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Smart Contract: A New Paradigm of Contracts in the Digital Era

Article by Aanchal Trivedi and Shilpi

Introduction

Primarily, ‘smart contracts’ are decentralized agreements built in computer code and stored on a blockchain.[1] Nick Szabo is known as the architect of smart contracts and he described it as “A set of promises, specified in digital form, including protocols within which the parties perform on these promises.

A ‘blockchain’ is a particular type of data structure (i.e., essentially a ‘chain’ of ‘blocks’) wherein the ‘blocks’ are used to store and transmit data and are connected to each other in a digital ‘chain’, forming a ledger. It utilizes cryptographic and algorithmic methods to record and synchronize data across a network in an irreversible manner.[2]

Henceforth, smart contracts are agreements entered into by the parties through digital codes and integrated into a decentralized blockchain. Execution of smart contracts are automated which is often effected through computer running code that has translated legal prose into an executable program.[3] Smart contracts can be further distinguished between strong and weak smart contracts. Strong smart contracts possess prohibitive costs of revocation and modification, while weak smart contracts lack the same.

Advantages of smart contracts

To tackle the increased competition between the businesses, benefits arising out of smart contracts can be employed. Primarily, smart contracts do not depend upon human intervention. Its implementation is guided by blockchain networks. The execution of such contracts depends upon a triggering event. Hence, once the triggering event takes place, the scripted contract self-executes.

One of the fundamental requirements of a smart contract is that the terms of a smart contract must be explicit and accurate. Smart contract entails if-then statements; hence, its implementation is accurate. For example- for subscription-based institutions, if x unit of cryptocurrency is paid,  then the subscription will be auto-renewed.

Breaches of a smart contract are rare to occur because the execution and continuation of a smart contract will depend upon pre-defined conditions. The penalty of breach will also be automatic as per the pre-decided mechanism, requiring no third-party intervention.  For example- when the seller fails to pay the amount to the vendor, a late payment will be automatically deducted from his account or his access to the software can be suspended.

Disadvantages of Smart contracts

Smart contracts carry various advantages; however, they are not devoid of some disadvantages. Smart contracts have some inherent characteristics of blockchain. One of such characteristics is it being immutable- meaning, once it is created, it cannot be modified. It means that in the event of any mistake in the code, the immutable nature of the smart contract will prevent it from being rectified.[4]

As these smart contracts, once executed, cannot be modified further, additional cost will also be incurred by the parties to determine ex ante terms of the agreement that can deal with all the circumstances arising out of that transaction. Additionally, the cost incurred in the process of negotiation and designing the smart contract will also increase the cost during the preparation phase.

The principle of ubi jus ibi remedium prescribes that when one’s right has been infringed, law bestows right upon that person to claim remedy. Smart contracts will certainly create some rights in favour of the parties to the contract, however in case of any breach of those rights, the entitlement of any remedy will become dubious, if the fundamental laws of India are not supporting the validity of those smart contracts. Individuals will be entitled for the remedy, provided, the Indian laws acknowledge the existence of such smart contracts.

The scope of smart contracts under the regime of Indian Legislations

INDIAN CONTRACT ACT, 1872: In India, contracts are regulated by the Indian Contract Act, 1872. As per the said Act, a valid contract must satisfy the fundamental criteria of including firstly an offer, secondly, absolute and unqualified acceptance, and lastly lawful consideration. It also mandates the existence of consensus ad idem, implying that the parties should agree on the same terms in the same sense.

