'Smart Contracts': Where Law Meets Technology

The second article in our Blockchain and the Law series

While the idea of "smart contracts" as a means of executing peer-to-peer transactions is not new, the advancement of blockchain technology as a public platform for recording and executing transactions may finally provide the basis for bringing smart contracts into commercial use.

The commercial utility of smart contracts stems from the ability to automatically self-execute transactions in accordance with pre-coded instructions. While this has the potential to reduce the contracting, enforcement and compliance costs associated with related transactions, it also comes with a multitude of risks and challenges, which have yet to be adequately addressed. The very term "smart contract" is of questionable utility when used in isolation.

Legal challenges presented: Fraud, Force Majeure and Frustration

The potential to use blockchain as a platform for uploading and storing smart contracts is as empowering as it is limiting, for there is an inherent expectation in smart contracts that once the self-executing code is properly recorded onto the blockchain it cannot be altered. Immutability, in this sense, is propounded as one of the integral features of blockchain.

This would present a significant limitation as it does not account for events that may occur outside the scope of the pre-coded contracting language that would potentially render contracts unenforceable in the legal sense. An example of this is where fraud is discovered in the underlying negotiations or related transaction, and one of the parties wishes to unwind or void the contract, as it may be entitled to do with a traditional contract.

Another example would be where the contract becomes impossible to perform for unforeseen reasons outside of the parties' control, such as war or an act of God, an event that would usually be caught under a force majeure clause in a traditional contract.

Finally, an event occurring after the contract is formed might strike at the root of the contract and, through no fault of the parties, make performance illegal or make it radically different from that contemplated by the parties at the time of the contract. This would result in frustration of the traditional contract.

As discussed in our previous article, this leads to a number of legal issues surrounding the ownership and liability of "Decentralised Autonomous Organisations" (DAOs), the entities made up of and operating through a series of smart...