Enhancing Dispute Resolution Through DLT: A Case For Regulatory Framework Of “Smart” Contracts

Urmil Shah, 3rd year law student, Auro University Surat

Introduction

There has been quite deliberations on distributed ledger technology and its application with smart contracts on utilizing it as a mode of dispute resolution, from a conflict management standpoint. Although, smart contracts provide endless potential to assist disputing management, particularly in the field of international arbitration due to its delocalized nature; however, the compliance of such contracts with the domestic legal regime of states is imperative to ascertain the validity, from legal certainty standpoint.


The article analyses and compares smart contracts firstly, as traditional contracts to seek domestic compliance with Indian contract law and secondly, as arbitration agreement with the “soft” international arbitration regime. The author attempts to establish that an effective sui generis legislation must be passed for the domestic regulation of such contracts and their increased compliance and utilization within most jurisdictions.

The convergence of technology and law enhances the efficiency of conventional mechanisms of dispute settlement. The emergence of technologies like distributed ledger technology (“DLT”) provides a wide array of avenues for alternative modes of dispute resolution. The prolific academic discourse on this theme has given the DLT a novel dimension as a tool for enforcement of agreements without human intervention.[i] DLT, also referred to as block-chain, refers to a collection of blocks (ledgers), linked through cryptography and distributed on an open-source. Some of the most striking characteristics of block chain-like, decentralization, flexibility[ii], immutability, traceability of data, and reduced third-party intervention allows for the operation of highly confidential transactions in a secure manner[iii], changing the dynamics of interaction.
Block chain has a diverse application as any transaction can be recorded on it; however, it is worth understanding the deployment of Smart Contracts (hereinafter ‘SCs’) in the context of dispute resolution.

A SC is similar to a traditional agreement containing coded instructions where the execution is automated. The essence lies in the fact that it is neither smart nor a contract. They often operate on “if-then” command. The terms are entered on the ledger (if-token-money-inserted-then-toffee-pops-out) and the triggering event (inserting-token-money) occurs resulting in self-execution of terms; however, once the transaction of inserting token money is initiated it cannot be revoked and the entire transaction is carried out without any human intervention. Such a revolutionary technology, when used on a large scale has the potential of removing intermediaries,[iv] thereby reducing transaction costs and leading to the creation of an environment where the need for trust between contracting parties is eliminated.


The potential of this technology can be explored for the construction of the contract whereby obligations of parties are entered on the ledger and at a particular date the enforcement of the agreement is automated, leaving no hassle approaching courts for enforcement of the contract.However, the application of SCs within the realm of DLT, to create and enforce contracts must seek compliance with the domestic laws of the contracting parties. The author argues for the positive compliance of SCs as traditional contracts within the contours of Indian Contract Act, 1872 to operate as an arbitration agreement when the Lex loci arbitri is India and compliance with the NY Convention to operate as an arbitration agreement in an international arbitration setup.


I. SMART CONTRACTS AS TRADITIONAL CONTRACTS


The SCs often lie on a spectrum and have rarely operated in isolation. They are usually amalgamated with a variety of hybrid agreements that pose numerous challenges to fundamental propositions of the domestic contract law. As a general rule, in case of international arbitration, the parties themselves determine the seat of arbitration, subsequently, domestic law applicable to the parties is ascertained.For an SC to be tested on the touchstone of traditional contracts, the domestic contract law of the parties has to be taken into consideration. For the purpose of regulatory analysis, the Contract Act is taken as a benchmark for determining the compliance of SCs. The ICA provides for certain fundamentals that distinguish a contract from a mere agreement, namely lawful consent, consideration, a lawful object, and competence of the parties. When dealing with SCs, there is a possibility that the consent of a contracting party is obtained by way of misrepresentation or mistake, since the terms of the contract are coded, making the understanding of obligations cumbersome for them.

Moreover, the ICA doesn’t deal with e-contracts; however, common law principles are referred to interpret such contracts. These contracts are signed through cryptographic hash key functions which require compliance with the IT Act, 2000 to be used as a lawful form of digital signature[v] and with the Indian Evidence Act, 1872 to be used as a valid form of evidence in Indian courts.  


The electronic and automated nature of SCs leaves a nagging space of conundrum where the lex loci is India and Indian laws are made applicable. The recognition of such disruptive technology requires a sui generis regulatory framework for their operation as a valid form of contracts as was the case with the Uniform Electronic Transactions Act.[vi]

II. SMART CONTRACTS AS AN ARBITRATION AGREEMENT


The raison d’être of international arbitration is its consensual and delocalized[vii] nature, which makes it an appropriate platform to resolve disputes arising out of SCs. Article II of the NYC provides a detailed understanding of the structure and fundamentals of an arbitration agreement. It states that the agreement must be in writing, defined legal relationship between contracting parties, which must concern an arbitrable subject-matter with an undertaking to submit differences to arbitration. The “writing” requirement complies when the agreement is signed by the parties; however, NYC doesn’t provide any guidance regarding the signature of parties. The UNCITRAL ML on e-Commerce provides a substantially broad determination to a signature where any method can be employed as long it identifies the person, his approval to information, and is reliable for the purpose of such information. The requirement is broad in its categorization but takes into account several non-exhaustive factors like the sophistication of equipment, kind of transaction, a function of signature, etc. to ascertain the intention of parties.


