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28 September 2018 / news

Introduction to programmable contracts: a dispute resolution perspective

Programmable contracts may revolutionise commercial transactions and the use of computer programming is likely to give rise to technologically complex disputes that the courts of justice and non-specialised alternative dispute resolution service providers will not be equipped to handle. The creation of a Blockchain Dispute Resolution Authority to administer distributed ledger technology and programmable contracts related disputes may be a solution to those new challenges.

Programmable contracts may revolutionise commercial transactions insofar as they create legally binding relations and are enforceable in a suitable dispute resolution forum. The use of computer programming is likely to give rise to technologically complex disputes that the courts of justice and non-specialised alternative dispute resolution service providers will not be equipped to handle. We suggest the creation of a Blockchain Dispute Resolution Authority to administer distributed ledger technology and programmable contracts related disputes, pursuant to industry tailored rules of procedure and with the assistance of technological and legal experts.

Introduction

The potential for Distributed Ledger Technology (DLT) reaches far beyond cryptocurrencies. A promising area of implementation of DLT enables high-value transactions in low-trust environments using self-executing, self-enforcing and tamper-proof programs written in Solidity, Java, C++, Go, etc, commonly referred to as “programmable contracts” or “smart contracts”.

At a basic level, a programmable contract is a piece of code capable of transferring tokens. In a more sophisticated commercial context, a programmable contract may embody the terms of an agreement, facilitate and execute a pre-coded task when triggered by the occurrence of a previously agreed upon event determined by an oracle. As such, the use of programmable contracts creates a new contracting environment enabling parties who do not know or trust each other — and do not want to rely on an intermediary — to directly transact in a transparent and secure manner with no single entity controlling the transaction process and in the absence of — or with limited — human involvement.

A limitless range of programmable contract permutations is possible depending on the amount of natural language encoded. For example, one may imagine a natural language contract with an encoded basic payment mechanism (or a more complex encoded performance), a legal agreement being translated into a programmable contract where the two versions coexist, or a contract entirely created in code with no natural language counterpart.

The future of commercial contracts may lie in a paper-plus-code model which allows the use of DLT to verify the authenticity of transactions and parties’ identities, while relying on a paper backup in the event of a disagreement as to the interpretation of the contract provisions or alleged breach.1 One day, programmable contracts may replace natural language agreements. However, for the time being, they seem to rely on (and reflect) an existing legally binding agreement and only constitute a tool to facilitate performance.2

Regardless of the amount of coding involved, it is likely that programmable contracts will become routine technology in the years to come. Yet, they pose a number of challenges such as whether they create a legally binding relationship, enforceability and the availability of suitable dispute resolution mechanisms. This article discusses potential real life uses of programmable contracts, the existing legal framework and the potential for disputes, and suggests the creation of a DLT specialised administrative Authority dedicated to ensuring appropriate legal recourse, in a specialised dispute resolution forum, for these highly technical disputes.

Programmable Contracts Potential Uses

Potential for real world application of immutable ledger technology, and programmable contracts automating and executing “if-then” contractual relationships, is found in the insurance and real estate industries.

In the insurance industry, programmable contracts can streamline and digitalise current activities in order to reduce inefficiencies and the cost of administrative processes. For example, where contracting parties to a life insurance contract define the policy terms with sufficient precision, the payment may be automatically executed by a programmed digital protocol upon the occurrence of a previously agreed upon event (ie, the policyholder’s death) monitored through the use of oracles.3 Authors have also described a scenario in which a group of farmers may create a pool of resources as an insurance against natural disaster and that the resources will be allocated automatically upon an oracle’s verification that such event occurred as per the agreed procedure (eg, checking weather records).4

In the real estate industry, DLT users include nation states. The Republic of Georgia uses blockchain technology to secure and validate the registration of land titles,5 and Sweden’s land-ownership authority, the Lantmäteriet, is developing a blockchain-based platform for real estate deals to reduce the delay between the signing of a purchase contract and the registration of the sale.6 Once the information on the title is recorded on the immutable ledger, an owner may transfer the property without further interaction with the registry, and any new transfer of property would build-out the chain of title on the ledger.7

