COALA 1

Article 1. NATURE— (1)The DAO is a legal entity that can be used for commercial, mutualistic, social, environmental or political purposes, the nature of which will be specified in its By-Laws. Commentary The aim of the Model Law is to allow a DAO that has not registered as a for-profit corporate entity or a non-profit entity to benefit from equivalent standing as a domestic limited liability company or limited liability cooperative. Most jurisdictions no longer require limited liability companies to have an object/purpose clause. Instead, many jurisdictions allow them to engage in any legal activity. The ultra vires doctrine has also fallen out of favor in several advanced corporate law jurisdictions. A common exception to this trend is charitable organisations, which 8 is regularly explained by their special tax status. The Model Law does not aim to secure any special tax status for DAOs and accordingly has not taken into account the prevailing requirement for charitable organisations to have an object/purpose clause. As such, this Article does not preclude DAOs from engaging in social, environmental or philanthropic activities alongside its economic activities. Specifically, the Model Law acknowledges that a DAO may not only be a for-profit entity but may be used for multiple non-commercial purposes. DAOs have already been used for non-commercial purposes.9 9 Early examples included "Hutten-DDO" (formed to support collaborations between a group of Siemens employees, such as their charitable donations), "YangDAO" (formed to support decentralized content creation for former US Presidential candidate Andrew Yang) and "OrochiDAO" (formed to coordinate around the creation of side events at blockchain conferences). 8 See, e.g., Lorraine Talbot, ‘Critical Corporate Governance and the Demise of The Ultra Vires Doctrine’ (2009) 38 Common Law World Review 170. 10 Article 2. LEGAL PERSONALITY— (1)A DAO within the scope of this Model Law will be deemed a legal entity separate and distinct from its Members. A DAO will, by its own name, be capable of: (a)suing and being sued; (b)acquiring, owning, holding and developing or disposing of property, both movable and immovable; and (c) doing and suffering such acts and things as bodies corporate may lawfully do and suffer. (2)A DAO within the scope of this Model Law must meet its liabilities through its On-Chain and Off-Chain Assets. (3)The validity of an action by a DAO within the scope of this Model Law may not be challenged on the ground that the DAO lacks power to act. Commentary The core public policy goal of legal personality is entity shielding. Attaining legal personality allows an entity to operate as a single contracting party distinct from those owning or managing the firm, with a single pool of assets distinct from the other assets of those owning and managing the firm. The entity’s pool of assets 10 may not be attached by the personal creditors of those owning or managing the firm, but only by the creditors of the entity itself. The latter are usually granted priority over the owners of the firm to the entity’s assets. To protect the entity from forced liquidation, entity shielding usually also entails rules that prevent the owners of the entity from withdrawing their share of assets at will. Through this 11 Article, the same rationale is extended to DAOs, so as to separate the assets and liabilities of Members and Participants from that of the DAO. The Model Law stipulates that jurisdictions should recognize a DAO to have legal personality so long as they are able to meet the same policy goals underlying 11 ibid. 10 Reinier Kraakman and others, The anatomy of corporate law: a comparative and functional approach (Oxford University Press 2009) section 1.2.1. 11 corporate law, as reflected in this Model Law. In order for this principle to stand, all jurisdictions should adopt the same criteria for legal personality as prescribed in the Model Law, otherwise the legal scope of a particular DAO could be fragmented and unpredictable. Article 3. DEFINITIONS— (1) “Accreditation Authority” means any public or private authority that a jurisdiction which adopts or transposes the Model Law recognizes as legitimate to ensure compliance with one or more Articles of the Model Law. (2) “Administrator” means a Person, irrespective of title, that is appointed in a manner specified in the By-Laws to take discretionary decisions, either individually or collectively with other Administrators, with regard to specific, predefined operations of the DAO. (3) “Airdrop” means a free distribution of Tokens initiated by a DAO to a Public Address, but does not include distributions of Tokens for which a person must execute a function to redeem the distributed Tokens. (4) “Asset” includes both On-Chain assets and Off-Chain assets. (5) “By-Laws” means the rules and regulations that govern the procedures followed by a DAO and the interaction of its Members and Participants, which must be set out in plain language, in text or sound, visual or audiovisual recording. (6) “Contentious Fork” means a Hard Fork that results in two divergent and potentially competing blockchains. 