Is Smart Contracts’ main feature (“self-executing”) acceptable by Law? Or could it perhaps be seen as taking the law into one’s own hands?

Is Smart Contracts’ main feature (“self-executing”) acceptable by Law? Or could it perhaps be seen as taking the law into one’s own hands? This question will be considered in light of the Starter Interrupter Device (SID) case, first mentioned by Nick Szabo in 1997 and later referred by Max Raskin, among others.

According to Monisha Coelho, Smart Contracts “are digital agreements that automatically execute transactions between parties, increasing speed, accuracy, and integrity in payment and performance.” Moreover, they “are legally enforceable if they comply with contract law”. Raskin similarly defines a Smart Contract as an “agreement whose execution is automated”, explaining that this automation is derived from “code that has translated legal prose into an executable program”.

Raskin further explains that Smart Contracts “allow contracting parties to ensure their agreement is enforced by raising the costs of any breach by a prohibitive amount.” The idea is to make any default (too) expensive for the counterparty, thus discouraging it from defaulting because it knows that the technological solution will bring about the final fulfilment of the obligation.

For this reason, Smart Contracts are defined by Raskin as agreements “wherein execution is automated, usually by computers”. These kinds of contracts are “designed to ensure performance without recourse to the courts”. As such, “automation ensures performance” (Raskin) without “human discretion from contract execution” (Raskin).

Maria Letizia Perugini and Paolo Dal Checco reinforced the notion of automation in preventing default: “smart contracts aim to be a preventive remedy for those breach of contracts that are subdued to enforcement. (…) The parties agree in advance about the automatic performance of some specific clause by means of a system input.”

Therefore, as explained by Clack, Bakshi and Braine, “…to be a smart contract we require that some part of the execution is capable of being automated (otherwise it is not “smart”)”. In addition, they state that “the contract must be enforceable” by its code. Thus, a Smart Contract is an agreement “whose execution is both automatable and enforceable”: it is automatable by a computer and enforceable by either the legal enforcement of rights and obligations or tamper-proof execution (Clack, Bakshi and Braine).

As seen from Perugini and Dal Checco’s perspective, “digital codification making some contractual provisions self-executing, this way preliminary solving the problems related to a possible breach of contract.” Smart Contracts are most definitely about code (Mafalda Siqueira Roldão), avoiding the non-performance of obligations and, in this particular case, also avoiding the intervention of third parties (Judicial Courts or Arbitration Tribunals).

Considering that the Smart Contract is “code” or “algorithmic account holders on the blockchain” (Balázs Bodó, Daniel Gervais and João Pedro Quintais) and assuming that “code is law”, what will be, or should be, the limits of a self-executing tech solution? Is there any limit? Is it dispensable to request an award or a prior judicial preliminary injunction? Let’s reflect on these questions keeping in mind the case of SID.

As previously mentioned, Nick Szabo referred to a “hypothetical digital security system for automobiles” which may have security protocols (“SID”) to ensure that control of the cryptographic keys for operating the property is in the hands of the person who rightfully owns that property, based on the terms of the contract. To redress this problem, Szabo states that “we can create a smart lien protocol: if the owner fails to make payments, the smart contract invokes the lien protocol, which returns control of the car keys to the bank.” (see similar approach in Max Raskin).

After excluding hard situations (which could put human lives in danger), Szabo concludes by summarising the “tech-self-execution procedure” in these terms: “In this process of successive refinement we’ve gone from a crude security system to a reified contract: (1) A lock to selectively let in the owner and exclude third parties; (2) A back door to let in the creditor; (3a) Creditor back door switched on only upon non-payment for a certain period of time; and (3b) The final electronic payment permanently switches off the back door.”

Max Raskin explains that “these are devices that are installed in cars by creditors, allowing them to remotely disable the car if a debtor has breached the terms of an agreement.” He is very clear about the mechanism: “A starter interrupter is a device that is installed in an automobile that allows for a remote party to prevent the engine from starting”.

Raskin further points out that this “is a current instance where courts have passed judgment on the legality of smart contracts, albeit not self-consciously. They were not setting out to rule on legality, but implicitly did so as a collateral matter”.

Thomas Hudson and Daniel Laudicina also argue that “courts have not directly addressed the legality of the use (…), although at least one reported case addressed the permissibility” (to learn more about this, see In Raskin’s words, the SID is an “archetypical example of a smart contract”, and “how the law deals with them is instructive in crafting appropriate legal regimes”. Hudson and Laudicina recall that as this is often the case

with new technology: “the law lags behind technology in that, with a few exceptions, the law does not expressly address the permissibility of or restrictions imposed on the use of such devices in credit transactions”.

There is no doubt that self-executing tech helps ensure the performance of the contract, relying on a computer-based system. However, is this provision in accordance with the Law? Legally speaking, is it possible for the “creditor” to repossess an asset already sold to the “debtor” without the intervention of the judiciary?

In the Brazilian case, for instance, the Federal Constitution rules that “no one shall be deprived of freedom or his assets without the due process of law” (Article 5, LIV, of the Brazilian Federal Constitution of 1988). Moreover, the Brazilian Penal Code (Decree-Act 2.848 of 1940) establishes (Article 345) that it is forbidden to take justice into  one’s own hands, except when permitted by law.

Nevertheless, in general, “the law does not permit parties to take the settlement of conflicting claims into their own hands.” (Max Raskin).

That is the main problem and most difficult question arising right now. A new era requires new thinking. How are we to deal with the new format of contracts (“blockchain format”, by  Jakub J. Szczerbowski) without reducing or prohibiting the development of technology?

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