How do I sign up to manage a DAO? Research on DAO Registration and Governance under Delaware Corporate Law

How do I sign up to manage a DAO? Research on DAO Registration and Governance under Delaware Corporate Law

1. Introduction

1.1. Research Background

The reputation of Delaware as the primary jurisdiction for corporate entities is well known. In recent years, Delaware has also emerged as a leader in providing cutting-edge alternatives to traditional corporate forms. The Delaware Limited Liability Company Act (6 Del.C. § 18-101, et seq., Delaware Limited Liability Company Act, Meanwhile, new organizational structures such as DAO (Decentralized Autonomous Organization) are emerging, which in form allow for decentralized decision-making through blockchain and token voting mechanisms. In traditional industrial enterprises that rely on the separation of ownership and management, DAO provides a completely different template for organizational participation, where ownership and management are merged - driven by smart contracts, fluid member identity, and transparent transaction channels.

The new organizational structure brings related governance and judicial issues, and the practical implementation of the Delaware Limited Liability Company Act (DLLCA) provides a feasible approach for many Web3 companies.

2. Overview of Delaware Company Law

2.1. The Form of Delaware Limited Liability Company (LLC)

Limited Liability

One of the most attractive aspects of DLLC is that its owners and managers bear limited liability. Under the DLLCA, DLLC owners are typically referred to as “members,” while the person designated to manage the entity’s business and affairs is called the “manager.” DLLC members can be but are not necessarily managers, thus opening the door for investors or other non-managers or entities to enjoy the benefits of DLLC. The DLLCA stipulates that no member or manager shall be personally liable for any debt, obligation, or liability of the DLLC solely by virtue of their member or manager status. Furthermore, the DLLCA explicitly authorizes DLLC “to indemnify and hold harmless any member or manager or other person from all claims and demands and liabilities of any kind whatsoever.” This limitation of personal liability and the broad scope of allowable compensation are no less favorable to the corresponding protections enjoyed by the shareholders, officers, and directors of Delaware corporations.

Contract Flexibility

The basic approach of the DLLCA is to allow the parties to determine their business relationships through a limited liability company agreement, with only those items not agreed upon being specified. A well-established policy of the DLLCA is to maximize the implementation of the principle of contractual freedom and the enforceability of limited liability company agreements. This important policy means that the parties can predictably establish and maintain relationships that are best suited to their business needs. For example, in a limited liability company agreement, the parties can specify different classes of members or managers (each class enjoying different rights, powers, and duties, including separate voting rights, economic rights, or management rights), or even specify categories of limited liability company interests or assets (each category enjoying different rights, powers, and duties, even with different business objectives, in specific property, profits, and losses). In fact, the parties can determine almost every aspect of their relationship through the agreement. If a member or manager of a Delaware limited liability company or another member or manager is liable (including fiduciary responsibility), the DLLCA provides that the limited liability company agreement can expand or limit or eliminate these liabilities (excluding the implied covenant of good faith and fair dealing). This flexibility stems from Delaware’s long-standing policy of supporting contractual freedom.

Management Flexibility

The principle of contractual freedom is particularly evident in management flexibility, which is the cornerstone of the DLLCA. Parties can choose the management arrangement that best suits them. Under the DLLCA, a limited liability company member can participate in management without affecting his or her limited liability, or choose to have someone else manage the limited liability company, or combine the two approaches. The limited liability company agreement can specify different levels of managers, each with the rights, powers, and duties set forth in the agreement. The limited liability company agreement may also contain provisions relating to the exercise of voting rights, including provisions regarding the time, place, or purpose of any meeting at which a vote is taken, the waiver of any such notice, the taking of action by consent without a meeting, the quorum requirements, and the rules for personally or by proxy voting. Members and managers of a Delaware limited liability company (DLLC) generally have the freedom to engage in transactions with the DLLC. Experienced entity service providers in Delaware are usually willing to provide or serve as a manager or “independent” manager (e.g., for commercial reasons, such as satisfying DLLC lender requirements) when necessary.