The Legal Framework

Technical writings often suggest that “code is law”8 and that programmable contracts require no legal foundation as everything is written into a code. However, DLT does not create lawless decentralised marketplaces that are free from the reach of regulation.9 Putting a smart contract “on” the blockchain does not place it outside of the legal system or otherwise insulate it from the laws of a given jurisdiction.10

If they are to succeed as a complement – or alternative – to natural language contracts, programmable contracts must take place within a clearly established legal and institutional framework, allowing them to be binding and enforceable. Sir Geoffrey Vos, Chancellor of the High Court in England and Wales, recently stated that “a legal basis will be required even for a self-executing smart derivatives contract recorded on a digital ledger across numerous servers.11

Although nothing prevents contracting parties from automating some aspects of contractual performance or embedding the terms of an agreement in a computer code, programmable contracts are subject to the traditional conditions of contract formation in order to carry legal obligations. In accordance with the most basic common-law contract principles, a contract will be formed and enforceable at law where an offer, recording the offeror’s firm intention to be bound by sufficiently complete and certain terms, is met by an offeree’s unconditional and unqualified acceptance of these terms. In addition, contracting parties shall have the capacity to contract, they must intend to create legal relations and their respective promises shall be supported by consideration.

In order to increase certainty, reduce the risk of unenforceability and ensure that the client’s interests are duly represented, the same lawyer shall ideally draft both the natural language contract and its coded counterpart. It is however more likely that commercial lawyers will develop the very basic programming skills required to collaborate with coders who will translate legal documents into executable code.

The Potential for Disputes

The use of programmable contracts, for example to automate certain aspects of contractual performance, may eliminate claims related to human intervention and non-performance. However, by reason of their tamper-proof and self-enforcing characteristics, programmable contracts carry with them just as much potential for disputes as (and perhaps more than) traditional paper contracts since they introduce the risks of programming errors, security breaches and discrepancies between the original intent and the actual implementation.12

Some issues that may give rise to full blown disputes include the following:

  1. Automating one’s performance upon the occurrence of an event may be over simplistic in situations where issues affecting contract formation or unforeseen circumstances may justify partial performance or no performance at all.13
  2. A programmable contract is likely to malfunction or execute incorrectly by reason of coding errors (“bugs”). Such errors are statistically inevitable and the number of errors increases in proportion to the number of lines of code.14
  3. Because rewriting information once blocks are hashed is nearly impossible, contracting parties may not alter the code (ie, amend the contract) to represent the evolution of the commercial relationship or adjust to new circumstances. They may only replace an existing agreement by another.
  4. When two parties have converted a natural language contract into a code, any disagreement regarding a term in the original contract would lead to a dispute as to the manner of implementation in the code.15
  5. A programmable contract may not accurately capture the parties’ intentions because of the difficulty to translate legal provisions into computer-readable language. A code would not be able to process the concepts of “good faith”, “reasonable endeavors”, “best efforts” or “due care” and may only faithfully execute the programmed instructions.
  6. As drafting a natural language agreement and its coded counterpart require collaboration between professionals with very distinct sets of skills, there is potential for discrepancies between the parties’ intentions and their coded implementation. Neither the parties nor their lawyers may ascertain whether the code correctly reflects the originating legal document.16
  7. Oracles, tasked with furnishing the technical infrastructure to communicate information about off-chain events, may not guarantee that an event occurred. Oracles obtain information from fallible and potentially contradictory external data sources (eg, websites or commercial providers), may encounter difficulties obtaining accurate information about private events, and operate in a binary manner thus not allowing for nuanced performance.17

While contracting parties may anticipate some of these issues by, for example, allocating the risk of occurrence of coding errors or committing to accept information about off-chain events from specific sources, other inevitable issues inherent to the use of the technology are bound to lead to disputes. As in any commercial setting, contracting parties must retain the ability to rely on effective dispute resolution mechanisms in the event of a disagreement.

Blockchain Dispute Resolution Authority

Disputes are a part of doing business and dispute resolution needs to be re-assessed in light of the emergence of DLT. In the likely event of a commercial dispute involving programmable contracts, the contracting parties want to ensure that an impartial and independent specialist has jurisdiction to hear it, in accordance with industry specific Blockchain Dispute Resolution (BDR) rules of procedure which shall be administered by a DLT specialised Authority.

