Smart contracts need smarter lawyers

Labour-intensive tasks can now be done more quickly with the help of computer technology. Smart contracts may be another step along the path to automation.

While the term is used loosely, 'smart contracts' usually refer to computer applications in which contracts are written into computer code and perform or execute automatically.When these applications are built on blockchains or distributed ledger platforms, they can take advantage of the greater certainty this technology can provide that the contractual obligations will be performed as programmed, as well as increasing automation and eliminating some manual tasks required in traditional contracting. 

This has some obvious applications to certain types of common contracts in financial services. For example, a trade finance smart contract might be programmed to make payment upon confirmation of the delivery of a shipment; a derivative smart contract could make payment calculated on the basis of the value of an underlying asset at a point in time.

SMART LAWYERS STILL HAVE A ROLE

Automating contracts could reduce the need for lawyers doing repetitive contract writing and interpretation. But predictions of the demise of the lawyer have been exaggerated.

Smart contracts are still best suited to arrangements where clearly defined outcomes can be programmed – computers do not understand ambiguity. Many contractual relationships will not lend themselves to programming.

Even where smart contracts on blockchain technology are appropriate, lawyers have an important role to play in the development of blockchain and smart contracts technology. There are four things lawyers can do computers still can't:

• Who can make your smart contract enforceable?

Computer code is not the law and does not give you legal rights. A smart contract is not necessarily a legal contract simply by virtue of its name. You might agree with a party how transactions in a distributed ledger system will be performed but have you got a binding contract and could you enforce your rights?

And while smart contracts can operate without the need for legal enforceability (if that is not important to the parties), that does not prevent the legal system applying to relationships entered into under smart contracts.

It is crucial to get legal advisers involved early to understand what legal rights need to be created and how they can be built into the architecture of the system, including what 'dumb' or traditional contract terms may need to operate side by side the smart ones. 

• If you are collaborating with others, you will need rules

Distributed ledgers and smart contract are really useful for transactions between parties. This means developing the technology will likely require collaboration and significant investment of time and money.

Wherever there is collaboration or joint venture, there needs to be clear thinking about the role of each party, what it will contribute, what say it will have in the running of the project or the enterprise, and what its responsibilities will be.

In short, collaboration requires a governance framework. This may be reflected formally in an agreement or constitution for a joint venture entity. The risks of an informal arrangement need to be clearly understood.

It is important those participating in any blockchain or smart contracting project understand the rights they will have and how they can be exercised and modified. Once a governance framework is established, it may be difficult to change.

• Lawyers can help pick up the pieces

Lawyers will also undoubtedly have a role to play in resolving disputes when something goes wrong. But a better use of lawyers may be in testing the design of distributed ledger and smart contracts systems and thinking about what could go wrong before it does.

Some errors may be simply problems with the computer code. There may be unexpected outcomes neither party bargained for. Lawyers can help design processes by which errors can be resolved and worked through when they arise. This may involve agreeing a process by which the code used by the parties can be rectified so it does what it is supposed to do.

Where the outcome was expected or understood by one party but not by the other, you have a recipe for dispute. Dispute resolution again should be thought about when the system is being designed (not when you get a letter of demand).

• Lawyers can help get the regulator on side

Australian regulators should not try to regulate blockchain and smart-contracting technology in isolation. Jurisdictions that have done this (for example New York) have stifled innovation or have driven away investment. The important point is how the technology is being used.

Australian regulators have so far taken a measured approach, which is welcome. But in some cases, intervention by the regulators or regulatory change may be required to realise its full potential.

It seems likely the first uses of the technology will be in payments and securities settlement, both key parts of our financial system. Having regulators who are informed and understand not just the technical code but also the legal issues and risks in using the technology, as well as the opportunities for risk reduction, will be crucial to success.

Simun Soljo is Managing Associate, Financial Services Regulation and David Rountree is Senior Associate, Technology, Media & Telecommunications at Allens.

Click here to read Allens’ Blockchain Reaction report.