CIP-16: Protect ourselves from legal risk by re-organizing

Proposals (CIPs)
1

Good Evening Everyone,

As some of you may know, I have been active in the #constitution Discord channel regarding the legal rights and liabilities that we as token-holders in CityDAO incur through our relationship with CityDAO LLC. As it stands, these are unclear. Because we are not members in the CityDAO LLC, we do not enjoy limited liability protection, and an action taken by our fellow Citizens could open any of us individually up to liability. Our DAO is unique in that it is associated with real property – land – which has a risk profile unlike other digital-only on-chain assets. Here’s a basic example to illuminate the risks:

The Citizens take a vote regarding setting up Parcel 1 as conversation land with an easement that allows the public to hike through it. 60% of Citizens vote and 70% vote in favor, passing the proposal. The Members of CityDAO LLC agree with this plan and enact it. (They are acting in accordance with the LLC Operating Agreement’s directive to follow the will of the Citizen token-holders.) One day, a young woman falls down while hiking through Parcel 1, is injured, and ultimately dies a few days later. Her family claims that we provided insufficient warning that the terrain is steep, rocky, and hiking it could result in loss of life. They claim that we are responsible out of negligence for her death. They sue CityDAO LLC along with the “Citizenship” token-holders.

These kind of suits happen all of the time, and the plaintiff (in our example the family) is incentivized to include as many defendants as possible to increase the potential payout. As you may have heard there is currently a lawsuit following the Astroworld Concert tragedy in Houston. Included in the suit are Travis Scott and Drake; their mere being on stage while it occurred, irrespective of how much their presence actually had to do with the tragic deaths, includes them.

At the same time, if we are made members of the LLC, our tokens are re-classified as securities and likely require registration with the SEC, which incurs its own costs and complexities, and it does not guarantee us absolute protection from personal liability. In fact, being made members of the LLC may not even be possible, and is really up to the discretion of Scott as (from what I have been able to tell from the public documentation) he is the sole-member of CityDAO LLC.

Closely related to these risks is our business model. It is currently being debated how we should use Parcel 0 and future Parcels, and whether we should seek to earn revenue from them in order to fund our operations (salaries, etc.) If we do seek to earn a profit from Parcel 0, we are likely to be legally classified as General Partners irrespective of our affiliation with CityDAO LLC. “[N]o governmental filing or public notice is required to create a general partnership. A general partnership is formed when two or more persons enter into an agreement for co-ownership of a business for profit” [1]. As general partners, we incur potentially unlimited liability, which puts our personal assets at risk, and we may be responsibility for CityDAO’s tax liabilities. This risk is unacceptable.

If, however, we agree not to seek a profit, token-holders gain legal recognition as an Unincorporated Nonprofit Association [2], and because of our stated mission – to explore on-chain ownership of real property – is scientific in nature, we can attempt recognition as a Section 501(c)(3) organization (usually known as a “Non-Profit” or “Charity”). The organization would likely need to exist as a legally separate entity from CityDAO LLC, and our Citizenship tokens be reissued by a new DAO. We would not longer be “Citizens”, but rather each token should be structured as a directorship on the org’s Board of Directors. This would clarify our legal rights and liabilities while maintaining our voting power and the ability to shape the future of our organization. As Directors in this organization, we would be insulated from personal liability and tax burdens, and our token purchases may be tax deductible [3].

I ask that you give this proposal serious consideration in spite of how anti-progress it may sound [4]. As it stands, our affiliation with CityDAO LLC as token-holders exposes each of us to serious legal and financial risk. If we recognize this fact and rectify it, we can achieve real progress. If we do not rectify it, I hope that you will join me in protecting yourself by selling your CityDAO tokens.

  1. https://a16z.com/wp-content/uploads/2021/10/DAO-Legal-Framework-Jennings-Kerr10.19.21-Final.pdf – See Footnote No. 27
  2. What is An Unincorporated Nonprofit Association? | Nolo
  3. Should Nonprofit Directors Worry About Personal Liability? | Nolo
  4. I did not come to this conclusion lightly or hastily, and was ultimately persuaded by Footnote No. 1. It is authored by the General Counsel of Crypto at
    Andreessen Horowitz, and I recommend you read it in full.
10 Likes
2

This is an extremely legitimate concern and should be sorted ASAP. Just so I understand the suggestion, are you saying we should form a second DAO in the form of an Unincorporated Nonprofit Association? And this Nonprofit DAO houses the citizen NFTs and is legally separate from CityDAO LLC while maintaining governance over it?

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3

thanks for putting this together. i recognize this is important and have been talking to a lawyer about similar concerns and our paths forward.

I think non-profit status would be one very legitimate path to consider and I can ask the lawyer we have been working with about this.

