Community-Run Crypto Project Tests Legal Standing by Forming LLC

A case before a federal judge in California is testing whether a limited liability company appointed by the members of a decentralized crypto group has standing to respond to token buyers and financial regulators in court.

The crypto outfit, Lido DAO—short for decentralized autonomous organization—is facing a lawsuit from crypto users who accuse it of selling unregistered securities.

Weighing how or whether to respond to the suit, Lido DAO’s members in July voted to appoint an LLC that would be funded up to $200,000. The LLC would appear in court for Lido DAO and, with the help of lawyers, file papers asking the case against it be dismissed.

It’s a new approach that appears at least partly designed to protect attorney-client privilege, attorneys said. But it also underscores the oddities of a community-run crypto project trying to defend itself in a courtroom, at a time when some DAOs—including those backed by Andreessen Horowitz and other Silicon Valley giants—have found themselves in the crosshairs of users and regulators.

“I don’t think there’s a clear-cut, ‘this is the correct way to do it,’” said Polsinelli PC attorney Jonathan Schmalfeld, who works in the blockchain technology space. “It’s just all so new.”

‘This Is Not a Thing’

Lido DAO runs a staking business, allowing people to earn money by verifying blockchain transactions. It also has a digital token, LDO, which the proposed class action alleges is analogous to stock in the company.

Dolphin CL LLC was formed in July, Delaware business records show. It filed a motion to dismiss the claims against the Lido DAO 10 days later, following the vote. Dolphin, which is represented by Brown Rudnick LLP, argues the DAO is just software.

“Software cannot appear in this Court and deny its legal personhood,” Dolphin said in the motion. “A legal person must so act.”

There is some legal support for Dolphin’s standing to appear in the case, the entity suggested in court filings, pointing to a 2010 federal court decision that allowed a person to request that a complaint filed against a website domain name be dismissed.

But the approach has been met with some skepticism, including from the judge overseeing the case.

During a hearing this month, Judge Vince Chhabria in the US District Court for the Northern District of California asked lawyers for the crypto users why they hadn’t pushed back harder on Dolphin’s filing of the dismissal motion.

“I was expecting you to respond by saying, ‘this is not a thing,’” Chhabria said. “If you’re an entity and you get sued in federal court, you can’t send some other entity to argue on your behalf.”

Charlie Gerstein of Gerstein Harrow LLP, an attorney for the plaintiffs, said if the case proceeds, they’ll likely argue Lido DAO should be held in default.

Attorney-Client Privilege

The emergence of DAOs in recent years has forced courts to grapple with questions about whether a DAO has the capacity to be sued, and how to serve it with notice of the lawsuit.

DAOs are also experimenting with new ways to interact with plaintiffs and regulators.

Members of the Mango DAO last month voted to approve a deal with the Securities and Exchange Commission to settle charges the DAO sold unregistered securities. The move was viewed by some in the industry as an example of decisions being made in a decentralized way.

But such public action has risks, potentially making it difficult to later claim attorney-client privilege to shield sensitive documents or attorney advice. Part of the motivation behind creating Dolphin, some lawyers suggested, could be an attempt to protect that privilege.

By spinning up an entity, “there’s very clear, defined individuals who would be ‘control people’ of that entity and people that have decision making powers within that entity,” Schmalfeld said. “Then a lawyer can talk to those people with the benefit of privilege.”

Another path is to seek a legal structure before litigation starts.

Tennessee and some other states let DAOs register as a kind of limited liability company. Wyoming has passed a law allowing DAOs to be recognized as nonprofit associations. The law, which took effect in July, provides DAOs with standing to defend a legal action.

Chilling Effect

The Lido DAO case has caught the attention of Silicon Valley.

The crypto users named heavyweight investment firms, including Andreessen Horowitz and Paradigm Operations LP as defendants. The plaintiffs argue Lido DAO is a general partnership and the investors are partners.

The argument that a DAO can be a general partnership has been accepted by at least one federal court.

The plaintiffs’ theory creates headaches for the investment firms. Each partner’s assets can be at risk in a general partnership, and each is responsible for the actions of other partners. The judge in California is weighing the firms’ requests to dismiss the claims against them.

“These investors probably never envisioned being pulled into a lawsuit with these DAOs,” said James Knox, the regional managing practice leader of Aon Plc’s technology, blockchain, and digital asset industry team.

Andreessen Horowitz has publicly identified several DAOs as being among its crypto investments. The potential liability that investment firms could face as general partners may have a chilling effect on future investment, some attorneys said.

Crypto collectives could face more pressure to register with states, which can shield a DAO’s members from being personally liable for the organization’s debts.

“You’re going to have to move toward a structure where people have more protection,” said Frost Brown Todd LLP partner Courtney Rogers Perrin, who works with companies in the digital asset and fintech industries. “I think you do push people toward needing to put in place legal protection now, rather than waiting to a later date.”

The Lido DAO case is Samuels v. Lido DAO, N.D. Cal., No. 23-cv-06492.