As a leading provider of director services for legal wrappers used for decentralized autonomous organizations (DAO's), it is important that directors understand their obligations and duties.
Why a Cayman Foundation is used as the DAO legal Wrapper?
Like a typical company, the foundation company has legal personality to enter into contracts and undertake actions with third parties such as banks, accountants, legal, developers, partnership development etc. It is also managed by directors who carry on the business of the DAO. However, unlike a company, the foundation company can be structured without shareholders. In essence, it can be ownerless – just like the DAO it represents.
In place of shareholders, the foundation company can be supervised by a supervisor (or even multiple supervisors if desired). A supervisor has no ownership or economic entitlement in the foundation company but simply acts as a steward, ensuring that the directors of the foundation company observe their obligations to the DAO pursuant to the foundation company's governing documents. Therefore, with no shareholders, all of the officers of a foundation company simply have the objectives of the DAO as their priority.
The governance framework of the foundation is then usually hardwired into the constitutional documents (the Memorandum and Articles of Association), to reflect voting mechanisms by members, appointing a security council or governance council to represent the members collectively etc. The flexible nature of Cayman Foundations allows governing rules and constitutional documents to be drafted in a highly bespoke manner with the organisation’s objectives at the forefront. This means that the organisation’s rules and its democratic decision-making process can be drafted to mirror that of a DAO.
Liability of DAO's
A Southern District of California federal district court in Sarcuni v. bZx DAO held on March 27, 2023, that decentralized autonomous organizations (“DAOs”), which are member-owned communities that maintain financial records and program rules on a blockchain, may be deemed general partnerships if they meet the general legal criteria for such entities. If followed elsewhere, this decision could mean that simply owning a cryptocurrency token could create legal liability for holders and necessitate careful consideration by DAOs and regulators.
In Samuels v. Lido DAO (2024), a federal judge in the Northern District of California denied defendants’ motions to dismiss, finding that the plaintiff sufficiently alleged that Lido DAO is a partnership under California law, making its members liable for the organization’s actions. The court held that token holders who participate in governance and earn staking rewards are co-owners of the business and may be held liable.
DAO creators and participants should consider forming a legal entity (Cayman foundation) to protect against personal liability, tax, and compliance risks. A suitable legal wrapper, such as a Cayman foundation can provide limited liability protection and help bridge on- and off-chain environments.
Nominee Directors
The term "nominee director" is also used in respect of persons who act as directors of a number of companies for an annual fee. For the avoidance of doubt, the duties owed by a director are personal, and it is immaterial that the director has been nominated by another person. Thus, a nominee director, like any other director must act in the interests of the company as a whole, and not simply in the interests of the person or persons by whom he or she has been nominated.
Web3 Directors Duties
The duties of a director under Cayman Islands law can be divided into three main categories:
(a) non-fiduciary duties owed at common law, being those of skill, care and diligence
(b) fiduciary duties
(c) statutory duties, including under the Companies Act and other statutes
Directors owe duties of skill, care and diligence in the exercise of their powers and in the conduct of the company’s affairs. A director is normally only obliged to exhibit such skill as he actually possesses and such care and diligence as would be displayed by a reasonable man in the circumstances. Case law has established that, with respect to the duty of skill, care and diligence (which contains both objective and subjective elements), a director:
(a) need not exhibit, in the performance of his duties, a greater degree of skill than may reasonably be expected from a person of his knowledge and experience but must act as a reasonable person in his position
(b) will be subject to a standard of care commensurate with any particular expertise and/or skills which enable him to meet a higher standard than a director without those skills'
(c) is not liable for mere errors of judgment
(d) unless otherwise agreed, is not required to be an expert in the business of the company, or to possess any particular skill
(e) is not bound to attend all meetings (but should attend such meetings as he ought to attend whenever, in the circumstances, he is reasonably able to do so)
(f) is permitted to delegate powers to service providers of a company but in so doing cannot be absolved from the duty to acquire information about the company’s financial affairs or exercise supervisory responsibility for the company (this is discussed more fully below)
(g) if a non-executive director, must attend to the affairs of the company with the level of diligence that, in all the circumstances, is reasonably necessary to enable him properly to ensure that the judgment he exercises is not only independent but also properly informed, and to ensure that his supervision of the executive management is effective.
Fiduciary Duties owed by the Directors to the company
Directorship is an office, which gives rise to a relationship of trust and confidence, and accordingly to obligations of loyalty, honesty and good faith towards the company.
Every director owes these duties individually and they are owed to the company as a whole. In the absence of special circumstances, they are not owed to other companies with which the company is associated, to the directors or to individual shareholders.
There are four main duties:
Bona fide - a director must act loyally, honestly and in good faith in what he considers (and not necessarily what a court might consider) is in the best interests of the company. Ordinarily, a court will therefore only interfere if it determines that no reasonable director could have concluded that a particular course of action was in the best interests of the company. The court is not concerned with the merits of the decision from a commercial point of view.
Proper purpose - a director must exercise the powers that are vested in him for the purpose for which they were conferred and not for some personal or collateral, or some other improper purpose. For example, a company’s articles of association may confer on the directors the power to issue additional shares, but it would be an improper exercise of that power if additional shares were issued solely with a view to enabling the directors to maintain personal control of the company in their capacity as shareholders.
Unfettered discretion - a director must not fetter the future exercise of his powers, for example, by agreeing to exercise his powers in accordance with the instructions of some third party. This will be of particular relevance to a nominee director or one who represents a particular shareholder.
Conflict of interest - as a fiduciary, a director must not put himself in a position where there is an actual or potential conflict between his duty to the company and his personal interests or a duty owed to another person, including a shareholder whom the director represents on the board. It is open to the company, as beneficiary of the fiduciary power, to waive a particular conflict. Under the general common law, such waiver can only be given by the company in general meeting (i.e. the shareholders by a majority vote, once the director has made full disclosure of the conflict or potential conflict).
Statutory duties
The Companies Act imposes various specific statutory duties in relation to the internal administration of the company and the registration and filing of certain decisions of and changes to the statutory registers of the company.
Although not a duty imposed on directors per se, Cayman Islands law also prohibits fraudulent trading. Specifically, if it appears, in the course of the winding up of a company, that any of its business has been carried on with intent to defraud the company’s creditors or creditors of any other person or for any fraudulent purpose, the court may declare that any persons who were knowingly parties to carrying on the business in that way are liable to make contributions to the company’s assets. Usually, each director will be knowingly a party to ways in which the business of the company is carried on and therefore potentially liable if that business is carried on for fraudulent trading.
Bell Rock Group - Web3 Director Services
Bell Rock Group is a leading provider of web3 director services and routinely acts on the board of Cayman foundations used as legal wrappers for DAO's, digital asset funds and virtual asset service providers (VASP's). Bell Rock Group has been regulated and licensed by the Cayman Islands Monetary Authority (CIMA) since 2013, and also provides Cayman foundation incorporation, registered office, secretary, supervisor, bank account opening and ongoing support services from our offices in the Cayman islands.
Comments