Legal Issues Surrounding "Smart Contracts"

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By: Emily A. Georgiades, Esq.

As technology advances so must the law. Recently, we have been seeing a surge in popularity in blockchain technology and the rise of "smart contracts". Articles have even been written stating that smart contracts may replace the need for lawyers. So why aren't lawyers panicking? Well, because there are issues with smart contracts that will require professional legal intervention.

"Smart contracts" are self-executing, self-enforcing, self-verifying1 contracts with the terms of the agreement between buyer and seller being directly written into lines of code which exist across a distributed, decentralized blockchain network. In theory, smart contracts will eliminate the need for a middleman and allow for the secure transfer of anything of value - including property, shares, virtual currency, etc. It is believed that smart contracts would reduce the need for court intervention. Ethereum is one such decentralized platform which is famous for its wide use of smart contracts. However, before smart contracts can be used on a grand scale, some technological adjustments have to be made to be able to sustain a large volume of transactions being executed simultaneously.

In January 2018, New York State introduced legislation2 which proposes to allow "signatures, records and contracts secured through blockchain technology to be considered in an electronic form and to be an electronic record and signature." Essentially, this would allow smart contracts to exist in commerce. Therefore, given that smart contracts may become more widely used in the near future, it is worth considering certain legal matters which may arise from using them. Such matters include:

  1. the language of the contract;
  2. who bears the responsibility if the smart contract does not properly execute and damages ensue as a result;
  3. what happens if the contract needs to be modified; and
  4. what is the legal status of a smart contract.

Contract Language

Smart contracts are algorithms/code which look something like this:
Formula.JPG

As with any contract, the terms of the contract must be made clear to all parties at the onset. In the case of an express contract, the lawyer drafts the agreement in a language mutually understood by the parties. If it is translated into other languages then a clause should typically be added to state which language prevails in the event of a dispute. This is very significant as the same word in two different languages can have very different meanings. However, smart contracts are written in code and in the event of a dispute it would take a tech expert to translate the code to discover what went wrong. This is not per se a problem but it is a consideration when using and examining smart contracts.

Jurisdictional & Liability Issues

In a traditional contract, generally the party who breaches the contract bears liability. In a smart contract, if the request is not properly executed then it could possibly be a result of an error in the algorithm. The code may have been defective (i.e., poorly written), or hackers could change the code either pre-execution or while the contract is in the process of being executed. The question to consider is "who is liable for damages in such instances?" Is it the original programmer of the algorithm? Is it the Blockchain that contains the smart contract? Then, one must consider in which forum one could sue for damages. Every transaction could potentially fall under the jurisdiction(s) of every node in the network. This could create a legal nightmare in that every jurisdiction has differing laws and the blockchain may have to comply with these various laws. Another consideration is whether the smart contract contains a clause stating in which forum disputes could be settled. Will disputes be settled by an automated settlement program or in traditional courts or arbitral tribunals? Since these contracts are electronic and could simultaneously be used by people of different nations, a settlement dispute clause is of the utmost important.

Modification

Contract modification is easy to handle when the contract is fully written but what happens when a self- executing smart contract is in the process of being executed and the agreement requires modification? Such a problem could occur where the law changes whilst the contract is being performed or an impossibility arises or performance of the contract becomes impracticable.3 There would need to be a master override on such contracts but the question becomes how could this be done and who would bear the responsibility of doing this.

Legal Status of Smart Contracts

In examining the nature of a smart contract, Dr. Maciej Hulicki4 points out that smart contracts can coexist independently from actual legal contracts. He states that smart contracts may be used as a tool for contract enforcement in some instances and as actual contracts in other instances. Whether a smart contract is an actual agreement or merely an enforcement tool would depend on whether the legal requirements of a contract (including the intent of the parties to be mutually bound by the agreement) are met. Therefore, lawyers should be aware of this potential issue in examining the nature of a smart contract when it is brought before them.

Conclusion

Although contract law is an established body of law, the above are just a few issues to consider when establishing smart contracts so that they may be widely used. Smart contracts have the potential to make transactions in the business world faster and more efficient if executed properly. Everyone enters into several contracts on a daily basis and so all lawyers should be aware of smart contracts and the issues that surround their use. The more issues that can be addressed before smart contracts are utilized on a grand scale, the easier it will be to avoid recourse to courts to solve these issues.

Emily A. Georgiades, Esq. is a member of the New York State Bar, the Bar of England & Wales and the Cyprus Bar Association. She is a business lawyer with a Master of Laws in Corporate, Banking and Finance Law from Fordham University School of Law, was a Deputy General Counsel of a business consulting firm in NY and teaches an advanced course in Business Law at Queens College in New York. Emily can be reached at Emily@altfinesq.com.


1. Tim Swanson, Great Chain of Numbers: A Guide to Smart Contracts, Smart Property and Trustless Asset Management 312 (2014).
2. NYS Assembly Bill A8780.
3. Max Raskin, The Law and Legality of Smart Contracts, 1 GEO. L. TECH. REV. 304 (2017).
4. Maciej Hulicki, The Legal Framework & Challenges of Smart Contract Applications, www.cs.bath.ac.uk/smartlaw2017/papers/SmartLaw2017_paper_3.pdf.


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This page contains a single entry by Justin Batten published on October 1, 2018 12:00 PM.

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