Amidst the implosion of several high-profile exchanges[1], Decentralized Autonomous Organizations (“DAOs”) have received little attention from governments. Indeed, most jurisdictions – including Canada – have yet to clarify the legal status of DAOs: Are they unincorporated associations, limited liability entities or some other corporate form?
DAOs are blockchain entities which enable a group of individuals to collaborate on a shared vision. For example, DAOs may permit its users to raise funds for a common cause, such as money to support those affected by the war in Ukraine (a function of the UkraineDAO). As decentralized and trustless systems, DAOs are different from ordinary fundraising vehicles like venture funds or charities because they do not rely on third parties but use smart contracts to achieve their purpose.
Like many blockchain innovations, DAOs operate under murky legal cover. In America, only three states – Wyoming[2], Vermont and Tennessee – recognize DAOs as legal entities. In Canada, governments have not addressed the legal status of DAOs. As both provincial[3] and federal governments have the authority to regulate (at least some types of) business entities, the legal status of DAOs could implicate either level.
Why should DAOs seek legal recognition? The benefit of legal clarity as a business form is that it acts as an offensive and defensive tool: Offensively, DAOs that have legal status can gain the ability to sue, purchase assets and take on debts. Defensively, DAOs with limited liability provide members with assurance that they are not personally liable for its actions.
In Canada, there are several different legal structures available to businesses[4]. Four common forms are sole proprietorships, partnerships, corporations and cooperatives. But as I discuss, few of these forms are suitable for DAOs.
DAOs Are Not Sole Proprietorships
DAOs do not fit the sole proprietorship business form. Not only is it nonsensical to allege that a DAO is owned by a single individual[5], but sole proprietorships do not permit limited liability and do not have the status of a separate legal entity.
DAOs Could Possibly Fit a Specific Form of Partnership
Recognizing DAOs as partnerships could be possible only for a small subset of the forms – the LLP. In Canada, partnerships are available only at the provincial level due to constitutional limits[6]. The precise types of partnerships that are recognized depends on the province though there are similarities. In all provinces, general and limited partnerships are recognized.
For DAOs, neither general nor limited partnerships would be attractive. Neither form offers legal protection for all members. General partnerships are made up of two or more general partners who run the business and are personally on the hook for debts. Limited partnerships can include limited partners who act as passive investors. However, even LPs require at least one general partner without liability from losses. More fundamentally, the decentralized structure of DAOs is at odds with the requirement of a GP who runs the day-to-day operations of the entity.
It is possible that a subtype of partnership – the LLP, or limited liability partnership – would meet the needs of DAOs. LLPs are not universal – they are only available in certain provinces (e.g., Ontario[7]) and in some cases, LLPs require partners[8] to be regulated professionals (doctors, accountants and lawyers).
In a sense, the LLP is a cousin of the American LLC, a business form that is not available in Canada. Wyoming, Vermont and Tennessee all recognize DAOs as types of LLCs, leading to them being dubbed as the “new LLCs”. But provincial LLP statutes can be tweaked to encompass the DAO.
For example, Ontario’s Partnerships Act permits LLPs to be formed where two or more persons enter in an agreement designating their partnership as an LLP and referring to the Partnerships Act as governing their agreement.[9] However, LLPs are only available for the purpose of practising a regulated profession.[10] Tailoring this statute to permit DAOs to operate could involve adding a provision that “notwithstanding section 44.2, this Act expressly permits decentralized autonomous organizations to operate as a limited liability partnership” and including a supplement defining DAOs and outlining conditions for their formation. Indeed, this is the approach that Wyoming has taken with its DAO laws.
In contrast to LPs and GPs, the LLP form protects partners for the acts of co-partners and the acts of the entity as a whole, though partners are still liable for their own wrongful acts. This expansion of liability protection would be attractive to DAO members.
The attractiveness of the LLP is more obvious when considering the deficiencies of the corporation and cooperative structures. This is the subject of Part II in the next post.
[1] Three Arrows Capital, Celsius Network, FTX have all gone under in 2022, to name a few.
[2] Wyoming was the first state to grant legal status to DAOs, passing legislation in March 2021 permitting DAOs to form with limited liability as LLCs.
[3] Territories also have the power to form corporations. When I write about “provinces” or “provincial” regulation, I refer as well to territorial regulation.
[4] The precise availability of these forms depends on whether federal or provincial regulation is sought (and if provincial, which province).
[5] A fundamental principle of DAOs is collective ownership.
[6] Partnerships fall under the property and civil rights powers exclusively assigned to provinces by the Constitution Act, 1867.
[7] Partnerships Act, RSO 1990, c P.5 (“Partnerships Act”).
[8] For DAOs, describing members as “partners” seems strange, but in function, this term only means that the members work together managing the entity. In most DAOs, governance decisions are made by the collective membership.
[9] Partnerships Act at section 44.1 (Formation).
[10] Partnerships Act at section 44.2 (Limitation on business activity).