How smart contracts are changing the legal industry

Smart contracts is a term used to describe computer code that automatically executes all or parts of an agreement and is stored on a blockchain. The code can either describe the entire agreement between parties or it can supplement a text based contract and execute certain clauses, such as termination of an agreement at a specific date or transfer of funds from one party to another.

Smart contracts require defined and objective input parameters and execution steps, such as if X occurs, then execute step Y, and once these criteria are met, smart contracts can self-execute, eliminating the need for intermediaries or third parties.

Transactions are recorded on the blockchain, which is a public database that records and monitors all automated contract executions in the order they occur. Because transactions cannot be reversed or rolled back, smart contracts are unmodifiable and final.

Smart contracts are gaining tranction within the legal industry given some of the potential benefits, including:

• contracts are self-executing as long as certain conditions are met, eliminating the need for third-party authorizations and decreasing the back and forth of creating, negotiating, and executing agreements. This has the potential to result in significant cost savings for the legal industry as a whole
• in order to execute, smart contracts require all terms and conditions to be precise and detailed, therefore technically allowing no room for miscommunication, misinterpretation, manipulation, bias, or error. However as we discuss later, the same principles that apply to 'traditional' contracts could equally arise in within smart contracts
• the terms and conditions of these contracts are fully visible and accessible to all relevant parties reducing disputes

However, while there are a number of possible benefits, there are also risks and areas to consider, including:

• the need to rely on a trusted, technical expert to either capture the parties' agreement in code or certify the accuracy of code created by a third party
• the need to be explicit about each provision and condition and translate that into contract code
• the requirement for additional levels of insurance and protection in the event that the smart contract code fails to execute or perform the necessary actions
• extra fees for contract execution on various blockchain platforms
• contract enforceability, particularly where performance is connected to a subjective criteria such as "reasonable" or “best endeavours”
• some of the underlying technology used to support smart contracts is still in its early stages, and there may be vulnerabilities or concerns that are not yet known

Sectors based on defined rules and quantifiable terms of engagement, such as banking, insurance, and real estate, would gain first from investing in this technology, particularly in areas like digital payments, claims settlements, and modifications to public registries.

A recent law commission report, published 25th November 2021, concluded that the current legal framework in England and Wales is clearly able to facilitate and support the use of smart legal contracts, without the need for any statutory law reform. In a recent update, Eversheds Sutherland Partner Craig Rogers, noted that the same principles that apply to “traditional” contracts (e.g. interpretation of terms and conditions and errors which are contrary to the intention of the parties) could equally arise in the context of smart contracts.

Craig also noted that whilst the report will not fundamentally change the way existing applications of smart contracts technology are deployed, it will give companies and organizations (and their legal advisors) the confidence to develop smart contract solutions - and to attract investment - on the basis of a solid foundation based on existing legal principles.

Smart contracts have the potential to significantly alter the way the legal industry manages contracts, and businesses would benefit from exploring the opportunities and risks they present. However, there is still a long way to go and a number of key questions to be answered before smart contracts become widely adopted. Similar to other technology advances (e.g. electronic signatures), smart contracts are likely to have a beneficial influence on the way lawyers operate, while also increasing demand for legal services.