Can Smart Contracts Be Legally Binding?

A couple weeks ago, I was pointed to this whitepaper (h/t @squarelyrooted) by law firm Norton Rose Fulbright that asks, Can smart contracts be legally binding contracts? I was totally gonna read it and post a summary, except that I couldn’t manage to get past the first page without vomiting.

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Turns out I had norovirus (the KFC on El Camino, I bet), but I’m all better now so let’s get to it.

I’ll skip straight to the whitepaper’s conclusion: Can smart contracts be legally binding? It depends! Okay, done.

But being written by lawyers, the key findings are summarized using a lot more words:

Legally binding contractual effect depends on a number of variables. It is tempting to conclude that, just because the moniker “smart contract” includes the word contract, it is a legally binding contract as a matter of law. This is not necessarily correct. Whether it is so in a given situation may turn in part on the type of smart contract at issue, the factual matrix within which it operates, and the applicable law determining the issue.

Huh. The conclusion is nonsensical because the entire question is nonsensical. Asking whether smart contracts can be legally binding is like asking whether submarines have gills or blowholes. You’re thinking of the wrong animal! Except you’ve not only got the wrong animal, you’ve got the entirely wrong thing.

A smart contract isn’t a legally binding contract. It makes no attempt to be a legally binding contract. It’s only called a “contract” because it mimics the effect of a legal contract.

Legal contracts exist to provide incentives for certain actions. One really big incentive that legal contracts provide is “Do the things you promised or else I will take you to court.”

You could also call that a threat, but that’s just the other side of the same token. “Do things or I will take you to court” is a really shitty and expensive incentive that most people only turn to as a last resort.

Smart contracts incentivize performance too, but they do it using software instead of the threat of litigation. The incentives tend to look more like “Make your car payments on time or else your ignition won’t start,” or “Deposit a quarter or else you don’t get a candy bar.”

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The whitepaper isn’t just 52 pages of ambivalence; it explores nuances like the elements needed to form a legally binding contract. Under English common law, that means there needs to be an offer, acceptance, an exchange of value (consideration), intent, and certainty.

Like, does a stationary vending machine constitute an offer? The paper says Yes, as demonstrated in the case of Thornton v Shoe Lane Parking.

And if you put money into the vending machine, does that constitute acceptance?

In the case of Thornton v Shoe Lane, some guy named Francis Thornton bought a parking lot ticket from a vending machine, parked his car, and later got hit by another car. He sued the parking lot company for his injuries, and there was a lot of arguing because the vending machine had printed a ticket that said: “This ticket is issued subject to the conditions of issue as displayed on the premises.”

There were signs on the parking lot pillars that said the management shall not be held liable for damage or injury, but Thornton was not aware that those signs applied to him until the ticket told him so. Really, those signs could have been for anybody. So the acceptance didn’t count cuz the terms were uncertain.

The Norton Rose Fulbright paper also draws comparisons to clickwrap agreements. When you download an iPhone update and click “I Agree” on the Terms & Conditions, is that legally binding??

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It doesn’t matter! None of this is a smart contract!

Smart contracts make it so lawyers don’t get to argue over nonsense and write 52-page papers discussing clickwrap case law. The whole point of a smart contract is to NOT go to court.

If you need to ask whether your smart contract is legally enforceable, you’re doing it wrong. Smart contracts make it so people don’t have to litigate over details like “Did this guy pay for parking or not?” Sure, smart contracts should be designed to model the common-law process of contract formation – not because that makes them legally binding, but because it’s a highly-evolved process that has been used for hundreds of years.

And in higher-value cases, smart contracts can be used with traditional contracts to control the burden of lawsuit. But if you’re worried about how the courts might interpret the terms of your smart contract, you should probably try using words.

See Also:
Nick Szabo, Formalizing and Securing Relationships on Public Networks. 1997.

18 thoughts on “Can Smart Contracts Be Legally Binding?

  1. I think you’re missing one scenario (which I have only thought about because I’ve read random things on the internet about this).

    Alice creates a smart contract with Bob in which Alice lends Bob a car that won’t start unless Bob puts in a dollar every day. Alice and Bob agree that all that matters is the text of the code, and anything allowed by the code is permissible, even if there’s a vulnerability that allows Bob to get the car for free.

