COALA 3

Chapter 5 DAO specific provisions Chapter 5 acknowledges that DAOs present new opportunities but also challenges. These opportunities and challenges must be addressed explicitly in the Model Law, and therefore do not have a counterpart in traditional corporate law rules. We have included provisions on Contentious Forks in the underlying blockchain (Articles 3(6), 16), DAO restructuring (Article 17), and DAO failure events (Article 18). As to Article 16, unlike corporations which can act as one authoritative counterparty in their dealings by way of their separate legal personality, DAOs can experience Hard Forks pursuant to which multiple blockchain forks coexist, assets are duplicated and multiple instantiations of a DAO are created on different chains. During a Contentious Fork, there is an absence of an authority that makes a definitive choice of a chain and thus, there is a lack of an authoritative counterparty for a DAO. This is a particularly acute problem when dealing with Off-Chain Assets and Persons, as the existence of a single, authoritative counterparty is routinely expected. Considering Article 17, the technological infrastructure of a DAO is subject to continuous change as a result of upgrades, modifications and migrations. The Model Law requires that DAOs maintain certain minimum standards throughout these changes to ensure that ‘restructurings’ do not subvert the standards and protections provided by this Model Law. These standards were introduced so as to allow DAOs to continue to have legal personality and their Members to retain limited liability as the DAO evolves. In the short history of DAOs, we have witnessed a series of Failure Events. In Article 18, we address potential technical failures of DAOs rendering DAOs unoperational or frustrating a DAO’s expected operation. Providing for legal personality and limited liability to DAOs under this Model Law, we consider it important to clarify that DAOs subjected to Failure Events do not lose such protections but only to the extent necessary to protect DAO Members and Participants from personal liability. 42 In contrast, there are standard provisions of business organization law that are deliberately not addressed by this Model Law. There are three main reasons for this. First, as discussed in the Preamble, the technological infrastructure of DAOs recognized by this Model Law allow them to meet certain legal requirements and achieve certain policy objectives by way of functional and regulatory equivalence. Such legal requirements, which are often enshrined in provisions related to financial disclosures or share transfers, are automatically met by the technological guarantees provided by a blockchain-based system and do not need to be specified by law. For example, a corporate statute may include a provision that a share should be annotated with relevant information to trace ownership when the share is transferred to another entity (e.g., a trust), but the inscription of the transfer on a public, Permissionless Blockchain makes this information transparent by way of its ordinary functioning. This is a functionally equivalent outcome, as this inscription on a Permissionless Blockchain provides another means for tracing ownership other than an annotation on the face of a share or an electronic record update. As it is anticipated that a jurisdiction interested in adopting the Model Law will also facilitate such functional equivalence, such an example has not been addressed in this Model Law. At the same time, some of the articles in the Model Law strive to achieve regulatory equivalence, and might therefore introduce new regulatory requirements that may either complement or supplement traditional regulatory constraints. For instance, the article related to formation requirements (Article 4) seeks to achieve regulatory equivalence with typical corporate registration requirements. Second, this Model Law provides a high degree of discretion to DAOs in how they establish their organizational, governance and capital structure (Chapter 4). As such, issues such as limitations on the transferability and negotiability of tokens, criteria by which Members are excluded from DAOs, internal and external dispute resolution mechanisms and threshold requirements for By-Law amendments, among other topics, are beyond the scope of this Model Law and left to the individual discretion of DAOs. Third, there are typical provisions of corporate law that concern transactions that have yet to materialize with respect to DAOs. These include Members’ agreements, the substantial sale of the DAO’s Off-Chain Assets, conversions into DAOs, mergers with DAOs and liquidation and dissolution. New legislation, such as the State of Wyoming’s legislation on decentralized autonomous organizations, addresses these 43 provisions in the context of the jurisdiction’s own corporate law. However, at this 43 juncture, without more concrete examples of these transactions—or at least, efforts at achieving the same—the drafting of model provisions would be a largely speculative exercise and may ultimately not support the ends that Participants and Members seek to achieve through these transactions. Article 16. CONTENTIOUS FORKS IN THE UNDERLYING BLOCKCHAIN― In the event of a Hard Fork in the underlying Permissionless Blockchain: (1) By default, the legal representation of the DAO remains on the Majority Chain and any Off-Chain Assets will belong to the DAO on the Majority Chain. (2) The DAO may choose to maintain legal presence on a Minority Chain if it expresses its intent to do so by Public Signaling, and in that case any Off-Chain Assets will belong to the DAO on the selected Minority Chain. (3) The DAO may liquidate its On-Chain Assets following a Hard Fork in order to move those Assets to the chosen chain. (4) Alternatively, the DAO may choose to split into multiple legal entities, each on a separate chain, if it communicates by Public Signaling: (a) its intent to do so, and (b) there is a definitive distribution of Off-Chain Assets between the Majority and Minority Chain(s). 