12 (7) “Decentralized Autonomous Organization” (DAO) refers to smart contracts (i.e. blockchain-based software) deployed on a public Permissionless Blockchain, which implements specific 12 decision-making or governance rules enabling a multiplicity of actors to coordinate themselves in a decentralized fashion. These governance rules must be technically, although not necessarily operationally, decentralized. (8) “Developer” means a person involved in the development or maintenance of the DAO, whether through the contribution of software code, design, business, legal or ancillary support. (9) “Dispute Resolution Mechanism” means an On-Chain alternative dispute resolution system, such as arbitration, expert determination, or an On-Chain alternative court system, which enables anyone to resolve their disputes, controversies or claims with, arising out of, or in connection with, a DAO. Any such award, decision or judgment will be accorded the same status and treatment as an international arbitral award. (10) “Externally Owned Account” means a Public Address controlled by a private key and that has no associated code. (11) “Failure Event” means a DAO encountering a technical bug or exploit which renders the DAO unoperational or fundamentally changes the expected operation of the DAO. (12) “GUI” means a graphical user interface, publicly accessible by all DAO Members and Participants, whether hosted via centralized or decentralized means, through which users interact with computer software via visual indicator representations. This can include, but is not limited to, a web interface or standalone application. 12 This definition shall also apply to any layer 2 solutions. 13 (13) “Hard Fork” means a blockchain software upgrade that is not compatible with previous versions of the blockchain software, and therefore requires all users to upgrade. (14) “Jurisdiction” means a territory that is under a defined legal authority. (15) “Legal Representative” means a Person who is appointed in a manner specified in the By-Laws to perform procedural functions Off-Chain. (16) “Majority Chain” means the version of the chain accepted by more than 50% of the blockchain’s validators following a Hard Fork. (17) “Meeting” means a synchronous or asynchronous event for the purpose of discussing and acting upon DAO-related matters by Members or Participants. (18) “Member” means any person or DAO who has governance rights in a DAO. (19) "Minority Chain" means the version of the chain that is not the Majority Chain following a Hard Fork. (20) “Model Law” means this DAO Model Law. (21) “Off-Chain” means any action or transaction that is not On-Chain. (22) “On-Chain” means any action or transaction that is recorded and verified on a blockchain. (23) “On-Chain Contribution” refers to any Token segregated and locked in one of the DAO’s Smart Contracts for the purpose of Member buy-in to the DAO and the provision of withdrawable capital. 14 (24) “Open-Source Format” means the Open Source Initiative’s definition of open source. 13 (25) “Participants” means any person interacting with or holding native tokens in a DAO other than Members. (26) “Permissionless Blockchain” means a public distributed ledger, allowing any entity to transact and produce blocks in accordance with the blockchain protocol, whereby the validity of the block is not determined by the identity of the producer. (27) “Person” means an individual, a company or any other body of persons. (28) “Proposal” means a suggestion for actions to be taken by the DAO, to be decided on in accordance with the By-Laws of the DAO. (29) “Public Address” means a unique, durable identifier that person(s) can transact with on a Permissionless Blockchain. (30) “Public Forum” means a freely accessible online environment that is commonly used for the exercise of speech and public debate. (31) “Public Signaling” means a declaration authorised by way of Proposal by the DAO in a Public Forum. (32) “Quality Assurance” means that the code of the DAO has undergone security review according to industry standards, namely: (1) the completion of professional software security audit with an audit report available to the public with no significant security risks remaining, as well as the completion of a public bug bounty; (2) a formal verification by means of a mathematical proof-based methodology in which the Smart Contract’s bytecode is directly checked as correct-by-construction to show the full functional 13 Open Source Initiative, “The Open Source Definition” (The Open Source Definition | Open Source Initiative, March 22, 2007) accessed May 8, 2021. 15 correctness of security-critical properties of the Smart Contract; or (3) any other process recognized as meeting the same security standards. (33) “Smart Contract” is code deployed in a blockchain environment. It is made of a set of predefined and deterministic instructions executed in a distributed manner by the nodes of the underlying blockchain network, if and when the underlying conditions are met. Execution of a Smart Contract will produce a change in the blockchain state. (34) “Token” means a record on a Permissionless Blockchain, typically representing an Asset, participation right, or other entitlement. (35) “Transaction” means a new entry in a Permissionless Blockchain, often but not exclusively, recording a change in ownership of an Asset or participation in a DAO. Commentary With respect to Administrator (Article 3(2)), common terms used for Administrators may include ‘Directors’, ‘Trustees’ or ‘Committee Members,’ depending on the preference of the DAO in question. With respect to Decentralized Autonomous Organizations (Article 3(7)), the definition distinguishes between Smart Contracts that qualify as DAOs for the purpose of this Model Law and those that do not qualify as DAOs, based on the technical design and implementation of their governance structure. The governance of a DAO is always technically—although not necessarily operationally—decentralized. From a purely technical perspective, the DAO must provide at least the potential of decentralized governance. For example, a Smart Contract that is controlled by an Externally Owned Account will not qualify as a DAO within the scope of this Model Law, because one single entity can unilaterally affect the operation of said Smart Contract. This holds true even if the actions of said single entity are determined by a distributed governance system operating outside of the blockchain. Conversely, a Smart Contract whose governance is based 16 on a Token-based system will most likely qualify as a DAO, even if a single entity could theoretically control a