Energy, technology and arbitration – The latest buzz

Technological innovation continues to disrupt the status quo in established industries, presenting both opportunities and threats to established industry leaders. In this article, we focus on the disputes that might arise from changes in the energy sector, and emerging avenues for avoiding and resolving such disputes.

Reenergizing the energy sector – digitalization, big data, smart contracts and the internet of things

We are in the midst of the “fourth industrial revolution”. As discussed in our guide Unlocking the blockchain: Digitizing the energy value chain, distributed ledger technology (DLT), and the applications enabled by it, has the potential to lead to a fundamental change in how the energy industry shares data and transacts, and may even alter market structures.

DLT refers to software applications that deploy a digital database of transactions (i.e. a ledger) which is distributed (i.e. identical copies of the ledger are maintained on multiple computer systems). A common iteration of DLT is “blockchain”. The significance of DLT is that it allows data gathering and record-keeping on enormous scales and facilitates the efficient sharing of certain data between parties to a transaction. DLT has important B2B applications throughout the energy sector, and is potentially disruptive at every stage of the value chain including in asset management, trading, commodities tracking and certification, transport and logistics and payment mechanisms.

When combined with data analytic software, DLT is also an incredibly powerful B2C tool. It enables much deeper understanding of customer attitudes and behaviors and closer monitoring of market trends, facilitating closer interaction with retail customers.

DLT also has the potential to automate many activities, when used in combination with smart contracts. A smart contract is a “set of promises, specified in digital form, including protocols within which the parties perform on these promises” (Nick Szabo, Smart Contracts: Building Blocks for Digital Markets, 1996).

A smart contract is

• Digital – it is in code for.
• Embedded – contractual clauses are embedded (as code) in hardware or software.
• Performance is mediated by technological means – actions are enabled by technology and rulesbased operations.
• Irrevocable – performance is automatic and, once initiated, the outcome encoded to be performed typically cannot be stopped (unless the outcome depends on an unmet condition).

As smart contracts are simply automating code other technology could also be used, but smart contracts are typically deployed on DLT.

A key virtue of a smart contract is its “disintermediation”, in that the parties can transact on a peer-to-peer basis, without the need for an intermediary – whether that be a central authority or third party. The system facilitates correspondence between the parties’ respective copies of the ledger, and the smart contract performs automatically, as coded, when pre-agreed events or values are recorded on the ledger.

This has significant implications in the energy sector. In energy trading, for example, cost reductions in deal execution and decreased credit risk may be achieved by enhanced information flow and disintermediation, using smart contracts to automate the execution of trades.

The potential uses are even more exciting when combined with the Internet of Things (IOT). IOT refers to the connectivity between intelligent sensors and devices via a network. Sensors are already used throughout the energy industry, for example, monitoring and maintaining temperatures during oil extraction and in maximizing gas distribution by managing pressures and identifying leakages. Combining this with DLT, smart contracts and IOT could lead to unprecedented automation of operations across the industry. For example, electricity network faults could be identified using smart sensors (rather than visual inspection) and maintenance automatically scheduled by a selfexecuting smart contract.

Potential disputes

However, any business innovation, whilst creating opportunities, also creates new areas for disputes. Given that much of this technology, and the potential use cases, are rapidly evolving, the exact nature of disputes likely to arise is difficult to predict. To complicate matters, most laws that will apply to such disputes were developed in a world that did not even contemplate such technologies.

One fundamental issue is whether smart contracts in fact have any legally binding contractual effect at all. Under the common law a contract requires: offer and acceptance, consideration, intention to create legal relations and certainty of terms. The coding of a smart contract may lack these essential legal elements. Furthermore, by its very nature a smart contract may not satisfy prescribed formalities for legal validity e.g. a certain form and/or method of execution. There is a clear risk to parties if commercial arrangements lack legally binding effect.

Coding errors may also give rise to legal uncertainties, and these matters will be more complicated when things go wrong in situations without any human involvement. In some circumstances, it may be difficult in accordance with established legal thinking to establish liability and/or even identify the defendant against whom to seek redress. For example, if an automatically generated invoice is sent to and automatically paid by a customer but an audit later proves it to have been wrong (based on an inaccurate reading from a defective sensor or due to some small programming error in the algorithm). Another foreseeable example is where a bug or error in a smart contract results in a mistake in what the parties thought they had agreed or some entirely unintended outcome. Most jurisdictions have legal mechanisms to deal with the consequences of or correcting mistakes in contracts, but we are yet to see how the courts will apply such laws to smart contracts.

