Replacing Traditional Capitalization Tables with Blockchain-Based Ledgers

Delaware amended the Delaware General Corporation Law (DGCL) and the Delaware Limited Liability Company Act (DLLCA) in 2017 and 2018, respectively, to permit corporations and limited liability companies to represent capital stock, record equity transactions, and communicate with equity holders via blockchain-based distributed ledgers. (S. 69, 149th Gen. Assembly, Del. 2017; S. 183, 149th Gen. Assembly, Del. 2018.)  The DGCL and DLLCA refer to these blockchain-based distributed ledgers as “Electronic Networks.”  Rather than treating an Electronic Network as a novel equity regime, Delaware law views an Electronic Network as a traditional uncertificated ownership record—akin to when a company foregoes stock[1] certificates and instead represents equity in a paper ledger or schedule to an operating agreement.  This article discusses costs and benefits that a company should consider when choosing whether to institute an Electronic Network to represent its capitalization table.

Benefits:

1. Efficient Stockholder Voting: Companies can rely on blockchain voting for stockholder approvals, which can be more efficient than traditional paper, pdf, or e-signature voting.  The distributed ledger would also maintain a verifiable record of historical stockholder votes.
2. Ability to Enforce Transfer Restrictions Electronically: Companies can build transfer restrictions into the Electronic Network, making enforcement of restrictions contained in their governance documents and stockholder agreements easier and less costly.
3. Cost-Effective Secondary Stock Transfer: An Electronic Network could reduce transaction costs for stock transfers that are completed using company-approved smart contracts.
4. Limited Additional Legal Requirements: From a legal standpoint, creating an Electronic Network is not a “transaction” accompanied by onerous statutory and procedural requirements. There are only a handful of requirements imposed on an Electronic Network in addition to the traditional requirements applicable to all uncertificated stock.  These additional requirements include:

• Production of Paper Voting Record—Stockholders may vote via an Electronic Network, provided that the Electronic Network creates a voting record (i) that may be “retained, retrieved and reviewed” and (ii) “that may be directly reproduced in paper form through an automated process.” (DGCL § 232(d); DLLCA § 18-101(5).)
• Conversion to Written Form—Companies must be able to convert their Electronic Networks into written form “within a reasonable time.”  (DGCL § 224; DLLCA § 18-305.) A company’s converted written records are required to include some or all of the following information depending on such company’s legal structure: (i) each current stockholder’s name, last known business, and residence or mailing address; (ii) the amount of cash and a description and statement of the agreed value of property or services contributed by each stockholder (or agreed to be contributed in the future); and (iii) the date on which each stockholder obtained their securities.
• Record of Stock Transfers—Companies must maintain a record of stock transfers.

Costs:

1. Ability to Change Transfer Restrictions: Companies launching Electronic Networks should be thoughtful about which of the technological restrictions imposed on their stock can be modified and which are immutable.  It may be difficult to change the restrictions applicable to issued stock if the Electronic Network is not initially built with flexibility.
2. Initial Implementation Costs: Whereas implementing a traditional certificated or uncertificated equity regime is practically costless, launching an Electronic Network would require technological implementation, legal advice to confirm compliance with applicable law, and stockholder education.
3. Familiarity with Blockchain Ledgers: Investors and other stockholders may not be familiar with Blockchain technologies or Electronic Networks.  Implementing an Electronic Network could create difficulties for such investors.
4. Early Mover Problems: Representing a company’s capitalization as an Electronic Network is a relatively new concept, and it is possible that there are legal or technological pitfalls that have not yet come to light.

Conclusion:

Using an Electronic Network to represent a company’s capitalization can be a cost-saving and secure way to track stockholder voting, enforce transfer restrictions, and record equity transfers.  If you are considering implementing a blockchain-based equity regime, we recommend consulting with an attorney to explore how the costs and benefits discussed in this article relate to your company.

[1] This article refers to “stock” and “stockholders” for simplicity, but the discussion applies to “units” and “unitholders” as well, except as indicated.