Contract Law Primer for DLT/Crypto
Distributed Ledger Technologies (DLT) — blockchain, crypto instruments, and so-called “smart contracts” — face a major obstacle on their march to global domination: themselves.
DLT is akin to the introduction of the Internet in the 1990s and the introduction of the “wiki” as a tool for real-time collaboration. In its transformative potential, DLT can be likened to the spread of fully mobile computing. DLT/Crypto/Blockchain is a very big deal.
Yet one of the biggest obstacles to DLT’s continued growth remain big conceptual questions and questions of nomenclature.
There is a strong need for convergence around interoperability standards, for instance. Many development teams realize this and are working hard to make DLT platforms and projects interoperable along different planes.
The only way to appreciate the urgency of this is to take a quick foray into some contract law basics. That is the purpose of this 20-minute primer.
Please note that CleanApp Foundation is not the only body urging a move away from “smart contract” terminology in the DLT space. Sherman Lee recently published an article in Forbes asking: “are smart contracts more trouble than they are worth?”
As we’ve stated before, the answer is a qualified “yes,” but for totally different reasons than the ones explored by Lee.
We continue to be bothered by the presumptuous prefix “smart,” because of its propensity to mislead even sophisticated market actors operating on the leading edge of DLT development. As The Devil’s Advocate reminds us, vanity is a very slippery slope.
The main reason we think ‘smart contracts’ are far more trouble that they are worth has to do with terminology — the fact that the DLT community embraced a formal legal term to describe what are, at heart, non-legal analytical processes.
With a conceptual divide that big, serious trouble is not far behind.
The Conceptual Cracks Are Showing
Everyone should have started seeing cracks in this ‘contract-ish’ conceptual matrix the first time regulators asked whether a given crypto toin (token and/or coin and/or Tangle and/or 5D7Z instrument, whatever it calls itself) was a “security” — a particular type of legal form, with specific legal implications.
Today, the smartest developers, market-leading investors, and the best lawyers realize that the security v. not-security debate isn’t just the tip of a much larger iceberg. It’s much bigger than that. How the DLT community engages with the legal community in the next several years will determine how much of a role DLTs will play in global governance.
Right now, DLT actors are just sticking their first toes into a tumultuous ocean of law. But the sharks, medusas and crocodiles are already frothing at the mouth.
Knowledge of contract law and legal theory determines whether you eat or get eaten.
As a Term, “Smart Contract” Must Go
The immediate impulse for this piece was a refreshingly analytical thread by Kate Sills on Twitter. In this thread, Sills uses Anthony T. Kronman & Richard A. Posner’s book, The Economics of Contract Law, as a launchpad for interrogating the essence of the thing we call “smart contracts.”
The thread is so refreshing because it asks whether a particular “smart contract” transaction really is an enforceable contract or not. It’s not clear whether Sills is a lawyer, but her analytical posture is Exhibit A of good lawyering: assume nothing, question everything. We’ll return to her argument shortly.
But first, here’s our narrow thesis in this piece:
Continuing usage of the term ‘smart contract’ in DLT discourse will breed even more incoherence, conceptual slippage, and … trouble. The benefits of moving on from this misnomer far outweigh the costs of keeping it.
If you’ve used the term ‘smart contract’ in the past week, you owe it to yourself to work through the argument below. The few minutes spent here will repay themselves multiple times over. Guaranteed.
What’s in a Name?
In civilian (Roman-inspired) and common law (Anglo-inspired) legal systems, a contract (shorthand, “K”) is any agreement, no matter how it’s formed or how it’s called, between two or more parties that is enforceable by law. There are important differences of approach with respect to contract formation in these two big families of legal systems.
For our purposes, however, the core commonality is more important than the differences: a contract is a legal form, a legal instrument, enforceable by legal institutions.
The centrality of legal institutions in the process of contract formation and contract disputes cannot be over-emphasized. From a legal perspective, a contract simply does not exist until such time that it is said to exist by a legal actor.
A contract, in other words, is a legal fiction, a ghost — a chimera.
Even lawyers (the sorcerers who claim to create & invoke these ghosts) have limited powers.
The legal essence — the enforceability — of a wannabe contract-ghost (including the super-duper ghosts conjured up by lawyers) is illusory until such time as contract rights are actually enforced.
If you think this is too theoretical and not useful, you are wrong.
