REUTERS | Kacper Pempel

How smart does a contract need to be to be a smart contract?

Smart is the new black! We use smart-phones to make calls, smart-watches to check the time, and watch news on smart-TVs, while sipping tea prepared by a smart-kettle. Smart-cars driving us through the streets of smart-cities to our smart-homes, while we are doing a bit of smart-working, are just around the corner.

The legal profession is trying to smarten up too, but there is one “smart” that lawyers still approach with caution: smart contracts. In the last two or three years they have generated a lot of hype, with some commentators predicting that they will fundamentally change how we contract with each other, eventually eradicating the need for lawyers to draft contracts and for judges to adjudicate on them. These contracts will be so smart that they will do whatever is required automatically, leaving no room for non-performance, competing interpretations or disputes. Sounds fantastic; but is it feasible and how exactly are these smart contracts different from conventional contracts?

Legal Statement on cryptoassets and smart contracts

In November 2019, the LawTech Delivery Panel, a body established by the government to promote the use of technology in the UK legal sector, published a Legal Statement on cryptoassets and smart contracts. The authors acknowledged the difficulty in formulating a precise definition of smart contracts, and instead offered “automaticity” as a characteristic feature of such contracts. This means that a contract:

“is performed, at least in part, automatically and without the need for, and in some cases without the possibility of, human intervention.”

The Statement analyses contract formation, enforceability and interpretation. It concludes that smart contacts should not be treated any differently from conventional contracts and that the normal rules of formation and contractual interpretation shall apply.

When a smart contract exists solely in computer code without a separate underlying natural language contract, which that code is meant to execute, and it is the code itself that is intended to define the parties’ rights and obligations, the meaning of the contract will be determined by how it is expressed in the code. The rationale is that unlike natural human language, computer code, subject to certain exceptions, “is generally clear, unambiguous and self-consistent.” However, the Statement does not give such code-only smart contracts any dispensation from the normal rules of interpretation:

“[Even where the] code is unambiguous, the judge may well need to do no more than decide that the parties intend to be bound by the code – whatever it does.”

Consequently, no matter how smart a contract is, it is still just a contract, and English law will deal with it in the usual way. The Statement concludes that:

“English law is well able to deal with technological developments and it has an impressive track record of doing so.”

Digitising the law

So, if smart contracts are just contracts with more “automaticity”, they are essentially no different to the contracts that we enter into every day (for example, by touching-in our travel card or dropping a coin into a vending machine). On this basis, should in-house lawyers be concerned about them? I posed that question to Akber Datoo, a member of the Law Society’s Technology and Law Committee and the CEO and Founder of D2 Legal Technology (D2LT), a global legal data consulting firm, which is focused on the “digitisation of law”.

In August 2018, D2LT published an article on smart contracts that, while acknowledging the relative immaturity of the technology, nevertheless forecasted its rapid adoption. The article also provided some practical suggestions to lawyers wishing to prepare themselves for when smart contracts become mainstream.

Unfortunately, in the last 18 months, the legal sector has failed to take advantage of the development potential in this area. Technology and the law are intended to support business (or broader societal) outcomes. Automating a poor process or “back-of-the-envelope arrangement” simply leads to a faster and more expensive route to failure, and is especially damaging if we fail to learn any lessons from that failure. What we are currently missing is the development of defined business processes, outcomes and data elements that we can refer to in our contracts and which will help the automation journey.

Developments in the OTC derivatives market

A recent initiative by the International Swaps and Derivatives Association, Inc. (ISDA) in the OTC derivatives market is an important step in the right direction, albeit for a niche community application. Here, a clause taxonomy and library was built that highlights the business outcomes which might be the subject of contract between the parties to an ISDA Master Agreement.

A sister initiative, the ISDA Common Domain Model (ISDA CDM) seeks to standardise the business process and events that are relevant for the derivatives trade lifecycle. Combining the ISDA CDM with the Clause Taxonomy creates the foundational building blocks to unlock business value through smart contracts, in due course.

PAS on smart legal contracts

In March 2020, the British Standards Institute published a draft publicly available specification (PAS) on smart legal contracts. The scope of the PAS is intended to provide some universal technical parameters to assist organisations wishing to develop or adopt smart contracts, or to digitise their conventional contracts. It specifically excludes:

“the process of negotiating, interpreting or enforcing the legal elements of a contract.”

However, the document still operates with such terminology as:

  • “Compliant implementations.”
  • “A minimum set of requirements.”
  • “The scope of permissible contract codification.”

The draft PAS contains some useful tips for software developers creating semi-automated contract templates, details some suggestions for organisations considering adopting smart contracts, and lists a set of “potential difficulties in using smart contracts”. For example, “jurisdictional limitations” or warnings that a smart contract, while being legal, “might not accurately specify the spirit of the agreement between the parties” or “accurately specify the intent of legal text.” This could put PAS users in a somewhat uncomfortable position where a document that purports to establish “standards” expressly states that doing everything by such “standards” will not guarantee that your smart contract is enforceable.

Automation of contractual templates and processes is undoubtedly useful and can potentially generate great efficiency savings. Every in-house team would therefore be well advised to begin such work in earnest now. However, in my view, the smartness of a contract still needs to be judged not by the level of its automaticity, but by how accurately it reflects the bargain between the parties and its ability to predict what might happen in future; which is what smart lawyers are good at.

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