If you haven’t seen it, a California Court has recently ruled that members of the Lido DAO could potentially be held liable under partnership laws.

This decision raises important questions: Does participation in a DAO expose members to joint and several liability? Which members? And how to prevent or limit that?

The Implications of the Ruling

At first glance, the ruling may seem concerning. However, it’s important to note that this decision is preliminary. The court merely denied a motion to dismiss, meaning that the case will proceed to be judged on its merits. This procedural step doesn’t establish liability but does have broader implications:

1. Prolonged Uncertainty: Allowing the case to proceed means extended ambiguity over the legal questions involved, along with increased legal costs for parties to the case.
2. Highlighting Risks for DAOs: The decision underscores the risks associated with unstructured or unincorporated DAOs, particularly those lacking legal protections.

In his ruling, Judge Chhabria stated:

“[The case] presents several new and important questions about the ability of people in the crypto world to inoculate themselves from liability by creating novel legal arrangements to profit from exotic financial instruments.”

The Case at Hand

Here’s a brief overview of the lawsuit:

• The Plaintiff: A private investor purchased 132 Lido (LDO) tokens on an exchange in April/May 2023, sold them at a loss in June 2023, and subsequently followed to sue the Lido DAO. The investor alleged that the DAO engaged in the unregistered sale of securities, seeking reimbursement for losses and encouraging anybody in a similar situation to join the suit.
• The Defendants: Major investors in the Lido DAO argued for dismissal, and are contending that:

The Lido DAO cannot be sued because it is not a legal entity but merely a protocol and a set of smart contracts.

The investors cannot be held liable as they are not general partners in the DAO.

The Lido DAO was not the seller of the tokens as the transactions occurred on a secondary exchange.

The Court’s Key Findings

Judge Chhabria rejected these arguments, ruling as follows:

1. The DAO as a General Partnership:
   Under California law, a general partnership does not require formal registration. If individuals act collectively with the intent to carry out business for profit, they can be treated as partners. The court found sufficient grounds to consider the Lido DAO a general partnership.
2. Liability of Participants as General Partners:
   The judge pointed to the plaintiff’s allegations that DAO members, particularly major investors, actively participated in, and benefited from, the DAO’s operations. This activity could potentially classify them as general partners and expose them to liability.
3. Secondary Market Liability under the Securities Act:
   Judge Chhabria interpreted the Securities Act to mean that issuers can still be held liable for unregistered securities, even when the assets are purchased on secondary markets. This interpretation challenges a common defence in crypto-related cases.

Legal Lessons from the Lido DAO Case: Structuring DAOs to Minimise Liability

This recent ruling underscores a critical message for DAO participants: legal structure matters. This decision, which highlighted the risks of unincorporated DAOs being treated as general partnerships, raises pressing questions about liability exposure, compliance, and best practices. For DAOs to thrive, they must carefully consider how to structure themselves to avoid legal pitfalls.

The Importance of Structuring DAOs

DAOs are innovative governance structures, however, without proper legal frameworks, their participants may unknowingly expose themselves to significant risks. As this case illustrates, operating without a legal entity can lead to joint and several liability among DAO participants under partnership laws. This can result in personal financial liability for members whose involvement is sufficient enough to deem them as general partners.

DAOs can adopt different structural models:

DAOs Without a Formal Legal Entity:
This model — used by Lido DAO — offers no legal shield for participants. While it may seem simpler and less bureaucratic, it comes with significant downsides: challenges in signing contracts, paying taxes, or defending legal claims. More critically, it leaves participants vulnerable to being deemed general partners, exposing them to unlimited liability.

DAOs Represented by a Legal Entity:
A common approach is to establish a legal entity, such as a non-profit foundation, to represent the DAO. For instance, Switzerland’s legal framework allows for foundations to separate the DAO’s operations from the personal liability of its participants. Foundations do not have capital shares, ultimate beneficial owners, or profit distribution rights, which can help safeguard against financial liabilities.

DAOs Wrapped in a Legal Entity:
Another emerging model involves wrapping the DAO within a purpose-built legal entity, such as the Marshall Islands DAO LLC or the Wyoming Decentralised Unincorporated Nonprofit Association. These structures aim to provide greater protection by aligning DAO governance models with legal personality and limited liability principles. Foundations or associations may also represent an effective solution as a DAO legal wrapper. However, these structures remain relatively untested in courts and may not fully address the complexities of international operations, or securities regulations.

Practical Recommendations for DAOs

While the legal landscape around DAOs continues to evolve, there are several steps DAO creators and participants can take to reduce risk:

Incorporate a Legal Entity:
Even if current options like non-profit foundations or DAO-specific entities are imperfect, having some form of legal representation is a crucial first step. This helps manage obligations like taxation, contract negotiation, and liability shielding.

Implement Robust Governance Practices:
Clear and enforceable governance mechanisms are essential. This includes well-drafted operating agreements, transparent communication, and a clear delineation of participant roles.

Consult Legal Experts Early:
Given the rapidly shifting regulatory environment, DAO participants should consult experienced legal counsel during the formation phase. Legal experts can help tailor the structure to meet compliance requirements while mitigating potential liability.

Stay Updated on Regulatory Trends:
As cases like Lido DAO demonstrate, regulatory interpretation of DAOs is evolving. Engaging in ongoing legal reviews ensures that your DAO adapts to new developments and remains compliant.

A Call for Regulatory Clarity

The Lido DAO case also highlights a broader issue: existing securities, financial and corporate laws are poorly adapted to the unique nature of DAOs and other Web3 innovations. This lack of clarity creates uncertainty and exposes participants to unnecessary risk. There is an urgent need for comprehensive legal and regulatory frameworks that enable DAOs to operate with confidence, while also protecting participants and investors.

Until such frameworks are established, DAO creators must take proactive steps to protect themselves. While DAOs represent a revolutionary approach to governance and collaboration, careful planning and expert guidance are essential to ensure their long-term success.

How We Can Help

At STORM Partners, we specialise in helping DAOs and blockchain-based projects to navigate the complexities of regulatory compliance, governance structuring, and liability management. Whether you’re forming a new DAO, restructuring an existing one, or addressing a legal challenge, our experienced team can guide you every step of the way.

Contact us today to schedule a consultation and explore how we can support your DAO’s success in a legally compliant and secure manner.