The Ghosts of Stormy Pasts
To see the real-world implications of this, just turn on CNN and ask yourself the following. Is/are there: (1) a K and/or Ks between Stormy Daniels and DJT, (2) a K and/or Ks between Stormy Daniels and Michael Cohen, (3) a K and/or Ks between Stormy Daniels and Essential Consultants, LLC, (4) a K and/or Ks between Stormy Daniels and Keith M. Davidson, her lawyer in the original “hush agreement” scheme, (5) a K and/or Ks between Stormy Daniels and Michael Avenatti, (6) a K and/or Ks between Stormy Daniels and Michael Avenatti’s firm, Avenatti & Associates, APC, (7) a K and/or Ks between Stormy Daniels & Michael Avenatti’s previous firm, Eagan Avenatti, LLP, (8) etc. […].
The most important of these questions is #8 — the lesson to stay humble and keep scanning the field for potential attack vectors that you might have overlooked. Sound familiar? It should. If you’re a vigilant coder, this is precisely the due diligence that you do before you compile. Both law-coders and tech-coders know the far-ranging consequences of failure.
Now that we’re on the same page, now that we see what’s really at stake, feel free to go back to the list above and ask yourself how many Ks you thought there were between Stormy Daniels & DJT — and this a legal story that has been front page news, globally, for more than a year.
What Can Stormy Daniels Teach DLT?
Now that our contract juices are pumping, we can train our analytical scalpels on the myriad new “partnerships” and “alliances” we’re seeing in the DLT space. What, precisely, is the legal form of the “long lasting partnership” between Ethereum’s Status & OmiseGO announced just a few days ago? Is it a contract? If so, is it a so-called “smart contract?” And so on…
These are not broad theoretical or narrow technical questions. These are the questions everyone in the DLT community should direct to the principals behind these partnerships. We should not lose sight of the fact that the main technological innovations DLT is selling to the world are stronger, better, clearer transactional networks. Yet,
If DLT players keep making this pitch to users while relying on the same opaque “dumb contract” mechanisms in relations with one another, this isn’t merely disingenuousness — it shows lack of faith in one’s underlying vision.
When the Wi-Fi Alliance was planning to take over the world, they knew they had a winning technology not because of the awesome mathematical proofs backing them up (which were and remain key, as we all know). The Wi-Fi Alliance knew they would rule the world when they started setting up small Wi-Fi hotspots in their own early internal meetings, realizing that it was much faster to share documents this way than running cables everywhere or dispatching secretaries to copy centers.
The Wi-Fi anecdote is a real story — one that shows faith in one’s own big idea, and in an even bigger collective idea.
DLT Must Lead By Example
If one of the key DLT innovations are “smart contracts,” DLT players need to be broadcasting links to their own “smart [inter-DLT] partnership contracts” and “smart [X] contracts” right and left. They should be demoing just how smart these technologies really are at aligning the interests of disparate actors with potentially divergent strategic aims through clear incentive structures.
By failing to do this, the DLT community sends out the following message: “everyone should learn how to do ‘smart contracts’ — it’s easy, it’s free, it’s great; but, of course, for the really big deals, like the Status-OmiseGO or Stanford & E+5 dealio, well, of course, there we need, …you know, well, our lawyers tell us, that, …well, you know, we’re going to go with a more traditional partnership.”
It’d be like the Wi-Fi Alliance folks getting together and saying, “yeah, we know we have the hardware and software to set up a hotspot, but you know, it’s just that, we have so much, you know trade secrets, and knowhow, and IP and specifications, we just don’t feel right about transferring that over the air. Sam, can you hand me the Ethernet cable?”
Getting Back to Maybe
Returning to the list of Stormy Daniels questions or our continuing questions about DLT contracting practices, we can start building operational toolkits.
Here’s one insight that every law student is taught on the first day of law school: a good lawyer’s honest answer to any of the legal questions above is “maybe” or “it depends.”
“Maybe” is the most that anyone (including impartial judges, third party legal experts, and arbitrators) can say about the contract-ness of any of the above relationships, and potential instruments.
The reason the Stormy Daniels example is so useful is because it shows that no amount of formalism and no amount of lawyer sorcery can move the needle away from Maybe-land towards definitely Yes-town, or definitely No-ville.
