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Rewards-Based Crowdfunding: Locating a Risk-Proportional Regulatory Solution in CPA, 2019

The author is Sukarm Sharma, a second year student at National Law School University of India.


Rewards-Based Crowdfunding (“RBC”) refers to a form of funding where solicitation of capital to develop a project is done in exchange for some future reward. This reward may be in the form of membership, a consumer product or other perks. RBC is almost entirely unregulated in India. This is in contrast to the other two financial crowdfunding models. The P2P crowdfunding model is regulated by RBI’s Master Directions on P2P Lending, while the Equity-Based crowdfunding model is currently under scrutiny by SEBI, which has proposed restrictions under its recent consultation paper.

There can be competing arguments, both for and against the regulation of RBCs in this case. The argument for regulation of RBC highlights the strong consumer risk that can be posed by such unregulated models. This is because the high information asymmetry, fraud risks and the absence of any financial compliance requirements associated with RBCs endanger consumer welfare. The argument against such regulation is that RBCs are nascent and do not pose any significant systemic or financial risk, in contrast to P2P or Equity crowdfunding. In that light, regulation by a financial authority could smother innovation and impose unnecessary restrictions on a new and fragile industry.

To this end, I shall make three arguments. Firstly, establishing the need for some form of regulation in contrast to the status quo of “wait and see.” Secondly, the alternative, i.e., imposing capital and compliance restrictions on RBCs similar to other forms of crowdfunding would be disproportionately restrictive and against regulatory principles of risk-based regulation and promoting financial innovation. This would establish that both the current alternatives for regulating fintech are disproportionate. Thirdly, therefore , I propose a solution through a risk-proportional regulation of RBCs by their inclusion under the Consumer Protection Act 2019 (“CPA”), rather than financial regulation per se. For this, I rely on regulatory theory to argue that a CPA-based regulation framework would be more proportional and tailored to the specific requirements of RBCs.

The ‘Why’ to Regulating RBCs: Regulatory Goals Beyond Financial Stability

Marlene Amstad recognized the goals of financial regulation as broadly two-fold: protecting market integrity and securing financial stability. Although RBCs may not pose systemic risks as strong as other crowdfunding models, I argue that a contractual relation alone is not sufficient to safeguard consumer interests, which requires greater regulatory scrutiny.

It is conceded that RBCs do not pose risks to the financial system on a macroeconomic level. However, they pose strong risks to market integrity, which is a significant regulatory goal in itself. Market integrity refers to the protection of consumer welfare, increasing information asymmetry and reducing market fraud. This necessitates a robust regulatory mechanism for RBCs in India, which cannot be left to contract law alone.

The rationale for this is first, RBCs are based on raising capital for a specific project which leads to greater information asymmetry between the consumer and the seller. This is because most projects in RBCs are research-based or development-based, and consumers are often not in the position to assess the efficacy or suitability of the same. There exists a strong chasm between consumer and producer knowledge of the product in question vis-à-vis other financial/consumer instruments, entailing greater information asymmetry. Secondly, even if a contractual obligation exists between the consumer and the campaign owner, it is uncertain and undetermined. Every transaction is not governed by an independent contract between the consumer and the campaign owner, rather they are both governed by the terms of use of the funding platform. For example, Indiegogo, one of the largest rewards-based crowdfunding platforms accessible globally, follows this model. A simple perusal indicates that any independent contractual obligation is ambiguous. An example of this is “HELP ME TO FINISH MY STUDIO AND BE REWARDED WITH AN ORIGINAL PIECE OF ART... OR TWO.” This is the extent of the contractual obligation between the campaign owner and the funder, while the only other obligation is derived from the terms of use. It is unspecified for example, what qualifies as an “original piece of art”, or what its valuation may be. The terms of use themselves are insufficient in protecting consumer interests. The only significant obligation imposed on them is a “good faith” requirement. This is not to claim that RBCs are a homogenous group, but to highlight the broad problems in major RBCs. Thirdly, the consumer protection laws of India are currently evaded by these platforms. Despite being available globally, RBCs typically evade the jurisdiction of any state other than their host state. For example, Indiegogo only obliges its campaign owners to abide by the rules of California’s Consumer Protection agency.

RBCs: The White Sheep of Crowdfunding?

