On April 6, the Tennessee General Assembly passed new legislation recognizing decentralized autonomous organizations (DAOs), a step first taken by Wyoming[1] less than a year ago. Amending and adding a new chapter to Tennessee Code Annotated, Title 48, the legislation permits Tennessee limited liability companies to convert into a DAO.

What Are DAOs and How Are They Used?

In short, DAOs are crypto cooperatives, or online “organizations” with a bank account. DAOs are “autonomous,” since they operate automatically according to preset rules run by software (also known as a “smart contract”) operating on a blockchain[2], and are often widely held, making them “decentralized.” We often hear about DAOs in the context of businesses and ventures that deal in cryptocurrency and digital assets, which leverage the same blockchain benefits.

Most DAOs have been registered in Wyoming but used to conduct business outside of Wyoming. Now, the Tennessee General Assembly hopes to provide an attractive alternative to Wyoming DAOs in the form of this legislation. However, it is important to note that DOAs, like other forms of digital assets, are subject to considerable regulatory uncertainty. The Securities and Exchange Commission has previously taken the position that interests held in DAOs are securities because those interests were “investment contracts” under the test set out in SEC v. W. J. Howey Co., 328 U.S. 293 (1946).

Summary of the New Law 

The new legislation provides that the Tennessee Revised Limited Liability Company Act (the Act)[3] applies to DAOs to the extent consistent with the new legislation.[4] In short, under the new legislation, a DAO is an LLC whose articles of organization include a specific statement that the LLC is a DAO. Foreign DAOs may apply for a certificate of authority, but not if such DAO’s are “based outside the United States”.[5] In order for an LLC to elect to be a DAO, the articles of organization must contain a statement appearing conspicuously and conforming substantially to the form provided in 48-250-102(c). The statement may define the DAO as a smart contract-managed DAO or a member-managed DAO.[6] In both cases, unless otherwise provided in the articles of organization or operating agreement, DAO management is vested in the smart-contract if smart contract-managed and in its members if member-managed.[7] DAO formation under the new law mirrors LLC formation under the Act except that a smart contract-managed DAO may only be formed if the underlying smart contracts are able to be amended.[8] 

In addition to the specific statement described above, a DAO’s articles of organization must also include a publicly available identifier directly used to manage, facilitate or operate the DAO.[9] Both the articles of organization and the underlying smart contracts of a DAO generally govern all aspects of a DAO including its activity, its members’ relations, its members’ rights and duties, the transfers and withdrawals of membership interests, distributions to members prior to dissolution, and the procedures for amending the articles of organization as well as the applicable smart contracts.[10] Amending a DAO’s smart contracts requires amending its articles of organization.[11] If the articles of organization conflict with its underlying smart contracts, the smart contracts prevail absent a contrary provision in the Act.[12]

Under the new law, membership interests accompany voting rights like under the Act.[13] A member may not dissolve a DAO for its failure to return capital contributed by that member.[14] DAO dissolution under the new law mirrors LLC dissolution under the Act.[15] Unless the articles of organization or operating agreement provide otherwise, DAO members do not have fiduciary duties to the DAO or its members but are subject to the implied contractual covenant of good faith and fair dealing.[16]A member does not have a right under the new law to separately inspect or copy DAO records, and the DAO has no obligation to furnish information about its activities, financial condition or other circumstances to the extent that such information is available on publicly available distributed ledger technology (or blockchain).[17]

Ryan McDowell is a corporate and securities associate at Riggs Davie PLC in Nashville. He works with private equity funds, investment advisers and various other entities seeking legal advice on corporate formation and financing.