majority of these tokens. With respect to Smart Contract (Article 3(33)), the reference to “predefined conditions" means that all terms are explicitly fixed and immutable, whereas "deterministic conditions” means that for any valid input provided, the same result is returned regardless of when the function is executed. With respect to Person (Article 3(27)), we follow the approach of the OECD Model Tax Convention (2017), which defines a person as “an individual, a company and any other body of persons”. The OECD Report on the Application of the OECD 14 Model Tax Convention (1999), clarifies that this term also covers foundations and partnerships.15 Formation and Proof of Existence Article 4. FORMATION REQUIREMENTS— (1)In order for a DAO to benefit from legal personality, it must fulfill the following requirements: (a)The DAO must be deployed on a Permissionless Blockchain; (b)The DAO must provide a unique Public Address through which anyone can review the DAOs’ activities and monitor its operations; (c) The whole software code of the DAO must be in Open-Source Format in a Public Forum to allow anyone to review it; (d)The software code of the DAO must have undergone Quality Assurance; (e)There must be at least one GUI that will allow a layperson to read the value of the key variables of the DAO’s smart contracts and monitor all transactions originating from, or addressed to, any of the DAO’s Smart Contracts. The GUI will also specify whether Members are able to redeem their Tokens without restrictions and if not, the GUI will clearly mention the restrictions that are in place; (f) The DAO must have By-Laws that are comprehensible to a layperson. The By-Laws must be publicly accessible via a GUI or a Public Forum. Sensitive information may be redacted from the By-Laws before their publication, if those redactions are necessary to protect the privacy of individual Members or Participants in the DAO; 18 (g)The governance system of the DAO must be technically decentralized, although not necessarily operationally decentralized, as per Article 3(7). (h)Independent of the chosen governance system, there must always be at least one Member of the DAO at any given time; (i) There must be a publicly specified mechanism that allows a layperson to contact the DAO. All Members and Administrators of the DAO must be able to access the contents of this communication mechanism; (j) The DAO must refer to or provide a Dispute Resolution Mechanism that the DAO, Members and Participants will be bound by; (k)The DAO must refer to or provide a Dispute Resolution Mechanism to resolve any disputes with third parties that, by their nature, are capable of being settled by alternative dispute resolution. (2)The DAO will, upon meeting the formation requirements in Article 4(1), have limited liability by default, subject to the provisions of Article 5. (3)Concurrent fulfillment of the requirements in Article 4(1), and an announcement by the DAO that it has fulfilled those requirements is deemed conclusive evidence of the DAO’s recognition under this Model Law and does not require certification from, or registration by, an Accreditation Authority. (4)A jurisdiction adopting the Model Law may authorize an Accreditation Authority to monitor whether a DAO continues to meet the requirements for legal personality under the Model Law. (5)A DAO may request confirmation from an Accreditation Authority, if such an authority exists, to determine whether the DAO complies with the requirements for legal personality under the Model Law. 19 Commentary As the objective of the Model Law is to bridge the technical and legal gap between the multiple existing and potential activities of DAOs and traditional regulatory frameworks that have yet to adapt to the new social organizations enabled by permissionless participation, the Model Law applies only to DAOs operating on Permissionless Blockchains. Permissionless Blockchains enable a multiplicity of participants to coordinate on a decentralized basis, in which control of the DAO is established among various actors via a Token-based system, and such permissionless participation is the foundational basis of DAOs. These emergent forms of social and economic coordination require updates to traditional corporate legal frameworks to apply public policy mechanisms in a manner that takes technical realities into account. New political and legal economies that can be gained from the technical functionalities afforded by DAOs require this kind of cautious and effective adaptation of corporate law frameworks to DAOs. Permissionless Blockchains can be distinguished from permissioned blockchains, in which blockchain software is deployed by a narrow subset of pre-defined actors by a series of predefined accounts and can therefore be considered centrally controlled and coordinated. Permissioned blockchains are more akin to a traditional private corporation or foundation in terms of having centralized governance,, and, as such, applications on permissioned blockchains do not require new legal frameworks to operate. DAOs deployed on Permissionless Blockchains raise the possibility of interacting with persons and entities one does not know. In the late 1770s, in writing about penal law, Bentham posed the question: “Who are you, with whom I have to deal?”16 This question strikes at the heart of the problem of being able to accurately and truthfully identify a stranger. At the time, the lack of standardization of proper names provided numerous opportunities to deceive counterparties. As Fichte noted soon after, this lack of identifiability compromised policing. While both had the 17 identifiability of natural persons in mind, the need to know who one is dealing 18 with is also essential for legal persons. 18 Colin Koopman, How We Became Our Data: A Genealogy of the Informational Person (University of Chicago Press 2019) 29. 