• The Law Gazette

A Shift to the era of Smart Contracts and their validity under the CISG

Technology is overtaking the world of cross-border trading, with the development of ‘smart contracts’ being the next-big-thing in the market. Although its idea has been in existence since the nineties, when the scholar, Nick Szabo, first defined the term,[i] its contractual enforcement remains in an area of legal ambiguity, which this article attempts to address, specifically in the context of international sale of goods. Szabo defined the term as a set of promises and protocols which the parties to the contract perform or implement with programs on computer networks.[ii]


BACKGROUND

In other words, these are software codes or algorithms embedded with the terms and conditions of a contract[iii] used for a variety of partial or fully automated self-executing electronic transactions.[iv] Such an automated performance is enabled technologically when actions are signaled on the doing of a pre-decided act or fulfilling a condition,[v] no different than the humanly executed and performed contracts with a hint of technology. It ranges from a fully code-based agreement to a manual one with partially automated performance,[vi] stored on a blockchain-based platform.[vii] It only leads to a decrease in transactional costs and an increase in performance-efficiency,[viii] even while executing more complex transactions, furthering the basic objectives with which International Conventions dealing with cross-border contractual obligations are drafted.


Due to the advent of smart contracts in international trade, potentially seen as revolutionary by the WTO [ix] and a lack of UNCITRAL Model law governing it, it is important to analyze its legal validity and implication in respect of the United Nations Convention on Contracts for the International Sale of Goods (hereinafter, ‘CISG’). This shall be done in a two-pronged manner; firstly, studying whether it meets the contract-formation essentials under the Convention to constitute a contract of international sale of goods, explicitly governed by CISG, and secondly, upon the presumption or proof of it being a valid contract, whether its features can be accommodated under the provisions of the CISG for its consequential acts to be governed by it.


SCOPE OF CISG’S APPLICATION ON SMART CONTRACTS

A. LEGAL VALIDITY IN CONTRACT FORMATION

Smart contracts can fall within the ambit of the CISG only if it meets the pre-requisites of contract formation, as under its provisions. A contract under the Convention is limited to that of sale, governing the rights of buyers and sellers arising from as, as envisioned under Article 4. However, it explicitly rules out adjudging upon the question of its very validity, a matter often left to the discretion of municipal law. Therefore, the only issues that may arise in the path of smart contracts being subject to the CISG, are, firstly, the contract formation, i.e., whether the mandatory criteria of offer and acceptance are met, as provided under it, and secondly, whether the contract, as a whole, can be classified as that of ‘sale of goods’.


Offer and Acceptance, as per the Convention, are not subject to requirements of form and manner.[x] However, each has its own set of essentials to be adhered to. Article 14, regulating a proposal, deems one valid if it encompasses, (i) one or more specific offerees; (ii) determinable and definite content, indicating the goods, its quantity and price; and (iii) the intention of the offeror to be bound by it.[xi] The first ingredient is easily catered to by the blockchain medium, which relies on a mechanism of two keys- one identifying the party’s account address (public key) and the other acting as its electronic signature (private key).[xii] Identification of the respective keys makes the offeree sufficiently identifiable. It may also be read in light with the UNCITRAL Model Law on Electronic Commerce[xiii] (hereinafter, ‘MLEC’) which traces back the source of an automatically generated data message to the entity legally responsible for operating the concerned computer, thus, revealing the said offeree. Concerning the second ingredient, the computer algorithm involved in coding the said contract, partially or wholly, is sufficiently determinable as to the unavoidable specifics and even in cases of certain ambiguities, it may be interpreted in light of open terms in CISG and doesn’t invalidate a contract by itself.


An underlying theme of the CISG is that of the intention of the contracting parties, the third and sine qua non element of an offer. The CISG provides for an approach of flexibility in this regard, excluding the parol evidence rule,[xiv] i.e., evidence beyond the four corners of the expressly written contract, to determine intention, vide Article 8. When due consideration is given to surrounding circumstances of party negotiations, usages, subsequent conduct, etc.,[xv] intent can be easily gathered in executing a smart contract. Sharing of the two keys, in itself, is well-indicative of intent.[xvi]


Acceptance, on the other hand, as provided under Article 18, requires a simple conveyance of assent, express or implied.[xvii] This is, again, read in light with party intention and implied consent by the offeree by the performance of its obligations. Since smart contracts are automated performance when once initiated by the concerned party, assent isn’t difficult to implicate. Blockchain, itself, provides for an efficient way of tracking such conduct, through its time-stamp feature.[xviii]


Further, the controversial area related to determining whether smart contracts fall within the ambit of a ‘contract of sale’ of goods is mostly limited to its inclusion of cryptocurrencies, either as the subject-matter, or the consideration. Firstly, addressing a situation of the subject-matter being cryptocurrency (with consideration being in traditional currency), it ought to be read in light of Article 2, the exemption clause of the Convention’s scope, which excludes certain ‘goods’ such as money, stocks, shares, etc. Cryptocurrency is nothing but an alternative to money or a virtual currency. It cannot be perfectly equated to money, but in line with judicial/arbitral precedence which has earlier equated Bitcoin with money[xix] for such purposes, an analogy can easily be drawn.


