The UK Law Commission paper on Smart Contracts states
1.1 Emerging technologies, such as distributed ledgers, are increasingly used to create “smart contracts”: computer programs which run automatically, in whole or in part, without the need for human intervention. Smart contracts can perform transactions on decentralised cryptocurrency exchanges, facilitate games and the exchange of collectibles between participants on a distributed ledger, and run online gambling programs.
1.2 Smart contracts can also be used to define and perform the obligations of a legally binding contract. It is this specific type of smart contract – a “smart legal contract” – that is the subject of our analysis. For the purposes of this paper, we define a smart legal contract as 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 contracts, including smart legal contracts, tend to follow a conditional logic with specific and objective inputs: if “X” occurs, then execute step “Y”.
1.3 Smart legal contracts are expected to revolutionise the way we do business, particularly by increasing efficiency and transparency in transactions. They are increasingly being considered by contracting parties as a means of automating specific processes within conventional contracts, from payment of insurance claims to managing supply chains. Currently, smart legal contracts are likely to be useful in respect of only fairly rudimentary agreements, such as to transfer an amount of cryptocurrency to a person’s wallet when certain conditions are met. However, as the technology underpinning smart legal contracts becomes increasingly sophisticated, a greater range of obligations may be suitable for coding, resulting in these contracts becoming increasingly more complex and able to perform a greater range of tasks.
1.4 Smart legal contracts can take a variety of forms with varying degrees of automation. In the first instance, a smart legal contract may take the form of a natural language agreement with performance automated by code. Alternatively, a smart legal contract may be written solely in (and performed by) code. In between these two extremes, a smart legal contract may take the form of a hybrid contract, consisting of both natural language and coded terms. Different forms of smart legal contract give rise to different legal considerations.
1.5 Automation should be considered on a spectrum. Smart legal contracts which involve elements of standard automation, such as payment by way of direct debit, have been in use for many years and are therefore unlikely to give rise to novel legal issues. However, a smart legal contract drafted primarily or solely in code and recorded on a distributed ledger, is likely to give rise to novel legal questions; the automation in question takes the contract out of the realm of legal familiarity.
Background
1.6 The Law Commission was asked by the Lord Chancellor to include work on smart legal contracts as part of our 13th programme, agreed in December 2017. After discussions with stakeholders, our initial intention was to publish a call for evidence in January 2019.
1.7 In the same period, the Lawtech Delivery Panel was created with the support of Government. There was clearly some common ground between the proposed Law Commission work and that of the Delivery Panel, and in particular its UK Jurisdiction Taskforce (“UKJT”). In those circumstances, we agreed to pause our work until such time as the conclusions of the UKJT were known.
1.8 In November 2019, the UKJT published its legal statement on cryptoassets and smart contracts. The UKJT Legal Statement concluded that, in principle, smart contracts are capable of giving rise to binding legal obligations, enforceable in accordance with their terms. Following this, the Ministry of Justice asked the Law Commission to undertake a scoping study on smart legal contracts.
1.9 The purpose of the scoping exercise is to provide an analysis of the current law as it applies to smart legal contracts, highlighting any uncertainties or gaps, and identifying such further work as may be required now or in the future. The project is intended to build on the foundations laid by the UKJT Legal Statement, and consider additional questions raised by stakeholders regarding smart legal contracts. Our terms of reference do not include other areas of law in so far as they relate to smart legal contracts, such as tax and data protection. Our full terms of reference are set out at Appendix 1.
Call for evidence
1.10 In December 2020, we published a call for evidence, which closed on 31 March 2021. The primary function of the call for evidence was to seek views about, and evidence of, the ways in which smart legal contracts were being used, and the extent to which the existing law could accommodate them. In each chapter of the call for evidence, we set out our understanding of law and practice, and asked consultees for their views. We did not make any proposals for law reform.
1.11 We received 47 responses to the call for evidence. The responses were from a mix of stakeholders, including individuals who responded in their personal capacity, individuals who responded on behalf of organisations, and academics. We summarise our findings and conclusions to the consultation exercise in this paper. A list of all consultees who responded to the call for evidence is set out in Appendix 2.
Extent
1.12 This project focuses on the law of England and Wales. International conventions, including the United Nations Convention on Contracts for the International Sale of Goods, are not considered.
1.13 In relation to Wales, we consider that the subject matter of the project is reserved, being primarily a matter of private law.
1.14 The project does not consider the law of Scotland or of Northern Ireland.
Activity in other jurisdictions
1.15 Some other countries have already taken steps to put smart legal contracts and associated concepts on a statutory footing. In addition, courts in other jurisdictions have had the opportunity to consider some of the issues that we discuss in this paper. Given the cross-border nature of many of the transactions which take place using smart legal contracts, it is and will continue to be important to be aware of developments elsewhere, with the hope that legal approaches will be broadly compatible. In the call for evidence, we asked consultees which other jurisdictions we should look to for their approach to smart legal contracts.
1.16 Consultees noted that various states in the United States of America including Arizona, Illinois and Tennessee have introduced legislation which defines the term “smart contract”, and provides that a contract is not to be denied legal effect solely because it is a smart contract.
1.17 Some consultees mentioned other jurisdictions which are perceived as being particularly proactive in the development and use of smart legal contracts and distributed ledger technology, including Australia, China, Dubai, Estonia, India, New Zealand, Sweden and Switzerland. Several consultees commented that Singapore is particularly important because of its advanced use of smart legal contracts, and for its developing jurisprudence on smart legal contracts following High Court and Court of Appeal decisions in Quoine Pte Ltd v B2C2 Ltd.