    Two days later, Bob hacks the car, and gets it for free, and not only that but his vulnerability allows him to “buy” ten more cars from the dealership for free before Alice fixes the problem.

    Alice says, “Wait a minute, I was actually mistaken, I never wanted this possibility in the first place and I was misled because I didn’t fully understand the ramifications of what I was agreeing to.” and sues Bob to get the cars back. Will the court uphold Alice’s side, or Bob’s side?

    This is what I think is often meant when people ask “are smart-contracts legally enforceable?” If the answer is “yes,” Bob gets to keep his eleven cars and Alice is out of luck, because the contract was clear: all that matters is the code. If “no,” Bob has to return the cars and suffer whatever legal consequences there are for hacking and stealing eleven cars (YMMV depending on race and religion and income).

    From what I’ve read, the answer is obvious: Bob has to return the cars. This is because it’s happened before. Forget smart contracts, lawyers have tried writing shitty loopholes into contracts since contracts were invented, and courts tend to side with the person who didn’t realize what they were signing up for.

    I think lawyers tend to snicker at programmers and mathematicians who think they can clean up contract law by writing programs, the reason being that whether a contract is valid ultimately depends on whether it’s “fair,” and whether it’s “fair” is a human question, not a logic question. And logic tends to be unfair.

    1. Technically, this is the legally binding contract:

      “Alice and Bob agree that all that matters is the text of the code, and anything allowed by the code is permissible, even if there’s a vulnerability that allows Bob to get the car for free.”

      If they go to court, the thing they’re arguing over is that written statement, and whether or not the outcome was what the contracting parties intended when they entered into that agreement. The only role of the smart contract here is to serve as evidence that Bob took 11 cars (instead of Bob arguing that anyone could have taken the cars).

      But that’s just a bad legal contract.

      An ATM is a smart contract. If I hack an ATM and take all the money, obviously the bank is gonna take me to court. But that’s why an ATM debit card comes with 10-page legal agreements (example) saying what I can and can’t do, and how errors should be resolved.

      On the other hand, if I hack a vending machine and steal all the candy, the vending machine owner will probably let it go. The machine owner is the legal owner of that property and probably could sue me, but the burden of lawsuit is too high to be worth pursuing.

      The ATM, and any smart contract, is just a tool that moves the burden of lawsuit from one party to another. Kinda like a repo man.

      1. Aren’t smart contract advocates calling for the _replacement_ of standard contracts with smart contracts? In that case one just makes all contracts bad legal documents. Are you using “smart contract” informally to mean any system that programmatically blocks you from doing a thing until you meet its requirements? (In which case, “smart contract” seems like a bit of a misnomer, as my entire day job is interacting with smart contracts)

        1. Hmm… not sure which advocates you’re referring to.

          Smart contracts were originally described as a way to facilitate the contracting process: The ATM performs the actions of the bank teller who signs a withdrawal agreement that transfers legal title of the cash from the bank to the customer, and simultaneously decreases the amount of debt that the bank owes to the customer.

  2. I think the point of EVERY contract is to not go to court. In my (limited) experience, contracts only end up in court for one of two reasons:
    1) The two parties disagree on the interpretation of the contract
    2) One party believes that the contract is not enforceable due to the legal framework existing outside of the contract itself

    The second concern never goes away, whether you are relying on code or paper. In the DAO example, just because the code allowed a person to transfer the money doesn’t mean that the transfer was legally allowable.

    In theory smart contracts ‘may’ mitigate the first issue, if the code that is agreed upon is fully deterministic and independently executing. But even then there are a host of concerns that can arise:
    1) what if a long-term smart contract depends upon an input that ceases to be available (such as LIBOR)?
    2) what if a long-term contract depends upon inputs that are later deemed to have been inappropriate, manipulated, broken in some legal way?
    3) What if there are grey areas between what a smart contract technically allows, and what participants believe it to allow (a mild-manner version of the hacking question)?

    In all these cases, we would then expect a court to step in.

    1. Nobody ever wants to go to court, but the purpose of a legally-binding contract is to have the *option* of going to court, and have the court force the other person to do something. That’s where the term “legally-enforceable” comes from.

