Smart Contracts and International Trade Law

An insight into smart contracts and international trade by Bashar Fteiha

With the development and the progression of blockchain technologies, the concerns behind using smart contracts have become more pressing than ever. Although, there has been a huge difficulty in establishing a suitable definition for a smart contract, some legal scholars define it as “a self-executing contract that contains a set of programming codes that are automatically and immediately executed on a blockchain or a distributed ledger once predetermined conditions are triggered”. While smart contracts have the capacity to enhance commercial efficiency, lower fraud loss, and lower transactional legal costs, they undoubtably challenge the legal order. They pose a significant number of legal challenges, starting from finding a proper definition of smart contracts to establishing clarity in contract formation regarding the allocation of liabilities and available remedies. When examined in the context of international trade, smart contracts offer innovative features that make them cost effective in international trade undertakings. However, the uncertainties around the legal status of smart contracts under the current legal framework underlying international trade represents a significant hinderance for the future use of such contracts in cross-border trade.

It is sufficient to state, at this stage, that the legal status of smart contracts is highly complex and unclear. This is because an international legal framework tailored for the use of smart contracts in cross-border trade deals does not exist. However, the United Nations Commission on International Trade Law (UNCITRAL) has been continuously developing laws for electronic modes of communication in international trade. Over the past years, UNCITRAL has been adopting certain regulations on the role of electronic modes of communication in international trade such as The Model Law on Electronic Commerce (MLEC) 1996, the Convention on the Use of Electronic Communications in international Contracts (ECC) 2005, and the Model Law on Electronic Transferrable Records (MLETR). Nevertheless, the question that remains unanswered is whether UNCITRAL Model laws and Regulations set out clear rules and guidelines on the use of smart contracts in international trade practice. Although it could be argued that the existing UNCITRAL laws could potentially govern the use of smart contracts in cross-border trade, the absence of some recommendations on how to write and use a legally binding smart contract under these regulations and the legal consequences that may arise as a result will lead to unnecessary legal uncertainty concerning the use of smart contracts in international trade.

A significant legal challenge in relation to the determination of applicable law and competent jurisdiction can arise with the use of smart contracts. Given that the technical nature of smart contracts does not allow any provisions that are not automatically executable by software, it is difficult to see how a smart contract could contain a provision on the applicable law and competent jurisdiction. One might also suggest that the inclusion of applicable law and competent jurisdictions in smart contracts is not feasible simply because the very nature of these contracts does not allow for third-party judicial enforcement. Additionally, the absence of an express provision relating to the applicable law and competent jurisdiction may generate enormous problems. In this context, it is still unclear how the applicable law and competent jurisdiction will be determined when smart contracts are used in a context that involves a contractual relationship with multiple international elements. For instance, a smart contract with a blockchain platform based in Germany with contracting parties in Japan and US. In that situation, which country’s regulations may govern such contract? Which courts would have jurisdiction to resolve disputes between both parties, and what law would courts and judicial bodies apply? It is still unclear how the UNICTRAL Model Laws and Regulations will address these legal questions relating to applicable law and jurisdiction.

Furthermore, one of the main characteristics of smart contracts is their ability to automatically execute the transaction without the need for third-party intervention. Therefore, this self-enforcement mechanism has been designed to guarantee that smart contracts are performed without any risk for breach. However, smart contracts could still be breached, which in turn entails that future legal disputes between the contracting parties will inevitably arise. Accordingly, the fact that there is a little possibility that the performance of smart contracts would not be as expected or intended by the parties, presents one of the greatest legal challenges to the adoption of smart contracts in international trade practice. For instance, with traditional contracts, it is relatively easy to establish liability and identify the remedies available for the aggrieved party. With a smart contract, it seems unrealistically hard to establish labiality particularly in situations where the smart contract is breached due to coding errors which fall outside both parties’ contractual responsibility. In principle, there are potential sources of smart contract disputes such as unexpected performance issues (bugs, coding errors, cyber-attacks), and parties’ intention to unwind transaction because of misrepresentation, mistakes or duress.

The question that arises in this context concerns whether the current UNCITRAL Laws and Regulations provide clear rules for establishing liability and providing remedies in case of breach of smart contract. While certain UNCITRAL Laws and Regulations such as ECC apply to smart contracts used in cross-border trade, there is no legal provision that provides clear guidance on how liability should be established or the remedies available for the aggrieved party. The lack of any guidance on establishing liability and remedies complicates further the use of smart contracts in cross- border trade undertakings.

In conclusion, it is indisputable that current international rules contain jurisdictional and substantial, which render them incapable of providing clear guidance on the use of smart contracts in international trade. Given that smart contracts will become a matter of law the near future, it would be very useful to investigate how the current UNCITRAL texts will address such questions in the near future. In any case, such legal questions need to be resolved in order to ensure that smart contracts are used in an effective and proper manner in international trade dealings