Smart contracts have come a long way in a short time. But what are they specifically? When we refer to smart contracts we talk about tools that will help realize the development of Distributed Ledger Technology (DLT).
The certainty of results, theautomation of performance and the efficiencies in simplification processes are sufficient reasons to define smart contracts as a fundamental tool for the dissemination of DLT.
Their potential is assessed and developed in a number of very heterogeneous sectors, such as: financial services, legal services, healthcare, technology and telecommunications, transport, energy, infrastructure, mining and merchandise,to name a few.
In the field of financial services, for example, no one will be surprised to see smart contracts used in areas such as securities clearing and settlement, warranty management, derivative scan contracts, financial services administration, international money transfers and perhaps even consortia loans.
For many industries, what’s interesting is the fact that smart contracts easily adapt to existing business processes; for others it is the potential that smart contracts have in reduce the risk of execution (making the transfer of resources or the instrument in question almost inevitable thanks to automated procedures).
There are so many questions about smart contracts and the DLT to answer: when can a smart contract be legally binding? Can its electronic nature deprive it of its contractual effects? Is that a guarantee? Can you transfer assets or refine a transfer of the stock?
Legal certainty in relation to smart contracts is also important for other unrelated technological developments.
Where could we see the use of electronic agents? Among the evolving technologies surely the one mentioned the most is artificial intelligence.
But let’s try to put artificial intelligence machine learning together with electronic agents like smart contracts. What we get is a function that decides on its own and then automatically acts, allowing peer-to-peer interactions and reducing the risks typical of business transactions as we know it. From this point of view the potential of smart contracts is huge.
Although the term “smart contract” immediately leads lawyers to ask questions of contract law, the reality is that smart contracts are neither particularly ingenious nor are they automatically intended to be used as contracts in the sense legal of the word.
A smart contract – in the context of
blockchain technology
– can be defined as follows:
“A computer code that, when one or more specific conditions occur, is capable of operating automatically based on specified functions. The code can be stored or processed on a Distributed Registry and will record any changes that will occur in the Distributed Registry.”
The crux of this definition is the recognition that a smart contract is not necessarily a contract in the legal sense.
Indeed, it is essentially an advanced form of the conditional expression “if-then”, written in a computer code.
THE CHALLENGES OF SMART CONTRACTS: TRAINING, EDITING AND EXECUTION
First, it’s good to understand if and when smart contracts can meet all the elements of a contract.
In order to understand whether a smart contract can create a legally valid and effective contract,it is necessary to consider whether all the essential elements of a legally binding contract are respected.
THE DIVISORIA LINE: When is the SMART CONTRACTS CONSING CONSING SINSONS CONSINS BINDING?
Now let’s set out the common principles that smart contract developers use when assessing whether the proposed model will result in legally binding contracts according to the applicable legal systems(s), if that is the intention.
A smart contract is simply an electronic code that, when a specific condition or condition occurs, is able to function automatically on the basis of predetermined functions. It is not as a legally binding contract.
Smart contracts can be used (and they are) in applications that have very little to do with acting as a legally binding contract (distribution chain management, self-sovereign identity and traceability of provenance).
This does not mean that smart contracts may never constitute or form part of a legally binding contract.
Under certain conditions, smart contracts may comply with the elements of a legally binding contract under common law and civil law systems.
In addition, legislation in some jurisdictions can help support the outcome. For example:
– In Italy, in February 2019 the so-called “d.Simplifications decree,which will ensure that technologies based on distributed logs and smart contracts have finally entered our system by de-giving to theAgency for Digital Italy technical standards required for full recognition legal value to these technological instruments.
Art. 8-ter of the law of conversion – Law 11 February 2019 conversion of D.L. 14 December 2018 n. 135 – introduces the heading “Technologies based on distributed registers and smart contracts“.
Section 1 encompasses the definition of ‘distributed register-based technologies’; The definition of smart contract is, on the other hand, expressed in paragraph 2, in the third paragraph time validationis standardised.
