MinterEllisonRuddWatts Partner Tom Maasland, and MinterEllison Sydney Partner Anthony Lloyd and Associate Alexander Horder, discuss the rise of Smart Contracts and where they stand under the laws of New Zealand and Australia.
What are smart contracts?
A “smart contract” is a self-executing contract made by a computer program that records and carries out an agreement between parties. It is computer code for the automation of a promise. The self-enforcing nature of a smart contract separates it from a traditional contract — a smart contract’s outcome is directly coded into the contract itself.
Smart contracts are not an entirely new invention. Consider a simple example of a smart contract: a vending machine.[i] The vending machine offers goods for sale and, on a person providing the required payment, the goods are automatically dispensed. Automatic bank payments are also a form of smart contract.
The sudden excitement for smart contracts today comes from “blockchain” technology. The blockchain, in its traditional form, allows for a network of computers to form a trusted system that is an authority for “truth”, while being (generally speaking) decentralised and under no one person’s control. The result of this is large, public (and in some cases private) platforms on which smart contracts can operate.
Smart contracts have huge potential for business. Used in the right situation, smart contracts could allow agreements to be carried out more efficiently and without human involvement, creating the potential for increased certainty of outcomes.
Distributed Ledger Technology: Blockchain
Blockchain is the technology underpinning smart contracts. Blockchain creates a distributed ledger (an online database across multiple nodes (aka computers)) that is de-centralised and rapidly stores and updates across all computers running the blockchain software in the peer-to-peer network. The most well-known example of blockchain is Bitcoin, which operates as a monetary system without requiring any central bank to keep a record of money, or payment processing company to clear payment.
Blockchain records transactions, where groups of new transactions are added as “blocks”. Each block references the previous block in the ledger, creating a chain. Any new transaction is broadcast to participants in the blockchain for validation, and once validated, the addition to the ledger is replicated across the network.
As the “internet of things” increasingly “tokenises” the world, it will be easier for more types of contract to be smart. For example, insurance pay-outs might flow automatically following the occurrence of an event (i.e. a delayed flight, or lost bag), royalty payments might be automatically made on the use of a creators IP (like a song played on Spotify) etc.
What type of contracts might be smart?
Some examples of where smart contracts are currently being used, or might be used, are:
(a) Banking and financial services:
(i) Peer to peer lending with no intermediary.
(ii) Automating purchase and sale of shares on a stock market.
(iii) Automating loan payments and drawdowns under facility documents.
(iv) Protection of security interests. For example, car starter interrupters might be linked to a smart contract to automatically prevent a car from starting if loan payments are overdue.[ii] In the future, self-driving cars might repossess themselves if payments are not made.
(i) Peer to peer insurance with no intermediary.
(ii) Automating insurance payments. For example, automatic payment of travel insurance on a flight’s delay. As soon as a flight delay of over two hours is registered on air traffic databases, compensation payments are automatically triggered.[iii]
(c) Real property:
(i) Recording title and interests in real property on a blockchain. It has been assumed that this would have primary use in countries where the central authority is not trusted. However, the UK Land Registry is looking to trial blockchain technology as part of a wide-ranging digitization effort.
(ii) Property conveyancing. Smart contracts could transfer title in property on receipt of payment, reducing the need for payment to be passed through a solicitors’ trust account.
(d) Intellectual property:
(i) Recording digital ownership.
(ii) Automating payment for licensing and royalties without an intermediary. For example, it might be possible for systems similar to Spotify and iHeart Radio to exist where payments are made directly to content producers on playing.
(i) Payment of employees in real time for each hour worked.
(ii) Verification of university qualifications or employment history.[iv]
(f) Wills and trusts:
(i) Automatic distribution of a person’s assets after death. This could be linked to an official record of deaths.
(g) Capital raising:
(i) Initial coin offerings / Coin generating events.
(ii) Utility coin offerings.
Smart contracts and the law
There are many significant legal issues surrounding smart contracts, including determining the jurisdiction a contract comes under, how to enforce dispute resolution outcomes and liability of certain parties for negligence. We focus on just one for the purpose of this note:
Liability for negligence
The “drafting” (i.e. coding) of smart contracts raises new areas of possible liability for negligence.
Smart contracts would likely be unreadable to non-coders, and it is possible that no one party in a contract (the contracting parties, the lawyers, nor the coders of a smart contract) will have a full understanding of the contract on their own. Within this broader issue, there is the possibility that the coders get things wrong and the contract has errors, or just does not match the intended position. With a smart contract on the blockchain, a mistaken step (i.e. a new block) cannot be reversed.
Although in this instance the parties may still be able to seek remedy against the coder for negligence, this does not solve for the problem of; what is to become of the contract itself? The parties will likely encounter difficulties in accessing remedy in respect of the contract, as the traditional remedies under common law or equity [v] such as rectification, rescission or voiding a contract on the basis of mistake could turn out to be ineffective,[vi] due to the automated performance of the contract and an inability to amend the block in which the contract sits.
