This article has been written by Krati Agarwal, pursuing the Diploma in M&A, Institutional Finance, and Investment Laws (PE and VC transactions) from LawSikho.
Smart contracts refer to the new age contracts formed with the use of technology. With the development of blockchain and other distributed ledger technology the cumbersome process of entering into written/printed contracts is simplified. A smart contract is an agreement in the form of a computer code that executes itself when the conditions for which it is programmed are met. These contracts are built on blockchain technology wherein once the block is added to the chain, it can’t be altered easily, hence offering authenticity and credibility. A smart contract can be of two types, first where the whole agreement is coded and second where the smart contract complements the traditional paper-based contracts and help the parties in only executing the terms.
Most of the smart contracts today are at their primitive stage wherein every action is pre-programmed. If ‘X happens, ‘Y’ will be executed. But as we advance in technology, we will see the development of complex smart contracts where automatic intelligent actions can be performed by these contracts.
Some of the tasks performed by smart contracts in M&A transactions
An M&A transaction involves complex, intricate agreements and deal structures, and knotty legal issues. A lot of time and energy can be saved if M&A transactions incorporate few aspects of smart contracts in their work. Once a blueprint of an M&A deal is added to the smart contracts, it can start executing itself. As and when the pre-conditions given to the code are fulfilled, smart contracts can be used for:
- Releasing the funds to the party identified;
- Sending notifications to the person intended;
- Issuing receipt;
- Imposing penalty when certain conditions are not fulfilled within a specific time period;
- Allow or cut access to any service once the payment is made or not made;
- Tracking the status of any transaction.
Once these actions are to be performed, i.e. once the block is added, it becomes permanent. It cannot be changed by anyone and only the parties having access or the key can see it.
Advantages of smart contract in M&A transactions
- Accurate: Smart contracts are the most accurate form of contracts. This is a basic requirement in technology because an omission of any data can render the transaction erroneous. Smart contracts facilitate M&A transactions by being accurate and on point. This reduces the need for cross-checking at every stage of the transaction.
- Clear communication: With accurate information made available, there will be no lack of communication and all the communication made will be clear and to the point.
- High speed: The tiresome and slow processes of M&A can be replaced by fast-speed transactions with the help of smart contracts.
- Back-up: There is no need for duplicating the important documents in case of their loss. Smart contracts will always stay in the system and cannot be deleted. Hence, a backup is always available for M&A lawyers and other players for reference.
- Increases transparency and integrity: It is very difficult to alter or delete the data once entered. No party other than the one having access can view the details and hence it eliminates the intervention by the III parties.
- Increases efficiency: Since the contracts are auto-executing, there is no requirement for middlemen to operate them. It also reduces the need for duplicating all the data and files.
- Reduces cost: With fewer intermediaries and interventions, the overall cost in conducting a typical M&A transaction goes down.
Specific advantages to M&A deals
Apart from these general advantages of smart contracts, the specific benefits smart contracts can offer in M&A transactions are:
- The non-disclosure agreements entered at the preliminary stage of the transaction if entered via smart technology can efficiently reduce the labor, time, and cost of both parties. It will also be easier to manage the terms of the contract and to terminate it easily if things don’t go well.
- Assessment and evaluation of the target company become much easier with this technology in hand. It eliminates manual labor to a much greater extent and delivers results faster.
- Condition precedents are sine qua non for every M&A deal. These are essential for both parties to have a successful transaction. Monitoring conditions precedents via smart contract technology can reduce the burden to a great extent.
- Transfer of money and the penalties of late payment can be managed easily and much more efficiently via smart contract technology.
- A typical escrow transaction involves entering into a contract, opening a bank account, notifying the banker, making bank transfers, etc. With the use of smart contract technology, we can have a smart escrow wherewith the development of computer code, all the additional steps are taken can be replaced by that code.
- Transfer or release of collateral can be automated and managed by smart contracts efficiently. It will be like any other typical blockchain transaction, where on the satisfaction of certain commands, the desired result is generated.
- Indemnity transactions can be initiated and completed very quickly by the use of smart contract technology. Indemnity clauses are very common in M&A deals. They are used by buyers to reduce the cost post transaction if any representation and warranty given by the seller go wrong. Once the command of representation and warranty going wrong is triggered, an automatic liability is created, which has to be fulfilled within a specific time period. This can reduce all the hassle of notification, bank transfer, etc.
Down-side of smart contract technology in M&A
The main risk in smart contract technology is that there might be a risk of flaws in the computer program. This is an inherent risk and requires a technician to fix it. This makes the need for human intervention a necessity. Another disadvantage of smart contract technology is that it is not easy to alter it. In a typical M&A transaction, a lot of negotiation takes place which keeps on changing the terms of the deal multiple times before execution. Once a contract is written in the computer code, it is very expensive and time-consuming to change it. This defeats the whole purpose of using the Smart Contract technology in the first place.
Not all legal clauses of a contract in an M&A transaction can be termed as “if and then”. Blockchain presently works only in this format. Hence, it is not able to find its place in more complex deals. They are best suited for transactions that have standard terms in them rather than more complex terms.
Smart contracts are also very high maintenance. It requires an experienced programmer to make fail-proof code that will work for the parties in the long run. Although smart contracts remove human bias from transactions, there might still be a discrepancy between what is originally intended by the party and what is coded finally. This will require a technician who understands legal requirements properly or a lawyer who understands the technical aspects. This combination can be rare and hence in a way this process becomes costly. A smart contract is considered very safe, but there are still chances of a security breach as at the end of the day it is still a computer code that can be broken into by an unwanted party.
There is a huge potential for smart contracts in the legal industry. There are many debates going around the world about how technology will replace lawyers in the coming future. If looked at objectively, smart contracts are in fact not contracts in a real sense. They are merely commands which are given to the computer to be executed upon the happening of an event. They can take over the rudimentary tasks to make them cost-effective, paperless, and to be achieved in less time. Hence, human intervention still has a very important role to play.
Smart contract technology is presently used all over the world by M&A lawyers to carry on transactions easily and close the deals for their clients quickly. Even though we saw disadvantages of this technology that presents a real problem, we cannot negate the possibility this technology can bring in the coming future. Present developments are just the beginning of the journey of smart contracts. We do not know what developments will take place in the future, but will surely make the legal work more efficient and error-less.
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