Such forum will likely be better equipped than domestic courts to hear these disputes for the following reasons:

  1. Rigid court procedures will apply regardless of the industry at hand and leave the parties no control over the conduct of the proceedings. BDR rules may be flexible enough to tailor the procedure in accordance with the needs of each case and allow the parties to exchange pleadings, and conduct meetings and hearings, using technological tools.
  2. The costs of court litigation may deter parties from bringing a claim. Parties may also be engaged in litigation across jurisdictions, as in R3 Holdco LLC v Ripple Labs, Inc and XRP II LLC,18 thus increasing costs considerably. BDR rules may allow parties to consolidate proceedings in a single procedure.
  3. As court proceedings are public, there is no expectation of privacy and confidentiality. However, as the technical and technological complexity of disputes increases, the importance of rules of procedure providing comprehensive confidentiality provisions increases proportionally.
  4. Even if disputes were heard in commercial or intellectual property specialised courts, the court’s lack of expertise in DLT and programmable contracts would not lend itself to an efficient resolution. In particular where computer programming is involved, the technological features of disputes call for the appointment of specialists.

We suggest establishing a BDR Authority dedicated to accommodating the dispute resolution needs arising out of the revolutionary developments of the DLT. This Authority shall make available rules of procedure drafted in collaboration with leading experts in the fields of contract law, cross-border dispute settlement (ie, international arbitration, alternative and online dispute resolution), computer science, distributed ledgers and associated technologies. It shall also maintain a database of technological and legal experts well versed in alternative dispute resolution (“ADR”) and programming available for appointment, assist smart-contracting parties in incorporating suitable BDR clauses in their agreements and administer any resulting disputes.

Appointed decision makers shall have the ability to grant effective DLT specific and directly enforceable on-chain relief. Where provided accordingly ab initio in the programmable contract, the decision maker may, for example, fill in a gap or modify an existing contractual relationship, determine a contractual obligation to be performed under an agreement, allow the parties to amend the contract to accurately reflect factual developments and the evolution of the relationship, adjust the price payable under an agreement, award some (or all) of the monies contained in a smart contract, issue declaratory relief as to the parties’ rights and obligations, establish facts, determine the quality of the goods delivered or services provided, etc. In the future, decision makers may also be able to attach assets or take funds out of a debtor’s digital wallet if, for example, the monies contained in the smart contract do not suffice to compensate for the prejudice suffered.

Given the technological complexity of the expected areas of dispute, the specificities of the remedies and the need to accommodate smaller disputes, Expert Determination may constitute an appropriate dispute resolution option to handle most disputes in the first instance. Expert Determination procedures are known to be highly flexible and particularly suitable to make qualitative assessments, determine issues of law, quantum, valuation and complex technological matters, as well as handle disputes under long-term agreements where the parties wish to maintain the quality of the relationship. Expert Determination is not subject to any formal legislation or statutory procedural law but is governed by the terms of the contract and the procedural rules indicated therein, allowing for a large degree of flexibility. The expert does not however enjoy absolute freedom as it must be appointed in accordance with the parties’ instructions (contained in the BDR clause) and not exceed the scope of its mandate. Also, the expert is bound by rules of natural justice and must observe several principles of due process (eg, audi alteram partem, independence and impartiality, state its reasons, etc.). The expert shall render a determination, on the basis of the parties’ submissions, the evidence obtained from the parties, its own expertise and investigations conducted.

A BDR clause may provide for the constitution of an Expert Panel, in accordance with industry tailored Expert Determination rules, leading to the issuance of a technological and legal expert’s binding decision. The Expert Panel shall render a decision that is binding and enforceable with immediate effect. In order to accommodate larger and more complex cross-border disputes, a BDR clause may provide that a dissatisfied party may appeal the determination to international arbitration, in accordance with the rules of an existing leading arbitral institution, within 30 days of its communication to the parties. The determination shall become final if it is not challenged within the time and in the manner provided for in the clause.

