As more people begin to recognize the potential of smart contacts, the uses for them across distributed ledger technologies continue to grow. And as it grows, the legal systems in the United States and other countries have been trying to catch up. Since the term "smart contract" implies a legally binding contract, it's natural to wonder whether the term "smart legal contracts" is redundant. There are differences, however. It's time to look at the intersection of blockchains and common law.
What you will learn
Smart legal contracts explained
Is a smart contract a legal contract?
Hybrid smart contracts
A smart contract is computer code working as part of a blockchain that can execute the terms of a contract or agreement when predetermined conditions are met. A smart contract can be part of a binding legal contract. It also can have no connection to one. The deciding factors are the ways in which the smart contract conforms to the legal definition of a contract.
Smart contracts can function more as agreements than what would technically be considered legal contracts. Part of the value of smart contracts is that they are decentralized and trustless. No central party is needed to fulfill or monitor the execution of the contract. They are recorded solely in the smart contract coding. It follows then that many smart contracts are portals to an agreement that is between parties who are unknown to each other and that is carried out by only the coded terms. So, Anonymous Person A can deposit cryptocurrency in Anonymous Person B's wallet, and the smart contract carries out the transaction as long as all the terms of the agreement have been met. If not, the programming shuts down the transaction.
On the other hand, a smart legal contract satisfies all the legal requirements for a binding legal agreement or contract. In Great Britain, the Law Commission performed an extensive study of blockchain technology and how that nation's laws should deal with it.
Among other findings, the report decided that a smart legal contract "may take the form of a natural language agreement with performance automated by code. Second, a smart legal contract may be written solely in (and performed by) code. Third, and in between these two extremes, a smart legal contract may take the form of a hybrid contract, where some contractual obligations are contained in natural language terms and others are recorded in code."
Smart contracts and smart legal contracts are disruptive technologies that, as trustless executors of agreements, might do the work of lawyers and entire legal teams. Will all lawyers eventually need to learn how to code? Are law firms going to need massive departments full of coders to bring everything together? The disruptive nature of blockchain technology raises a wide range of important questions.
Traditional contracts have touched off plenty of lawsuits. Contractual interpretation is as much an art as a science. There's no reason to think that technology can guarantee no-muss, no-fuss smart contracts with no legal issues. One problem involves the fact that only skilled computer programmers can know what a smart legal contract says. Two average people, and their attorneys, cannot read the coding. How do they know what they are agreeing to?
They must rely on the natural language terms of a contract and the ability of programmers to translate that into action. One can easily envision lawsuits claiming negligence or bad faith on the part of a programmer, or disputes about what a reasonable coder should have done in translating a natural language contract. The days of contract lawyers are not over just yet.
Increased adoption of smart contracts can be expected to result in governing law designed to identify an “offer," “acceptance” and "compensation," in terms of a smart legal contract. When e-signatures first became popular, plenty of debate centered around whether they were legally enforceable. Fortunately, legislation took care of this issue, and it’s reasonable to assume some federal legislation will come into effect.
Let’s circle back to the idea of smart contracts representing only part of a broader transaction. Hybrid contracts combine on-chain code with off-chain oracles. This means you can have smart contract applications that verify external events or trigger specific actions on systems. Suddenly, this opens up a wide range of different possibilities for smart contracts.
Across the globe, the legal profession is working hard to catch up to smart contract technology and get a handle on this new tool. For instance, Great Britain's Law Commission published its extensive report, Smart legal contracts: Advice to Government, covers the underlying principles of the technology and explores how smart legal contracts are used. The report also serves as a good primer on blockchain and distributed ledger technologies.
In the United States, two major legal associations, The Uniform Law Commission and the American Law Institute, have formed a committee to study the Uniform Commercial Code and distributed ledger technologies. The Uniform Commercial Code and Emerging Technologies Committee is working on its own report about reconciling the law and this new technology.
And in the private sector, the Accord Project is working to promote the use of smart legal contracts. Started by the Linux Foundation, this non-profit organization offers open-source tools for people who want to develop smart legal contracts.
At this stage, smart legal contracts have the capability to work well for relatively simple or transactions. Looking forward, many experts predict that this blockchain technology will perform more complex functions.
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