The content of paragraph 4 of this article, which givesAgid the institutional role of identifying technical standards, which the platforms referred to in paragraph 1 will have to adopt in order to constitute temporal validation, is fundamental. opposable to third parties.
Pending further preceptive rules, which will be absolutely necessary to effectively regulate these new technologies, we refer to the constant insights of our BLOG for the appropriate follow-up.
– Malta was the first jurisdiction to have adopted a blockchain-specificregulatory framework.
– In Switzerland, the Swiss Federal Council has begun consultations on the adaptation of the Distributed Ledger Technologies Act.
– U.S. legislation such as the ESIGN Act and the ETA may influence analysis of whether an automated contract, including a smart contract, constitutes a legally binding contract.
– Several U.S. state legislatures (Arizona and Tennessee) have implemented or are planning to implement specific legislation seeking to authorize the use of smart contracts on electronic media and signatures, so that they are entirely workable by a court.
– Wyoming has recently implemented a number of laws promoting the use of blockchain technology.
The legislation established a Blockchain Taskforce to further facilitate regulatory oversight of blockchain initiatives within a state.
The analysis of the Spanish and US legislation invites the following observations:
– The use of smart contracts or any other automated contract aimed at supporting legally binding contracts does not require implementation of the legislation and is supported by the Spanish civil code by specifice-commercelegislation.
– Subject to the point below, the form by which a smart contract is expressed is not decisive in the fact that it can form legally binding contractual relationships.
For example, in Spain,the language of writing code would be a valid mechanism under Spanish contract law to define the rights and obligations of the parties(private lex), if this is the intention of the parties. Similarly, according to U.S. law, the form in which a contract is registered is not typically decisive for a legally binding contract to exist.
– Contracts that require adherence to particular legal formalities (for example, that real estate transactions are entered into an act and registered) or to deal with consumers, do not lead on their own to the use of smart contracts, unless they do other legal requirements are met.
– Even if the use of a smart contract does not create a legally binding contract, it still covers legal relations between the parties (or with third parties in the event of contractual liability).
As a result, those involved in the use of smart contracts should still consider the broader legal effects of a smart contract (in relation to parties and third parties), although they are sure that they will not give birth to a contract legally Binding.
A SMART CONTRACT SARA’S SUFFICIENT FOR PARTS NEEDS? WHAT MODELS COULD BE USED TO MEET THESE NEEDS?
Some commentators note that the language of writing a smart contract can create less ambiguity than conventional contract terms since it must be stretched according to precise operational terms.
However, it is difficult to codify all possible aspects of a contractual relationship.
– For example, the logic of the programming language may not be able to define and incorporate all abstract legal concepts covered by “major force” or “common sense“.
In addition, when contracting electronically with consumers,information must be provided in clear terms, including the language or languages in which the agreement must be available.
Consumers are not required to understand the language of software.
– Parties may need to use a broader contractual structure to define and document their relationship or provide governance arrangements. A smart contract may not be suitable for this.
– Complicated transactions regulated by smart contracts would probably need a contractual structure that defines non-operative clauses in natural language (choice of law, competent jurisdiction or resolution mechanisms disputes).
– As analyzed above, ensuring that changes or changes to a smart contract will be legally binding is currently problematic from a legal perspective.
For these reasons, both smart contracts and contracts in conventional natural language could necessarily coexist in relation to the subject itself or the related one.
In these circumstances, courts may need to look at the entire legal structure within which the smart contract operates – whether any contract written in a connected natural language is smart contract, and any documentation or encryption in addition – to determine whether there is a legally binding contract between the parties and, if it exists, what its conditions are.
In addition, there are several models of smart contracts.
The suitability of a specific model to create a legally binding agreement will often depend on the different types of activities that a particular smart contract intends to cover.
Parties should consider when the smart contract or a contract drawn up in a natural language prevails, or how they work together.
For example, a banking consortium might decide to make only payments using smart contracts and the rest of the contractual terms leave them to natural language.
The following is an analysis of possible smart contracts models.
DIFFERENT SMART CONTRACT MODELS
| External | Internal |
| The code does not in its entirety constitute the legal agreement of the parties, but only makes certain of its terms automatic. | The code could include the entire agreement between the parties and replace the other clauses written in natural language. Anything beyond the code simply explains the terms.