Arguendo, the majority of CISG judicial and scholarly opinion supports its application only to the sale of tangible goods,[xx] whereas cryptocurrencies are intangible, often not even classified as a property that can be owned.[xxi]Secondly, when the consideration is in the form of cryptocurrency, it’s down to the domestic laws in question, since it may or may not be deemed as ‘payment of price’ under the CISG, and if it is not, as per municipal laws, it will be reduced to a mere contract of barter, inequitable with ‘contract of sale’.[xxii] The majority opinion, although, supports cryptocurrency as a mode of consideration, to rightly be classified as valid under CISG, provided the goods are tangible.[xxiii]


B. PRAGMATIC ROADBLOCKS IN THE APPLICATION OF CISG

An important aspect governed by the CISG is the parties’ obligations towards each other and their breaches, thereof. Since smart contracts are based on programmable software, it either increases efficiency manifold, if rightly programmed, or increases potential breaches due to the smallest glitch,[xxiv] unstoppable by human interference, unlike in traditional contracts, except an emergency stop-button many aren’t built with.[xxv]


Another issue that may arise due to its self-enforcement feature is the lack of fulfillment of party expectations, due to jurisdictional variations or cultural barriers failing to achieve a meeting of the minds, leading to huge-scale fundamental breaches and an unintended increase in costs or damages. It also raises the simple yet fundamental question of whom to impose liability on in case of such breaches, since the automated transaction feature makes it difficult the identify the defaulter, in the absence of specific provisions dealing with this.[xxvi] Although, such an issue can be tackled to a limited extent through clauses of dispute resolution, similar to the traditional ways.


Some scholars believe that irrespective of smart contracts fulfilling the CISG contract formation requirements and getting past all pragmatic concerns, they cannot be deemed as legal contracts in themselves, but are mere enforcement mechanism of underlying traditional contracts.[xxvii] A counter to that argument lies in the interpretation of Article 13 in a new light, as per which smart contracts can be defined as electronic communication, falling within the ambit of ‘writing’ to prove the contract, since earlier judicial pronouncements have known to interpret the Article in a wider sense, going beyond telegram and telex.[xxviii] This is also in line with the definition of data messages in MLEC, as mentioned earlier. Essentially, it is enough to constitute a contract, and if the parties mutually consent to a technologically driven, automatic enforcement, away from being governed as per the default provisions, the CISG provides them the flexibility to. After all, party intent and mutual agreement are the only fundamentals the CISG mandatorily adheres to.


CONCLUSION

Smart Contracts are revolutionary in every sense of the word, making the cross-border sale of goods efficient and extremely cost-effective, with the least amount of manual inconvenience. The biggest hurdle in its path of smooth functioning and enforceability is the lack of a specific international law dealing with it and the ambiguity of its position within the existing law. While the possibility of human errors is negligible, it does carry with it the issues every new technology does- a possibility of technologically induced errors and their dangers in the international forum leading to irrevocable consequences. Its efficacy is only limited to that of its code;[xxix] one small bug and the result may be altered substantially as against what was intended by the parties, risking everything the CISG stands for.


An emergency stop feature is a preferred solution to avoid such mishaps or hacks.[xxx] Other issues of uncertainty in areas specifically governed by domestic law under the CISG also remain, so does unresolved questions of liability imposition, remedies and the application of its exemption clauses; the scope of modification post-contract finalization, that the CISG otherwise provides for; the option of anticipatory breach usually enjoyed by parties, and many other small yet practical problems. Therefore, the question of it fitting within the spectrum of contracts covered under the CISG is a tricky and uncertain one, but the majority favor its inclusion until a Model Law governing it is adopted, and rightly so.


