SMART LEGAL CONTRACTS: THE GOOD, THE BAD & THE UGLY


 

1. What is a smart legal contract?

This is a legally binding automated contract in which some or all the contractual obligations are defined and/or performed automatically by a computer program referred to as a ‘code’.[1] The code and the terms contained in a smart contract exist across a distributed decentralized blockchain network.[2] They tend to follow a conditional logic i.e., if “‘A’ occurs, then execute step ‘B’”. To this end, the code controls the execution of a smart contract which is irreversible.

There are three (3) main types of smart contracts which are all executed in three (3) stages[3] being (a) Negotiations (b) Terms; and (c) Performance. The types of smart constructs are illustrated below:

Type 1: Natural Language Contract with Automated Performance

  1. Natural language
  2. Natural language
  3. Code

Type 2: Hybrid Smart Contract

  1. Natural language
  2. Natural language & code
  3. Code

Type 3: Solely Code Contract

  1. Natural language and/or Code
  2. Code
  3. Code

2. Advantages of a smart contract

  • Accuracy and clear communication: A code is precise and removes any transaction errors that could take place. Further, smart contracts ensures that there is clear communication between parties noting that the blockchain is irreversible and thus parties are not able to rectify any terms after execution.
  • Efficient: The effect of accuracy and clear communication in smart contracts is that there is improved efficiency thereby encouraging parties to enter into more value-generating transactions.
  • Cost-effective: Smart contracts remove the need for intermediaries who require transaction costs and fees.
  • Certainty of execution: Once a condition is met, the contract is executed immediately. Therefore, the time delays in execution of contracts is significantly reduced.
  • Transparency: The terms and conditions of smart contracts are fully visible and accessible to all parties involved due to the operation of the blockchain technology.  

3. How will Kenya benefit from the use of smart contracts

3.1 Land transactions and land registries; ardhisasa

Kenya's government may consider implementing smart contracts to manage land transactions via blockchains. This would be advantageous since it would automate land ownership, use, and transfer of records. The adoption of smart contracts could similarly aid in eradicating the publicly reported challenges that have plagued land transactions for years. In addition, persons or entities transacting in land will use a significantly shorter period to complete land transactions in view of the automated processes. As a result, the adoption of smart contracts would greatly help in the achievement of  ardhisasa's goals, which include, among other things, making land more accessible.

3.2 Protection of intellectual property

The mismanagement of intellectual property has resulted in significant financial losses for creators in terms of prospective earnings. With the implementation of smart contracts, it is expected that the management of intellectual property will be automated thus reducing the likelihood of copyright infringement and redistribution.

3.3 Full realization of ‘internet agreements’ in the Consumer Protection Act

According to the Consumer Protection Act, an internet agreement is defined as a consumer agreement formed by text-based internet communications[4]. The use of smart contracts would widen the definition of internet agreements to include smart contracts, allowing for some regulatory control of smart contracts and, as a result, providing a legal basis for the use of smart legal contracts in Kenya.

3.4 Government voting system

Smart contracts, if adopted in the electoral process, would create a more secure voting environment since the voting mechanism would be less vulnerable to tampering. Markedly, smart contract votes would be more secure noting that there blockchain technology is less vulnerable to hacking and decoding. Furthermore, because some voters are turned off by the current inefficient system, smart contracts would potentially increase voter turnout.

4. General challenges of smart contracts

4.1 Jurisdictional challenge

In their smart legal contract, parties are usually encouraged to include a jurisdictional clause (and/or a governing law clause) as it may be difficult to identify the geographical location of breaches in smart legal contracts involving digital assets.[5]

4.2 Breach of contract

In instances where the code is only a device utilized by the parties to perform their contractual obligations beneath a normal language contract, a party may be obligated for breach of the contract if the code comes up short to perform the counter-party’s obligations accurately. Where the code isn't just a tool for performing the parties’ legally binding obligations, but instead characterizes those obligations, it may be more difficult to set up a tool that declares a breach of contract. This is because establishing a breach of the coded terms of a smart legal contract is likely to begin with requiring the parties to set up the meaning of those terms and translating coded terms which is by and large a tough assignment. [6] 

4.3 Rectification

Usually, smart contracts cannot be edited if they are on an immutable distributed ledger. Therefore, it is not possible to rectify the terms and content of a smart contract. Additionally, parties can only discover an error in the contract after it has been executed which may force parties to terminate a contract and enter a new contract in situations where they wish to alter the terms of the contract.[7]

4.4 Illegality

Some distributed ledgers permit parties to a transaction to transact using pseudonyms, which may present itself as a challenge as parties may not be cognizant of who they are transacting with. Additionally, since smart contracts remove the need for intermediaries, this may become disadvantageous as professionals such as advocates and bankers play an important role in detecting illegal activity. 

5. Conclusion

Although Kenyan laws do not explicitly prohibit the use of smart contracts, there are no explicit provisions for the same. Therefore, Kenya’s laws need to accommodate the use of smart contracts as it will generally improve the ease of doing business within the country, assist with the achievement of equitable access to land[8], promote and protect the intellectual property rights of Kenyans[9] and generally achieving a globally competitive and prosperous nation.[10]

Article by Nyokabi Njoroge and Ernest Muriungi. Nyokabi is a Pupil at MMAN Advocates and Ernest is a Junior Associate with a background in Litigation and Commercial Dispute Resolution.

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[2] Max Raskin, ‘The Law and Legality of Smart Contracts’, Georgetown Law Technology Review, 309.

[3] Law Commission of England and Wales, ‘Smart Legal Contracts: Summary’, 8.

[4] Section 2, Consumer Protection Act, No. 46 of 2012

[5] Khan S.N., Loukil F., Ghedira-Guegan C., Behnkelifa E. and Bani-Hani A, ‘Blockchain smart contracts: Applications, challenges and future trends’, 18.

[6] Raskin M., ‘The Law and Legality of Smart Contracts’, Georgetown Law Technology Review, 328.

[7] Khan S.N., Loukil F., Ghedira-Guegan C., Behnkelifa E. and Bani-Hani A, ‘Blockchain smart contracts: Applications, challenges and future trends’, 19

[8] Article 60(1)(a), Constitution of Kenya, 2010

[9] Article 40(5), Constitution of Kenya, 2010





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