COALA preamble

New models of blockchain-based organizations, often referred to as Decentralized Autonomous Organizations (DAOs), face significant legal uncertainty that can be detrimental to their development and utilization. This Model Law (ML) aims to create uniformity and legal certainty, while, unlike other regulatory frameworks for DAOs, still accommodating flexibility for further innovation by not imposing formal registration requirements. The drafters and contributors to the ML have sought to consciously address the vertical (principal-agent), horizontal (majority-minority principals) and firm-stakeholder agency problems that can be seen in corporate entity forms irrespective of jurisdiction, while still being sensitive to, and retaining, the particular features of DAOs and crypto-economic systems that make these forms of organization and coordination unique and valuable as emergent social and commercial vehicles. States are encouraged to adopt or transpose the ML’s provisions into their domestic law. In a State that has transposed or adopted the ML into their domestic legal system, a DAO that is constituted according to the requirements of the transposed or adopted legal rules will qualify and be recognized as a legal entity by that State. This will result in the DAO being granted legal personality in any State that has adopted or transposed the ML, which is essential to guarantee the legal effect of the DAO’s action. If the ML’s provisions are complied with, the DAO’s Members will additionally enjoy limited liability. To allow for DAOs to qualify as legal entities in the maximum number of States, the ML provides a minimum level of rights, duties and protections that are generally recognized in legislation on analogous corporate entities in major jurisdictions. In addition, if a DAO qualifies as a legal entity in a particular jurisdiction, the legal effects of its actions and the protections offered to its Members, Participants, Legal Representatives and Administrators may be more easily recognized in other jurisdictions that have not adopted or transposed the ML under private international law principles. As many unregistered DAOs will fail to comply with existing corporate rules by nature of their intrinsic operation, and will not be able to implement all of the necessary legal requirements formally articulated in existing corporate rules, the ML strives to achieve functional and regulatory equivalence through specific provisions of the ML. Functional equivalence allows the establishment of equivalence between an object already within the realm of a legal rule and another object not yet encompassed by it. For instance, the UNCITRAL Model Law for 2 Electronic Commerce establishes functional equivalence between a paper-based document and an electronic document. As this Model Law demonstrates, this approach is useful for simplifying the regulation of DAOs. For example, instead of introducing new corporate rules specifically applicable to ‘tokenized’ shares, shares that are recorded on a blockchain-based system could be regarded as valid titles to a share, transferable via a blockchain-based registry. Regulatory equivalence relies on the same technique, but identifies the object or purpose of any given regulation as goal. It allows for the establishment of equivalence between the function of a legal rule and the function of a technology. A pertinent example of regulatory equivalence is the relationship between registration requirements for corporate entities and the deployment of a DAO on a Permissionless Blockchain. 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. Following a public announcement of the Public Address of the DAO, the deployment is verifiable by anyone, as it is inscribed on a Permissionless Blockchain. In view of the above objectives, the ML consists of the following Chapters: Chapter 1 sets out the broad range of economic and social activities that DAOs can engage in, the rights and obligations that DAOs can enjoy as a separate legal person, and important definitions used in the ML. Chapter 2 sets out the eleven technical and governance requirements that a DAO needs to meet to benefit from legal personality, and for its Members to receive limited liability protection. Chapter 3 sets out the potential actions that may lead to Members forfeiting limited liability protection, namely fraud and failure to comply with binding arbitral awards or court orders. This is intended to limit the grounds on which a Member may be jointly liable with a DAO, while not precluding the possibility that a Member may be personally liable (e.g., under tort law principles). The chapter also clarifies that minimum capital requirements are not mandatory for DAOs, as is increasingly the case with traditional corporate entities, while still acknowledging that some DAOs may wish to voluntarily introduce reserve funds and insurance schemes to enhance public confidence in their ability to meet their debts to third party creditors. The remainder of the chapter is devoted to governance rights, providing considerable leeway to DAOs to create multiple classes of participation and diverse voting rights structures, as well as the possibility to protect minorities and appoint proxies. Chapter 4 builds on the question of how a DAO under the ML is to be governed. It seeks to allow individual DAOs to have considerable flexibility in how their internal 3 organization and procedures take place, without being bound by the same constraints that a number of corporate entities are subject to (e.g., in-person, physical meetings). The ML enables management by consensus as well as the appointment of Administrator(s). It