How to Sue A Decentralized Autonomous Organization

In this opinion piece, Stephen D Palley discusses the potential legal liabilities facing those who run distributed autonomous organizations.

AccessTimeIconMar 20, 2016 at 3:17 p.m. UTC
Updated Mar 6, 2023 at 3:11 p.m. UTC

A lawyer at Washington, DC-based Palley Law, PLLC, Stephen D Palley represents construction and technology companies in connection with litigation, insurance coverage matters and product design and development. 

In this opinion piece, Palley discusses decentralized autonomous organizations and the potential legal liabilities that could be raised by this application of blockchain technology.

The term decentralized autonomous organization (DAO) is often used in the same breath as "smart contract" or "blockchain". DAOs are touted as a new form of legal structure in which ownership, management and control are automated and human involvement is limited or removed, based on a previously agreed upon set of rules.

To a lawyer, this sounds a lot like a corporation, a legal fiction that grants personhood to a human created organization governed based upon a rule set (either contractually agreed upon or imposed by law).

Among other things, a corporation can sue or be sued, enter into contracts, and by virtue of incorporating, offer its human owners and agents some measure of liability protection.

are offered as a step past corporations, an evolutionary structure in which human governance is replaced by code, and the organization acts without human meddling.

As described by Ethereum startup (emphasis added):

A DAO is an organization that's self-governing and that isn't influenced by outside forces: its software operates on its own, with its bylaws immutably written on the blockchain, not controlled by its creators. DAOs are formed by groups of like-minded individuals with specific projects and goals in mind . . . A DAO purely manages funds: in itself it does not have the capabilities to build a product, write code or develop hardware. It requires a Service Provider for this purpose, which it hires by signing off on a proposal.

Sounds interesting, and I am not dismissing the utility or potential benefit of automating many elements of a corporate structure by using software, with or without blockchain or smart contract functionality.

Still, as I read about DAOs, a couple of questions and concerns arise. First, the words 'general partnership' and 'unincorporated association' keep popping into my mind.

Causes for concern

Here's the concern: if you don't formalize a legal structure for a human-created entity, courts will impose one for you. As most lawyers will tell you, a general partnership, unless properly formalized or a deliberately created structure, is a very bad thing.

Among other things, the members of a general partnership can end up jointly and severally liable on a personal basis for partnership obligations. One potential flaw in their structure is that they may not have assets from which to indemnify third parties.

This seems wrong to me, or beside the point, and a big concern to a DAO creator or participant regardless. Lacking assets or a legal form, I expect that a court would see the entity that isn't really an entity as a fiction and could allow a lawsuit to proceed against the individual members.

That's what I might argue if I represented someone who had a quarrel with a DAO.

Real liability

What if a DAO doesn't have human members or participants?

A court would look to see who designed the thing, and keep looking until it found a first mover, or a human hand. Whether or not a judgment is ultimately collectible, you can usually find someone holding the hot potato.

As a legal matter, I'm skeptical that it's really possible to abstract human agency, ownership or control from an entity. As a policy matter, I'm not sure it's a terribly good idea, either.

Second, for a DAO to operate in a world in which legal relationships are formalized by contracts, and enforced by courts, I don't see how a DAO can act unless it is either a corporation or it has no corporate form and it is simply an extension of its human members.

Go to the definition above and re-read this sentence (emphasis added):

"It [the DAO] requires a service provider for this purpose, which it hires by signing off on a proposal."

How can a DAO 'sign off' on a proposal if it isn't a corporate entity of some kind? Who will the service provider sue if it's unhappy with the DAO's performance?

Taking action

To sue an unincorporated DAO, you'd start with its members.

If you can't find members, you sue the DAO's first mover: the person or entity that first created the DAO.

And how do you avoid this? If you're creating a DAO, consider whether this evolutionary structure might benefit from some basic corporate structure, and whether doing so really limits the DAO's functionality in a meaningful fashion.

I'd also ask whether a DAO can actually do anything useful if it does not have some recognized corporate form.

Further discussion on this topic can be found on the Ethereum Reddit channel.

This post originally appeared on LinkedIn and has been republished here with the author's permission.

Law image via Shutterstock


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