Smart contracts - Law Commission gives green light

Back in November 2019, the UK Jurisdiction Taskforce published a Legal Statement on the Status of Cryptoassets and Smart Contracts (see our previous briefing). 

The Taskforce's classification of cryptoassets as property and smart contracts as equivalent to traditional contracts was "a watershed for English law and the UK’s jurisdictions….and is something that no other jurisdiction has attempted. It is genuinely ground-breaking" (Sir Geoffrey Vos, then Chancellor of the High Court). 

The next step was for the Law Commission to consider whether any legislation should follow. 

Fast forward two years, and the Law Commission has done just that, in relation to smart contracts at least, publishing its advice to Government on 25 November.

Commission conclusion

The Commission concluded that the current legal framework in England and Wales is clearly able to facilitate and support the use of smart legal contracts, without the need for any statutory law reform. 

Current legal principles can apply to smart legal contracts in much the same way as they do to traditional contracts, although an incremental and principled development of the common law will be needed in specific contexts. 

Potential areas of uncertainty 

In general, difficulties associated with applying the existing law to smart legal contracts are not unique to smart contracts and could equally arise in the context of traditional contracts. Although some types of smart legal contract may give rise to novel legal issues and factual scenarios, these can be accommodated within existing legal principles.

The Commission encourages parties to anticipate and cater for potential uncertainties in the legal treatment of smart contracts by including express terms aimed at addressing them in their contracts. It set outs a non-exhaustive list of the sorts of issues parties should consider and provide for to reduce the scope for potential disputes. Such issues include, among others: 

• making clear the role of the code in the contract and, in particular, whether the code is intended both to define contractual obligations as well as to perform them;
• where the contract contains coded terms, providing a natural language explanation of the workings of the code and making clear that such explanation forms part of the contract;
• considering the relationship between any natural language and coded terms and, where the same term is expressed in both natural language and in code, making clear which term takes precedence in the event of a conflict;
• making clear in natural language, either in a separate agreement or by way of comments in the code, where the parties intend their transactions on a DLT system or other smart contract platform to create legal relations;
• providing for and allocating risk in relation to: a malfunctioning oracle or inaccurate data inputs; external events beyond the parties’ control which may affect performance of the code; bugs and coding errors in the code; and any potential mistakes that may arise due to the parties holding certain beliefs or assumptions about how the code will perform;
• including choice of court and choice of law clauses in the contract, either in a separate natural language agreement, or by way of comments in the code, to mitigate possible uncertainties around where the defendant is based and where the contract was formed (the Commission is undertaking further work in this area).

In addition, there are difficulties when a contract must be entered into by deed. Deeds are documents executed with a high degree of formality and there is some uncertainty as to whether smart contract technology can facilitate compliance with those formalities. The Commission is also undertaking further work in this area.

The future

As smart legal contracts become more prevalent, the Commission anticipates that the market will develop established practices and model clauses that parties can make use of when negotiating and drafting their smart legal contracts. It hopes that work in this area will be led by the UK Jurisdiction Taskforce or LawtechUK.

As noted above, deeds and private international law are the two areas where the Commission believes further work is required to support the use of smart contract technology in appropriate circumstances.

In addition, the Commission is continuing its work on digital assets and has been asked by the Government to make recommendations for reform to ensure that the law recognises and protects digital assets and is capable of accommodating them in a way that allows the possibilities of the technology to flourish.

On publication of the advice, Professor Sarah Green, Law Commissioner for the commercial and common law team, said: 

"Smart legal contracts could revolutionise the way we do business, particularly by increasing efficiency and transparency in transactions. We have concluded that the current legal framework is clearly able to facilitate and support the use of smart legal contracts; an important step in ensuring increased recognition and facilitation of these agreements.

Our related work on digital assets and conflict of laws will further establish England and Wales as a global leader for technological innovations in the digital sphere."