DAOs: Looking for Limited Liability & Legal Personality
July 11, 2022
If you have been reading our series about decentralized autonomous organizations (if not, you can catch up here), you probably appreciate how transformative DAOs are for corporate formation. But you also likely appreciate DAOs’ limitations in their natural state—the absence of limited liability and legal personality. Because of this, DAOs need to take on legal form to contract with stakeholders and to perform more traditional functions, while also limiting personal liability. In this edition of our DAOs series, we look at promising legal entities that remedy some of these limitations. And we are focusing on some popular destinations for DAOs: the Cayman Islands (with help from Cayman Islands corporate co-counsel, Conyers), Singapore (with help from Singapore corporate co-counsel, Simmons), Vermont, Wyoming, Tennessee, and Colorado. Although not all of the entities are perfect, they provide some degree of private ordering in a decentralized world, depending on a DAO’s needs.
Cayman Foundation Dao
A Cayman Foundation differs from an ordinary company primarily because a Cayman Foundation does not need to have members. The Cayman Companies Act governs a Cayman Foundation—unless the Cayman Companies Act is excluded, modified, or inconsistent with the Cayman Foundation Companies Act. The fundamental corporate structure of a Cayman Foundation is tried and tested, and legal jurisprudence regarding Cayman companies also applies to a Cayman Foundation.
Key features of a Cayman Foundation DAO
- Purpose: Cayman Foundations may be formed for any lawful purpose, including a charitable one. This is an attractive feature for DAOs, which may have different objectives than for-profit companies.
- Separate legal personality: A Cayman Foundation is defined as a legal person, which means the DAO can be a contracting entity and it can:
- interact and form contracts with third parties;
- file and pay taxes;
- open bank accounts and make cash transactions;
- hold and protect off-chain assets;
- limit the liabilities of its members (if it has members—more on this later);
- protect intellectual property;
- serve as a vehicle for airdrops and grants; and
- act as a parent or holding entity with subsidiaries to carry out functions for a project.
Flexibility: The governing rules, structure, and roles of a Cayman Foundation can be adapted to suit a range of bespoke needs. And, because the constitution of a Cayman Foundation can be supplemented with bylaws that are not filed with the Register of Companies, they are private, affording the Cayman Foundation some privacy and the flexibility to set its own rules about structure and management. The bylaws may relate to any aspect of the Cayman Foundation or to any of the duties or powers of the directors or other officeholders, including how to achieve the foundation’s objectives. For DAOs, the substantive rules about how community members will govern the DAO typically live in the bylaws, which may also restrict the directors’ powers in keeping with the DAO’s democratic governance model.
Limited liability: DAOs can incorporate a Cayman Foundation with one or more members whose liability is limited (although in practice the shares are cancelled upon incorporation). Also, since the Cayman Foundation is still a company, it has liability protection—for example, for the developers of a DAO from any personal liability—since the directors manage the objectives and business of the DAO for the Cayman Foundation, which is acting as the DAO’s legal wrapper.
Roles in a Cayman Foundation
These are the typical roles in a Cayman Foundation:
- Founder: This is usually the person who established the structure through a contribution of assets. The Foundation Act does not formally define the role of “Founder,” so the governing documents may specify what (if any) powers the Founder retains. For example, the Founder may reserve the power to appoint the directors or amend the governing documents, but the Founder may also have no ongoing role in the foundation. Since DAOs utilize a bottom-up governance structure, the Founder would not normally retain any powers in the Cayman Foundation.
- Director(s): As with an ordinary company, a Cayman Foundation is managed by a board of directors, with the same powers as in an ordinary Cayman company, though they may be restricted to align with the DAO’s specific objectives.
- Members/shareholders (if there are any): While a Cayman Foundation must initially be incorporated with one or more members (the same as an ordinary company), one of the key features of a Cayman Foundation is that it can cease to have members at any time, without affecting the foundation’s existence, capacity, or powers. A Cayman Foundation DAO may therefore exist as an orphan entity without any members or shareholders. An ownerless Cayman Foundation DAO jibes nicely with the ethos of the hierarchy-less DAO and its community.