Flexibility in Business Combinations

In addition to providing flexibility during the formation and operation stages of the DLLC, the DLLCA also provides multiple methods for reorganizing the DLLC for all parties involved. For example, under the DLLCA, a Delaware limited liability company can merge or be merged with another Delaware limited liability company or “other business entities” (including but not limited to corporations, statutory trusts, common law trusts, associations, and partnerships), regardless of whether the other business entities are formed or organized under Delaware law or the laws of another jurisdiction. Delaware provides more flexibility by allowing DLLCs to be reorganized through asset sales, conversions, and transfers. Furthermore, the DLLCA even allows commercial entities formed under the laws of another jurisdiction to convert into a Delaware limited liability company or be domesticated without having to cease business operations or undergo liquidation and termination of the original business entity.

Easy to assemble

DLLC is easy to form and maintain, and the formation of DLLC requires only (1) an agreement among one or more members of the limited liability company (without a written agreement); and (2) the filing of a certificate of formation with the Delaware Secretary of State.

Upon filing the certificate of formation with the Delaware Secretary of State, DLLC is deemed to be formed. Although the certificate of formation only needs to state the name of the DLLC and the name and address of the registered agent and registered office of the DLLC in Delaware, it may also include any other matters that the members decide to include.

The limited liability company agreement is a private contract between the members. It is not a public document. Therefore, under the DLLCA, the identity of the members and managers of a Delaware limited liability company and the terms of their relationship can be kept confidential. The DLLCA does not impose any minimum capital investment requirement. Non-US entities and individuals generally have the freedom to form and operate DLLCs, as the DLLCA does not require the members or managers of DLLCs to be natural persons or US citizens or residents. Furthermore, the records or principal place of business of a DLLC do not need to be located in Delaware. They can be located in any place that is convenient for the parties, including any jurisdiction outside the United States. Furthermore, such records can be maintained electronically or in other non-written forms.

No Delaware business activities are required.

Delaware law does not require an LLC to engage in business activities in Delaware or to establish or maintain any place of business (except for registered agents and registered offices). There are numerous service providers in Delaware who can provide such services at a minimal cost.

In addition to paying the minimum annual fee (called the franchise tax) to Delaware, an LLC is not required to pay taxes to the United States federal government or Delaware simply because the LLC was formed under Delaware law. Generally, if an LLC conducts business in Delaware or receives income from Delaware, it may be required to pay Delaware income tax. Similarly, if an LLC conducts business in the United States or receives income from a source in the United States, it may be subject to federal income tax.

Avoiding Double Taxation

Under federal income tax law in the United States, the structure of an LLC can allow it to be taxed at the business level, rather than at the corporate level. Therefore, from a tax perspective, the LLC provides an attractive alternative because companies are typically taxed at the corporate level. The members of an LLC can explicitly agree to this tax treatment in their limited liability company agreement. Of course, the contractual freedom conferred by the DLLCA allows members to agree to other tax treatment methods according to their own wishes.

3. Compatibility Analysis of Delaware State Company Law and DAO

3.1. Amendment to the Delaware General Corporation Law (DGCL) in 2017

On July 21, 2017, the Governor of Delaware issued new legislation that allows companies to use “distributed electronic networks or databases” (also known as blockchain technology) to maintain company records, including stock ledgers. By allowing companies to use blockchain technology to record and transmit company information.

Blockchain technology for company record keeping

The amendment to Section 224 of the Delaware General Corporation Law (DGCL) relates to the form in which companies keep their records: as long as this information can be converted to paper form within a reasonable time, it allows companies to use blockchain technology to record any company records, including stock ledgers. Specifically, the amendment allows chain-based records “managed by the company or on behalf of the company,” rather than being “kept” by the company, which means that blockchain can replace the function of traditional company executives or agents who have been responsible for keeping such records.