43 Wyoming Decentralized Autonomous Organization Supplement, Wyo. Stat. § 17-31-110 to 17-31-116 (enters into force on 1 July 2021) accessed 8 May 2021. 44 Commentary Blockchains can undergo Hard Forks, as defined in Article 3(11). Multiple blockchain forks can coexist and the decision concerning which fork to use is a consensus-driven process that must be achieved without a definitive source of authority making the decision for Members and Participants. Ultimately, individual Members and Participants can decide which fork to subscribe to. This presents difficulties for interfacing with persons and entities outside of the given blockchain, which expect one authoritative counterparty for their dealings. Hard Forks could cause confusion because they create multiple possible counterparties, where different instantiations of the DAO reside on different chains. This is not an issue for On-chain Assets, because they will be replicated on both forks, and therefore can be managed and disposed of on the respective chains. However, with Off-Chain Assets, which are scarce, third parties (e.g., governments, property registers, custodians, brokers, potentially insolvency professionals) interfacing with the DAO need to have one definitive counterparty that is recognized as having legal ownership of Off-Chain Assets and liabilities, as well as identified Legal Representatives for that counterparty. For example, if two DAOs replicated on competing forks were both to make a claim on the same piece of real property, it can be difficult to ascertain which of the two has a genuine and legitimate claim over this property. This Model Law makes the Majority Chain the default choice, since Minority Chains without significant support are typically not considered to be authoritative representatives of the view of the community of the DAO. Usually, the Majority Chain can be fairly and quickly identified immediately after the Hard Fork. However, in the case of Contentious Forks, it is possible that the Majority Chain may not be immediately determined from the moment of the Hard Fork. Caution should be exercised in this transition period. If the Majority Chain is not obvious after the Fork, the following factors may be taken into account in order to determine which fork should be regarded as the authoritative Majority Chain: ● Security: The blockchain with the greatest hashing power in the case of a proof of work, or with the highest amount of deposits in the case of a proof of stake. 45 ● Applications, Services and Service Providers: The blockchain that is recognized and accepted by a majority of ancillary services and service providers (e.g, trading protocols, exchanges, wallet providers, oracles, data gateways), tokens and applications. ● Market Capitalization: The blockchain whose Token is the most valued by the market. ● Community Recognition: the blockchain recognized by the majority of developers, thought leaders, end users and other Members and Participants. ● Trademark: the blockchain that is formally recognized by the entity holding the trademark (e.g., the Ethereum Foundation holds the Ethereum trademark). Article 17. DAO RESTRUCTURING― (1) In the event that there is not a Contentious Fork and a DAO’s Smart Contract is restructured through modification, upgrade or migration, it will retain its legal personality and limited liability only to the extent that: (a) The new code of the DAO continues to fulfill all the formation requirements of Article 4; (b) In the event of migration, where the DAO has to be associated with a new unique Public Address, proper notice is provided by way of Public Signaling. Failure to meet these requirements will result in a loss of legal personality and limited liability effective at the time of restructuring. (2) The DAO restructured in accordance with subsection (1) will be the universal successor of the original DAO and inherit its rights and obligations. 46 Commentary A DAO may modify, upgrade or migrate its Smart Contracts to resolve a software bug, augment capabilities, change operating procedure, meet legal requirements or for technical maintenance. Modifications are simple changes to the data in the DAO’s smart contract, such as modifications of voting majority thresholds. Upgrades can be made through an existing function (e.g., via a proxy contract). Finally, migrations involve more substantial coordination, as entirely new Smart Contracts may be deployed and migrated to. For example, a new DAO could be constituted with the same membership distribution, and then the old DAO would vote to move all funds and legal personality to the new DAO. There is an important distinction between upgrades and modifications on the one hand, where the DAO can still be identified through its unique Public Address, and a migration on the other, where its identifying Public Address has changed. This distinction implies that within instances of modification or upgrades, there should not be any ambiguity as to the validity of the upgrade or modification, so long as the DAO continues to conform with the requirements of its legal status. However, if a DAO migrates to a different Public Address, the DAO must provide clear Public Signaling to move legal personality and all assets and liabilities to the new Public Address. An example of Public Signalling to help interpret Article 17(1)(b): A DAO plans to migrate to a different Smart Contract with a different, unique Public Address, but maintaining an identical distribution of control and ownership rights among the same set of Members. The Members of the DAO then pass a Proposal to such effect. If the Proposal is passed and proper notice is given on the DAO’s website and social media accounts, then the legal personality of the DAO will be deemed to have passed from the predecessor DAO to the successor DAO without interruption. The original DAO will be deemed to have passed all rights and obligations to its successor. 