Alternatively, the code could form only an integral part of a legally binding contract (rather than the entirety of the contract) and would replace any other clause written in natural language. |
A. EXTERNAL MODEL – THE CONTRATTO IN DIVERSI LINGUAGGI
The parts of a smart contract may decide to enter into a conventional agreement, known as the “external model“.
In this case, the code does not constitute the legal agreement of the parties in full, but simply automates the execution of some of its terms.
Thus, the natural language version of a smart contract would override the code and control the execution of contract terms through the code.
These problems are similar to those that emerge from contracts written in different languages, where one version typically predominates the others in case of discrepancy.
When using the “external model”, the parties should make it clear that the legal relationship will be governed by the natural language version of the contract, rather than by the code.
Otherwise, the courts may find themselves faced with complicated interpretive problems concerning the intention of the parties. The outcome of this assessment would be uncertain, given that at the moment the courts do not have enough legal precedent to rely on and the assessment would focus on particular facts.
B. INTERNAL MODEL – THE CODE HOW READ
There are two possible types of smart contracts with“internal model”:
– The code would include the entire agreement between the parties and replace the other clauses written in natural language.
Anything beyond the code simply explains the terms.
For example, the DAO terms of service predicted that the smart contract in the Ethereum Blockchain controlled, with the terms of use in natural language had no legal effect.
– Alternatively, the code could only constitute an integral part of the legally binding contract (rather than the entirety of the contract) and would replace any other clause written in natural language.
In this internal model iteration, the smart contract could still use the natural language version for “non-operational clauses.”
The novelty is that the code itself becomes an integral part of the agreement and not a translation of its terms.
In activating certain clauses, the code constitutes a legally binding agreement between the parties.
C. FORECAST FLESSIBILITY IN THE SCELTO MODEL
Changing or varying a smart contract (or derogating to a certain condition) is currently problematic,at least at the current state of technology.
Automatic and irrevocable management could create difficulties in the event of error coding or legal implementation or in situations where a party is simply likely to extend performance time or change obligations.
Similarly, when an electronic contract is contrary to the law or the interest of consumers, a party can, in many jurisdictions, take the case to a court to terminate the automatic effects of a contract (it is the case, for example, of Spanish law.)
When changing circumstances (export bans or trade sanctions) make performance illegal, the parties may need to suspend performance.
Often the law requires the ability to rectify errors in a way that would be difficult to implement in an immutable distributed ledger.
Amendments or amendments are relatively easy in conventional contracts and the parties can waive the provisions if they do so. However, smart contracts, compared to conventional contracts, do not have flexibility from a semantic and execution point of view.
The electronic code can only withstand precise conditional instructions (if-then).
For example, there is no flexibility for parts to incorporate a term that has meaning at run time and that can be interpreted differently during run time.
Concepts such as “good faith,” “commercially reasonable,” or “major strength” in contracts often give parties the flexibility to agree on a particular interpretation of contract terms or even renegotiate them to avoid Disputes.
The incorporation of these provisions in the context of legal smart contracts would be difficult, if not impossible.
These considerations should be included in the selection in the smart contract model and in the regulatory framework in which it operates, which could include improvements that address the fact that that performance is unavoidable a contract has started.
Some smart contracts are easier to edit than others, leading to the distinction made by some commentators between” soft” and” hard” smart contracts.
However, the inflexibility of the automatic handling mechanism within a smart contract makes it potentially impossible to alter a smart contract during its management phase, unless the code has somehow foreseen the possibility of (perhaps in predictive programs).
Multiple-signature agreements or requirements could be explored as a mechanism to block, unlock, or modify smart contracts.
For example, a smart contract intended to have legally binding effects could include a provision it controls to replace smart contracts countersigned by the parties to the original contract.
Without the development of mechanisms that allow the parties to deal with changing circumstances and more easily adjust the terms, the usefulness of smart contracts intended to have legal effects would be limited, particularly in the complete transactions. In these circumstances, the necessary flexibility and management of contract changes would be provided by increasing smart contracts with a framework agreement or conventional contract (natural language), or a global participation or framework legally binding.
