How to customize a legal entity for DAO?

Decentralized Autonomous Organizations represent a new organizational structure that formally allows decentralized decision-making using blockchain and token voting mechanisms. Where traditional industrial firms rely on separation of governance and ownership, DAOs offer a radically different template for organizational engagement, where ownership and governance are merged — driven by smart contracts, liquid membership, and transparent transaction channels.

One of the most frequently discussed aspects of DAOs is the ongoing debate around their legal status and structure and the mechanisms that allow DAOs to interact with the rest of the world. What mechanisms allow an organization that is essentially global to benefit from legal personality and limited liability? Would this happen if it wasn’t included in one jurisdiction? What is the ideal jurisdiction and entity structure? At the end of the day, can an on-chain organization comply with the jurisdiction’s legal obligations while retaining its sovereignty? Do they really want to?

Incorporation of DAOs into any jurisdiction is often not straightforward due to administrative (rather than substantive) hurdles. Most jurisdictions do not accept the registration of on-chain code as an operating agreement or charter. Additionally, identifying anonymous members of an organization can be problematic for obvious reasons. Incorporating or associating a DAO with a pre-existing legal entity structure is often akin to inserting a square peg into a round hole. With enough manipulation or pounding, it may eventually work, but your stake will almost certainly no longer retain its original desirable properties.

A handful of forward-thinking jurisdictions are already making changes to current entity structures or working to create new structures to support DAO registrations in their territories:

  • In the U.S., Wyoming, Vermont, and Tennessee have made changes to existing limited liability company (LLC) laws, in addition to recently proposing federal legislation on DAO recognition.
  • The Republic of the Marshall Islands (RMI) has passed legislation for not-for-profit DAO LLC structures and is working to bring more for-profit structures into effect.
  • The Kazakh government is modifying the existing structure with the ultimate goal of creating a custom structure that can accommodate both for-profit and non-profit DAOs within a special economic zone called AIFC.
  • Additionally, in 2021, the Coalition for the Application of Legal Automation (COALA) ​​published a proposed model law emphasizing jurisdictional recognition rather than registration to accommodate the global and transnational nature of DAOs.

Legal uncertainty continues to hinder the development and widespread acceptance of this new form of social organization. However, many may have forgotten that US LLCs were only formed in the late 1970s. Only since then have LLCs gained comprehensive tax and liability protection advantages, making them one of the most commonly used corporate structures since the early 1990s. The legislative changes needed to get to this point have only been possible thanks to the lobbying efforts of affected businesses and related interest groups. Promoting the widespread adoption and use of DAOs as a viable organizational structure or business model may require similar efforts on an international scale.

LLCs in the US are a product of Generation X

As mentioned earlier, the U.S. LLC structure was developed in the late 1970s to address the disparate tax regimes levied on registered and partnership-structured businesses and the lack of limited liability for non-registered U.S. entities. Partnership tax provisions only tax the owner level and offer many other benefits including the ability to distribute profits and losses more flexibly. Corporate tax regulations require companies to pay two levels of taxation, one at the entity level and another at the level of their respective shareholders.

At the time of the LLC’s creation in 1977, the Partnership Classification Regulations administered by the Internal Revenue Service (IRS) imposed certain requirements on all unincorporated business organizations seeking the tax benefits of partnerships and excluded limited application to unincorporated organizations. responsibility. In 1988, the IRS issued Tax Ruling No. 88-76, allowing the original Wyoming LLC to be classified as a partnership despite the existence of limited liability protections. The adoption of LLCs as a recognized entity structure ultimately represents a new solution that addresses the limitations imposed on the two-tier corporate tax structure and excludes the liability limitations of unincorporated organizations.

In 1977, the Wyoming Limited Liability Company (LLC) Act established the first unincorporated business entity in the United States to combine statutory limited liability protection with the ability to pay federal income taxes as a partnership.

The Wyoming Act was created specifically for the Hamilton Brothers Oil Company. Due to the high risk and speculative nature of their investments, Hamilton needed a liquid entity to provide a level 1 tax and limited liability protection similar to Panama’s “limitada”. In contrast to the US entities of the time, limitada provided direct limited liability and the opportunity to secure partnership status for US income tax purposes.

