This article has been written by Sanjay Kumar Sah pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution at LawSikho, and has been edited by Shashwat Kaushik.
It has been published by Rachit Garg.
Table of Contents
Before we start the discussion on the title “whether smart contracts can serve as a substitute for contract law : an analysis”, we must know something about smart contracts, like what a smart contract is and how it is different from a normal contract, etc. We know that we are living in an era in which technology is growing very fast in such a way that if a new technology comes in one day, it will be replaced by another superior technology in a few days, especially in the world of IT Technology. IT technology is a very fast-growing area where uncertainty always exists. No one would forecast the timing of a new technology, i.e., up until which time it will be replaced by another superior technology.
What is a smart contract
A smart contract also establishes the terms of an agreement. But a smart contract’s terms are executed as code running on a blockchain like Ethereum. Smart contracts allow developers to build apps that take advantage of blockchain security, reliability, and accessibility while offering, unlike a traditional contract, sophisticated peer-to-peer functionality—everything from loans and insurance to logistics and gaming.
Contract law is the law of the land under which an agreement/contract is to be constituted between at least two parties, to which both parties consent. A contract by civil law is, as embedded meaning implies, a contract that is formed under the law of the land between two or more parties who are sound minded, majority age, competent to contract, enter into an agreement with each other’s consent after a long deliberation between them, and last but not least, is enforceable by the law of the land. The contract by law contains two major ingredients like “Force Majeure” and “Third party rights’ ‘. Force Majeure is a specific clause that indicates situations that are outside the control of the parties, are unforeseeable, and under which the parties cannot be compelled to perform under the agreement. Usually a duration is specified, and if the force majeure period extends beyond the specified duration, the parties can choose to terminate the agreement.
Third party and smart contracts
Whereas third party rights specify that the rights under the agreement are for the benefit of the successors and permitted assigns of the parties and not any other third party. Only third parties with express authorisation from parties to the agreement may be allowed to enforce the provisions of the agreement. This clause aims to restrict third-party claims under the agreement.
If we analyse the above information about smart contracts and contract law, we find that a smart contract is written in a specific machine language, such as block chain technology, which is encrypted and does not involve third-party intervention. It cannot be tempered. It is self-verified and self enforced. For example, a vending machine works on the same principle, i.e., the seller, through the printed description on the machine, tells about the services he is providing through the machine, and if anybody wants to take the service of the seller, he puts some coins in the machine, and the machine delivers the product of his choice. During this process, the seller and the buyer enter into a contract between them for selling and buying goods that is self-enforced, however temporary. But if the machine fails to deliver the specified service despite payment due to a technical or power failure, the buyer cannot claim or return his money at the same time. If he wants to claim his money back, the only remedy is to take legal action in a court of law, which is a very expensive and cumbersome task for a small amount in comparison to the legal expenditure he will have to bear.
On the other hand, contract law specifically provides the way for any loss to any party due to breach; they have the equal right to claim in the specified court of law mentioned in the contract, which is mandatory under contract law.
Can smart contracts serve as a substitute for Contract Law?
Without a doubt, both contracts—contract law and smart contracts—apply the human mind’s application. But how the two documents were prepared was very different. In preparing smart contracts, specific machine language, which is in coded form, is used. No one knows whether any deliberations take place between the parties or not because smart contracts have a set machine format. Like Bitcoins, it is neither legal nor respects the sovereignty of any country because the specific machine language is the sole intellectual property of a human/company that is situated in a far-flung remote area, and the user is another person who is seated/situated in another country/area. The supporters of smart contracts claim that this is tamper-proof, but can it be true. As we all know, any computer program has a source code that is not shared by the company with its customers who use their software. In these circumstances, can anybody say that smart contracts could not be tempered by those who have reached the source code of the software?
On the other hand, while preparing contract law, detailed deliberations have taken place. It passed through many stages, from preparing bills for putting in the Assembly of Parliament, as the case may be, to passing by the Assembly or Parliament. The contract law respects the sovereignty of the country and is also enforceable by a court of law, which is the pious soul of it and is not possessed by smart contracts.
Enforceability of smart contracts
Generally, people are unaware of the enforceability of smart contracts and are dicey about them because of their unique nature. Its unique nature means that it is different from traditional paper contracts. However, smart contracts are enforceable in court as long as they adhere to traditional contractual rules. Those rules include the following:
- Offer, acceptance and consideration
- Offer- It is the first step in the formation of a contract. When one or both parties offer the terms of the agreement.
- Acceptance- Acceptance means when one or both parties accept the invitation or offer.
- Consideration- When a party accepts the terms of the agreement and gives something in return, it is said to be a consideration. Consideration is very
- Legally permissible terms
The terms of the contract must not be illegal or impossible to perform. This means the terms should not ask the party to commit an act contrary to the law. For e.g- Waiving off a right that the party cannot legally waive off.
- Legal to sign electronically
The smart contract must be legally electronically signable, as there are lot of agreements that are not legally signable like wills, testimonies, court orders, etc. So an electronic signature is an important factor here.
Legal challenges to smart contracts
Once smart contracts are in place, they cannot be modified. New technological advancements bring about new problems, such as:
- Automatic enforcement
Once a smart contract is set in place, it is automatically enforced, so any flaw or illegality can’t be modified or removed afterwards.
- Modifying the contract
Once a smart contract is set in motion, it cannot be modified; it can only be withdrawn or cancelled. Maintaining a backup is also recommended for this reason. So a careful analysis of smart contracts is a must before setting them in motion.
- Handling disputes
Each party to the smart contract must be thorough with the terms to avoid any dispute because handling disputes gets difficult once it’s set in motion as it cannot be amended; it can only be cancelled.
In view of the above deliberations, in my opinion, smart contracts could not be a substitute for contract law unless and until efforts are made to bring them under the law of the land. Smart contracts will likely be widely used in the future but not in the present because of their rigid nature and limitations. These contracts can’t be used in every field, whereas normal paper contracts can be used in every field.
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