Including ‘smart contracts’ in the legal frameworks of contracts in India could be an evolution of traditional contracts and transactions. This evolution can be in some areas of existing laws or a total advancement. Transactions and contracts are relevant at a global level at present times, especially when we are witnessing the legal integration of our country at the international level. Digitalization of contracts can solve security issues that may arise and will be effective in administration at the international level. This integration of technology and law will result in less paperwork and make contract procedures less time-consuming. The prominent concerns of scholars regarding this are the immutability of smart contracts and consumer protection. This paper attempts to look into these issues and discusses possible solutions to them. Smart contracts work on a simple if-then logic; if the smart contracts and the Indian Contract Act become compatible and implemented; then there will be a better use of technology resulting in beneficial implications.
Immutability, Blockchain, Linguistic, Traditional, Self-executing
Smart Contracts are coding programs stored on a blockchain that run on a simple if-then logic. They are used to implement the contract terms using a computerized protocol for immutable transactions. However, the traditional method of contracts in India is a legal contract governed by the Indian Contract Act, 1872. This act regulates the rights and obligations of parties engaged in transactions. These present different ways of executing contracts; the main differences between smart contracts and legal contracts are the involvement of third parties, the risk of fraud, the speed of execution, the transparency, and the legal enforceability of the agreements. Therefore, they have different advantages and disadvantages. ‘The global smart contracts market size was valued at USD 684.3 million in 2022 and is expected to grow at a compound annual growth rate (CAGR) of 82.2% from 2023 to 2030.’This paper tries to find a possibility to enhance the benefits and reduce the risks by integrating the legal framework of the Indian Contract Act and the technical features of smart contracts. To start the integration, we first need to find the similarities and differences between the definitions and elements of contracts in both systems. For instance, according to Section 2(h) of the Indian Contract Act, a contract can be defined as ‘an agreement enforceable by law’. Similarly, a smart contract is an agreement encoded on a blockchain enforced by its rules. However, a notable difference is visible from Section 56 of the Indian Contract Act, which says that a contract becomes void when it becomes impossible or unlawful to perform due to some unforeseen event. This is not possible for a smart contract as it is immutable and self-executing regardless of the circumstances. However, this does not mean that the integration of smart contracts and legal contracts is impossible. Some of the challenges posed by the immutability and other features of smart contracts can be overcome with software design patterns inspired by real faults and solutions in smart contracts and other modern inventions. By overcoming these challenges, smart contracts and legal contracts can offer many advantages, such as facilitating cross-border transactions, reducing paperwork and intermediaries, and ensuring transparency and trust among parties along with the legal validity of legal contracts.
The paper evaluates the compatibility of ‘smart contracts’ and ‘legal contracts’ based on their similarity and differences: for instance, both are binding agreements that specify the rights and obligations of the parties, but smart contracts are self-executing and immutable, while legal contracts are subject to interpretation and modification. However, the paper also looks into the challenges of integrating the two: legal validity, technical complexity, and regulatory compliance. Therefore, it discusses the possibility of overcoming these challenges with software design patterns inspired by real faults and solutions in smart contracts and other modern inventions. Additionally, the paper describes how this can be done with examples of existing or proposed solutions. The paper then examines the benefits of the integration and the future implications: such as facilitating cross-border transactions, reducing paperwork and intermediaries, and ensuring transparency and trust among parties along with the legal validity of legal contracts. Finally, the paper offers concluding remarks and suggestions for further research.
The qualitative analysis of the existing research paper online on the topic is used to deduce the challenge that they do not discuss integrating or overcoming the challenges that come in the way of smart and legal contracts.
Review of Literature
Satoshi Nakamoto introduced the concept of Bitcoin as a peer-to-peer electronic cash system. Further, Ethereum (2014) extended the idea of blockchain technology to allow the creation of smart contracts and decentralized applications. The term ‘smart contract’ was coined by Nick Sabzo. But these and several other platforms like them faced legal challenges such as security and validity which limited their adoption in legal contracts. Addressing these issues; several research papers were published for instance, Peer-to-Peer Networking and Applications (2021) suggested adapting software engineering technologies, and Raskin (2017) argued for a hybrid approach that combines code and natural language to create smart legal contracts. These solutions offer some benefits, such as efficiency, transparency, and trust, but the gap is that they do not give much information on overcoming the challenges in integration of the smart contracts with the legal contracts, that need further investigation and clarification.
Smart and Indian Contract Act: A Compatibility Test
A general law that governs the formation, performance, and enforcement of contracts in India is the Indian Contract Act, of 1872 (ICA) which applies to all kinds of contracts, whether written or oral, except those that are expressly excluded by other specific laws. ‘A smart contract by itself is not a legal contract. It may become a legal contract if it meets the requirements of contract law.’ However, not all of the sections of the ICA can be applied to smart contracts, which are self-executing digital contracts that run on a blockchain network using code.