Conclusion

While there are no obstacles to the use of DLT in commercial transactions, the success of programmable contracts remains uncertain if users seeking to create legal relations (eg, transfer of ownership of certain assets from one person to the other) enter into agreements that do not create a binding relationship and are not enforceable in a suitable dispute resolution forum.

These technological tools are not as safe and secure as technical writings suggest. Anticipating that, by 2022, approximately three trillion financial transactions each year will involve smart contracts and DLT, Sir Geoffrey Vos stated that: 

“We need to ensure that we understand the smart contracts, the DLT and the AI […]. You cannot have three trillion contracts per year globally without expecting some of them to give rise to a dispute. We need to ensure that our judges are sufficiently educated in the legal basis of them, and in the computer code that underlies them so that we can deal with these disputes and help to shape the legal environment in which these revolutionary developments will occur. We cannot just pretend that nothing is happening.”19

As such, programmable contracts create a new paradigm of contractual interactions in the cyberspace disrupting both lawyers’ provision of legal services and dispute resolution providers’ provision of out-of-court mechanisms and case management services.

The suggested BDR Authority shall address Sir Geoffrey Vos’s concerns by allowing a swift and-cost efficient resolution of DLT and programmable contracts related disputes, by legal and technological experts, pursuant to sets of rules specifically tailored to the technology and that it shall administer. This Authority is needed to address the BDR needs of the decentralised marketplaces and other applications running on blockchains, reinforce the consumer trust in the technology, foster the DLT economy and generally boost international (digital) commerce.

 

1 A Morrison, How Smart Contracts Automate Digital Business, PwC (March 22, 2016)

2 E Mik, Smart Contracts: Terminology, Technical Limitations and Real World Complexity (2017), p 14.

3 A Cohn, T West, C Parker, Smart After All: Blockchain, Smart Contracts, Parametric Insurance, and Smart Energy Grids, Geo L Tech Rev 273 (2017), p 290.

4 A Savelyev, Contract Law 2.0: «Smart» Contracts as the Beginning of the End of Classic Contract Law (December 14, 2016), Higher School of Economics Research Paper No WP BRP 71/LAW/2016, p 10.

5 L Shin, The First Government to Secure Land Titles on the Bitcoin Blockchain Expands Project, FORBES (February 7, 2017).

6 S Anand, A Pioneer in Real Estate Blockchain Emerges in Europe, WSJ (March 6, 2018).

7 A Spielman, Blockchain: Digitally Rebuilding the Real Estate Industry, MIT (September 2016).

8 L Lessig, Code version 2.0, Basic Books (1999)

9 A Wright, P Filippi, Decentralised Blockchain Technology and the Rise of Lex Cryptographia (2015), p 104.

10 E Mik, Smart Contracts: Terminology, Technical Limitations and Real World Complexity (2017), p. 15.

11 Sir Geoffrey Vos, The Future for the UK’s Jurisdiction and English Law after Brexit, Presentation to a Legal Business Seminar in Frankfurt (November 28, 2017), p 4.

12 E Mik, Smart Contracts: Terminology, Technical Limitations and Real World Complexity (2017), p 26.

13 For example, where the death of a life insurance policyholder triggers automatic payment to the beneficiaries, the insurer may argue that it is under no obligation to make payment as the death was caused by an excluded act.

14 E Mik, Smart Contracts: Terminology, Technical Limitations and Real World Complexity (2017), p 11, 20.

15 A Cohn, T West, C Parker, Smart After All: Blockchain, Smart Contracts, Parametric Insurance, and Smart Energy Grids, Geo L Tech Rev 273 (2017), p 285.

16 E Mik, Smart Contracts: Terminology, Technical Limitations and Real World Complexity (2017), p 18.

17 E Mik, Smart Contracts: Terminology, Technical Limitations and Real World Complexity (2017), p 23-24.

18 R3 Holdco LLC v Ripple Labs, Inc and XRP II LLC, Index Number 655781/2017.

19 Sir Geoffrey Vos, The Future for the UK’s Jurisdiction and English Law after Brexit, Presentation to a Legal Business Seminar in Frankfurt, 28th November 2017, p 9.

 

The article was first published in the september 2018 issue of the Singapore Law Gazette, the official publication of the Law Society of Singapore



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