Now, after establishing that RBCs require some form of oversight, greater than a contractual one, a question arises as to the model of the same. One might be tempted to group them together with other consumer financial products and crowdfunding models. However, it is necessary to acknowledge that a qualitative difference exists between RBCs and other consumer finance products, i.e., with respect to its integrity to the financial system, because of which it would be disproportionate to regulate it in the same manner. There exist two broad parameters for comparing the financial risks of non-banking financial instruments. These are (i) contagion (ii) credit risk. I argue that none of these three is similar to the risks posed by other crowdfunding platforms.

(i) Contagion refers to the possible effect of a failure of this financial component on the broader financial system. In cases of P2P crowdfunding or equity-based crowdfunding there exists a strong link to the larger banking system. This is because of the larger capital involved and greater interconnectivity among the lenders. For example, the failure of a P2P platform would impact a large consumer base, as well as any connected banks which often sign an FLDG (First-Loss Default Guarantee) with the partnered platform. In such cases, the risk of contagion is high and entails greater regulation. In RBCs on the other hand, the lending model is more decentralized. The funding is project-specific, therefore, the risk of the failure of the platform as a whole is unlikely. Even if that happens, its effect on the broader financial system is unlikely to be strong due to the lower capital requirements and decentralized lending. For (ii), credit risk is unlikely to be a strong problem in RBCs, as compared to say, equity-based crowdfunding. This is because there is no credit in RBCs as such. It is closer in that aspect, to a sale. The amount given to a project is not a loan, rather it is the consideration for a perk from the project it is supporting.

Therefore, a sale-based regulation is far more logical for RBCs than financial regulation, even though its sibling platforms are closer to financial products, regulated by the RBI and SEBI. Similar regulation for RBCs could disincentivize financial innovation and discourage a nascent fintech industry from developing in India. Therefore, a more proportionate approach is pertinent.

Proportionate Regulation: Consumer Protection Act, 2019

As discussed in the previous section, RBCs are qualitatively similar to consumer marketplaces than they are to financial instruments. The principle of activity-based regulation would entail that the regulation must be functional, rather than form based. This means that the regulation must focus on the in-effect activity of what is being regulated, rather than its formal form. This is similar to the Howey Test, which says that “"If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck." Even though an activity is ostensibly a financial activity, if in effect its function is that of a retail marketplace, then its regulation must be according to the same principle.

Therefore, rather than devising a separate regulatory model, it must be brought within the Consumer Protection Act, 2019. This would balance market integrity concerns, since the primary purpose of CPA is to alleviate the same, without disproportionate financial regulation. Moreover, such a regulation would strike a better balance between the risk posed by the object of the regulation, and the stringency of the regulation. A more stringent regulatory model would make the mistake of regulating based on the formal type of the activity, i.e., crowdfunding, rather than its in-effect function, i.e., a sale of an uncertain good.

However, this would require a more expansive reading of what is a ‘service’ or a ‘good’ under s. 2(42) and 2(21) of CPA respectively. Section 2(21) of the CPA defines goods as “every kind of movable property and includes food.” RBCs cannot be goods in that sense, since there is no “movable property” being transferred. The critical test for anything to be considered ‘goods’ is typically whether it can be (i) stored and (ii) transferred. This has been affirmed in CST v. Madhya Pradesh Electricity Board and BSNL v. Union of India. It is therefore evident that RBC is a model, not a good and cannot be stored or transferred. Neither do RBCs clearly fall within a service defined under s. 2(42), since there is no clear contract for or of service between the platform, the fundraising institute or the consumer. Therefore, RBCs do not fit into a typical financial service under s. 2(42) nor is it a clear sale of goods, because the ‘reward’ may be either in the form of a good or as a perk. However, it can be argued that RBCs may fit in an expansive reading of goods, as was given in Birla v. Neutral Glass, where intangibles like software were held to be ‘goods’. After all, RBCs is essentially sale of goods, albeit with two additional characteristics (i) they will come into existence in future and (ii) they are uncertain at the time of sale. This is not to make a definite claim for their inclusion, but to point out its possibility, which needs to be examined further.


In this blog, I have attempted to locate the regulation of RBCs within the CPA, 2019, through a broader reading of its s. 2(21) and 2. (7). I first highlighted that the unregulated contractual model is insufficient to safeguard consumer interest in light of the strong information asymmetry in RBCs. Secondly, I argued against a distinct financial regulatory system for RBCs in light of the low risks to systemic financial stability. Finally, I argued for CPA as a regulatory tool since it would balance financial innovation with consumer risks, as an alternative to the lopsided proposals of either leaving it unregulated or imposing capital requirements which vitiate either of the two goals of consumer finance regulation

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