The article was originally published in "GC Talk" in November 2019 and is reproduced with permission from the publisher.

What is a smart contract? Is a smart contract legally enforceable? Will smart contracts make lawyers redundant? With the buzz around blockchain, these questions are being asked more frequently as companies seek more efficient and more certain ways of executing contracts automatically via smart contracts. This article serves to answer these questions from a technical and legal perspective (within the context of the UAE laws), whilst also touching upon some of the legal issues that arise as a result of the use of smart contracts.

The evolution of smart contracts

Nick Szabo, a computer scientist, law scholar and cryptographer is credited for inventing the smart contract in 1996. He defined it as "a set of promises, specified in digital form, including protocols within which the parties perform on these promises" including negotiation, performance and adjudication.

The idea of a smart contract remained abstract up until the invention of blockchain by Satoshi Nakamoto in 2008 and whilst blockchain technology has thus far primarily manifested itself in the form of cryptocurrencies, we have recently begun to see the potential use cases of blockchain expand into more traditional contracting territory. An example of this is Propy, a company which uses blockchain to streamline the sale and purchase of real estate.

What exactly are smart contracts?

Smart contracts are:

  • digital: made up of computer programs;
  • embedded: contractual or other outcome based clauses are embedded as computer code in software;
  • automatic: the release of payments and other outputs are enabled by technology and rules-based operations; and
  • irrevocable: once initiated, the outcomes for which a smart contract is encoded to perform cannot generally be stopped or reversed.

Our article Rise of the Blockchain: A GCC Legal Perspective provides more information on what a blockchain is and when a smart contract is formed.

As execution over the blockchain network eliminates the need for intermediary parties to confirm the transaction, leading to self-executing contractual provisions, many have suggested that the rise of smart contracts may lead to the demise of the legal profession. However, to date, there have been few examples of intermediaries being fully replaced by smart contracts and even in circumstances where smart contracts have been implemented, this has often been to streamline a process controlled by an intermediary rather than with a view to replacing the intermediary altogether.

Different schools of thoughts on the composition of smart contracts

On a spectrum of options, one extreme school of thought is that a smart contract can be made up entirely of code, whereas an opposing view is that it is a natural language contract but with digitised performance based on business logic. Other possibilities include the coded contract being replicated into a natural language document or, alternatively, the coding of only those performance obligations that do not require human intervention with the wider human obligations and contractual provisions being written into natural language. In respect of the latter, both the code and natural language text would together form the contract.

Irrespective of what school of thought you follow, a common set of questions and legal considerations arise. We start by unpicking some of the more underlying questions. Perhaps the most obvious is whether it is appropriate or possible to code complex commercial agreements that require some form of legal analysis and interpretation into smart contracts (for example, can smart contracts be coded to include non-exact, legal terminology such as "best endeavours", "reasonable efforts" and "negligence"?). Such legal phrases require judgment and a question of degree which is perhaps not well suited to computer codes. To answer this, we must first explore the issues of validity and enforceability.

Validity

A key question regarding smart contracts is whether or not they constitute a valid contract under UAE law. Article 12 of the Electronic Transactions Law, which was published back in 2006 prior to the invention of blockchain, appears to specifically allow for the formation of contracts using computer code, with it providing that:

"A contract may be formed by the interaction of Automated Electronic Agents that include two or more Electronic Information Systems pre-set and pre-programmed to carry out these tasks. Such a contract would be valid and enforceable even if no individual was directly involved in the conclusion of the contract within such systems".

Notwithstanding the wording of the Electronic Transactions Law, the requirements for contract formation as stipulated under the UAE Civil Code would also need to be met in order for a smart contract to be considered valid from a UAE law perspective. This would essentially require the agreement of the parties as to the key contract terms (offer and acceptance) and for the smart contract to be for a lawful purpose.

Without taking each element in turn, it is arguable whether in every case a smart contract is formed, a "legal contract" exists. It is tempting to conclude that, just because "smart contract" includes the word "contract", it is a legally binding contract and the principle of smart contracts override all legal principles which govern contracts, but whether or not a contract is legally binding or not is dependent on a number of factors, such as its use case and form. Legal contracts must be understood to be enforceable and the parties should know exactly what they have agreed on. It is questionable whether terms in code or partly in code are sufficiently clear, which begs the question "how effective are smart contracts?"

Enforceability

Since smart contracts are pre-written computer codes, their use may present enforceability questions if attempting to analyse them within the traditional "contract" definition. This is particularly true where smart contracts are built on permissionless blockchains, which do not allow for a central controlling authority. Since the point of such blockchains is to decentralise authority, they might not provision for an arbiter to resolve any disputes that arise over a contract that is executed automatically.

Customers should ensure that smart contracts include governing law and dispute resolution provisions to reduce uncertainty and provide for a mechanism in the event of a dispute. This is particularly true with cross-border transactions since the operation of smart contracts is through distributed nodes, rendering it difficult to agree on which jurisdiction's law is applicable. It is most likely that such provisions would need to be set out in natural language as opposed to code and how this is done is based on the different school of thought you belong to, but in our view it would be in a separate contract that sits alongside the smart contract.

Now back to the questions?

Recent use cases have evidenced that smart contracts can automate many different kinds of operations and processes, particularly in the banking and finance sector, the most obvious being payment and actions conditional on payment. In addition, the insurance sector can benefit from use of smart contracts and DLA Piper recently advised a major insurance company with the development of its smart contract for the automation of certain insurance contracts.

Nonetheless, it is still far from certain that smart contracts can be translated more broadly into all sectors in all circumstances and remove the need for human intervention and lawyers' time and expertise in assisting with complex legal contractual issues. On the basis that smart contracts to date have been best suited to deal with less complex exchanges between two or more parties (and even in such cases, lawyers have been required to draft the smart contracts in natural language), in our view the legal profession is not at threat.

The article was originally published in "GC Talk" in November 2019 .

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.