Law commission

Summary of advice from the Law in Government Commission on smart legal contracts

SMART CONTRACTS

The Right to Government Commission’s opinion (November 2021) builds on the findings of the Legal Statement on Crypto-Assets and Smart Contracts (November 2019) issued by the UK Jurisdiction Taskforce.

In summary, the current UK legal framework already facilitates and supports the use of smart legal contracts (defined as “legally binding contracts in which some or all of the contractual obligations are defined in and/or performed automatically by a computer program “), without the need for legislative reform.

Three potential forms of smart contracts have been identified: (i) a natural language contract where some of the obligations have been performed by code, i.e. the code is only the means by which the obligation is filled; (ii) a hybrid of explanations and natural language terms but where, primarily, the code would define and perform the contract; and, (iii) a contract written entirely in code.

Regardless of form, the Law Commission found that the jurisdiction of England and Wales, combined with common law, provides a flexible platform in which “smart legal contracts” can already operate. The Law Commission addresses some of the potential legal uncertainties as follows:

  • contract formation (other than for deeds) is not an issue, provided the terms of the smart legal contract are defined in source code which uses words and symbols (and not a lower level of machine code which is expressed only mathematically) i.e. provided that the terms of the contract can be “read” by an ordinary human (see below), the fact that they are expressed in high-level computer code does not then being not an obstacle to training;
  • questions of contractual interpretation should be resolved through a “reasonable coder” test, i.e. what a coder would understand to mean the code; as opposed to how the code would be implemented by a computer;
  • although the immutable nature of the blockchain may mean that the contract cannot be terminated (for example due to misrepresentation), “practical justice” can nevertheless be achieved via a court ordering the parties to enter into a second transaction “equal and opposite” to counter the first transaction.

The paper also discusses other issues that might be encountered in relation to the formation of smart legal contracts such as:

  • whether the source code is intended both to define contractual obligations and to perform them, or only to perform them;
  • the relationship between natural language and coded terms, which terms would take precedence in the event of a conflict;
  • allocation of risk from faulty oracles (external data sources that the smart contract depends on to function properly), inaccurate data entries, system upgrades, bugs and coding errors, and any potential erroneous beliefs or assumptions about how the code will work; and
  • applicable law and jurisdiction.

FUTURE PLANS

The Law Commission’s project on legal smart contracts is itself linked to a wider set of projects which together address the extent to which English law and England and Wales, as a jurisdiction , are able to facilitate and attract the booming markets of digital assets and crypto assets, for example, “tokenized” assets such as NFTs. The Digital Assets Law Commission and Conflict of Laws projects aim to resolve the perceived legal uncertainty surrounding, respectively, the ownership (and transfer of ownership rights to) a digital asset and the assignment of a actual location to a digital asset.

There will likely be substantial updates to this set of Law Commission projects during 2022.