Investors and general partnerships: beware of the personal liability risk

July 29, 2022 | By Patrick T. McCloskey

A recently amended class action complaint filed in the Southern District of California (Ométak v. bZx DAO (No. 22-cv-618)) alleges that a Decentralized Autonomous Organization (DAO) is a general partnership.

Why is that significant?

While the focus on potential liability related to digital assets (under securities laws, for IP infringement etc.) tends to be limited to the company, its control persons and buyers and sellers, general partnership status would render each investor (i.e., each “partner”) jointly and severally liable for the obligations of the DAO.

The alleged losses in the above referenced class action: $55 million.

While the claim in this lawsuit has been challenged as circular because the plaintiffs themselves are also investors, the concept is scary because a general partnership does not require a written agreement among the partners.

Under the New York Partnership Law, a general partnership is defined as “an association of two or more persons to carry on as co-owners a business for profit.”¹ Subject to certain exceptions “the receipt by a person of a share of the profits is prima facie evidence that [such person] is a partner in the business.”²

The issue under New York law in the DAO context is currently before the EDNY in Kent v. PoolTogether (No. 21-cv-6025).

These cases should serve as a cautionary reminder for investors, and the risk is not limited to DAOs. When investing as a stockholder in a corporation, a member of a limited liability company or a limited partner of a limited partnership, absent rare circumstances when there are grounds to “pierce the corporate veil,” the investor has no personal liability for the obligations of the business entity. Put another way, the investor’s risk is, for the most part, limited to the investment. That is not the case with a general partnership.

One way to address this risk is to make sure the business you are investing in is a corporation, limited liability company or, if a limited partnership, that you are investing as a limited partner. If the business you are investing in refuses to form a business entity, you can form a business entity yourself (such as an LLC) so that the potential liability as a “partner” is limited to the assets of the business entity and your assets outside of the investment are not at risk.

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This post is for general informational purposes only and does not constitute legal advice. No one should rely on the information in this blog post without seeking appropriate legal, accounting, tax or other appropriate advice from an attorney, accountant or other professional properly licensed in the applicable jurisdiction(s).

1See  New York Partnership Law §10(1).

2See New York Partnership Law §11(4)