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5 things you need to know about … the Law Commission's Paper on Smart Legal Contracts

1. What is the Law Commission's paper on smart legal contracts? 

On 25 November 2021, the Law Commission published its advice to the UK government on smart legal contracts (the "Paper") (see here). Among other things, the Paper considers how English law applies to smart legal contracts, and identifies particular areas of uncertainty and where reform may be required. The Paper builds on previous work carried out by the UK Jurisdiction Taskforce (see our briefing note here).

 

2. What is a smart legal contract? 

A smart legal contract is a legally binding contract, in which some or all of the obligations are recorded in and/or performed automatically by a computer program. The key characteristic here is automaticity – i.e., performance (at least in part) is rendered automatically, without human involvement. 

There are three forms a smart legal contract can take, depending on the role played by the code: (i) a natural language contract with automated performance by code; (ii) a hybrid contract; or (iii) a solely code contract.   

Smart legal contracts are often (but not always) deployed on distributed ledger technology, such as blockchain. They are now used in numerous sectors, including insurance, finance, decentralised finance, real estate, supply chain, and intellectual property.

 

3. Is legal reform needed?

The Law Commission confirms that "the current legal framework is clearly able to facilitate and support the use of smart legal contracts". In particular, it highlights the flexibility of English common law as an advantage when it comes to technological development, providing "an ideal platform for business and innovation, without the need for statutory law reform". At the same time, the Law Commission also recognises that incremental and principled development of the common law may be necessary in areas such as contractual interpretation. Agreeing with previous comments by the UK Jurisdiction Taskforce that "it is unnecessary to declare smart contracts as a special category of contracts to which the normal rules of interpretation are dis-applied" (see here at [150]), the Law Commission concludes that, when interpreting coded terms, the appropriate legal test is "what a person with knowledge and understanding of code would understand the coded term to mean" (i.e., the "reasonable coder" test).

 

4. Are there any problem areas? 

Deeds and private international law are two areas where the Law Commission considers further work may be needed to support the use of smart legal contract technology. Since deeds have various formality requirements (e.g., they must be witnessed and attested), the Law Commission is not confident that – as matters currently stand – hybrid or solely code contracts can be used to create a deed. Separately, difficulties may arise in relation to determining jurisdiction and applicable law for some smart legal contracts, particularly where the smart legal contracts are unilateral and solely in code, or formed by autonomous interaction of computer programs. While these difficulties are not insurmountable, express choice of law and jurisdiction clauses are therefore considered advisable.  The issue of digital location (i.e., the need to ascribe real-world locations to digital assets, and to actions that "take place" on a distributed ledger) also poses a significant challenge. The Law Commission has stated that it will consider this issue as part of its future project on conflicts of laws in the context of emerging technology.

 

5. What should parties do? 

As smart legal contracts become more common, the Law Commission anticipates that the market will develop established practices and model contracts that parties can use when negotiating and drafting their smart legal contracts. To address uncertainty and reduce the scope for disputes, parties are encouraged to include express terms in their smart legal contracts, such as choice of law and jurisdiction clauses.  Appendix 3 of the Paper helpfully includes a non-exhaustive list of issues that parties may wish to address in their smart legal contracts in order to promote certainty and party autonomy. 

 

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