Smart legal contracts under English law - Part 3: Remedies, consumer contracts, jurisdiction and governing law
The Law Commission has concluded its investigation into how the current law of contract is able to apply to smart legal contracts. Our previous two posts considered the landscape of English contract law and how it might need to adapt to address the challenges presented by smart legal contracts, as well as more detailed consideration as to how the fundamental tenets of contract law – formation and interpretation – may work in practice.
In our final post, we consider a range of dispute-focussed challenges that smart legal contracts may throw up, and why it is important to consider them prior to entering into a smart legal contract, rather than waiting until a dispute has arisen.
Remedies
It is currently unclear how many of the remedies available under English law the courts would apply in the context of smart legal contracts. The following issues, highlighted by the Law Commission, are likely to be of particular concern.
Rectification
While in principle rectification may provide the court with a mechanism for amending code to resolve errors, the report was concerned that there would be practical difficulties with implementing any such decision.
For example, it is unclear how an immutable distributed ledger would be amended. Rather than rectification in the classical sense, the report envisages the court ordering the parties to deploy revised code, reversing or overriding the initial coded obligation. However, this method may face further challenges where an error in the code of a smart legal contract is only discovered after the code has been executed. While the Law Commission considered that rectification may form the basis of other remedies, it found rectification to be more relevant to situations involving continuous performance.
Vitiating factors
Mistake
Code-only obligations in smart legal contracts create an increased risk that the parties’ belief as to how the code will perform is mistaken. The Law Commission’s view was that the doctrine of common mistake should apply to smart legal contracts, just as it applies to traditional contracts, and that the doctrine’s current form was sufficient to address any issues that may arise.
It was noted that the doctrine of unilateral mistake may require adaptation, but only in the context of smart legal contracts autonomously agreed by computers on behalf of parties. As the computer’s program will only operate on the basis of the programmer’s instructions, the Law Commission recommends that the courts adapt the relevant tests to clarify “whose knowledge of the mistake is relevant, the time frame for assessing that person’s knowledge, and the type of knowledge that is required.”
Remedies in the context of vitiated contracts
The Law Commission considered that there would likely be situations in which smart legal contracts were vitiated, and that unlike traditional contracts it may be impossible to unwind the agreement. A voided smart legal contract may act as the basis for a claim in unjust enrichment, the natural remedy being restitution of the benefits of the smart legal contract.
Just as with rectification, restitution may run into practical difficulties where the transaction is recorded on a distributed ledger. Again, the Law Commission considers that “practical justice” could be achieved by ordering the parties to enter into an “equal and opposite” second transaction. Such second transaction may not be truly equal and opposite where the smart legal contract has been stopped after the code has been partly performed.
In the context of traditional contracts, the court may order party B to return an object or sum to party A. The remedy involves the legal fiction that the pair of transaction never occurred. How such a legal fiction could be achieved on an immutable distributed ledger is not clear, where a second transaction may, for example, create the impression that party B held legal title between the first and second transactions. In commercial contexts, this could lead to significant complications in scenarios such as tax and cross-defaults, especially where those scenarios themselves involve further smart legal contracts.
Breach of contract
Code which fails to perform the natural language obligations in a smart legal contract may result in the court ordering damages designed to put the party in the position they would have been, but for the breach. While the Law Commission did not foresee any novel legal issues in such an event, the report noted that immutable distributed ledgers may not allow for termination of the smart legal contract for breach, and that parties may wish to program termination methods into the smart legal contracts themselves.
In the context of code-only obligations under a smart legal contract, interpretation of the obligations is likely to cause difficulty in establishing a breach of contract. However, once any obligations have been established and the meaning of the coded terms determined, existing remedies for breach of contract should apply.
Frustration
The Law Commission noted that in addition to the traditional external factors which may result in frustration, the performance of the code might itself become an impossibility. The example given was where the platform hosting the code is destroyed or shut down due to an unforeseen event.