ENDNOTES [i] Szabo, Smart Contracts: Building Blocks for Digital Markets (1996), http://www.fon.hum.uva.nl/rob/Courses/InformationInSpeech/CDROM/Literature/LOTwinterschool2006/szabo.best.vwh.net/smart_contracts_2.html. [ii] Id. [iii] Dr Sara Hourani, Cross-Border Smart Contracts: Boosting International Digital Trade through Trust and Adequate Remedies, https://www.uncitral.org/pdf/english/congress/Papers_for_Programme/11-HOURANI-Cross-Border_Smart_Contracts.pdf. [iv] Id. [v] Smart Contracts Alliance in collaboration with Deloitte Report, Smart Contracts: 12 Use Cases for Business & Beyond: A Technology, Legal & Regulatory Introduction-Foreword by Nick Szabo, December 2016 http://digitalchamber.org/assets/Smart-contracts-12-use-cases-for-business-and-beyond.pdf; P De Filippi & S Hassan, Blockchain Technology as a Regulatory Technology: From Code is Law to Law to Law is Code, First Monday, Volume 21, Number 12, 5 December 2016 Section IIA. [vi] Chelsea Chan, The Power and Pitfalls of Smart Contracts: A Recap, LawTech.Asia (Apr. 24, 2018), http://perma.cc/LRQ6-57LQ. [vii] Stuart D. Levi & Alex B. Lipton, An Introduction to Smart Contracts and Their Potential and Inherent Limitations, Harvard Law School Forum on Corporate Governance and Financial Regulation (May 26, 2018), http://perma.cc/UM6E-8WU8. [viii] Anna Duke, What Does the CISG Have to Say About Smart Contracts? A Legal Analysis, Chicago Journal of International Law, https://cjil.uchicago.edu/publication/what-does-cisg-have-say-about-smart-contracts-legal-analysis. [ix] Ganne, E., Can Blockchain Revolutionize International Trade (2018) https://www.wto.org/english/res_e/booksp_e/blockchainrev18_e.pdf. [x] United Nations Convention on Contracts for the International Sale of Goods, Art. 11. [xi] United Nations Convention on Contracts for the International Sale of Goods, Art. 14. [xii] Emir Bayramoğlu, A Legal Analysis on CISG’s Scope of Application from Smart Contracts’ Perspective, Turkish Law Blog, Tilburg University (20 January, 2020) https://turkishlawblog.com/read/article/193/a-legal-analysis-on-cisg-s-scope-of-application-from-smart-contracts-perspective. [xiii] The UNCITRAL Model Law on Electronic Commerce with Guide to Enactment 1996, https://www.uncitral.org/pdf/english/texts/electcom/05-89450_Ebook.pdf. [xiv] MCC-Marble Ceramic Ctr. v. Ceramica Nuova D’Agostino S.P.A., 144 F.3d 1384, 1390 (11th Cir. 1998). [xv] United Nations Convention on Contracts for the International Sale of Goods, Art. 8(3). [xvi] Kevin Werbach & Nicolas Cornell, Contracts Ex Machina, 67 Duke L.J. 313, 368 (2017). [xvii] United Nations Convention on Contracts for the International Sale of Goods, Art. 18. [xviii] Supra xii. [xix] S.E.C. v. Shavers, No. 4:13-CV-416, E.D. Tex. Aug. 6, 2013; S.E.C. v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946). [xx] Munoz, Software Technology in CISG Contracts, Uniform Law Review (2019), 24(2), pp. 4-5. [xxi] Tokyo Court: Bitcoin is Not Subject to Ownership, https://www.coindesk.com/tokyo-court-bitcoin-not-subject-to-ownership-2/. [xxii] Schelectriem, Requirements of Application and Sphere of Applicability of the CISG (2005), p. 787, https://www.victoria.ac.nz/law/research/publications/vuwlr/prev-issues/vol-36-4/cisg-schlechtrieum.pdf. [xxiii] Supra xii. [xxiv] Supra iii. [xxv] Jeremy M. Sklaroff, Smart Contracts and the Cost of Inflexibility, 166 U. Pa. L. Rev. 263, 273 (2017). [xxvi] Supra iii. [xxvii] Supra xvi. [xxviii] Hossam A. El-Saghir, The Interpretation of the CISG in the Arab World, in CISG Methodology 355, 365 (Andre Janssen & Olaf Meyer eds., 2009), http://perma.cc/YU7G-QWTP. [xxix] Adam J. Kolber, Not-So-Smart Blockchain Contracts and Artificial Responsibility, 21 Stan. Tech. L. Rev. 198 (2018). [xxx] Supra viii.


ABOUT THE AUTHOR

This blog has been authored by Ishita Khurana, who is a 4th Year B.A., LL.B. (Hons.) student at University School of Law and Legal Studies, IP University, New Delhi.


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