Smart Contract Law: What Every Business Should Know

Let’s talk about a few smart contract law matters. For example: Are they enforceable in court? What do businesses need to consider?

Below, we’ll dissect algorithmic terms with a legal scalpel and outline their foundational parameters. Then we’ll examine a handful of considerations that may arise when negotiating, drafting, and coding smart contracts.

Smart Contracts Explained in 30 Seconds

Smart contracts are autonomous, logic-coded agreements that operate on a blockchain. Since they automatically execute on pre-programmed sets of conditions, smart contracts can remove the need for intermediaries.

So, for example, a company could create a smart contract to release funds every two weeks for payroll or other fixed costs, or tie it to a triggering transaction. The possibilities are limitless.

Benefits of Smart Contracts

Why is the tech world all over smart contracts? For starters, they’re a new way to streamline mundane, bureaucratic tasks, including routine payments. Moreover, smart contracts can lower transaction fees and eliminate the need for third-party intermediaries in certain situations. They can hold funds in escrow and issue insurance payments. The elimination of the middle men results in:

1. 1. Lower costs
   2. Mitigated risk of system failure
   3. Elimination of arbitrary delays and mistakes

Furthermore, smart contracts are encrypted and decentralized.

Immutability: Changing Smart Contracts Is Hard to Do

Smart contracts are immutable. In other words: once you launch one, there’s no changing it. The only way to alter a smart contract is to either fork the blockchain or deploy another smart contract that overrides the problem one.

Keep in mind that it’s easier to “fix” an errant smart contract on a proof-of-stake network than a proof-of-work model because the former is faster and requires fewer computers to participate in the process.

Self-Enforcing Contracts

We can’t stress enough that smart contracts are self-enforcing. Once you set one in motion, there’s no stopping it — which is arguably it’s biggest drawback. However, if you put thought into the terms and coding process, smart contracts make a whole lot of sense for certain types of transactions.

The upshot of self-enforcing contracts is that you can fulfill multiple obligations simultaneously, and signatories cannot breach the terms.

Signing Smart Contracts: Legal Considerations

If smart contracts are digital, how are they signed?

Currently, the Uniform Electronic Transaction Act (UETA) and the Federal E-SIGN Act legitimize electronic signatures. Though it hasn’t been tested in court, the cryptographic keys that holders use to sign smart contracts are the equivalent of “electronic signatures.” Plus, the transaction keys could be framed as evidence of intent.

The Legality of Building Oracles Into Smart Contracts

Smart contracts can be triggered by oracles, aka outside happenings that propel a given smart contract into action. Time, geographic location, payments, transfers, and even weather events have all been used as smart contract oracles.

Since they’re usually implemented via DApps, oracles can present a security risk if not properly integrated. Legal challenges may also arise in certain situations, as a judge could rule that oracle-based contracts don’t satisfy elements of enforceable agreements. For example, a payroll smart contract may execute on a predetermined payday, but it doesn’t automatically entitle payment unless the contract’s structure includes an offer and acceptance mechanism — or some other exchange of consideration.

To date, however, we’ve yet to see a lawsuit that challenges some statutory aspect of a blockchain oracle, so it remains an untested area of blockchain law.

Security and Privacy: Public, Private, and Hybrid Blockchains

It’s true that blockchain technology is more secure than its predecessors. But more secure and 100 percent secure are not the same thing. In other words: yes, hackers have successfully attacked blockchains.

So what should you look for in terms of security, if privacy is a concern? A platform’s relative security is rooted in several factors. Was the DApp well-coded in the first place? Is the deployed structural blockchain model public, private, or a hybrid? Be aware that transactions on public blockchains are visible to everyone with access.

Infamous blockchain hacks include:

• 2016 attack on The DAO
• 2011 attack on Allinvain
• 2011 attack on Mt. Gox
• 2016 attack on Bitfinex
• 2018 attack on Coincheck

Pro-Blockchain States

In the US, some states are more crypto- and blockchain-friendly than others.

Arizona, Tenesseem, Wyoming, Nevada, and Ohio have all passed legislation that recognizes blockchain transactions, and they updated their electronic signature codes to include smart contract transactions.

To ensure enforceability, states adhering to the Uniform Commercial Code’s model statute for contracts may need to update their statutes to accommodate smart contracts since the UCC recommends that certain agreements should be in writing. Note, however, that the Uniform Law Commission is currently in the midst of an extensive study examining how blockchain fits into the UCC.

Generally speaking, smart contracts that violate federal public policy or facilitate criminal endeavors aren’t enforceable.

Drafting Smart Contracts: Legal Considerations

Smart Contract Law: Immutability

Before coding smart contracts, it’s essential — vital — to quadruple check the terms. Ask yourself:

• • Are there provisions for late payments?
  • Is the trigger event properly defined?
  • What about the timing interval? Amount?
  • Does it comply with local, state, federal, and international law?

Smart Contract Law: Conditional Logic

When drafting smart contract terms, remember that they only perform conditional logic. Keep in mind that binary intelligence may not work for agreements requiring fluid terms.

Smart Contract Law: Coding Intent

Since a contract’s legality requires an element of intent, you must code it into smart contracts to ensure enforceability.

Smart Contract Law: The Judicial-Innovation Lag

The gap between judicial understanding and technological innovation has long plagued American jurisprudence, and the trend will likely hold true for smart contracts. For example, in the current legal climate, a court may deem a smart contract invalid because one party didn’t understand the code. This hasn’t yet happened, but it theoretically could.

Getting the judiciary up to speed will require educational lobbying efforts. However, it shouldn’t be a monumental task, as many legislators welcome innovation. Besides, previously legislation already cleared the electronic signature hurdle.

Smart Contract Law: Notice

Notice parameters and standards are another thing to keep in mind when working with smart contracts. Traditionally, courts don’t like to enforce contracts if both parties haven’t received adequate notice of the terms.
So, to play it safe, memorialize the terms in a written document. It may even be sufficient to include them in a service agreement.

Smart Contract Law: Jurisdictional Considerations

Since blockchains — and by extension smart contracts — are borderless, venue issues may arise, and litigants may mount jurisdictional objections. In such scenarios, the courts may look at:

• Where the parties live
• IP addresses
• Location of where the contract was negotiated, coded, executed, performed
• Prior agreements

Smart Contract Law Attorney

The Kelly Law Firm helps businesses and individuals with smart contract legalities. If you want to ensure that a smart contract’s terms are legally sound, we can help.

Managing attorney Aaron Kelly was an early crypto adopter and has considerable experience in the niche. He understands the market, the technology, and how they tie together.

Contact the Kelly Law Firm using the form below, and we’ll be in touch within 24 hours.

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