Real World Asset Legal Structures - A comparison

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Introduction.

This paper assesses the potential structures for the Maker protocol’s adoption of real world assets.

As the Maker protocol is not a legal entity itself, this paper contemplates both the creation of a legal entity engaged with the Maker protocol (the “Governance Avatar”) and a legal entity to be engaged with the real world asset (the “RWA Entity”).

The Governance Avatar and the RWA Entity are assessed against the following criteria:

  • An orphaned special purpose entity that is bankruptcy remote.

  • Locus of decision-making (Maker protocol or delegated to a third party (trustee, service provider, authorized person)).

  • Nature of fiduciary duties to the extent of delegated decision-making to a third party.

  • Separation between the Maker protocol and the real world asset.

  • Simplicity.

This paper assesses the following hypothetical Governance Avatars and RWA Entities:

Governance Avatars -

  • a Cayman company owned by a Cayman charitable trust, and
  • a Cayman foundation company without members.

RWA Entities -

  • a Delaware statutory trust, and
  • a single, member-managed Delaware limited liability company owned and managed by the Governance Avatar.

There are other potential jurisdictions and legal entities that could be adopted for the Governance Avatar and the RWA Entity.

The appropriateness of the potential jurisdiction and legal entity type may be influenced by:

  • The physical location of the real world asset (United States, Europe, Singapore, etc).

  • The type of real world asset (treasuries, corporate bonds, ETFs, loan portfolios and within loan portfolios, the type of asset - trade receivables, real estate, renewable energy, distressed debt, agriculture, etc).

Analysis



The options above are neither exhaustive nor exclusive. It is entirely possible to mix and match Governance Avatars with different RWA Entities. Further, depending on the jurisdiction of the real world asset (United States, EU, Singapore, etc.), the type of real world asset, and the acceptability of one option over the other in a relevant market, one option (or combination) may be more attractive than the other.

For clarity, this paper does not address the tax consequences of the above structures. Further, this paper does not address how the Maker protocol interacts with the Governance Avatar in terms of funding and the accounting treatment of such funding. Finally, this paper does not address each of the contracts likely to be needed to ensure that there is not any leakage of DAI or fiat currency from the overall structure (i.e., escrow accounts, payment instructions, etc.).

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This excellent work by @christiancdpetersen shows us how complex those legal structures are. They are complex as they are quite flexible and the name could be misleading.

For instance, in the chat @PaperImperium rightfully asked if the Foundation directors have a fiduciary duty (they have). But no one did ask if the Trustees of a Delaware Statutory Trust have a fiduciary duty. It seems obvious. Well …

For sake of precision, the Delaware LLC presented here is specific in its purpose. Other kinds of construct can be made with a Delaware LLC, it’s just a flexible structure. You can read here to see that the difference between a Delaware Statutory Trust and a Delaware LLC is thinner than what you might think.

While the discussion in the community was mainly on the structure names, we are in the view that a discussion is much needed regarding the “Locus of decision-making”. What should MakerDAO keep as control and what it should delegate (and to who?). While it seems simple as “let’s give the baby to a reputable trustee with a fiduciary duty and all should be fine, it will decrease governance burden and remove us from the heat from a regulatory PoV”, well … this doesn’t seem like the world we live in.

A deal like SolarX will require some decision-making (like is the milestone achieved, is it defaulting?, …). If MakerDAO keeps/makes the decision, this could put us in light for the regulator. Or we can trust a service provider or some community members. Or we could say we don’t want to invest where we need to make a decision. The latter would limit us to financial products (like bonds). Easier to manage, less risky from a regulatory point of view but is it “banking the unbanked”? Isn’t it missing the best opportunity to show the world that DeFi is creating a better world and not just farming the financial markets for yield (some might this would be like TradFi)? Isn’t public support and societal good the best tools to influence a possible future regulation?

As the RWF facilitator, I don’t really have a view. But I think MakerDAO should have one. We can explore and experiment, but at some point, we will have to decide (speaking about the previous questions, for the legal structure we can have many types, and having many structure jurisdictions is better).

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What about Ricardian Contracts? Are they enforceable? Is there a reason as to why they have not gain any traction? I see that a protocol called Mattereum (Ethereum based) is using such for RE/NFTs: https://mattereum.com/wp-content/uploads/2020/02/mattereum_workingpaper.pdf

Also, the UK Jurisdiction Taskforce has written some guidelines with regards to cryptoassets being property and Smart Contracts are contracts under English law. https://35z8e83m1ih83drye280o9d1-wpengine.netdna-ssl.com/wp-content/uploads/2021/04/Lawtech_DDRR_Final.pdf

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Thanks for putting this matrix together @christiancdpetersen , I am sure many will find it helpful!

This kind of analysis gets me excited, because in the midst of everything I see a nice marriage of the different structures. I think the idea of a Cayman Foundation sponsoring (with limited powers, such as those given to the Trust Sponsor in the 6s Capital structure) a Delaware Statutory Trust gets us a really nice balance of flexibility, decentralization and determinism. I’m looking forward to exploring this further with you guys.