What is the APPLICABLE READ OF SMART CONTRACTS?
Blockchain technology exists on a network of computers with nodes and users typically located all over the world.
Will the laws of which jurisdiction apply to smart contracts in this distributed network?
Generally speaking, parties to an agreement can contractually select the law applicable to the smart contract.
However, in some jurisdictions the applicable law chosen by the parties must have some connection with the activity in question.
If a smart contract is challenged in a Spanish court, but does not include a provision of choice of law, the Preliminary Title of the Spanish Civil Code provides the legal criteria for the court to determine the law applicable to the contract.
The most developed legal systems have similar laws regarding this problem, often enacted in accordance with international treaties and often increased by a court’s decisions on conflicts of law to determine the problem when the parties do not they predicted it.
In the United States,questions about the choice of law are typically the subject of individual state policies and jurisprudence. Generally speaking, when the parties to an agreement have expressly selected the law of a particular state, or if the court draws from the provisions of an agreement that the parties wanted the law of a particular state to apply, the court will apply the rights and the duties of that state.
However, a U.S. court will not apply the rights and duties of a state if, alternatively:
1) the chosen state does not have a substantive relationship with any of the parties, and there is no reasonable basis for the choice of parties;
2) the application of the law of the chosen state would be “contrary to the fundamental policy of the state that has a materially greater interest than the chosen state.”
In the absence of an express selection of the state of applicable law, a Redefinition (Second) of the Conflicts of Law looks at the state that has “the most significant relationship with the transaction and the parties,” as evidenced by the place of bargaining, the place of the place of execution, the place of the subject of the contract, and the domicile, residence, nationality, place of establishment, or place of business of the parties.
The parties should bear in mind that U.S. courts might consider the parties’ reports and how the contract was presented when determining applicable state law.
Courts should be careful with contracts that are “unilaterally drafted” by the dominant party and then presented on the basis of “take or leave” to the weaker counterpart who does not have a real opportunity to bargain on terms.
For Blockchain contracts,the supply structure, acceptance and consideration would be indices to which the Court would look to see if there was a “dominant party” that made the proposal to “take or leave” when it came to determine the applicable state law.
In Europe,where the parts of a legal smart contract are located in several countries, but have not made a specific legal choice, the EU Regulation “Rome I” can help a court in determining the applicable law for that smart contract.
The following general principles are set out in the Rome Regulation I:
– “A contract for the provision of services must be regulated by the law of the country where the service provider has his permanent residence.”
– In the case of financial instruments traded in a multilateral trading system, “a contract concluded within this multilateral system that brings together or facilitates the rapprochement of multiple buying and selling interests in the instruments in accordance with non-discretionary rules and regulated by a single law, must be regulated by that law.”
– These principles may be applicable by analogy to other areas. For example, rights in rem (registration of securities or real estate) are typically related to the law of the country where the property is registered or localized.
– The law of the country where the part that is held “to the most characteristic performance” has permanent residence, will apply in residual cases where the smart contract is not covered by any of the other criteria, or where you could apply more than one.
– Electronically executed contracts with consumers are executed where the consumer has his or her permanent address.
– Where it cannot be determined otherwise, the law of the country most connected to the smart contract can also be applied.
As noted above, other developed legal systems have legislation that addresses the issue of law choice, often implemented according to international treaties and typically reinforced by court decisions within the principles of legal conflicts.
Although laws exist to help determine the case, parties to a legal smart contract may want to avoid the uncertainties of not having specifically provided for the law to be settled and on which their legal agreement must be built.
The choice of the law governing the legal smart contract should take into account the design of the Blockchain,its commercial interest, technical complexity,the number of participants and the judicial reach,among other things.
ENFORCEMENT OF SMART CONTRACTS LEGAL BINDINGS
When a smart contract fully integrates a “legal smart contract”, a part of that contract will face some challenges in seeking judicial enforcement.
