By John Cahill and Jana S. Farmer
Business and tech deals in the cryptocurrency industry often lack formal agreements and are finalized with a simple handshake, explain Wilson Elser attorneys John Cahill and Jana Farmer. They caution this approach often leads protracted litigation, liability risks, and even adverse tax consequences.
Blockchain technology enables professionals around the world to work collectively on non-fungible token projects, create new cryptocurrencies, build decentralized crypto-exchanges, or DEX, and engage with other facets of the web3.
However, because business deals in the crypto space often lack formal arrangements, such as written contracts or a corporate formation, the parties may be exposing themselves to unnecessary expenses, liability risks, and even adverse tax consequences.
Although having a written contract is not a panacea, a recent case illustrates how one party’s litigation position would have been much stronger with one in place.
In Bendtrand Global Services S.A. v. Silvers, a case in the Northern District of Illinois, a founder and a developer of a proposed DEX entered into a handshake deal for software. The founder claims that after paying all agreed-upon expenses, the developer was unable to deliver the software.
Because of a lack of written agreements, the founder is likely facing a protracted and expensive litigation and the inability to recover costs of delay or lost opportunity costs.
Traditional legal protections that limit liability exposures are useful when dealing with business venture partners in the cryptocurrency industry.
As the Bentrand shows, not having a written agreement can deny plaintiffs traditional cost-saving measures such as agreed-upon limitations of liability, choice of law and venue, representations and warranties, liquidated damages, and other clauses.
Without these terms, parties’ intent must be interpreted through reviewing emails and messaging platforms, all while litigation costs mount.
In addition, parties may find themselves in inconvenient forums or will have to prove their financial outlay before they can recover any damages.
Too many written agreements also lack the input of attorneys and are composed by parties finding sample agreements or isolated clauses via a search engine. Such creations are often full of internal inconsistencies and jumbled terminology, and the enforcement of these agreements is in question.
Considering that authentication and verification is a significant benefit of blockchain, not having a written agreement seems counterproductive.
Furthermore, without corporate formation and following corporate formalities, business venture partners are likely to be considered a general partnership, which, under the rules of most jurisdictions, exposes them to joint and several liability for the debts, fines, or judgments against such a partnership.
Decentralized autonomous organizations, a novel entity structure gaining popularity in the blockchain community, may have thousands of members on different continents, no central leadership, and no usual corporate form protections from liability.
A member of such a partnership may face personal liability for the actions of the DAO and other members (perhaps located abroad) where they have no knowledge of any bad acts that may have taken place.
Generally, when participants sell or trade virtual currencies, they will pay taxes on any capital gains from the transaction because the IRS has classified virtual currencies as property since 2014.
Blockchain companies that enjoyed the bull market have been forced to set aside up to 40% of their short-term profits. Organizations without agreements addressing the allocation of taxes have difficulty properly calculating the taxes owed. Additionally, due to the transparent nature of the blockchain, the IRS is capable of tracking and accounting for transactions.
The regulations surrounding cryptocurrencies lag behind the developing market practices, and absent a written agreement detailing how taxes are handled, the owner of the wallet will be held accountable to the IRS for the wallet’s taxes.
Unfortunately, for many blockchain projects the wallet is linked to a founder and there is no written agreement on how taxes are to be allocated.
For an industry that operates through smart contracts and values transparency, the lack of written agreements is staggering. Many in the blockchain industry are willing to trust anonymous strangers based on an exchange of messages on social media or messaging apps.
Until there are laws in place that will take the market realities of the crypto space into account, lack of appropriate agreements will cost founders, investors, and transacting parties time, money, and worry.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
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John Cahill is an associate in Wilson Elser’s White Plains, N.Y., office. His practice focuses on cryptocurrencies, NFTs in particular, and he researches current trends to ensure that clients are in compliance with any current and developing legal restrictions.
Jana S. Farmer is a partner in Wilson Elser’s White Plains office. She chairs the firm’s Art Law practice, and is a member of the firm’s Intellectual Property and Technology practice. She focuses on the development, acquisition, licensing, and exploitation of intellectual property, including in transactions involving NFTs.
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