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Smart Legal Contracts – The Only Viable Approach to the Arbitration of Blockchain Disputes?

- Aishwarya Julinka Anand and Shreya Gupta*

Honourable Mention, 1st RGNUL Arbitration Essay Writing Competition


Introduction

The advent of blockchain technology has brought about a paradigm shift in the way people transact. The technology, or more specifically, “Blockchain Ledgers” allows for a secure, immutable, and tamper-evident alternative to conventional transactional models, providing improved traceability, accountability, and transparency.[1] These benefits and advantages have paved the way for an accelerated shift from traditional, oral, and written contracts or agreements to “Smart Contracts” that are automatically executing, blockchain-implemented agreements.


While the use of smart contracts is not widespread as of yet, its commercial use will inevitably rise considering the trajectory for the growth of blockchain technology and the transactions that will arise out of the same. It is suggested that the ultimate solution to this growing dilemma is an inexpensive, fast, transparent, and reliable arbitral system, with decentralized jurisdiction, with the ability to render enforceable awards. However, there are several elements at the stage of formation of the arbitration agreement, that must first be defined and structured for this system to be functional.


Smart Contracts v. Smart Legal Contracts

The term “Smart Contracts” is often a misnomer that is used without adequate consideration. In essence, a smart contract is a “self-executing digital transaction using decentralized cryptographic mechanisms for enforcement.” [2] It depends on the execution of a series of “if-then” logic statements that cannot be stopped once executed, for the transfer of assets.[3] The concern that arises with smart contracts is the legality or enforceability of a contract that is simply a manifestation of self-executing code. While it is true that this code is often accompanied by a document containing natural, semantic language, such as a conventional contract, it is not a given as to whether the former performs in conformance with the latter, leading to sub-optimal results.[4]


It is to this problem that “Smart Legal Contracts” provide a solution. A smart legal contract is “a smart contract that articulates and is capable of self-executing, on a legally-enforceable basis, the terms of an agreement between two or more parties.”[5] A tangible example of this is the open, standardised format for smart legal contracts that is being developed by the Accord Project,[6] which they view as both a machine and human-readable singular digital agreement with both components.


Arbitrations are often riddled with disagreement over the interpretation of the Agreement or the formation of the Arbitration clause itself, which is further exacerbated with a smart contract. Some of these common disagreements and questions that often arise have been further discussed throughout this essay. Another variation of smart legal contracts is Ricardian Contracts, which are smart contracts that can be read by both humans and machines. These contracts have clear and significant advantages over conventional, oral, or written agreements. Although quite early in the developmental phase, smart legal contracts or Ricardian contracts show much promise for the efficient arbitration of blockchain transaction disputes.


Arbitration Clauses in Smart Legal Contracts

Arbitration clauses cannot be drafted within a self-standing smart contract since it is a conditional logic that cannot be embedded and is hence a ‘non-operational’ clause. Assuming that it could be expressed using code, several jurisdictions,[7] and more importantly the New York Convention on the Recognition and Enforcement of Arbitral Awards (NYC) requires arbitration clauses to be written.[8] A smart legal contract provides for the inclusion of the arbitration clause within the conventional text-based component of the singular digital contract, which possesses both components. This would allow parties to sufficiently address all concerns while forming the arbitration agreement.


Consent to Arbitrate

Arbitration agreements are often bound by form requirements, both under domestic and international regimes that govern a certain dispute. The ‘written form’ requirement under Article II of the NYC[9] is one such requirement, which states that an agreement is written when “an arbitral clause in a contract or an arbitration agreement, signed by the parties or contained in an exchange of letters or telegrams.” Where smart contracts fail to meet this requirement due to it being composed purely of software code, smart legal contracts allow for “consent to arbitrate” to be established through its text-based component, thereby meeting the form requirement.


While it is true that the capacity of the parties to a smart legal contract to consent is not affected merely by the fact that it is through software code, the concern arises when such consent must be identified ex-post,[10] since very few possess the necessary knowledge to fully understand what it is that they are consenting to when it is expressed through code.[11] Hence, a singular digital contract with both the necessary components would prevent any discrepancy in ascertaining the consent and the terms of the agreement between the parties.

