LAW SCIENCE AND TECHNOLOGY

TESTING THE SMARTNESS OF SMART CONTRACTS

Dr. Ram Manohar Lohiya National Law University

Lucknow (India)
2019-20
Submitted by: Submitted to:

SAURAV SINGH DR. SHASHANK SHEKHAR

Section-B Assistant Professor

Enroll- 150101119 Dr. Ram Manohar Lohiya

9TH Semester National Law University

1
 ACKNOWLEDGEMENT

A major research project like this is never the work of anyone alone. Firstly, I would like to

thank respected Asst. Professor SHASHANK SHEKHAR, for giving me such a golden

opportunity to show my skills and capability through this project.

This project is the result of the extensive ultrapure study, hard work and labour, put into to make

it worth reading. This project has been completed through the generous co-operation of various

persons, especially my seniors, who, in their different potentials helped me a lot in giving the

finishing touch to the project.

This project couldn’t be completed without the help of my university’s library Dr. Madhu

Limaye Library and its internet facility.

‘I am glad to have made it’

2
 CONTENTS

 OBJECTIVES
 RESEARCH METHODOLOGY

 INTRODUCTION

 SMART CONTRACTS

 SMART CONTRACTS AND THE UNITED STATES

 LEGAL & PRACTICAL ISSUES WITH SMART CONTRACTS

 SUGGESTIONS FOR SMART CONTRACTS

 CONCLUDING REMARKS

3
OBJECTIVES-
The main aim and objective of making this project is to know what smart contracts are and why
it is not used worldwide.?

RESEARCH METHODOLOGY-
The methodology used in making this project is purely doctrinal.

INTRODUCTION

Ever since the world has been hit by the IT boom, the IT industry has been inventing or
formulating various computer programs to push this world towards automation or self-reliance.
May it be self-driven cars, Alexa Echo, Google Home or iRobot.

One such concept is “Smart Contracts”, which is revolutionizing the world of contracts and is
being hailed as having the potential to change the way entities enter into commercial contracts.
On 22nd July, 2019 the report of an inter-ministerial committee set up by the government on
virtual currencies praised the distributed ledger technology or the blockchain technology,
recommended the Department of Economic Affairs to identify the use of the blockchain
technology, and also highlighted the use of Smart Contracts in automatic transfer of amounts, for
settlement of insurance claims, and automatic execution of transactions.1 The committee
mentioned that-

“One prominent example is the automatic triggering of a payment when a specified event is
completed, or a specified date is reached. Through such mechanisms, Smart Contracts obviate
the need for intermediation. This feature brings several benefits such as faster and automatic
execution, lower transaction costs, and non-ambiguity in performance of the contract by making
the execution more objective.”2

SMART CONTRACTS

The term “Smart Contract” was first mentioned by Nick Szabo in 1997, an American legal
scholar, computer programmer and a cryptographer.3 He defined Smart Contracts as-

1
Report of the Committee to propose specific actions to be taken in relation to Virtual Currencies, The Department
of Economic Affairs, available at https://dea.gov.in/sites/default/files/Approved%20and%20Signed%20Report
%20and%20Bill%20of%20IMC%20on%20VCs%2028%20Feb%202019.pdf.
2
Report of the Committee to propose specific actions to be taken in relation to Virtual Currencies, The Department
of Economic Affairs, available at https://dea.gov.in/sites/default/files/Approved%20and%20Signed%20Report
%20and%20Bill%20of%20IMC%20on%20VCs%2028%20Feb%202019.pdf.
3
Nick Szabo, Smart Contracts: Formalizing and Securing Relationships on Public Networks, First Moday (1997).

4
“Smart Contracts combine protocols with user interfaces to formalize and secure relationships
over computer networks. Objectives and principles for the design of these systems are derived
from legal principles, economic theory, and theories of reliable and secure protocols.”4

Smart Contracts are just like traditional contracts. The major difference is that Smart Contracts
are digital codes operating on a blockchain which are self-executing,5 and lack paperwork. They
are encoded computer programs, with protocols that facilitate verify, execute or embody the
terms of a contract, stored inside a blockchain.6 Identical to the online standard form of contract,
Smart Contracts envisage pre-determined terms and conditions and are automatically executed
once those terms and conditions are fulfilled by the parties. It runs on an “if-then” mechanism,
hence, if a condition is fulfilled then the obligation corresponding to that condition is enforced
automatically by the program behind the smart contract.

