How are smart contracts characterised within your legal framework? Are there any enforceability issues specific to the operation of smart contracts which do not arise in the case of traditional legal contracts?
Smart contracts (including self-executing contracts) are permitted in Australia under the Electronic Transactions Act 1999 (Cth) (ETA) and the equivalent Australian state and territory legislation. The ETA provides a legal framework to enable electronic commerce to operate in the same manner as paper-based transactions. Under the ETA, self-executing transactions are permitted in Australia, provided that they meet all traditional elements of a legal contract; intention to create legally binding obligations, offer and acceptance, certainty and consideration.
The pre-determined and self-executing form of smart contracts creates difficulties where there is a required element of discretion by either party, particularly relating to dispute mechanisms (eg, arbitration and mediation) and non-deterministic provisions. There has been very little case law on the subject. Self-executing contracts may alter traditional dispute resolution in Australia based on the possibility of self-executing dispute resolution through online dispute resolution platforms.
Smart contracts are not specifically defined or referred to under French law. It is generally accepted that smart contracts do not strictly constitute “contracts”, but an algorithm or protocol, based on the blockchain technology, which manages (or executes) a contractual arrangement entered into by the parties : electronic instructions are thus automatically triggered and executed as and when pre-determined conditions agreed by the parties are satisfied.
As Smart Contracts encode traditional contracts, the law applicable to Smart Contracts is determined according to general principles. This means that the question of whether a legal contract was concluded depends on the applicable legal provisions, which may, for example, require certain formalities.
The risks associated with Smart Contracts primarily have to do with the lack of a central entity which can take corrective action against any intentional or unintentional misconduct. Furthermore, Smart Contracts might result in legal risks. It is currently unclear whether decisions made by the program code will also be recognised as binding by the courts. It is also highly questionable whether market participants would accept such proceedings or whether courts should even be allowed to take action in the event of illegitimate or inefficient decisions. Furthermore, there is also the question of how comprehensible the contract conditions stipulated in the program code are to consumers or retail investors.
There is no guidance on the enforceability of smart contracts issued in Ireland and there has been no relevant case law meaning the legal status of smart contracts remains unclear. However, if all of the legal formalities of a valid contract are present (i.e. offer, acceptance, consideration and an intention to create legal relations), there is no reason to suspect that a smart contract would not be enforceable under Irish law.
Irish law recognises the validity of electronic contracts and signatures through the Electronic Communications Act 2000 (ECA). This removes the argument that a signature will be held invalid purely because it is in electronic form. Smart contracts share the same key concern as electronic signatures - evidencing the authority of the parties to enter the contract. This, along with other issues, such as risks in relation to proving that contracts were entered without 'duress', will have to be considered before the use smart contracts becomes more prevalent.
As previously mentioned (see No. 3), the Italian legislator introduce new provisions on smart contracts in Law No. 12/2019. Indeed, Art. 8-ter defines smart contracts as “a computer program that works through distributed ledger technology and whose performance automatically binds two or more parties based on effects defined by the parties themselves”.
The Italian government also appointed the AgID as the administrative authority in charge of identifying the technical standards needed to regulate smart contracts. However, these standards have yet to be published.
Unlike traditional contracts, which can be amended or updated at any time, smart contracts cannot be suspended or amended once entered into. However, it is too early to predict whether and what enforceability issues might arise from the use of smart contracts because they are still at a very preliminary stage.
It is therefore unclear whether smart contracts can be considered to comply with the written form requirements (when applicable). Moreover, to ensure the written form requirements are met, an electronic signature system able to identify the parties must be in place. The system must be an advanced electronic signature or a qualified one; both are envisaged by European Regulation No. 1999/93 and Italian Legislative Decree No. 82/2005.
There is not clear definition of “smart contracts” under Japanese law, nor is there any specific regulation of smart contracts in Japan.
Assuming that smart contracts generally mean “self-executing contracts containing terms that are pre-determined pursuant to specific programming codes”, the use of smart contracts may raise issues of enforceability, although the costs of resolving such issues may be offset by the use of smart contracts.