However, Hamilton soon discovered that limitada faced administrative challenges in the United States, and that no similar company existed, raising questions about the extent to which U.S. courts would recognize its limited liability features. With no viable domestic entity combining limited liability and partnership taxes, Hamilton used attorneys and lobbyists to create an unincorporated domestic entity similar to a foreign limitada in a friendly jurisdiction. The proposed entity would meet the literal criteria of a partnership, while also providing direct limited liability protection to all participants.

Modeled on Germany’s “GmbH Code” and Panama’s “LLC Act”. These solid structures have four basic characteristics:

  1. An LLC’s name must contain some form of the word “limited.”
  2. A limited liability company is given full legal personality.
  3. LLCs can use the partnership concept of a “delectus personae,” where the LLC is given control over the admission of new members.
  4. Unless the articles of incorporation provide otherwise, an LLC will be dissolved upon the death of one of its members.

     

The newly developed LLC structure was initially submitted to the Alaska Legislature but was rejected. Shortly after the Alaska LLC legislation was rejected, Hamilton submitted an identical LLC bill to the Wyoming Legislature, which was quickly passed on March 4, 1977.

With the newly enacted Wyoming LLC legislation, Hamilton filed a request for a positive partnership classification ruling with the IRS, which is responsible for determining whether unincorporated businesses secede from association status. In 1980, after much lobbying, the IRS issued a favorable private letter ruling to Hamilton Brothers Oil Company over its Wyoming LLC. Unfortunately, this form of opinion is only available to the soliciting party. In early 1983, the IRS announced that it would review the effects of limited liability for organizations classified as unincorporated. While the tax status and limitations of liability for LLCs remain unresolved during the five-year study period, it is foreseeable that further development of LLC legislation and businesses adopting the structure will stall. As long as there are questions about their tax status, LLCs are unlikely to be adopted on a large scale.

On September 2, 1988, the IRS issued Tax Ruling No. 88-76, allowing a Wyoming LLC to be classified as a partnership despite its limited liability attributes. After the IRS made a landmark decision recognizing that LLCs are entitled to pay taxes under the partnership rules, states began implementing legislation to adopt LLCs as a business structure. By the end of 1996, all 50 states and the District of Columbia had passed legislation allowing LLCs to be incorporated within their borders. In less than 20 years, this new form of business has grown from obscurity to a viable alternative to partnerships and corporations at a rate unprecedented in the evolution of business organizations.

Ultimately, the fight for an LLC to become a separate, viable business alternative revolves around convincing the IRS that it meets the partnership classification requirements. The current viability of an LLC as an entity structure is only achieved through a concerted lobbying effort, and DAO proponents should understand that in order for a DAO to function optimally without sacrificing its inherent properties, this Targeted efforts are certainly necessary to enact legislation.

Current legislative work in the United States

How to customize a legal entity for DAO?

In 2022, Senator Cynthia Lummis, Republican of Wyoming, and Kirsten Gillibrand, Democrat of New York, co-sponsored the Responsible Financial Innovation Act. Half of the 69 pages of legislation deals with the recognition of the DAO. The Act states that the default classification for these community-led entities is a business entity for tax purposes. It also requires most DAOs to be properly registered under the existing laws of an identifiable jurisdiction (such as a limited liability company or partnership). The bill allows proposed DAOs to circumvent commercial disclosure requirements and not be considered commercial entities if they can demonstrate that they are sufficiently “decentralized.” Ultimately, the legislation leaves a lot to be desired. However, this is at least a starting point.

At the state level, Wyoming, Vermont, and Tennessee have accommodated DAOs by enacting laws that explicitly recognize the validity of blockchain smart contracts as governing documents. In theory, this allows a DAO to legally verify membership of an LLC by simply pointing to the corresponding blockchain or contract, while maintaining the benefits of blockchain technology – privacy and immutability.

Jordan Teague and other crypto attorneys discuss some of the inherent limitations and design choices associated with existing U.S. DAO LLCs.

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In the U.S., legislative efforts to accommodate DAO registration have largely been associated with minor administrative changes compared to the creation of the Wyoming LLC in the 1970s. Whereas earlier Wyoming LLC Acts combined attributes of different existing legal structures, the U.S. LLC Act made only administrative concessions. Due to the unique properties associated with DAOs, customized entity structures—designed to accommodate the unique needs of on-chain entities while still allowing for real-world interactions and limited liability—could ultimately be the ideal way to accommodate DAO registrations and activities.

