The UK’s Law Commission has today confirmed that ‘the existing law of England and Wales is able to accommodate and apply to smart legal contracts, without the need for statutory law reform’. In effect this gives smart contracts the green light to be used with confidence, and for lawyers to start drawing them up for clients without fearing they are in a legal grey area.
The Law Commission added that their analysis ‘demonstrates the flexibility of the common law to accommodate technological developments, particularly in the context of smart legal contracts. It confirms that the jurisdiction of England and Wales provides an ideal platform for business and innovation’.
These findings build on the conclusions reached by the UK Jurisdiction Taskforce’s legal statement on cryptoassets and smart contracts. The legal statement established that the current legal framework is sufficiently robust and adaptable so as to facilitate and support the use of smart legal contracts; a view reinforced by the Law Commission’s advice, they said.
The Law Commission also encouraged the market to ‘anticipate and cater for potential uncertainties in the legal treatment of smart legal contracts by encouraging parties to include express terms aimed at addressing them’.
Examples of such provisions include: clauses allocating risk in relation to the performance of the code, and setting out clearly the relationship between any natural language and coded components.
In addition, as smart legal contracts become increasingly prevalent, the Commission anticipates that the market will develop established practices and model clauses that parties can use to simplify the process of negotiating and drafting their smart legal contracts.
Professor Sarah Green, the Law Commissioner for the Commercial and Common Law Team, said: ‘Smart legal contracts could revolutionise the way we do business, particularly by increasing efficiency and transparency in transactions.
‘We have concluded that the current legal framework is clearly able to facilitate and support the use of smart legal contracts; an important step in ensuring increased recognition and facilitation of these agreements.’
Lord David Wolfson of Tredegar QC, Parliamentary Under-Secretary of State, Ministry of Justice, added: ‘I would like to thank the Law Commission for this important paper analysing the current law as it applies to smart legal contracts. We in Government are excited about the transformative potential of emerging technologies, including smart legal contracts. We want a world-leading legal services sector, and that means ensuring English law can accommodate the technologies of the future.
‘The Law Commission’s findings provide that all-important legal certainty for those seeking to use smart legal contracts. I also want to thank the Commission for their update paper on digital assets, as well as to highlight their new project on conflict of laws – both are essential to ensure English Law supports emerging technologies.’
However, it’s not all neat and tidy on a global basis, and the Commission highlighted conflict of laws – that is, the area of law that primarily determines where disputes should be adjudicated, and the law applicable to those disputes – as an area where further work is required, they added.
The Commission’s analysis highlighted, in particular, the difficulties inherent in applying existing conflict of law rules to smart legal contracts and associated technologies, including distributed ledger technology, which can give rise to multiple connecting factors across various jurisdictions.
The problem of digital location – that is, the difficulty of ascribing real-world locations to digital actions and digital objects – is amongst the most significant challenges that private international law will have to overcome in relation to emerging technology, including smart legal contracts, they explained.
In this regard, the Law Commission has agreed with Government to undertake a project looking at the rules relating to conflict of laws as they apply to emerging technology, including smart legal contracts and digital assets, and considering whether reform is required. The Law Commissions hopes to be in a position to begin work on the new conflict of laws project in mid-2022.
The Law Commission’s main findings:
- A smart legal contract is a legally binding contract in which some or all of the contractual obligations are defined in and/or performed automatically by a computer program. Smart legal contracts are frequently (although they need not be) deployed on a distributed ledger. Smart contracts, including smart legal contracts, tend to follow a conditional logic with specific and objective inputs: if “X” occurs, then execute step “Y”.
- Smart legal contracts are currently being considered by contracting parties as a means of automating specific processes within conventional contracts, from the payment of insurance claims in the context of parametric insurance, to managing supply chains across various industries. Smart legal contracts can operate in the business to business, peer to peer, and business to consumer sectors.
- Smart legal contracts are capable of meeting the requirements for the formation of a legally binding contract under the law of England and Wales. However, additional complexities arise in relation to deeds, which are subject to additional formality requirements.
- The existing principles of contractual interpretation can apply to smart legal contracts; albeit with an incremental development to the existing test. In particular, interpretation of a term defined by code should be determined by asking what the term would mean to a reasonable person with knowledge and understanding of code – that is, a “reasonable coder”. This is the most appropriate way to ascertain the meaning of the coded terms of a smart legal contract, and more closely resembles the existing test for contractual interpretation in the context of non-coded terms.
- The existing legal principles relating to contractual remedies can apply to smart legal contracts. However, a court may face practical difficulties in awarding remedies such as rescission and rectification. In order to achieve the practical effects of these remedies, a court may need to be flexible and creative when fashioning its order.
- Parties can structure their smart legal contract to include “kill switches” and related mechanisms to halt performance of the code in certain circumstances, for example, where one of the parties terminates the contract following a breach.
- Traders who wish to enter into smart legal contracts with consumers will need to take steps to ensure that they comply with existing consumer protection rules. For example, traders who wish to offer smart legal contracts to consumers which contain coded terms would be well advised to provide clear and informative pre-contractual literature to the consumer, explaining those terms and how they operate, in order to comply with the transparency requirement.
- In an appendix to the paper, the Law Commission includes a non-exhaustive list of issues parties could usefully consider and address in the terms of their smart legal contract. Dealing directly with these issues in contractual terms should reduce uncertainties regarding the legal treatment of the parties’ smart legal contract, and reduce the scope for potential disputes.
You can find the main paper here.
What Happens Next?
This is all very positive. But, of course, people could already use smart contracts if they wanted to – just without much legal certainty – and that may have been stopping what we can call ‘complex smart contracts’ from being used. So, this helps remove doubt and allows clients to move forwards with this tech – if they want it.
When it comes to what we can term ‘simple smart contracts’ i.e. what are primarily transactional agreements for use in trading cryptocurrencies, these have been used for some years already, as there is not a lot contractual complexity to most of them. Again, what it does here is remove any fears that traders cannot use English law as it stands if a deal runs into problems.
But, for this site, the real focus is around supporting the idea that a contract can be connected to the outside world and able to respond to information that it receives, i.e. ‘connected contracting’, and this relates primarily to longer, complex smart contracts, i.e. like the contracts used in the commercial legal world that we see every day – just with coded and connected elements.
The main challenge here is around self-execution. Do clients really want their contracts to execute parts of an agreement without lawyers, or some other subject matter expert, checking things first? They may not, except where the execution is very benign, such as sending information to a dashboard that updates the prior data held by the client. After that someone can then activate that part of the contract based on the information provided.
And when it comes to payments in the mainstream and non-crypto economy, those can already be made very quickly using the world’s existing payment infrastructure and via direct human intervention, so one could argue that the risks of automated self-execution of financial agreements could outweigh the benefits, and it’s simply safer to keep a ‘human in the loop’ approach.
However, and going back to the connected point, smart contracts would be a big improvement on ‘static’ or ‘cut off’ contracts, and allow a client – or a law firm – to actively see via dashboards exactly what state each contract was in and what parts of it had been executed, as well as see associated information that related to terms in that contract, e.g. values of assets that may change over time and impact the value of that contract.
Also, as part of any wide-scale use of smart contracts comes a lot of standardisation and structuring of key legal clauses – as connected elements will need to be coded – and that could help drive efficiency in contracting more broadly. This is something (see above) that the Commission also notes.
Overall then a very welcome move that may help real world adoption of complex smart contracts and give confidence to those already working in this area.