LLC-type DAOs are coming to Japan

Important ordinance revisions that will enable the establishment of DAOs in the form of limited liability companies (LLCs) in Japan have finally been announced. Under previous regulations, tokenizing LLC membership rights as “Paragraph I Securities” under the Financial Instruments and Exchange Act (FIEA) subjected them to strict disclosure and sales regulations, making them functionally impractical.

With these revisions, tokenized LLC membership rights can be treated as “Paragraph II Securities” under certain conditions, exempting them from the above regulations and allowing LLCs with tokenized rights to be established and operated like normal LLCs.

Source: FSA Market Entry Guidebook

The Financial Services Agency (FSA) has detailed the changes to the FIEA and collects public comments until March 4, 2024. After completing the public comment period, the plan will be promulgated and put into effect after completing the necessary procedures.

Background

In the “Web3 White Paper” published by the Liberal Democratic Party’s “Headquarters for the Promotion of Digital Society” in April 2023, the “Establishment of Special Laws for LLC-type DAOs” was a key point of policy to be addressed.

The following issues were identified:

• The NFT White Paper [published by the LDP in 2022] suggested that there is an urgent need to clarify the legal position of DAOs (decentralized autonomous organizations) that are autonomously operated by token holders based on codes recorded on distributed ledgers such as blockchain, and to establish a system that allows DAOs to be incorporated by clarifying the legal rights and obligations of its members and tax implications. Recently, there has been an increase in the use of DAOs in various fields such as regional revitalization, solving social issues, and community management. DAOs have great potential for revitalizing the Japanese economy and local communities.
• However, there is no clear legal framework for DAOs that ensures limited liability for its members and provides a corporate or association form of organization that is suitable for the agile establishment and operation of DAOs. Although there are cases in which limited liability is recognized based on the legal theory of “unincorporated association” that is only recognized in case law and academic discourse, and there remain unclear points regarding the treatment of DAOs if this theory is applied.
• Therefore, there is an increasing need to clarify the legal position of DAOs under Japanese law.

The following recommendations were made:

• If legal personality is to be granted to DAOs, among various existing corporate forms, a limited liability company (LLC) has a relatively high affinity with the nature of DAOs as it assumes the unity of ownership and management and relatively broad autonomy under its articles of incorporation1. Therefore, the establishment of a special law for LLC-type DAOs is considered a viable policy option, which would include amending some of the regulations of the Limited Liability Company Act and the regulations on member rights tokens under the Financial Instruments and Exchange Act. Legislative action by members of the Diet should also be considered for early legislation.
• Specifically, it is necessary to amend the regulations for LLCs to make them more suitable for the agile establishment and operation of DAOs, taking into account the characteristics of DAOs. For example, under the current regulations, the name, address, and other information of an LLC’s members are required to be included in its articles of incorporation, which is not suitable for the agile establishment and operation of DAOs.
• It should be noted that the legislative establishment of LLC-type DAOs aims to expand the options for establishing DAOs and does not negate the establishment and activities of DAOs in other legal forms. Furthermore, even if LLC-type DAOs are chosen, it should not prevent DAOs from issuing tokens other than member rights tokens that represent ownership in the LLC.

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