This article is written by Pratham Dave pursuing a Certificate Course in Advanced Commercial Contract Drafting, Negotiation & Dispute Resolution.
This article has been published by Sneha Mahawar.
Table of Contents
Introduction
With the modernization of the world and innovation, we are heading toward a more technology-driven world in which automation is the norm. The blockchain, artificial intelligence, and big data ideas are revolutionary, and they are ready to transform the way corporate industry and human infrastructure operate. Today, these ideas are closer to us than you might realize, and they have the potential to forever impact our lives.
This leads us to the idea of smart contracts. Simply said, a smart contract is a self-executing contract that is initiated when certain predetermined events occur. The notion of a smart contract can be traced back to a 1996 paper titled “Smart Contracts: Building Blocks for Digital Markets” by American computer scientist Nick Szabo. In the work, Szabo investigates the idea of incorporating certain types of contractual provisions in the hardware and software of a computer algorithm, which are built in such a way that violation of contract would be extremely expensive, if not prohibitively so, for the breaching party. He illustrates this concept using the example of a vending machine, in which smart contracts pass through the machine to deliver the desired product: to function in a vending machine, you would need to enter a command, a certain amount of money (consideration), and then the machine would deliver the product (acceptance). Generally, you should get the same outcomes every time if you utilize the same resources to operate the machine. Vending machines are fundamentally automated machinery, and smart contracts are the automation of their software.
What are smart contracts
Smart Contracts are a set of blockchain-based codes that execute themselves when certain conditions are met. In layman’s terms, they define a contract’s rules and regulations and automatically carry out the specified tasks when the requirements are met. They are known as ‘If’ and ‘Then’ programs in computer language. “If” something happens, “then” that should be executed. Smart Contracts are also known as “E-contracts.”
The Validity of contracts formed through electronic [i.e., Smart Contracts] means in India can be derived from Section 10A of the Information Technology Act,2000.
Smart contracts are treated the same as regular paper contracts, as long as they meet all of the essential conditions for the enforcement of a valid contract under the Indian Contract Act of 1872.
The IT Act, 2000 on the whole does not apply to:
- Negotiable Instruments
- Power of Attorney
- Will
- Trust Deeds
- Any agreement for sale or conveyance of immovable property.
Difference between smart contracts and traditional contracts
Traditional contracts require someone to enforce them; smart contracts, on the other hand, are programs that execute exactly as they are set up (coded, programmed) by their creators. This way, all participants can be certain of the outcome right away, without the involvement of an intermediary or the loss of time. Smart Contracts can also automate a workflow by automatically triggering the next action when certain conditions are met.
Smart contracts are enforceable by code in the same way that traditional contracts are. In a nutshell, smart contracts allow people to transact with greater trust, speed, and security.
Here are two use cases for smart contracts
Real estate
Once the complete payment has been paid to the seller’s account, a smart contract can be formed to transfer ownership of the property. Sellers can direct the process. Smart contracts make property title management more transparent and cost-effective. Title problems can obstruct transfers, resulting in legal expenditures. On the other hand, smart contracts keep track of a property’s history, location, and any other crucial facts that will be required for title assessment. They help to prevent fraud by using tamper-proof and secure encrypted codes. This will lower the amount of money spent on brokerage and other middlemen and the number of fraudulent actions.
Democratic elections process
Blockchain voting technologies could be the way elections are conducted in the future. Smart contracts would be able to confirm voters’ identities, preventing fraudulent votes or duplicate votes from being cast, which is a common target of election hackers. Blockchain voting will boost system confidence, improve voter engagement, and speed upvotes to tally and reporting. Many Americans, for example, still believe the 2020 election was rigged, and this lack of trust in their institutions has resulted in a fragmented country. Blockchain technology can assist in mitigating these concerns.
Types of smart contracts
There are five types of Smart Contracts, they are as follows:
Shrinkwrap agreements
Shrink Wrap Contracts are typically licensing agreements for software [Agreements packaged with products]. In general, the term Shrink Wrap Agreements refers to boilerplate or license agreements, as well as the terms and conditions that come with the products. The consumer’s acceptance of the contract in this sort of contract is determined by his or her use of the product.
Clickwrap agreements
The term Click Wrap Agreements means giving consent for any purpose or for not giving consent for any purpose by clicking the button. [i.e., “Accept” or “Reject”]
Browse wrap agreements
The term Browse Wrap Agreements means to use materials available on a website or to have access to the downloadable product. The individual can only access the contents of the web page if he agrees to the terms and conditions on the web page.
E-mails
Emails can also be electronically signed, which is a crucial factor in determining whether an agreement becomes a contract. Smart Contracts which are executed through e-mails have been ruled in several cases, to constitute a legally binding contract.
