Smart contracts and the blockchain – the changing world of lawyers involved in drafting commercial contracts.
What are smart contracts?
A “smart contract” comprises some digital code stored on a blockchain that records the terms of a transaction between two or more parties and then automatically implements those terms as the necessary events occur; in other words it ‘self-executes’. Smart contracts respond to events and implement the required response on an “if that …. then this” basis. A smart contract which has the fundamentals needed to create a legal contract (offer, acceptance, consideration and consensus) is just as binding and enforceable as a traditional written contract.
A blockchain operates across a de-centralised network of computing nodes which use secure cryptography to continuously validate information and provide an incorruptible digital ledger or database across the blockchain. A blockchain is technically robust as, being de-centralised, it has no single point of failure and its ledgers are transparent, easily verifiable and cannot be tampered with or corrupted. For more information on blockchain refer to http://tc-consultancy.co.uk/blockchain/.
Blockchain technology is beginning to radically transform many social, business and economic structures by creating a trusted environment for parties to deal directly with each other thus removing the need for middlemen e.g. banks and escrow agents. Blockchain’s many commercial applications include complex logistic chains, cross-border transactions, B2B finance, payment services, trading platforms, asset verification, data storage, voting systems and quality marks.
As an example of blockchain technology and smart contracts, consider the transportation by sea of a container of goods from a factory in China to a customer in the UK via several transit ports. That journey will involve multiple occasions when the container’s movements and location need to be tracked accurately for the purposes of key events and payments relating to insurance risk, customs duties, regulatory compliance, carriers, contractors and the transfer of ownership. A blockchain can track the container’s progress, automatically triggering the required payments or paperwork at each stage and producing a transparent and unchangeable record for the financiers, insurers, carriers, regulatory authorities, owners and other parties involved in the transaction. Such a process eliminates fraud, human error, delay and uncertainty and reduces the time and costs involved in a traditional logistic chain.
Business lawyers will certainly need to adapt their skills and roles as smart legal contracts become more prevalent in the business world. Those that can adapt will find there is still a demand for their legal knowledge, skills, business acumen and experience. So, the role of business lawyers is going to be different, not reduced. Let me suggest some reasons why that will be the case.
Someone needs to create the contract terms and advise on the underlying legal issues
A smart contract can only execute what it is coded to execute, so someone needs to take the ‘deal’ and convert it into legally binding principles. Business lawyers are trained to do that and are experienced in drafting clear, precise and legally compliant contracts. Lawyers also ensure that a contract will protect their client’s interests in all foreseeable situations including litigation if the arrangement breaks down. Online drafting tools can’t replicate the package of skills and perspective that a business lawyer brings to bear when considering the drafting of a legal contract. There is no reason why that role should change radically in the foreseeable future and certainly not until artificial intelligence has developed way beyond its current capabilities.
Even contracts for small business transactions require careful thought and there is rarely a ‘one-size-fits-all’ contract available that can easily be converted into a smart contract. It is self-evident that in more complex, higher value transactions the stakes are higher which reflects in the need for experienced commercial lawyers to analyse all relevant aspects and draft a bespoke and sophisticated contract.
Clients need to be advised on the overall content and structure of a contract with the benefit of a full and balanced appreciation of all the relevant commercial, legal and regulatory issues that impact on the transaction, many of which may be nuanced and require prior experience of the law and practice in the particular business sector. An online contract template is not able to do that and probably never will unless artificial intelligence makes the most extraordinary advances.
Smart contracts need to work alongside traditional written contracts
Most smart legal contracts address relatively basic transactions that do not require human or external intervention and that is likely to remain their place in the scheme of things for some time to come. They are, for instance, useful tools in recording and implementing the procedure for the automatic release, or not, of funds depending on whether certain pre-determined events occur.
