A significant legal distinction between DAOs and traditional companies is that DAOs do not by default impose fiduciary duties on their members. The traditional fiduciary duties include: the duty of care, the duty of loyalty, the duty of good faith, the duty of confidentiality, the duty of prudence, and the duty of disclosure. These fiduciary duties allow for legal action to be taken against the violating party. I will explain each of the aforementioned duties individually, although there is some overlap between them, and you can decide whether they might be a good fit for your DAO.
The duty of care requires that directors and officers (in the case of corporations), and members (in the case of LLCs), inform themselves prior to making a business decision of “all material information reasonably available to them." Smith v. Van Gorkem, 488 A.2d 858 (1985). The stereotypical example here would be the executive who pays no attention to the market, industry, or products of a toothpaste company and yet shows up to the board meeting and irrationally advocates for the company to purchase a golf course he likes. While any reasonable person would see that the golf course does not align with the organization’s interests and may even bankrupt the company, the director persuades the board to pursue this opportunity. The violation of the duty of care may then be pursued by a shareholder against the board of directors.
If a DAO were to adopt this duty, DAO members should define the scope of what might be considered “material information.” For example, it could be required that all DAO members read a particular newsletter and acknowledge receipt of it. While traditional companies are bound by caselaw that more specifically defines the facts that might violate this duty, the flexibility of DAOs allows for DAO members to determine how best, if it all, to adapt this duty to their organization.
The duty of loyalty is particularly important as it requires directors, officers and members to avoid self-dealing, which are transactions which may present conflicts of interest. For example, if a member were to discover an opportunity in the line of business of the organization, but instead of informing the organization about the opportunity, he or she pursued it himself, that would be a violation of the duty of loyalty. Also, forcing the sale of the organization’s assets at an artificially low price so as to benefit a particular member may also be a violation of the duty of loyalty.
Note that violation of the duty of loyalty can be avoided by defining proper procedures of how members may pursue business opportunities in the organization’s line of business in an individual capacity, such as presenting the opportunity to the organization’s members and allowing them vote on whether to pursue the opportunity. If the members elect not to pursue the opportunity, then the member is free to pursue the opportunity. The duty of loyalty is a good duty for DAOs to adopt if members are pursuing a collective goal in which the fruits of that pursuit should be shared collectively.
The duty of good faith requires that directors, officers, and members of the organization advance the interests of the organization and do so without violating the law. In re The Walt Disney Co. Derivative Litig., 906 A.2d 27 (Del. 2006). This is a good duty for mission focused DAOs to impose on their members in order to keep the organization aligned with its mission and to reinforce legal boundaries on members, which can help to reinforce the position that the DAO operates for a lawful purpose and that any criminal conduct on behalf of an individual member is not an act on behalf of the DAO as an organization.
The Wyoming DAO LLC statute does not impose any other fiduciary duties on members other than good faith and fair dealing. If a DAO were to have an unchangeable mission that is hard to enforce because its mission is a broad pronouncement such as "To reverse the effects of the existential threat of climate change," then imposing the duty of good faith may help to ensure protection from members who may seek to pursue opportunities that do not reasonably fulfill that mission. The extreme example of this would be when some mischievous advocate members try to co-opt a climate change DAO to invest in fossil fuels. The more mild example might be simply pursuing tangential activities such as investing in climate photography in order to mint them into NFTs, an act which may not reasonably promote the goal of the DAO (although there is an argument that these could raise investment funds to support the cause).
The duty of confidentiality requires that directors, officers and members keep the organization's information confidential and to not disclose it for their own benefit. As the crypto community is a very open and vocal one, this duty may not be a good fit for DAOs. Moreover, the transparency benefit of DAOs would be hindered if there were a heightened duty of confidentiality. Nevertheless, there may be some instances of some DAOs that would prefer to operate with confidentiality perhaps due to the sensitive nature of the information contained within them (healthcare data, for example) and therefore it maybe a good idea to impose this duty on members in certain contexts.
The duty of prudence typically applies to trusts and organizations that govern professionals of a particular skillset. It requires that those parties operate with the degree of care, skill, and caution that is reasonable for a person of that position. Trust administrators therefore must know about investing, and invest the trust’s resources with prudence. A DAO governing an insurance fund for stuntmen could impose the duty of prudence to ensure that the stuntmen take the necessary precautions typical of their stunts in order for the stuntmen to obtain relief in the event they are injured. This avoids the abuse of stuntmen who are reckless and will drain the fund with their injuries.
The duty of disclosure requires directors, officers and members to act with "complete candor" and disclose "all the facts and circumstances" relevant to their decisions in the organization. This is probably too much of a burden for most DAOs as it would constrain decision making by requiring a very high standard of disclosure. DAOs represent a nimble organizational form that can pass votes at the click of a button. Efficiency would be stifled if every decision were to be contested for lack of “complete candor.”
I hope that expanding on these fiduciary duties provides you with a better idea of which fiduciary duties may or may not be a good idea for your DAO. While imposing these duties might seem onerous and constrain the DAO from making more efficient decisions, remember to balance procedural efficiency with these fiduciary duties to incentivize good conduct and mission adherence. Please reach out if you have any further questions.
Disclaimer: This blog is not intended to provide legal advice or my legal opinion. Any legal references or citations mentioned in these articles may be out-of-date.
It is your responsibility to speak with an attorney before relying on any information included in these articles. Should you need a legal opinion on any topic discussed in this blog, please do not hesitate to contact me.