Still not convinced? If you want to spend 25 minutes watching lawyers argue, please enjoy this master class:
Going back to the list of possible contracts above, you may think that there were two contracts between Stormy Daniels & DJT, including (1) the NDA, and (2) a separate side letter agreement. Or, you may deduce there was one overarching “hush agreement” between “the parties.” Or, you might hire a “straight up crypto lawyer” who, sensing your desire for certainty, can definitely answer, “On #1 through #5, there were definitely 8 formal contracts, 2 implied-in-law contracts, and 1 implied-in-fact contract; on #6 & 7, there were absolutely no contracts, express or implied.”
But here’s the thing, and we hope this doesn’t come across as rude: what you think or what your lawyer thinks is largely irrelevant for purposes of determining whether or not there is an enforceable contract.
As Tupac teaches, that’s just the way it is.
But We Reeeallly Think There’s a Contract
If both parties agree that their ‘smart unicorn’ is a contract, then there is no K formation dispute. There may still be a question of interpretation (or breach, or damages, etc.) but if parties agree there’s a K, there’s no need to resort to legal fictions or appeal to expensive legal actors to determine the narrow question of whether there’s a K. Right?
Wrong! Even there, when you thought you were standing on relatively uncontroversial solid ground, a contract that “both sides” agree exists can be ruled unenforceable on many legal and extra-legal grounds.
Judicial fiat power is vast, and many contracts in breakthrough fields like clinical trials, e-contracting, medicinal marijuana, and so on, are routinely invalidated on various statutory, public policy, or precedent-based illegality doctrines.
What more, third parties have numerous legal attack vectors that they can exploit to undo a “bulletproof contract” that two super sophisticated sets of parties spent years trying to put together. Global consumer protection statutes, antitrust law, environmental law, and other fields give numerous private rights of action that can be leveraged to pierce the purportedly bulletproof K.
Ok, But What About Contracts in Self-Contained Legal Systems?
If parties want to call their ‘will,’ their ‘MOU,’ their ‘governance compact’ a “contract,” and if the parties are doing what each side expects to be done under this, say, ‘MOU,’ then there’s no K dispute.
Where there’s no dispute, we don’t even need to decide whether or not there’s an actual K between the parties.
If both parties want there to a be a K, then a K can be said to exist between these parties functionally, operationally, pragmatically — but not legally.
Because there is no present dispute between the parties, there is no need for a legal intervention, and therefore, their ‘smart unicorn’ may look like a contract, act like a contract, feel like a contract:
The parties may proudly proclaim: We contract, therefore these are contracts!
But the only time we will ever have a legal answer to the question of whether the parties created an actual contract is if and only if there is a dispute about the contract and a legal institution steps in to resolve this dispute.
There’s No Such Thing as a Self-Contained Legal System
“Ah, here’s the thing you don’t understand, little CleanApp. Our DLT is a self-contained legal system! We have the best mathematicians and the best cryptographers who are working on the best incentive structures to implement X, Y, Z — as our very own legal universes.”
That’s not only a naïve understanding of how law works, but it’s also a very dangerous position for the DLT crew that’s trying to develop its own legal universe, and for the DLT community as a whole.
In case you haven’t noticed, lawyers don’t share well. Lawyers understand that this is how you may view the DLT socio-legal-institutional landscape:
But this is how lawyers view the world:
Don’t hate the player; hate the game. Please note that this is just another version of Newton’s First, ahem…, Law:
Actors in power stay in power and legal institutions in motion stay in motion with the same speed and going in the same direction unless acted upon by an unbalanced force.
The interesting thing about legal institutions, of course, is that when they are “acted upon” by an unbalanced force, they usually bite back.
Lawyers Are NIMJ-as
Lawyers guard their own turf zealously and will invent as many legal justifications to preserve their primacy as it takes. This is a totally mainstream legal stance that’s required of lawyers by … their own laws on lawyering. Consequently, this is how conventional legal institutions view DLT & the meta-level “threats” from ‘smart contracts’ —
You want to be a Blockchain disruptor along the lines of LegalZoom? You want to take over our property title and escrow functions? You want to do smart contracts as opposed to, what, our “dumb” contracts? Go ahead, try it out elsewhere, but NIMJ — Not In My Jurisdiction! (a play on NIMBY — Not In My Back Yard!)
Things like “jurisdiction” aren’t just polite or fancy ways of talking about what a certain actor would like to do in a certain place, or with respect to certain activities. Jurisdiction is simultaneously a stern warning to would-be encroachers. Back off!