17 Johann Gottlieb Fichte, Foundations of Natural Right: According to the Principles of the Wissenschaftslehre (Frederick Neuhouser ed, Michael Baur tr, Cambridge University Press 2000) 295. 16 Jeremy Bentham, “Principles of Penal Law” in John Bowring (ed), The Works of Jeremy Bentham, vol 1 (William Tate 1838) part 3, chapter 12, problem 9, 557. 20 In a majority of jurisdictions, this identifiability requirement is met by giving a company a unique name that distinguishes it from other companies, a unique identification number and a registered office address, which can be used to find the company in a business register. A search of such a business register usually provides the name of at least one of the directors of said company. Through the formation requirements mentioned in this Article 4, we strive for regulatory equivalence by meeting this identifiability objective, while also acknowledging the unique properties of DAOs and the implicit goal of DAOs to conduct transactions digitally and maintain the pseudonymity of Administrators, Members and Participants. An example of this is Article 4(1)(b), which requires the specification of a Public Address. Any DAO has—by technical requirement—at least one unique Public Address. The Public Address usually reveals the blockchain the DAO is based on, although this is not so in the case of a Hard Fork. The public policy goal requiring a company to have a name to distinguish one company from another is met by the identification of a Public Address of a DAO, which may be considered its default name in the absence of a unique name communicated by Public Signaling. This Public Address is communicated publicly as part of the requirement in Article 4(1)(c) to have the whole software code of the DAO published in Open Source Format. As mentioned above, in most jurisdictions, a legal person must have a physical, registered address. While there are varied policy goals behind this requirement, we consider (1) the need of stakeholders and third parties (e.g., a national legal system) to communicate with a legal entity; and (2) the need to determine its lex societatis (i.e., the national law that governs the entity), to be the two most important reasons for having a physical, registered address. In general, a physical, registered address—even if limited to a mailbox—is important due to the need for Persons or the legal system to serve legal documents. While service of documents by e-mail or fax is already possible in several jurisdictions for civil proceedings (e.g., England & Wales), it is not universally the case (e.g., in the Netherlands). 19 20 20 European Union, ‘Service of Documents- Netherlands’ (European e-Justice Portal - Cooperation in civil matters June 25, 2018) accessed May 8, 2021. 19 European Union, ‘Service of Documents - England & Wales’ (European e-Justice Portal - Cooperation in civil matters June 25, 2018) accessed May 8, 2021. 21 A jurisdiction that adopts the Model Law should also permit the electronic service of legal documents by any communication mechanism publicly specified by a DAO (Article 4(1)(i)), such as a secure website which the authorities of a jurisdiction can post notice to and from which it can receive cryptographically signed acknowledgement. Courts in both India and the United Kingdom have recently indicated support for novel electronic means of serving legal documents, so long as the intended recipient can be correctly identified and there is an indication that they have been served (e.g., a “blue double tick” on Whatsapp). In the case of DAO 21 Administrators or Members, identification would usually be enabled by their public address on the blockchain, not their name. For the sake of transparency and to avoid the maintainer of the communication mechanism being held inadvertently and individually responsible for the actions of a DAO, this publicly specified communication mechanism should be accessible by any Member of the DAO. At the same time, this communication mechanism should not permit a Member or Administrator to unilaterally delete or amend communications. The second policy goal of determining the laws and procedures that govern a DAO is met by specifying a Dispute Resolution Mechanism for disputes arising among Members (Article 4(1)(j)) and for disputes with third parties that can be subject to alternative dispute resolution mechanisms (Article 4(1)(k)). In other words, we consider that compliance by the DAO’s software code with Article 4 of the Model Law satisfies the policy goals behind the traditional requirement of having a seat. Instead of requiring a DAO to submit to and physically establish a presence in every jurisdiction in which they operate, the Dispute Resolution Mechanism gives Members and other stakeholders means of redress against the DAO, should the need arise. Dispute Resolution Mechanisms with non-member third parties do not have to meet minimum standards of due process for the time being, as no on-chain ADR process currently meets such standards and is unlikely to do so in the foreseeable future. However, third parties who enter into agreements with DAOs should be informed upfront about the Dispute Resolution Mechanism the DAO has opted into and that it may not meet the standards of due process that they might expect in an Off-Chain dispute resolution process, such as court litigation. This gives the third party prior notice and option to avoid transactions with the DAO and, if they choose to enter into such transactions, they do so on the basis of ‘participant beware’. However, at a minimum, any final decision or settlement resulting from the Dispute Resolution Mechanism must be made public, after anonymizing the names and other personally identifiable information of the 21 ServeNow Staff, “Service of Process via WhatsApp” (serve-now.com, March 12, 2019) accessed May 8, 2021. 