In India, a contract between two persons is governed under the Indian Contract Act, 1872 and essentially consists of an offer, acceptance and consideration. With respect to enforcing smart contracts, there isn’t a disparity with the Indian Contract Act, 1872 as all the essentials of a contract, as well as the other provisions of the Act governing contracts shall be applicable to the terms and clauses of a smart contract in pari materia. A smart contract is simply a contract in machine-readable language which is executed and enforced automatically with no human intervention using cryptographic mechanisms on the blockchain network. The terms of many contracts can be written in programming languages that are communicated to a machine. The reason for this is that the performance and enforcement of a contract essentially boil down to conditional statements, which are foundational to computing. Therefore the current contract legislation in India is sufficient to regulate and govern smart contracts with respect to the core elements of a contract. However, the issue arises with respect to the execution of smart contracts and the legal recognition of the same. These issues are as follows:
Authentication Of The Smart Contract
Under the Information Technology Act 2000, an electronic record may be authenticated by affixing a digital signature. However, Section 35 of the IT Act states that an electronic signature can be issued only by Certifying Authority established under the Act, provided all other conditions regulating the electronic signature are fulfilled. This mechanism which works for traditional contracts will not be applicable to a smart contract due to the fact that the very need for authentication using an electronic signature does not arise in a smart contract. Since smart contracts are facilitated on the blockchain network, the blockchain hash-key system acts as the validator and authenticator of the electronic record and there arises no requirement for an additional electronic signature. [1]
Therefore despite the contractual requirements of the law being fulfilled by a smart contract, it only is a matter of the law in India recognizing the facilitation of the Smart contract. The Information Technology Act 2000 must therefore lay down an additional aspect by which the smart contract may be validated and authenticated, which is through the cryptographic mechanism of the blockchain supporting the smart contract.
Evidentiary Value Of The Smart Contract
Despite the hash-key function of the blockchain technology in a smart contract performing the task of authenticating and validating the contract, there arises a cause for concern since the Indian Evidence Act 1872 does not recognize this hash key validation as evidence in a court of law, should there arise a dispute involving a smart contract. Section 85A of the Evidence Act states that ‘The Court shall presume that every electronic record purporting to be an agreement containing the electronic signature of the parties was so concluded by affixing the electronic signature of the parties. With respect to electronic records, Sections 65A and 65B, 67A, 73A, 85A, 85B, 85C, 88A, and 90A were added to the Evidence Act to demonstrate that the emphasis is to recognize the electronic records and digital signatures, as admissible pieces of evidence.[2]
However since the law has not included cryptographic encryption of the blockchain network as a form of authentication and validation of an electronic signature under the Information Technology Act 2000, it is clear that the law as it stands today will not accept a smart contract as evidence under the ambit of an electronic record. Though there are no cases yet in India which have faced this issue, it is inevitable that with the rapid growth of blockchain technology, especially with respect to smart contracts, this matter will come for discussion before the Court. In order to make the development and incorporation of smart contracts a reality in everyday life in India, there are two solutions that the legislature has to imbibe in order to keep up in line with blockchain technology. First, the Evidence Act should be amended to include a smart contract as an electronic record admissible in Court as evidence de facto, based on the validity of a hash key validated blockchain smart contract. Second, which is the alternative option, the IT Act should be amended to include hash key validation as a type of electronic signature. This will result in the smart contract satisfying the present criteria of admitting an electronic record as evidence in Court under the provisions of the Evidence Act.[3]
Jurisdictional Issue
In order to discuss the jurisdictional aspect of smart contracts, we must first understand the underlying blockchain machinery that enables the smart contract. Blockchain is a decentralized ledger system that stores data in a decentralized manner, which is different from any other data storage system existing at present. In a centralized server system, the data is stored at a given definite location such as data farms which are located in a particular State’s jurisdiction. However, in a blockchain system, the data is distributed across the blockchain network with nodes of data being stored in each of the peers connected to the network. This makes it impossible to definitely locate a particular node of data at any given time and place. Therefore this imposes a jurisdictional question when it comes to the cross-border applicability of laws when dealing with cross-border international smart contracts. Blockchain also poses questions concerning the ability to identify the parties to a transaction, to the extent a system utilizing this technology remains anonymous, which may raise a host of additional issues related to dispute resolution.[4]
The legal issue involving jurisdiction is that, especially in the case of uncontrolled public and license-free blockchains in blockchain participants, it may be that a jurisdiction recognizes certain laws that are not found in other jurisdictions, such as property ownership. This means that any transaction that takes place in the blockchain network must comply with ridiculous laws and regulations, and some of the parties to the transaction may not even think that the transaction will encounter these laws and regulations. Obviously, if this is the case, the development of blockchain-based technologies will stagnate. Furthermore, since blockchain transactions occur in a pseudonym manner, locating each node involved in a transaction and then identifying the geographic location of each node can be an almost impossible and incredibly heavy task.