For instance, a smart contract based on blockchain technology would be automatically enforced and irrevocable even if such contract is unenforceable for violating applicable law.
Contractual agreements may be entered into in written form, orally, or even conclusively/by implication. Therefore, if the essentials of an agreement are stipulated in a smart contracts it may also form the basis for a legally binding contract.
Agreements in the Netherlands are in principle form-free. No specific legal characteristics apply for smart contracts. Agreements on blockchains (smart or otherwise) are allowed, and formal requirements are usually no obstacle for agreements on blockchains (but, in specific instances, can be). Usually, two types of agreements via blockchain are distinguished:
- Agreements that are established by communication via a blockchain (where the conditions of the agreement can be recorded in an electronic deed);
- Agreements that are not only established and recorded via a blockchain, but are also partly executed via a blockchain (smart contracts).
In principle, normal contract law applies to both. In the Netherlands, as in most European jurisdictions, a court will determine the meaning of a contract based on the text of the contract and taking into account all relevant circumstances. Consequently, in practice, the code that forms and executes a smart contract may differ from the legal meaning of the smart contract (as determined by court taking into account all relevant circumstances). It is important that developers of smart contracts take this into consideration.
Information on blockchains as with any other information can be used as evidence in court,. Most private keys, based on the RSA algorithm, will qualify as the electronic signature. Therefore, transactions signed with electronic signatures will have the same evidential value as written deeds.
Specific rules are in place for Information Society services – that is to say, any service, which is normally provided for remuneration, at a distance, by electronic means and at the individual request of a recipient of services. These rules stem from European directives and include requirements on (i) information to be provided to potential purchasers (consumers) on, for example, the identity, address and means of communication of a party, and (ii) rules on entering into, proving and terminating agreements.
Practical enforceability issues may arise in cases where the identity of one or more parties to a contract is unknown.
Smart contracts, according to the recently adopted amendments to the Russian Civil Code, are considered as a condition of an automatic execution of a transaction. The labilities of the parties to a transaction (e.g. an ordinary civil contract) will be executed upon the registration of such event in the information system (distributed ledgers).
Provided that the amendments involving the concept of smart contracts entered into force in the beginning of October 2019 only, there aren’t many court cases where the enforceability of such contracts is in question. At the same time, some experts already raise some problematic issues concerning smart contracts. For example, how the assignment of the obligations under such contract may be done, how such contacts may be altered or unilaterally terminated.
Korean law generally does not require a particular form/structure in contract formation so long as there is an offer and acceptance between the parties. In other words, Korean contract does not have to be recorded in writing to be enforceable. Enforceability issues with smart contracts may arise, however, depending on how information is encoded in smart contracts. By this nature, smart contracts are comprised of programmed codes that usually cannot be easily understood by a lay person. As a result, the issue of whether there was a valid offer and acceptance between the parties is likely to arise. Moreover, there is no case precedent where a record of smart contract in a blockchain network has been admitted as evidence in Korean legal proceedings.
Swedish law concerning formation of contracts is technology neutral, meaning that entering into agreements electronically does not pose a problem per se. However, under Swedish law the formation of a contract in principle requires that the parties exchange declarations in some form. This requirement may cause problems where the agreement is concluded electronically automatically without or with very limited human influence, meaning that certain types of smart contracts may not meet the definition of a binding agreement.
Moreover, all electronically concluded contracts are seen as distance contracts since the parties do not meet when the agreement is concluded. This is in turn entails that the distance contract consumer protection legislation will be applicable where one of the parties is a consumer. Similarly, given that smart contracts are not specifically regulated, general principles regarding, for instance, consumer protection will apply.
In its report on the legal framework for distributed ledger technology and blockchain in Switzerland of 14 December 2018 (pp. 80 et seq.), the Federal Council characterised smart contracts as a computer protocol, usually based on a decentralised blockchain system, which allows automated contract execution between two or more parties with previously coded data. According to the Federal Council, a smart contract has three main characteristics:
1) No human intervention is required: The terms of the contract are first determined by the parties and then converted into machine-readable form so that it can be executed automatically.
