A smart contract is typically not a contract in the legal sense. It is a programme code that is communicated to, and stored on, a blockchain – a decentralised network of computers working as a distributed database that validates transactions and executes programme code irreversibly (distributed ledger technology). Smart contracts specify simple logic patterns, such as: if condition A has been met, operation B will be executed. The combination of the decentralised, transparent and irreversible nature of the blockchain and the automated self-executing programme code is at the heart of the popularity of smart contracts and many related research activities across the globe.
What are smart contracts legally?
Smart contracts can be used in two different ways:
- simple smart contracts, which are used as pure performance instruments for separately concluded legal contracts (such as vending machines in the real world) and do not qualify as legal contracts; or
- legal smart contracts, meaning that the underlying programme code itself qualifies as a legal contract.
The following questions arise with regards to legal smart contracts:
Can programme code be the contractual language of a legal contract?
Section 883 of the Austrian Civil Code (ABGB) pursues the principle of freedom of form (Formfreiheit) with regards to the conclusion of contracts. In principle, the law leaves it to the parties to decide how to declare their intent and conclude legal contracts. Consequently, a declaration of intent can also be expressed by using programme code, provided that the declarant understands the programme code and thus the content of his declaration of intent.
Certain legal transactions are subject to mandatory formal requirements under Austrian law, meaning that an underlying legal contract must be concluded, e.g. in writing or as a notarial deed. This applies, for example, to the transfer of shares in an Austrian limited liability company (which requires a notarial deed) or a simple surety agreement (which requires a written surety declaration). While it could be argued that smart contracts qualify as written contracts, stricter formal requirements (like notarial deeds) may impede the conclusion of legally binding contracts via programme code.
How to conclude legal smart contracts without separate agreements?
In addition to mere contract processing, blockchain technology and smart contracts can also be used to identify potential contract partners and then automatically conclude contracts with them. The blockchain is thus used as a kind of matching platform for declarations of intent. Under Austrian civil law, such a matching procedure may be qualified as an "offer to an unidentified person". This is particularly relevant where two machines conclude contracts with each other autonomously for, and against, their operators (known as "M2M transactions"). A wide variety of applications is already under development, such as self-driving electric cars that recharge their batteries as required and automatically conclude a legal smart contract with the relevant power supplier.
Under Section 869 of the ABGB, a declaration of intent must be made freely, seriously, clearly and understandably. The use of blockchain technology and smart contracts to declare intent does not contradict Section 869 of the ABGB. Insofar as all other conditions under Austrian law for the conclusion of a contract are met (in particular, legal capacity, formal requirements and consensus building), the legal smart contract may be qualified as a legally binding contract.
Who is actually declaring his intent?
Machines that conclude legal smart contracts are merely tools for making declarations of intent: they support natural or legal persons in communicating their intent. The declaration of intent is therefore always attributed to the person behind the machine.
Who is liable?
Blockchain technology is still in its infancy. Errors and deficiencies in the programme code of the blockchain or the smart contract itself as well as an incorrect understanding of the blockchain users are to be expected during and after the development phase. So, who is responsible for errors and defects? The first legal challenge is to subsume the contractual relationships entered into for a smart contract under civil law contract types and then to assign the disadvantages arising from errors and defects to the sphere of a particular contractual partner. Further challenges arise together with the irrevocability of smart contracts in connection with revocations or terminations of smart contracts. Technical and legal solutions must be found to prevent unwanted handling of assets or to avoid subsequent disputes.
International interdependence of blockchain transactions
The true complexity of an international peer-to-peer network through which smart contracts are concluded only becomes apparent in international legal relations (especially with non-EU countries). Identifying the contracting party and the applicable law will put known conflict of laws to the test. A first step in the direction of legal certainty would be to include provisions on applicable law and jurisdiction in the smart contract itself to prevent difficulties in international legal transactions.
If desired, contracts can be concluded directly on the blockchain via legal smart contracts, whereby declarations of intent are attributed in a proven manner to the underlying blockchain users. However, smart contract users should consider the possible legal pitfalls due to the international nature of the blockchain technology and non-transparent contractual structures and liability regimes.
This article was up to date as at the date of going to publishing on 10 December 2018.