The Law Commission has published its advice to the UK Government on smart legal contracts and concluded that “the current legal framework in England and Wales is clearly able to facilitate and support the use of smart legal contracts, without the need for statutory law reform”.
The advice forms part of an on-going project initially commissioned by the Lord Chancellor in 2019 into the ways in which smart contracts are being used, and the extent to which the existing law can accommodate them.
Here are our key takeaways:
The Commission’s advice is consistent with the UK Jurisdiction Taskforce's (UKJT) 2019 Legal Statement on Crypto Assets and Smart Contracts. In 2019, The UKJT Legal Statement concluded that, in principle, smart contracts are capable of giving rise to binding legal obligations, enforceable in accordance with their terms. This week’s publication by the Commission echoes the findings of the UKJT, stating that a smart legal contract is legally enforceable and, much like a traditional contract, “a court will only hold the agreement to be uncertain as a last resort.”
In its advice, the Commission defines a smart legal contract as “a legally binding contract in which some or all the contractual obligations are defined in and/ or performed automatically by a computer program.” The publication then goes on to detail three different forms of smart legal contracts, being: 1) a natural language contract with automated performance; 2) a “hybrid” smart contract; and 3) a solely code contract. Of the three forms of smart legal contract, all are performed in code. Interestingly, and in keeping with the majority of NFT sales we have seen to date (which are typically “hybrid” smart legal contracts), the Commission anticipates that the terms of most smart legal contracts will be negotiated and written in natural language: most smart legal contracts will require an accompanying natural language agreement setting out the key terms of sale and agreement. “Solely code smart legal contracts are likely to be rare in practice, given that commercial contracts are typically too nuanced to be reduced solely to code.”
The Commission advises that in most cases, whether a smart contract is legally binding will turn on whether it satisfies the same legal/formality requirements of a traditional contract. This is perhaps unsurprising given that the Commission envisages that smart contracts will continue to be largely accompanied by natural language agreements (though you have to wonder, given how nascent the technology, as the technology advances (smart contracts may become ‘smarter’ and move closer to solely code smart legal contracts) legal reform may well be needed after all). In their present form (i.e. hybrid smart contracts) the Commission does recognise that there are areas of uncertainty and possible difficulties that are unique to smart contracts. For example, identifying the place of formation could prove more difficult in the smart legal contract context and parties would be well advised to include a jurisdiction clause in their smart legal contract. “Smart legal contracts may present unique challenges when seeking to identify the geographical location of breaches, actions, and enrichments, particularly where the obligations under a smart legal contract concern a digital asset, rather than a physical asset with a clear real world location.”
On the point of determining geographical location and digital assets, the Commission does appear cognizant of the particular challenges here for smart contracts and notes that its work on these issues is not complete. In fact, the Commission goes so far as to state that “the problem of digital location – that is, the difficulty of ascribing real-world locations to digital actions and digital objects – is amongst the most significant challenges that private international law will have to overcome in relation to emerging technology.”
Next steps: the Law Commission has now agreed with the Government to undertake a project looking at the rules relating to conflict of laws as they apply to emerging technology, including smart legal contracts and digital assets, and considering whether reform is required. This project is expected to commence in mid-2022.