Smart Contracts Explained

Speaker: Marsha Simone Cadogan

February 16, 2023

In this video, CIGI Senior Fellow Marsha Simone Cadogan explains how smart contracts function and how the courts determine if smart contracts are legally enforceable.

Smart contracts are agreements entered into through blockchain systems such as Ethereum, where the terms of the contract are written into the system using computer code. When certain conditions are met, the contract self-executes the terms based on the code without human intervention.

Smart contracts can be used to track the sale and delivery of items, to simplify supply-chain logistics and to provide services. They reduce costs and save time by removing intermediaries and enable cross-border transactions.

Because a smart contract can be used for many types of transactions, there can be serious financial impacts if disputes between parties arise. As Marsha explains in this video, there is legal precedent in common law jurisdictions for smart contracts to be viewed as legally binding.

With the digitization of all aspects of commerce and society, we can anticipate smart contracts to play an increasing role in the legal system.

Hi, my name is Marsha Simone Cadogan, a CIGI senior fellow specializing in intellectual property, trade and technology law. Have you heard about smart legal contracts? If not, that’s okay. Let me explain.

Smart contracts execute and confirm transactions on the blockchain based on programmed commands that are written in the system.

It’s called a “smart” contract because it uses computer code to execute and enforce the terms autonomously, without human intervention.

Think of it like a vending machine: You can see the items for sale and the price. Once you select the item you want and insert payment, you are essentially accepting the terms of the contract.

The conditions of the contract have been met, you select and pay for the item, and now the vending machine must dispense the item to fulfill the contract.

Smart contracts act in a similar way: they’re often unilateral contracts, where the seller sets the terms, and because of the computer language used to program smart contracts, they can be inflexible, relying on “if” and “then” statements to set the conditions.

Even then, smart contracts present many potential benefits: they can reduce business-to-business transaction costs, improve transparency by recording data on blockchains and reduce waiting times through automation.

Smart contracts can be used to track the sale and delivery of items, both virtual and real-world things; they can be used to simplify supply-chain logistics; and they can be used for services too. For example, using a remittance blockchain service, user A can pay user B for services rendered. Often, the parties are located in different countries. A smart contract can be used to start and complete the entire process.

But there are potential for errors to occur. For example, a smart contract on the blockchain could record that vendor A paid vendor B for goods, but without outside inputs, the smart contract can’t verify that the goods actually arrived. Or there could be errors in the contract’s computer code.

Which brings us back to the vending machine example: What happens when you pay for an item, and it doesn’t come out? Something I’m sure we’ve all experienced at least once in our lives. In this case, the vending machine is here in the real world; it’s pretty easy to remedy the situation by banging on the glass or calling the company.

What happens when there’s a dispute between parties who enter into a smart legal contract?

This is the question my paper seeks to address, which you can read by clicking the link in the description.

In it, I look at how common law jurisdictions, like Canada, would determine if a smart contract was legally binding and enforceable. In very basic terms, the court would look to determine if the parties intended to enter into a legally binding agreement with each another; that there was capacity to contract, meaning that both parties knew what they were getting into; and what underlying agreements were also agreed to when entering into the contract.

The underlying agreements can have as much weight as the smart contract themselves, as terms of use often include arbitration clauses, which can impact what jurisdiction is involved in settling the dispute.

Canada, like many other common law jurisdictions, already recognizes contracts created with the aid of computer programs and validated by digital signatures.

As I outline in my paper, there is precedent for smart contracts to be viewed as legally binding.

With the digitization of all aspects of commerce and society, we can anticipate smart contracts to play an increasing role in the legal system, which is why my paper shares examples of past cases as they relate to digital contracts to better understand future impacts.

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