One of the major characteristics of a smart contract is that it is self-executing. Hence, they do not
require third-party facilitators, thus, decreasing the cost and time required for the performance of
the contract. A Smart Contract coded for flight delay insurance, where the Smart Contract is
connected with the flight and air traffic databases that record flight’s status. As soon as the flight
is delayed by more than the predetermined time, according to the terms of the Smart Contracts,
the customer is reimbursed automatically. This situation eliminates the need to send a claim to
the insurance company.

A smart contract functions on the logic built in a blockchain, inheriting its traits, i.e. distributed
ledger technology, making Smart Contracts decentralized, immutable, transparent accountable
and secure.7

SMART CONTRACTS AND THE UNITED STATES

To the date, the United States government has not come up with any regulations to regulate the
Smart Contract or the blockchain technology. However, few developments can be seen at the
state level. Even at the state level, the legal developments for Smart Contracts are concerned
about the legal recognition of Smart Contract and their evidentiary value. The state enactments
do not provide how the Smart Contracts shall be regulated. States which have passed the law
include- Arizona, Nevada, Vermont, and Tennessee.8

4
Id.
5
Vitalik Buterin, A Next Generation Smart Contract & Decentralized Application Platform, Ethereum White Pape,
available at http://blockchainlab.com/pdf/Ethereum_white_paper-
a_next_generation_smart_contract_and_decentralized_application_platform-vitalik-buterin.pdf.
6
Eliza Mik, Smart Contracts: Terminology, technical limitations and real world complexity, law, Innovation
Technology, volume 9 (2017).
7
Tania H., A Guide to Smart Contracts and Their Implementation, RubyGarage, available at
https://rubygarage.org/blog/guide-to-smart-contracts.
8
Scott h. Kimpel & Christopher Adcock, United States: Blockchain Legal Resource: The State of Smart Contract
Legislation, Mondaq, available at
http://www.mondaq.com/unitedstates/x/734320/fin+tech/The+State+Of+Smart+Contract+Legislation.

5
LEGAL & PRACTICAL ISSUES WITH SMART CONTRACTS

In the absence of any specific regulations or rules, Smart Contracts shall only be regulated by the
provisions of the Indian Contract Act, 1872 and the Information Technology Act, 2000 (IT Act)
in India. Smart Contracts are fast, economically feasible, secure with no room for ambiguity.
However, the grey clouds of doubt still hover over the concept of Smart Contracts.

1) Inability to Accommodate Amendments

First, remains its inability to accommodate any modification or amendment once the
execution of the contract starts. A traditional contract can always be amended either by
the forces of law or by a mutual amendment introduced by the parties to the contract.
However, when a smart contract is in the process of execution and either the parties wish
to change the terms of the contract due to change in circumstances under which the
contract was initially entered into or if the government declares the object of the contract
illegal which was legal when the contract was entered into by the parties, the smart
contract would not accommodate either of the modifications and would execute the
contract on the terms decided prior to execution. Hence, Smart Contracts ignore the
remedy of novation or alteration available under Section 62, the Indian Contract Act,
1872. This also gives rise to another issue, i.e. the parties effectively lose the hold over
the contract during its performance stage.
2) Ignorance of Important Principles of Contract Law
Not only that, important concepts of contract law like Frustration of Contract, Duress,
Undue Influence, Force Majure, Good-Faith, Intention of Parties cannot be contemplated
by self-executing Smart Contracts, due to the requirement of a case to case judgement
which can only be done in case of traditional contracts. Because of its self-executing
nature, once the acceptance is done digitally, even though not accepted under free will,
the contract shall be executed. Hence, a Smart Contract does not account for the implied
terms of a contract, an indispensable principle of contract law.9 This restricts the scope of
Smart Contracts.
3) Jurisdictional Issues
The blockchain technology is not characterized by territorial boundaries. The parties to a
Smart Contract could be scattered around the world. There could be situations where it
would become inevitable to knock the doors of the court, for example- the property
transferred under the terms of the contract was already in dispute before parties entered
into the Smart Contract which was not disclosed. In such situations, the determination of
court with relevant jurisdiction becomes another issue considering the boundary-less
nature of Smart Contracts.
4) Inability to Check the Competency
9
S. G. Chemicals and Dyes Trading Employees Union v. S. G. Chemicals and Dyes Trading Ltd. & Anr., 1986 SCR
(2) 126.