Regarding stock ledgers, the information recorded on the blockchain must include: (i) information that enables the company to compile a list of shareholders in accordance with Section 219 of the DGCL (Annual Meeting of Shareholders) and Section 220 (Inspection of Books and Records); (ii) Record the information prescribed by Section 156(partial payment of shares), Section 159(transfer by mortgage), Section 217(voting rights of trustees, pledgees, and joint stockholders) and Section 218(voting trusts and other voting agreements) of the DGCL; and (iii) Record the transfers prescribed by Article 6, Title 1, Section 8 of the DGCL.

The amendment further provides that blockchain-generated records shall be deemed valid, admissible as evidence, and acceptable for all other purposes. Essentially, blockchain records will be treated equally with the company’s paper records.

Blockchain technology for company notices and shareholder communications

One of the core features of blockchain technology is the ability to securely transmit information among multiple parties. Delaware recognized this, and therefore amended several provisions of the Delaware General Corporation Law (DGCL) to explicitly authorize “electronic transmission” of notices through blockchain technology.

Section 232 of the DGCL modified the definition of “electronic transmission” to include: the use or participation in one or more electronic networks or databases (including one or more distributed electronic networks or databases), the records created by which may be retained, retrieved, and reviewed by the recipient and may be directly reproduced by the recipient through an automated process in paper form. Additionally, the amendment allows companies to provide notice to shareholders holding non-certificated stock electronically, informing them of the information that must be disseminated under Section 151(f) (certificated and non-certificated stock; rights and their interpretation) and Section 202(a) (transfer of securities and ownership restrictions).

Delaware’s amendment allows companies to utilize technological innovations to expedite and optimize internal record-keeping and notice procedures. Companies that adopt such solutions by issuing digital securities can more easily manage and track shareholder voting, provide notice, and manage stock transfers.

3.2. Amendments to the Delaware Uniform Limited Partnership Act of 2019 (DRUPA).

Amendments to Sections 15-501 and 15-403 of the DRUPA provide explicit legal authority for the creation or maintenance of physical records and certain electronic transmissions using electronic database networks, including distributed ledgers and blockchains. These amendments are similar to those made last year to the DLLCA and DRULPA, and confirm that general partnerships can use this rapidly evolving technology.

3.3.Delaware Limited Liability Company Act (DLLCA) and Delaware General Corporation Law (DGCL) Discussion

Rights of the company registrant

According to§107 DGCL,if no initial directors are designated in the company’s articles of incorporation, the registrant will manage the company’s affairs before the election of the board of directors and may take all necessary and proper measures to perfect the company’s organization, including adopting the company’s original articles of incorporation and electing directors.

Regarding the articles of incorporation

Under DGCL §109(a), the original articles of incorporation may be adopted by the company’s registrant, the initial directors (if designated in the articles of incorporation), or the board of directors before the company receives any stock payments. Thereafter, the shareholders have the right to adopt, amend, or repeal the articles of incorporation. For non-stock corporations, this right belongs to the voting members. However, the company’s articles of incorporation may grant the directors or governing body the power to adopt, amend, or repeal the articles of incorporation. Even if such power is granted to the directors or governing body, it is important to note that shareholders or members retain the power to adopt, amend, or repeal the articles of incorporation.

Under DGCL § 141(b), the articles of incorporation may contain any provisions relating to the business, management, rights or powers of shareholders, directors, officers, employees, or any other party, so long as such provisions are not inconsistent with the law or the articles of incorporation. Furthermore, the articles of incorporation may not contain any provision that would make shareholders liable for an attorney’s fees or costs in an internal corporate claim.

As for the rights of directors,

Under DGCL§141(a), the business and affairs of every company formed under this chapter shall be managed by the board of directors or under its guidance. If there are any such provisions in the certificate of incorporation, then the powers and duties conferred or provided for by this chapter shall be exercised or performed by one or more persons as provided for in the certificate of incorporation.

