Why Smart Legal Contract Should Be a New Legal Concept Within Contract Law

In this article, I compare smart legal contracts (smart contracts that imply the creation of legal rights and obligations) to different contract law concepts, such as escrow agreements, electronic agreements, self-help and letter of credit concepts, and vending machines. I explain the common features smart legal contracts have with these concepts, and why it should be a new standalone legal concept.

Smart Legal Contract and Escrow Agreement

Some scholars notice common features between agreements based on smart contract technology and escrow agreements. In both cases, money or property are transferred to the parties only after a successful inspection regarding the compliance with certain specific conditions of the agreement. The difference here is that a smart legal contract does not imply the involvement of a third party, or an escrow agent. Moreover, smart legal contracts can be applied far beyond the escrow agreement.

Smart Legal Contract as a Letter of Credit

A letter of credit (LOC) is a document, assuring that a seller will receive payment up to the amount of the LOC if certain conditions have been met. While both smart legal contracts and LOCs have the feature of ensuring enforcement, a letter of credit is just an additional agreement to the main one and is not necessary. Moreover, a LOC typically involves a third party (a bank) that ensures the performance. In smart legal contracts, the enforcement is guaranteed by technical means and not by a third party. However, a LOC can be embedded within a smart legal contract.

Smart Legal Contract and Self-Help

Self-help is a legally permissible conduct that individuals undertake to remove the compulsion of law and without the assistance of a government official in efforts to prevent or remedy a civil wrong. Some scholars consider smart contracts one of the technological forms of self-help called starter interrupt device (SID). A smart legal contract that can be programmed with the help of an IoT device incorporated in a car can prevent the use of the car in question. So can an SID, which tracks a motor vehicle purchaser’s or lessee’s scheduled payments under a financing or lease agreement, and prevents the vehicle from starting if a scheduled payment is not received by its due date or within any applicable grace period. While both technologies do not involve any third parties to enforce an agreement, an SID does not deal with the substance of the respective contract and is a separate device that helps a party prevent or remedy a civil wrong.

Smart contracts and blockchain could be compared to a starter interrupt device because they make it possible to avoid enforcement by the state. However, a smart legal contract should not be confused with self-help and starter interrupters. Firstly, smart contract code is an indivisible part of the contract, which actually makes the contract ‘smart.’ Secondly, smart contract code and blockchain simply ensure the execution of promises, and their aim is not to prevent or remedy a civil wrong. Hence, the smart legal contract technology is a broader concept than self-help.

Smart Legal Contract as Virtual Vending Machine

A vending machine is a contract with a bearer: anybody with coins can participate in an exchange with the vendor. Lockboxes and other security mechanisms protect the stored coins and contents from attackers, thus enabling the successful deployment of vending machines. Once the coins or bills are in the belly of the machine, the value has been transferred. No third parties need to be involved in the process. With other payment mechanisms, such as checks or credit cards, an intermediary (such as a bank) must validate the transaction, and the client can call the bank to receive their money back.

The first known meeting between law and vending machines happened in the 17th century when Richard Carlile, an agitator and supporter of the freedom of speech, invented the book-dispensing machine to avoid prosecution and censorship. He thought that a contract would be formed between a human and the machine; however, his argument was not supported, and Carlile and his employee were both convicted of selling blasphemous literature through the device. Today, vending machines have an official status, and states try to regulate them, for example, by prohibiting vending machines selling cigarettes to protect minors, as seen in the case of Modern Cigarette, Inc. v. Town of Orange, 774 A.2d 969, 970–71 (Conn. 2001).

The creator of the smart contracts concept compared them to a vending machine, but a virtual one. However, although their performance is automated, it is in fact possible to shut down a vending machine, while you cannot shut down a smart legal contract. The applicability of vending machines is too narrow, and implies only simple transactions, while smart legal contracts are way more flexible. The main difference is that a vending machine is just a tool for a vendor to create an offer, which, of course, always results in a unilateral contract. A smart legal contract is much more sophisticated. It can result in a multilateral agreement, or incorporate the agreement in a code, and then even write it into a blockchain ledger, which is hardly possible for a vending machine.

Smart Legal Contracts and Different Electronic Agreements

Electronic contracts are mere written agreements in a digital form. An electronic contract is electronic only in its form,while its substance and execution are still dependent on humans. People encounter different types of electronic agreements every day without understanding that they enter a contract. There are many contracts that may fall into the definition of electronic agreements, but this section addresses only those that are regulated by law and have their place in the contract law vocabulary.

When a website posts terms and conditions which users have to accept, a so-called clickwrap agreement can be formed. Such agreements are enforceable under the Uniform Electronic Transactions Act (UETA) that is adopted in most of the US states. When users agree with the terms and conditions while opening or installing software, a so-called shrinkwrap agreement may be concluded. Usually, these agreements are formed when a user cannot install a program or proceed further to the website without accepting terms and conditions, and when such terms comply with the legal requirements for contracts in general. Reading such terms is not necessary, and the master of the offer can limit the actions required for acceptance. In some cases, there is no need to even click, and the awareness of the terms is enough to form an enforceable browsewrap agreement.

Smart legal contracts are concluded digitally. For some smart legal contracts, the process of concluding a contract can be similar to that of clickwrap or shrinkwrap agreements. However, the core difference between electronic agreements and a smart legal contract is that the execution (performance) of a smart legal contract is theoretically inevitable. An electronic agreement can be interrupted at any point by a human being, while once smart contract code is activated, it cannot be stopped. Additionally, electronic agreements mainly impose negative obligations (e.g., not to perform specific activities while using the service or not to object to certain activities performed by the service-provider) while smart contracts are more flexible in this regard. Finally, together with the agreements formed via a vending machine, electronic agreements may be classified as a unilateral contract, just because they are formed through an offer addressed to the whole world.

Conclusion

While having a lot in common with escrow agreements, some electronic agreements, self-help and letter of credit concepts, and vending machine transactions, smart legal contracts do not fit into any of these categories. They should be considered an entirely new kind of an agreement that should have its own legal definition. Nevertheless, none of the smart legal contracts’ features are new. Thus, automatic enforcement is a feature of vending machines. A smart legal contract is just a new type of agreement that encompasses certain features of different contract law concepts. Hence, to understand how the smart contract technology can fit into the existing contract law framework, we need to understand whether a smart legal contract can become a ‘contract’ in terms of contract law. Regardless the numerous common features with the regulated types of agreements, a smart legal contract is still a new type of contract with its own legal peculiarities.

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