To test the compatibility of smart contracts and the Indian Contract Act we can start by comparing them based on their similarities and differences. Both ICA and smart contracts follow some common principles of contract formation, such as offer, acceptance, consideration, consent, exchange of goods, and subject to some conditions. For example, Section 10 of the ICA, which talks about valid contracts, states that all agreements that are made with free consent and lawful consideration are contracts. In the same way, smart contracts can be seen as valid contracts because they fulfill the conditions and indicate the intention of the parties to enter into a legal agreement. Another example is Section 4 of the ICA, which signifies the importance of the knowledge of the communication of an offer to whom it is made. Similarly in the case of smart contracts the communication of an offer is ensured through the self-executing code which cannot be reversed once a certain condition is met. A third example is Section 11 of the ICA, which is regarding the capacity of parties to contract according to which a person who is of the age of majority according to the law and of sound mind and not disqualified by any law is competent to contract. These conditions can be ensured for smart contracts by using digital signatures, biometric authentication, and other data.
Some differences between the Indian Contract Act and smart contracts are that according to Section 9 of the ICA, which talks about communication and acceptance, acceptance of a proposal is a sign of approval to the proposal and needs communication. This feature contrasts with the features of smart contracts, where acceptance is implicit and does not require communication. Another difference is Section 14 of the ICA, which talks about consent on the same thing in the same sense and not forced. It is in contrast with the above because the code of the smart contract could not be fully understood by the parties which can affect their consent. A third difference can be observed through Section 28 of the ICA, according to which an agreement that restricts a party from enforcing their rights under a contract by the usual legal proceedings is void. However, in the case of smart contracts, the absence of any governing law and any clear jurisdiction, makes it difficult to enforce them through legal proceedings. A fourth difference is Section 56 of the ICA, which talks about the impossibility of performance and states that a contract becomes void when it becomes impossible to perform due to some event that the parties did not anticipate or control. However, in smart contracts, the performance is usually determined by the code of the contract, which is immutable and it is not possible to adjust them according to changing circumstances.
Challenges for Smart and Legal Contract Integration
Smart and legal contracts are not only different in ways of contracting and enforcing agreements, but they also present some challenges that need to be addressed. Some of the challenges in the integration of both are that if they are integrated, then the risks surrounding them could affect their integration. Smart contracts are prone to digital threats and vulnerable to cyberattacks, such as hacking, and denial-of-service attacks that can alter their security. ‘A flaw in the coding of DAO, a smart contract on the Ethereum blockchain, was found by a hacker on June 17, 2016. This gave the attacker the ability to ask the contract to send money to them repeatedly, leading to the theft of 3.6 million ETH, which was then valued at about $70 million.’ On the other hand, legal contracts are more trusted by people in this area because they are familiar, but at the same time prone to fraud and scams. Many people are not much aware of how to be safe from them or how to handle them, especially when it comes to digital threats. Immutability is another feature that is problematic according to many researchers. Legal contracts are flexible and can be changed or terminated by mutual consent and can be amended to circumstances. However, it is not possible in the case of smart contracts. They cannot be canceled in circumstances where modification is necessary. Another issue is ambiguity. It is not clear in the case of a smart contract who is making the offer and who is accepting it, and it becomes difficult for human understanding. However, legal contracts are written in natural language and are easier to comprehend and the involved parties can communicate. This presents a challenge in their integration. Next is legal enforceability. Smart contracts are self-executing and do not need any intermediary to enforce them, so it also suggests that they do not have any legal recognition or protection. If there is a breach in smart contracts, then it is difficult to compensate in court. ‘It is a known fact that we all move the e-universe in one way or another. There is no denying that the digital world is changing faster than the analog world. And for one reason or another, disputes arising from electronic commerce are rarely taken into account in conventional public courts.’
Traditional contracts can be argued in courts. In the case of smart contracts, the buyer must be aware of the risks and liabilities involved in the transaction and there is no guarantee, especially when there is a transfer of goods. However, legal contracts are subject to consumer protection laws. Linguistic contracts are easier to understand. We cannot add legal principles in codes of smart contracts that would outweigh the benefits and will require greater maintenance. The lack of a dedicated legal framework for validating smart contracts is a problem as it creates uncertainties. Also, there is a lack of awareness and trust. Many people would still not see it as a reliable source of contracting. Technical expertise and infrastructure are required to maintain them and also need a stable internet connection, which may not be available in all cases and circumstances.