22 disputing parties, where relevant. Jurisdictions should recognise any final decision reached by the Dispute Resolution Mechanism. For matters that cannot be resolved by an ADR or binding arbitration procedure, a Legal Representative will be appointed (Articles 3(15), 14) to represent the interests of a DAO as a legal entity. In many jurisdictions, the promoters assisting in the incorporation of a limited liability company must set authorized, subscribed and paid-in capital, along with the number of shares to be issued, the different classes of shares, their par value, and the terms and conditions on which the payment for their subscription will be made. We consider the overarching policy goal of this requirement to be ensuring that an entity has sufficient capital to meet its debts to creditors and to provide a structure for capital investments and tradability of shares. In the case of DAOs, the policy goal is automatically met by its technical reality: the funding situation, governance and any Token issuance may be read by anyone from the Permissionless Blockchain (Article 4(1)(a)). However, as only a minority of experts are able to reliably and accurately read the information from a blockchain directly, only DAOs that have a minimum of one publicly available GUI (Article 4(1)(e)) and have completed software Quality Assurance (Article 4(1)(d)) will be able to benefit from protection under the Model Law. Similarly, a limited liability company is typically required to have a statute or constitution, often known as the Articles of Association or By-Laws, sometimes supplemented by or encompassed in an Operating Agreement or Membership Agreement, which include rules for the management of the affairs of the company, including its administrators and its representatives in relation to third parties, along with the names and powers of any such persons or entity(ies). A DAO’s By-Laws are by default laid down in its software code. However, as only a minority of experts are able to reliably read the DAO’s code, only DAOs providing for a one-to-one version of the rules in plain language on a GUI (Article 4(1)(f)) and a governance system with at least one Member (Article 4(1)(h)) will be able to benefit from protection under the Model Law. 23 Chapter 3 Limited Liability, Asset Subscription and Members’ Rights Article 5. LIMITED LIABILITY― (1) Except as set forth in Articles 5(3) and Article 5(4), Members will only be responsible for providing the On-Chain Contributions that they have committed to the DAO, as required by the By-Laws. If the DAO exhausts its Assets, the Members will not be liable for excess liability. (2) Except as set forth in Articles 5(3) and Article 5(4) of this Model Law, Members will not be held liable for any obligations incurred by the DAO, including, but not limited to, labor and tax obligations. (3) If the DAO refuses to comply with an enforceable judgment, order or award entered against it, the Members who voted against compliance will be liable for any monetary payments ordered in the judgment, order or award in proportion to their share of governance rights in the DAO. (4) Articles 5(1) to 5(4) will not affect the personal liability of a Member in tort for their own wrongful act or omission, but a Member will not be personally liable for the wrongful act or omission of any other Member of the DAO. 24 Commentary Limited liability of shareholders, while being a defining and important feature of the modern corporation, has not always been an attribute of corporations. According to Harris, limited liability evolved since the 1600s over three distinct periods from a system of no limited liability (circa. 1600-1800) to a multiplicity of hybrid liability regimes (circa. 1800-1930) to ‘strong’ owner shielding in the twentieth century. It 22 was only in this third period that creditors were granted legal priority over equity holders in claiming corporate assets. There are several legal and economic grounds for why limited liability became a uniform attribute of the corporation. With the growth of large, complex corporations in the United States with dispersed shareholding structures, it became apparent that it was untenable for individual shareholders to have ‘moral culpability’ for the 23 actions of corporations, as they lacked the power and control mechanisms to discipline errant management. At the same time, limited liability allows risk-averse persons to take business risks that they may have otherwise avoided, thereby enhancing the chances of gaining a lucrative return, as the risks of a poor investment are shifted onto creditors and other third parties. Ordinarily, 24 shareholders that enjoy limited liability only stand to lose what they have invested in the event of insolvency. As a consequence, shareholders are also able to invest in multiple corporations without having to closely monitor any of them. This is a 25 clear example of how corporate legal requirements evolved to address the inherent trade-offs underlying public policy goals to enhance or enable political and social economies afforded by implementation of such rules. Voluntary creditors are able to, however, protect themselves from the moral hazard of shareholders by imposing higher interest rates on any loans extended to the corporation and by negotiating limitations on actions that a corporation can take without creditor approval. Involuntary creditors, such as tort victims, may seek to pierce the corporate veil so as to satisfy the claims they may have against individual shareholders or parent companies, but globally such efforts at veil piercing are generally unsuccessful outside of cases of fraud. 25 ibid, 59. 24 ibid, 49. 23 Stephen Bainbridge and M. Todd Henderson, Limited Liability: A Legal and Economic Analysis (Edward Elgar Publishing 2016) 46. 22 Ron Harris, ‘A New Understanding of the History of Limited Liability: an Invitation for Theoretical Reframing ’ (2020) 16 Journal of Institutional Economics 643, 644. 