Some authors argue that it is impossible to cancel a smart contract because the code is immutable and self-executing.
However, the vision fails to consider that people, as knowledge and interpretations change, are (ultimately) the parts of smart contracts. Disputes will inevitably arise over interpretive questions about the parties’ intent.
Litigation may also arise due to code errors or questions regarding the functionality of the smart contract platform itself.
In fact, the very nature of blockchain and DLTs is likely to pose new challenges to the courts, namely new applications of established legal principles.
A. LIMITI OF THE COURT PART
The nature of blockchain, distributed registers, legal smart contracts will inevitably generate chaos in court proceedings.
These issues can easily include:
– Jurisdiction over the parts of a contract (assuming those parties can be identified) and jurisdiction over the assets in question.
– Jurisdiction on the same platform as the smart contract.
– Jurisdiction for matter on the dispute, including consideration of whether and to what extent judicial enforcement is compatible with the “immutability” of distributed records and public order.
– In the case of a hybrid contract (contract in which parts of the contract are codified in traditional written form and parts of the contract in a smart contract self-executing), is the written contract prevailing or the code?
– Which law is applicable in the dispute of the parties, a problem traditionally related to factors such as the place of bargaining, the domicile of the parties, the place of the service, the subject of the contract, public order, etc.
– How could a court’s decision overturn a transaction made by a smart contract where, for example, the court has determined that a smart contract is null (never existed) or cancelable (the party may cancel the contract), due, for example, to example, of an error, lack of capacity, or coercion?
– Implementing a remedy to overturn the transaction in a distributed ledger could be difficult, if not impossible, for a number of factors, including the speed at which digital assets can be transferred off the smart platform principles regarding bona fide transfers.
– Enforcement of compensation against such distant and potentially anonymous entities.
– Judicial interventions on immutable blockchain.
B. MECCANISMIOFS AND AUTOMATIC EXTOUNMENT
Unless and until there is sufficient confidence in the applicability of a smart contract, parties wishing to have legally binding effects for their transaction may want to consider incorporating arbitration clauses, regulatory mechanisms or automatic application to limit the circumstances in which they will require judicial intervention or to facilitate the execution of arbitration or judicial decisions.
For example, the parties, or the platform itself, may want to build a filing procedure (despite the fact that this procedure could be perceived as detrimental to some smart contract benefits).
The parties could also consider building in their smart contracts mechanisms aimed at stopping automatic performance in the event of a dispute or, alternatively, mechanisms that allow to recover funds or other assets by granting the smart contract of certain profiles financed by the parties.
These self-execution mechanisms take place in current trade agreements. For example, banks include in their current accounts a provision regarding the bank’s ability to credit or charge an account in the event of an error.
The parties to the contract may also consider using a platform that already has alternative dispute resolution mechanisms(ADRs).
These mechanisms may be the most appropriate for smart contracts in decentralized registers.
However, as in other alternative dispute resolution procedures, such as arbitration, some degree of judicial control over interpretation and enforcement will likely remain necessary.
In some cases, the implementation of the alternative internal resolution mechanisms of a platform may require judicial intervention, forcing the participation of another party in the transaction or compliance with the decision made in accordance with agreed dispute resolution procedures.
Many authors have expressed the hope that smart contracts will eliminate, or at least reduce the onset of contract litigation.
At this point, however, it is clear that the self-execution mechanisms of smart contracts will not be able to completely supplant the need for judicial control and enforcement procedures.
SMART CONTRACTS REPORT
Responsibility for smart contracts could, of course, include contractual liability for non-compliance. The principles of contractual responsibility are well established and understood in many of the developed legal systems.
These well-established principles, however, will require adaptation when applied to smart contracts.
At this point a general observation can be made regarding the non-contractual liability that arises from the contractual default.
In many jurisdictions, a party is liable for damages from non-compliance whenever it has acted negligently in carrying out contractual obligations.
How can the lack of ordinary diligencebe translated into smart contracts? This could refer to routine technical infractions encountered in activating a Blockchain(security breaches caused by a failure to update the software or a failure of users to retain keys digital resource).