recognizes that, irrespective of how the DAO is managed, the DAO may need to have representation off-chain for certain purposes and activities. This chapter therefore provides a procedure for appointing a Legal Representative with narrowly-defined powers that can interact with territorially bound national jurisdictions. In the spirit of contractual freedom, DAOs are permitted to appoint fiduciaries if they wish, but the ML makes clear that merely holding a position with a particular title and having certain potentially discretionary decision-making power (e.g., core Developer, Administrator, Member) should not be in itself sufficient to imply fiduciary status. The provisions of Chapters 1-4 are akin to most corporate law statutes and address the aspects of DAOs that are similar to other business organizations. Chapter 5, in contrast, recognizes that DAOs have technical features that raise new questions that merit specific treatment. This Chapter, therefore, includes specific articles that concern the consequences of Contentious Forks, modifications, upgrades and migrations on the legal personality of a DAO (as well as its claims and assets) and the limited liability of its Members. Moreover, there may be Failure Events that are specific to DAOs, which under this chapter may lead to the liability of Persons who are grossly negligent or acting in manifest bad faith in making a decision, but will not attach to those not involved in the decision. Chapter 6 is the final part of the ML and includes two important miscellaneous provisions that are necessary in creating a coherently complete legal framework for DAOs. First, it specifies when general business organization law should be applied to DAOs by a jurisdiction that adopts the ML. Only lacunae in the by-laws and the ML should be filled by domestic general business organization law, and if there is any ambiguity arising from this gap-filling function, it should be resolved in a manner that upholds the objectives and letter of the ML. Second, it establishes the recognition of DAOs as pass-through entities for tax purposes, so as to simplify the process of taxation for DAOs which are non-territorial and transnational by their nature, and instead make Members and Participants responsible for tax compliance. 4 Model Law for Decentralized Autonomous Organizations (DAOs) with Explanatory Comments Preamble1 Introduction Decentralized Autonomous Organizations (DAOs) can be classified into two distinctive categories: registered DAOs, i.e. DAOs that are organized according to the laws of a State and that are registered in a corporate registry, and unregistered DAOs, i.e., DAOs that are created outside of the legal frameworks defined by national laws and are not registered in a corporate registry. The vast majority of existing DAOs are unregistered DAOs and their legal status is currently uncertain: they are alegal. The result is a great deal of legal uncertainty, which can be 2 detrimental to the development and utilization of this new model of social and business organization. Since DAOs are inherently transnational in nature, the drafters and contributors to the DAO Model Law (“Model Law”) believe that it would be desirable to adopt a uniform, model set of rules that could be implemented 2 Alegality is a concept that is useful for understanding actions that are currently not seen by the legal system, and that might potentially challenge the boundaries of the legal order, and the distinction between legal and illegal. Arguably, some of the activities undertaken on a public, permissionless blockchain could be regarded as alegal, either because they are not (yet) encompassed by the law, or because they stand outside of its reach. For instance, the decentralized nature of public blockchain networks makes them virtually impossible to shut down, even if one or more states shut down nodes within their jurisdiction. Moreover, because smart contract applications are run and executed in a decentralized fashion, any smart contracts or DAOs deployed on a public blockchain will continue to operate independently of the will of the parties deploying them, and will also be impossible to shut down. This brings them into the alegal realm. This is not to say, however, that the law cannot reconstitute its boundaries in order to accommodate their existence and to influence their operations. Yet, this requires a conscious intervention from the legislator in order to recognize them under the law so as to bring them within the scope of legality or illegality, depending on the circumstances. The adoption of the DAO Model Law by existing governments is a way for them to reconstitute their legal boundaries to accommodate the regulation of DAOs within their existing legal framework in a harmonized fashion. For more information on alegality, see Hans Lindahl, Fault Lines of Globalization: Legal Orders and the Politics of A-legality (Oxford University Press, 2013); Hans Lindahl, ‘Border Crossings by Immigrants: Legality, Illegality, and Alegality’ (2008) 14 Res Publica 117; Hans Lindahl, ‘The Opening: Alegality and Political Agonism’, in Andrew Schaap (Ed.), Law and Agonistic Politics (Ashgate 2009); Vanja Hamzić, ‘Alegality: Outside and beyond the legal logic of late capitalism’ in Honor Brabazon (Ed.), Neoliberal Legality: Understanding the Role of Law in the Neoliberal Project (Routledge 2017); Carys Hughes, ‘Action Between the Legal and the Illegal: A-Legality as a Political–Legal Strategy’ (2019) 28 Social & Legal Studies 470. 1 The Preamble provides the legal foundations of ‘regulatory equivalence’ and ‘functional equivalence’, as well as a discussion of the widespread recognition of certain forms of transnational private legal ordering and, in particular, the work on creating model laws for new corporate/organizational forms. 