Robert Neely (Partner) and Edward Lyons (Lawyer)
The concept of a 'smart legal contract' is frequently raised in discussions about the future of legal practice and the offerings that technology can provide to streamline legal services for clients. Exactly what a smart legal contract looks like, the nature of its capabilities and potential applications in practice have remained relatively obscure. This article will revisit basic concepts of smart legal contracts, explore a current case study, acknowledge hurdles to wider use and address future possibilities.
Lander & Rogers as a firm has been engaging in a number of different projects to stay at the forefront of the development, regulation and application of smart legal contracts, including:
- The Accord Project: Lander & Rogers is a member of the Accord Project, an international organization that brings together multi-disciplinary contributing members to buildsopen source code and documentation to maintain a common and consistent legal and technical foundation for contract management.
- Standards Australia Smart Contracts Subcommittee: Lander & Rogers Board Member Dr Phillipa Ryan (chair) and lawyers Joshua Butler and Madeleine Maslin (working group members) are working on leading the development of international standards and best practice that will grow confidence in the proliferation and use of smart contracts.
- BeNEXT: Lander & Rogers' LawTech Hub is a six-month immersion program for early stage companies building legal tech. As well as establishing a centre for the legal tech community in Australia, the LawTech Hub enables these companies to deploy, test and iterate their software inside a law firm, with feedback from lawyers and clients of the firm. BeNEXT is a current resident of the Melbourne-based LawTech Hub. We will consider a current application of smart legal contracts being developed by BeNEXT.
Smart legal contracts should not be confused with so-called “smart contracts”, which are self-executing scripts that necessarily operate on a blockchain system. Smart contracts may form part of a smart legal contract or smart document but do not represent the agreement in its entirety.
The Accord Project defines the concept of a smart legal contract as "a legally binding agreement that is digital and able to connect its terms and the performance of its obligations to external sources of data and software systems". Fundamental to the concept, and the main driver of efficiency through faster processing times, is the automatic performance of aspects of the contract without the need for human action or verification. A foreseeable outcome of this is lower transaction and operating costs compared to traditional contracts.
However, it is not just about efficiency. Smart legal contracts can also provide greater certainty and trust between the parties, particularly when incorporating blockchain or other distributed ledger elements which ensure immutability of input data.
Smart legal contracts contain natural language text with relevant provisions of the document drafted in machine executable components, that is, programmable code. The programmable elements interface with external sources of data (so-called "oracles") (such as Internet of Things device data) or other software systems. The oracles drive the real-time status of the contract, for example, by enabling clauses to self-execute if the external data shows that specified contract conditions are met. The contract sits in a real-time digital environment - a website, platform or app - that each party can log in to and view the current status of any relevant terms.
Consider, by way of example, a supply agreement between a manufacturer and a wholesaler of goods. Rather than manually monitoring stock levels and placing of individual purchase orders, the wholesaler would use sensor technology and Internet-of-Things connectivity to detect when the stock in the wholesaler's warehouse reaches an agreed level. The smart legal contract would be programmed to then reach out to the manufacturer's catalogue using API technology to determine the availability and current price of the items. If the price is within an acceptable range (as specified by the wholesaler), the smart legal contract would then issue an online purchase order to the manufacturer, prompting the manufacturer's order management systems to confirm the order and place it in the manufacturer's order fulfilment system for delivery. The smart legal contract could also be programmed to initiate payment once the order has been received.
The terms upon which the goods will be ordered, the order accepted and the goods delivered and paid for, have all been agreed between the parties, and may be recorded in a document in the usual way; however, the actual execution of the contract occurs automatically by virtue of the programmable aspects of the contract.
The Accord Project describes the benefits of a smart legal contract over a traditional contract as follows:
"A smart legal contract, by contrast [to a natural language contract], can be interpreted by machines. This enables a host of beneficial functionality, including making contracts searchable, analysable, real-time and integrated. Consequently, contracts are transformed from business liabilities in constant need of management to assets capable of providing real business intelligence and value."
As noted above, a smart legal contract does not necessarily require integration with blockchain. The Accord Project acknowledges that "although the operation of smart legal contracts may be enhanced by using blockchain technology, such as by securely sharing contract data among a business network, smart legal contracts can operate using traditional software systems without blockchain."
