Are we ready for smart contracts?

The development of crypto-currencies, which use blockchain technology, has given rise to some pressing legal questions. These questions may seem relevant only to those who trade in crypto-currencies.

The development of crypto-currencies, which use blockchain technology, has given rise to some pressing legal questions. These questions may seem relevant only to those who trade in crypto-currencies. However, the development of blockchain technology and its use in commerce raise legal issues of general application and concern, as parties increasingly have the ability to conduct business and execute transactions on blockchain platforms through the use of smart contracts.

A smart contract is a set of machine rules (if/then statements) that contain parties’ promises to, or agreements with, each other, including the protocols that will allow the parties to execute those promises or agreements. Blockchain technology, through platforms such as Ethereum and Hyperledger, can be used to develop smart contracts and is now being used in in a number of industries (like supply chain management, banking and insurance) to transact more efficiently.

Smart contracts can also be linked to natural language contracts, but they do not have to be. Interestingly, some legal technology companies are beginning to integrate and link natural language contractual terms with code that will execute those terms automatically through blockchain technology.

So how will smart contracts impact lawyers? Are these “smart contracts” actual contracts”? What happens if there is a dispute? What kind of remedies can you obtain if there is an issue? And are our current legal frameworks sufficient to address these issues?

The starting point for answering all of these questions will be: Does the smart contract meet the legal requirements of a valid contract? In other words, can we fit this new technology into existing frameworks? Since there is no requirement as to form, there is no reason why a contract written in code could not be a contract where the requirements of contract formation are met. In that sense, our legal framework might already be equipped to handle some of these questions and will develop (as it has historically) to address developments in technology.

For example, Canadian courts have already found clickwrap agreements to be enforceable (entered into by users clicking “I agree” to website terms and conditions). In those cases, courts have held that online contracts can be enforceable, but they should provide sufficient notice so that there is an opportunity to consider and decline the contract. Likewise, there is (surprisingly) old United States Supreme Court case law to the effect that telegraphic code (even where there was no natural language) could be used to enter into a contract — and that the important consideration was whether the other party had notice. The common law may likewise evolve organically to address the challenges posed by smart contracts.

Having said that, some states, such as Delaware, Arizona and Tennessee, have already enacted legislation that specifically addresses smart contracts, to reduce uncertainty about their legal effect. Legislators in Canada could do the same, in the same way that the Electronic Commerce Act, 2000, S.O. 2000, c. 17 was enacted to establish that a legal requirement that a document be signed is satisfied by an electronic signature (where certain conditions are met).

The use of smart contracts may also raise other, novel questions, particularly where parties wish to enforce their rights by way of a dispute resolution mechanism (note that, while some people say that smart contracts remove the possibility of disputes, this seems unlikely to be the case for a number of reasons, including that the code itself could have errors or be hacked). For example, many transactions on blockchain platforms are entered into pseudo­nymously, which could give rise to questions as to who the contracting party was (and whether it was capable of entering into a contract). If so, where does that party reside, and how can legal proceedings be commenced? Another novel issue concerns the remedies that may be available in the event of a dispute. For example, given that a smart contract on a blockchain is immutable (it cannot be reversed), it may not be possible to rescind the contract — such that contractual remedies may be limited.

It is possible that some of these issues could be dealt with in dispute resolution or arbitration clauses. To that end, there may be ways to add code that would direct an issue to arbitration and expert adjudicators. There are legal tech projects building in the ability to pause, resume, modify and end a smart contract where there is a dispute and connect the parties to an arbitration mechanism.

These issues may not be as pressing as those raised by crypto-currency trading (as demonstrated by the recent Quadriga proceedings), but they are likely to arise as the use cases for blockchain technology and smart contracts increase. The new issues raised by these platforms can likely, at first instance, be addressed by existing legal frameworks that will evolve incrementally with technology. We may also need to develop new tools to address the issues that the technology raises, arising from blockchain’s unique features such as anonymity and immutability. Lawyers may have a lot to contribute to the effective development and use of smart contracts in business. Accordingly, the question may not be whether lawyers are ready for blockchain technology but, rather, whether blockchain technology is ready for lawyers.

Chloe Snider is a partner in Dentons’ litigation and dispute resolution and transformative technologies groups. Her practice focuses on litigating complex commercial disputes, with a focus on technology-related issues, and assisting clients manage risk.

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