Pursuant to clause (f) of §141 DGCL, except as otherwise restricted by the Articles of Association or bylaws, any action required or permitted by any meeting of the Board or any Committee may be taken without the written consent of all members of the Board or Committee, as the case may be, or by electronic transmission, and the written consent or electronic transmission consent shall be filed with the minutes of the Board or Committee. If the minutes of the meeting are kept in paper form, they should be filed in paper form; If the minutes of the meeting are kept in electronic form, they shall be filed in electronic form. Any person, whether then a director or not, may, by giving instructions to the agent or otherwise provide that the consent to act will take effect at a future time (including the time fixed at the time of an event) within 60 days after the instruction or provision is given, and that consent shall be deemed to have been given for the purposes of this subsection at that effective time provided that person is then a director and has not withdrawn the consent before that time. Any such consent may be revoked before it becomes effective.

About electronic contracts

According to DLLCA §113(a)(1), any act or transaction provided for or involving this chapter or the limited liability company agreement may be executed electronically, and electronic transmission shall be deemed to be in writing.

According to DLLCA §113(a)(2), manual, fax, altered, or electronic signatures are valid in any form required or permitted by this chapter or the limited liability company agreement. An electronic signature refers to an electronic symbol or process attached to or logically related to a document and executed by a person who intended to execute, authenticate, or adopt the document. In other words, people can use electronic signatures to sign documents.

According to DLLCA §113(a)(3), unless otherwise provided in the limited liability company agreement or agreed upon by the sender and recipient, an electronic transmission is deemed delivered when it enters the information processing system designated by the recipient for receiving the type of electronic transmission, as long as the electronic transmission exists in a form that the system can handle and the recipient can retrieve it. In other words, the delivery of an electronic transmission depends on whether the recipient has designated an information processing system for receiving electronic transmissions and whether the transmission has entered that system. This means that smart contracts can serve as an effective decision-making tool without having to implement decisions through traditional boards or shareholder meetings.

Comprehensive conclusions

At present, the relevant regulations of the DLLCA and DGCL do recognize the feasibility of blockchain technology for corporate governance in Delaware, but this recognition has not yet reached the level of explicitly allowing the use of smart contract governance.

In terms of horizontal comparison, only three states in the United States, Wyoming, Tennessee, and Vermont, allow DAOs to be established as a form of limited liability company,[1] and the relevant legislation of these three states has specific provisions on smart contracts when it comes to the governance rules of DAOs, such as Vermont, which requires the company’s operating agreement to disclose voting procedures for resolving certain types of matters, and Wyoming requires DAOs to specify in the company’s articles of association how members manage the decentralized autonomous organization. This includes the extent to which it is managed algorithmically. [2] In comparison, DLLCA and DGCL do lack such a related statement.

4. Conflict between the Corporate Transparency Act (CTA) and DAOs

The Corporate Transparency Act raises new legal issues for the application of DAOs.DAOs are a relatively new type of business association that lacks traditional legal entities and therefore lacks legal governance and protection of participant responsibilities. As legislation is enacted to attempt to incorporate DAOs into traditional entity structures to promote their protection, DAOs operated through commercial entities will need to comply with the disclosure obligations of the Corporate Transparency Act.

4.1. Requirements of CTA

Starting from January 1, 2024, reporting companies operating in the United States must submit a Beneficial Ownership Secure System (BOSS) report to the U.S. Treasury Department’s Financial Crimes Enforcement Network, including the name, date of birth, address, and government-issued photo identification copy of the owner.

A reporting company is an entity such as a corporation, limited liability company, limited partnership, or business trust that is created or registered in the United States through the filing with the Secretary of State. Exemptions are available for closely regulated businesses such as public companies and their regulated advisors, financial institutions, insurance agencies, and 501(c)(3) non-profit organizations. In addition, large operating companies are also exempt, which are those with a physical street address in the United States, 21 or more full-time employees, and annual gross income or sales reported in the previous year’s tax return exceeding $5 million. Wholly owned subsidiaries of other exempt entities are also not included.

Companies established before December 31st must submit BOSS reports by December 31st, 2024. Companies established on January 1st, 2024 have 30 days to submit reports and make changes within that timeframe. Federal, state, local, and tribal law enforcement agencies, as well as financial institutions, may access BOSS reports with the consent of the customer, but not publicly, including through Freedom of Information Act requests. Beneficial owners include those with significant control over the company’s equity and those who directly or indirectly own 25% or more of the equity.

