Distributed Ledger Technology (DLT) is changing the way business is done and will impact dispute resolution. This article addresses the plan to use DLT in Belt and Road Initiative (BRI) projects and how the use of blockchain and smart contracting may impact dispute resolution.
DLT allows parties to enter into smart contracts that will facilitate transactions and payments along the Road. Investopedia defines distributed ledgers as an asset database that is consensually shared and synchronized across network spread across multiple sites, institutions and geographies.
A key feature of this shared information is that it is protected and verifiable in its entirety by cryptographic hashes that can be checked by anyone to guarantee the sequence and content of the changes recorded within it. Changes to the ledger are agreed upon by a network consensus mechanism and propagated to all users on the network, ensuring that every user has an identical and verified copy of the ledger. Transactions on the digital ledger are thus “witnessed” by all the users making the system transparent.
Ledgers can be designed and dedicated to certain industries and applications, e.g. the use of a diamond registry and tracking system, or a ledger that tracks courier movements and deliveries. The self-executing, self-authenticating and public nature of these transactions is the future for the Belt and Road, especially, in the near term, for contracts of insurance, loans, sale of goods, and logistics.
We have been unwittingly or wittingly entering into digital contracts for years – the online bank application, the acceptance to software terms and conditions, are all forms of digital contracts. Smart contracts are “a set of promises, specified in digital form, including protocols, within which the parties perform on these promises.” (Nick Szabo, Smart Contracts: Building Blocks for Digital Markets, 1996). Thus, smart contracts are a step beyond the rudimentary digital contracting we know, because smart contracts reflect and automate the terms of the agreements.
Smart contracts are software programs built onto the blockchain that are triggered in response to transactions. Once initiated a smart contract is irrevocable. They cannot be recalled and will begin to self-execute. Thus, they present unique challenges to traditional notions of contracting. The challenge is to ensure that the programmer of the smart contract has accurately and thoroughly captured all the terms the parties wished to incorporate. Whereas traditional contracts are ultimately subject to the interpretation of legal systems, with smart contracts the code is the law and the results of a transaction are immutable.
Recently, I have asked several Chinese blockchain entrepreneurs about whether we could expect smart contracting on the Belt and Road. The consensus is that smart contracting is still being developed and has quite a long way to go before it will be widely used. However, there has already been some success using smart contracts in the insurance industry. Most entrepreneurs I spoke with believe we are looking at least three to five years before they are used more generally in the commercial market. Similarly, some scholars in the field are of the view that Ethereum as a platform for smart contracting is not enough. They view smart contracts as limited because of cost and question the ability of smart contracts to fully address all the variables that are present in more complex contracts. Mark Beer, President of the International Association for Court Administration, and Chief Executive of the DIFC Dispute Resolution Authority, takes a much more optimistic view. Mr Beer believes that we will quickly be in an era of rapid adoption. He feels that the Ethereum proofs in use are half way there and that the remaining challenge is one of cost. “The pricing will come down with increasing ability to code complex contracts. The beauty is that it makes contracting in emerging markets better.”
Smart contracts will reduce disputes over quality and pricing. And, the contracts themselves cannot be changed once implemented, reducing the risk of fraud and corrupt payments. The use of smart contracting will result in paperless electronic international documents, facilitating trade and logistics. “It is no longer just about e-commerce, but e-customs and e-government." If we can imagine into the future, one could see a BRI project being automated and that same project being replicated in other jurisdictions with the same parties. A general contractor building a co-generation facility in Egypt might require GE turbines manufactured in France. The contractor, a Chinese party, enters into a digital contract with GE France but underneath that transaction are a host of steps that have to occur to complete the transaction from factory to installation and commissioning. The self-executing nature of the contract could allow for payment to transfer as soon as the equipment is on board ship. Additional software could use the contract to process any related export approvals and shipping documents. On arrival in Eqypt, the contract would further trigger software that processed import documents. The contract might also link to other software for port logistics that automatically would arrange the transportation from port to project. At the project, once the installed equipment meets certain programmed test requirements further payments might be triggered as well as final acceptance documentation and the release of any bonds. The smart contract would provide for a series of transactions from start to finish automated through code along the blockchain, entirely paperless and self-executing. As one can imagine, the software infrastructure requirements between the parties, third parties and governments is a massive undertaking that will take time to develop.
Smart Contract Disputes
Despite the advent of smart contracting, dispute resolution, other than for small cases, will still use traditional venues-- namely courts, international courts and arbitration. Smaller matters may be handled using artificial intelligence, just as online sales companies currently resolve consumer complaints. However, larger matters will continue to require a human review of evidence and determination of facts and law.
The nature of the disputes may differ. Disputes may be focused on issues of whether the coding accurately reflected the intent of the parties, or whether some failure of the coding resulted in an improper payment or misdirected goods and who should bear the costs of that error. For these disputes there will be a technical overlay. The disputes may be more complicated in that first, lawyers will need to prove the terms of the underlying contract, and second, lawyers will need to demonstrate that the code was an accurate reflection of the agreement.
