Smart Contracts: the Next Frontier?

This post comes to us from Andy Robinson and Tom Hingley from Freshfields Bruckhaus Deringer LLP.   

Before email (we are reliably informed), contracts would be posted, received, marked-up, re-posted and disappear for days until arriving back covered in further manuscript in a different coloured pen. Nowadays, we live in the age of emails, attachments, and the ability to instantly share comments. Here we ask: are smart contracts poised to be the next frontier in the life of a lawyer?

What is a smart contract?

As we set out in our Freshfields Digital article ‘A smart new world: blockchain and smart contracts’, a smart contract is a piece of computer code that is capable of monitoring, executing, and enforcing an agreement without the need for human interference or trusted intermediaries. Potential uses are numerous: assets could be transferred automatically upon receipt of cleared funds; credits under service level agreements could be automatically paid at the point of violation; and the monitoring and enforcement of financial covenants could be performed automatically.

What are the implications for lawyers?

If code is to be the next language of law, where does that leave lawyers? As we suggest in our article there will be those agreements (normally low value and/or simple transactions, such as the sale and purchase of a car) where a smart contract might be capable of being purchased and deployed ‘off-the-shelf’ without any need for review by lawyers. However, many of these transactions are unlikely to use lawyers now in any event.

The good news, for lawyers at least, is that smart contracts are unlikely to dispense of the need for detailed legal advice in the negotiation of more complex and higher value matters, particularly in respect of those agreements that require detailed negotiation and bespoke drafting. It is here that the worlds of the conventional contract and the smart contract may collide. The smart contract monitors and executes part of an agreement that has been negotiated and drafted by lawyers.

This inevitably leads to questions: who translates the legal agreement into code? Will drafting itself change? Who is liable for the code? These are issues to which, currently, there are no definitive answers. Nevertheless, here we share some of our thoughts as to how they may be dealt with.

Who translates the legal agreement into code?

In an ideal world, one might expect the lawyer closest to the negotiation and drafting to undertake the coding. But even when lawyers can code, is it realistic to expect them to code well enough to translate complex legal agreements into smart contracts? We expect clients to prefer their lawyers to draft the agreements and dedicated coders to translate them into smart contracts – not dissimilar to clients paying for professional language translation services today.

Will drafting itself change?

The format of drafting may develop to make it easier for coders to transform the written contract into code form. One route may be for drafting to become more modular. Each function in a contract may have its own clause, and the separation between clauses may be more tightly policed, to ensure that everything relevant to a function that will be translated into a smart contract is contained within one clause.

Considering the limitations of what code can foreseeably be expected to achieve, it is likely that only certain parts of agreements will be translated into smart contracts. For example, in a standard sale and purchase agreement, the clauses dealing with the payment of funds and transfer of title to shares may be coded and therefore executed automatically by the smart contract. Other actions, such as monitoring for warranty breaches, may continue to be done manually.

For clauses where code will apply, it may be that the code is included within the written agreement itself. A provision may state that the parties agree that the clause is to be represented by the following string of code. This might be broadly analogous to the way algorithmic examples are currently presented in certain agreements (such as financial adjustments in sale and purchase agreements).

Who is liable for code?

As we discussed in more detail in our article, code can never be wrong per se, but it can have unintended consequences. Liability for such unintended consequences is likely to depend on whether the coders are employed by the law firm or contracted on a third party basis. The terms on which third party coders translate legal agreements will need to be carefully reviewed. One of the great benefits of smart contracts – the speed at which they can execute agreements without the need for human oversight – can also lead to potentially huge liabilities when they go wrong. It is likely that the balance of this risk between coders, law firms and contracting parties will be a key point of negotiation.

The future?

Smart contracts are clearly going to play a part in the future of the legal world, but, perhaps in the medium-term, are not likely to significantly change the way law is practised. However, as technology improves, the number of provisions too complex to be coded is likely to shrink. We may one day reach a tipping point where the majority of legal concepts can be translated into code. It is at this point where the role of the lawyer may have to change to keep up.