What are Smart Contracts? Our first introduction of the smart contract analysis highlighted the absence of a clear definition that marks the difference and boundary with other related concepts of the crypto-cosmos, including the complementarity with Artificial Intelligence (AI).
Fewer questions arise though regarding benefits and costs savings: the simple fact that one copy is distributed to all parties and stored in the ledger busts already efficiency and reduces transactional costs.
Its automaticity simplifies the enforcement process compared to the traditional contracts: the parties cannot actually refuse to perform the obligation subject to the suspensive condition as the smart contract will do it by itself.
But although self-executed, smart contracts are not unanimously recognised as legally enforceable: this quality derives from the formation of the contract regulations of each country.
By nature, DLT base their roots on the absence of centralized control and legislative coverage.
So, what law is competent to regulate the obligation arising from these agreements?
Let’s have a look at the situation in the United Kingdom and the United States of America.
UK: the natural language to interpret the parties’ intention for Smart Contracts
The UK system requires the following requirements for the formation of a legally binding contract:
- 1) a formal agreement: this comprises an objectively determined offer and an acceptance, assumed by both parties’ conduct.
- 2) consideration, which is a promise performed by one party in exchange for a promise by the other party.
If the agreement were concluded in natural language, this would be analysed to assess the existence of consideration: England and Wales interpret what the language would mean to a reasonable person, with the knowledge available to the parties when the contract was made.
- 3) certainty and completeness: for instance, the terms cannot be too vague and must cover essential objects. The agreement must be practically possible to interpret in its content, and no conflict should arise between natural language and coded terms. Even so, the UK Supreme Court stated that supremacy should be given to the natural and ordinary meaning of the language in case of conflict.
- 4) intention to create legal relations: the only doubts that may arise are when parties expressly state that they do not intend to make a legally binding agreement. Based on the UK contract law, we could affirm that a natural language clause inserted in a smart contract expressing that both parties do not want to create any legal relations might be effective.
Also, if the parties reach the agreement entirely on a distributed ledger, without any natural language documents as a support, as they want their contract not to be subject to the traditional legal system, what would be the outcome?
So, what law is competent to regulate the obligation arising from these agreements?
English courts pay attention to the parties’ conduct: an intention to create a legal relationship can be inferred from their purposes of giving business reality to their transaction; therefore, the court can consider that as a legally binding contract.
- 5) formality requirements. Contracts can be legally binding when they are made in writing, orally or by conduct, but how a smart contract can be made in writing?
Writing needs to be interpreted extensively and includes also typing and printing and other forms of representation:
- a) if the smart contract takes the form of a natural language contract, this would meet the standard required for a contract to be made in writing;
- b) if the smart contract is partially recorded in computer code, it should also meet the standard requirement for the same extensive interpretation of the word.
Under the Rome I Regulation Article 3, if parties have chosen the law applicable to regulate their agreements, the UK courts will give effect to that choice.
If no governing law was chosen, Article 4 states the additional criteria which apply depending on the nature of the smart contract:
a sales of goods will be regulated by the law of the seller’s habitual residence, a provision of services by the law of the service provider’s habitual residence, and so on.
The USA and the concept of the meeting of the minds
In the United States, each state has different Contract law. However, one solid and generally accepted principle is that a legally binding contract holds three main elements: a meeting of the minds, an offer and acceptance and an exchange of consideration.
Some states require the contract to be formed in writing (statute of frauds) to be legally enforceable.
The writing must contain the signature of both parties (typewritten and private key digital signatures are enough to meet the obligations of statutes of frauds).
The requisite of acceptance is satisfied when the party receiving the offer express their agreement in the appropriate way depending on the contract’s object: a transfer of funds via a smart contract might serve as the offer (to unleash action of the counterparty) or acceptance (when it triggers its execution unequivocally).
Both the elements of the meeting of the minds and consideration need great clarity with reference to the terms of the contract: these should be defined and communicated in a way that avoids misunderstanding, given that smart contracts are also coded.
A smart contract that has not been fully appreciated in its content by one party is not likely to be legally enforceable against that party (lack of meeting of the minds).
What jurisdiction should apply to Smart Contracts?
US courts tend to preserve the parties’ choice of law provisions unless the chosen jurisdiction lacks a tangible relationship with the parties in full or where the application of such jurisdiction would disrupt public policy.
In the absence of a choice of law provision, some supplementary criteria come to the rescue, depending on the matter of the smart contract. The competent jurisdiction might relate to:
- a) the domicile of the parties;
- b) the IP addresses of the parties;
- c) the place where the contract was negotiated, coded, executed or performed.
As a last resort, we should look at any prior agreement between the parties.