Choice of Law Clause and Designating the Seat

Since smart legal contracts are blockchain implemented, they tend to be decentralized in nature, preventing parties from choosing a seat with ease, even when arbitration as a mechanism is detached from national legal systems.[12] There are two considerations that parties must be mindful of when choosing a seat and the applicable law, firstly, to ensure that they are designating the seat in a jurisdiction that validates arbitration agreements embedded within smart or digital contracts.[13] Secondly, when constructing the choice of law clause, it would be wise to choose a jurisdiction that has a consistent, well-developed and fair body of commercial jurisprudence which would validate the smart legal contract itself.[14]


Establishing Jurisdiction in Arbitration of Blockchain Disputes

Two other issues that remain to be the most disputed elements of an arbitration apart from the interpretation of the arbitration agreement as previously mentioned, are the arbitrability of the dispute and the jurisdiction of the arbitral tribunal. While this is inherent to most arbitrations arising out of conventional contracts, it is more so, for smart legal contracts. The arbitrability of a blockchain transaction dispute and establishing jurisdiction in these cases with complex conflict of laws issues have been further discussed below.

Arbitrability of a Blockchain Transaction Dispute

The digital and decentralized nature of a smart legal contract makes it versatile, allowing for it to be used in various kinds of transactions. The arbitration agreement embedded in such a contract could meet all the requirements of a valid one, but cannot be enforced if the subject matter of the dispute itself is non-arbitrable.[15] An example of this is the arbitral award granted by a tribunal for damages in a cryptocurrency dispute, that was set aside by the Shenzhen Intermediate People’s Court since China is yet to recognize digital currency and for being against public policy.[16] Hence, the embedding of a valid arbitration clause becomes meaningless if the subject matter is not arbitrable in the concerned jurisdiction.


Question of Jurisdiction – Seat and Governing law

The cardinal feature of blockchain technology is also the greatest challenge to ascertaining the jurisdiction of a dispute when it arises. Decentralized ledgers would allow the blockchain-based smart legal contracts to exist on a wide expanse of places geographically, which gives rise to a whole new domain of complex conflict of laws issues concerning the interpretation of the arbitration agreements and the jurisdiction to decide the dispute arising out of the smart legal contract.


Smart Legal Contracts will undoubtedly find foremost application in Cryptocurrency transactions, where parties could be contracting from anywhere in the world and the legal presence of the blockchain asset may be in another part of the world from where it could be readily transferred to another place halfway across the world for the transaction. The possible involvement of three different jurisdictions shows the inherent cross-border nature of blockchain disputes. The question that remains is which system of laws would govern the substantive and procedural aspects of the arbitration agreement and thereby the dispute itself.


Pseudonymity is another feature that makes blockchain technology appealing, as it allows for transactions to be performed pseudonymously. However, this is a serious concern when a dispute arising from such a transaction must be arbitrated. For example, most transactions on Ethereum occur between location-less and nameless parties,[17] which adds to the jurisdictional complications in arbitrating blockchain disputes.


The most viable solution that has been identified by scholars and programmers alike is arbitration through a blockchain-based platform.[18] This would allow for procedural matters such as appointing arbitrators to be addressed by the platform itself. The only aspect that would not be automated on the platform is rendering the arbitration award, for which the presence of human essence and judgement is still an essential feature. The award would then have to be re-introduced on to the Blockchain platform and in this respect, the arbitrator would act as an “oracle.”[19]


Recognition of Smart Legal Contracts: The Status Quo

United Nations Convention on Contracts for the International Sale of Goods (CISG)

The worldwide success of the CISG in harmonizing the governance of international sale of goods would become particularly important when smart legal contracts find increased commercial use.[20] It is also highly likely that the CISG will be coded into these smart legal contracts as the governing law with their increased use.[21] However, this is far from being reality due to the large chasm that is the interpretational gap for the scope of the convention to apply to these contracts, consequently leaving too many legal ambiguities and uncertainties.[22]

There are primarily two arguments made when it comes to applying the CISG to smart legal contracts. The first argument is that the Convention was not intended by the drafters to cover smart contracts and would have to significantly evolve to do so, while the second is that smart contracts are merely an enforcement mechanism of an underlying agreement and not the contract itself.[23] In order to address these arguments, one would have to interpret the scope of the Convention through the lens of Art. 13 of the CISG.[24]