1.18 We refer to specific developments in other jurisdictions throughout this paper, where they are relevant to the particular issues being discussed.
Related work within the Law Commission
1.19 The UKJT Legal Statement also considered the legal status of cryptoassets. The Law Commission is currently working on a separate digital assets project drawing on this aspect of the UKJT Legal Statement. We published a call for evidence on digital assets in April 2021. We are analysing the responses received, and intend to publish a consultation paper next year.
Structure of the paper
1.20 This paper analyses the current law as it applies to smart legal contracts, particularly in relation to:
(1) formation and enforceability, including in relation to deeds;
(2) interpretation;
(3) remedies;
(4) vitiating factors (mistake, misrepresentation, duress and undue influence);
(5) consumer protection; and
(6) jurisdiction.
1.21 It comprises six further chapters. In each chapter, we provide a summary of the responses we received to the various questions raised in the call for evidence. We build on additional insights provided by consultees, and provide more complex and detailed examples. We also explain where, and why, our thinking has changed and developed since the call for evidence, and draw on consultee views to inform our thinking and to formulate our conclusions.
1.22 In Chapter 2, we set out the background to smart legal contracts, our working definition of what a smart legal contract is, current use cases and a discussion of distributed ledger technology in the context of smart legal contracts. We include a discussion on the prevalence of the various forms of smart legal contracts, how they are used in practice, and the costs and benefits associated with smart legal contracts.
1.23 The next three chapters provide an analysis of the “lifecycle” of a contract formed under the law of England and Wales (from negotiation through to remedies for breach) and explain how the law might apply to smart legal contracts. Chapter 3 considers the formation of a smart legal contract, including whether the parties intended to enter into legal relations, with all the associated legal rules and remedies. In Chapter 4, we consider how the courts might interpret a smart legal contract, looking at existing principles of interpretation. In Chapter 5, we consider the remedies which might be relevant if things “go wrong”, such as where the code does not execute as one or more of the parties intended.
1.24 In Chapter 6, we specifically consider potential issues for consumers who enter into smart legal contracts, and consider how existing consumer protections might apply in the context of smart legal contracts.
1.25 In Chapter 7, we consider the factors which may determine whether the courts of England and Wales have jurisdiction in relation to a smart legal contract, in the absence of a jurisdiction or choice of court agreement between the parties.
Conclusions
Existing legal principles can accommodate smart legal contracts
1.26 In this paper, we undertake a detailed analysis of the application of existing contract law to smart legal contracts. Our findings conclude that the current legal framework is clearly able to facilitate and support the use of smart legal contracts. Current legal principles can apply to smart legal contracts in much the same way as they do to traditional contracts, albeit with an incremental and principled development of the common law in specific contexts. In general, difficulties associated with applying the existing law to smart legal contracts are not unique to them, and could equally arise in the context of traditional contracts. In addition, even though some types of smart legal contract may give rise to novel legal issues and factual scenarios, existing legal principles can accommodate them.
1.27 This paper therefore builds on the conclusions reached by the UKJT Legal Statement, which established that the current legal framework is sufficiently robust and adaptable so as to facilitate and support the use of smart legal contracts. The conclusions reached in this paper echo the view expressed by Sir Geoffrey Vos below.
English law is in a good position to provide the necessary legal infrastructure to facilitate smart legal contracts if, but only if, we try to keep any necessary reforms simple. We should, I think, keep sharply in focus the advantages of the common law. It is dependable and predictable and able to build on clear principles so as to apply them to new commercial situations. We should, therefore, be looking to identify and, if necessary, remove any fundamental legal impediment to the use of smart contracts. We should try to avoid the creation of a new legal and regulatory regime that will discourage the use of new technologies rather than provide the foundation for them to flourish.
1.28 The flexibility of our common law means that the jurisdiction of England and Wales provides an ideal platform for business and innovation, without the need for statutory law reform.
1.29 The market also has an opportunity 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. Throughout the paper, we identify particular issues that parties may wish to address in their smart legal contract in order to promote certainty and party autonomy. A non-exhaustive list of these issues is set out in Appendix 3 to this paper. In addition, as smart legal contracts become increasingly prevalent, we anticipate that the market will develop established practices and model clauses that parties can make use of when negotiating and drafting their smart legal contracts. We hope that work in this area could be led by the UKJT or LawtechUK.
1.30 We also consider separate, related areas of law, such as the law of deeds and the rules on jurisdiction. Deeds and private international law are the two areas where we think future work is required to support the use of smart contract technology in appropriate circumstances. In relation to both of these areas, future law reform projects are in train.
Related technological advancements
1.31 Smart legal contracts should not be considered in isolation. Related technological developments, such as the evolution of sophisticated smart contract platforms and the digitisation of contracts, have a direct bearing on smart legal contracts and their uptake. Digital contract initiatives and associated technologies are aimed at digitising commercial and legal documentation. Rather than being written in natural language and stored as such, such technologies enable a contract to be produced in structured formats, with supporting code that acts as a map or set of instructions, enabling a computer to read it. Legal documents produced in such a format can have their contents more easily read for reporting, analysis, automated processing, and lifecycle management.16 Even though a digital contract does not need to be a smart legal contract, digital contracts will likely trend towards the inclusion of coded elements. Although these developments are outside the scope of this paper, it is worth noting their advancements.
1.32 The development of smart legal contracts may introduce new issues and harms which the law needs to respond to. For example, oracles (external data sources which transmit information to a computer program) may require further consideration or indeed regulation. As technology and use cases develop, it will be important to keep the law under review, and consider whether reform or regulatory intervention is necessary to address novel issues which arise.