Adjustment of RMI and creation of custom entities

As of 2022, the Republic of the Marshall Islands (RMI) officially recognizes the DAO as a legal entity, thanks to the Amended Not-for-Profit Entities Act of 2021 (Act). The Act allows the DAO to be registered as a Marshall Islands not-for-profit DAO LLC, based on legislation passed by the Marshall Islands government with the assistance of the founders of MIDAO Directory Services, Inc. (MIDAO). In addition to its legislative efforts, MIDAO is a multinational organization established to act as the registered agent of the Marshall Islands DAO and to assist the DAO in its registration in the Marshall Islands under the new amendments.

As mentioned earlier, MIDAO has spearheaded the legislative reforms that support the DAO. Former RMI chief secretary and MIDAO co-founder Bobby Muller said his country recognizes that now is a “unique moment to lead the blockchain revolution” and that DAOs will play an important role in creating “more efficient, less hierarchical organizations” . MIDAO’s strategy is to offer competitive registration costs, a supportive government with internationally recognized courts, and an environment open to technological advancement. In addition to the not-for-profit LLC structure, MIDAO is currently working on legislation to allow the registration of a for-profit DAO LLC option that may be particularly useful for investing in DAOs.

Adjustment of AIFC and creation of custom entities

Poko is a Y Combinator-backed startup that, in addition to on-chain DAO governance tools, focuses on wrapping or associating DAOs with relevant legal entity frameworks to make them as accessible as possible. Poko believes that operating in a DAO should not prevent projects or members from taking advantage of the benefits obtained by a government-recognized legal entity, including the ability to enter into contracts, limitations of liability, tax implications, and other advantages related to corporate or judicial personality. Poko is working on legislation in an iterative cycle to create a real-time model jurisdiction that enables DAOs to have a legal form compatible with on-chain governance.

Poko is working with the Kazakh government to establish a new DAO jurisdiction at the Astana International Financial Center (AIFC). AIFC is a common law special economic zone located in Kazakhstan that is developing innovative and forward-looking financial regulations. AIFC was established in 2018 to create a modern financial and legal hub between Asia and Europe. In 2021, bitcoin miners and other crypto-related entities have flocked to the region due to China’s “cryptocurrency ban.” As a result of this exposure, Kazakhstan has developed an interest in developing the crypto/Web3 industry. To facilitate this initiative, the president approved a national cryptocurrency strategy.

Cryptocurrency exchanges such as Binance and Bitfinex will be operating at AIFC by the end of 2022. Compared to other offshore centers, AIFC and the government are implementing training programs to accommodate more than 100,000 information and technology engineers, with the goal of providing value to the crypto economy through a pool of trained employees. In order to become a well-regulated Web3 jurisdiction, the AIFC has implemented or is considering the following legislation:

  • National cryptocurrency strategy, establishing a cryptocurrency-fiat banking track.
  • Introducing a central bank digital currency.
  • Acknowledging that NFTs are a unique form of intellectual property.
  • Experimentation of DAO governance structure and development of public goods.

Poko gets an exception in AIFC to create an initial limited number of “test” DAOs, linking them to existing legal entity frameworks (foundations and special purpose vehicles). To simplify the process, a test DAO removes certain requirements that a DAO might struggle to meet. Poko has established the first investment DAO SPV in AIFC and is working with regulators to approve the next 100 test DAOs by the end of July 2022. The adaptation of the DAO to the initial SPV structure includes streamlining the entire registration process, ensuring a fully electronic process, determining the best way to enforce KYC/AML/CFT requirements, issuing tax registration numbers, and establishing a crypto-fiat banking track.

Based on the findings of testing the DAO, Poko will develop and introduce a proposed DAO-specific legal structure to AIFC in 2023. Considerations for this bespoke entity include: 1) zero tax rates on corporations, income, capital gains and dividend distributions until 2066; 2) the first use of a common law legal system based on English law in Central Asia; 3) can be combined with An accessible enterprise e-filing system integrated with the Poko dashboard; 4) An independent court in charge of dispute resolution by British judges and the International Arbitration Center. Poko has also partnered with the Banking Authority to build an experimental crypto-fiat banking facility to accommodate crypto-native transactions.

