What are smart contracts?
There is no agreed upon definition of a smart contract. At its most basic, a smart contract is computer code that executes on the occurrence of predetermined events.
For the purpose of this article I will be considering Smart Legal Contracts (SLC) which are a type of smart contract. These smart contracts are the process of digitalising an enforceable legal contract to incorporate computer code to automate some or all of the obligations or functions of the contract. These SLCs will be recorded and stored on a distributed ledger like the blockchain.
The UK Jurisdiction Taskforce Legal Statement identified three forms of smart contracts:
- A natural language contract in which some or all of the contractual obligations are performed automatically by the code of the computer program deployed on a distributed ledger. The code itself does not record any contractual obligations but is merely a tool employed by parties to perform those obligations.
- A hybrid contract in which some contractual obligations are recorded in natural language and others are recorded in the code of a computer program deployed on a distributed ledger. At one end of the spectrum, the terms of a hybrid contract could primarily be written in code with natural language terms employed to add certain provisions (for example, governing law and jurisdiction clauses and dispute resolution mechanisms). At the other end of the spectrum, the terms of a hybrid contract could be primarily written in natural language and include, by reference, just one or two terms written in code.
- A contract that is recorded solely in the code of a computer program deployed on a distributed ledger. No natural language version of the agreement exists: all the contractual obligations are recorded in, and performed by, the code.
Most of the SLCs used today stem from natural language contracts but it is thought that over time the other forms of smart contracts will become more popular as technology evolves, and as the use of SLCs become more widespread.
Advantages of adopting SLCs
There are various benefits to adopting SLC in the real estate industry. There are the obvious advantages that automating certain obligations and functions of a contract will offer such as cost savings and increasing the efficiency of the life cycle of a contract. There are also further advantages that may be less obvious.
For example, the use of SLCs will ensure that there is increased accuracy and potential transparency of contractual terms (although viewing these terms may be restricted to transacting parties only) which should reduce manual errors in processing the functions of the contract.
Less scope for misinterpretation
There may also be less scope for misinterpretation of contractual terms since a SLC will automatically execute on predetermined conditions that may rely on independent third party data. Contractual disputes can also be dealt with more effectively under a SLC as they have the ability to automatically escrow or transfer agreed upon funds as a result of a predetermined event or breach.
This would allow an arbitrator time to determine the issue at hand and direct payment of such funds to the correct parties, hopefully reducing the need for post-litigation enforcement proceedings. SLC also offers interoperability, allowing updated data to be imported or exported into a SLC automatically reducing the need for manual calculations or processing of contractual terms.
Disadvantages of SLCs
However, SLCs also come with certain disadvantages. It is important to remember that not all contracts (or contractual terms) can be or should be automated as this may restrict the flexibility of the contract.
Often parties will want some flexibility in their contracts and this is not possible with SLCs stored on a distributed ledger as it is immutable once uploaded.
There is also the problem of having to rely on objective sources of external data to complete certain contractual terms. This data has to be trusted by all parties and there is no guarantee that it will always be available.
This is known as the Oracle Problem. There are also practicalities around what functions the SLC can offer. Although it is possible for SLC to automate movements of monies (or other value) under certain pre-conditions it would, in reality, require the parties to prefund specific accounts.
This will not always be desirable for the contracting parties as it means such monies cannot be utilised while held in the prefunded account.
Use of SLCs in real estate transactions
As mentioned above, it is not appropriate or beneficial to digitalise and automate all contracts. There can be many reasons for this decision. In relation to real estate transactions, the Digital Street project, run by HM Land Registry, did not digitalise the Standard Conditions of Sale due to their complexity.
However, they did digitalise and automate more administrative contractual obligations such as registering transfer documents at HM Land Registry.
These types of administrative clauses lend themselves to being automated and assist in increasing efficiency of the registration process. The automatic registration of a transfer eliminates the registration gap and produces cost savings for clients, solicitors and the land registry.
The future of SLCs
Looking to the future there are other such administrative tasks or contractual obligations that occur frequently during real estate transactions that could be automated to increase efficiencies and cost savings.
Payment of any fees or commissions could be automated as part of the completion process to reduce post administrative tasks.
It may also be possible to digitalise and automate other administrative payments that would significantly decrease the time taken to complete a transfer of property and its registration.
Automating the payment of SDLT or mortgage redemption funds via SLC are a couple of examples of such payments. However such automation would require cooperation with parties such as the government and institutional lenders.
It would also require interoperability between the SLC and the systems already in pace at these institutions.
Such cooperation and interoperability may be achievable but not without further developments in the technology and a more in depth consideration of the legal risks involved in particular to confidentiality and data protection.
Even with technological and legal advancements that would allow us to overcome any issues with the use of SLC there is one concern that would dominate a lawyers mind - who is liable for ensuring SLC actually carry out the functions required under the natural language contract?
Most lawyers cannot read computer code and so will have no way of checking that any code incorporated in a SLC is correct and achieves the intended goals of the contract.
In the same vein, most computer coders are not legally trained and would not be expected to be held responsible for any unintended legal consequence caused due to the code incorporated in any SLC.
Currently, the solution seems to be that law firms and in-house legal departments considering the use of SLCs will employ their own developers or contract with specific developers to code their own SLCs.
However, this will not be an option for all legal firms and a more accessible alternative, which is also acceptable to legal insurers, will need to be found in order for SLCs to be more widely adopted in the legal industry.
Visit our 'future of real estate' hub to learn more about the technological advances in the legal real estate market.