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Is it smart? Is it a contract? Legal nitty-gritty on what constitutes a smart contract

Distributed ledger technology is rapidly opening up new possibilities for how businesses communicate with each other, but do we always understand exactly what the new terminology means? For example, what do we mean by a smart contract? Is it smart? Is it a contract? Do lawyers and technologists understand each other when they use these terms? Norton Rose Fulbright, together with the R3 consortium, set out to answer these questions, to promote clarity and to establish a “consensus of understanding between industry stakeholders, lawyers and technologists in relation to smart contracts”.

The result is a white paper that discusses exactly what constitutes a smart contract and whether it can be legally binding under the law of a number of key contracting jurisdictions. The research also touches on the practicalities of enforceability and provides some suggestions for dispute resolution. These are the key findings from the white paper:

1. Different smart contract models

Some models promote the “code is contract” approach (that is, that the entirety of a natural language contract can be encoded). Other models see smart contracts as consisting of digitising performance of business logic (for example, payment), which may or may not be associated with a natural language contract. In between these two extremes a number of permutations are likely to emerge including, for example, a “split” smart contract model under which natural language contract terms are connected to computer code via parameters (for example, a smart contract template) that feed into computer systems for execution.

2. Legally binding?

It is tempting to conclude that, just because the moniker “smart contract” includes the word contract, it is a legally binding contract as a matter of law. This is not necessarily correct. Whether it is so in a given situation may depend in part on the type of smart contract at issue, the factual matrix within which it operates, and the applicable law determining the issue.

3. Jurisdictional variations

The white paper goes into detail on but whether or not smart contracts are binding in law varies significantly depending on the jurisdiction.

4. Enforceability

Where a smart contract has legally binding contractual effect, the technology within which it is deployed may sometimes give rise to problems in relation to legal enforceability (this is particularly so in the case of a so-called “permissionless” distributed ledger). This may be because, for example, there may be no central administering authority to decide a dispute, there may be no obvious defendant, or enforcement of a court judgment or arbitration award in respect of a transaction using particular distributed ledger technologies may be problematic.

5. Dispute resolution mechanisms

Inserting a dispute resolution mechanism into a smart contract may help to address the issues around enforceability and jurisdictional variations.

CTMfile take: Smart contracts are likely to be an important part of B2B communications in future and will play an important role in bank account management, legal agreements between companies, trade clearing & settlement, as well as supply chain and trade finance documentation. CTMfile has already written about the possibilities of smart contracts for finance and treasury. This white paper provides another important step in understanding exactly how – practically and legally – smart contracts could fit into the corporate treasury world.

This item appears in the following sections:
Best Practices & Benchmarking in Operations
Control & Compliance in Operations
Operational Risk Management

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