Each reporting company must report at least one person, and refusal to disclose by the owner may send a violation signal to the Financial Crimes Enforcement Network. The fines and penalties for non-reporting or false reporting can be very severe.

4.2. How does the CTA apply to and affect DAOs

The CTA assumes that the reporting company is a legal entity with beneficial ownership and governance systems that a DAO may not have. Traditional partnership DAOs will not be subject to the jurisdiction of the CTA, but those DAOs that are subject to traditional state forms and are considered legal entities will need to consider complying with the CTA.

Given the structure and framework of DAOs (i.e., DAOs lack managers, directors, or officers), the CTA reporting requirements will be particularly onerous for DAOs, so each member (rather than the DAO as an organization) may need to determine whether they have substantial control or 25% ownership of the DAO. DAOs that are member-managed limited liability companies under state law require each member to submit a BOSS report.

The CTA prohibits blank shares and anonymous reporting of corporate ownership, which directly contradicts the compelling anonymity characteristics of DAOs. The Financial Crimes Enforcement Network has made recommendations to non-traditional entities that substantive control includes control exercised in novel and less traditional ways, and that control can be applied to different flexible governance structures, such as DAOs. Different control indicators may be more relevant to DAOs. Although the Financial Crimes Enforcement Network is unsure how the CTA applies, it still applies to DAOs established by countries.

The CTA does not address certain DAO-specific issues, such as whether token ownership membership is considered beneficial ownership for the purposes of the CTA.

In reality, without directors and executives, it will be difficult for DAOs to appoint compliance personnel. Wrapping DAOs into traditional structures has already exposed them to reporting requirements and compliance agreements, and now it has expanded to include CTA compliance. Using traditional DAO parameters to regulate non-traditional businesses may not be compatible with the innovative and constantly changing nature and autonomy of DAOs. DAOs that need to comply with CTA compliance will need to monitor the CTA guidelines as they are continuously introduced.

State-registered DAOs may find it easier to comply with the CTA, or may lack the personnel to track the requirements of the CTA, but they still need to track these requirements. The DAO entity should develop a CTA compliance agreement (including a contact person) and track ongoing compliance. Since DAOs operate through blockchain and smart contracts, it may not be practical to build DAOs to adopt the CTA disclosure process. Traditional DAOs operating as general law partnerships do not face CTA risks, while DAOs operating as or through entities established by state law filing must comply with the CTA. The inherent characteristics of DAOs and blockchain technology will make CTA compliance challenging.

5. Conclusion

The Delaware Limited Liability Company Act (DLLCA) has an important position in the field of business law due to its flexibility and tax advantages. As an alternative entity, DLLC has the advantages of avoiding double taxation, contract flexibility, and limited liability, and has a wide range of applicability and adaptability. Delaware also passed an amendment to allow companies to use blockchain technology to record and transmit company information, providing a more efficient solution for businesses.

With the advent of the Web3 era, DAOs, as a new organizational structure, are on the rise. The Delaware legal framework provides a feasible approach for DAO organizations. However, the Corporate Transparency Act (CTA) also poses new challenges for DAO organizations, requiring them to comply with traditional disclosure obligations. Therefore, the inspiration for Web3 corporate governance is that although the Delaware legal framework provides some support for DAO organizations, they need to be more flexible and innovative in the face of new regulations and legal requirements, in order to adapt to the constantly changing legal environment and maintain compliance and sustainable development.


[1]Decentralized Autonomous Organizations: The New LLCs?

[2]Starting a DAO in the USA? Steer Clear of DAO Legislation - The Defiant

[3] Morris James.(2014).An Overview of the Delaware Limited Liability Company Act.

[4] Bull Blockchain Law.(2017).Delaware Endorses Blockchain With New Amendments to the DGCL.

[5] The National Law Review.(2023).Corporate Transparency Act Compliance for DAOs Is Unclear.

[6] Elsevier.(2021).Regulating smart contracts: Legal revolution or simply evolution.