Why Is It Crucial to Make Sure Your Smart Contract Is a Legal Contract
In this article, I explain what smart legal contracts are, and why the smart contracts tech should be within the contract law framework.
Firstly, I want to be clear about what kind of smart contracts I am speaking. This technology can be used for smart records for governments or smart cities, for real estate registries, or for enabling self-sovereign identity. It has a potential to change the corporate governance, data sharing between clinical institutions, and even the gun control regulations in the United States. While such broad applicability is impressive, I narrow the focus of the article just to smart legal contracts.
For the sake of this feature, a smart contract is an agreement implemented in software. Such agreement implies the creation of legal obligations for the parties. Once the agreement is automatized and triggered, computer ensures the execution of promises. Hence, not all smart contracts can be smart legal contracts.
Basically, it is an ordinary contract that uses some technology to be “smart.” It can be an insurance contract, a delivery contract, an escrow agreement, and basically any other sort of a legal contract that we use together with smart contract technology.
I have asked many developers whether smart contracts that I can build using their network are admissible in any court and whether a dispute concerning them can be adjudicated. The typical answer is “I don’t know.” There are even more dramatic answers like “Code is law. We don’t need regulators!” So let’s try to understand why we should know the answer to this question, and why we should not neglect contract law that was developed a long time ago, and is one amongst the most important achievements of our civilization.
Smart Contract Is Just a Sequence of Algorithms That Have Limitations
The primary attribute of any smart contract is the smart contract code, which is nothing but a software (electronic) agent, a computer program that executes promises on behalf of the parties to the agreement. A computer program consists of algorithms that are bound by the terms and context and limitations of their human programmers. Additionally, computers are limited by the logic they are implementing, whether it is Boolean logic (for all most all computers) or not.
Operational contract clauses and some legal provisions can be represented in a conditional formal logic, and conclusion may be given using syllogism. Hence, smart contracts can mimic the operation of some contractual provisions or the decision-making in court. But if we look at the good faith clause that is prescribed by Article 205 of the Restatement (Second) of Contracts and Section 1-304 of the UCC, or at reasonableness clauses in contracts, we understand that not everything can be easily expressed in a code for a computer to execute.
Let’s say there’s a contract for marine towage. We use a smart contract that sends money when the towed vessels return to the owner or at least get delivered to the nearest seaport. The contract may use GPS data to ensure the condition of return is met. We are happy as it was faster and cheaper than the services we used before, but then we understand that our vessel was returned in a damaged condition due to the poor quality service.
We know the Supreme Court case of Stevens v. The White City (1932) that tells us that we need to prove the lack of reasonable care and maritime skills. How can we claim damages without going to court or using private enforcement mechanisms such as reputation and good relations? If a service provider does not care about their reputation, and our smart contract is not admissible or is not a contract in a legal sense of the word, we are left with our damaged vessel and no chance for compensation.
Can a computer solve this problem? Theoretically, with the help of additional devices in our vessel and the towboat, the computer can calculate the damage and analyze the movements of the towboat, the weather conditions, and other factors that have actually caused the damage. Deep learning techniques might teach the artificial intelligence what reasonable care is in this specific case. However, I doubt that any AI-based method at the moment is capable of providing a result comparable to that provided by human experts. Moreover, if you add such clause to a smart contract it will become too expensive.
Inevitability of Interpretation and the Need for Ex-Post Gap-Filing
If you are a lawyer or an entrepreneur, you know what it’s like to negotiate every single word in a contract. And even after tough negotiations, you can still find yourself in a court asking for an interpretation of the agreement you created. Contract law is about meetings of minds and intentions. Would you fully trust technology to interpret your intentions, and is it really capable of that?
While court interprets events ex-post, a computer has to interpret all possibilities ex-ante. If a computer has to be as efficient as a human court, it needs not only to understand the existing situations, but also to identify all possible changes to the situation. Maybe, in the future, there will be such powerful artificially intelligent machines, but now there are none.
Moreover, after intense negotiations, you can still find gaps left intentionally or not in your contract. Transaction cost is too high to discuss every possible outcome. We do not do it because we have law and commercial customs that were being formed and shaped for more than two thousand years, and we still use them. They are dynamic and flexible, and the idea behind them is about ensuring efficient and fair resolution of disputes. Of course, no rules are perfect, and their implementation could be faster, but they are still more useful for the interpretation and gap-filling than everything that today’s technology can offer at the moment.
We use law because it is a remedial institution. It helps us clean a mess created by an incomplete contract and solve disputes without blood-spilling vendettas. We use language to conclude contracts, and then we use semantics and teleological interpretation to understand the meanings of our words and intentions. We strive for fairness and efficient result, at least when it is beneficial for us.
Rules applicable to contracts help us achieve this. We have consumer protection and different contract law doctrines to protect weak parties. Why would anybody give up the protection and the possibility to solve disputes provided to us by law? Maybe in the future, we will be able to entrust computers with such important tasks, but right now it is just too early for that as the technology is too primitive.
Smart contracts help us solve the trust problem. I can trust a computer to execute promises on my behalf, but what if a code was erratic, or something unpredictable happened? If I cannot solve my problems via alternative dispute resolution methods, I just have to go to court and ask for help to settle my dispute.
Hence, I would not advise using smart contracts that are not contracts in a legal sense for something serious unless you are absolutely sure that the dispute can be adjudicated.
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