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@SebVentures

I am new here.

Think the decision making will be similar to a syndicated loan.

Minor breaches-50% of the token holders can waive or condone the breach

Major breaches- 2/3rd majority. Examples include financial covenant breaches, change in material terms, extension of timeline to submit financial statements, covenant certificates, replacement of collateral

Payment/restructuring/enforcement related matters: 100% lenders to approve

in my banking days, we used debtdomain.com and the agent acted as a trustee, account bank and managed the information flow thru DD for benefit of all the stakeholders including counsel, borrower (SPV in this case), lenders among other stakeholder

Sharing in case it helps.

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Thanks that’s helpful. But it’s even how to get what MakerDAO wants to do? When should it be decided by MakerDAO Governance and when should it delegate to someone else? Like minor breaches can be decided by some defined community members (or finding a willing servicer that will make the call) and payment/restructuring/enforcement related matters should come to MakerDAO Governance? Should we centralize some decision-making or keep everything decentralized.

This is a fascinating discussion. I am relatively new in crypto but have been in financial services for a good while. Here are some observations/questions, if I may.

  1. Bigger decisions matter more to MakerDao: the larger the value involved, the more important the decision, particularly if there is a wider range of expected outcomes. Meaning a big decision is one that is economically sizable and isnt trivial (one choice clearly dominates).

  2. Thus bigger decisions require more attention/focus than smaller ones. Perhaps create value metrics to determine where the decision is made at: servicer, subgroup at MakerDao, MakerDao Governance?

  3. As MakerDao scales up, its portfolio of assets will significantly increase, requiring many more decisions. Thus a decision process needs to scale, which means creating a process that can (eventually) make many decisions competently and efficiently.

  4. In my experience servicers generally can make small decisions reasonably well but larger decisions can be more problematic as their interests are not always well aligned with the economic owners and they do not like/get paid for legal liability around bigger decisions.

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Happy to get your perspective @Eumenes, indeed, the key criteria should probably be on the economic value.

We learned today that the fiduciary duty of the Cayman Foundation directors is stronger than expected and that there is no escape. Even if the constitution says they should listen to a committee or a DAO Resolution, they are responsible for the decision. This is a strong incentive to avoid issues and bad decisions. At the same time, they will not be confident having to act on anyone’s input but would be more confident working with professionals. Usually, they are managing funds so there is a professional investment manager to tell them what to do. They are happy to comply as listening to a professional seems the right things to do.

I wonder as well if we shouldn’t just push most decisions to the servicer who is probably more knowledgeable in the space (and we can get a specific servicer per collateral, being an expert in the field). For the most important decisions (still TBD), the servicer will revert to the director (or the trustee) that will probably revert to the DAO (or the Trust Sponsor which might as well, hopefully, revert to the DAO) if it’s not obvious.

The servicer could still be at some point a Core Unit (and, in any case, could be changed from time to time by MakerDAO whish), but they should be professionals. Is there a reason we want it otherwise?

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Maybe I misunderstood—but this sounds like a “nominated Director” must act in the interests of the “company” as a whole, and not simply in the interests of the persons by whom he or she has been nominated (MKR token holders). This sounds like a director can take a company/DAO in a different direction—even without consideration to what the community might want. Am I right—or am I completely off here? Thanks in advance.

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The director has a fiduciary duty to the company. In the most typical case, a company will have shareholders/members. As such, the director will have a duty to the shareholders/members (owners of the company) too. In the case of the Foundation Company, we have structured the Foundation Company so that it is a pure orphaned entity - i.e., it does not have any members/shareholders.

For certain pre-agreed matters, the organizational documents of the Foundation Company will require the director to follow the directions of Maker if the Maker community votes in favor of that certain action. So, in this respect, the director will follow the instructions set forth in a DAO Resolution.

Of course, there may be scenarios (very unlikely) where the Maker community votes in favor of a certain matter that the director cannot perform. The most obvious, for example, is if the Maker community votes on a matter that requires the director to breach Cayman law. I suspect that the director will not carry out the will of the Maker community and will instead resign.

There is a spectrum between centralization (taking direction from the Maker community as if Maker was a shareholder) and decentralization (where Maker has zero influence in the Foundation Company).

From my perspective, as a lawyer, I am seeking to identify where the Maker community is comfortable along that spectrum. I think the points raised by @Eumenes and @Vishal_Mehta above indicate different points along that spectrum.

And I think your question is another point along the spectrum.

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@Eumenes and @Vishal_Mehta - Thank you for your contributions. You have succinctly identified the different types of decisions required in the administration of a loan. I would be happy to discuss with you how we have sought to allocate decision-making along the lines you have identified above … getting into the details of defaults, events of default, acceleration, waivers, amendments, etc. Your additional insights will be appreciated. You can DM me separately at your convenience.

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@SebVentures
I agree with you but think its helpful if we walk through a specific example. I would like to hear your thoughts.

Lets consider an asset backed deal with many small sized assets so that the performance of any given asset will not drive overall performance. I am making assumptions below to give more structure to this example. I hope it is helpful.