Moreover, the definition of a data message is also “not limited to” the methods provided under the treaty, thereby increasing the scope of acceptance of hash keys.Since the legitimacy of a contract and an arbitration agreement is governed by the law of the seat of arbitration, the requirement of a defined legal relationship may be difficult to determine since very few jurisdictions consider SCs a valid form of contracting. The term “arbitrabilityof the subject-matter” has often had different interpretations[viii] and is also to be determined by the law of the seat; however the UNCITRAL Model Law doesn’t provide any guidance as to the arbitrability of disputes and the Working Group’s view was that ML should not contain a provision delimiting non-arbitrable issues[ix], where often there is inconsistency among jurisdictions for a standardized arbitrable subject matter.[x]For instance,

In A. Ayyasamy v. A. Paramasivam, (2016) 10 SCC 386, it considered that disputes involving insolvency and bankruptcy are non-arbitrable whereas the US Federal Rules of Bankruptcy Procedure provides for arbitration as a viable model for dispute resolution for insolvency and bankruptcy purposes.]
Although, the regulatory framework pertaining to usage of SCs as an arbitration agreement is broad enough to capture the technological peculiarity; the paradox lies in the fact these rules also, refer to the law of the seat of arbitration. This creates a situation where, although the arbitration agreement has the capacity to significantly alter the existing mode of dispute resolution; however, the regulatory structure pertaining to SCs domestically represents a somber picture. SCs provides a novel perspective of utilizing it as an efficient mode of ADR a mechanism, replacing the existing modes involving courts and middlemen which creates an environment of corruption and red-tape bureaucracy; however the present the legal regime of most jurisdictions doesn’t provide for them as “valid and legal” mode of dispute resolution.


CONCLUSION

The proliferation of DLT and SCs have been primarily affected due to the “trustless” factor; however, it’s worth noting that the accuracy of SCs depends entirely upon the original coding. The potential application of blockchain is countless ranging from banking and finance, real estate, insurance, auditing, art, stock exchanges, intellectual-property to almost all commercial transaction capable of being recorded on a ledger. The most interesting of such application is when it is used to form a legal and binding contract. Blockchain provides endless opportunities for forming effective, creative, yet diverse agreements capable of reducing inefficiencies existing within the enforcement of traditional contracts. However, for proper implementation of such contracts within the  purview of a regulatory regime, it must comply with domestic regulations. SCs have not developed for the potential where it can be utilized for resolving disputes via arbitration in an automated manner; however, the prospective scope has to be channelized to effect a regulated mechanism capable of dispute settlement.  


[i] Max Raskin, The Law and Legality of Smart Contracts, 1 GEO. L. TECH. REV. 305 (2017).

[ii] Jeremy Sklaroff, Smart Contracts and the Cost of Inflexibility, 166 U. PA. L. REV. 263 (2017).

[iii] De Filippi, Blockchain and the Law: The Rule of Code, Harvard University Press, (2018)

[iv] Scott McKinney, Smart Contracts, Blockchain, and The Next Frontier of Transactional Law, 13 WASH. J.L. TECH. & ARTS 313 (2018)

[v] The IT Act is silent on the aspect of private and public hash keys as a valid form of signature and merely provides for validity of digital e-signatures, refer, Rishi A, The Legality of SCs in India, IndiaCorpLaw, https://indiacorplaw.in/2017/12/legality-smart-contracts-india.html

[vi] Section 7 UETA provides for legal recognition to e-signatures, records, and contracts. See, Alan Cohn, Smart After All: Blockchain, Smart ContractsParametric Insurance, and Smart Energy Grids, 1 GEO. L. TECH. REV. 273 (2017).

[vii] Jan Paulsson, Delocalisation of International Commercial Arbitration: When and Why It Matters, 32 ICLQ 1 (1983)

.[viii] Mahmood Bagheri, International Contracts and National Economic Regulation: Dispute Resolution through International Commercial Arbitration, Kluwer Law International, 11 (2000).

[ix] A/CN.9/216, 23 March 1982

.[x] In Olympus Superstructures v. Meena Khetan, 1999 (3) SC 514, the Supreme Court took the view that only dispute arising of specific performance of the contract are arbitrable.

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