What are smart legal contracts?
An animated smart legal contracts explainer video – with example use cases.
The story so far...
Contracts have been around for millennia. Chiseled into stone, signed in blood, written on paper or sealed with wax.
In recent times, technology has improved things a little with the introduction of electronic documents which can be digitally signed and emailed as a Word document or PDF.
However, despite the many years and recent advances in technology, they haven’t changed that much.
People still debate and negotiate over the words, write them in documents, and then, if everyone is happy, they sign it.
And then, after everyone has signed, the contract often simply gets stored somewhere. Either in a filing cabinet or maybe on a cloud server somewhere. Potentially the contract may never even be read again. Except if something goes wrong!
Battalions of lawyers exist to draft contracts and, if a dispute arises, more battalions of lawyers exist to debate them in courts of law.
Whole departments, software systems and processes have been created to help companies meet their contractual obligations.
This is because, despite the many hours of hard work and intelligence put in by lawyers, and the clever words they contain, legal contracts are essentially dumb. Even those in digital or PDF format!
They are static, fixed, language-heavy documents that don’t actually do anything.
Wouldn’t it be nice if legal contracts could actually do something with the cleverness they contain and make better use of the legal thought put into them?
Well, the good news is that, smart legal contracts are here to help!
Anatomy of a smart legal contract
A smart legal contract consists of three main parts. These are, the text, the data, and the logic.
The text consists of the legal words that many people, and every lawyer, will be familiar with.
The data details the various parties, dates, locations, pricing etc. Any information that is specific to the particular agreement.
The logic is the smart part. It informs the contract about what needs to happen when certain events occur, or when specific triggers are fired.
A smart legal contract exists as executable code and, as such, it can interact with many other software systems.
Systems such as e-commerce platforms, banking and finance systems, I.O.T. devices, blockchains and cryptocurrency systems, digital signatures and identity services, industry and manufacturing, and the list goes on.
Scenario 1 - The Wine Merchant
Let’s look at an example and compare the way contracts are traditionally executed and how a smart legal contract could make life easier.
First the traditional way.
Consider a wine merchant that sells their product to a buyer in a distant location. After the usual negotiations, an agreement would be drafted, and then, when both parties are happy, the contract is signed. So far, so good!
Now let’s assume that the consignment of wine needs to travel a long distance. As wine is susceptible to being spoiled, the wine buyer has stipulated a clause in the contract that the consignment should be kept in a temperature controlled environment at all times and must not exceed 25 degrees celsius at any time during transit.
Now let’s assume that, for whatever reason, the wine gets hot in transit and is spoiled as a result. This may or may not be known until the wine is inspected upon arrival.
At this point, the wine buyer will communicate the breach in the agreement to the wine merchant and hope that all parties honour the terms of the contract. If someone chooses not to, then a dispute arises and the usual dispute resolution process begins, which may or may not be an expensive and time consuming process.
Now the smart legal contract way.
Now let’s replay that scenario with a smart legal contract. The same negotiation phase happens and the smart legal contract is created. Then, when both parties are happy, the smart legal contract is digitally signed.
Let’s assume the same 25 degree celsius temperature clause is present in the smart legal contract and, sadly, the same incident occurs in transit and the wine is spoiled.
The difference this time, however, is that the smart legal contract has been communicating with an IOT temperature sensor in real-time while the wine was in transit. The moment the smart legal contract detects that the temperature exceeded the limits set in the agreement, then it can immediately initiate the logic within that clause.
For example, if the parties had agreed there would be a financial penalty attached to the temperature clause, then the smart legal contract could initiate financial transactions automatically, thereby preventing either party from reneging on their contractual obligations and reducing legal disputes.
Scenario 1 - The Wind Farm
Let’s consider another example where smart legal contracts can add substantial value.
Let’s assume you are a wind farm operator. Wind farms require many interrelated contracts to be negotiated and signed, and many of these contracts are dependent on one another.
As a forward-thinking wind farm operator, you have wisely executed all your agreements as smart legal contracts. Each of these contracts contain their own specific clauses and logic, which they execute automatically according to their interactions with the real world.
Because smart legal contracts can communicate with each other, they can notify each other when clauses are triggered or when there are changes to their data.
For example, let’s say there is a smart legal contract which is a construction agreement with a contractor, for the operational delivery of a turbine.
Now, let’s say another smart legal contract is an agreement with a power network, for the commencement of delivery of electricity by the same turbine on a certain date.
Let’s say the construction contractor reports a delay of the operational delivery of a turbine due to some reason. This specific construction smart legal contract can immediately notify this date change to any dependent agreements, including the power delivery smart legal contract, and the various impacts of this new information can trigger whatever logic is required within these dependent smart legal contracts.
In this example, the commencement of delivery smart legal contract could simply notify the power network of the delay, and update its commencement date accordingly.
Alternatively, if there are commercial actions that need to be taken, in order to avoid contractual breaches, then the power delivery smart legal contract could initiate these too.
These are just a couple of examples of how smart legal contracts can be used to improve compliance and governance while at the same time, helping to reduce disputes and litigation.
Smart legal contracts and documents
It’s worth noting that, while smart legal contracts are software, they can still output human-readable legal documents. For example, Adobe Acrobat PDF, Microsoft Word or HTML formats, to name a few. These human-readable legal documents can then be printed or imported into traditional legal document management systems.
However, the very important but subtle distinction to note is that the outputted human-readable, printable, legal documents are not the contracts! These documents are copies, or renderings, of the actual contracts!
The actual contracts would remain as the digitally signed, and tamper-proof, smart legal contracts, which would be executing on whichever platform was being used to host them.
beNEXT smart legal platform
beNEXT has developed just such a Smart Legal Contracts platform. We have the skills, and technology, to create and host smart legal contracts. And we can do this today!
The beNEXT smart legal contracts platform is in active use in Australia, for real estate contracts, as well as in the United States for loans and property finance agreements. These are real, legally-binding contracts, and controlling assets each worth millions of dollars.
beNEXT's smart legal contracts are based on the Accord Project, an open source community of legal professionals and software engineers who are building software tools and libraries, and is the emerging global standard for smart legal contracts.
If you'd like to learn more about smart legal contracts, then please drop us a line at email@example.com
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