Why a handshake won’t seal a crypto business deal
Blockchain technology enables professionals worldwide to work collectively on non-fungible token projects, create new cryptocurrencies, build decentralized crypto exchanges or DEXs, 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 company formation, the parties can expose themselves to unnecessary expenses, liability risks and even unfavorable tax consequences.
While having a written contract is not a panacea, a recent case illustrates how a party’s legal position would be much stronger with one in place.
IN Bendtrand Global Services SA v. Silvers, a case in the Northern District of Illinois, a founder and a developer of a proposed DEX entered into a software handshake agreement. The founder claims that after paying all agreed expenses, the developer failed to deliver the software.
Due to the lack of written agreements, the founder is likely to face a lengthy and expensive lawsuit and the inability to recover the costs of delay or lost opportunity costs.
Possible liability exposures
Traditional legal protections that limit liability exposure are useful when dealing with business partners in the cryptocurrency industry.
As Benstrand shows, not having a written agreement can deny plaintiffs traditional cost-saving measures such as agreed limitations of liability, choice of law and venue, representations and warranties, liquidation and other clauses.
Without these terms, the parties’ intent must be interpreted through a review of e-mails and messaging platforms, all while the legal costs increase.
In addition, parties may find themselves in inconvenient forums or have to prove their financial outlays before they can recover any damages.
Too many written agreements also lack input from lawyers and are composed of the parties finding sample agreements or isolated clauses via a search engine. Such creations are often full of internal inconsistencies and muddled terminology, and the enforcement of these agreements is questionable.
Considering that authentication and verification is a significant benefit of blockchain, not having a written agreement seems counterproductive.
Furthermore, without incorporation 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 debts, fines or judgments against such partnership.
Decentralized autonomous organizations, a new entity structure gaining popularity in the blockchain community, can have thousands of members on different continents, no central leadership, and no regular corporate form protection from liability.
A member of such a partnership may face personal liability for the actions of the DAO and other members (perhaps located overseas) where they have no knowledge of any wrongdoing that may have taken place.
Fiscal consequences
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 short-term profits. Organizations without agreements on the distribution of taxes have difficulties in calculating the tax owed correctly. Additionally, due to the transparent nature of the blockchain, the IRS is able to track and account for transactions.
The regulations surrounding cryptocurrencies lag behind the development of market practice, and in the absence of a written agreement describing how taxes are handled, the owner of the wallet will be held accountable to the tax authorities for the wallet’s taxes.
Unfortunately, for many blockchain projects, the wallet is tied to a founder and there is no written agreement on how taxes will be distributed.
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 exchanging messages on social media or messaging apps.
Until laws are in place that take the market realities of the crypto space into account, a lack of appropriate agreements will cost founders, investors and transaction partners 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 the White Plains, NY office of Wilson Elser. His practice focuses on cryptocurrencies, particularly NFTs, and he examines current trends to ensure clients are compliant with current and evolving legal restrictions.
Jana S. Farmer is a partner in Wilson Elser’s White Plains office. She leads 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.