As a result of the technical aspects underpinning these disputes, the profiles of judges and arbitrators will need to be considered. We may see the development of specialized international courts or arbitral institutions to handle these types of cases. At a minimum, the existing institutions will need to adapt to this new landscape.
Smart contracts of course present unique challenges in terms of disputes. Use of pseudonyms in contracting may present issues for identifying proper parties. If the contract is written in code in the Czech Republic for parties in China and the US, if not clearly stated, what country will claim jurisdiction over the contract and related dispute? What if some of the countries involved do not recognize smart contracts as enforceable contracts? As such, smart contracts may present unique enforcement questions. If the seat of the arbitration allows for smart contracting but it is illegal in the country of enforcement, then the arbitration award will likely be challenged on public policy grounds. Disputes will likely occur at earlier stages of the project as failures in performance of a contract will become clear if the expectations of the parties are not realized in the code. Will traditional concepts such as repudiation, wrongful termination and waiver, still have a place in the world of smart contracts? These are but a few questions that will arise as this technology advances to be a reality.
Sovereign Backed Cryptocurrency
Given the challenges of the convertibility of the Renminbi (RMB) in most jurisdictions, one could also easily foresee the Chinese government electing to develop a sovereign-backed cryptocurrency for use on Belt and Road projects. There are a number of advantages, including convertibility and control over currency fluctuation. Moreover, it would create a closed ecosystem of regular players on the BRI and increase the quality and efficiency of those projects by virtue of known reliable parties all working on projects where they have ease of contracting and currency. The cryptocurrency would likely be pegged to a currency to allow purchases outside the BRI ecosystem. The concept of a sovereign-backed and regulated cryptocurrency goes against the intent of the founders of Bitcoin and other cryptocurrencies, who hoped to move outside a regulatory environment in favor of a decentralized DLT platform that would rely on users to create the value by mining coins and engaging in transactions along the blockchain. However, China could not allow such freedom on Belt and Road projects, so they would likely have a controlled approach. Despite its regulated nature, it could still be a facilitator on the BRI. A sovereign-backed currency gives users confidence. Sovereign-backed cryptocurrency would facilitate payments under smart contracts across the many jurisdictions of the Belt and Road.
Institutions proactively addressing technology in trade, trade finance and disputes
Mark Beer is the co-founder of the Courts of the Future Forum, a joint initiative of the DIFC Courts and the Dubai Future Foundation. Mr Beer and a group of forward-thinking business and legal professionals and scholars are representatives of the Courts of the Future (“COF”) Forum, who are focused on analyzing the judicial implications of emerging technologies.
The COF held a Forum in March 2018 where five key pillars were reviewed to gauge how disputes on these topics would be decided in the future: artificial intelligence, self-driving cars, blockchain, 3D-printing and unmanned aircraft systems. These pillars are certainly topical and undoubtedly appeal to the millennial base which will become our industry’s future. The COF also considered the future of technology in law. Increasing efficiency and reducing the backlog of cases is viewed as a key area where blockchain and artificial intelligence could be employed.
Another interesting development is the Memorandum of Understanding (“MOU”) between Singapore and Hong Kong on cross-border trade on 13 December 2017, known as the Global Trade Connectivity Network (“GTCN”). The MOU is the first of its kind to promote DLT as the intended infrastructure to digitise trade and trade financing between the two cities, which they hope to roll out across the region as it has been designed with ‘open architecture’, allowing other prospective users to plug into it relatively easily. Hong Kong’s Monetary Authority is due to launch its Trade Finance Platform (“TFP”) in September 2018 which is based on blockchain technology and feeds into the larger GTCN. If the TPF runs successfully, this could bring blockchain technology to mainstream financial trade in a revolutionary way.
Many institutions are only now beginning to grapple with the implications of DLT. Those who are already studying and evaluating its impact may be uniquely placed in ten years. Even if you choose not to be at the vanguard of this new technology, it behooves you and your company do understand what it means and the implications for your business in the years to come.
I suppose in my mind’s eye I foresee a future on the Belt and Road of smart contracts executing projects seamlessly and insuring payments in digital currency. It would be an ecosystem in which the players have experience and are using technology to speed project completion. Paid in digital currency, the projects will be immune from political and economic influence of the local governments or foreign governments. But there are limitations. How will digital ledger technology address the ad hoc regulations issued by nations that impact the implementation of the terms? For example, in the earlier turbine case, the turbines would be efficiently transferred to the project. If a third- arty nation imposes regulation with extra-territorial reach, e.g. the US imposes sanctions on one of the countries or actors in the transaction, then the transaction could become illegal. A smart contract unless somehow revocable could result in an unintended illegal consequence. These and other issues may delay the implementation of smart contracting or limit its application. I remain optimistic that DLT will be increasingly used to automate systems, such as shipments, and tracking and processing associated logistics paperwork. As this infrastructure develops, the variables that now challenge smart contracting success will decrease and ideally allow for the more efficient contracting on the Belt and Road. Invariably, those contracts will be breached, and it will be exciting to see how practitioners manage those disputes, which will require both technical and legal expertise.