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Blockchain Companies Should Be Banging Down the BBLLC Doors

Oliver Goodenough and Katie Taylor

Many blockchain pioneers are utopians and libertarians.  Stephen Tual, one of the developers of the infamous blockchain investment fund The Dao, has argued that blockchain activities are not bound by laws and regulations but rather by “the code.” The idea has its appeal.  After all, the United States legal system is an intrusive, centralized, and hierarchical organism, whose rules on things like securities involve costly and restrictive compliance. Furthermore, the fit of the legacy system’s approaches to innovative developments like blockchain is at best imperfect, and at worst nonsensical.

Existing outside the reach of such legacy law is the dream of any company or industry that’s innovating rapidly, especially one that not only thrives on disrupting the status quo but is also deeply committed to the equity of decentralization.

The problem is that while they may not be interested in recognizing the legal system, the legal system is definitely interested in recognizing them – but within the existing framework. Courts are focused on an organization’s legal structure, not on the technological underpinnings of a business or its transactions. If there is a challenge to an action taken or not taken by a blockchain entity (and inevitably there will be), the legacy legal system will jump in, saying “hey, we have a box for that — if you’re a for-profit joint enterprise with no other specified format, we’re going to call you a partnership. Congratulations, everyone involved is jointly and severally liable for everything.”

That’s not the result any enterprise wants.

Companies operating on the blockchain can try to thumb their noses at the legal world, but this invites eventual disaster.  As the Clash song reminds us, “I fought the law, and the law won.”  Responsible innovators need to reconcile the experimentation and openness of the blockchain and DAO approaches with the traditional structures of the legal system, in the process, setting themselves up for a more secure future.

When the State of Vermont established blockchain-based LLCs (BBLLCs), its aim was to create a flexible law that would recognize a broad range of online-style governance while at the same time providing a limited liability format desirable for entities. BBLLCs create a bridge between blockchain experimentation and the legacy formats that the law recognizes by allowing a blockchain entity to elect to be structured as a Limited Liability Company.

Why does that matter? As the name suggests, a BBLLC provides a shield against the vicarious liability that could attach to participants in a DAO or distributed ledger that falls into the partnership default trap.

Consider another area where planning can help: taxes.  If the members in a partnership reside in multiple countries, United States tax law may view the structure as a pass-through entity that requires them all to file as taxpayers in the US as well as in their own countries – a major disincentive for global participation.  The United States has addressed this dilemma by permitting many organizations to elect treatment as a C Corp, which can break that inadvertent US tax presence, but it needs to be an intentional step.  A company established as a BBLLC could benefit from that election.

The BBLLC law has also clarified the fiduciary duties that participants owe each other, expressly permitting a single individual to have both a participant role and a contracting role. Thus, someone (or some entity) could be a member from the standpoint of managing the enterprise and an independent contractor from the standpoint of billable work.

This works particularly well for a company like dOrg, a cooperative of DAO development freelancers that relies on the sharing economy. dOrg is also the first known DAO company in the US to obtain legal status by becoming a BBLLC.

The blockchain provides an incredible opportunity for changing the way organizations operate. There is an explosion of thinking about how to structure productive interaction, how to bring people together to accomplish something. In terms of company formation, the blockchain is allowing a whole new universe of ways to structure things: more loosely, with more participation, where people are polled immediately, where an entity can accumulate votes, assign different values to things, or distribute rewards automatically. Things that used to be hard to do in terms of direct tracking of participation are now made easy.

But if those organizations exist outside legacy legal frameworks, these innovative companies could find themselves forced into structures they didn’t choose with results that are disastrous for their continued existence.  Don’t fight the law – find a way to engage it intentionally, and take advantage of opportunities like the Vermont BBLLC that will help you mold the law to support the innovation you are so good at creating.

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ABA Journal Features Vermont Blockchain Laws and Gravel & Shea Special Counsel

ABA Article Screengrab

In a recent article, the ABA Journal highlighted actions states like Wyoming and Vermont are taking to improve the legal landscape for blockchain companies.

While Wyoming has opted for a deregulation model, Gravel & Shea attorneys have been active in Vermont’s efforts to create a useful legal structure based on the needs of blockchain companies.

Oliver Goodenough, Gravel & Shea Special Counsel and a law professor at Vermont Law School, has advocated for creation of a regulatory sandbox that would allow state government and blockchain businesses to work together to create structures that will foster the smart growth of the industry.

Goodenough told the ABA Journal that the purpose of recently passed blockchain legislation was to “provide the ability to opt into a structure rather than wait for the courts to impose something on top of you.”

To that end, in 2018, Vermont passed a law creating blockchain-based limited liability companies (BBLLCs) and personal information protection companies (PIPCs).

To read the full article, click here.

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Why Blockchain Governance Matters

by Oliver Goodenough

In 2016, developers of Ethereum, one of the most well-known blockchain technologies, made history by crowdfunding $150 million — the largest crowdfunded figure ever, and completely in Ether — for the Decentralized Autonomous Organization (DAO). They were then promptly hacked. A predator exploited a software flaw in the DAO, successfully misdirecting at least $89 million into improper ownership.

