There has been much discussion across the past few years about the legal status of a DAO.
For those new to the concept a DAO (a decentralized autonomous organization) is a Blockchain based “organization” encoded as a transparent computer program, controlled by the organization members rather than by any outside entity or authority.
As discussed in a previous article the primary aim behind the creation of a DAO is to create a virtual entity to replace the central management of previous forms of organization. A decentralized autonomous organization (DAO), is an organization, particularized by rules encoded as a computer program, that is transparent, and controlled by the organization members. In terms of decision making a DAO is, in effect, unable to be influenced by any outside party including any central government.
Legal challenges can come into play if a DAO wants to own Intellectual Property eg a Patent (Can a DAO in fact own a patent? It’s a moot point currently being debated by final year IP law students in high level law schools!). There’s also the inherent litigation risk associated with any unincorporated Association. If a DAO were to be sued – without the protection of having been incorporated as a Limited Liability body – the individual members of the DAO would be jointly and severally liable for any judgment debt that may be entered.
Enter the progressive Financial Centre that is the Caymans Islands which passed amendments to its Companies Law in 2017 to give birth to a product now at the forefont of DAO Industry developments ie the “Foundation Company”.
Over the course of the past few years we have seen numerous DAOs congregate as Private Foundations. The jury is still out however in terms of whether a Foundation can deliver the necessary commercial flexibility that a DAO may need to take a product (or service) to market. Typically a Foundation with commercial objectives would form a subsidiary Company - which would enter into some form of Licensing or Royalty agreement with the parent Foundation – such as would enable the Company to commercialise any IP owned or developed by the Foundation.
A Foundation Company potentially can cover both objectives within one legal shell.
Cayman Islands Foundation Companies – Overview
The Caymans Islands Foundation Company is a remarkably flexible vehicle that operates like an incorporated trust, allowing it to function like a civil-law foundation or common-law trust while retaining the separate legal personality and limited liability of a company.
The passing of this new Law was timely as it coincided with the nascent emergence of the DAO in the Blockchain space. As DAOs are launched with the ultimate goal of becoming fully decentralised and governed by the DAO’s community, a Foundation Company vehicle can assist the Founders of DAOs to achieve a range of goals.
The Need for Legal Personality
DAO Founders are often reluctant to create a legal personality for the DAO. As the purpose of a DAO is to be a decentralised organisation that is governed by a community, the idea of centralising responsibilities or ownership rights into a legal person is often seen as anathema to the core values of the project.
Moreover, the legal structures available in many jurisdictions require some person or group to act as the owner of the DAO. However, DAOs without legal personality run into problems. These include the inability of the DAO to:
(a) interact with third parties outside the DAO
(b) enter into contracts (particularly with digital asset exchanges)
(c) hold assets
(d) protect valuable intellectual property that may be imitated by other projects or DAOs, and
(e) carry out the wishes of the DAO where the community has voted for the DAO to undertake an action vis a vis third parties.
As a result, DAO Founders can sometimes find themselves carrying out actions on behalf of the DAO and, consequently, be personally exposed to potential liability.
Foundation Company as a Solution
The solution to the problems above is for the DAO to establish a Foundation Company. Like a typical company, the Foundation Company has legal personality to enter into contracts and undertake actions with third parties. It is also managed by directors who carry on the business of the DAO. However, unlike a company, a Foundation Company can be structured without shareholders. In essence, it can be ownerless – just like the DAO it represents.
In place of shareholders, a Foundation Company can be supervised by a supervisor (or even multiple supervisors if desired). A supervisor has no ownership or economic entitlement in the Foundation Company but simply acts as a steward, ensuring that the directors of the Foundation Company observe their obligations to the DAO pursuant to the Foundation Company’s governing documents. Therefore, with no shareholders, all of the officers of a Foundation Company simply have the objectives of the DAO as their priority – similar to trustees and enforcers carrying out the objectives of a trust.
As a further benefit, the Caymans Law provides the utmost flexibility to a Foundation Company when drafting the governing documents of a DAO. These governing documents comprise of the memorandum and articles of association (the M&A). With some limitations and restrictions, the M&A of a Foundation Company could include almost any form of governance structure so long as the Foundation Company is managed by at least one director, is supervised by at least one supervisor and has a secretary.
The director(s) and the supervisor(s) need not be natural persons (e.g. they could be corporate vehicles) and could even be the same person. The M&A could even mirror the governance structure of the DAO itself, with each user or node of the DAO entitled to one vote on any number and type of matters included as such in the M&A.
At the very least, the M&A could include provisions that require the director(s) and the supervisor(s) of a DAO to carry out the decisions of the DAO or could provide that the director(s) and/or the supervisor(s) be nominated by majority resolution passed by the DAO. The possibilities are truly endless and the foundation company’s flexibility is a great advantage to any existing or future DAO.
Works like a Trust
DAOs often wish to hold assets for the benefit of the DAO community or issue tokens or distribute rewards to users. Once again, the Foundation Company is a great fit as it acts like a legal trust and has the power to designate beneficiaries. However, one particular benefit of the Law’s concept of a beneficiary is that it will not be treated as a beneficiary under a legal or common law trust arrangement. This is because the starting position under the Law is that a designated beneficiary has no rights or powers as against the foundation company.
The Law therefore excludes the creation of any inadvertent common law trust rights and limits the beneficiary’s rights to those expressly stated by the Foundation Company. This is particularly useful for DAOs which are then free to designate the users or the nodes of a DAO as beneficiaries but with limited rights.
Another attractive feature is that a Caymans Foundation Company does not have to maintain a register of its beneficiaries. This means that a Caymans Foundation Company need not specify individuals as beneficiaries but can designate beneficiaries by class of persons (e.g. “tokenholders” or “node operators”) and also reward those beneficiaries according to that class. Whilst anti-money laundering considerations are always a factor, this could be particularly useful for DAOs built on blockchain technology where the DAO intends to undertake distributions, airdrops of tokens or other rewards to the DAO community.
Tax and Economic Substance
As a DAO is decentralised and in theory has no fixed location, many DAO Founders are reluctant to incorporate their DAO in any particular jurisdiction as this may lead to unintended and unwanted tax consequences. However, as a tax neutral jurisdiction, a Caymans domiciled Foundation Company need not worry about taxes being levied against it in the Cayman Islands.
Interestingly, a Foundation Company limited by guarantee is specifically exempted from the economic substance regime of the Cayman Islands. Hence a DAO incorporated as a Caymans Foundation Company does not have to move staff, nodes or resources to the Cayman Islands to prove that it has substance here. This means that the DAO can be a truly internationally focused project. It also means that it can hold the intellectual property of the DAO and even make profit from the intellectual property (or any other relevant activity under the substance regime) without creating substance in any particular jurisdiction.
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DISCLAIMER: Information current at 31.10.22. OCI is a Company/Trust/LLC/LP/Foundation Formation Agency. We are not tax advisers or legal advisers. You are advised to seek local legal/tax/financial advice in regards to your local reporting/tax requirements before committing to set up or use an Offshore Company or other entity.