What legal beasts are DAOs? COALA's DAO Model Law

Decentralized Autonomous Organizations (DAOs) are no longer a fiction. They already exist and operate on-chain. How the law deals with DAOs and DAO users or contributors, however, is far from clear.
 

To reduce legal uncertainty, a DAO Model Law was drafted by a working group of COALA (Coalition of Automated Legal Applications).

The Model Law for Decentralized Organizations (DAO Model Law) offers a template for lawmakers around the world to turn DAOs into entities with legal personality, mimicking several aspects of traditional corporate law, but tweaked to accommodate a DAO’s unique features.

Why do we need new laws for DAOs, you may wonder?

Very few DAOs are incorporated as a company. Having company status gives several benefits to an association, including separate legal personality (which means it can enter into contracts, for example, or start a lawsuit in its own name) and, by default, limited liability for its shareholders. To benefit from these features, however, a business formally has to incorporate as a business, following the necessary legal procedures, such as (typically) registration with a company registry, submission of formal documents such as a list of initial shareholders, legal name, type of company (private or public, for example), number of shares, etc.

Any business or other association that does not follow these formalities will not be recognized by law as a company. Since most DAOs do not go through the formal incorporation process, they will typically not be a ‘company’ in any jurisdiction.

This does not mean they are necessarily unregulated or outside of the scope of law, however.

Many jurisdictions will apply a default legal category to an organization that undertakes commercial activities of some sort, without having the legal status of a company. This means DAOs not incorporated as a company may be, by default, categorized as another type of legally recognized association.

In some jurisdictions, the default legal category may be that of partnership. Carla Reyes, for example, analysed how DAOs could be classified as partnerships under US law. A partnership classification raises serious concerns for DAO members, as partners in a partnership face unlimited liability for the partnership’s debts, typically. If we classify DAOs as partnerships, by legal default, DAO members and contributors could unwittingly face unlimited liability claims for the DAO ‘partnership’ debt.

Reyes suggested that the old US concept of a business trust could be dusted off for DAOs. That may be suitable in the US, but many jurisdictions are unfamiliar with the concept of a trust or business trust.

The US State of Wyoming took a different approach. It amended its company law rules to allow for a new type of limited liability company (LLC), the DAO LLC. The ‘Wyoming Decentralized Autonomous Organization Supplement’ amends the Wyoming Limited Liability Company Act. A DAO can incorporate as a special type of LLC. Doing so gives the DAO the advantage of separate legal personality for itself and limited liability for its members. Such DAO LLC will have to make clear in its name that it is a DAO or LAO (limited liability autonomous organization). Traditional fiduciary duties in such DAO LLC may be reduced or eliminated. The DAO may also restrict transfer of ownership interest, withdrawal or resignation.

Wyoming’s DAO LLC has been criticised as too flexible or not flexible enough. It remains an odd merger between a traditional corporate form and the particular features of a DAO.

COALA’s DAO Model Law aims to overcome such odd hybrids, by allowing a DAO to become a new type of legal person, with legal provisions adapted to its needs.

The DAO Model Law very much leans on traditional corporate law scholarship. The commentary mentions familiar discussions on agency costs, for example. Where possible, it replaces off-chain obligations from traditional company law with on-chain technological equivalents:

‘The deployment of a smart contract on a blockchain with relevant data about a DAO is not functionally equivalent to registration into a corporate registry, but the policy objectives of publicity and certainty are fully achieved.’

The DAO must provide a unique Public Address through which anyone can review the DAO’s activities and monitor its operations. Software must be available to allow a layperson to ‘read’ the key variables of the DAO’s on-chain smart contracts. The Model Law also requires a ‘publicly specified mechanism’ that allows any layperson to contact the DAO. A DAO must also have a dispute resolution mechanism binding on the DAO members and participants, and one to solve conflicts with third parties.

Notwithstanding these publicity and transparency requirements, the Model Law leans on the overall principle of ‘participant beware’ – an approach not all regulators may favour.

The Model Law also offers limited liability to DAO members (those with governance rights in the DAO), much like shareholders in a traditional company. The veil can be pierced in cases of fraud ‘and failure to comply with binding arbitral awards or court orders’, however, mirroring exemptions to shareholder limited liability in many jurisdictions. DAO members who vote against DAO compliance with a binding arbitral award or court order would face (proportionate) unlimited liability under the draft rules.

The Model Law mirrors many aspects of traditional company law and has provisions on meetings, (off-chain) representation, voting rights, proxies and minority protection. It gives much flexibility to the DAO to decide on its governance and rights given to members (for example, minority protection is not mandatory). Developers, members, participants or legal representatives of a DAO shall not have any fiduciary duties, unless so provided by the DAO by-laws (or if they explicitly hold themselves out as fiduciaries).

It also adds DAO-specific provisions, for example on contentious forks, DAO restructuring and failure events (modelled on directors’ liability provisions: liability may attach for gross negligence and bad faith). On  taxation, it proposes to make a DAO a ‘see-through’ entity for tax purposes.  

Some aspects of this DAO Model Law, including the ‘participant beware’ approach, may not be appealing to lawmakers in all jurisdictions. However, it is an important step in getting the discussion going on how the law deals with decentralized autonomous organizations.

Contributors to the DAO Model Law are Constance Choi, Primavera De Filippi, Rick Dudley, Silke Noa Elrifai, Fatemeh Fannizadeh, Florence Guillaume, Andrea Leiter, Morshed Mannan, Greg McMullen, Sven Riva and Ori Shimony.

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