How is this legal? Specifically, distributing copyrighted assets and using their name/logo without permission.
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As I understand it, Lego is aware of the project (there's been a significant increase in interest in Lego Island in the past few years, with attempts to obtain the original source code) and simply does not care. It's an ancient IP and can't realistically compete with anything new, at least not in a way that would significantly affect Lego's revenue. This is not unlike the way several other companies have acted when their respective older games have been given the same treatment; if a fan project is not actively causing problems (reputational, financial, etc.), most companies will just leave it alone. For companies that actually seem to care about public opinion (as opposed to, say, Nintendo), I think it's fair to assume that the bad optics of taking legal action against a random fan project, however legally justified it might be, far outweigh any possible benefits.
Just last month LEGO shut down Masks of Power, the Bionicle fan game. They were really close to a release and LEGO had allegedly met the team and given them permission in the past.
I'm increasingly convinced that fan projects should be developed quietly and announced right on release, so they at least exist somewhere on the internet if they get shut down immediately after.
Also, this wasn't the only Bionicle game that LEGO had endorsed, Quest for Mata Nui too, which makes this even more of a heel-turn. They won't have to shut down that one, though: the team went silent and then the main dev passed away.
I see the project itself didn't accept donations but they pointed visitors at each dev's personal donation page, with no guarantee that it would go towards the project. I can see legal thinking that's bullshit, although I'd be surprised if most of those hadn't already been setup by the time LEGO originally gave them the ok.