In New Zealand, Subpart 2 of Part 2 of the Contract and Commercial Law Act 2017 provides relief for various forms of contractual mistake: known mistake by one party (inducing the other party into entering the contract), mutual mistake, and different mistake about the same matter of fact or law.[vii] This does not however include a mistake on how a contract was interpreted.[viii] How this applies to smart contracts will depend on the chosen approach to interpretation. Taking the view that “the code is the contract” will likely see mistakes in a smart contract go to interpretation and not come within the categories of relief provided for under the Act. However, taking a wider view of the parties’ intentions, if parties err in drafting the contract’s code — for example they intend a payment to go from A to B and the payment goes from B to A — the parties would both be mistaken as to how the platform interprets their contract and the usual relief for mistakes in contracts would apply.
In Australia, there is no explicit legislative treatment of the concept of contractual mistake and accordingly, relief for the various forms of mistake; common (both parties making the same mistake), mutual (each party making a different mistake) or unilateral (only one party making a mistake) is determined by the principles of common law equity.[ix] Taking the view once again that “the code is the contract”, if a mistake is made by the coder, there exists the potential for the parties to assert that the contract is invalid due to that coding error. It is likely therefore, that this would be interpreted by a court to be a ‘common’ mistake of both parties due to a misalignment of; how the contract was intended to operate, and how it operated in practice. This would then require the court to understand the intention of the parties in entering into said contract, and to understand the effect of the mistake on that contract, with a view to granting a remedy accordingly. However, as noted above, in the context of smart contracts, the opportunity for remedy may be decidedly limited.
As lawyers, the possibility that a contract has errors is a typical concern. One way we provide assurance to clients is through providing a legal opinion to “sign-off” aspects of a transaction. Similar assurances may need to be provided by coders or other advisors to parties to smart contracts. One may expect smart contract “drafters” to maintain the same or similar levels of professional indemnity insurance as lawyers currently retain to cover any such errors.
Over time, it is expected that a library of contract code (like templates and precedents) will develop that is trusted to work and produces expected results. People will learn to work within that library and the risk of a contract going wrong will be reduced.
Smart contracts are an exciting development in law and offer huge potential for businesses. But, equally, they continue to raise questions around the application of laws to them. A number of legal issues like liability for negligence (addressed above) need to be fully considered before smart contracts can become the mainstay of the mainstream legal process.
Tom Maasland is a Partner in top tier law firm MinterEllisonRuddWatts. He has an extensive Technology, Media and Telecommunications (TMT) practice – and the team has been recognised by international legal directory, Asia Pacific Legal500, as Tier 1 for TMT in New Zealand. Tom advises on the full gambit of technology law issues – from advising clients on major technology transformation programs and large scale technology procurement, through outsourcing and managed services and “as a service” arrangements, to the more run of the mill software licensing and support agreements. He advises on privacy and data protection, as well as emerging technology areas such as cyber security, artificial intelligence, blockchain and smart contract related advice. Contact Tom at firstname.lastname@example.org
Anthony Lloyd, Partner at MinterEllison Sydney, is an internationally recognised technology and telecommunications expert, with a wealth of experience in commercial law, particularly in the financial services and communications industries. Anthony leads MinterEllison’s Technology Practice. His goal is to provide complete solutions that meet clients’ technology requirements – ranging from strategy, execution and implementation to ongoing management. Anthony has advised senior leadership teams on complex, critical technology and communications solutions, and on technology disputes. He is also a leading authority on cybersecurity, having acted in relation to several high-profile incidents and advised boards and senior management on anticipating and responding to cyber threats. Anthony is a director of MinterEllison’s Safetrac Group, providing innovative and intuitive governance, legal risk and compliance solutions to international clients. Contact Anthony at email@example.com
Alexander Horder, Associate (Technology and Outsourcing) at MinterEllison Sydney, was admitted as a Solicitor to the Supreme Court of New South Wales in February 2014 and practices as a Technology, Media and Communications (TMT) Lawyer at MinterEllison, Sydney. Alexander has gained experience in a broad range of TMT and general commercial matters, advising Government entities and corporations, both domestic and international, on a range of TMT projects, including; outsourcing, joint ventures, transitional services, services and supply procurement and corporate support. Alexander has also acquired experience in providing advice and other legal services in relation to; online security and privacy, licensing, commercialisation, marketing and sponsorship.
[i] Nick Szabo “The Idea of Smart Contracts” (1997) Phonetic Sciences, Amsterdam <http://www.fon.hum.uva.nl/>.
[ii] Max Raskin “The Law and Legality of Smart Contracts” (2017) 1 Geo L Tech Rev 305 at 329–333.
[iii] Maria Terekhova “AXA turns to smart contracts for flight-delay insurance” (15 September 2017) Business Insider <http://www.businessinsider.com>.
[iv] Henry Williams “Blockchain May Offer a Resume You Can Trust” (11 March 2018) The Wall Street Journal <https://www.wsj.com>.
[v] J Dewey and S Amuial “Blockchain Technology will Transform the Practice of Law” (2015) Bloomberg BNA available online at https://bol.bna.com
[vi] B Wang, “Blockchain and the Law” (February 2016) Internet Law Bulletin 250 at 252
[vii] Contract and Commercial Law Act 2017, s 24.
[viii] Contract and Commercial Law Act 2017, s 25.
[ix] J W Carter, LexisAdvance, Carter on Contract (at 10 Jan 2009 [22-001 – 22-130]