Legal Issues With DAO Entity Formation

People all over the world have started or joined a DAO (decentralized autonomous organization) without thinking about the potential legal entity ramifications in the DAO’s structure. These foundational issues need to be discussed and determined by DAO organizers, developers, members, and investors. “Jurisdictional arbitrage” is an emerging term of art used to describe this process of determining what type of structure best fits the DAO based on its members, goals, and resources.

Harris Bricken attorneys Jonathan Bench and Arlo Kipfer sat down again to discuss Decentralized Autonomous Organizations (DAOs) and the legal issues common to their creation. Check out the last conversation HERE. A rough transcription of this talk can be found below.

Transcript:

Jonathan Bench  00:06

So Arlo, welcome back. This is our second video on DAOs. And last time last video, we talked a little bit about some initial questions we have for DAO owners, or DAO creators, or DAO executive teams and what exactly they should think about in terms of honing down their mission, their vision, and who’s involved in making those decisions. Now, this question we’re going to talk about is, do we start with a DAO? Or do we start with a legal entity? And can we flow back and forth between those structures? You know, I think it’s very common. A lot of people in DAOs don’t even think about legal entities. They don’t care about the legal entities. But you and I know as lawyers that the legal entities are coming for you whether you want it or not, right there is the default is your partnership, at least under U.S. law. And you don’t want to be a partnership. And so what do you think is a better way to start if you had friends, a group of friends coming to you and saying, Arlo, we’ve got a great idea, we want to start DAO, what’s the best place to start?

 

Arlo Kipfer  01:08

Well, as he’s mentioned, many of our clients and potential clients have already started a DAO without thinking about legal entity, and that’s the reality that we can help them deal with. But if someone comes to me, as you said, and they’re like, we’re thinking about a DAO, we have this idea, we have this focus, we have this community, we feel like we can access it, should we just start it or start a legal entity? I would tell them, if you have a choice, it’s not really that smart to start a DAO without some type of protection. I mean, as you mentioned, under common law, and in the U.S. and other common law countries, as well, as a lot of civil jurisdictions, this, anytime you bring people together for a purpose, it’s going to be a general partnership, or maybe a civil partnership or civil, some type of a social unincorporated association. And in those in those type of structures, they’re not registered with the government. So people think you have to register with the government to be liable or connected. Actually, it’s just any people joining together as you know, and in that situation, there’s unlimited liability for the members, maybe the developers, the corporation, that’s, you know, putting the money in to develop it. And you wouldn’t want to willingly put yourself into unlimited liability situation with other people that may be anonymous to you, or you don’t really know. And so, you know, what we usually recommend, what I recommend is, I say we need to set up we need to do some jurisdiction shopping, we could set up a see what kind of rapid you know what kind of legal entities that we could establish that will wrap around the DAO. And one phrase I’ve heard that I think is really good is you kind of need jurisdictional arbitrage, which means you kind of siloing off different parts of the DAO depending on the nature of the DAO, if there’s a Treasury or if there’s protocols, you know, that governance section, and you can go shopping, and you can go shopping. In, for example, like offshore, in the Marshall Islands, you know, February of this year, just last month, they signed, the Nonprofit Corporate Action Act was afterwork. Malta has established a legal framework for DAOs. I’ve heard that in Switzerland, that, you know, associations in Switzerland are really good if you’re running just a protocol, but not really involved with financial products. Estonia, you can in less than a week, you can launch a token issuing entity, get an opinion and engage with regulators within just less than a week’s time. If you’re based in Asia, you can tap into some of those Asia facing jurisdictions such as Singapore, maybe Hong Kong, there’s just lots of options out there. And then once you have this entity established, or maybe multiple entities, you can morph that into a DAO, you can come up with a DAO, as I said before, it’s sort of like a governance. It’s like a brain that controls all the entities and allows you to make to handle the governance of that group in a very, as we said, a very collaborative approach, just kind of the one of the novel features of a DAO.

 

Jonathan Bench  04:10

And I think when we’re working with clients that are asking the question, maybe they’re not a DAO, I had a conversation just last week with a really well established company, no debt, great revenues, good business model proven business model. And they excuse me, they were looking to do an acquisition. And they said, well, you know, the traditional capital markets are not appealing to us. We’re not getting good deals, good terms from VC firms. We thought maybe we would, we would DAO-ify this in some way. And so we talked about how the know the implications for using a traditional entity and DAO-ifying that entity and going around and shopping that on, you know, within the crypto market right and going to see who’s interested in backing a company that has a proven business model and is now going into a new jurisdiction with their with their proof. and business model. And for me when I’m thinking about, you know, do I want to join a DAO, where if you’re looking at discord, it looks like pure insanity, versus going with a traditional company that has one or two or three owners that has a proven track record that knows what they’re doing. And they want to bring in a wider net of people who want to be involved and share in the upside. And certainly to me, as you’re coming in from my standpoint, I’m going to go with that option versus an unproven doubt with unproven leadership with may or may not have a good governance model set up and may not have good protocols setup.

 

Arlo Kipfer  05:38

Right. And one of the things too, that if you do go with an entity and an entity that’s in some jurisdiction already been established, is you can take advantage of some default rules, maybe your contracts, or some of your organizational documents don’t don’t deal with every event that’s gonna come up. And as we know, some of the things like smart contracts are supposed to be immutable. And at least currently, and so when you have these default rules to fall back on, that really is helpful can be helpful in sorting out future issues.

 

Jonathan Bench  06:12

I think it’s good to note that these jurisdictions are all grappling with it, right. I mean, I think it’s interesting that Estonia is is one of the frontrunners, I’ve heard good things about Singapore, good things about BVI. There are a lot of these offshore jurisdictions that are trying to revamp their code, their tax code, their corporations code, as quickly as possible to take advantage of this opportunity, because everyone is talking about it, everyone knows. And so it will continue to be our job to monitor those jurisdictions and see which ones are most attractive. And of course, you know, when the U.S. for us for and for our U.S. clients, when those default U.S. rules apply it right, I was talking to a group of members the other day, some DAO members about when U.S. jurisdiction will apply, regardless of what type of entity you have set up, right. And so if you have, for instance, a U.S. company, or you have a foreign company with more than 50% of the operations in the U.S. or of the shareholders in the U.S., the owners of the participants in the U.S., you could be by default, a U.S. company and some some don’t want to deal with that. And so we have to deal with more creative ways to, to do an end run around that a bit and at least give, you know, a possible explanation as to why these this international data, this international group should not be beholden to U.S. jurisdiction. So it’s complicated, but it’s it’s doable. That’s what I keep telling people there. It’s doable. It’s complicated. And, and certainly it’s changing. Do you have any parting thoughts on this idea on whether we go down to traditional company or traditional company and doubt are low before we head off?

 

Arlo Kipfer  07:47

No, I mean, other than just if you haven’t started out yet, talk to somebody about possibly finding an appropriate entity, whether it’s in this in, in your country that you’re a resident or offshore and sorted out, because as I said, the big part is the liability. Just getting that sorted out so you’re not signing up to somebody, something that somebody that’s going to backfire for you later.

 

Jonathan Bench  08:11

Awesome. Thanks, Arlo. We’ll chat soon. Appreciate it.

 

Arlo Kipfer  08:15

Okay. Thanks, Jonathan.

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