Legal Aspects of Blockchain Technology: Governance

Authors: Markus Kaulartz, Jonas Gross, Constantin Lichti, Philipp Sandner

This article addresses the question in which manner a consortium using a collaborative blockchain can be organized legally. In this article, we distinguish between the (1) “contract solution” and the (2) “legal person solution”. Not only national but also cross-border collaborations can essentially be organized by these solutions. Furthermore, we illustrate the advantages and disadvantages of bilateral and multilateral contractual governance in detail. This will be done against the background of the laws of Germany.

Preamble

This article is the sixth publication of the series “legal aspects of blockchain technology” by the Frankfurt School Blockchain Center (FSBC), Datarella, and CMS Hasche Sigle. This research is part of the KOSMoS project, a research project funded by the German Federal Ministry of Education and Research (BMBF) under the funding code 02P17D020. The Frankfurt School Blockchain Center gGmbH and Datarella GmbH are part of the “KOSMoS” consortium. Together with partners from the industry (Schwäbische Werkzeugmaschinen GmbH, Alfred H. Schütte GmbH & Co. KG, ASYS Automatisierungssysteme GmbH), academia (Universität Stuttgart, Hochschule Furtwangen), and software development (inovex GmbH, Ondics GmbH), they create a blockchain-based solution allowing manufacturing companies to establish a DLT-based framework for producing machines in order to (a) execute dynamic leasing contracts, (b) provide transparent maintenance documentation and © ensure high-quality documentation of manufactured products.

Introduction

More and more companies use blockchain technology for their business models and operations, integrating blockchain technology into the core of their organisational structure. This raises the need for legal backing of increasingly complex organisational structures that include a blockchain, e.g., in terms of auditing, leasing, privacy questions, or consortial use. The current legislation around blockchain technology is getting clearer and provides the legal boundaries of possibilities and restrictions for the organisation of these business models.

There is a responsibility for members that have access to a blockchain and operate on it as well as responsibility for legal governance e.g., towards third parties. The distributed nature of blockchains divides the responsibility of operating and running the network amongst the various nodes. Depending on the architecture of the blockchain, the nodes have equal or differing degrees of responsibility in operational governance matters (e.g., altering the protocol). Analogously as there can be various nodes that run a blockchain and share the blockchain’s operational governance, there can be a consortium with several members which share the blockchain’s legal liability.

If a blockchain is used by a consortium, the question arises how the consortium members should be organized legally to distribute liabilities. We will analyze this question in this article.

Legal Organization of a Collaborative Consortium

Regardless of which of the two legal organizational structures is chosen, the governance of a collaborative consortium has the goal of protecting its consortial members. Disputes can arise either amongst members or with parties external to the consortium.

Network participants, consortium members and, if applicable, the consortium entity as the alliance of the individual members in such a consortium are the participants that make use of the collaborative blockchain. Non-compliance with either the network agreements and policies or pertinent law are examples for how litigation bringing charges against a consortium might occur. The governance provides the framework to resolve such litigations. There are in principle two ways in which the consortium could be organized legally (see Figure 1): a “contract solution” or a “legal person solution”.

Figure 1: Different types of legal organizational structures involving a blockchain

Source: Own illustration.

Contract Solution

The consortium members specify a multilateral contract to which all consortium members agree. This contract contains extensive provisions on governance. Instead of a multilateral contract, a contractual chain is also possible to be set up. In Figure 1, this is indicated by the lines that connect every consortium member with one another individually. Here, the consortium members enter into a bilateral contract and, if needed, can selectively assert rights against single members. However, the latter is likely more complex due to the mutual rights and obligations. In addition, it is also possible to accept service providers as contractual partners, for example, for the technical maintenance of the software necessary for the operation of the blockchain.

The key advantages of the contract solution are that company law regulations do not necessarily apply to them. This means that members are free to covenant their relationship with each other as well as the structure of governance. The disadvantage of this solution is that there is not solely one responsible person or entity for the operation of the blockchain. The more members the consortium has, the less responsibility individuals typically feel for themselves. In addition, the contract has as many contracting parties as it has consortium members. This could be an obstacle, especially for the service provider, to sign the contract as well since the contractual partner risk is higher with more parties involved. Instead of one collective lawsuit, several individual ones with possibly differing contractual rights and obligations make it more compley. Furthermore, the coordination of litigation becomes more paperwork heavy and more logistically challenging to set up.