The developers mounted a counterattack, reaching out to their Twitter network, and reclaimed the majority of the funds within hours. While admirable in most people’s eyes, the countermeasures were essentially extra-legal, constituting a “posse” of actors undoing the permanence of the ledger that is supposed to be the core safeguard of a blockchain currency.

It’s a sensational example of the potential dangers inherent in a complex cryptocurrency system without clear governance structures, but there are also day-to-day concerns that impact every participant in blockchain activity.

The Liability of Partnership in Blockchain Transactions

Blockchains in general and cryptocurrencies in particular come in a wide variety of structures and “flavors.” While some have been launched on a proprietary basis and managed centrally through traditional business organization structures, a number — including the highly visible BitCoin and Ethereum coins — exist largely as a loose network of independent operators. The technological infrastructure provides the operational framework, rather than any word-based statement of governance principles or structures.

This organizational looseness could pose a number of significant challenges for participants in such a cryptocurrency. One of the most concerning is the potential for collective liability for the participants — without any of the shielding that would be provided by a corporation or LLC.

Under US law, when a group of people join together to carry on business for profit, they’re presumed to be a partnership. The problem with this result is that a simple partnership creates unlimited mutual liability for all the partners for all the debts of the partnership, as well as unlimited mutual agency for the creation of any liabilities that are sufficiently connected with the business of the partnership.

If the miners and nodes of a cryptocurrency were deemed to be partners in its business — and there are good, although not necessarily conclusive, arguments to suggest they could be — they could face the potential of daunting liability.

Market Concerns Over Lack of Accountability

Other governance concerns have arisen as currencies seek to change their architecture to promote efficiencies in recordation and mining or to change the proof of work approaches for better security.  The authority to make such changes is unclear in any chain without a formal structure of some kind.

The need for better governance has been recognized by many in the field.  It was referenced in the January, 2017 FINRA report Distributed Ledger Technology: Implications of Blockchain for the Securities Industry: “For example, recent events have shown that lack of a central governing body for the evolving Bitcoin Network has created concerns for the network, as participants try to determine an approach to handle increased transaction volume. Therefore, a [distributed ledger technology] network based on the use of a trustless network, where no party is responsible or accountable for the proper operation of the system, may present risks to markets and investors.”

The subject is also getting private sector attention: both the Tezos Foundation and Hyperledger have initiatives aimed at developing improved governance frameworks.

Solving the Blockchain Governance Problem

Like blockchain networks themselves, governance solutions don’t all have to follow the same formats, but most should, at the very least, address certain issues:

  • Provisions that permit the governance to be provided in whole or in part through the technological architecture of the system
  • Provisions assigning the roles of members and managers to participants – nodes, miners, etc
  • Provisions granting limited liability protection to these participants and authorizing the limitation of their agency authority with respect to the system as a whole
  • Provisions granting authority for the kinds of counter-hacks that the Ether system has carried out when under attack
  • Provisions creating governance procedures for innovations and changes in the currency architecture.

The missing link in many of the efforts to date is how to get legal recognition and enforceability for the solutions. While many blockchain protagonists like to think that all the answers can be embedded in the code itself, there are places where traditional law can be usefully invoked. Recognizing the governance gap, the State of Vermont recently passed blockchain legislation that creates a new business organization form — a blockchain-based limited liability company, or BBLLC. This law allows blockchain companies to protect owners, managers and blockchain participants from unwarranted liability by forming BBLLCs.  And it provides blockchain companies an enforceable legal framework to create custom blockchain governance structures that perfectly fit their unique technology and circumstances. It also allows a lot of the structure to be expressed directly in code – the preferred outcome in the blockchain tradition.

While other potential organizing structures also exist, a Vermont BBLLC should be considered as a framing structure for any existing or planned blockchain structure.  Going without a well-crafted solution to these governance concerns is a bit like driving without a seat belt – OK until there is a problem, and then maybe too late to fix.

Additional Resources:

Bramanathan, Reuben et al. A Securities Law Framework for Blockchain Tokens, Dec. 7, 2016. https://www.coinbase.com/legal/securities-law-framework.pdf

Goodenough, Oliver. “Financial Technology Report,” Center for Legal Innovation, Vermont Law School, December, 2017. https://www.vermontlaw.edu/sites/default/files/2017-12/CLI_Legislative_Report_2017.pdf

Hacker, Philipp. “Corporate Governance for Complex Cryptocurrencies” Oxford Business Law Blog, Aug 18, 2017. https://www.law.ox.ac.uk/business-law-blog/blog/2017/08/corporategovernance-complex-cryptocurrencies

Norton Rose Fulbright. “Briefing: Legal analysis of the governed blockchain.” June, 2018. http://www.nortonrosefulbright.com/knowledge/publications/167968/legal-analysis-of-the-governed-blockchain

Reyes, Carla L. “Moving Beyond Bitcoin to an Endogenous Theory of Decentralized Ledger Technology Regulation: An Initial Proposal,” Villanova L. Rev. 61: 191 (2016). https://digitalcommons.law.villanova.edu/vlr/vol61/iss1/5/

Samans, Richard & Krieger, Zvika. “Realizing the Potential of Blockchain: A Multistakeholder Approach to the Stewardship of Blockchain and Cryptocurrencies,”World Economic Forum White Paper, June 2017. http://www3.weforum.org/docs/WEF_Realizing_Potential_Blockchain.pdf