2) A smart contract is immutable, i.e. the code cannot be changed by any party. It is thus, in principle, the absolute embodiment of the principle pacta sunt servanda.
3) The smart contract is limited to the digital world. Typically, only electronic goods or services (exchange of digital goods, transfer of money etc.) can be the subject of a smart contract.
The term "smart contract" is somewhat of a misnomer, as it denotes technology for contract execution rather than a contract in the sense of the Swiss Code of Obligations. That said, what can be agreed within the framework of party autonomy under general principles of Swiss law should also be permissible within the framework of a smart contract. However, Swiss legal doctrine and practice in this area are still in a very early phase of development and potential issues such as liability for programming errors or execution errors have not yet been fully explored. We are further not aware of any relevant Swiss case law in the area of smart contracts. Certainly, the immutability of smart contracts raises questions as to how changing circumstances and dispute resolution can be adequately addressed (cf. Federal Council report "Legal basis for distributed ledger technology and blockchain in Switzerland" dated 14 December 2018, p. 81).
Smart contracts have not yet been characterized. The issue is yet to arise and be tested in the legal framework and court system.
Although the legal characterisation of a smart contract has been discussed at length by UK commentators, there is at present no definitive authority demonstrating that smart contracts are legally binding and enforceable under English law, either in the form of a test case or legislation. The prevailing view is that it should be possible to enter into a binding smart contract as long as the usual requirements for a valid contract under English law are met, namely, an offer and acceptance, an intention to create a legal relationship; certainty of terms; and each party giving something of benefit, referred to as “consideration”.
One important interpretative difficulty with this approach is whether and how smart contracts might be avoided in cases of frustration, mistake or fraud. The automatic, self-executing and immutable nature of smart contracts gives rise to doubts as to whether they could be void, voidable and rescinded under English law, either by the parties or the courts.
Another challenge is the application to smart contracts of English legal rules which require certain documents to be “signed” or “in writing”. On this point, the general consensus is that a statutory “signature” requirement can be met by a private key, or where the code element of a smart contract is recorded in source code. There is, as yet, no definitive solution to this issue in the case of a smart contract which is represented only in object code, as it is not considered to be in a form that can be “read”.
There is no requirement under English law for parties to a contract to know each other’s real identity and, as such, a smart legal contract between anonymous or pseudonymous parties ought to be capable of giving rise to binding legal relations. There are, however, likely to be practical problems in an enforcement scenario where one party is unable to identify a named defendant for the purpose of proceedings where the smart contract is not performed, or is performed incorrectly.
The US is still relying on its traditional legal contract regime to account for smart contracts, including state law implementations of the statute of frauds and the Uniform Commercial Code (“UCC”), and some not-blockchain-specific tech-related updates such as the Electronic Signatures in Global and National Commerce Act, and state laws modelled on the Uniform Electronic Transactions Act (“UETA”). Both at the federal and state level, these laws ensure a general recognition that e-signatures are legal and can create a binding contract. There has been little litigation, so it is difficult to determine if the current infrastructure is sufficient. There is some debate whether states that do not expressly recognise that contracts can be formed via an “electronic agent,” technically recognize smart contracts. Over the past few years, several states have sought to clarify the enforceability of smart contracts, akin to legal agreements. However, similar to the issues with blockchain legislation as a whole, there remains no uniform definition of “smart contracts” and what they encompass. From this seminal issue of what is being legislated, flows directly the uncertainty of which legal regime to apply. As a consequence, there have been movements urging for a clear classification of smart contracts and even urging the creation of a new category specific to smart contracts affecting blockchain-based assets.
There is no statutory definition or characterisation of a smart contract, though the case of B2C2 does not preclude a smart contract from being a legally binding contract.