While it may be true that neither the Convention nor the drafters have expressly considered smart legal contracts under the text, the jurisprudence, legislative history of Art. 13 which was followed by the legislative text of UNCITRAL all affirm that smart legal contracts can indeed be governed by the CISG. The word ‘includes’ in Art. 13 clearly indicates that other forms of electronic communication apart from telex and telegram could be considered as a contract in ‘writing’ as required.[25] While the scope of the convention clearly excludes the sale of intangible goods such as Cryptocurrency,[26] smart legal contracts can most definitely be used for transactions on the sale of tangible goods, since they meet the criteria of ‘other forms of electronic communication’ under Art. 13.


The distinction that is to be established here is the difference between the sale of cryptocurrency and the sale of tangible goods using cryptocurrency as the medium of payment, since the former would be excluded from the Convention’s scope under Article 2, while the latter is not. Smart legal contracts can indeed be governed by the CISG for all intents and purposes, if the requisites under the rules of contract formation under Articles 14-24 are met since they are considered to be valid written contracts under Art. 13.[27]


New York Convention on the Recognition and Enforcement of Arbitral Awards, 1958 (NYC)

The NYC, as the comprehensive procedure on enforcement of awards has remained static since 1958. In a world that is technologically progressing by the minute, with the possibility of awards being rendered on digital platforms, the need for a dynamic procedure to enforce such awards is imminent. If the NYC cannot be amended without losing its traditional essence, the introduction of “smart awards” can satisfy the enforcement of awards rendered in blockchain arbitrations.


The smart award would also be enabled by blockchain technology and would entail automatic enforcement. The blockchain platform would have access to all the necessary features required to execute the award. In tandem, an appeal procedure for these smart awards would have to be carefully formulated and executed, which would be in line with the principles of natural justice, while promoting arbitration on these platforms. If a “smart award” does transpire into reality, it could replace the multiple procedures of present-day award enforcement mechanisms that are complex and cumbersome..


Suggestions and Conclusions

Smart contracts are popularly recognized as contracts that are based on pre-made templates. Unlike traditional contracts, an arbitration clause in a smart contract cannot be like any other boiler plate clause. It must be unique in terms of seat and governing law. It is difficult to understand how jurisdiction will be established using such a clause when the parties to a smart legal contract have minimum to no interaction at all, and at times are anonymous. Since the jurisdiction lays the foundation for the enforcement of the award rendered, it is quintessential for traditional arbitration methods to include blockchain arbitration within its scope and formulate a universally accepted mechanism for determining the best regime for transnational disputes arising out of blockchain transaction disputes.


There is no denying that blockchain-based arbitration is the future of dispute resolution. “The combination of speed, confidentiality, international enforcement and removal of the need of trust in central institutions is the calling card for blockchain”.[28] A blockchain-based platform, prima facie seems to be the solution to all the problems in arbitrating a blockchain dispute, arising from a smart legal contract. However, this would be viable only when the several issues identified in this essay, such as consent, choice of law, jurisdiction, and the recognition and enforcement of awards, are sufficiently addressed.


The CISG has been a driving force in bringing uniformity to commercial transactions across the world. It would continue to do so, if the scope of the convention was widened to include the sale intangible goods. It is essential to acknowledge that the dawn of the IoT (Internet of Things) era has brought with it the need to adapt to a world that is increasingly becoming digital. Failing to do so poses the threat of rendering Conventions like the CISG obsolete in the future. Smart Legal Contracts that are governed by a universal convention such as the CISG is the future of international commercial blockchain-based arbitration.



 