The same is true with contract. A contract is a legal creature, with its own supporting argumentation, instrumentation, and institutional frameworks. To actually enforce contractual rights in the material world, one must resort to legal enforcement mechanisms. The root operator here is “force.” Please let that sink in. Law enforcement = legitimate exercise of police force. And who gets to say whether the force or threat of use of force is legitimate in particular contexts? You got it: lawyers!
Even so-called “informal” dispute resolution mechanisms like arbitration aren’t the shortcuts they appear to be at first blush.
Even if you’re fortunate to get an arbitral award in your favor, if the other side won’t honor it, you must still go through an enforcement action. Law is inescapable.
To lawyers all over the world, it doesn’t matter if you want to create your very own legal universe. At the end of the day, the flesh-and-blood lawyer knows that you must come to them for a flesh-and-blood legal remedy once you’ve exhausted all of your “sorta-legal” remedies in your so-called “self-contained legal system.”
This is why, from global legal perspective, there is no such thing as a self-contained legal system. In fact, the best lawyers will tell you there cannot be such a thing as a self-contained legal system, not in the virtual world and not in the material world. This is what lawyers mean when they say that “law structures everything” and that “law is [constitutive] code.”
Lawyers say these things and get away with saying these things because they have given themselves a legal monopoly on law practice — the legal right to say these things. Simultaneously, the self-regulated monopoly includes the power to punish those who act in contravention to this order of things.
When lawyers hear DLT coders proclaim that “code is law,” the first response is “duh!” — because what the lawyer hears is reaffirmation of law’s pride of place. When the lawyers realize that’s not what coders mean, the second response is to look for as many attack vectors as possible to contain the potential insurgents.
Coders may not see themselves as insurgents in this respect. But to a lawyer, that’s irrelevant.
Even a potential threat to law’s sovereignty and law’s primacy is a serious threat to law’s sovereignty and lawyers’ primacy.
Here’s how all this plays out in contract law.
Parties’ Legal Intention is Irrelevant
One of the best ways of illustrating the implications of the themes above, and the centrality of conventional legal institutions (like law firms, lawyers, bar associations, arbitration chambers, courts, etc.) to contract enforcement is to recall a foundational principle of American contract law.
Here’s what the American Law Institute teaches in its Restatement (Second) of Contracts:
§21. INTENTION TO BE LEGALLY BOUND
Neither real nor apparent intention that a promise be legally binding is essential to the formation of a contract, but a manifestation of intention that a promise shall not affect legal relations may prevent the formation of a contract.
You read that right. Whether parties wanted there to be a K or not is largely irrelevant: your real intention that you were entering into a “smart contract” is not essential to the question of whether your “smart contract” is actually a contract or not.
R2C § 21 encapsulates what’s known as the “objective theory of contract formation” — the idea of invoking a hypothetical reasonable objective third party and asking them the following question, “Putting aside whether the parties thought they were entering into a K (because it’s so easy for parties to lie about that after the fact), what do you think, dear reasonable person — based on the facts presented — do you think there was a K?”
This may seem bizarre to non-lawyers. It may also seem bizarre to civil law lawyers, at first. But this isn’t the most bizarre feature of this foundational rule of contract law. Please remember: whether or not you wanted or intended to have a legally binding K is largely irrelevant.
However, if you somehow made it clear that you did not want to have legal relations with that “smart contracting” party, that intention to not have a K may prevent the formation of a contract.
How can you tell if you manifested enough intention to not enter into a K in your particular “smart contract” context? Hint: call a lawyer.
The lawyer will start the billable timer, and the process starts from scratch.
WTF? No Wonder Vitalik Wants Self-Sustaining Legal Systems
We get that this is infuriating at first. This level of indeterminacy is also frustrating for baby lawyers who are grinding their baby shark teeth on these squishy medusa-like concepts.
But there are manifold theoretical and practical reasons why indeterminacy is built into legal process, and there are many ways to operationalize this indeterminacy in one’s favor. Most lawyers start learning the latter only in practice, when they realize that the answer to the question at the top of the client’s mind — “Is my ‘smart contract’ a real K?” — is really, truly, ever, actually, a … “maybe.”