Blockchains go beyond jurisdictional boundaries because they exist as a globally distributed network of nodes and are not controlled by specific entities. Similarly, the implementation of smart contracts is not easily applicable to the traditional basis of territorial jurisdiction. Therefore, it is difficult to determine which jurisdiction's laws apply to the management of contractual issues related to a particular smart contract and which court has the power to hear any resulting legal claims. Uncertainty in this regard may lead to satellite disputes because of the jurisdiction in which the parties apply the law, as well as the appropriate forum for claims (eg. anti-suit injunctions, forum non-coveniens claims, etc.).[5]
The law applicable to the determination of contracts is of great importance to Parties because they must be able to determine certainly the potential obligations and responsibilities under the contract. Therefore, overcoming these complex jurisdiction issues is critical to the effectiveness of smart contracts. This can be as simple as ensuring that the parties include the choice of law and the choice of court terms in the contract in order to predetermine and agree on these issues before the smart contract is initiated.[6]
The solution to the jurisdiction problem, therefore, is not a complex one involving the amending of laws across different jurisdictions. It is the mere addition of a dispute resolution clause as a mandatory requirement in the smart contract. The clause should lay down the governing law as well as the place of resolving the dispute, similar to that of an arbitration clause in a traditional contract. Given the lack of a central enforcement agency and established precedent, it is difficult to predict with certainty how such issues will be dealt with and resolved. It is therefore advisable that parties include a dispute resolution or arbitration clause when contracting via a smart contract. Thus the issue of jurisdiction created by the smart contract can be addressed by the smart contract itself.[7]
CRITIQUE OF SMART CONTRACTS
It cannot be denied that contracts are deeply social tools and not just a legal mechanism.[8] Despite the multiple applications and efficiencies that smart contracts strive to bring into society, there is a large dissent in the legal and tech community as to the true impact of smart contracts: whether it actually does make a positive impact on trade and commerce or if the technology is too out of sync with the nuances of the real world contract and barter system. ‘Blockchain-based contracts rely on careful pre-specification of terms and automatic execution of obligations. As a result, these contracts impose a degree of inflexibility on the contractor's relationship, which may shorten many of the alternative uses of the law. Code-based rules are often strongly supported by the technical community because of their computability and perceived efficiency. But when these rules touch the foundations of real practice, habits, and human behavior, their effects may be non-obvious, even counterintuitive.[9]
One of the fundamental issues with smart contracts is the anonymity aspect. In a blockchain network, every single peer connected to the network is completely anonymous with each other. While entering into a smart contract, the two parties doing so will be anonymous and will be oblivious of the identity of the party they are contracting with, except if they choose to reveal their identity. Though anonymity may have its benefits in some cases, hiding the identity of the parties, opens up avenues for criminal activities such as money laundering, tax evasion, terrorist funding, etc. as persons will be more incentivized to commit such crimes due to the anonymity blanket. For example, a gun manufacturer selling arms and ammunition will be oblivious of who is purchasing his goods if done through a smart blanket, as the person on the other side of the blockchain could be anyone from a Mexican drug cartel or a terrorist from the Boko Haram. Therefore this aspect of anonymity involved in smart contracts is a huge cause for concern in its development process.[10]
Another shortcoming of a smart contract is that it is strictly objective in nature to the extent that the machine-readable code operating the contract is based on ‘if-then’ conditions which result in only two outcomes: yes or no for every condition of the contract. What smart contracts do not imbibe is the subjectivity aspect of traditional contracts. The rule of code cannot replace the rule of law and the subjectivity aspect of a judge deciding a matter in a common law legal system. Components of contract law such as frustration, duress, undue influence, force majeure, unconscionable dealings, etc all require a subjective interpretation of the matter at hand on a case-by-case basis. These subjective components cannot be replaced by a pure logic-based objective smart contract. This is a serious impediment to the application of smart contracts in complex transactions.
________________________________________
[1] Ronald L. Chichester, Technology And The Law: Wide Open Spaces: How Blockchain Has Moved Beyond Currency, 80 TEX. B. J. 228, (2017)
[2] Wright, Aaron & De Filippi, Primavera, Decentralized Blockchain Technology and the Rise of Lex Cryptographia, SOCIAL SCIENCE RESEARCH NETWORK, (2015) available at SSRN: https://ssrn.com/abstract=2580664
[3] Id.
[4] Turpin & Jonathan B, Bitcoin: The Economic Case for a Global, Virtual Currency Operating in an Unexplored Legal Framework, 21 INDIANA JOURNAL OF GLOBAL LEGAL STUDIES 1, 335–368 (2014).
[5] Matthias Berberich & Malgorzata Steiner, Blockchain Technology and the GDPR - How to Reconcile Privacy and Distributed Ledgers, 2 EUR. DATA PROT. L. REV. 422, 426 (2016)
[6] Id.
[7] ISDA Linklaters, Whitepaper Smart Contracts and Distributed Ledger – A Legal Perspective, INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION (ISDA) AND LINKLATERS, (August 2017), available at https://www.isda.org/a/6EKDE/smart-contracts-and-distributed-ledger-a-legal-perspective.pdf
[8] Karen E. C. Levy, Book-Smart, Not Street-Smart: Blockchain-Based Smart Contracts and The Social Workings of Law, Engaging Science, Technology, and Society, 3 CORNELL UNIVERSITY, 1-15, (2017).
[9] Rose, C. M., Crystals and Mud in Property Law, 40 STANFORD LAW REVIEW 577-610, (1988)
[10] [10] Jeremy M. Sklaroff, Smart Contracts and the Cost of Inflexibility, 166 U. PA. L. REV. 263 (2017)