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4

I’m thinking something along these lines:

  1. We form a new DAO that clearly states, on-chain, its mission not to seek a profit. By default it is a Unincorporated Nonprofit Association.
  2. Register the new DAO as a Section 501(c)(3).
  3. Create governance tokens for this DAO and structure them so that each token holder is legally recognized as a director on the DAO’s Board of Directors.
  4. Airdrop the tokens to all “Citizen” token holders.
  5. CityDAO LLC transfers ownership of Parcel 0 to the new DAO.
  6. Burn the CityDAO LLC “Citizen” tokens. This should be satisfactory to permanently insulate ourselves from any potential liability related to the LLC.

Steps 2, 3, and 5 would require help from an attorney. This may be a convoluted approach if CityDAO LLC can be converted into an 501c3 and our tokens recognized as Directorships without setting up a new DAO, etc. but this is the general gist. I’m not an attorney and only have experience converting LLCs to C-Corps.

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5

It generally takes years to get a 501c3 recognized, which probably isn’t a viable timeline for this project, at least at this point.

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6

Can you say more on this? Aside from the document preparation, my research has indicated up to a month for hearing back from the IRS on a filed a 1023-EZ and up to a year for 1023.

7

Hi Scott, thanks for replying to this. Are the current legal discussions documented anywhere? I.e. What you’re asking the lawyers about and what the high level summary is. I think many would be interested in this given its importance to the DAO.

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8

@will I’m not a lawyer, but I’ve seen 501c3 be held up for year+. Maybe there are expedited ways now.

9

+1 for this. Thanks for laying this out Will. Super important topic and absolutely needs to be a priority. The concern about “anti progress” is not a concern because the reality is a judge can step in as-is, regardless of how novel and cool we think this whole experiment is.

Even if this exact path isn’t what ends up happening, sorting this out informs a ton of aspects which are currently unknowns, and some are scary (at a minimum, we need to have some confidence that participating in this brand new entity thing doesn’t leave us open for individual liability, or end up being an achillies heel for the DAO). Let’s be real, there are some bloodthirsty people out there who aren’t interested in playing a fair game, only winning, and right now there’s an ~$8m prize (plus individual assets?) available to anyone who can wrestle it from a loosely defined organization. Would selling my citizenship be enough to get out if something shady happens while I was a member? Let’s also not forget about the gray area that a regulatory agency might use to say “no more experimenting with this, the party is over” - too easy for someone else to define what we are. Or maybe Scott isn’t as cool as we things he is and he ends up like :man_shrugging: thanks for the :money_with_wings: this new beach lifestyle is really nice (that said, I’m here because I believe in the leadership and the project, but it’s simply waaaaay too loosely defined at the moment).

We need some real heavyweights on our side here, even if that costs a boatload of time/money/etc. Probably need input from Wyoming, potentially federal entities as well, and crypto lawyers (maybe consider engaging with the likes of a16z’s web3 arsenal?) to help us understand our options and ensure that we do our best in whatever path is best for the DAO.

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Agree we need a big name advocate for us. Vitalik is a fan but we need someone that will actively vouch for us with their influence. Trying to identify who or what that might be.

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It can take a while to be recognized, but you get to operate under the assumption you will be approved until you receive a rejection. All contributions would be tax deductible, etc. I’ve run 501c3s and 501c4s.

One more benefit of the 501c3 status is that it allows us to become a “dumping ground” for wealthy crypto-traders who find themselves facing a big tax bill. Why not give to citydao instead?

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If we do go this route, I have all the necessary paperwork from a few I’ve previously set up. You need bylaws with some specific provisions, and a conflict of interest policy.

14

Sorry i cannot participate more because i don’t know enough the US laws.

Just my 2 cents for the last paragraph

I participated in the creation of a startup that needed a new type of specific insurance because it was the opportunity to use a gray part of the law. So we had to check with the people who carried them out and check if a company wanted to create a new insurance for this specific project
=> Yes it was done with debats and it was implemented step by step and improved each time that a confidence threshold was reached.

In all case, we need protection as real people will be involved and incident/injuries may happen. (maybe it is too european)

15

Good point. Why not Cuban? He has some visibility. or are you thinking something else?

16

All these points are very well explored.

However, It is still confusing to me why we dont represent every citizen NFT as nothing but an NFT that gates you access to voicing an opinion.

Then,

All legal liability falls on the person that chooses to execute this opinion/proposal as ultimately they get the ability to refuse or accept the final decision ?

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17

Cuban would be a good one, although we’d want someone who is accessible for advice. Cuban is likely extremely busy, out of all the high profile citizens, he’s the only one who never even introduced himself.

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18

THere is another option - couldn’t we become a Cooperative instead of a non-profit? cooperatives dont require as much legal maintenance or limitations on our activities as a nonprofit, and they can be designed however we want them to be (i.e. it could explicitly not be about the member-owners gaining profit from the project)

19

im pretty sure we can just convert an LLC to a nonprofit LLC