In the absence of statutory definition and judicial guidance on what a smart contract is, whether a smart contract will be characterised as a programmatic code that automates a specific process or a legally binding contract, will depend on various factors including the nature of and subject matter of the smart contract, and whether the legal elements typically required to constitute a legally binding contract such as offer, acceptance, intention to create legal relations, are fulfilled as regards the smart contract – all of which are to be assessed with reference to the factual matrix applicable to the smart contract.
To illustrate, since any intention to create legal relations is more capable of being objectively established where such intention has been documented in natural language rather than in programming code, a smart contract that has terms set out in natural language with the programming code automating some aspect of performance of the agreed terms is more likely to be construed as a legally binding contract than a smart contract which comprises of programming code, purely executing transactions with no or only partial documentation of contractual terms in natural language.
However, assuming a smart contract constitutes a legally binding contract, under Singapore’s legal system, there remain prerequisites to enforceability such as the exchange of promises with the intention to create legal relations; such promises being supported by consideration; parties intending to enter into legal relations having the capacity to contract; and where applicable, fulfilment of formality requirements such as those as prescribed under Singapore’s Civil Law Act (Chapter 43) (“Civil Law Act”).
The Civil Law Act for example prescribes that a contract for sale of immovable property has to be in writing and signed in order to be enforceable. This requirement that the contract be in writing could be challenging to fulfil in the context of a smart contract for sale of immovable property, if the smart contract does not contain the full natural language documentation of the terms of sale with the consequence that the enforceability of such smart contract could be uncertain.
The HKMA’s Second DLT Whitepaper, reflecting input from the Technology Committee of The Law Society of Hong Kong, provides that a smart contract may be considered as an arrangement whereby autonomous software running on a DLT platform automatically exchanges assets that are stored or represented on the DLT platform (e.g. the delivery vs payment arrangement). Whether a smart contract can be considered as a legal contract is still an open debate. However, the notion that smart contracts can be used to completely replace legal contracts or govern the relationships between participants in a DLT platform is misguided. Using a smart contract without explicit contractual terms could cause uncertainty for participants in the event of unforeseen consequences or disputes.
The Second DLT Whitepaper points to the 2016 Decentralised Autonomous Organisation (“DAO”) Ethereum hack as a wake-up call and a reminder that programming/modelling errors and complex contract interdependencies can give rise to the risk of smart contracts failing to reflect the intention of the creator. Steps must therefore be taken to ensure that, if an undesirable consequence should occur, there is already a pre-agreed governance structure and contractual framework in place to handle the situation. Furthermore, the smart contract should contain an “escape hatch” or clean path for modifying and undoing the smart contract in light of unforeseen eventualities, which would allow human intervention under strict conditions (e.g. all party approval) without realistically threatening the immutability of the smart contract.
The Annex to the Second DLT Whitepaper drafted by the Technology Committee of The Law Society of Hong Kong provides further elaboration on the concepts described above. Its starting point is that whilst smart contracts may have the effect of a contract, they take on many forms and should not be understood simply as contractual documents in digital form. Whilst a smart contract usually contains the mechanics for execution, performance and enforcement, it may not contain the entirety of terms forming the contract at law. The relevant question is therefore what sort of legal remedies are sought and under what claims. If a party desires to seek contractual remedies and enforce the smart contract as a contract at law, then the common law contract requirements would need to be proven to have existed contemporaneously during the purported contractual relationship between the relevant parties. There may, however, be other ways to characterise the smart contract and its relationships with the relevant stakeholders, which could give rise to legal recourse. This might be founded on a legal binding contract, such as securities trading on exchange or DAO, or some other grounds, such as negligence, restitution and fiduciary duty. The remedy of unjust enrichment – often associated with mistakes of fact or law, total failure of consideration, duress and undue influence – might be available in the case of the restitution of unjust gains resulting from a breach of a smart contract. The bottom line, however, is that given the underlying risks of modelling errors and complex contract interdependencies, the performance of each smart contract carries the risk of failing to reflect the intentions of its creators. The Law Society therefore recommends that smart contracts should be adopted only if their design follows the latest best practices and international standards, such as the “escape hatches” referred to above.