California limited liability company disputes | Courtroom war stories and lessons learned

The DAO Jungle?

A DAO is a Decentralized Autonomous Organization.  It’s a blockchain thing.

How do DAOs relate to LLCs?  And why are DAOs the subject of this post on The LLC Jungle blog?

Read on….

What is a DAO?

In basic terms, a DAO is a new type of business structure where control and governance are spread out among the members instead of hierarchical.  In contrast, LLCs with a designated manager are hierarchical, as are corporations with a board of directors.

DAOs are organized using smart contracts, and can even be managed by smart contracts.  DAO members typically use governance tokens to vote on topics such as allocation of funds.

Today, DAOs are used for a variety of purposes, including: cryptocurrency projects (such as MakerDAO), collecting non-fungible tokens aka NFTs (such as FlamingoDAO), and investment / grant funding (such as MolochDAO).

DAOs are attractive for their collaborative and transparent nature.  But, as with any form of organization, DAOs can suffer from disputes with third parties and disagreements within their communities.

One of the biggest risks with DAOs is uncertainty as to how they will be treated under the legal system in whatever jurisdiction they operate.  There is a legitimate concern that DAO members might be held personally liable for the actions of the DAO under “general partnership” principles.  It’s safe to assume that most DAO members join a DAO to participate in the DAO community’s goals and objective — NOT to increase their risk of personal liability for the DAO’s actions.

Wyoming Legislation: LLC protections for DAOs

Wyoming (a State known as “blockchain and crypto-friendly”) recently passed Bill 38 — a “Decentralized Autonomous Organization Supplement” to its Wyoming Limited Liability Company Act.  The bill allows DAOs to form as LLCs under Wyoming law.

As a result, DAO members in Wyoming can enjoy the limited liability and other protections for which LLCs are known and loved.

DAO LLCs organized in Wyoming are primarily governed by their articles of organization, operating agreements, and smart contracts, all of which can detail the rights and duties of the DAO’s members.  Management of a Wyoming DAO LLC can either be vested in its members (if member-managed) or the smart contract (if algorithmically managed).

Under the bill, the default rule on “standards of conduct for members” states: “Unless otherwise provided for in the articles of organization or operating agreement, no member of a [DAO] shall have any fiduciary duty to the organization or any member except that the members shall be subject to the implied contractual covenant of good faith and fair dealing.

In other words, just like in LLCs, DAO members can always be held liable for bad faith conduct.  This is similar to California law, where members must act “consistent with the obligation of good faith and fair dealing” — even if the LLC is manager-managed.  (California Corporations Code section 17704.09, subdivisions (d) and (f)(2).)

The DAO Jungle?

Will DAOs inspire the same type of litigation covered here at The LLC Jungle blog?

It’s too early to tell.

In one sense, having an algorithmically-managed entity should dramatically reduce the potential for managerial misconduct, which is an outsized source of LLC litigation.

However, as long as the DAO members with voting rights are human, bad faith conduct is going to be part of the picture, and that will lead to litigation.  Courts in many jurisdictions have recognized that the right to vote in an entity is a valuable “personal property right,” and that actions circumventing or frustrating an individual’s voting rights can support a legal claim.

We will be monitoring developments in this space with great interest.