25 As a corollary to this, there are legal and economic grounds for why unlimited liability is less favored by contemporary corporate entities, although certain corporate entities have unlimited liability as a mandatory rule (e.g., in general partnerships) or as a default rule (e.g., cooperative societies in some jurisdictions). While unlimited liability would offer voluntary and involuntary creditors some solace that shareholders would be jointly and severally liable for any claims that remain unsatisfied by the corporate entity, this would be poorly suited to the interests of members of an entity that has potentially thousands-if not millions-of anonymous members and aspires towards participatory governance, such as a DAO. It is the combination of these two attributes, among other things, that makes the governance of a DAO distinct from that of an archetypical Berle-Means corporation. It could be argued that, as with other business organizations with unlimited liability, the ability of Members to participate in governance would be sufficient to ameliorate vertical (principal-agent) and horizontal agency problems (majority-minority principals). However, the fact that many of the other Members are unknown would, in principle, heighten the apprehension of Members that Tokens could be sold to poorer third parties and thereby increase their collective risk. In other words, in the absence of limited liability, DAOs would have to adopt 26 a rule similar to general partnerships, that to sell their membership-conferring Tokens on a secondary market would require unanimous consent of all Members27 ―a requirement that would be cumbersome and costly for DAOs, as it would decrease the liquidity of their tokens. For voluntary and involuntary creditors,28 joint and several liability may also lose its appeal when confronted with the reality that they would potentially have to pursue individual claims against several, dispersed Members. It is arguable that it is even unfair that creditors be able to arbitrarily pursue actions against individual Members, based on the accessibility of the Members’ jurisdiction or wealth. At the same time, it creates social costs as it is society that has to bear the costs related to the public enforcement of these liability claims. The above summarizes some of the main advantages of an entity having limited liability and the central disadvantages of having unlimited liability, so as to explain why the Members of a DAO should be extended limited liability. In addition to the 28 See in the context of pro rata shareholder liability, Henry Hansmann and Reinier Kraakman, ‘Toward Unlimited Liability for Corporate Torts’ (1991) 100 Yale Law Journal 1879, 1880. 27 Stephen Bainbridge and M. Todd Henderson, Limited Liability: A Legal and Economic Analysis (Edward Elgar Publishing 2016) 61. 26 On this risk with respect to shareholders of unlimited liability entities, see Richard Posner, Economic Analysis of Law (4th ed., Little, Brown and Company 1992) 394. 26 aforementioned legal and economic benefits of limited liability, the absence of such protection for Members would discourage participation in a growing market and stymie the development of innovative financial and non-financial products. While limited liability can be privately ordered―for example, by having representatives of the entity negotiate contractual clauses where creditors agree to waive any claim on Members’ assets―this is an expensive exercise prone to moral hazard. Instead, we 29 seek limited liability to be granted to DAOs compliant with other requirements articulated in the Model Law, as it has been in the past with a multitude of other corporate entities and as it has recently come into force in the State of Wyoming. 30 31 Understandably, there may be concerns regarding the abuse of limited liability. This may be addressed by DAOs by introducing a requirement for Members to make a financial contribution to a reserve fund or towards the premiums of an appropriate insurance policy for the benefit of limited liability. Such a bond in exchange for limited liability has been advocated by Robert Rhee and Abraham Singer. Some 32 DAOs may decide to sequester some of their On-Chain Assets in a specially designed Smart Contract, which will pay out in case of liability. Insurance customised to the needs of a DAO may be able to cover a larger share of potential future liabilities, however, the novelty and riskiness inherent in this sector make such coverage prohibitively expensive. Nonetheless, we have included this voluntary option with the view that insurance providers will gradually emerge to respond to the needs of this space, as can be seen with the example of Nexus Mutual. In addition, the veil piercing option in Article 5(3) further mitigates risks 33 of abuse of Members’ limited liability, while Article 5(3) ensures Members cannot simply refuse to pay a judgment against the DAO. Note that Articles 5(1) and (3) does not make Members liable for excess liability the DAO is unable to pay from its Assets, but only for an outright refusal by the DAO to respond to judgment against it. 33 Nexus Mutual, ‘FAQ’ (Nexus Mutual Gitbook, February 2021) accessed 8 May 2021. 32 Abraham Singer, The Form of the Firm: A Normative Political Theory of the Corporation (Oxford University Press 2019) 185-186; Robert Rhee, ‘Bonding Limited Liability’ (2010) 51 William and Mary Law Review 1417, 1450-1453. 31 Wyoming Decentralized Autonomous Organization Supplement, Wyo. Stat. § 17-31-110 to 17-31-116. accessed 8 May 2021. 30 Anton Jäger, ‘State and Corporation in American Populist Political Philosophy, 1877-1902’, The Historical Journal (online first view), 9-10. 29 Henry Hansmann, Reinier Kraakman and Richard Squire, ‘Law and the Rise of the Firm’ (2006) 119 Harvard Law Review 1333, 1341. 