Smart Contracts: Are they a Viable Replacement to the Standard Civil Law Contract?
News    ·   21-12-2017

AUTHOR: Andrei Vella; Krista Ellul

We are currently experiencing a technological revolution, possibly the biggest revelation since the inception of the Internet. Words such as blockchain, cryptocurrency and Bitcoin have not only found a place in our daily vocabulary but have sparked worldwide debate, challenging and questioning the functioning of the world as we know it.

Whilst one must certainly appreciate the magnitude of such inventions, the intricacy of such technologies and concepts is undeniable. Words such as blockchain and Bitcoin have been used interchangeably and various applications of blockchain technology such as that of smart contracts and cryptocurrencies, have been placed in the same basket and treated as one and the same thing despite the great differences between them. This invariably creates a lot of confusion but as advisors, it is crucial that we are able to recognise and comprehend that the various applications of blockchain technology differentiate in their applicability and suitability.

Arguably, a comparison between cryptocurrencies such as Bitcoin and smart contracts is a clear example of this. Whilst cryptocurrencies may revolutionise the way we make payments and possibly even providing an adequate alternative to the traditional methods, may the same be said with respect to smart contracts – do they have what it takes to push aside the traditional civil law contract?

The words ‘smart contract’ indicates the use of computer code to draft, verify and finally execute an agreement between two or more parties. Therefore in this case, the computer code replaces the utilisation of natural language. This seems pretty straightforward with regards to the drafting and articulating of the agreement as in such instances, natural language is simply replaced with programming language. Being predicated on unambiguous language, smart contracts also do away with third party intermediation thereby allowing for automated execution.

However, is this all there is to them? – probably not. A few questions come to mind - How can we programme the way an agreement is to be finalised and understood during the pendency of its applicability when we already have difficulties agreeing on a sole correct interpretation of a standard civil law contract? Doesn’t this necessarily imply a human factor? Smart contracts do quite the opposite by completely removing the human element of an agreement once the contract is programmed in a certain way.

A smart contract would seem to be perfect for certain automated, non-ambiguous situations, the typical ‘vending-machine’ scenario drawn up by Nick Szabo back in 1997 comes to mind. A vending machine is programmed to release a certain refreshment or food product once the correct payment is inserted into the machine; the machine verifies the means of payment, sees that it is sufficient to pay for the product chosen by the buyer, disburses any extra change and releases the product. The concept itself is therefore far from revolutionary and has been around for some time, what is indeed revolutionary is the operational aspect of this concept which has been realised on the creation and incorporation of blockchain technology.

A contract simply evidences an agreement between two or more parties, sometimes following a lengthy negotiation period and thus equates to some form of compromise. In the case of a smart contract, the agreement is programmed with a number of defined and unambiguous inputs and conditions and once realised, the contract is executed and becomes law for the respective parties, completely negating the legal system from the entire process. It is submitted however that removing the human element from the interpretation, execution and enforcement of contracts may not necessarily always be a beneficial outcome. Think of a credit institution which grants a loan to a borrower; the borrower defaults and the smart contract automatically enforces the lender’s rights under the loan or enforces collateral securing the same. That seems right, or does it? Often enough lenders may in similar situations opt to exercise their discretion and decide not to call in the loan straight away upon default but to enter into discussions with the defaulting borrower to examine possible ways how to allow the defaulting borrower to get back on its feet – after all, a performing borrower is far better than a non-performing one.

Other similar contracts raising similar qualms come to mind – at its most basic level, an insurance contract is designed in a way that the insurer makes a payment to the insured upon the happening of a specific event. Invariably, there may be matters which are excluded and therefore would not trigger a payment under the policy notwithstanding the occurrence of the agreed event – say, an “Act of God”. How would the automated execution of a smart contract operate in such a context?

Smart contracts may also be immutable, that is once created they will be recorded forever. However, as legal practitioners we are frequently faced with situations where a factual happening becomes – ex post facto - legally void.

Certain doctrinal issues also arise. Whilst the negation of the legal system increases the efficiency and simplicity in the way we execute agreements, now that court intervention is removed from the picture, what is stopping someone from articulating and executing an illegal smart contract? Contract law today provides certain restrictions and requirements such as that of ‘consideration’, that are necessary in order for a contract to be validly concluded in accordance with law, in default of such requisites, there is simply no contract which binds the parties. Additionally, no court is going to enforce an illegal or incomplete contract. In the case of smart contracts, the contract is executed and enforced instantaneously, once all the pre-determined and pre-programmed conditions are realised. Here the smart contract also takes the form of a pre-empted form of self-help, allowing one party to get his due, without any court intervention, with justice being placed in the hands of the parties to the smart contract. This leads to another possible fundamental matter – save for specific ad hoc legislative interventions, the extent of self-help is at best, of doubtful validity under Maltese law. There have been various judgments in Malta which provide that a party claiming a right may crystallise such right only through court intervention. This would seem to cut across certain benefits inherent in smart contracts.

This brings us back to the first argument that it is important to differentiate between the various applications of blockchain technology and as it has been shown in the case of smart contracts; sometimes this analysis must go a step further. Smart contracts are indeed a viable replacement for certain types of agreements but are not a viable replacement for all standard civil law contracts. A similar issue was debated in the case of Artificial Intelligence and a similar conclusion was reached, yes robotics and technology can address and completely take over certain mundane tasks but certain tasks, matters and in this case contractual relationships necessitate a human element.

Blockchain technology and its countless applications are here to stay and thus it is greatly advisable that everyone and anyone get familiar with it. It is submitted that notwithstanding the advent of smart contracts on blockchain, these will still need to be underpinned by cardinal principles regulating contract law in general – short of doing so, we will be running the risk of putting the cart before the horse.

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