INTRODUCTION
As a result of the increased rate of technological innovations, contracts have been created, executed, and enforced differently. In particular, while initially legal relations were regulated by traditional paper-based contracts that have formed the legal basis for decades and even centuries, today’s contracts are shifting to digital agreements and moving to a more advanced level of smart contracts. Though the above advancements provide numerous advantages, they have cross-legal issues that must be solved to make the innovations effective and legally binding.
DIGITAL AND SMART CONTRACTS
Digital contracts:
Digital contracts are legally binding agreements that are created, signed, and executed electronically. Unlike traditional paper contracts, which require physical signatures and manual handling, digital contracts are entirely digital, making them more efficient and easier to manage. They are widely used across various industries for transactions, agreements, and legal commitments. The main features of these types of contracts are as follows:
- These contracts are established through software assistance that enables the parties to write, revise, and intervene in the agreement’s provisions through the use of computers. It is done using digital signatures, tackler cryptographic means meant to authenticate the signer.
- Digital contracts are stored electronically, they can be accessed, signed, and managed from anywhere with an internet connection. This accessibility speeds up the contracting process and reduces the need for physical meetings.
- In digital contracts, typically, there are applied security measures such as encryption and authentication to minimize the threats of unauthorized access and changes. Digital signatures are globally accepted forms of signatures that have legal recognition.
Smart contracts:
Smart contracts are automatically operationalized contracts where the statements of the contract are coded. They perform and implement the stipulations set out within the contract to the letter when certain preconditions prevail or occur, and this occurs without the use of middlemen or experts such as lawyers or notaries.[1] Smart contracts are designed to run on a blockchain solution such as Ethereum which is an ecosystem where these smart contracts work. [2]Special features of smart contracts are as follows:
- Smart contracts are programmed to automatically perform specific actions when certain conditions are met.
- Smart contracts do not depend upon a specific authority or third party to execute the contractual terms and conditions like normal contracts; they run on Blockchain technology. This implies that none of the participants own the contract and therefore, the contract cannot be altered or censored.
LEGAL CHALLENGES UNDERLYING THE DIGITAL AND SMART CONTRACTS
Jurisdiction and Enforcement Challenge: One of the main issues with digital and smart contracts is jurisdiction. While traditional contracts have a court’s specified jurisdiction, which is the place where the contract is made, digital and smart contracts make it challenging to determine which court has jurisdiction over a particular case. In digital contracts parties in the contracts can specify which court will have the jurisdiction if any conflict arises between the parties but the jurisdiction of the international contracts is very difficult to find as there can be various courts claiming jurisdiction.[3] Section 20 of the Civil Procedure Code of 1908 [4]determines a court’s jurisdiction depending on the defendant’s residence or the location of the cause of action. In the case of smart contracts and digital contracts where automated code executes without human interaction and transactions take place across worldwide networks, defining where the cause of action arises or where the defendant “resides” is particularly challenging. It also becomes difficult to determine which court has the jurisdiction if they solely operate on decentralized blockchain networks that are not tied to any geographical location. [5]According to Section 1(2) of the IT Act of 2000[6], the IT Act applies to the entire country of India as well as any offence or contravention committed outside of India with a computer, computer system, or network located in India. This raises concerns regarding the enforceability of smart contracts involving individuals and systems in many jurisdictions, especially in decentralized systems such as blockchain, which lack defined geographical boundaries. Due to the difficulty in determining the jurisdiction the enforcement of the said contracts becomes a challenge.
Legal Recognition: Some nations also do not recognize smart contracts that are based on codes or some blockchain technology. Section 4 of the Information Technology Act of 2000[7], provides legal recognition for information in electronic form. Digital contracts are considered electronic documents, but the section excludes more complicated digital agreements such as smart contracts, which function on blockchain. The traditional contracts have the proper statutes for their creation, execution, and enforcement, smart and digital contracts do not come under any of the statutes hence the legal recognition of these contracts is one of the primary challenges. [8]Section 2(h) of the Indian Contract Act, 1872[9] States that a contract is a legally enforceable agreement. While this includes digital contracts, customary interpretations focus on physical agreements, making it difficult to apply to self-executing smart contracts. Smart contracts are written in programming code, which most parties might not fully comprehend, as opposed to traditional contracts, which are stated in plain language. This begs the question of whether those who are unable to understand the code may consent to the conditions. Section 13 of the Indian Contract Act of 1872 [10]Specifies that for a contract to be legal, consent must be “free,” which means it was not obtained through coercion, fraud, or misrepresentation. It is uncertain how free consent may be assessed in a smart contract because consent is frequently implicit in code execution rather than explicit human action. So, it becomes very difficult to give the status of the contract to smart and digital contracts or not hence, many countries are still debating on this issue.