DECISION MAKING ROLES

  1. Servicer: Asset Decisions (non Material Decisions?)
    Typically the asset originator will not only originate the assets but also service them as well which makes sense for alignment of interests, though sometimes the securitization assets may be serviced by unrelated third party servicers. Regardless the servicer will be an expert in managing the specific asset type. The servicer will follow Servicing Policy which are required by the securitization. These policies/procedures mandate how the servicer makes decisions for each specific asset.
    Given that (a) each asset is relatively small (non-Material), (b) the servicer is an expert is managing the assets, (c) the Servicing Policy has been reviewed/approved by investors for the securitization and (d) there any many many assets to be managed, it makes sense that the servicer make decisions at the asset level. Note at the asset level the economic value of each asset decision is small (non Material) and many asset decisions need to be made.

  2. Director: Material Decisions
    The Director(s) are appointed to oversee and manage the Servicers. I think the Directors make Material Decisions (ones that potentially impact many assets - which may meaningfully impact the trust). Material Decisions would typically include items such as approving changes to the Servicing Policy, approving amendments, approving actions to manage a securitization in distress (covenant violations, events of default…). Many of these actions may be proposed by the Servicer but need review and approval by the Director(s).

  3. Maker: Strategic Decisions
    The Maker should make Strategic Decisions which I think are meant to address large economic value issues primarily. Perhaps an economic threshold needs to be set. Material Decisions for a very large transaction could meet this threshold but I would typically expect Strategic Decisions to be ones that impact the portfolio across multiple deals. For example an important Servicing Policy change that would impact multiple deals in the same portfolio would likely qualify. I also suggest that many portfolio liability decisions may be Strategic as thee likely impact a large part of the liabilities and thus could have large economic impact.

A few notes:

A large corporate loan would likely need more involvement by the Director(s) as it is one lumpy Material Exposure, unlike the ABS example above.

How should the Trust Sponsor role fit here?

What framework addressed Maker liability decisions? Many of these could have significant economic impact and thus be Strategic Decisions.

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christiancdpetersen

thanks. I would like to see the specifics. How do I DM you?

And just to understand this correctly – Directors of a Cayman Foundation have to be Cayman residents, since I’m assuming they have to be familiar with Cayman law? Or, can a Director be a Canadian (as an example) or better yet, a “shadow Director”?

Also, with regards to non-fiduciary duties of skill, is a Director obliged to exhibit blockchain technology skills, knowledge, and/or experience? Thank you in advanced.

I think only the secretary should be Cayman residents. But as you assume, it makes sense to have one expert in Cayman law and located in Cayman Islands. We haven’t thought otherwise at least. It could also make sense if we fall under the economic substance rule (we don’t in the current setup but who knows what is the future).

No, but those with whom we are discussing are. They should be comfortable understanding how a blockchain and a DAO work. We are not the only ones in crypto with a Cayman Foundation.

Like some are directors for hedge funds. They don’t make the investment decision, they are given an investment manager (or a committee) and they follow what they say. As long as those people are professionals, the director doesn’t have a problem following them.

At the SPV level, it makes sense to delegate to experts in the specific collateral.

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I can’t figure out how to DM you.

this is what I would do:

  1. Google a syndicated loan document
  2. Go the schedule for covenants, indemnity, facility agent role, consequences of EOD

You will get a pretty good idea of what is material and what’s not from a lender perspective.

Hope it helps.

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A Credit Authorization Manual (CAM) at the MakerDAO level can be drafted and approved on-chain by way of a vote (similar to a board-approved policy) and it can be reviewed every 3 months. The manual can deal with decisions that add risks- operational, credit, legal, regulatory, technology, reputational to list a few Delegation defined upfront will solve a lot of problems, and taking decisions based on a policy framework helps with speed and provides clarity for everyone involved. Even with a well-defined CAM, it will not be possible to cover all the scenarios and in that case, members from relevant CUs can collectively work together to secure the interests of MakerDao first and interests of the borrower and other stakeholders will be second.
Related question: Can MakerDao or its members be sued in a court of law by the borrower or other entities involved in the transaction? Has MakerDao’s counsel specifically signed off on this point?

CurioDAO just proposed a novel structuring approach, one that is compliant with EU but most importantly, builds upon the so call “blockchain law” out of Vaduz, Liechtenstein. The region is known as Crypto Valley hosting over 900 crypto ventures. I would genuinely be available to support the creation of an additional Matrix, one that includes our the CurioDAO setup.
I would appreciate you and your peers reviewing our application and provide feedback so we can move forward with this initiative. On behalf of the Curio, I want to thank you for your time and contribution to the MakerDAO community and to our proposal.

Hello Fernando,

I am not on the relevant team dealing with this but I will answer you anyway as they are probably too busy.

I have looked into CurioDAO and found it interesting. It is most likely a reasonably solid model that could even expand beyond cars into arts, yachts, wine, jewelry, and whatnotelse wealthy individuals have lying around.

The problem is the overload of applications atm so there might be some time before you get a response. Please don’t mistake silence for rejection however.

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Many thanks for the heads up! appreciated!