Legal Person Solution

As an alternative to the contract solution, the consortium members have the possibility to establish their own legal entity. This involves bilateral contracts between the legal entity and each consortium member as well as with the external service provider.

A legal entity can be an association, a cooperative, or a foundation. Companies such as GmbHs or AGs are also possible, but practice has shown that consortium members are rather reluctant to become shareholders of another company for accounting reasons. Therefore, they prefer being a member of an association, a cooperative or even entering the contractual commitment of a foundation. The selection of the suitable legal entity is further complicated by the choice of a suitable legal system — the German, Liechtenstein and Swiss foundations often compete with each other, meaning that depending on the contractual specifications the strategic choice of a suitable legal entity can be decisive for whether the consortium will be successful or not.

The key advantage of the legal person solution is evidently that the consortium has “one face” to the outside world. Moreover, there is no need for a contract with a large number of contracting parties as figure 1 shows confrontingly. It may also be more convenient for the service provider to have only one contractual partner instead of the entire consortium. However, establishing a separate legal entity also implies higher costs. Even if the costs of setting up a company seem negligible, the company has to be managed and may need an employee and may have to file a tax statement at the end of the year.

Cross-Border Governance

In principle, it is possible to admit foreign companies as “members” in both contractual and legal person solutions. Even if the contract (contractual solution) and the legal entity (legal person solution) may be subject to German law, the law of the country in which the foreign company has its registered office is generally applicable to the foreign companies. If the consortium operates a blockchain, this could indirectly affect the operation of the blockchain, for example, if individual aspects of the blockchain were regulated in the respective foreign legal system differently. In addition, special tax law questions may arise.

The contracts with the foreign companies could, therefore, for example, stipulate that the respective foreign company ensures that the operation of the blockchain is in accordance with the applicable foreign law and that there is a special right of termination in the event of irreconcilable conflicts.

About KOSMoS

KOSMoS is a research project funded by the German Federal Ministry of Education and Research (BMBF) under the funding code 02P17D020. More information about the project can be found on the website.

Remarks

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Dr. Markus Kaulartz used to be a software developer and is now a lawyer at CMS Hasche Sigle. He specializes in IT and data privacy laws and focuses on challenges arising from the increasing digitalization (FinTech, Blockchain, Smart Contracts, AI, SaaS, etc.). Since Markus’ clients are both innovative startups and tier one global players, he has gained much experience in advising on legal issues of future technologies and new business models, such as blockchain and artificial intelligence. Markus has particular tech expertise and insights that contribute to his legal advisory practice. His input is often sought where challenges arise at the interface of technology and law. Markus is co-editor of the legal handbook on smart contracts and the legal handbook on artificial intelligence and machine learning.

Jonas Gross is a project manager and research assistant at the Frankfurt School Blockchain Center (FSBC) and also works for the KOSMoS research project. His fields of interests are primarily crypto currencies. Besides, in the context of his Ph.D., he has been analyzing the impact of blockchain technology on the monetary policy of worldwide central banks. He mainly studies innovations as central bank digital currencies (CBDC) and central bank crypto currencies (CBCC). You can contact him via email (jonas.gross@fs-blockchain.de), LinkedIn (https://www.linkedin.com/in/jonasgross94/) and via Twitter (@Jonas__Gross).

Constantin Lichti is a research assistant and project manager at the Frankfurt School Blockchain Center (FSBC), and also works for the KOSMoS research project. Furthermore, he is responsible for project proposals and grants as well as studies published at the FSBC. As a doctoral candidate his research interests include public blockchains and their individual adoption, as well as how the discourse on blockchain technology is reflected in (social) media. He graduated from the Technical University of Munich with a master’s degree in industrial engineering and management. You can contact him via email (constantin.lichti@fs-blockchain.de) and LinkedIn.

Prof. Dr. Philipp Sandner is head of the Frankfurt School Blockchain Center (FSBC) at the Frankfurt School of Finance & Management. In 2018, he was ranked as one of the “Top 30” economists by the Frankfurter Allgemeine Zeitung (FAZ), a major newspaper in Germany. Further, he belongs to the “Top 40 under 40” — a ranking by the German business magazine Capital. The expertise of Prof. Sandner, in particular, includes blockchain technology, crypto assets, distributed ledger technology (DLT), Euro-on-Ledger, initial coin offerings (ICOs), security tokens (STOs), digital transformation and entrepreneurship. You can contact him via mail (email@philipp-sandner.de), via LinkedIn (https://www.linkedin.com/in/philippsandner/), or follow him on Twitter (@philippsandner).