Smart contracts – a false smart?

Shayhan Patelmaster | Senior | Law | +44 207 9809 507 | shayhan.patelmaster@uk.ey.com

The concept of smart contracts is not a new one. Since the term was first coined by Nick Szabo in 1994, commercial lawyers have debated whether smart contracts have the potential to replace conventional commercial contracts. Whilst there are a number of significant legal hurdles to overcome if smart contracts are to become widely used, there is a broad consensus that it is only a matter of time until smart contracts become commercially-viable business solutions. The key question is, has that time arrived?

It is not simple to define the term smart contract. Specialists in different fields may use the same term (or its constituent parts), however each may intend a different meaning. In contrast, under English Law the concept of a contract is well established. Under English Law, any contract (whether smart or not) must meet long-established requirements for a contract to exist, including an intention by the parties to create legal relations, a clear offer and acceptance by the parties, valid consideration underpinning the contract and certain and unambiguous terms of the contract.

Szabo’s use of the term is designed to emphasise different qualities, which are likely to coexist alongside such legal requirements. Szabo envisaged self-executing arrangements for the movement of units of value, represented in sequences of code, that are transparent, secure and reliable – irrespective of the extent to which the parties to the arrangements trust each other. Such arrangements lend themselves to deployment through a distributed ledger system, but it is important to note that smart contracts do not necessarily require the use of a distributed ledger platform. Even if smart contracts are built into a distributed ledger, they may operate on a permissionless and public ledger, on a permissioned and private ledger, or on a hybrid distributed ledger. The choice of platform should be determined by the particular business requirements for the smart contract in question, but the important point to note is that Szabo’s smart contract can take many forms across a range of systems and platforms.

The question is therefore whether the smart contract (in Szabo’s usage) is compatible with the legal requirements of a contract. The answer to this question is not currently clear, although the picture is becoming clearer with increased academic and professional scrutiny of the issue. The Law Commission has launched a project to investigate the legal status of smart contracts and consider changes required to the existing legal framework. However, this project is currently on hold pending the outcome of parallel work by the LawTech Delivery Panel in the area.

Over time, such projects will provide increased certainty over which types of smart contracts meet the applicable tests for a valid legal contract. Certain problems may be more difficult to overcome, for example whether smart contracts on a certain technology platform are compliant with uncertain regulatory requirements, such as the GDPR-mandated requirement to allow data subjects the right to be forgotten. However, over time the legal position is likely to become clearer, at least for more conventional uses of smart contracts.

So when is the right time to start using smart contracts given the legal uncertainty surrounding their use? The answer will depend on the business benefit to using smart contracts, balanced against the legal risks of using them. Businesses may wish to use smart contracts in low risk, low value business areas where the benefits outweigh the legal risks of using such technologies. These businesses will then be in a stronger position to roll out the technology to more high value or core business applications once the technology is more mature.

In order to achieve this, it will be essential for businesses to partner with organisations that can deliver both technical expertise in smart contracts and legal expertise in their use. The technical experts will need to work hand-in-hand with the legal experts to advise the business effectively. Organisations with both technical and legal capabilities are likely to be best placed to properly advise clients on smart contracts, both now and in the future.

About Law at EY

Our multi-disciplinary approach to law means that we are ideally positioned to offer commercial advice on smart contracts from both a technical and legal perspective. Contact a member of our Commercial and Tech Leadership Team , if you would like to discuss any of the points raised in this article.