Unlimited liability? Naked DAOs might want to consider wrapping up...

A judge in the Northern District of California has caused concern in the crypto community, rejecting a motion brought by a "DAO adjacent" company seeking to dismiss proceedings brought by a token purchaser who lost money on a small token purchase.

The background to the matter is that Lido DAO issued tokens, as many crypto projects do. However, Lido DAO did not have any kind of legal wrapper around the DAO, such as a foundation company, which have become a common vehicle to permit DAOs to engage in contracts with other parties.

One of the token purchasers, who bought and sold a small number of tokens, claims to have lost money in doing so and has sued Lido DAO together with several prominent crypto venture capital funds, seeking to represent every token purchaser who lost money, alleging that Lido DAO should have been registered under the US securities laws and that all owners of tokens are in a general partnership with unlimited liability.

After the court found that Lido DAO had been properly served (itself an interesting question as a DAO typically has no legal personality at law), Lido DAO held a governance vote to authorise the engagement of a law firm by a DAO adjacent company in order to file and argue a motion seeking to dismiss the legal proceedings on the basis that the Plaintiff was trying to sue software and not an entity (along with other arguments).

Prominent crypto lawyer Stephen Palley was engaged to argue the motion and a number of other leading crypto lawyers and projects filed amicus briefs in support of the motion to dismiss. These kinds of interlocutory motions are difficult to win as the mover must show there is no prospects of the action being successful, or that there is some flaw so fatal to the case it should not proceed further. The court hearing revealed a skeptical judge who challenged why the Plaintiff had not objected to the motion being filed by an entity which wasn't Lido DAO.

The decision of the court rejecting the motion to dismiss including comments which have concerned some in the crypto community, including the defendants:

“DAO” stands for Decentralized Autonomous Organization—a type of organization that seems designed, at least in part, to avoid legal liability for its activities.

Lido's alleged actions are not those of an autonomous software program—they are the actions of an entity run by people

In response, Miles Jennings, General Counsel of a16z posted on X that this was "a huge blow to decentralised governance":

Rodrigo from Paradigm noted the way that the Plaintiffs had argued the case was by suggesting DAOs were set up to avoid liability:

Take aways

While the decision is not binding precedent for other cases and motions to dismiss are difficult to win in many circumstances, the take away is that DAOs, and their token holders and VCs who buy tokens, and which are seeking to operate as "pure software" without a legal wrapper, are on heightened risk of litigation in the USA with all the expense and distraction that entails.

The motion alone cost the Lido DAO treasury at least USD$200,000, when the costs of establishing a wrapper entity, such as a Cayman Island foundation, one of the most popular forms of crypto structures, would have been well below that sum.

The ongoing costs of the litigation, not just for Lido DAO, but also for defendants Paradigm, a16z and DragonFly, will be substantial and remove funds which could have supported further projects.

The clear takeaway is that a legal wrapper is increasingly not an optional item for DAOs, but is really a necessity from the start of a DAOs establishment.

By Michael Bacina

Disclosure: the writer works at Travers Thorp Alberga and has been advising DAOs to be wrapped, including with Cayman Foundations, for many years.