The legal frontier: BLOCKCHAIN and smart contracts
Blockchain and smart contracts have tremendous potential to decrease costs, improve efficiency and security, as well as promoting collaboration.
I’ll start with some basic definitions to give context for those new to this area.
Benefits and legal risks
By their nature, Blockchains and smart contracts have the potential to reduce costs, increase speed and security, and make fraud more difficult to perpetuate. The availability of a real-time, change-resistant and hack-resistant record of data with trustworthy time entries increases the reliability, integrity and transparency of the data. This, in turn, has a positive effect of increasing trust and collaboration between the parties.
However, with multiple eco-systems, immutable data and differing quality control, procedures and terminology, as well as an absence of common standards, if parties do not clarify the intended scope of use and agreed processes from the outset, they open up the real risk of the technology failing to fulfil the intended purposes, mismanaged expectations and resulting disputes.
For obvious reasons there’s currently an absence of case law on Blockchain and smart contracts and, as we have seen with the first BIM court case of Trant v Mott MacDonald, in the absence of an established common law position it is vital that parties ensure clarity of their risks and responsibilities in a written contract.
Wikipedia claims that “the aim with smart contracts is to provide security that is superior to traditional contract law and to reduce other transaction costs associated with contracting”. This is arguably an oversimplification of the purposes and operation of contract law.
Smart contracts are unlikely to replace “traditional” contracts but, working with Blockchain technology, they do represent an important and helpful addition to the arsenal of tools to make contractual relationships more efficient and effective.
Some of the main potential legal issues are considered below.
Who bears the risk of malfunctions and software errors (given the wide exclusion clauses implemented by software providers), cyber security (because nothing is perfect) and confidentiality (such as who controls/monitors access)?
Standard of care/measure of performance
It would be helpful to confirm the parties’ respective standard of care and scope of obligations. The technology itself may directly impact the measure of contract compliance and each party will want to consider if they are content with this position. For example, Ethereum, described by the Economist as “the most ambitious crypto-ledger project”, reportedly aims to introduce a functionality that is designed to verify a party’s contractual performance.
Variations (in scope, payment terms and more)
While the immutable nature of Blockchain and smart contracts is a strength, it is also a potential weakness insofar as the long running, variable and complex nature of construction projects is concerned. This will need to be taken into account when considering the manner and extent that Blockchain and/or smart contracts can be used within a project’s processes, and indeed borne in mind as the legal community works with the software community to develop smart contracts suitable for our industry.
What grounds would there be for terminating the smart contract or terminating use of – or access to – the Blockchain, and how will it accommodate events such as force majeure? Equally important, what then happens to the data on termination – for example does it need to be deleted and/or handed over and are processes in place to facilitate this if needed?
Expressly agreed processes and policies could ensure a common understanding and risk management given the lack of industry-wide standardised terminology, understanding and established legal position and case law. A developing question will also be what standards and/or legislation will apply over time, and the standardised processes required to facilitate compliance.
Parties would need to consider and agree ownership of the data sets and blocks, permitted transfers of the data and the ownership and scope of licences for solutions and/or technology developed during the project.
Can access to information be appropriately restricted, and are there some contract situations when the use of Blockchain will not be possible due to the visibility of information (such as in a public procurement or open tender process)? How can the functionality be adapted to take into account a party’s right over personal data, including the “right to be forgotten” and other matters arising from the 2018 GDPR?
Corruption, bribery etc
The impact and/or effect of events occurring outside the underlying code, ie frustration, coercion/duress, illegality, bribery and modern slavery (it may be that this is dealt with in the provisions setting out the impact of termination generally)
Legal standing and enforceability of contracting parties
The Decentralised Autonomous Organisations (“dAOs”) which execute/operate smart contracts do not have clear legal standing, and it is worthwhile considering which legally-recognised entity bears responsibility for the dAOs’ actions.
An agreed, appropriate alternative dispute resolution suitable for Blockchain and smart contracts in particular may be useful. Don Tapscott, the author or Blockchain Revolution, coined the phrase “smart contract mediator” for such disputes.
Applicable governing law and jurisdiction
It could be useful to ensure the applicable law and jurisdiction for Blockchain and smart contracts in use is clear to provide legal certainty given that, for example, the nodes of a smart contract may be located in multiple jurisdictions.
Blockchain and smart contracts have tremendous potential to decrease costs, improve efficiency and security, as well as promoting collaboration. However, all such new innovations and technologies bring new risks and untested potential legal issues, particularly bearing in mind that Blockchain and smart contracts are still at fledgling or proof-of-concept stage in many areas.
For this reason, it is important to be aware of the obstacles and risks involved, to cater for them with clear and express contract terms and other mitigation measures. This minimises the risk of parties inadvertently taking on unintended (and possibly uninsured) obligations, as well as of the occurrence of disputes arising from misunderstandings and mismatched expectations that only come to light when something goes wrong.
For Blockchain and smart contracts to function seamlessly within the industry, as well as the practical aspects such as training, software and storage capacity, it will require collaboration between legal, software development and coding.
Lawyers contribute their knowledge of contract law and structure, software developers will need to work with the lawyers to “translate” legal into self-executing transactional structures using Blockchain and the various digitisation tools available, and coders or programmers will undertake the actual coding of these agreed “terms” of contract.
All this will require the legal community to increase their knowledge and understanding of the workings of such technologies to have the skill and knowledge sufficient to provide relevant advices and contract terms.
The legal community is currently facing a similar challenge with BIM, and with the digitisation of processes and implementation of technologies such as 3D printing, AR and VR – previously only imagined in science fiction – we as lawyers are all going to have to be more forward-thinking and reactive to the ever-increasing pace of change.