State Legislation Bolsters Case for Smart Contract Enforceability
Last year, the Governor of Illinois signed into law the state’s Blockchain Technology Act. The act, which took effect on January 1, 2020, attempts to answer lingering questions over the legality of smart contracts.
Under the act, a “smart contract” is “a contract stored as an electronic record which is verified by the use of a blockchain.” In practice, a smart contract is pretty simple: it’s a digital agreement that operates using conditional “if-then” logic. For example, some flight insurance products utilize smart contract technology.
A traveler, for instance, pays $10 (i.e., a premium and consent to the agreement terms) to the smart contract platform, while the insurance company pays $90 (i.e., valid formation of a contract). If the traveler’s flight is on time, as recorded by publicly available and immutable flight records monitored by the smart contract system, then the smart contract deposits $100 with the insurance company. But if the flight is delayed by more than the time designated in the paper agreement terms, then the traveler is sent $100. The automatic process accelerates claim resolutions, reduces the risk of fraudulent claims or conversely breach of contract, and frees up resources.
This is a simple consumer example, but business-to-business applications are also ample.
Straightforward as they can be, these computerized agreement are much different than traditional paper contracts.
It’s not uncommon for a reviewing court, when analyzing a contract, to expect that all essential terms of the parties’ agreement will appear within the four corners of a signed document. There is a concern that the rising popularity of smart contracts in commercial transactions will fall off if courts refuse to enforce smart contracts simply because of their event-driven, self-executing nature.
With the passage of the Blockchain Technology Act, Illinois is the latest jurisdiction to take proactive measures to calm this anxiety. The act makes smart contracts and blockchain records admissible as evidence in legal proceedings and prohibits a court from denying a smart contract legal effect because it utilizes blockchain technology. The act also denies local authorities the ability to tax smart contracts or to require permits or licenses for their use.
Other states have passed similar legislation – among them Arizona, Delaware, Nevada, Ohio, Tennessee, and Wyoming – but the Illinois law is notable for being the most comprehensive. For example, the act puts limits on how a smart contract and blockchain technology cannot be used: to supply written notice under specific situations, such as when announcing a product recall, repossessing property, or terminating a person’s healthcare insurance.
General counsel and contract managers with smart contracts implemented in Illinois should take comfort in the act’s passage. The law provides certainty in knowing that a court cannot refuse to enforce a smart contract simply because it’s built on the blockchain. And by removing local authorities’ regulatory power, the act ensures that General counsel and contract managers will avoid the hassle that comes with having to navigate a maze of local regulation.
To be sure, there are plenty of legal questions about smart contracts and blockchain technology not answered by the new law.
It doesn’t immunize smart contracts from all forms of legal challenge; mistakes in the self-executing code, as one example, could support a court’s decision to void the agreement. And the act doesn’t speak to the application of legal contractual remedies. For instance, there is no instruction provided for how a court might reverse a transaction that occurs across a distributed ledger (or whether such undoing is even possible) or how a court might assess monetary damages against a potentially anonymous entity.
Finally, the multi-jurisdictional nature of smart contracts requires consistency among state law to ensure predictable enforcement outcomes. And yet discrepancies between pending legislation that is currently proceeding through several state legislatures will undoubtedly arise. The differences may present interpretation and enforcement challenges for smart contracts. As such, as new laws continue to emerge, general counsel and contract managers should closely track developing trends in legislation.
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