5 internationally to provide legal certainty for DAOs and their members and participants. The Model Law is designed as a best practice guide for DAOs and States are encouraged to adopt or transpose its provisions into their domestic law. States should hew as closely as possible to the letter and objectives of the Model Law to avoid regulatory fragmentation and provide a consistent foundation for the legal status of DAOs on a transnational basis. Objective The objective of the Model Law is to bridge the gap between the multiple existing and potential activities of unregistered DAOs—those that have not been wrapped in a corporate form in any jurisdiction—and the regulatory frameworks in the many jurisdictions within which unregistered DAOs already operate. The Model Law provides legal rules that can be effectively applied, while taking into account technical constraints and opportunities of these novel forms of organization. It is essential that the legal rules are flexible enough to accompany and encourage the development of DAOs. The rules proposed in the Model Law seek to strike a balance between the need for legal certainty and the need for DAO developers, administrators, members and participants to retain the freedom necessary to enable the technology to evolve. Recognizing the importance of legal protections and a sound regulatory framework, as well as the importance of experimental freedom in technological development and innovation, the Model Law provides a framework for the effective regulation of DAOs without being unduly burdensome. It achieves this by, first, using a principle-based approach to identify the policy objectives and principles underlying provisions of corporate law in major jurisdictions. Second, the Model Law seeks to implement these objectives and principles by limiting its scope to DAOs that meet specific technical and governance standards and by providing rules that recognize that these DAOs’ technological features offer satisfactory protections and meet purposes in a manner that is equivalent to existing law. Scope The Model Law provides uniform rules of law that can serve as a model for national legislators who wish to adopt substantive national law rules on DAOs. In a State that has transposed or adopted the Model Law into their domestic legal system, a DAO that is constituted according to the requirements of the transposed or adopted legal rules will qualify as a legal entity. This will result in the DAO being granted legal existence and legal personality in any State that has adopted or transposed the Model Law, which is essential to guarantee the legal effect of its actions. 6 The Model Law contributes to an emerging international consensus on the legal situation of DAOs. It is therefore desirable that the rules of the Model Law be adopted by as many States as possible so that the legal scope of DAOs corresponds to their transnational nature. To allow for DAOs to qualify as legal entities in the maximum number of States, it provides a minimum level of rights, duties and protections that is generally recognized in legislation on corporate entities in major jurisdictions. In addition, when a DAO qualifies as a legal entity in a particular jurisdiction, its status in other jurisdictions that have not adopted or transposed the Model Law may be more easily established under private international law principles. The contributors to the Model Law have sought to consciously address 3 the vertical (principal-agent), horizontal (majority-minority principals) and firm-stakeholder agency problems that can be seen in corporate entity forms irrespective of jurisdiction, while still being sensitive to, and retaining, the particular features of DAOs and crypto-economic systems that make these forms of organization and coordination unique and valuable as emergent social and commercial vehicles. For example, many of the issues concerning the protection of minority shareholders, creditors and other stakeholders are addressed through the conferral of exit rights and disclosures, on the principle of ‘participant beware’. Format This document is drafted in the form of a Model Law containing substantive and procedural rules that can be adopted by States in their national law in order to draft their own legislation concerning DAOs. It provides commentary on some of the articles in order to explain their intended meaning and practical scope. Additionally, it may serve as a foundational document for the development of best practices for developers, administrators, members and participants of DAOs. Important Concepts Functional equivalence allows the establishment of equivalence between an object already within the realm of a legal rule and another object not yet encompassed by it. Through functional equivalence, the “means” by which a regulated process, procedure or activity will be considered as compliant with the 3 This understanding draws on, among other things, the principle laid down by the US Supreme Court in Bank of Augusto v. Earle, 38 US 519 (1839) that though a legal entity (such as a corporation) is an artificial creature of national law and only exists because of that law, “it does not by any means follows that its existence there will not be recognised in other places; and its residence in one state creates no insuperable objection to its power of contracting in another.” Also see, Katharina Pistor, The Code of Capital: How the Law Creates Wealth and Inequality (Princeton University Press, 2019), 68. 