30th May 2022
Confused by the terminology? Sally Mewies, Head of Walker Morris’ Technology & Digital Group, explains what a smart legal contract is and sets out some of the practical legal considerations for commercial parties to keep in mind. You can also view Sally’s brief explainer video here.
Please contact Sally if you have any queries about the points covered below or need any advice or assistance. Our Technology & Digital experts are well placed to advise on all aspects of commercial agreements, disputes involving blockchain and other technologies and any concerns from a regulatory perspective.
A smart legal contract is a contract which creates binding legal obligations on the parties, but which is wholly or partly written as a computer programme.
The computer programme is written so that instead of a party to a contract having to take steps to exercise certain rights or comply with certain obligations, the computer programme executes those elements automatically without human intervention. Often this will be done on a prompt from data or information received by the computer programme from a trusted source. There will be many commercial contracts, for example services agreements, where only part of the contract can be executed as a computer programme because other obligations need to occur in the physical world.
Smart legal contracts come in three forms: (i) a contract which is entirely written as a computer programme but also has a complete natural language version; (ii) a contract which is partly written in natural language and partly as a computer programme; and (iii) a contract which is entirely written as a computer programme.
An example of a smart legal contract might be a cloud services agreement with a service level regime. Certain terms governing the contract could be in the natural language version, but the service level regime could be written as a computer programme. Data from a trusted source would tell the computer programme if there had been a service level breach that entitled the customer to receive a service credit, and the service credit would be paid automatically without the supplier taking any action or issuing any instruction.
Access to the cloud services could also be governed by a computer programme, in that payment could trigger the access and non-payment could terminate the access. Clearly issues relating to termination/ suspension of use of cloud services can be business impacting in a commercial agreement and this binary operation of access might not work in all cases, which is where the natural language version plays a role. For these reasons, smart legal contracts are likely to be hybrid i.e. partly code and partly natural language in many business scenarios.
Smart legal contracts in theory are technology neutral, but currently are made possible by distributed ledger technologies (DLTs). Blockchain and Ethereum are both examples of DLTs. DLTs are often generically referred to as the more familiar term “Blockchain” which we use in this article (see our brief explainer video here).
Blockchain has special properties which mean that records, data or information written on the Blockchain can be trusted as being accurate. Blockchain creates a trusted shared record between parties who do not know each other or who cannot trust each other. Parties to a wholly or partly coded contract need to trust the underlying system that enables that computer programme to execute, and want to be sure that neither party (or a third party) can unilaterally amend the contract in an unintended way. Some Blockchains have the technology to support these requirements and that is why they are ideal for supporting smart legal contracts.
Smart legal contracts are written on the Blockchain and are programmed to execute commands and actions depending on the terms of the contract.
The Law Commission recently concluded that smart legal contracts are compatible with existing English law principles and are therefore legally binding and enforceable. However, the application of common law principles and case law to smart legal contracts needs careful consideration by the parties and in most cases will necessitate part of your smart legal contract being in a natural language, i.e. a hybrid smart legal contract.
Setting up a smart legal contract requires different considerations from a entering into a wholly natural language contract and initially most are likely to be a combination of natural language and code.
Clearly it will be necessary for the parties to work with a programme coder and select the correct Blockchain for the relevant smart legal contract, but there is the legal side to consider too and this involves looking at how certain legal principles may play out in an automated situation.
Here are some practical legal considerations that will need to be thought about and agreed by the parties at the outset, and included in the natural language part of any smart legal contract. Issues that are not necessarily spelt out in detail in the natural language contract because they are compatible with the natural language contract and work with it, may need additional provisions/explanation where a contract is partly written in computer code: