Insights

As the rules and procedures are being developed through cases of first impression, thousands of DAOs¹ and other crypto enthusiasts are watching the CFTC v. Ooki DAO legal battle for clues about how our legal system will treat new decentralized entities. Recently, the court was tasked with determining whether and how Ooki DAO could be sued, which in turn required answering if Ooki DAO had the capacity to be sued and whether it was properly served in that capacity.

On Dec. 20, 2022, Judge William Orrick of the U.S. District Court for the Northern District of California concluded² that Ooki DAO could be sued because Ooki DAO was an unincorporated association, and – to the disappointment to many advocates in the crypto community – that the CFTC’s service made through the DAO’s online community forum was sufficient.

This alert focuses on Ooki’s status as an unincorporated association and the “default” treatment for DAOs in certain states. Although the case is still to be decided on the merits, this procedural decision sheds important light on the legal status of many DAOs that have not been formed as a legal entity and underscores the importance of carefully considering a legal entity at the outset of a project.

Background

As a way of background, on Sept. 22, 2022, the Commodity Futures Trading Commission (CFTC) filed a complaint³ against Ooki DAO alleging that Ooki DAO violated the Commodity Exchange Act (CEA) by allowing users to engage in retail commodity derivative trading transactions without complying with CEA requirements to register their trading platform (the “Protocol”) and conduct customer due diligence. The CFTC further alleged that the Ooki DAO was intentionally structured as a DAO to avoid regulatory oversight thanks to the anonymity of its users. The DAO users, all of which are holders of a token native to Ooki DAO (“Token Holders”), communicate through the online community forum, propose changes to the Protocol, and vote their tokens on matters related to the DAO’s business. As such, the CFTC alleged that Ooki DAO was an unincorporated association comprised of Token Holders.

Discussion

Several organizations, including venture capital firm Anderseen Horowitz (a16z), filed amicus briefs⁴ in support of the defendant Ooki DAO. The issue before the court, as expressed in the amici’s argument, was that Ooki DAO can neither be served nor be a defendant because:

1. It is a technology, not an entity;
2. It is not subject to enforcement under the CEA; and
3. It is not an unincorporated association.

Each argument was unsuccessful. First, according to Judge Orrick, the Protocol is controlled by the Token with administrative keys, and it was the actions of these Token Holders that the CFTC sought to regulate, not the Protocol itself. Therefore, the court held that the DAO was not merely a technology. Second, the court ruled that Ooki DAO was subject to the CEA because the CEA makes it unlawful for any “person” to engage in activities that do not conform to the requirements of the CEA,⁵ and the CEA’s definition of a “person” includes “individuals, associations, partnerships, corporations, and trusts.”⁶ Therefore, an unincorporated association falls within the definition of a “person” under the CEA and may subject to the CEA.

The Federal Rules of Civil Procedure provide that for parties other than individuals and corporations, the capacity to sue is determined “by the law of the state where the court is located.”⁷ Like many states, California law allows unincorporated associations to be sued pursuant to the California Civil Procedure Code, which states that “a partnership or other unincorporated association, whether organized for profit or not, may sue and be sued in the name it has assumed or by which it is known.”⁸ It is interesting to note that, according to that same California Civil Procedure Code section 369.5, a general partnership can also sue or be sued “in the name it has assumed.” Even though the CFTC chose to bring its complaint against Ooki DAO as an unincorporated association, suing Ooki DAO as a partnership in California was also possible and could have significant implications for participants.

California law defines an “unincorporated association” as “an unincorporated group of two or more persons joined by mutual consent for common lawful purpose, whether organized for profit or not.”⁹ California law imposes a threshold requirement that a plaintiff may only serve an unincorporated association if it has established that the alleged association has a “common lawful purpose.”¹⁰ If Ooki DAO falls within the definition of an “unincorporated association,” it can be sued in California. Judge Orrick reasoned that the Token Holders joined the Ooki DAO voluntarily and that the trading Protocol in itself was not illegal. Therefore, the court held that Ooki DAO was an unincorporated association.¹¹

Unincorporated associations typically include golf clubs, social clubs, book clubs, neighborhood associations, non-profits, charities, and other similar groups or associations. A general partnership is also a form of unincorporated association that has a for-profit purpose.¹² Several states, including California, recognize unincorporated associations. California allows an unincorporated association to, “in its name, acquire, hold, manage, encumber, or transfer an interest in real or personal property,”¹³ and provides for limited liability of its members and agents acting within the scope of the association.¹⁴

Not all states recognize unincorporated associations, which means that if the CFTC – or any other regulator – chose to file a lawsuit in a state that does not formally recognize unincorporated associations, Ooki DAO could by default be treated as a common law general partnership, where the members’ liability for the organization’s debts and judgments would not be limited and where all members would be jointly and severally¹⁵ liable for the partnership’s debts and judgments.