Frustration due to external factors would face similar problems. Parties would be well advised to include a mechanism enabling a smart legal contract to be amended upon the occurrence of an unforeseen event that would otherwise frustrate performance. A market standard frustration clause with a ‘kill switch’ mechanism would, in the authors’ view, help mitigate any drafting risk surrounding this issue, allowing traditional dispute resolution methods to determine whether or not the smart legal contract was frustrated and the kill switch should be used.
Illegality
The Law Commission found that the illegality doctrine did not need modification to address smart legal contracts. The practical issue is likely to be how to halt a smart contract the performance of which is agreed or found to be illegal.
Consumer contracts
The Consumer Rights Act 2015[1] requires that written terms in consumer contracts are transparent. A term will be transparent if it is “expressed in plain and intelligible language and it is legible”. Source code and machine code may not be considered ‘transparent’.
The Law Commission recommended that, as code is unlikely to be transparent from a consumer’s perspective, a natural language explanation should be provided to consumers. Otherwise, the courts may find smart legal contracts between businesses and consumers to be unfair.
Further, the report flags that statements in such natural language explanations which suggest that the explanation itself is not intended to create a legally binding relationship between the business and consumer may themselves be found to be unfair under s. 62(2) Consumer Rights Act 2015.
Jurisdiction and governing law
Lack of clarity as to which court has jurisdiction is a fundamental issue for smart legal contracts. The Law Commission’s report focuses on smart legal contracts which lack a jurisdiction clause, where jurisdiction is determined under private international law. Other, more common matters such as conflicting jurisdiction clauses and split jurisdiction clauses, will also need careful consideration.
Under private international law there are various factors which may be relevant to determining the jurisdiction of a jurisdiction-clause-less smart legal contract. Factors involving physical location of the parties are naturally more complicated in the context of smart legal contracts than under traditional contracts.
Physical location of a defendant
Smart legal contracts which are entered into pseudonymously pose challenges for determining the jurisdiction of the parties.
Where is a smart legal contract formed?
The jurisdiction of a traditional contract can be the law of the place where the contract was entered into, the lex loci contractus. Smart legal contracts may be agreed without any natural language communication between the parties and different elements of the smart legal contract may have been dispersed or validated across multiple computers located in multiple physical jurisdictions.
The most-widely cited example of multiple jurisdictional acts are those carried out on a distributed ledger by a cross-border network of computers. Ascribing a physical location to a distributed act appears inherently implausible and new legal fictions must be found for locating such acts.
Is a coder an agent?
“Under the common law rules, a court will have jurisdiction if a contract was made by or through an agent trading or residing in England or Wales.” The Law Commission’s view is that while it would be a question of fact, coders may be considered agents for one or more contracting parties.
The Law Commission’s view was that a computer program itself would not be an agent, but the report did not discuss this in the context of a computer program, such as a decentralised autonomous organisation (a DAO), which can have a separate legal personality. As discussed in an earlier article, English courts will recognise the legal personalities created by the laws of a foreign country.
Governing law
Again, lack of clarity as to the governing law of a smart legal contract may require the application of private international law, and such factors may in turn weigh upon the appropriate jurisdiction. While many of the existing factors relevant to governing law are unlikely to need modification to address smart legal contracts, the report suggests that the English courts may consider various new factors, including “the location of any private key, or the domicile of any central administrator, if the relevant ledger is permissioned.”
Digital location
Many of the above issues are rooted in what the Law Commission calls the issue of ‘digital location’, which comes down to two fundamental questions:
- Where is a digital asset located?
- Where is an act, which takes place on a distributed ledger, located?
Key Takeaways
The flexibility of remedies under English contract law is such that smart legal contracts are unlikely to create substantial challenges to the application of practical justice.
The issue of jurisdiction and governing law of digital assets and digital acts is a key area where the development of English law is likely to be required. Consequently, the Law Commission is recommending a further separate consultation on these topics.