*Aishwarya Julinka Anand, Symbiosis Law School, Hyderabad, +91 8867502450, aishwarya_julinka_anand@student.slsh.edu.in Shreya Gupta, Symbiosis Law School, Hyderabad, +91 81062 09027, shreya_gupta@student.slsh.edu.in [1] Peter L. Michaelson; Sandra A. Jeskie, Arbitrating Disputes Involving Blockchains, Smart Contracts, and Smart Legal Contracts, Dispute Resolution Journal, p. 89 (2019). [2] Kevin Werbach & Nicolas Cornell, Contracts Ex Machina, 67 DUKE L.J. p. 313 (2017). [3] Jeremy M. Sklaroff, Comment, Smart Contracts and the Cost of Inflexibility, 166 U. PA. L. REV. 291 (2017) [4] Michael Buchwald, Smart Contract Dispute Resolution: The Inescapable Flaws of Blockchain-Based Arbitration, 168 University of Pennsylvania Law Review, p. 1381, (2020). [5] Alliance, Smart Contracts: Is the Law Ready?, Chamber of Digital Commerce, 12 (2018), <https://digitalchamber.org/download/9420/> (last visited May 31, 2022) [6] Accord Project, Accord Project (2022), <https://www.accordproject.org/> (last visited May 31, 2022). [7] Arbitration Act 1996, §5. [8] Article 2, New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards (1958). [9]Article 2, New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards (1958). [10] Jurgen Goossens and Krisof Verslype, Blockchain and smart contracts, p. 40 (2018). [11] Olivier Hari and Ulysse duPasquier, Blockchain and Distributed Ledger Technology: Academic Overview Of The Technical And Legal Framework And Challenges For Lawyers, 5 International Business Law 423, 444 (2018). [12] Francisco Uribarri Soares, New Technologies and Arbitration, VII (1) Indian Journal of Arbitration Law, 84. [13] Ibrahim Mohamed Nour Shehata, Arbitration of Smart Contracts Part 3 – Issues to Consider When Choosing Arbitration to Resolve Smart Contracts Disputes, Kluwer Arbitration Blog <http://arbitrationblog.kluwerarbitration.com/2018/08/30/arbitration-smart-contracts-part-3/> (last visited May 21, 2022). [14] Supra note 1 at p. 132. [15] Shaun Leong, Part 2: Key Issues in International Arbitration of Cryptocurrency Disputes, Fin Tech–Worldwide, Mondaq.com (2022), <https://www.mondaq.com/fin-tech/1182884/part-2-key-issues-in-international-arbitration-of-cryptocurrency-disputes> (last visited May 31, 2022). [16] Gao Zheyu v. Shenzhen Yunsilu Innovation Development Fund Enterprise (LP) and Li Bin, (2018) Yue 03 Min Te No. 719. [17] Supra note 15. [18] Supra note 4 at p. 1373. [19] Supra note 4 at p. 1381. [20] Emir Bayramoğlu, A Legal Analysis on CISG’s Scope of Application from Smart Contracts’ Perspective, emir20 January 2020, <https://turkishlawblog.com/read/article/193/a-legal-analysis-on-cisg-s-scope-of-application-from-smart-contracts-perspective#_ftnref9> (Last visited May 28, 2022). [21] For instance, Maersk, a prominent player in logistics industry, collaborates with IBM to develop a blockchain based platform which includes the automation of various business processes such as import and export clearance via smart contracts. [22] Duke, A., What Does the CISG Have to Say About Smart Contracts? A Legal Analysis, 20 (1) Chicago Journal of International Law: Article 4 (2019). [23] Jennifer E. Hill, The Future of Electronic Contracts in International Sales: Gaps and Natural Remedies under the United Nations Convention on Contracts for the International Sale of Goods p. 3; Alan Cohn et al., Smart After All: Blockchain, Smart Contracts, Parametric Insurance, and Smart Energy Grids, 1 Geo. L. Tech. Rev. 273, 288 (2017). [24]United Nations Convention on Contracts for the International Sale of Goods Art. 13, Apr. 11, 1980, 14 U.N.T.S. 3. [25] United Nations Convention on Contracts for the International Sale of Goods Art. 11 and Art. 13, Apr. 11, 1980, 14 U.N.T.S. 3; Hossam A. El-Saghir, The Interpretation of the CISG in the Arab World, in CISG Methodology 355, 365 (Andre Janssen & Olaf Meyer eds., 2009), <http://perma.cc/YU7G-QWTP> (Last visited August 10, 2022). [26] Munoz, E., Software Technology in CISG Contracts, 24(2) Uniform Law Review, 4 (2019). [27] Supra note 20. [28] Lise Alm, What is Blockchain Arbitration, and Can it replace the New York Convention? <https://sccinstitute.com/about-the-scc/news/scc-forecasts/what-is-blockchain-arbitration-and-can-it-replace-the-ny-convention/>,(last visited May 28, 2022).

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