Hong Kong Court ordered disclosure of accounts to maintain healthy operation of decentralised autonomous organisation (DAO)

In a recent decision Mantra DAO Inc. and Another v John Patrick Mullin and Others [2024] HKCFI 2099, the Hong Kong Court issued a disclosure order requiring the managers of a decentralised autonomous organisation ("DAO") to provide accounts related to its operation.

Background

The dispute concerns the ownership, management and control of a DAO-based finance platform project (the "Project") in the cryptocurrency industry.

The Plaintiffs claimed that they set up the Project and subsequently delegated its day-to-day management to some of the Defendants, who were employees of the 2nd Plaintiff. The Plaintiffs also alleged that, among other things, some of the Defendants failed to report the project operation to the Plaintiffs, began to treat the DAO Project as their own with other Defendants, and misappropriated the underlying crypto assets.

On the other hand, the Defendants argued that, being a DAO, the Project was not intended to be owned by any single entities (including the Plaintiffs). Instead, the ultimate decision-making power of a DAO lied with the holders of digital tokens operating through computer codes on a blockchain. The operation of the Project in the present case is governed by a governance agreement which was reflected in the Project's whitepaper, which allegedly provides a separate governance system.

Insofar as the allegation on misappropriation of the underlying crypto assets is concerned, the Defendants' case is that: (1) the relevant Defendants had authority to authorise the asset withdrawal for legitimate purposes as envisaged in the Project's whitepaper, and (2) the shareholder(s) of the 2nd Plaintiff was informed of this and indeed authorised the withdrawal.

The Plaintiffs originally sought a wide range of interim reliefs against the Defendants including injunctions against disposing of cryptocurrencies, prohibition against use of trademarks and passing-off, as well as disclosure and transfer of assets. The Hong Kong court refused to grant these reliefs on an interim-interim basis.

In the subsequent substantive hearing, the Plaintiffs narrowed the reliefs to an order requiring the Defendants to disclose books and records relating to the financial operation of the Project (the "Accounts Disclosure Order").

Discussion

The Court recognised that "cryptocurrency trading is a new, novel and innovative business." Many jurisdictions, including Hong Kong, "have little experience in dealing with such kind of disputes." Given the novelty of the business, the legal effects of the Project governance documents and the employment relationships have to be investigated at the trial. Accordingly, the Court was not in a position to form any preliminary view about the merits of the claims at this stage. In considering the application for the Accounts Disclosure Order, it decided to focus on the balance of convenience issues and the effect of granting and the non-granting of the Accounts Disclosure Order on the parties.     

The Court held that the balance of convenience favours the granting of the Accounts Disclosure Order. Specifically:

1. Damages are not an adequate remedy if the order is not granted. The Court recognised that "[t]he cryptocurrency industry is fast-growing, and decisions are often made with a view to obtaining a first-mover advantage." It is important for the Plaintiffs to receive regular updates on the financial operation of the Project which they claimed to own, manage and control. Otherwise, the Plaintiffs would have difficulties in quantifying their loss, knowing or challenging the basis of the Defendants' decisions on the project. This will be further complicated by the difficulties in tracing anonymised cryptocurrency transactions.

2. The Accounts Disclosure Order would not disrupt the Project's cryptocurrency trading business. The relevant Defendants should have a duty to keep proper account for the Project. Even in the Defendants' case, they would have a duty to account to the relevant token holders about the funds in the Project. Therefore, the order should not cause any additional hardship on these Defendants.

3. A proper undertaking by the Plaintiffs' legal and financial advisers could alleviate the Defendants' concern about the leak of their trade secrets.

The Court therefore ordered that the Defendants should disclose the financial spreadsheets of the Project, and the relevant supporting documents for each entry in the spreadsheets, subject to non-disclosure undertakings.

Comment

The concept of DAOs has attracted public attention since the cryptocurrency market boom in 2021. Despite the absence of a universal definition, it is widely accepted that a DAO is an organisation designed to be governed by rules expressed in computer code, often via blockchain. However, it remains uncertain how participants and managers of an unincorporated DAO should be held accountable for its conducts and transactions. For example, on 11 July 2024, the UK Law Commission published a scoping paper on the DAOs to consider how the DAOs can be characterised and identify current issues around the DAOs. 

This Hong Kong decision serves as a reminder for those operating decentralised cryptocurrency projects (including DAOs) about their obligations to maintain books and records. They should also be prepared to disclose such information to relevant stakeholders, notwithstanding the legal uncertainties on the ownership and governance of these projects. This obligation is particularly relevant to good governance and the protection of stakeholders' interest in the cryptocurrency world, where blockchain transactions are often anonymised and nearly impossible to unwind.

For more information, please contact Jojo Fan, Partner, Troy Song, Associate or your usual Herbert Smith Freehills contact.