Smart contracts are best suited to work alongside traditionally written contracts as part of a suite of documents where their role is to carry out those operational aspects of a transaction which do not require any human intervention or external judgement to be triggered and so can be implemented by computer code. So, even where part of a transaction can be dealt with by a smart contract, business lawyers will still be required to draft bespoke written contracts in the traditional form for many other aspects of a transaction. Whilst it may be theoretically be possible to ‘translate’ the written contract into computer code it would in many cases simply be inappropriate, unnecessary and the costs would outweigh any useful benefit.
Contracts are intentionally full of subjective determinations
A practical limitation of smart contracts is their inability to enforce contracts where the performance in certain situations is tied to a subjective standard or judgement.
Business contract are littered with the word “reasonable” and phrases such as “within a reasonable time”, “consent not to be unreasonably withheld”, “best endeavours” and “good faith”. They are used to cover situations where it is impossible to state specifically in the contract how the parties are required to act in a given situation, usually because the precise circumstances of every given situation cannot be foreseen when the contract is negotiated. By their very nature, such words and phrases lack certainty and leave open the question of whether, in a particular situation, a party has performed their contractual obligations to an acceptable standard within the intentions of the contract. Decisions on questions like that can only be decided by a human analysing all the relevant events and exercising subjective judgement in a way that a smart contract cannot.
Such words and phrases also recognise that many contracts are more relational than transactional; relationships evolve and contracts often need scope to be adaptable and evolve with them. Standards, like “reasonableness” offer that flexibility in a way that the concrete rules or metrics of a smart contract would not.
The computer code used by smart contracts is based upon logic that doesn’t deal well with the unpredictable vagaries of the real world. Oracles are often presented as the solution to the separation between the real world and the conditional data used by smart contract code. However, a decision needs to be made about whether or not to consult an oracle in the first place and, in any event, most oracles aren’t equipped to make a decision because they require judgement calls.
Written business contracts will remain replete with subjective determinations that can’t be recorded into a smart contract or outsourced to an oracle.
Sometimes new situations arise that no one was thinking about while the contract was being negotiated
It is normal for transacting parties to negotiate again even after the contract has already been made and signed. For paper contracts, this poses no problem as the parties only need to make amendments , usually only a few additional pieces of paper and a quick signature. However, since the blockchain is permanent, amending smart contracts that are not programmed for pre-established modifications could be significantly more challenging than it currently is in the offline world.
Conflict and disputes often arise
If all parties to a smart contract abide by its terms and complete all the required contractual performance without dispute then things will move smoothly on the blockchain. But, what happens when one of the parties doesn’t follow the terms of the contract or when one party thinks they have fully and properly performed and the other party disagrees? For example, in the case of an escrow smart contract, what happens if the item delivered is broken on arrival but because it is recorded on the blockchain as delivered the smart contract has automatically released the funds to pay for it?
Smart contracts have their own risks
Whilst not without its vulnerabilities or risks, blockchain technology has the potential to be secure and immutable. To be that, however, the supporting blockchain needs to be coded flawlessly as does the smart contract code and there have been several notable malicious hacks of blockchain networks due to vulnerabilities in the underlying code. Due to the way parties to a contract are identified by reference to public addresses there can also be issues in identifying the precise identity of the parties to a smart contract which might render it invalid.
There will always be those who don’t trust the technology, people who believe that the technology itself is the biggest risk in the equation. For them, a physical contract, not smart contracts, will remain the medium of choice.
Summary – The evolving role of business lawyers
The increasing use of blockchain technology and smart contracts is inevitable. We haven’t begun to see the extent of the impact they’ll have on our current systems and business practices, nor is yet clear how these technologies will actually be implemented in specific contexts.
It is unlikely that business lawyers will need to learn to create the computer code that drives smart contracts but they will need to educate themselves on the role of smart contracts in commercial transactions and become familiar with blockchain technology so they can work closely with code developers to create customised smart legal contracts for transactions suited to the blockchain.
Lawyers are still irreplaceable, even with smart contracts soon to be conveniently within the grasp of many business organisations.
This article is for general guidance only and specific advice should always be taken before acting on any of the matters discussed.
For more information or to talk to me about blockchain or smart contracts please contact me at:
t: +44 1491 411579