Solutions for Smart and Legal Contract Integration
One of the ways to overcome the challenges in smart contracts is to use various design patterns, which are proven, reusable solutions to common problems encountered in smart contract development. For example, the Oracle pattern allows a contract to access external data or services that are not available on the blockchain, such as prices, weather, or sports results. This may be useful for creating contracts that depend on real-world events or information, which may affect the performance or outcome of the contract. The proxy pattern allows a contract to delegate calls to another contract, which can be upgraded or changed without affecting the original contract’s address or state. This may be useful for creating upgradable contracts, which can fix bugs or add features without breaking the existing functionality or losing the users’ trust. For example, a proxy contract may forward calls to an implementation contract, which can be updated by the owner or a governance mechanism. The observer pattern allows a contract to notify other contracts or users about certain events or changes that occur in the contract. This may be useful for creating contracts that have a dynamic or interactive behavior, which may affect or interest other parties. For example, an observer contract may emit events or send messages to other contracts or users when a certain condition is met or a certain function is executed in the contract. The circuit breaker pattern allows a contract to pause or stop its functionality in case of an emergency or a malfunction, to prevent further damage or loss. This may be useful for creating contracts that have a critical or sensitive functionality, which may require human intervention or verification. For example, a circuit breaker contract may have a switch or a modifier that can be activated by the owner or a governance mechanism, which can disable or enable certain functions or features in the contract.
Linguistic contracts are natural language contracts that can be translated into code and executed on the blockchain. ‘As emerging technology develops, lawyers and technologists increasingly use the same words as terms of art with very different meanings within their own fields.’Another possible way is to use hybrid contracts, which are smart contracts that incorporate legal principles and clauses that can be enforced by the courts. These are some of the possible solutions that can help overcome the challenges of smart and legal contract integration.
Benefits and Opportunities of Smart and Legal Contract Integration
The integration of smart and legal contracts can facilitate cross-border transactions as it can overcome the barriers of legal complexities and at the same time, legal contracts provide legal recognition which will be beneficial for the parties involved even across different countries and regions. Justice D.Y. Chandrachud, Judge of the Supreme Court of India made reference to smart contracts in his speech to demonstrate the technological advancements in the sphere of commercial transactions and identified arbitration as the means to resolve disputes relating to smart contracts. Their integration can reduce reliance on intermediaries and in case of disputes legal contracts can provide backup. Their integration can increase the efficiency and transparency of the contract process, it eliminates the need for further actions like signing, and witnessing and is less time-consuming. ‘Smart contracts have the potential to increase commercial efficiency, lower transaction and legal costs, and increase transparency.’ Smart contracts can provide automation and verification of the execution and legal contracts can provide a clear and understandable record of the contract agreement. ‘The main advantages of a smart contract include its observability – the ability to monitor the execution of the contract at all stages and make sure that the counterparty completed its part of the transaction; verifiability and the existence of a mechanism for enforcement of the provisions of the smart contract.’
To reap the benefits and opportunities of technology and law, thinking about integrating the two is essential. The integration of smart contracts and legal contracts has the potential to evolve the processing of contracts in India. If we have a clear and comprehensive legal framework that defines and validates, enforces, and provides remedies for dispute resolution for smart contracts, then it could be harmonized with the existing laws. Also, increasing awareness and trust by educating people about the benefits of smart contracts can increase its adoption. Improvement of technical expertise and infrastructure would further facilitate the acceptance of such ideas.
The integration of smart contracts and legal contracts can prove to be an evolution of the present legislation, as it can offer a combination of efficiency, security, transparency, flexibility, clarity, and legitimacy. Smart contracts can be included under the ambit of the Indian Contract Act, which would ensure the legality of smart contracts and also provide a method of addressing the issues that may arise. There are many challenges in doing so, such as immutability, ambiguity, enforceability, and lack of awareness and trust, but the solutions are no less. The immutability feature of smart contracts can be handled by the circuit breaker design pattern, which can pause or stop the contract functionality in case of an emergency or a malfunction. The ambiguity issue can be resolved by using linguistic contracts, which are natural language contracts that can be translated into code and executed on the blockchain. The enforceability problem can be tackled by using hybrid contracts, which are smart contracts that incorporate legal principles and clauses that can be enforced by the courts. The lack of awareness and trust can be overcome by educating the users and stakeholders about the benefits and risks of smart contracts and providing them with technical support and guidance. These solutions can help overcome the challenges of smart contracts and legal contract integration facilitate cross-border transactions without the interference of third parties and use technology in a better way. To reap these benefits, a proper legal framework is needed for enforcing their integration. This would have many future implications, such as enhancing the efficiency, security, and transparency of contractual processes, reducing the reliance on intermediaries and the costs of transactions, and creating new opportunities and markets for smart and legal contracts. Therefore, the integration of smart contracts and legal contracts is a promising and innovative idea that can revolutionize the field of contract law and benefit society at large.
University of Allahabad