47 Article 18. FAILURE EVENT― In the case of a Failure Event: (1) Legal personality and limited liability are maintained to the extent necessary to protect DAO Members and Participants from personal liability. (2) A Failure Event may trigger liability on the Person(s) deploying or upgrading the DAO if that Person(s): (a) acted in manifest bad faith; or (b) engaged in gross negligence. Commentary The Failure Event provisions are analogous to directors’ liability under corporate law. They are intended to address situations in which a person with decision-making authority in a DAO acts in bad faith or, through gross negligence, causes a technical failure that harms Members, Participants, or the general public. As with director liability, there is not an expectation that a person’s decisions or actions will be perfect, but they must be taken with the best interests of the DAO in mind and fall within a reasonable range of possible decisions or actions. After a Failure Event, legal personality and limited liability will typically be maintained in order to protect the interests of the DAO Members and Participants. For example, in the case of a hack, a person who can be said to have acted in bad faith or through gross negligence may face liability for losses incurred in the Failure Event, but DAO Members and Participants who simply took part would still be shielded by the DAO’s legal personhood and limited liability. 48 Chapter 6 Miscellaneous Provisions Article 19. APPLICATION OF GENERAL BUSINESS ORGANIZATION LAW― The DAO will be governed by: (1) The By-Laws; (2) The Model Law, as adopted or transposed into domestic legislation; and (3) To the extent that any lacunae remain, general business organization law of the State that recognizes the DAO. Any ambiguity resulting from this application will be resolved in a manner that upholds the letter and objectives of the Model Law. Commentary There may be a few instances in which the By-Laws of a DAO and the Model Law are not able to address all of the organizational and governance issues that arise from the operation of a DAO. In such circumstances, the general business organization law of the State that recognizes the DAO may be used to address these lacunae. However, as general business organization laws are generally drafted with centralized organizations in mind, applying these laws may present their own difficulties. As a consequence, any such application of general business organization laws must only be done if the By-Laws and Model Law cannot be applied and any resulting ambiguity must be resolved in a manner that upholds the letter and objectives of the Model Law. These objectives can be found in the Preamble of this Model Law. 49 Article 20. TAXATION OF DAOs― The taxation of DAOs recognized by this Model Law will be based on the following principles: (1) By default, any DAO recognized by this Model Law will be treated as a pass-through entity for tax purposes, with no entity-level tax accruing to the DAO. Any realized gains will pass through to the DAO’s Members in proportion to their Token holdings. (2) Where a Member itself is not a taxable entity, such as another DAO, the realized gains allocated to such Members will pass to the first taxable person in the same manner as specified in Article 20(1). Commentary With regards to their taxation treatment, the distinction between the internet and cyberspace, as outlined by Lawrence Lessig, provides a useful framework to characterize the unique attributes of DAOs vis-a-vis digital entities hosted in the cloud. While transactions occurring over the internet typically entail a clear 44 correspondence with those of taxable entities with a real-world existence, a DAO cannot be conventionally connected to an agent or location on Earth. This is primarily due to the fact that its processes and procedures are predefined and deterministic, carried out by code existing in cyberspace. Furthermore, the emergence of blockchain-based anonymization techniques and decentralized exchanges compromise the enforcement of a regulatory framework for taxation akin to that of cloud-based agents. In that sense, David Shakow acknowledges that "the pure blockchain form does not work well for an entity under the IRC [United States Internal Revenue Code]".45 45 David Shakow, ‘The Tao of The DAO: Taxing an Entity That Lives on a Blockchain’ (2018) 160 Tax Notes 929, 937. Insertion is ours. 44 Lawrence Lessig, Code: And Other Laws of Cyberspace, version 2.0 (Basic Books, 2006), 5. 50 Many questions regarding the taxation of DAO remain unaddressed by the tax laws of national jurisdictions. These questions, highlighted by Shakow, include the classification of DAOs as entities under tax law, the tax residence of DAOs, the level at which investments in DAOs should be taxed (entity-level or Member-level), the taxation of Members liquidating their investment, the filing of tax returns and the treatment of Hard Forks as taxable events for Token-holders who receive Tokens from the forked chain. In addition, Airdrops as defined in Article 3(4) pose additional unresolved complexity for the tax laws of national jurisdictions. Despite the difficulties in achieving regulatory equivalence, taxation is material for DAOs to recognize the social and environmental costs inherent in the operation of DAOs that, in the absence of taxation, would be imposed on other members of society. As the tokenomics of DAOs imply that the value of a DAO is reflected in the value of the Token(s) issued by the DAO or governing the DAO, making DAOs pass-through entities for tax purposes seems to be the correct approach. As such, the responsibility of paying tax on gains should fall on Members and Participants, because in the case of unregistered DAOs, which this Model Law addresses, only Members and Participants are anchored in a jurisdiction. Accordingly, each Member or Participant is solely responsible for declaring their financial stake in a DAO, if required by the jurisdiction in which each Member or Participant is a tax resident. It should be the sole obligation of the Members or Participants to declare their capital gains on the disposition of DAO-related Tokens or similar transactions.