To some extent, the association of smart legal contracts with blockchain may be hindering adoption, by presenting smart legal contracts as something highly technically complex and requiring significant existing digital infrastructure. The reality is that smart legal contracts do not need to use complex information technology and may be created from readily available software elements. While some contexts (and use cases) will recommend themselves to a blockchain element (for instance, where trust in the oracle is paramount), it may be easier for most users to 'dip their toe in the water' regarding smart legal contracts by experimenting with uses that don’t involve blockchain.
BeNEXT is a specialist legal technology firm focussing on applying smart legal contracts technology to drive efficiency in industries previously dominated by a high volume of standardised forms. BeNEXT is currently developing a smart contract-based application for real estate agents and owners to use to manage the agency arrangement. It uses a software as a service model to convert what currently are paper-based forms to an electronic format and present them in a website or application for consumers, agents and advisors. The benefit is in minimising time, human error and vastly improving the user experience.
In designing its smart agency agreement, BeNEXT has focussed on the end customer experience, making the process as simple as possible in order to alleviate the stress and time wasted from repeating the same story to agents, advisors and financiers.
BeNEXT also sees the potential for further streamlining smart legal contracts in the real property space by linking to government records such as title deeds and integrating with the Australian online property settlement service, PEXA, which would result in a completely digitised end to end solution.
Roadblocks and the Way Forward
Despite the hype, the use of smart legal contracts has been limited to date. Some of this low take up is due to a threshold concern about adopting self-executing contracts, particularly for high value transactions. However, it also is due to a poor understanding of what smart legal contracts are and how they can be designed to reflect the risk appetite of the parties. In our view, smart legal contracts need not be any more risky than traditional contracts and, in many cases, can alleviate some of the risks associated with traditional contracts.
However, in order to implement a smart legal contract, the parties first must agree on the agreement design; in particular, the programmable elements and their interaction with external data sources. Such agreement requires a degree of comfort with the technology and with the other party. It may therefore be difficult and time-consuming to negotiate smart legal contract design on a case by case basis. For that reason, the use of smart legal contracts may make more sense where the parties are well known to each other and regularly engage in transactions which have common elements.
The creation of smart legal contracts also requires a multi-disciplinary approach. Both lawyers and coders must understand and respect the other's role and work collaboratively to achieve an effective design.
The Accord Project
The Accord Project is an international NFP organisation that is working to build a greater understanding and take up of smart legal contracts. The Accord Project is developing an ecosystem and open source tools for smart legal contracts. It is currently managed within the Linux Foundation. Members of the Accord Project come from around the world and from a range of disciplines.
A key feature of the community is the emphasis on open source programming which means that anyone can freely use and contribute to development. The Accord Project is organized into working groups focused on transactions, supply chain, financial services, intellectual property, venture and token sales, real estate and construction, and on dispute resolution.
The fundamental goal of the Accord Project is to establish and maintain a common and consistent legal and technical foundation for smart legal contracts with a view that such consistency generates familiarity, comfort and ultimately trust in users - both individuals, companies, lawyers and financial advisors. The Accord Project notes that:
"With an increased focus on enterprise digitalization, adoption of blockchain technologies and the growth of the API economy, the usage of computable agreements is rapidly increasing. Having a common format for “computable” legal agreements is an important cornerstone for the future of commercial relationships. One of the main purposes of Accord Project is to provide a vendor-neutral “.doc” format for smart legal agreements."
Standards can also play an important role in promoting the uptake of innovative technologies and have a role to play with smart legal contracts.
Standards Australia has taken a leadership role in developing a standard for smart contracts, in the context of blockchain. Standards Australia was also instrumentally involved in and contributed to the recent Technical Report on smart contracts issued by the International Organization for Standardization (ISO). The report outlines the potential of smart contracts, describes the functions of smart contracts and how they interact with each other on blockchains and other distributed ledger environments.
On the role that government and industry backed standards can play in building trust in, and promoting adoption of smart contracts, Philippa Ryan, Chair of the ISO Australian mirror committee for Smart Contracts and Board Member of Lander & Rogers said:
“Standards and other publications…can improve the reputation of innovative technologies and lead the way in describing best practice. Developing and setting standards requires consensus, which encourages an international community of experts to share, collaborate and agree. This report is an example of successful international cooperation, with Australia leading the cause.”
Establishing an effective governance framework via the further development of international standards, especially those endorsed by an organisation such as the ISO, has significant potential to grow awareness about, confidence in and legitimacy of smart contracts in both the public and private sectors. This is particularly the case given the cross border nature of smart legal contracts, which can make it difficult for sovereign legislators to regulate them.