Security and fraud: Smart and digital contracts are based on blockchain technology so security is the paramount issue. While these contracts offer increased efficiency and automation, they contract can also expose the contracting parties to various security risks and fraud leading to financial and legal issues. Digital contracts are transferred through the Internet which can make the contract susceptible to security breaches. Cyber crimes are also frequent and phishing attacks and social engineering techniques are tools that cyber criminals might employ to fool people into signing fake contracts or divulging private information. In digital contracts, digital signatures can be forged even though they are meant to be safe. Section 66C of the Information Technology Act of 2000 [11]discusses identity theft and using someone else’s unique identifiers (such as digital signatures or keys). However, smart contracts and digital contracts often use cryptographic keys and electronic signatures rather than traditional signatures, which may not be fully compliant with existing legislation.[12] Smart contracts are written in codes so if the codes are flawed or compromised there could be dire repercussions if malevolent parties take advantage of these vulnerabilities. Since smart contracts are based on decentralized blockchain technology there is no centralized authority to take control if something goes wrong. For example, Section 43 of the Information Technology Act of 2000 [13]penalizes unauthorized access, damage, or tampering with computer systems; however, smart contracts that execute automatically may lack adequate preventive measures to mitigate this risk, particularly on decentralized platforms where such actions are difficult to trace. Once the transactions are made in smart contracts there is no option to retrieve the losses if the codes are flawed or hacked by hackers.
Regulatory compliance: Smart and digital contracts are based on technological innovation hence the existing laws are not meant for these types of contracts so it is very difficult to regulate these under the existing laws. For example, smart and digital contracts have to comply with the existing anti-money laundering act or the Contract Act but there is a lack of these regulatory mechanisms. Cross-border digital and smart contracts might make it difficult to comply with several, frequently contradicting regulatory regimes. For example, a contract between parties from the United States and the European Union may need to abide by both the data privacy regulations in the United States and the EU’s General Data Protection Regulation (GDPR), which may have different requirements. A single transaction may occasionally come within the purview of several regulatory agencies, each with its own set of regulations that make it difficult to comply. Digital and smart contracts are difficult to regulate and comply with as many legal frameworks are not designed with these contracts in mind.[14]
CONCLUSION
The digital space is improving daily, thus making it possible for smart and digital contracts to be very beneficial in terms of efficiency, automation as well as innovation. However, they present a myriad of legal problems that need to be addressed carefully if they are to fit into the 21st-century legal and business systems.
The acceptance of smart contracts and digital contracts cannot be said to be without its problems as it relates to jurisdictional matters and enforcement issues, legal recognition complexities, validity issues, security concerns, and fraud prevention mechanisms among others. Hence, there is a need for adjustment in the legal systems for them to tackle these changing matters adequately at hand.
The collaboration of technologists, lawyers, regulators as well as other enterprises is necessary for creating sound frameworks that will be able to cater to the specificities of smart contracts and digital ones. Henceforth emerging legal precedents and guidelines show that this is an area where all parties concerned must remain abreast by proactively tackling these challenges.
Author(s) Name: Purva Mehta (Dr. BR Ambedkar National Law Univerisity, Sonipat, Haryana)
References:
[1] IBM “What are Smart contracts on blockchain” <https://www.ibm.com>. Accessed 20 September 2024
[2] Sanhita Chauriha “Are Smart contacts really smart?” Lawschoolpolicyreview.com<https:/lawschoolpolicyreview.com/> Accessed 20 Sep. 2024.
[3] Medium, ‘Smart Contracts: Key Legal Issues’ (medium.com 2018) <https://medium.com/> accessed 20 September, 2024
[4] Civil Procedure Code, 1908 s.20
[5] Vidushi Vats & Shashi Bhushan, ‘SMART CONTRACTS AND LEGAL ENFORCEABILITY ‘ (ijalr.in ) <https://ijalr.in/> accessed 20 September, 2024
[6] Information Technology Act, 2000 s.1(2)
[7] Information Technology Act, 2000 s.4
[8] BITLAW, ‘Smart Contracts and the Law’ (bitlaw.com ) <https://www.bitlaw.com/> accessed 20 September, 2024
[9] Indian Contract Act, 1872 s. 2(h)
[10] Indian Contract Act, 1872 s.13
[11] Information Technology Act, 2000 s.66c
[12] Impana Halgeri, ‘Issues relating to Smart Contracts in the Indian Context and their effect on NFTs’ (crispr.nliu.ac.in 2022) <https://csipr.nliu.ac.in/> accessed 20 September, 2024
[13] Information Technology Act, 2000 s.43
[14] Vidushi Vats & Shashi Bhushan, ‘SMART CONTRACTS AND LEGAL ENFORCEABILITY ‘ (ijalr.in ) <https://ijalr.in/> accessed 20 September, 2024