27 Article 6. ASSET SUBSCRIPTION AND PAYMENT― (1) No minimum capital requirements will apply to a DAO recognised by the Model Law. If the DAO wishes to maintain a minimum amount of capital, the By-Laws of the DAO will specify the rules for subscription and payment. (2) The By-Laws must specify the rules for exiting the DAO that address the consequences of voluntary and involuntary Member and Participant exit on subscriptions and payments they have made. (3) No Member will be able to compel the dissolution of the DAO for failure to return their On-Chain Contribution. Commentary The subscription of minimum capital, with a large amount paid up front before the commencement of business, has typically been a mechanism to prevent the abuse of the privilege of limited liability. The policy objectives of having a minimum capital requirement include protecting creditors, signaling the availability of certain assets to meet the claims of creditors (particularly involuntary ones who cannot bargain for better protections), preventing the frivolous formation of limited liability companies, demonstrating that a new business is credit-worthy and nudging directors to recapitalize an undercapitalized business. However, as is current 34 practice with private limited liability companies in several jurisdictions, we do not 35 see minimum capital subscription as being necessary for DAOs, due to its inadequacy in serving its main intended purpose: protecting creditors from members and fiduciaries siphoning assets. In the European Union, the Centros 36 36 Massimo Miola, ‘Legal Capital and Limited Liability Companies: The European Perspective’ (2005) 4 European Company and Financial Law Review, 413, 419. 35 DLA Paper, ‘Minimum Capital Requirement’ (DLA Piper Intelligence.com, 2 April 2021) accessed 8 May 2021. 34 Fritz Ewang, ‘EU Minimum Capitalisation Requirement: An Analysis and Critique of the EU’s Minimum Capitalisation Requirement’ (2007) 15 accessed 8 May 2021. 28 judgment has made clear that companies are free to circumvent minimum capital rules by registering in a foreign jurisdiction which provides lower minimum capital requirements, given that there are other mechanisms to protect the interests of creditors. The paying-up of a portion of minimum capital prior to the formation 37 and operation of a business does not prevent the business from returning the cash of promoters as a salary, in exchange for goodwill or as a loan soon after it becomes operational. Nor are the sums committed to these businesses typically sufficient to 38 meet the claims of unsecured, involuntary creditors, such as employees. Voluntary creditors do not look towards minimum capital to determine the credit-worthiness of a business but instead concentrate on other metrics such as net worth or cash flow, as well as the business’s ability to furnish security. Given existing market-based challenges and formation requirements imposed by this Model Law, we do not see a justification for creating an additional barrier to entry to small, under-resourced DAOs in the form of a minimum capital requirement, particularly where such a requirement is rapidly falling out of favor for the reasons discussed above. Instead, as the inherent technical features of a Permissionless Blockchain and this Model Law require a DAO’s software code, On-Chain Assets and transaction records to be publicly available (Article 4(1)(e)), the financial position of a DAO and the risks inherent in it are made transparent to any creditors. As such, the signaling functions of minimum capital requirements are achieved through technological means. Furthermore, DAOs have diverse mechanisms for entry and exit designed according to the needs of their Members, such as withdrawal of Tokens (akin to the withdrawal of shares in cooperatives in the UK) or the transfer of TTokens to third parties (akin to the transfer of shares in limited liability companies). We believe the law should allow for this flexibility to protect the interests of Members with minority Token holdings. We anticipate that one of the critiques of not having a minimum capital and granting limited liability to DAOs will be that it will allow an insolvent or near-insolvent DAO seeking to exploit its undercapitalization and the limited liability of its Members to engage in risky ventures that could, among other things, lead to tort liability. Due to its poor financial position, such a DAO may not be able to meet tort claims, while shielding Members from liability. However, multinational corporations engage in such risk transfer practices on a regular basis. The financial position of a DAO will be transparent to all stakeholders due to the existence of a 38 Fritz Ewang, ‘EU Minimum Capitalisation Requirement: An Analysis and Critique of the EU’s Minimum Capitalisation Requirement’ (2007) 5, 17 accessed 8 May 2021. 37 Case C-212/97 Centros Ltd v Erhvervs- og Selskabsstyrelsen [1999] ECR I-1459. 29 GUI that can be used to examine its Assets (Article 4(1)(e)). To assuage concerns regarding economic credibility and creditworthiness, a DAO that seeks limited liability protection for its Members may consider maintaining relevant insurance coverage or reserve funds in escrow to satisfy such claims. Article 7. CLASSES OF PERSONS PARTICIPATING IN THE DAO― (1) A DAO may have multiple classes of participation rights defined in, and granted in accordance with, its By-Laws. (2) Where the DAO has Tokens providing governance powers to the Token holder, the Token holder will be considered a Member of the DAO: (a) From the time the ownership of the Tokens is established to be in the possession of an address, or (b) From the time when ownership is first acknowledged by the Token holder through an On-Chain interaction with the DAO, through staking the Tokens, voting with the Tokens Off-chain whereby results are implemented On-Chain, submitting a Proposal or transferring the Tokens to another address, in the event that no action has been taken by a Token holder to acquire a Token, such as in an Airdrop. (3) This Article does not apply in the event of a Contentious Fork. (4) This Article does not apply to Airdrops. 