7 law can be broadened. For instance, the UNCITRAL Model Law for Electronic Commerce establishes functional equivalence between a paper-based document and 4 an electronic document; similarly, certain electronic signatures that comply with specific requirements are held to be functionally equivalent to a handwritten signature. It thus conceptualizes both legal rules and technologies as means to an 5 end, or instruments that can fulfill a particular purpose. This includes, but is not limited to, protective purposes, preventive purposes, and punitive purposes. For functional equivalence to be established, one has to identify a policy objective or a purpose and then demonstrate that this objective or purpose could be achieved either by the enforcement of a legal rule or by relying on a particular application of a technology. As this Model Law demonstrates, this approach is useful for simplifying the regulation of DAOs. For example, instead of introducing new corporate rules specifically applicable to ‘tokenized’ shares, shares that are recorded on a blockchain-based system could be regarded as valid titles to a share, transferable via a blockchain-based registry. Regulatory equivalence relies on the same technique, but identifies the object or purpose of any given regulation as goal. It allows for the establishment of equivalence between the function of a legal rule and the function of a technology. 6 Through regulatory equivalence, the realm of processes and procedures for achieving a policy objective of any given law can be broadened. The first step is the identification of the policy objective of a regulation and then, in a second step, the consideration of processes and procedures that can be deemed to fulfill this purpose. In our conceptualization of regulatory equivalence, there is then a third step in which we assess how this objective, and the consequent processes and procedures, can be achieved through the use of a particular technology. The goal is to achieve traditional objectives of corporate law by relying on technological means where possible. The advantage of this approach is that it allows for the incorporation of new technologies into the existing legal framework without necessitating large-scale legal reforms, preventing the fragmentation of the regulatory field and the creation of ever more specialized laws for the regulation of a particular technology. A pertinent example of regulatory equivalence is the relationship between registration requirements for corporate entities and the deployment of a DAO on a blockchain. Registration requirements are driven by the objective of publicity and 6 Regulatory equivalence in its most common use refers to the equivalence of the regulatory regime of two different jurisdictions, often in the context of trade or financial regulations. 5 See, e.g., Regulation (EU) No. 910/2014 of 23 July 2014 on electronic identification and trust services for electronic transactions in the internal market and repealing Directive 1999/93/EC [2014] OJ L 257/73, art 25(2). 4 United Nations Commission on International Trade Law. UNCITRAL Model Law on Electronic Commerce, with Guide to Enactment, 1996: with Additional Article 5 Bis as Adopted in 1998. 8 reliability, which is underwritten by the trust that people have in public authorities. 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. Following a public announcement of the address of the DAO, the deployment is verifiable by anyone, as it is inscribed on a public blockchain. Thus, even if unregistered DAOs do not fully comply with existing legal requirements, the features of the technology meet some of these requirements through a different process or procedure. Registration is one of many such examples considered in this Model Law. Many unregistered DAOs will fail to comply with existing corporate rules and will not be able to implement all of the necessary legal requirements. The Model Law identifies the extent to which some DAO features can be held to be functionally equivalent, and therefore compliant with various legal requirements. We also identify the extent to which their technical features, while not functionally equivalent, achieve the same policy objectives. As a result, DAOs should benefit from legal personhood and at least some of the various rights and obligations of the existing frameworks of corporate law, even if they do not use an entity form under the law. The adoption of this Model Law by States, and thus the recognition of features of functional and regulatory equivalence of DAOs, would encourage DAO developers, administrators and members to implement these features into their DAOs so as to benefit from legal personality. Bringing DAOs into a regulatory framework would, 7 in turn, increase legal certainty from the perspective of members, participants, administrators and developers of DAOs, as well as from the perspective of regulators and third parties, including the general public. In addition, it leaves room for DAO developers, administrators, members and innovators to experiment and propose sound technological solutions that could be later recognized by regulators as being either functionally or regulatorily equivalent to existing corporate law rules and formalities. 7 Note that some jurisdictions have adopted a different approach than our Model Law by creating new types of registered DAO forms (e.g., Malta, Wyoming) rather than providing a legal framework where unregistered DAOs qualify as legal entities if they meet certain conditions such as those outlined in the Model Law. In our opinion these approaches are limited in that they do not properly leverage the technological and crossborder characteristics of blockchain technology