In our series of articles addressing the legal structures of smart contracts or dynamic contracts – some of which will utilise blockchain technology – it has been shown that existing legal principles and structures are more than capable of providing a suitable framework to enable the development of such arrangements to flourish.
We previously looked at arbitrating blockchain disputes, but now take those thoughts further looking firstly at how inconsistent dispute resolution clauses can arise and the problems they cause, and secondly why arbitration is a suitable dispute resolution method for blockchain disputes. The framework is such that lends itself to the parties agreeing an umbrella agreement at the outset.
The danger of inconsistent dispute resolution agreements – a worked example
Consider an agreement under which X (a Chinese company) ships goods to Y (a Tanzanian company). A Decentralised Autonomous Organisation (DAO) or simple host management arrangement operates through computers stored in Estonia (the Administrator). The Administrator uses smart contracts to trigger payments from Y to X on delivery of the goods and satisfactory data downloaded from the vessel during transportation as to humidity etc. X sends approximately 100 shipments to Y per year, all of which are paid upon the trigger under the smart contract.
- X and Y have a contract providing for arbitration in London under English law.
- X and Y both have separate contracts with the Administrator (assuming the Administrator is a legal entity capable of contracting which is not a given): X's contract provides for litigation in China under Chinese law; Y's provides for litigation in Estonia under Estonian law.
- At a mid-point in the year, X ships goods to Y, Y receives them but no payment is made (Y being unaware payment hasn't been made as the payment should have been automatic).
- The 'failure' may be in the software which is physically based in Estonia and, arguably, the failure happened when the 'trigger failed' on delivery to Y in Tanzania. The failure could however be due to an Act of God, frustration or other event which would, in one view render the Administrator/chain not liable for the failure of the trigger.
- X sues Y for the unpaid sums and consequential loss commencing arbitration in London. From X's point of view it is a simple debt claim, Y receives the goods but did not pay. The arbitration should be unnecessary or, at worst, quick and cheap.
- Y sues the Administrator in Estonia under Estonian law while defending the arbitration in London. From Y's perspective it is not at fault for not paying (and any resulting loss) as it had the smart contract in place to ensure payment was made and Y is not at fault if that mechanism fails.
- Y cannot bring the Administrator into the arbitration as it is not a party and is not party to any compatible arbitration clause that could lead to a consolidation.
- There is then the further complication of Y's liability being tested under English law and the Administrator's liability being tested under Estonian law. There is no compulsion for compatible judgments to be made as between an arbitral tribunal and an Estonian court leaving all three parties in an unsatisfactory position.
What's the solution to inconsistent dispute resolution provisions?
Having the worked example above in mind, it is clear that just as every transaction needs careful consideration, so does every dispute resolution agreement throughout the chain or a contractual relationship. As one party is unlikely to control the chain, or even be aware of all of the relationships within it, it is key to address the dispute resolution provision at an early stage in order to establish what the method will be and how it will permeate through the chain. The choice of method and jurisdiction will be impacted by many factors including the nature and location of the parties and their assets, and, significantly, the parties' relative bargaining-power.
The clearest solution is for the parties to enter into a master or 'umbrella' dispute resolution agreement which ensures that the same law and dispute resolution procedure is applicable throughout the chain (and linked to any related letter of credit, performance band or insurance protection). Such an agreement (whether it provide for litigation or arbitration) should enable disputes to be joined or consolidated in appropriate circumstances. Consolidation and joinder have come to the fore in arbitration in recent years in recognition of the increase in complex trading relationships, indeed, all of the leading arbitral institutions now provide how and when joinder and consolidation may be ordered.
An umbrella agreement of this nature would require clear direction and management (our tripartite example above being overly simplistic) but may well save time and costs incurred in fighting in a variety of jurisdictions and the eventual potential incompatible judgments or awards. A note of caution must be exercised over the enforcement of umbrella agreements and parties' knowledge or agreement to having entered into them. This can be addressed in the direction and management required as stated above.
The benefits of arbitration for blockchain
Given the international nature of the parties and relationships engaged in many blockchain initiatives, thoughts naturally turn to the sphere of arbitration as the appropriate choice of dispute resolution. The key drivers behind any choice of arbitration are:
- Flexibilty: Whilst there are currently no specialist rules, commercial arbitration rules such as those of the London Court of International Arbitration (LCIA) are deliberately designed to enable flexibility within the procedure so that it can be adapted to suit the needs of the parties and the nature of the dispute.
- Choice of tribunal: The tribunal will either be appointed by the parties or a chosen arbitral institution. The arbitration agreement can provide for the arbitrator(s) to have the expertise required to determine any dispute or, preferably, the parties can nominate or appoint arbitrators with an understanding of the complexities of this field at the time of appointment. In either event, a specialised tribunal should result in saved time and costs and avoid an award based on misunderstandings or misconceptions. This is not in any way to cast doubt on the abilities of many specialist judges, simply to say that in arbitration, with a well-considered arbitration clause you can avoid the risk of a judge who is out of step with the technology in question.
- Choice of Forum: In choosing an arbitral seat the parties can choose a recognised arbitral forum where the local laws and judiciary are supportive of the process. Combined with the choice of tribunal this gives the parties greater security of a fair and robust process.
- Speed: Blockchain's strengths lie in multi or serial transactions potentially over a long period of time. Given this, dispute resolution might be required mid-relationship and a speedy resolution required in order to preserve the relationship and enable the parties to continue. Expedited procedures are available from several of the leading arbitral institutions or can be agreed between the parties in their arbitration agreement or at the time a dispute arises. There are various ways of achieving this such as documents only procedures, limited disclosure and/or evidence or full-arbitration procedures within an expedited timescale. Interim measures are also available from the tribunal, for example to protect assets or the courts of the seat, assuming a strong seat is selected, are able to act quickly and effectively to support the arbitral process. The key, again, is in a well-drafted agreement, and which is tailored to interact with the code in the smart contract. We are actively engaged in considering blockchain agreements which build in an automatic 'pause' or 'reflection' period, pursuant to which fast-track arbitration can be instigated.
- Confidentiality: Arbitration is a confidential process between the parties. Hearings are not held in open court and are not reported. It is well recognised as the dispute resolution mechanism of choice for the protection of commercial interests (this said a separate confidentiality agreement for clarity is often advised).
- Enforcement: Arbitral awards are enforceable under the 'New York Convention' in 157 countries worldwide and enforcement can only be challenged on very strict grounds. While court judgments from many jurisdictions have reciprocal enforcement regimes, they can be more difficult and take longer to process. Whether litigation or arbitration is chosen, the effectiveness of any future considered at the outset and protections such as insurance considered and, if necessary, provided for.
The admitted limitation of arbitration, which is also one of its key strengths in many regards, is the privacy of the arbitration agreement. It only applies between the parties who entered into the arbitration agreement. Under most sets of institutional arbitral rules a third party can be joined with the consent of all parties but this is not straightforward. As stated above, an umbrella agreement is one way to address this.
While blockchain related smart or dynamic contracts continue to develop, we continue to learn how it relates to the many and varied legal systems in which it operates. In anticipating potential future disputes we seek to place clients in the best possible should the worst happen - if it might rain, consider taking an umbrella.