- Beneficiaries: Cayman Foundations may choose to have beneficiaries. Unless otherwise specified, the beneficiaries will not have any powers, rights, or standing to sue the foundation (such a supervisory function is vested in a “supervisor”). Beneficiaries may be specified people or a class of people—for example, token-holders or certain community members, whom the Cayman Foundation DAO may be structured to reward. As beneficiaries of the Cayman Foundation DAO, token-holders would not have any personal liability for the foundation’s debts or financial losses.
- Supervisor(s): If a Cayman Foundation ceases to have members, it must have one or more “supervisors” (who may also be directors). As suggested by their title, supervisors enforce the rules of the Cayman Foundation and typically have the right to access its files, books, and accounts. A supervisor has no ownership or economic entitlement in a Cayman Foundation.
What is the VASP Act?
The Caymans’ Virtual Asset Service Providers (VASP) Act offers a regulatory framework for virtual asset service providers. It defines “virtual assets” as digital representations of value that can be traded or transferred and that can be used for payment or investment purposes. A DAO that offers tokens may constitute a VASP. The act requires entities engaging in virtual asset services to get licensed and/or to register with the Cayman Islands Monetary Authority. The law has only been in effect since October 2020, but in the long term, it could help Cayman Islands entities undertake fintech‑related services and activities.
Singapore Company DAO
Some DAOs seeking legal status have made a home in Singapore by retooling corporate structures to work for the DAO. Although the corporate structures are not perfect, they provide sufficient private ordering until legislators create more tailored structures.
As a starting point, in Singapore, the most common legal entity is a company limited by shares, and it is created by registering with the country’s Accounting and Corporate Regulatory Authority (ACRA). While the incorporation process and ACRA’s platform are lauded for their efficiency, the share-transfer process is not instantaneous. This complicates things for a DAO, where a transfer of tokens on a public ledger is immediate—a member’s register would not keep up in real-time. Also, DAO organizers should know that members of a Singapore company are not anonymous; anyone can purchase a business profile, which would identify them, on the ACRA platform
However, there are ways to potentially to work around these limitations.
First, it is usually better if a DAO organizes itself as a Singapore company limited by guarantee. Unlike a company limited by shares, a company limited by guarantee is more suitable for DAOs with a non-profit element, like a collector DAO or a social DAO. A company limited by guarantee is prohibited from paying any dividends or profits to its members.
Next, a Singapore company DAO would establish an advisory board represented by token holders. Under this structure, these token holders would serve as the pseudo-decision-makers of the company by initiating and voting on proposals. Then, a project team or other party, acting as members of the company, would execute the DAO’s decisions. These members would then appoint directors, who owe a fiduciary duty to the company to act in its best interests, and they would in turn implement the will of the advisory board. The constitution of the company would establish the advisory board, while specifying that the members and directors are obligated to execute the wishes of the DAO advisory board.
Vermont Blockchain-Based LLC
In 2018, Vermont enacted a law establishing blockchain-based limited liability companies (BBLLCs)—one of the first states to enact LLC legislation tailored to blockchain-based companies. While the law does not explicitly mention DAOs, it generally applies to companies that “utilize blockchain technology for a material portion of its business activities.” To qualify for the BBLLC designation (and its limited liability protection), a company’s operating agreement must include (1) a description of its mission or purpose; (2) the level of its decentralization; (3) an indication if the blockchain is public or private; (4) its voting and governance procedures; (5) its security-breach mitigation protocols; (6) its membership-acquisition process; and (7) an account of the rights and obligations of the participants.
Wyoming DAO LLC
Last year, the state of Wyoming passed a law—which was subsequently amended in March 2022—that allows a DAO to incorporate itself as an LLC and defines DAOs as “a limited liability company whose articles of organization contain a statement that the company is a decentralized autonomous organization.” The traditional legal protections and personality afforded to a Wyoming LLC are extended to algorithmic and member-managed DAOs incorporated under the law, with a few exceptions.
