Smart contracts: Law can interpret a term defined by code
There is no need for new legislation on smart contracts because the existing laws of England and Wales can accommodate them, the Law Commission has said.
The commission said current principles of contractual interpretation could apply to smart contracts, with only “incremental development” required to the existing test by asking what a term in code would mean to a “reasonable coder”.
In a paper published today giving advice to government on smart contracts, the Law Commission said its findings built on a statement by the UK jurisdiction taskforce in 2019, which found that the current legal framework was sufficiently robust and adaptable to accommodate smart contracts.
On interpretation, the commission said existing principles could apply “albeit with an incremental development” to the existing test.
“In particular, interpretation of a term defined by code should be determined by asking what the term would mean to a reasonable person with knowledge and understanding of code – that is, a ‘reasonable coder’.
“This is the most appropriate way to ascertain the meaning of the coded terms of a smart legal contract, and more closely resembles the existing test for contractual interpretation in the context of non-coded terms.”
The commission said parties could structure their smart contract to include ‘kill switches’ to halt performance of the code in certain circumstances, for example, where one of the parties terminated the contract following a breach.
Traders wanting to enter into smart contracts with consumers were advised to take steps to ensure that they complied with existing consumer protection rules.
“For example, traders who wish to offer smart legal contracts to consumers which contain coded terms would be well advised to provide clear and informative pre-contractual literature to the consumer, explaining those terms and how they operate, in order to comply with the transparency requirement”.
The Law Commission said the market should “anticipate and cater for potential uncertainties” in the treatment of smart contracts by “encouraging parties to include express terms aimed at addressing them”.
Recommended clauses included those allocating risk in relation to performance of the code and setting out clearly the relationship between any natural language and coded components.
As smart legal contracts became more common, the commission predicted that the market would “develop established practices and model clauses that parties could use to simplify the process of negotiating and drafting”.
However, it pointed to “complexities” in some areas, warning that smart contracts were unlikely to be recognised as deeds.
“We do not consider that parties can be confident that the current law supports the creation of deeds which are wholly or partly defined by code.”
Further complexities arose when courts awarded remedies such as rescission and rectification.
“In order to achieve the practical effects of these remedies, a court may need to be flexible and creative when fashioning its order.”
Professor Sarah Green, Law Commissioner for the commercial and common law team, commented: “Smart legal contracts could revolutionise the way we do business, particularly by increasing efficiency and transparency in transactions.
“We have concluded that the current legal framework is clearly able to facilitate and support the use of smart legal contracts; an important step in ensuring increased recognition and facilitation of these agreements.”
The Law Commission added that it had agreed with the government to look at the rules relating to conflict of laws as they applied to emerging technology, including smart contracts and digital assets.
It hopes to be in a position to begin work on this project by the middle of next year.
The project on smart contracts was announced by the Law Commission as part of its 13th programme of law reform in December 2017, but was paused pending the work of the UK jurisdiction taskforce, which declared in November 2019 that cryptoassets should be treated in law as property and smart contracts could create legal relationships just as well as more traditional ones.
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