Smart Contracts and Smart Legal Contracts – An Overview

What are smart contracts?

Smart contracts are programs stored on a blockchain that self-execute when predetermined conditions are met. They typically are used to automate the execution of an agreement so that all participants can be immediately certain of the outcome, without any intermediary’s involvement or time loss. Smart contracts work by following simple “if/when…then…” statements that are written into code on a blockchain. A network of computers then executes the actions when these predetermined conditions have been met and verified. These actions could include releasing funds to the appropriate parties, registering a vehicle, sending notifications, or issuing a ticket.

A key feature of smart contracts is that they are decentralised, meaning they can reduce or even eliminate the need for third-party intermediaries which has many benefits including speed, savings and transparency.

Smart Legal Contracts

Smart contracts already have many use cases across industries such as finance, gaming and healthcare. In the legal industry, there are also some developments that display their potential to be innovative and revolutionary by allowing parties to securely automate and digitalise the performance of their traditional contracts.

Smart legal contracts are legally enforceable contracts that are completely available in natural language and partially available in computer code stored on the blockchain. The natural language portion documents the parties' agreement and the computer code serves to automate aspects of the contract, usually relating to performance. Almost any contract can be a smart legal contract which creates numerous benefits including:

• Connectivity – to digital devices, sources, systems etc so the contract can interact with and act on information from the data-rich world e.g. receiving confirmation of a weather event or an update to relevant legislation

• Automation – contractually agreed, coded rules can take information from digital connections and automatically perform functions in response like making a payment, adjusting prices or rent etc. 

• Single source of truth – smart legal contracts provide a single shared and secured version of the contract so parties know where to find the current contract

• Data – can generate and collect valuable data on performance, business operations and relationships which can structure and immutable record of transactions and events stemming from the contract

• Security – privacy and data protection through encryption etc.

Outside of Australia, some U.S. states have begun to permit the use of smart contracts and blockchain in the legal industry in certain contexts. For example, Arizona allows enforceable legal agreements to be created via smart contracts, and California allows marriage licenses to be issued via blockchain technology.

Commercial law issues

For now, it is rather uncertain how some elements of contract law apply to smart contracts. However, it is clear that smart contracts must abide by contract law to be legally binding and enforceable. A key concern in this area arises where a party’s identity cannot be determined or a party’s capacity to enter into the contract is unknown. Another potential issue is the understanding and interpretation of the contract terms when they are converted into code which could lead to allegations of misrepresentation and misleading/deceptive conduct.

Additionally, there is potential for issues in reversibility of performance and dispute resolution. As these contracts are generally executed immediately and automatically, there can be less protection for parties once the instant execution has taken place if they want to challenge the validity of the contract compared to traditional contracting methods. These procedural issues, such as deciding how disputes are resolved will require careful consideration and agreement by all parties involved.  

Lastly, if a code contained in a smart contact makes an error, there are likely to be difficulties addressing the question of which party should be responsible and how can jurisdiction be established. This is even more crucial due to the automated nature of smart contracts as they hinder the ability for parties to make subjective decisions, creating errors in relation to the true intention of the parties. 

If you have any concerns regarding smart contracts or smart legal contracts and their application, please contact:

Paul Gray
Principal
T: 03 5225 5231 | M: 0414 195 886
E: pgray@ha.legal

Ryan Popovski
Lawyer
T: 03 5226 8572
E: rpopovski@ha.legal