30 Commentary Participation rights in DAOs may take the form of tokenized governance powers, which may include the ability to propose, vote, and veto Proposals, as well as confer financial rights, which may include revenue and profit-sharing, bonding redemption rights, and service access rights, among others. Such participation rights and responsibilities, whether in the form of governance or financial powers, may be purchased, earned programmatically, granted through proposals, or distributed in any way defined in the DAO’s By-Laws. The Model Law requires a DAO’s software code, On-Chain Assets and transaction record to be publicly available and transparent to Members and Participants, so it does not impose a restriction on distributions, as with traditional non-profit companies or foundations. These ‘non-distribution constraints’ exist in such organizations to prevent fiduciaries and key employees siphoning valuable assets from the organization for personal gain, and to build trust in the organization’s capacity to achieve their social, environmental or charitable purpose. The signaling function provided by the technological guarantees of a DAO, as well as the diverse mechanisms designed by Members to enter and exit a DAO, provide sufficient safeguards to dispense with the need for specific restrictions on distributions within a DAO. In the traditional corporate form, governance and financial rights usually coincide, but this is not necessarily the case for DAOs. A DAO can delineate various governance and financial rights via its Token-based system and distinguish amongst its participants those Token-holders to whom governance powers have also been granted. This Model Law contemplates that only those persons holding governance rights should be considered Members of the DAO who determine the actions of the DAO, and thus hold a higher level of responsibility. An example of an important stakeholder in the DAO ecosystem who would not be classified as Members are persons who hold Tokens on centralized exchanges. In such situations, the user usually only has a claim on the centralized exchange, but doesn’t have actual ownership of the Tokens, which is a prerequisite for membership. The lack of actual ownership of Tokens by users was well demonstrated in a dispute in 2020 over the Steemit platform. In March 2020, centralized exchanges, including 39 Binance, Poloniex and Huobi, used user deposits of STEEM, the native Token of the Steemit blockchain, to help oust all of Steemit’s nodes known as “witnesses” that 39 Yilun Cheng, ‘Tron takeover? Steem community in uproar as crypto exchanges back reversal of blockchain governance soft fork’ (The Block, 2 March 2020) accessed 8 May 2021. 31 secure the Steemit blockchain in favour of one single witness (node) controlled by Tron’s founder Justin Sun. The move was heavily criticized within the blockchain ecosystem, which has arguably resulted in more hesitant usage of user deposits by centralized exchanges. However, the matter highlights the discrepancy between legal ownership, possession and lack of actual control by users over Token deposits in centralized exchanges, which, therefore, should not qualify as conferring membership rights. This Article does not apply to Contentious Forks (Article 16 and commentary). Blockchains can undergo hard forks, as defined in Articles 3(13) and 16. As such, multiple blockchain forks can coexist and which fork to use is a consensus-driven process that must be achieved without a definitive source of authority determining the result. Because these replications can occur without affirmative action on the part of Participants, this Model Law does not contemplate that governance responsibilities should be automatically conferred to Members of a DAO involuntarily subject to a Hard Fork. As described in Chapter 5, there are several factors to be considered in the determination of the majority fork. Ultimately, individual participants and market aggregations decide which fork emerges as the authoritative counterparty in transactions. In this Model Law, Article 7(2)(b) requires a Token holder to make an affirmative action or acknowledgement to be considered a Member participating in a DAO, and therefore the involuntary doubling of Tokens and associated governance and financial participation rights that occurs during blockchain forks are exempted from this Article.40 Similarly, this Model Law exempts Airdrops (Article 3(3)) from Article 7. Airdrops occur when a DAO distributes tokens to Public Address without knowledge or consent from the owner of the Public Address. Due to the nature of blockchains, a Public Address cannot block incoming transactions. As such, Airdrop distributions confer Tokens and associated participation rights on Persons involuntarily, and are therefore exempt from Article 7. This Model Law requires that Token holders voluntarily and affirmatively engage in an On-Chain interaction with a DAO (Article 7(2)(b)) to be considered a Member of a DAO. Recently, many governance token distributions have been organised as so-called “merkle airdrops” (or merkledrops), which require the user whose Public Address received the merkledrop to actively redeem the Tokens and pay any associated transaction fees. The definition of Airdrops (see Article 3(3)) used in this Model Law does not encompass 40 Additionally, this Model Law distinguishes a DAO split, in which members of a DAO affirmatively vote to separate a DAO’s assets, governance and financial rights, from a blockchain fork. A DAO split is analogous to a traditional private company contemplating divestment, demerger or hive down. 32 merkledrops, for which users must affirmatively and voluntarily accept the merkledrop and the associated participation and governance rights.