Also fundamental are questions of jurisdiction and governing law. The energy industry is global, and transactions and supply-chains commonly have cross-border elements. That brings with it questions of which court(s) has jurisdiction to hear disputes and which law(s) should be applied. Pity the court that has to determine governing law and jurisdiction in this hypothetical DLT use case example: disputes arise in respect of a DLT based commodity trading platform created and provided by a Swiss technology company, on which a South African buyer and a US seller transact, with the commodity to be delivered in Italy. It is not that there is necessarily a legal vacuum to decide these issues, and courts are of course accustomed to dealing with difficult jurisdictional and conflict of law issues. But we are yet to see how these issues will be dealt with by the courts in practice.

Legal and regulatory risk in the energy sector is already a complex matrix, complicated by the fact that the sector involves global players but there is no single, universal, legal system. There is a plethora of different and often conflicting systems across the globe, and as disputes arise, multiple courts will grapple with and laws will evolve (or be legislated) to address challenges created by fast emerging new business realities. These few examples are intended only as an introduction to the novel legal risk profile of innovative technologies. The biggest risks are of course likely still unknown.

Majority risk

Parties can take steps to minimise risk. This requires careful analysis of the risk profile of the particular use case in the specific context. Critically, this should be done at the outset. Some issues may be ameliorated, at least to some degree, by incorporating contractual provisions in the smart contract (directly or by reference to terms and conditions). To deal with liability, for example, parties may include provisions to allocate risk or to limit or exclude liability (on a back-toback basis, as appropriate). Parties may also include provisions to deal with events that amount to force majeure or arise from third-party (mis)conduct. Jurisdictional problems may be assisted by choice of law or jurisdiction clauses.

However, the very nature of emerging technologies means that not all risks can be anticipated. Given the commercial and legal uncertainties, arguably the most important decision will be the choice of governing law and dispute resolution mechanism in the smart contract.

The role of arbitration in smart contract disputes

As discussed in our article Arbitrating smart contract disputes, arbitration is uniquely well-suited to deal with disputes relating to innovative technologies arising in the energy sector.

Arbitration often has significant advantages in respect of enforcing the parties’ agreement to arbitrate, as well as any arbitral award subsequently rendered. It offers a neutral forum, and allows parties to avoid recourse to courts where, for example, there might be issues with bias, corruption, lack of expertise, or excessive cost or delay. Importantly, parties to arbitration can also choose their arbitrator(s) – a significant benefit where the alternative would be judges or juries with no relevant expertise. As arbitration is a consensual, contractual process, parties also have greater flexibility to tailor the arbitral procedure to their specific needs.

As a process, arbitration is more readily able to adapt to the new status quo brought about by innovation than many national courts, and can offer innovative dispute resolution solutions. Innovators in arbitration are already developing automated dispute resolution processes that operate in the same way that a smart contract does.

For example, parties could agree and code into the smart contract that an arbitrator(s) will be automatically appointed from a pre-agreed list (perhaps chosen at random) and that the arbitrator’s decision is to be fed back into the smart contract giving it immediate effect and circumventing enforcement issues. This idea of “decentralised” arbitration was mooted in 2016 by Vitalik Buterin, the individual behind the blockchain platform Ethereum. This concept could be expanded to add provisions as to how the disputes will be resolved, such as a fast-track process, decided by reference to only certain preagreed external data and in accordance with certain laws or rules. For certain types of disputes, a largely automated (and cost effective) arrangement such as this would be welcomed. Other examples of innovative arbitration are set out in the table below.

At the furthest end of the spectrum is so-called “AI Arbitrators”. As business activity in the energy sector becomes increasingly automated, and ever greater volumes of data are generated and inter-connected, it is conceivable that arbitration could eventually offer wholly automated dispute resolution solutions by applying analytical tools and artificial intelligence to decide disputes based on data input automatically by the smart contract and which are automatically given effect in the smart contract. In this way technological innovation has great potential to disrupt not only the energy sector, but also dispute resolution itself.

Conclusion

These are exciting times for the energy sector, with emerging technologies offering incredible opportunities. Parties do need to ensure, however, that they also consider the potential new areas of risk, and ensure that they have incorporated appropriate contractual protections and an effective and enforceable mechanism for enforcing the contract and resolving disputes.

With special thanks to Khawaja Akbar, trainee, for his assistance with this article.

Innovations in DLT arbitration