For example, in the case of Trimex International FZE vs. Vedanta Aluminium Limited, India 2010, the Supreme Court has ruled on the validity of an unregistered and unsigned contract discussed by email, confirming the contract’s enforceability via email.
Digitally executed agreements
Electronic signatures are the digital and verified equivalents of traditional wet signatures. Electronic signatures are used to sign documents online in one of two methods –
- Aadhaar-based digital signatures with an OTP
- Digital signatures that use an asymmetric public key system and hash methodologies and allow users to sign documents with a password.
Features of smart contracts
Distributed and transparent
Smart contracts are maintained on a blockchain, they operate on a peer-to-peer network, which means they are dispersed among all nodes running the blockchain and anybody can read the contract’s information.
Customisable
Before implementation, smart contracts can be programmed in a variety of ways to meet the demands of the transacting parties.
Deterministic
No matter who executes smart contracts, the outcome is always the same depending on the actions they are designed to perform.
Benefits of smart contracts
Automation
Smart Contracts can help to automate a lot of processes.
Efficient
Since the contracts are saved on computers, they carry out the functions as soon as the prerequisites are met.
Security and storage
The contracts are recorded digitally on a blockchain, they are protected by encryption, and the possibility of losing or misplacing them is eliminated.
Immutable
Contracts that have been deployed cannot be modified, thereby removing the possibility of manipulation by other parties or any of the parties participating in the agreement.
Cheaper
Intermediaries typically charge a fee to facilitate transactions between two parties, which will be significantly reduced, if not eliminated, with smart contracts.
Limitations of smart contracts
Inability to adjust
Smart contracts are immutable, any errors or flaws in the contract cannot be fixed after they are stored on the blockchain. Contracts can be cancelled if a ‘SELF-DESTRUCT’ function is introduced while they are being created.
Software bugs
Since all of the data is stored in computer codes, it may be prone to software faults.
Third-party
Smart contracts cannot completely replace third parties as some processes do require human intelligence that cannot be replaced.
Vague terms
Since contracts include terms that are not always understood, smart contracts are not always able to handle terms and conditions that are vague.
Validity & enforceability of smart contracts
As per Section 10 of the Indian Contract Act, 1872, the following criteria must be satisfied for a legitimate contract:
- The parties to the contract must be competent to contract.
- The Contract must be based on the free consent of the parties.
- The Consideration and Object must be lawful, and
- The Agreement must not be expressly declared to be void
The Indian Contract Act,1872 shows no evidence of the following requirements:
- A written contract unless there is a legal requirement to have a contract in writing;
- A signature either physically or electronically.
Thus, Smart Contracts are enforceable in India as long as they meet the aforementioned criteria.
Section 5 and 10 of the Indian Information Technology Act, 2000 legally recognize digital signatures and acknowledge a contract as authentic and enforceable through electronic methods. Furthermore, Section 65B of the Indian Evidence Act, 1872 stipulates that a contract that has been digitally signed is admissible in a court of law. As a result, the government can take legal action to resolve the issue between the parties.
Smart Contracts, in essence, give a framework for negotiating with parties who may or may not know each other and who may or may not be liable for the risk. Smart contracts may be enforceable under Indian law, but if caution is not exercised about the party with whom you are dealing, the repercussions of failed transactions must be carried alone, as the legal system lacks a detailed framework in place to control smart contracts.
Smart contracts may not be enforceable under Indian law if the consideration for the contract is not mutual. This can happen if the contract is unilateral. Contracts are not valid in Indian courts without mutual consideration; however, smart contracts without mutual consideration can still be enforced through code; however, a breach of such a contract would not be considered a breach in Indian courts because, in the eyes of the court, there would not have been a contract in the first place due to the lack of mutual consideration, an important factor of contract.
The legality of smart contracts in India permits the use of smart contracts; however, it does not provide the parties involved in the smart contract with legal protection if they become liable or incur damages because there is no supervisory framework in place to govern the smart contracts; however, the law will assist to the best of its ability if the smart contracts fall within the limits of contract law as defined in the statute.
Conclusion
There is no doubt that the application and expansion of smart contracts is the next stage in innovation and can directly lead to billions of dollars in overhead expenses being reduced while making the entire system more efficient.
However, regulatory concerns arise, particularly in India, where there are no regulations governing the finer aspects of smart contracts. If particular laws are not enacted, widespread usage of the technology will necessitate modifications to the Indian Evidence Act of 1872 and the Information Technology Act of 2000.
As a result, while there has been some progress in legislation and business sector adoption of the smart contract concept, the law is still operating in a murky area, and a strong commitment is necessary to develop an intricate structure to regulate the operation of smart contracts in India.
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