smart contracts legally binding

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What are Smart Contracts and are they Legally Binding?

April 11, 2022         Fatima Raza

Smart contracts are computing programs that automatically execute all parts of a contract. They are also stored on a block-chain based platform. Implementing smart contracts into your business is useful however not all smart contracts are legally binding.

What is a Smart Contract? 

Smart contracts are used to automate the execution of an agreement so that all participants can be notified of the outcome without time loss or any intermediary involvement. The code within smart contracts can either be the agreement between the parties or a traditional text-based contract that executes certain provisions such as transferring funds from A to B. 

Four Types of Smart Contracts

Smart contracts can come in different forms such as: 

  • Expressed only in code with no separate version of the contract written in a natural language;
  • Contains a separate version of the contract written in a natural language;
  • “Split” natural language contract with encoded performance; or
  • Natural language contract containing an encoded payment mechanism.

Are Smart Contracts Legally Enforceable? 

For a contract to be legally enforceable they must satisfy the fundamental elements of a valid contract which are: 

  • Offer; 
  • Acceptance;
  • Consideration; 
  • Intention to create and binded to legal relations;
  • Capacity to contract.

Smart contracts must therefore also satisfy the above requirements. For smart contracts It can be said that an offer has taken place when an offeror posts the smart contract containing the terms of the agreement on the blockchain. The offeree can then accept or reject. Acceptance can be proven through performance. Smart contracts tend to be unilateral in nature thus performance can conclude as consideration. Difficulty lies within proving that there was an intention to create legal relations in blockchain smart contracts.

Blockchain smart contracts also do not check if parties have full legal capacity to enter into contracts, this can lead to minors and such entering into smart contracts. 

Each different type of smart contract has different issues relating to whether or not they satisfy all elements of a traditional contract. A contract that is expressed only in code with no separate version in a natural language is unlikely to be considered a legally binding contract as it lacks human intervention. Thus meaning identifying the parties can be difficult. 

Due to the fact that smart contracts are still in an area that is continually progressing, it is encouraged to draft a separate natural contract along with it.

Where are Smart Contracts Used? 

  1. Insurance Groups– Some insurance groups have added smart contracts to help with security and reduce long waiting times. 
  2. Real Estate- Smart contracts can reduce the risks associated with real estate transactions.
  3. Health Care System- The use of smart contracts for securing and sharing patient health records which avoids human error.
  4. Voting systems- Because they are tamper proof it reduces the risks of manipulation and mistakes. 

Advantages of Smart Contracts?

  • Speed, efficiency and accuracy– Because smart contracts are digital and automated the contract is executed immediately meaning there is no paperwork nor time spent correcting errors.
  • Transparency and trust- No need to question whether information has been changed for personal benefit as there is no third party and encrypted records are shared to the parties. 
  • Security- Blockchain transaction records are encrypted which makes it difficult to hack.
  • Savings- Removes the need for intermediaries to intervene thus reducing time delays.

Disadvantages of Smart Contracts? 

  • Less accessible for contract parties- smart contracts remove the human aspect of contracts.
  • Mistakes can be costly- Smart contracts are immutable so if mistakes are made they’ll be costly. 
  • Uncollaborative- They’re often too technical and removes the use of human engagement.
  • Zero flexibility- They are very rigid and leave no room for mistakes, ambiguity and changes. The negotiation process shapes commercial relationships and this removes that. 

Conclusion

Smart contracts are designed to be self executing business agreements, and thus it’s important to understand whether they are legally binding or not. If you’re a business interested in implementing blockchain smart contracts legal advice should be sought in order to ensure they can be relied on. If you need any assistance or have any enquiries about blockchain smart contracts, get in touch with our team via the contact form or by calling 1300 337 997.

About Fatima Raza

Fatima is a legal intern at Openlegal and is currently in her third year studying Law and Media and communications at Macquarie University. Her interests are commercial, property and international law.