Key features of a Wyoming DAO LLC
- DAO LLCs must keep a registered agent in Wyoming
- A DAO’s legal name must include “DAO” or “LAO” (Limited Autonomous Organization) or “DAO LLC”
- A DAO LLC is presumed to be member-managed unless the Articles of Organization define it as algorithmically managed
- The Articles of Organization must include the DAO’s smart contract, which must be amended whenever the smart contract changes, and the contract prevails if there is any conflict with the Articles of Organization
- If a DAO LLC does not approve any proposals or take any actions for one year, it is automatically dissolved
- Except as specifically modified by the DAO law, the laws governing regular Wyoming LLCs apply to DAO LLCs
- Members do not owe any fiduciary duties, unless the articles state otherwise
In Tennessee, DAOs are "Dos"
Tennessee is the most recent state to enter the DAO arena. In April, Tennessee amended its Limited Liability Company Act to include decentralized organizations (DOs). The requirements for a Tennessee DO LLC are nearly identical to that of a Wyoming DAO LLC with a few exceptions. For example, the Tennessee law requires a quorum of a majority of members for a vote, while Wyoming allows a DAO’s articles to define its quorum.
Colorado Uniform Limited Cooperative Association
Colorado has an innovative legal structure that can provide some DAOs adequate legal personality and limited liability. A limited cooperative association (LCA) is a mix of a corporation and an LLC. An LCA under the Colorado Uniform Limited Cooperative Association (CULCA) Act, is “an autonomous, unincorporated association of persons united to meet their mutual interests through a jointly owned enterprise primarily controlled by those persons.” Unlike LLCs, a CULCA can have two types of members: patrons who conduct business for the CULCA, and investors who only make contributions. Patron members have financial rights, and a CULCA can disburse patrons’ profits in proportion to their individual contributions or services; members can vote based on membership (one vote for each member) or on token holdings. A CULCA is governed by its articles and bylaws which allow for the integration of DAO-based governance principles.
Although a DAO seeking a legal identity can be organized as a Vermont BBLLC, Wyoming LLC, Tennessee DO LLC, CULCA DAO under state laws, such legal entities remain subject to restrictions under federal laws—such as the Investment Companies Act of 1940 and the Securities Exchange Act of 1934—addressing, for example, the maximum number of members it can have and whether any member can be a non-accredited investor without triggering the registration, reporting, or other requirements, obligations or penalties under such laws. Additionally, the Corporate Transparency Act, passed as part of the 2021 National Defense Authorization Act, increases reporting requirements to identify members of LLCs and LCAs, which may hamper the efforts of any DAO organized under such entities to keep its members anonymous.
Unincorporated Nonprofit Association
Under the Uniform Unincorporated Nonprofit Association Act (UUNAA), an Unincorporated Nonprofit Association (UNA) is formed when two or more members join under an agreement—which can be oral, in a record, or implied from conduct—with at least one common, nonprofit purpose. Social, charitable, or collector DAOs formed without a for-profit purpose might find it useful to become a UNA to order their activities and limit liability. Two facts to note: The UUNAA defines staking and liquidity-mining profits used to maintain a DAO’s protocol as nonprofit; and liability protection is dependent on jurisdiction—not all states recognize a UNA.
Placing a DAO in a corporate structure does not necessarily dilute its decentralized purpose. The DAO’s community members are still free to make collective decisions (for example, to purchase art or donate and direct assets to a particular cause or project). The DAO can also keep its bottom-up, distributed governance model. And for DAOs seeking to limit the liability of their members and developers and for DAOs that want to interact with parties off-chain, some form of legal structure is necessary.
Also, eventually, some parties may grow weary of doing business with a DAO with unlimited liability. So, DAOs might want to adapt and embrace the private ordering that corporate organization confers. Another incentive? As the U.S. government applies a “tech-neutral” approach to regulating the digital asset economy, it may look to regulate DAOs like traditional corporations; it might serve a DAO well to be structured in a way that facilitates interacting with regulators, including through paying taxes.
Every DAO is different, as is every legal entity. O’Melveny, with its partners across the world—including Conyers and Simmons—can assist DAOs in devising the appropriate legal structure and offering regulatory counselling. Conyers also has an affiliated company that provides registered office, administration, and corporate services to Cayman Foundation structures.
O’Melveny will closely monitor developments regarding the legal issues surrounding DAOs, including additional structuring options. Please contact the attorneys listed on this Client Alert or your O’Melveny counsel to see how we can help you.
Each client alert in this series includes some crypto-lingo at the end to help you navigate the cryptoverse. Here are some terms:
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