The goal of Poko is to facilitate decentralized on-chain and off-chain decision-making and allow DAOs and their members to choose their own on-chain and off-chain governance structures. Poko will provide AIFC (and other jurisdictions) entities with the resources they need to succeed. Poko said it is working to make Astana an “A” of the “ABCD” (Astana, British Virgin Islands, Cayman Islands and Delaware) among the most popular DAO legal entity options.

COALA DAO Model Law

The DAO Model Law (ML) was published by the Coalition for the Automatic Application of Law (COALA) ​​in June 2021. COALA is an international, multidisciplinary research and development initiative to elucidate blockchain technology, smart contracts and decentralized applications. The initiative is made up of lawyers, academics, economists and computer scientists, among others. ML seeks to strike a balance between the importance of innovation and freedom of experimentation in technological development.

As mentioned earlier, DAOs face significant legal uncertainty, which may limit their development and use. ML aims to create uniformity and legal certainty while allowing for more innovation. Unlike other regulatory frameworks or entity structures, it does not require formal registration in a jurisdiction, which helps in packaging or being associated with a DAO. ML combines the autonomy of DAO members with the DAO’s independent legal personality to encourage anonymous participation and to recognize that human-machine or machine-to-machine interactions can perform valid legal acts. According to ML, the participants of the DAO are also granted limited liability. ML is ultimately designed to allow DAOs to retain their essential characteristics and properties while providing legal persons with all associated protections and benefits.

Since DAOs are multinational in nature, ML strives to adopt a consistent set of rules that can be enforced across jurisdictions. A DAO formed in accordance with ML’s formation requirements will be considered a separate legal entity from its members. To ensure its broad applicability, ML provides a minimum set of rights, obligations and protections that are widely recognized in the legislation of similar corporate entities in major jurisdictions. ML also contains specific provisions for dealing with the unique characteristics and challenges faced by DAOs, including procedures in the event of an adversarial fork, DAO reorganization, or failure event in the underlying blockchain. While no government agency can directly enforce ML terms on DAOs, a baseline of legal certainty is designed to incentivize adoption.

Despite ongoing and active discussions on the DAO entity structure in the Web3 community, ML received little attention when it was announced in 2021. Also, it didn’t generate enough discussion. However, this may just be based on the timing of the announcement or other unknown considerations. Nonetheless, ML at least represents a useful starting point for dialogue with regulators and should not be overlooked. It is also worth noting that this is only the first iteration of the proposed Model Law. The executive summary of ML mentions the Model Law on Electronic Commerce as a loose paradigm for ML. In the 25 years since the enactment of the Model Law on Electronic Commerce in 1996, only 85 of the 193 member states of the United Nations have passed legislation based on the Model Law on Electronic Commerce.

Proponents of ML may face significant challenges in convincing lawmakers that the principles of functional and regulatory equivalence on which ML is based protects interests in their jurisdictions. As with the development of limited liability companies in the United States in the 1970s, the development of a viable DAO model law requires a bottom-up, community-driven approach that needs to be understood by legal scholars and policymakers, but also by Experience of field staff and those who interact with the DAO on a daily basis.

We are still in the early stages….

As more people and money flock to DAOs, it will be important to address the legacy of the legal rights and responsibilities of these entities and their members. In the US, states are leading the charge. Outside the U.S., entities like MIDAO and Poko are pushing for more significant legislative reforms to make DAOs seen as a viable entity structure suitable for widespread adoption. And, while slightly esoteric in form, COALA’s Model Law provides a useful roadmap for DAO proponents trying to enact legislative change.

From 1977 to 1996, it took nearly 20 years for the LLC entity structure to be created and widely adopted in the United States. This seemingly long period also represents an unprecedented rate of adoption. Wyoming’s DAO LLC legislation, enacted in August 2021, does not ultimately represent a significant or groundbreaking modification of the entity’s structure compared to the LLC’s transfer taxation and limited liability protections.

In the future, iterations or combinations of existing entity structures to accommodate “wrappers” or other legal entities’ associations with DAOs will almost certainly occur before a more desirable structure is modified or created. Needless to say, the legal life cycle of DAOs and their associated legal structures is still relatively early, and existing structures are likely to change, or new ones to be developed in ways that have not yet been considered.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/how-to-customize-a-legal-entity-for-dao/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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