Taking parallel inference between the fundamental requirements of a valid contract under the Indian Contract Act, 1872 and the smart contract; it can be concluded that a smart contract is a valid contract under the Indian Contract Act, 1872. To validate the aforesaid statement, following inferences can be drawn:

  1. As per Section 2(a) of the Indian Contract Act, 1872, when one person signifies his willingness to do or to abstain from doing anything, with a view to obtain the assent of other person to such act or abstinence, it is said that an offer has been made. In smart contract, the act of publishing the self-executing code shall represent the intention of one party to enter into a contract with another party, and, hence, making an offer.
  2. According to Section 2(b) of the Indian Contract Act, 1872, when the other person accepts the proposal, it is said to be accepted. In smart contracts, it is a pre-requirement that the other party carries out certain pre-determined functions that the contract prescribes. Thereafter, upon completion of those prescribed functions, the offer shall be considered to be accepted.
  3. As per the Section 2(d) of the Indian Contract Act, 1872, consideration includes any act/abstinence from an act at the desire of a   Similarly, in a smart contract, performance of the pre- determined functions by the party will amount to a valid consideration.
  4. The Contract Act prescribes for consensus ad idem as an essential requirement of a valid contract. In smart contracts, as long as the smart contracts are triggered (code agreed between the parties) by the parties, the requirement of consensus ad idem will be abided by, thereby forming a valid contract.

INDIAN EVIDENCE ACT, 1872 AND THE INFORMATION TECHNOLOGY ACT, 2000: Indian Evidence Act, 1872 is the governing law regarding admissibility of any document in a judicial proceeding. Section 65B of the Evidence Act provides that “any information contained in an electronic record ….. in optical or magnetic media produced by a computer shall be deemed to be also a document…. would be admissible.” Section 85A of the Act, further provides that “the Court shall presume that every record purporting to be an agreement containing the electronic signature of the parties was so concluded by affixing the electronic signature of the parties.” According to Section 85A, for conclusion of an agreement, affixation of electronic signature is mandatory.

Section 5 of the IT Act, 2000 provides that these electronic signatures are legally enforceable if they are affixed in the manner as prescribed by the Central Government. Section 10 of the IT Act empowers the Central Government to make rules governing the electronic signatures.

Conclusively, in Evidence Act, an electronic contract is only considered to be valid, if it has been affixed by an electronic signature, as obtained in accordance with the provisions of law. However, smart contracts are indeed more technologically sophisticated, electronic signature is not required for its execution. Therefore, the absence of electronic signature might disentitle smart contract from being recognised as electronic contracts under the laws of India.

CODE OF CIVIL PROCEDURE, 1908: Section 15 to 20 of CPC, 1908 provide the provisions dealing with the jurisdiction of the Court to try a dispute. Prima facie reading of the same imparts a difficulty in reconciliation of the concept of ‘cause of action’ and smart contracts. Inherently, cause of action prescribes for a physical concept, whereas, in smart contracts, territorial delineation per se does not exist. Therefore, having a dispute regarding the territorial jurisdiction, it will become a bit challenging to enforce it in a court of law. To overcome this concern, party autonomy can be granted and, henceforth, the parties can agree on the question of jurisdiction.

Conclusion

Considering the fact that the future entails increased digital transactions, smart contract will become inevitable which will further change the course of contractual transactions in India. Nonetheless, if it would not be regulated appropriately, it will act as Achilles’s heel. Liberal interpretation of Indian Laws has the potential to bring smart contracts within the confines of Indian Contract Act. As smart contracts hold the capacity to become a part of digital transactions in future, its recognition under the Indian Laws for its proper regulation is imperative.

[1] Jeremy M. Sklaroff, Smart Contracts and the cost of inflexibility, Univ. of Penn. L. Rev. 263, 263-303 (2017).
[2] World Bank Group, Distributed Ledger Technology and Blockchain, October 2017, https://documents1.worldbank.org/curated/en/177911513714062215/pdf/122140-WP-PUBLIC-Distributed-Ledger-Technology-and-Blockchain-Fintech-Notes.pdf.
[3] Max Raskin, The Law and Legality of Smart Contracts, Geo. L. Tech. Rev. 309, 305-341 (2017).
[4] Gauci-Maistre Xynou, Immutability in a smart contract: a blessing or a curse?, Lexology (Oct. 07, 2023, 03:30PM), https://www.lexology.com/library/detail.aspx?g=9b0e1787-f6cc-428a-8d55-93e5994bf416.
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