The UK's Law Commission is conducting a review to ensure the English legal and regulatory framework facilitates the use of smart contracts. Initial research has commenced and the review will run for 9 to 18 months. It will be conducted alongside a review of the law on electronic signatures, another aspect of the digitalisation of contracts. This is part of an initiative to ensure that English courts and law remain a competitive choice for business, particularly in the context of Brexit. As explained in the Law Commission's Annual Report:
"The purpose of this project would be to ensure that the law is sufficiently certain and flexible to apply in a global, digital context and to highlight any topics which lack clarity or certainty."
What is a smart contract?
Smart contracts involve the encoding of contractual provisions or functions on a blockchain (discussed in more detail in our introduction to the key legal issues around blockchain). It is often said that:
- they are not very smart. There is typically no "intelligence" or autonomous decision-making involved, just a straightforward sequence of "if A happens, then B will follow". If this defined event occurs, then that insurance pay-out will be made by X to Y; if Bank A receives this sum from B, then product C will be shipped to B. Smart contracts offer automated performance, rather than intelligence; and
- they are not self-standing contracts. Typically, a smart contract takes particular elements of a contract and provides for self-execution. Wider provisions, which might include boilerplate provisions and any subjective element, may well not be suited to locked-down blockchain coding. Generally, therefore, a smart contract exists under a contractual framework setting out the full relationship between the parties.
The Law Commission is an independent public body tasked with keeping the law of England and Wales under review. Its reports typically review the legal status quo for the topic in question, proposing changes where gaps or problems are identified. It cannot make new law but its influence is significant, with more than two thirds of its recommendations being accepted in whole or part.
The Law Commission observes that smart contracts offer the potential to increase efficiency in business, with the underlying blockchain technology increasing certainty and trust. It also highlights some of the legal problems that smart contracts could give rise to:
- The "immutability" of data recorded on a blockchain is often touted as a benefit of this new way of recording and sharing data. But in a contractual context, this can create potential problems as regards amending or correcting the contract terms, either by the parties or by a court.
- Immutability of provisions also creates difficulties where, for example, a contractual provision is held to be "void ab initio" – i.e. the clause is void from the outset – meaning that rights and obligations should be assessed as if it had never existed (as opposed to being void going forward).
- Immutability creates difficulties with data protection law – for example, the General Data Protection Regulation provides for a right to be forgotten (to have data erased) in certain circumstances, and to have data corrected.
- The interplay of smart contracts and terms which are implied into contracts by statute may need to be considered. In other words, how will smart contracts take into account provisions that are not expressly provided for but that the law requires to be addressed?
Osborne Clarke comment
Smart contracts have the potential to deliver benefits and efficiencies for business and consumer contracts. However, like the blockchain technology that underpins them, careful consideration must be given to whether they are appropriate in the given circumstances, including an awareness of their limitations.
We will be monitoring the progress of this review. In due course the Law Commission will conduct a consultation on these issues: if you are interested in responding, please contact us.