The Law and Smart Contracts

Joshua Davis
Predict
Published in
7 min readOct 16, 2019

Smart contracts create coordination not obligation

The ideal architecture for decentralized insurance is optimized to mitigate regulatory liability and costs required to remain regulatory compliant. The best way to remove this liability is to completely eliminate any legally enforceable contractual obligations between the parties. There are multiple types of platform architectures that use smart contract applications. Some of these may create contractual obligations and some of these may not. The platform architectures that don’t create these obligations are less likely to be understood as failing to comply with government regulations.

Optimizing for regulatory compliance is the safest way to allow communities to achieve a type of joint custody that doesn’t violate the law. When funds are held in joint custody by a nonprofit, the law considers the circumstances under which those funds were received and how they are held. Given what the circumstances were, it is possible to determine if there is any contractual obligation created by the parties. The unique quality of smart contracts is that they enable a new type of joint custody. This type of joint custody permits coordination by the parties without imposing any obligation that the parties give up custody of funds.

A contract is a legally binding agreement which recognizes and governs the rights and duties of the parties to the agreement. A contract is legally enforceable because it meets the requirements and approval of the law. An agreement typically involves the exchange of goods, services, money, or promises of any of those. For a contract to be considered legally enforceable it must contain the following elements:

  • Offer
  • Acceptance
  • Consideration
  • A mutual intent to be bound

Where there is no consideration, a contract is not seen as being legally binding. The unique quality of TandaPay’s architecture is that the agreement between the parties is not legally binding because there is no promise of consideration guaranteed by the agreement.

No promise of consideration in TandaPay’s architecture

Consideration is a benefit which must be bargained for between the parties of a contract, and is the essential reason for a party to enter into a contract.

Consideration must be of value from the perspective of the parties. It is exchanged for the performance or promise of performance by the other party; such performance itself is consideration. In a contract, one consideration, the thing given, is exchanged for another consideration. Not doing an act, which is called forbearance, can be consideration. For example, one party could state, “I will pay you $1,000 not to build a road next to my fence.”

Contracts may become unenforceable or void for “failure of consideration” when the intended consideration is found to be worth less than expected. If consideration does not exist, then a contract can be found to be invalid.

Differentiating between a claim award and a claim payment

For the purposes of protecting claimants from paying a fraudulent claim, Tandapay distinguishes the difference between a claim award and a claim payment.

  • Claim award: an acknowledgement by the community that a claim meets the standards of the community’s charter. This charter is created when a community is founded and once written the only way it can be changed is if a group disbands and reforms a new community with a new charter.
  • Claim payment: the transferring of premiums directly from a policyholder to a claimant once they have been approved by the community to receive a claim award. A single claim payment is made up of an aggregate of payments from all the members within a community. A smart contract enables each member to approve a claim award for a claim payment and it then bundles these together into a single payment.

TandaPay allows participants to agree to place their funds into an escrow in exchange for eligibility to receive a future claim award. A claim award is only the community’s acknowledgement that the claim which was submitted is valid to the standard of the charter. On the surface, it seems as if there is consideration because the following items of value are being exchanged:

  • The participant is agreeing to coordinate with the community by placing their funds into an escrow
  • The community is agreeing to consider that the participant is eligible to receive a future claim award

In reality, consideration does not exist in this context because the locking of these funds in no way imposes an obligation upon a participant to give up custody of these funds in the future. The escrow itself may temporarily prevent funds from being spent, but it in no way denies a participant their right to future ownership. Even if a community determines that an eligible claimant is entitled to receive a claim award, this determination never conveys with it a guarantee of payment.

This is because receiving a claim award is a separate step from receiving a claim payment. A claim award in no way guarantees a claim payment. Since there is no guarantee of payment, there is no obligation for anyone to pay. Since there is no obligation to pay there is no consideration. Since there is no consideration there is no legally binding valid contract that could potentially create regulatory liability for the participants.

Individual safe analogy

Imagine that a group has 50 members. Each member has their own personal safe in their own home. Inside each safe is a webcam that is constantly sending time-stamped images to a public internet forum. The members agree that the following is true:

  1. The 50 members agree that if anyone can prove that they have a $500 deductible for an associated auto insurance claim within that month, then it can be submitted to the group. If the paperwork with the associated claim for the $500 deductible is found to be valid, then it becomes eligible for payment (i.e. approved for a claim award). This is equivalent to creating a community charter in TandaPay.
  2. In order to participate and be considered eligible in a given month, a member must put a $50 bill into their own personal safe. They agree to lock the safe and not take that bill out for the entire month. This is equivalent to paying a premium to the smart contract in TandaPay.
  3. The group now corporately has $2,500, or the ability to pay 5 auto insurance deductibles.
  4. Once a list of members with a valid claim award is finalized at the end of the month, these claimants must now wait to receive payment from each participant individually. Each participant now has the choice to give each claimant $10. This is equivalent to waiting for members to finalize their monthly payment in TandaPay.
  5. Each participant of the group can choose not to give a claimant $10, but if they do that then they don’t participate in any future months. This effectively means that they have left the group. This is equivalent to defecting in TandaPay.

GoFundMe analogy

The individual safe analogy emphasizes the concept of not giving up custody of funds during the month-long period. The concept illustrates how blockchain technology both secures and provides proof of the existence of funds. It allows members to prove that these funds have been reserved for payment of a future claim. It also illustrates that proving that funds have been reserved does not require anyone to give up custody of their funds. The GoFundMe analogy is more apt to describe how people think about the technology in its practical application.

Imagine that a group has 50 members. Each participant agrees that the following is true:

  1. The 50 members agree that if anyone can prove that they have a $500 deductible for an associated auto insurance claim within that month, then it can be submitted to the group. If the paperwork with the associated claim for the $500 deductible is found to be valid, then that member can create a GoFundMe page and solicit donations from the group.
  2. Once a list of members with a valid claim award is finalized at the end of the month, these claimants are told that they must now wait to receive payment from each participant individually. Each participant now has the choice to give each claimant $10 (via their GoFundMe page).
  3. Each participant of the group can choose not to give a claimant $10, but if they do this then they don’t participate in any future months. This effectively means that they have left the group.

Conclusion

The point of these two analogies is that none of the individual community members are obligated to pay an eligible claim award. TandaPay allows groups to coordinate to jointly pay a future claim, without creating a demand that each member pays claims they believe are invalid. This coordination in no way implies obligation. This is because none of the individual participants are under any actual obligation to obey the direction given by the group. In other words, if an individual participant disagrees with the group’s decision that a claim is eligible for payment, they are not obligated to relinquish their funds.

This is one way TandaPay enables participants to coordinate using architecture that remains regulatory compliant. This proves that the types of smart contracts TandaPay utilizes are not valid contracts under the scope of contract law because the requirement of consideration is not met.

Further reading

Chamber of Digital Commerce: Smart Contracts: Is the Law Ready?

Harvard Law School: An Introduction to Smart Contracts and Their Potential and Inherent Limitations

SSRN: Smart Contracts: (How) Do They Fit Under Existing Legal Frameworks?

Can a Smart Legal Contract Be Considered a Contract According to the U.S. Contract Law? by lawless.tech

TandaPay Explained: The individual lock box analogy and the logical lock box architecture test

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