      1. …and if you want to have the option of going to court, it’s a good idea to have something written in a language that the court can understand. For example, the DAO had their terms and conditions:

        “The terms of The DAO Creation are set forth in the smart contract code existing on the Ethereum blockchain at 0xbb9bc244d798123fde783fcc1c72d3bb8c189413. Nothing in this explanation of terms or in any other document or communication may modify or add any additional obligations or guarantees beyond those set forth in The DAO’s code.”

  3. So in effect – smart contracts are neither “smart” (is a ‘fork’ a feature or a bug?) or contractually binding. So WTF are they? We don’t know – but trust us because they *sound* great? Uh – maybe in the realm of illegal activity that needs anonymity on the dark web (no alternative there), but other stuff? Nope. I like the idea that courts can – and will – adjudicate disputes on the part of individuals who have been fleeced by private and public entities (acting individually or collectively). That fork thingy on the DAO cost a lot of investors some all too real cash.

  4. I don’t think it’s the right question.
    I can write a legal cheque on the side of a cow, and we can form legal contracts verbally. Contracts take many forms. There is no doubt a piece of code that operates according to some properly formed agreement can lead to actions that are binding.

    The more interesting claims that are being made by Smart Contract devotees are:

    (1) That these scripts are somehow different from all the many pieces of code that already control machinery and payments. I don’t see how. They’re written in weird new languages and run on virtual machines but so what? My mortgage is paid every month via what’s probably COBOL. Klunky language but Turing complete and legal.

    And (2) Smart Contracts are somehow above the law, in that parties will never need go to court, or indeed won’t be allowed to go to court. In other words, the notion is that the entire contract is formed in code. That seems errant nonsense to me. The crucial part of any Smart Contract is the agreement by parties to submit to a piece of code. As a matter of logic, that agreement has to be formed outside of the code, and will be subject to extant contract law which likewise exists outside the contract.

    Smart contracts aren’t magic spells.

    1. (1) is a little different. Presumably you can cancel your mortgage payments at will, and then it’s the bank’s problem to foreclose on your house. In theory, a smart contract can’t be terminated by one party (unless it’s programmed to allow that, in which case it’s pointless).

      Oh, and you can’t write a cheque on a cow. See Board of Inland Revenue v Haddock 🙂

    1. Well, a contract that can be terminated by one party is pointless. In a legal contract, each party needs to have something at stake (“consideration“). If one party can terminate the contract at will, then that party doesn’t have anything at stake. For example, you could make all your mortgage payments, and then the bank could cancel the contract, including the part where it was supposed to remove the lien on your property.

      1. But circumstances change. All non-trivial contracts contemplate changes to conditions that may render an original agreement obsolete. That’s life. It seems utopian (or dystopian) to imagine sealing a deal for all time, as if the parties have perfect foresight.
        Which brings me back to lawyers. The reason many arguments end up in court is a contract’s terms turn out to be invalid, and that can be because one party knew things the other did not. In a perfect world, everyone would know everything, contracts would never change, and sure, we wouldn’t need courts. If only …

        1. Sure, it’s perfectly reasonable to renegotiate a contract. You can even put a “renegotiate” function in a smart contract. There’s no rule that a smart contract can never be updated; the only thing that’s not allowed is for one party to make modifications or cancel the contract without the other’s consent.

          And it’s reasonable to expect that some contracts assisted by smart contracts will still end up in court. In theory, smart contracts do a better job of enforcing outcomes that meet both parties’ expectations, but yeah, the world isn’t perfect. That’s why traditional legal contracts are still important.

          1. I don’t mean to troll but here’s a great counter point for our discussion.
            Smart Contracts doyen Nick Szabo is quoted here as saying they will “replace the job of traditional contracts” and “completely redefine” contract management. http://www.pcmag.com/article/350088/blockchain-in-2017-the-year-of-smart-contracts

            But no. Disputes will persist over definitions and over the law; lawyers and courts will remain; and apart from a few marginal cases, contracts as we know them won’t fundamentally change at all.

          2. I have great respect for Szabo but I’m gonna side with you on this one. Smart contracts won’t replace traditional contracts, but they’ll make certain transactions more affordable by automating the rules of exchange. Like that vending machine example — the vending machine makes it possible to buy a soda for 50 cents in the middle of the night. If you had a person sitting there overseeing the transaction, it would be way more expensive.

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