However, a breach of routine diligence would be extremely difficult to prove in reference to a contractual failure of predictive execution performed by algorithms.
Regardless of when a smart contract has binding legal effects, other types of responsibilities (extra-contractual) may arise in connection with the transaction, both between the parties and with third parties.
The smart contracts transaction, even if it does not constitute a legally binding contract, can in any way give effect (or change) the legal relationships between the parties (for example, transferring ownership of an asset).
Several potential extra-contractual responsibilities could arise in relation to particular transactions made through blockchains or automated contracts.
Greater responsibilities could arise in relation to the same technology platform, rather than in relation to individual smart contracts on the platform.
These issues could include distributed transparency, data protection, insider trading and market abuse practices, identity theft, cybersecurity risks and various operational risks.
Both common law systems and civil law systems typically include contractual liability for negligence, fraud, breach of fiduciary obligations. Laws that aim to prevent unfair and illusory business practices could be enforced.
In addition, in the context of product responsibility, legal systems could impose objective liability (without the need to establish certain traditional principles about wrongdoing). Can these types of wrongdoing responsibilities arise in relation to smart contracts?
However, as several commentators have noted regarding software or automated contracts, the current accountability regimes that govern intentional impropriety, negligence, and objective liability do not concur with algorithms.
In the U.S. context, for example, it has been said that “TheSoftware Responsibility Act seems to be strangely underdeveloped, considering the size of the computer industry and the infiltration of software into every virtual aspect of our lives… And despite legal experts predicting a big expansion of accountability for faulty software since 1980… this has not happened.”
It remains to be seen whether and how these types of unlawful liability will arise in relation to smart contracts, whether between the parties or in relation to third parties.
An alternative standard of wrongdoing liability – objective liability – can be applied in some jurisdictions even in the absence of guilt.
In the context of objective product liability, for example, the plaintiff, generally, must prove only the existence of the defect, the damage, and the causal relationship between defect and damage.
The rule against recovery for sheer economic loss can also limit recovery for damages for objective liability from wrongdoing under U.S. law.
A similar position applies in Europe on Product Responsibility,implementing the European Directive on Liability for Damage from Faulty Products (1985), which applies objective responsibility to manufacturers, importers of intermediaries in the supply chain.
Objective liability is intended to protect consumers in cases of defective products that have caused injury, death, or damage to personal property, but excludes economic loss.
It is unclear whether and how these principles of responsibility can be applied to smart contracts.
In conclusion, a blockchain or distributed ledger is similar to any other computer messaging platform used to agree on transactions. Courts have already agreed that email messages can create legally binding contracts in many jurisdictions.
Automatic management is automatic in stock markets and algorithmic trading.
Current regulatory systems (including e-commerce laws) may in many cases already be sufficient in the case of smart contract training.
In some jurisdictions, under specific circumstances, smart contracts may be considered legally binding contracts.
A smart contract may contain some legally binding clausesif the parties agree.
However, it would be wrong to assume that the conclusions reached in one jurisdiction must necessarily prove to be true for another, for example contractual requirements differ between common law and civil law.
Since blockchains do not recognize boundaries, it will be necessary to consider those situations to which the use of smart contract operates internationally.
It is important to note that current smart contracts do not replace (the total) natural language contracts with electronic codes, especially in the case of complicated transactions or where the stakes are high. This is for various reasons, such as the lack of flexibility of the writing language.
Parties that enter into legally binding contracts through smart contracts should carefully consider the control and governance mechanisms that may affect their ability to modify the original contract. If more flexibility is needed, further control measures would be needed.
Finally, developments in technology could provide the necessary solutions.
The parties should specify the choice of the law and the mechanisms for regulating disputes that govern the smart contract, taking into account the Blockchain model, its commercial interest, technical complexity, the number of participants, the judicial scope, among other considerations.
For developers and users of smart contracts, it will be important to be clear that the responsibility (whether the smart contract has legally binding contractual effects or does not have them) could extend beyond the parties themselves.
Smart contracts entities need to consider these risks in their governance, especially when dealing with consumers and investment stability.