Will smart contracts disrupt the legal industry?

Introduction to blockchain and smart contracts

By Dick Ting

"Whenever blockchain comes up, the discussion almost always involves some mention of ‘smart contracts’. As lawyers, we hope ‘smart’ contracts have been around for a long time —  we at least try not to write dumb ones."

—  Simun Soljo, Managing Associate at Allens

Blockchains are a special type of ‘Distributed Ledger’ Technology (DLT). Distributed ledgers are essentially an asset database that allows all participants in a network to own an identical copy of the ledger on the network. Any changes to the ledger are reflected and distributed by all copies of the ledger within seconds or minutes.

An emerging solution using blockchain is smart contracts. The term ‘smart contract’ was popularised by computer scientist Nick Szabo in his 1997 paper — ‘The Idea of Smart Contracts’. Smart contracts are computer programs that automatically execute the terms of a contract.  While a regular contract must be executed by legal practitioners or a court system, smart contracts can be performed without the need for human verification.

At its crux, Szabo contends that smart contracts operating on blockchain can replace the legal practitioners in the future — that is, they become the ultimate trusted third party for all transactions.

Blockchain enables record holders to share official records with others in a safe, tamper-proof and trusted manner, which makes the following scenario possible. Imagine that instead of needing a law firm to draft your contract and have them enforced by a judge if one party defaults on its obligations —  with the costs and uncertainty that goes along with the court’s involvement —  the execution of those obligations can be automated by software, verified by the blockchain.

Szabo’s idea came into fruition in 2014, when the programmer Vitalik Buterin created the Ethereum blockchain protocol. This made it possible to write smart contracts in computer programming language that automatically executes itself.

What does a smart contract look like?

Well, quite simply, lines of code.

Consider a simple sale of shares contract that entitles the owner to sell their security at a defined price: Fiona, our buyer would purchase 100 shares of Tesla Inc. from John at a defined price of $10 per share. The contract has an expiry date, after which, Fiona can no longer purchase the shares.

Expressed in lines of code, it might look like this:

Contract Option {
strikePrice = $10
purchaser = Fiona
seller = John
asset = 100 shares of Tesla.Inc.
expiryDate = 1 January, 2018
function exercise ( ) {
If Message Sender = purchaser, and
If Current Date < expiryDate, then
purchaser send($1,000) to seller, and
seller send(asset) to purchaser
}

In this simple smart contract, the function first checks to see if Fiona, the entity triggering the contract, is the purchaser, and then checks to see if it is within the expiry date, defined as the first day of 2018.

If both are true, the contract immediately executes. Fiona’s digital cash and John’s shares that were deposited into the contract beforehand are transferred into the respective digital wallets of the new owners, in accordance with the contract terms.

A more complex smart contract could have several thousand lines - just as a sophisticated regular contract might span several hundred pages.

Targeted disruption

The most compelling use of smart contracts are in the financial and legal industry where there are repetitive and mundane tasks involved. There are three key factors why smart contracts could potentially disrupt the legal services industry.

Firstly, smart contracts allow lower transaction and operation costs compared to traditional contracts. When submitted, smart contracts become self-sufficient and do not require costly human interaction to take place afterwards. Secondly, the certainty of smart contracts avoids the possibility of ambiguity associated with legalese, which in turn, minimises legal disputes. Lastly, the processing times of smart contracts are dramatically reduced given the lack of human interaction and possibility for error.

Richard Susskind, author of Tomorrow’s Lawyers, claims that the working practices of the legal profession have not changed much since the time of Charles Dickens.

He confidently predicts that the legal profession is poised to change radically over the next two decades, where future lawyers will become massively dependent on or having expertise in information technology.

Allens, one of Australia’s largest law firms said in a report: ‘For almost 200 years, our own business has been built on the basis that people need to transact but often lack the trust to rely on a handshake alone’. So when smart contracts come along and commoditise trust by guaranteeing security and certainty of performance in accordance with coded terms, there is no doubt that lawyers would be concerned of its disruptive potential.

Are lawyers safe from smart contracts?

During his talk at the Smart Contract Symposium at Microsoft’s New York Headquarters held in December 2016, Szabo gave an update on the industry he first envisioned twenty years ago.

He believes that instead of legal jobs being at risk, it’s those in other industries with repeatable tasks with the most to lose: ‘Lawyers worried about losing their jobs to robots, you're actually doing something that's mostly complimentary to a smart contract. Smart contracts are mostly making possible new things that haven’t been done before.’

In other words, although lawyers today are becoming increasingly subject to disintermediation, with many contracts that may be automated in the future, any slightly complex interaction requiring judgement is still performed best by human lawyers.

The current emerging view is that smart contracts will not disrupt the legal industry, but nonetheless will influence the role of a lawyer in the future. Lawyers must become ‘smarter’ by learning how to utilise this technology. However, the biggest obstacles to the viability and adoption of smart contracts today are the same characteristics that make it great. For instance, smart contracts lack the flexibility of traditional contracts which often contains intentional ambiguity. The deterministic and rigid nature of smart contracts removes the fundamental ability for lawyers and the court to construct the terms of the agreement and leaves no place for value judgements or generality such as ‘reasonableness’ and ‘good faith’.

Jazek Czarnecki, associate in New Technologies Practice of Wardnski & Partners argues that ‘traditional legal solutions and smart contracts need not be opponents’. He argues that skilful marriage between the certainties of smart contracts with the flexibility of traditional legal agreements can be extremely useful.

This sentiment is echoed by various other legal practitioners in the field. John Stark, lawyer and head of operations at Ledger Labs, a blockchain consulting firm, provided the example of a supplier who enters into a smart contract with their retailer. The payment terms are defined in code and automatically executed via smart contract but the retailer may insist on a paper legal contract with an indemnity clause that refers to their smart contract.

Adapting to Disruption

The area of smart contracts is fast moving but remains significantly unregulated. Even when we have fully formed self-executing contracts, we will still need to refer to legal terms and concepts that will define each party’s rights and liabilities.

Therefore, the ability to understand smart contracts in their coding language on top of the evaluation of common legal practice will promise a range of new opportunities for people trained in law and technology.

Skills and education in digital technology is critical to ensure that many in the industry are not left behind when the day arrives for smart contracts to become viable enough to replace traditional contracts.

Legal academic, David Thompson, describes the difference between ‘learning about’ and ‘learning to be’. He argues that the legal careers of students today frequently change directions because more sophisticated technologies are developed over the course of their careers, and likely more than once.

Therefore, forward-thinking law schools should assist students in tooling up their digital technology capabilities and encourage students with technology aspirations to learn dual skills of law and computer programming.

Some larger law firms have already begun adapting to smart contracts. For example, Ashurst partner, Phil Trinca, said lawyers today are already advising clients about smart contracts and blockchain technology, with firms equipping their lawyers with the necessary skills and training to engage with them.

Conclusion

Smart contracts are great for reducing operational risk and can be seen as an automated trustworthy workflow between parties without a central specific co-ordinator. However, like all disruptive technologies, it has a number of hurdles to adoption.

Ultimately, smart contracts require smart lawyers and for now, the legal profession is safe. One thing remains clear — that amidst the hype and the hopes of new disruptive technology, being wilfully blind to the change brought about by blockchain technology and smart contracts, is not an option for the lawyers of tomorrow.

This article originally appeared in TechUp Law, a student publication written by Monash Law Student Ambassadors that specifically caters to law students’ understanding of digital technologies in the legal sector.

Email: