Where Do Smart Contracts Find Themselves Within English Contract Law?

The phrase ‘smart contract’ understandably evokes futuristic images of autonomous robots conducting agreements with each other. In actuality, smart contracts are modelled on the basic concept of a digitalised entity automatically conducting a transaction on the behalf of contracting parties - much like the idea of a vending machine (more on this later).

Surprisingly, the rudiments of the smart contract find themselves in the early 1990s, taking root in the works of lawyer, computer scientist, and cryptographer Nick Szabo. He proposed smart contracts as simply being “a set of promises, specified in digital form”. Today, with the development of technology, we find ourselves in a position where this “digital form” is evolving to become Artificial Intelligence (AI), capable of orchestrating contracts independently, and minimising the need for human intervention. 

Before smart contracts can become an established legal concept, however, there is still a myriad of questions to be answered - most importantly, how must the codified law of contract evolve to accommodate and account for smart contracts, and what hurdles must be crossed in order for this to happen?

Traditional vs. smart contracts

A traditional contract is defined as a binding legal agreement between two parties and requires the existence of an offer and acceptance (an agreement), consideration, and mutual intention to be bound by the contract. The resulting contract places legal rights and obligations on both parties. The traditional offer acceptance framework accounts for a breach of contract, stipulating that any deviation from the terms of the agreement will result in the injured party being entitled to compensation from the other. 

A smart contract deviates from the standard offer acceptance framework whereby one or both parties in the agreement is doing so as AI machinery. There is no official definition of the term, but the fundamental criteria for a ‘smart’ contract is a ‘code’ which will self-execute upon certain conditions being fulfilled by the other (human) party. 

The Virtual Vending Machine 

To put an example to the terms at hand, we can use what Szabo alluded to as the idea of a ‘Virtual Vending Machine’. When an individual purchases something from a vending machine, they are offering consideration in exchange for an item. While the machine is not a legal entity, this exchange is regarded as a valid purchase contract as the automated technology has replaced the need for a third party to give the exchange legitimacy. However, this analogy is only applicable to a limited extent - visions for smart contracts extend beyond the simple concept of a tool used by a vendor to create an offer which produces a simple unilateral contract. 

Why are smart contracts the future?

The renewed interest in smart contracts follows the recent development of blockchain technology. A ‘blockchain’ is a series of time-stamped blocks of data that are linked together and encrypted against fraudulent modification. The security offered by this technology makes it an attractive method of contracting which can be enforced without the need for human intervention, thereby reducing the potential for human error or moral hazards. The AI would play the role of an “autonomous software agent”, providing the sense of trust that normally accompanies the third-party involvement of solicitors. 

Beyond replacing the role of a third party to validate a contract, the current vision for smart contracts places them in instances where there is a need for greater efficiency and security. This includes the provision of financial services or the purchase of property, where an automated transfer of goods or services would be contingent upon the stipulations of the blockchain mechanism being fulfilled. 

“Beyond replacing the role of a third party to validate a contract, the current vision for smart contracts places them in instances where there is a need for greater efficiency and security. ”

Furthermore, the following existing concepts within contract law lend credence to the standalone idea of smart contracts:

• An escrow agreement is most commonly used in property transaction and involves an independent third party (called an escrow agent). The independent agent holds on to the asset until the contractual conditions are met. 

• Electronic contracts are written agreements in digital form, which we encounter every day - such as when we agree to the Terms and Conditions of a website. However, this mechanism is merely an electronic form of a contract which is still drafted and executed by humans.

The features of the above devices can help to understand how a smart contract is proposed to work, and also to place the potential idea within the field of contract law - a smart contract would borrow the concept of the independent third party from the escrow agreement, while taking the form of an electronic contract. However, it would also diverge from the above devices by replacing the role of the third party with the machine (who would itself be a party to the agreement), thereby removing the need for humans to formulate the conditions of the contract.

Where is the law currently lacking? 

The law does not currently recognise ‘smart legal contracts’ as valid and binding legal agreements. There is very little case law on the concept, with none falling under the jurisdiction of English law, leading to a vacuum in legal guidance. The law interprets the term ‘smart contract’ in the same way as electronic forms, rather than as independent contractual agreements carried out by machines. This makes any evolution of the law an arduous process; it favours enshrined tradition over innovation.

This makes any evolution of the law an arduous process; it favours enshrined tradition over innovation.

The primary point of contention regarding the validity of smart contracts is the inability to classify machines as ‘legal entities’ under existing law. Moreover, if an autonomous machine is granted the ability to conduct activity on behalf of a legal human entity, where would liability be placed in the instance of a contractual breach? It would be unjust to hold the human party liable, as they will have blindly consented to only machine-readable code - however, liability also could not be placed on the machine, as it is not classed as a legal entity under existing law.

Future direction

In November 2019, the LawTech Delivery Panel (established by the Government, Judiciary, and Law Society) sought to address these gaps through the publication of an official legal statement on ‘Cryptoassets and Smart Contracts’. While this does not qualify as binding legal authority, it is the most legitimate advice on the matter and is used as guidance by commercial entities. It concludes that, where the three key features of contract formation are present (an agreement, consideration, and intention to create legal relations), the existing rules of English contract law should apply to smart contracts. Whether this will actually manifest in the legal world is yet to be seen.

On the whole, many gaps within contract law remain. When consideration is given to the increasing use of AI by law firms, smart contracts seem the natural next step. However, there is no doubt that the concept of smart contracts would require large scale changes to existing law or perhaps even the creation of entirely novel legal doctrines.