6
 Further, while entering into a Smart Contract, an online contract with no territorial
boundaries & only in machine code readable form, the identity of parties are hidden, i.e.
the inability to check the competency of a party to enter into a contract as provided by
section 11, the Indian Contract Act, 1872.
5) Problem of Memorialization
The terms and conditions of a Smart Contract are encoded into a digital program by a
coder/ computer programmer, i.e. a thirty party to the contract and not by the parties,
because of which Smart Contracts are not completely devoid of the problem of
memorialization, i.e. the inability to put in the written contract what is actually on the
mind of the parties. The program would ascribe such meanings to the terms as encoded
by the coder and would not be bound by the understanding of law and language of the
parties to the contract. Hence, the execution would lack the intention of the parties.

SUGGESTIONS FOR SMART CONTRACTS

Though a smart contract has the essential features of a valid contract, i.e. Offer, Acceptance and
Consideration, but Smart Contracts still fall short in certain places.

1) The major hurdle in case of Smart Contracts is as to which law shall apply and which
courts will have the jurisdiction over the terms of the contract. Parties intending to enter
into Smart Contracts should, therefore, give an advance thought as to which court would
have the jurisdiction and which law shall be applicable. A pre-decided law would help to
decide the legal rules for competency of the parties to enter into a contract and the
resolution of disputes.
2) As to overcome the issue of competency, a Smart Contract should incorporate a provision
for uploading an official ID issued by a recognized authority, after which, the other party
shall be given an option to check the competency, i.e. whether an individual is minor or
not, and accordingly the parties, after verification, can enter into the contract.
3) The law has to be made to accept Cryptographic signatures as electronic signatures or an
arrangement should be made for verification of Smart Contracts through electronic
signature issued as per the IT Act, because a Smart Contract is verified through
cryptographic signature (hash key generated through blockchain technology) and as per
Section 5, IT Act and Section 85B of the Indian Evidence Act, 1872 only recognize
digital contracts verified by electronic signature issued by a certifying authority of
government under per Section 35, IT Act.

7
 4) A solution to any default during the execution of a Smart Contract could be an option
given to the parties to stop the execution and opt for an online dispute mechanism,
recognized by the law, to solve the dispute and after the resolution, the online arbitrator
or juror can send the command to the contract to accordingly execute or terminate the
contract, giving relief to the aggrieved party. Online dispute resolution can be very
helpful in cases of competency of the parties, the inability of the code to execute the
contract according to the mutual understanding of parties, and when a party takes more
time to complete the given task etc. However, the national laws would have to be
amended to accommodate for the online dispute resolution and to hold its enforceability.

CONCLUDING REMARKS

Presently, the entire concept of Smart Contracts is at a very nascent stage and the authorities are
still trying to figure out the scope and functioning of Smart Contracts. Also, at present, Smart
Contracts have a very limited use, restricted only to “if-then” terms, due to which the parties may
not face such practical issues as mentioned above. There is a positive reaction towards the
technology behind Smart Contracts, but their scope cannot be broadened without making clear
rules for the above mentioned issues.

The digitization of trust through certainty of execution forms the heart and soul of Smart
Contracts. It has a huge potential principally in e-commerce, payment transfer, insurance,
financial market, digital management of rights, Healthcare etc.10 Not only legal scholars but also
the government panel set up by the Indian government for virtual currencies has praised the
Smart Contracts technology. Smart Contracts have the potential to transform how parties enter
into contracts in the present time because they reduce cost, save time and make the whole
process very secure due to its feature to leave a clear audit trail. Smart Contracts have a lot of
potentials but still require a lot of research plus specific regulations pertaining to blockchain
technology are required to efficiently tap the full potential of Smart Contracts. There lies a
continuum space between nowadays Smart Contracts and traditional contracts and efforts should
be made to explore that space.

10
Bhabendu Kumar Mohanta, Soumyashree S Panda & Debasish Jena, An Overview of Smart Contract and Use
cases in Blockchain Technology (2018), available at
https://www.researchgate.net/publication/328581609_An_Overview_of_Smart_Contract_and_Use_Cases_in_Block
chain_Technology.