:54] So if this was granted, Open AI would be required to release all
[10:59] of their work to the public and continue working without any
[11:03] financial benefit. In a rather funny article on The
[11:07] Verge, Nilay Patel dismisses the entire complaint as a nuisance
[11:12] lawsuit that's likely to be dismissed by the court.
[11:16] He writes that Musk's lawyers have figured out that letting
[11:19] the world's richest man rack up billable hours filing
[11:22] nonsensical lawsuits is more lucrative than fitting the facts
[11:27] to the law or whatever it is that regular lawyers do.
[11:31] He writes that the breach of contract claim admits that the
[11:35] founding agreement is basically a vibe everyone caught in some
[11:40] emails moving on from the breach of contract claims.
[11:44] The breach of fiduciary duty claim doesn't hold much water
[11:48] either. The Supreme Court clarified in
[11:51] Atherton versus FDIC that under the internal affairs doctrine,
[11:56] the law of the state of incorporation of the
[11:59] organization is the applicable law regarding the fiduciary
[12:04] duties of corporate directors and officers.
[12:07] So this part of the case would need to be litigated in
[12:10] Delaware, not in California. Under Delaware case law,
[12:15] directors are charged with an unyielding fiduciary duty to
[12:20] protect the interests of the corporation and to act in the
[12:24] best interests of its members. As I mentioned earlier, there
[12:29] are no members or shareholders in a Delaware nonprofit
[12:33] corporation and thus the board has no fiduciary duty to mask.
[12:38] The Financial Times wrote in an article on Thursday that the
[12:43] lawsuit reads like a mash up between a science fiction film
[12:47] script and a letter from a jilted lover.
[12:50] The section on unfair business practices is confusing.
[12:55] It doesn't describe any business practices or competitive
[12:58] behaviours, but it does say that the practices deceived Musk and
[13:03] are likely to deceive other members of the public.
[13:08] The most interesting part of the lawsuit, as I mentioned earlier,
[13:11] is the section on how availing of tax breaks by launching as a
[13:16] non profit before transferring the IP into a for profit venture
[13:21] once the technology has been proved if allowed, would mean
[13:25] that all startups would follow this path.
[13:28] I don't know if a California court can judge on this, but it
[13:32] does appear to be quite a tax loophole that other startups
[13:36] could possibly exploit. Sometimes companies find and
[13:41] exploit tax loopholes, and if a government decides not to close
[13:45] them up, they go on to become the way things are done going
[13:48] forward. the US government might decide that they're happy to
[13:52] allow this loophole in order to incentivize investment in
[13:56] startups. The four O 1K retirement plan
[14:00] came about when Hughes Aircraft Company used a loophole in the
[14:05] IRS Revenue Code to convert its after tax savings plan into what
[14:10] we now call a Four O 1K plan. While Musk has highlighted this
[14:15] issue in his lawsuit, I don't believe the California court
[14:19] will decide on an issue like this.
[14:22] But the press around this lawsuit may draw the attention
[14:25] of the Office of Tax Policy. In the wake of the lawsuit, Open
[14:31] AI Chief Strategy Officer Jason Kwan wrote an internal memo,
[14:36] which has been seen by numerous press organizations, which said
[14:40] we believe the claims in this suit may stem from Elon's
[14:44] regrets about not being involved with the company.
[14:47] Today Open AI disputes Musk's version of events and is moved
[14:52] to dismiss his legal claims. In a blog post this Tuesday,
[14:57] Open AI's Co founders released a number of emails sent by Elon
[15:02] Musk which showed that Musk had supported Open AI's move to
[15:06] create a for profit business entity and had even wanted to
[15:10] fold the company into Tesla, the blog post says.
[15:14] In late 2017, we and Elon decided the next step for the
[15:19] mission was to create a for profit entity.
[15:23] Elon wanted majority equity, initial board control and to be
[15:28] CEO. In the middle of these
[15:29] discussions, he withheld funding.
[15:32] Reed Hoffman bridged the gap to cover salaries and operations in
[15:38] one of the released emails. Musk discouraged making the
[15:42] research freely available, saying if you can't seriously
[15:45] compete but continue to do research in the open, you might
[15:50] in fact be making things worse and helping them, meaning Google
[15:55] out for free because any advances are fairly easy for
[15:58] them to copy and immediately incorporate at scale in the same
[16:03] 2018 e-mail, he writes. A for profit pivot might create
[16:08] a more sustainable revenue stream over time and would, with
[16:12] the current team, likely bring in a lot of investment.
[16:16] He goes on to say the most promising option I can think of,
[16:20] as I mentioned earlier, would be for Open AI to attach to Tesla
[16:25] as its cash cow. The Open AI founders claim that
[16:30] Elon soon chose to leave Open AI, saying that our probability
[16:35] of success was 0 and that he planned to build an AGI
[16:39] competitor within Tesla. When he left in late February
[16:43] 2018, he told our team he was supportive of us finding our own
[16:48] path to raising billions of dollars.
[16:51] Musk's lawsuit is asking the court to return his donations,
[16:55] pay him damages, and for an order forcing Open AI to release
[17:00] all of their source code into the public domain and end
[17:04] Microsoft's exclusive license agreement.
[17:07] The court will of course be aware that Musk runs a competing
[17:12] for profit artificial intelligence company called XAI,
[17:17] along with other companies that claim to use artificial
[17:21] intelligence like Tesla and Twitter.
[17:24] Matt Levine at Bloomberg points out that Musk's protests about
[17:28] Open AIS unseemly pursued of AI profit for investors looks a
[17:33] little insincere since he's doing the exact same thing at
[17:37] his other firms. The Centre for AI Policy wrote
[17:41] in an open letter on their website that it's possible that
[17:45] Musk is simply tech washing and creating chaos in the
[17:48] marketplace. The unusual corporate structure
[17:52] of Open AI has allowed Microsoft to put billions of dollars into
[17:57] the company over the last several years.
[17:59] Open AI is using Microsoft's computing resources to develop
[18:04] its technology and Microsoft is integrating Open AI services
[18:09] into its core products. Microsoft has been able to do
[18:13] this without attracting antitrust scrutiny as they claim
[18:17] to not exercise any control over the limited for profit company
[18:22] controlled by a non profit organization.
[18:25] That lack of control has since been called into question after
[18:29] Microsoft stepped in when Sam Altman was fired late last year.
[18:34] The Justice Department and the Federal Trade Commission are now
[18:38] reported to be deep in discussions over which agency
[18:42] can probe Microsoft's involvement with Open AI on
[18:46] antitrust grounds. The relationship between the two
[18:50] firms has additionally drawn scrutiny from the UK's
[18:54] Competition and Markets Authority and the European
[18:58] Commission. I'm not sure that Musk's lawsuit
[19:01] will lead to much. Noah Feldman, a professor at
[19:04] Harvard Law School, told the New York Times that the contract
[19:08] Musk claims Open AI and the Altman breached contains a hole
[19:13] you can drive a truck through. Open AI Certificate of
[19:17] Incorporation, which Musk's lawyers claim is part of the
[19:21] founding agreement, says the AI maker will seek to open its work
[19:26] to the public for its benefit when applicable.
[19:30] And Open AI can easily argue that it is adhering to this
[19:34] term, which is vague. While the lawsuit itself may not
[19:39] be awfully interesting, it does highlight the unusual structure
[19:43] of Open AI, which has all sorts of tax and antitrust
[19:48] implications which are of great interest in corporate finance.
[19:52] Thanks for tuning into this week's podcast, with a special
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