Why Smart Contracts Need Lawyers
Smart contracts are widely hailed as one of the most transformative applications of the blockchain technology. Many of its proponents have touted its potential to reduce legal work, and even eliminate the need for contract litigation altogether.
So just what are these things?
Smart contracts are computer protocols meant to digitally facilitate, verify, or enforce the execution of contracts. Smart contracts can self-execute when certain conditions are met, seamlessly enforcing contractual obligations without the added expense of a middleman. Though the idea of smart contracts preceded the blockchain, the blockchain is thought to add value by making these contracts immutable and transparent. Proponents see use-cases in everything from share-trading to employer agreements.
The Role of Law in Smart Contracts
If you were to listen to some people speak about the implications of smart contracts, you might believe them to herald an escape from the established law. After all, it seems like the primary reason we abide by contract law is because of issues of trust: the government necessarily stands between every contractual agreement, assuring that the terms will be enforced even if one party tries to renege on their end of the bargain. Government won’t be there to enforce a contract, however, if the contract contravenes its laws. Thus, to assure enforcement, we must acquiesce to its law’s demands.
But if agreements’ terms can be enforced automatically via computer code, why abide by the government’s rules at all? From this perspective, the law — conceptualized in this context as the government’s terms for its role as third-party enforcer — seems entirely unnecessary in a world of smart contracts .
This line of thinking takes the automation of the contractual process as akin to a vending machine: drop a (bit)coin into the vending machine (i.e. blockchain contract), and out pops your soda (e.g. whatever good is stipulated to be given in exchange). No third party necessary, just you and a preset protocol.
But the law does in fact have a hand in even the most mechanical exchanges. Take the vending machine example: when you drop a quarter into a vending machine, it may seem like there is no role for a third party like government — like it is simply metal-on-metal processes at work. But this is an illusion. In fact, the law penetrates that transaction in many ways: contract law is implied by dropping a quarter into the machine with reasonable expectation that the machine will produce the promised good as a result; product liability law regulates the type of goods that can be contained within the vending machine; property law protects the machine itself from theft. In short, law envelopes the exchange. A processes degree of automation has little effect on its need to be legally compliant — smart contracts, like vending machines, operate in the same legal space as everything else.
Contracts can always be voided if illegal or against public policy. Even in contracts where the relationships and obligations of the parties are perfectly clear, contracts do not escape the law. For example, in Campbell Soup v Wentz, a large food producer (Campbell Soup) had a contract with farmers that stipulated farmers were only allowed to sell their farm’s carrots to Campbell Soup. A farmer breached the contract by selling to another vendor. Campbell Soup sued.
Though all parties admitted the contract made both sides’ obligations unmistakably clear and the farmer was in clear violation of its terms, the court found against Campbell Soup. Setting the contract’s text aside, the court held its terms unconscionable, and refused to enforce the contract.
Even if a turing-complete blockchain seems to remove the state from a contract, the state is always a party, and a ‘court of conscience’ can and will assert itself to overrule ‘smart’ contract terms it judges egregiously unfair or one-sided.
Thus, on the one hand, it might not be the best idea to create smart contracts without professional legal advice. Though findings of unconscionability are context-dependent and unpredictable, contracts generally are a highly specialized field of law, requiring particular terms to ensure specific legal outcomes in the event of a dispute. An understanding of the law is therefore critical to many types of smart contracts.
On the other hand, it may not be a great idea to enter into a smart contract without legal advice. The law will not intervene in every instance, even where we may intuitively think it should. For example, in Morales v. Sun Constructors, Inc., a court ruled to enforce a contract against a man who was made to sign to its terms written in a language he didn’t understand. The court held that, without proof of intentional fraud or misrepresentation, an individual’s inability to understand the contents of a contract is immaterial to the contract’s enforceability.
Analogously, your inability to comprehend a smart contract’s code will likely fail as a legal defense in an American court of law. This can be a big problem: smart contract code is often opaque, written by human coders with different syntactical styles that are challenging to interpret. As a result, smart contracts are difficult to audit, and susceptible to defects. Though the doctrine of mutual mistake can protect parties who are both mistaken about the same material fact within their contract (e.g., a security flaw), contract law jurisprudence instantiated by Morales suggests you may not have legal recourse if you fail to appreciate the terms of your smart contract.
Mistaking Features for Bugs
Finally, it’s not clear that all of smart contracts’ purported benefits actually add value. For example, smart contract proponents tout automated, boolean-logic contracts’ ability to consider every condition, and explicitly specify what happens in the event of that condition. Perfect information, it’s thought, leads to a perfectly fair outcome that won’t surprise anyone, and so will never require litigation.
This ignores a key lesson in contract law: ambiguity is often intentionally inserted into contracts’ clauses. This is because many issues in contracts are overly-contentious. For example, negotiation of severance packages while hiring a new CEO might create tension over an eventuality that may never come about. In such cases, it is more efficient to write some terms in inexact language, so as not to derail negotiation talks that might otherwise amount to a mutually beneficial outcome. Thus, ambiguity is inserted into the clause to shelf the issue, tacitly agreeing to trust that the courts will find a fair outcome if need be.
Smart contracts’ issues are by no means intractable. They may be appropriate for standardized contracts that require little nuance, and their applications in areas like corporate governance are indeed exciting. Decentralized autonomous organizations run by smart contract rules offer new business models that give investors more options to diversify their portfolio so long as contract rules are transparent and compliant with law. Another possible benefit of smart contracts is control of means of resolving contract disputes, for example with strictly confined and economic Alternative Dispute Resolutions (perhaps even with AI). But smart contracts should be made with a view toward extant law, and leave space for ambiguity in some circumstances. Because litigation is a fundamental corollary of the human condition, and smart contracts won’t change that (though they might minimize certain types of disputes). And besides, laws aren’t all bad (a few are actually useful!), and sometimes, the legal system has a role to play in ensuring a just outcome.