The more important question comes when the lawyer turns to the client and says:
“Hmmm… that’s interesting… but let me ask you this, do you want your ‘smart contract’ to be a K? Because I can make equally strong arguments for Yes, as well as for No.”
You can fight this uncertainty, ambivalence, and indeterminacy all you want, but you can’t code around it when anything non-trivial is actually on the line.
This is why the “smart contract” label is such a misnomer, so slippery, and so misleading. If anything, what’s being described when people use the term “smart contract” is “smart [maybe] contract.”
We realize that “smart maybe contracts” don’t have the same ring to them as “smart contracts.” But it’s a far more accurate term to describe what’s really taking place. That, or as we proposed, returning to something far more whimsical and expressly non-legal — for obvious tactical and strategic freedom of maneuver reasons — instead of “smart contracts,” or even transactions, or bargains, just call them what they are: “smart unicorns.”
With This Much Uncertainty, How Is It Law?
One of the things that bothers the heck out of parties is how anything can be done with this much legal indeterminacy in the basic building blocks of contract formation.
If it’s really this unclear whether we ever have a contract (or not) in any given context, how can we ever aspire to certainty and predictability in contractual relations.
These are the operational questions that Sills asks in her Twitter thread, and in her separate blog posts. On the one hand, Sills posits:
Smart contracts are not legal contracts, and in many cases may not be a good replacement for legal contracts.
On the other hand, Sills suggests:
We can imagine two scenarios. Suppose I make a contract to pay $100 dollars for a domain name. In one scenario, the person sends me the domain name, and I send them the $100, and if there is a dispute I can supposedly take them to court.
In the second scenario, I still send them the money, and they still send me the domain name, but we use a mechanism that ensures that the transaction is atomic (essentially simultaneous).
Is this still a contract? I think so. It just has additional enforcement mechanisms. Curious to hear people’s thoughts. End.
Which of these is correct? The curious legal answer is … both. Maybe.
Legal Indeterminacy Is Real. Get Used to It!
Putting Sills in conversation with Sills is not meant to “call out” Sills in attempt to expose inconsistencies. Quite the opposite, it’s an illustration of an extremely nimble legal mind — the ability to take one set of facts and develop two seemingly contradictory legal arguments from those facts.
In so doing, Sills exposes the danger of deterministic legal thinking, such as that deployed by Kronman and Posner, who should know better than anyone not to make a rookie move like this:
“[Hypothetical facts, hypothetical facts … more hypothetical facts…and now…. drumroll…] It would be pretentious to speak of a contract between A and B, though technically there is one (if a section of the paper is missing, A can probably rescind the contract and get his 20 cents back).”
No, Judge Posner, technically there is no contract here (unless we overlooked the Kronman & Posner definition of the word “technically” in our read of The Economics of Contract Law). There is no technical mechanism for determining whether or not we have a contract. That’s the whole point of this piece. If we did, we would not have a need for Judge Posner.
Instead of “Technically. Yes. Contract!” the only thing we’re left with are potential contract arguments that one party may deploy against the other in case of a dispute. The other party can then bring its own arguments to bear.
Outcomes are uncertain. Law is messy. But so are the human arguments that ripen into law disputes.
And while messy and structurally biased, the law is quintessentially human, full of aspirations and imperfections.
As pertaining to matters that concern human relations in the material world, current contractarian DLT constitution schemes and “smart contract” regimes outline a world that nobody should want to live in.
Not even the architects of this brave new world seem comfortable entering into “smart contracts” of their own design with their own intellectual and institutional siblings.
Why!?! Perhaps its because a world where contract rights are capable of being determined fully in technical, fully autonomous ways necessarily implies law en-force-ment actions in increasingly technical, fully autonomous ways.
Crypto-anarchy seems kewl right up until the point RoboCop knocks on your door to collect the on-chain, Coinbase-verified gaming debt that you swear you didn’t incur. Then the indeterminacy of “dumb” contract law will start rushing back as flashbacks. Except it could be too late.
In the end:
Neither party in an actual contract dispute knows what will eventually happen.
Therein lie the bugs and features of contract law, and law generally. This is why the folks behind real smart contracts don’t ever call their creations that. It’s not just pretentious. It’s reckless.
Instead, mindful of all the possible attack vectors and the many things that can go wrong, great lawyers work really hard to avoid contract disputes in the first place and throughout the life of those fragile legal relationships — something automatons don’t yet, and perhaps may never, understand.