Simply choosing a court located in California, however, does not mean that Ooki DAO is a California unincorporated association. There is no state filing requirement, and the location of its operations and all its users is unknown. Therefore, the question of Ooki DAO’s true legal status remains unclear and the limited liability of its Token Holders is uncertain.

Conclusion

In conclusion, while other federal courts may not adopt the logic of Judge Orrick, this decision provides an affirmative answer to the key question of whether a DAO can be sued. A DAO is not a legal corporate form in itself. The concept of a DAO was little known to the general world until the SEC’s 2017 DAO Report that analyzed operations of a DAO. But even five years after the DAO Report, the regulators still maintain that a DAO may be viewed as an unincorporated association. Currently, there are thousands of DAOs, some of which are structured as corporations, some – as limited liability companies, some – as unincorporated nonprofit associations, and some – as offshore entities. However, most of the DAOs do not associate with any form of legal entity. By default, these DAOs are general partnerships, and therefore, unincorporated associations. They still carry legal liability for the actions of their members, and since there is no limited liability shield, the group liability becomes the liability of each individual member of such DAO.

It remains to be seen whether DAOs will become the future of corporate structure in the United States and around the world. However, one thing is clear: a DAO is not a shield simply because DAO members are able hide behind pseudonyms; anonymity is not an escape from legal responsibility. Any person establishing a DAO should proceed with caution.

^{1 DAO is an acronym for a “decentralized autonomous organization,” where members who are holders of a native digital asset token agree to abide by the rules encoded in a blockchain-based code. A DAO a “virtual” organization embodied in computer code. Several states including Wyoming and Tennessee have adopted laws that authorize the formation of DAOs as limited liability companies.}

^{2 Commodity Futures Trading Comm’n v. Ooki DAO, No. 3:22-cv-05416-WHO, 2022 BL 454541, 2022 U.S. Dist. LEXIS 228820 (N.D. Cal. Dec. 20, 2022).}

^{3 CFTC complaint against Ooki DAO.}

^{4 See, e.g., Amicus Curiae Brief of Andreessen Horowitz Regarding Plaintiff’s Motion for Alternative Service.}

^{5 7 U.S.C. § 6(a).}

^{6 7 U.S.C. § 1(38).}

^{7 Fed. R. Civ. Proc. 17(b)(3).}

^{8 Cal. Civil. Procedure Code § 369.5(a).}

^{9 Cal. Corp. Code § 18035(a).}

^{10 Id.}

^{11 This conclusion echoes the conclusion of the U.S. Securities and Exchange Commission (“SEC”) in the DAO Report which involved the creation of a DAO by Slock.it UG which was deemed an unincorporated association that was subject to the jurisdiction of the SEC. See, e.g., Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO (Exchange Act Rel. No. 81207) (July 25, 2017) ("The DAO Report").}

^{12 According to the Revised Uniform Partnership Act that has been adopted in most states, “[A] partnership is created by the association of persons whose intent is to carry on as co-owners a business for profit, regardless of their subjective intention to be ‘partners.’” RUPA § 202 (1997). Absent a specific state legislature, a general partnership does not provide limited liability for its members.}

^{13 Cal. Corp. Code § 18105.}

^{14 “Except as otherwise provided by law, an unincorporated association is liable for its act or omission and for the act or omission of its director, officer, agent, or employee, acting within the scope of the office, agency, or employment, to the same extent as if the association were a natural person.” Cal. Corp. Code § 18250. “A money judgment against an unincorporated association, whether organized for profit or not, may be enforced only against the property of the association.” Cal. Corp. Code § 18260.}

^{15 Joint and several liability means that each member is independently liable for the full amount of damages. For example, if a plaintiff wins a money judgment against all members collectively, the plaintiff may collect the full value of the judgment from any one of them.}