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Smart Contracts And The Indian Perspective

Bhaskar Vishwajeet
28 March 2022 3:47 PM GMT
Smart Contracts And The Indian Perspective
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Of the many innovations the 21st century has seen, Blockchain is arguably the most important. Briefly put, a blockchain is a virtual platform that records and stores exchanges or transactions that involve digital assets, primarily cryptocurrencies. To have a blockchain one needs multiple individuals, more than three preferably to create a distributed network, thereby ensuring the network...

Of the many innovations the 21st century has seen, Blockchain is arguably the most important. Briefly put, a blockchain is a virtual platform that records and stores exchanges or transactions that involve digital assets, primarily cryptocurrencies. To have a blockchain one needs multiple individuals, more than three preferably to create a distributed network, thereby ensuring the network or platform is not in the hands of anyone, i.e., it is decentralized. A given number of transactions or exchanges can be recorded within each block, forming a chain for every subsequent block which has been formed on the platform, creating a chain of records of each transaction. Ethereum, one of the most widely used blockchain platforms permits 70 transactions to a block. For each transaction, a transaction fee must be paid, for Ethereum it is a 'gas' fee. Each recorded transaction is irreversible and transparently available on the chain. To verify each record, an asymmetric cryptosystem[1] is used. It provides a key pair for creating a digital signature for a transaction and public verification access to confirm the same. Blockchains are of two types, public, where the source code and access are open for all and private or 'permissioned' blockchains where only identifiable parties have access to terms and the contents of the platform.

Smart Contracts In The World Of Contracts

Within this realm are smart contracts[2], which are simply computer programmed protocols defining the terms of a self-performing contract, that is, a contract that doesn't need to be prompted to execute but does so automatically once its conditions are met. Three aspects define the alleged utility of smart contracts; the First, how noticeable performance is when smart contracts come into play. Because of the pre-defined (pre-programmed) nature of smart contracts, performance is instantaneous (the contract self-executes once the conditions are met). Second, smart contracts are easily verifiable, the blockchain records each transaction and makes it immutable and permanent, making it easy to verify performance. The third aspect concerns the parties in that there is no middleman in the transaction process. This freedom from ratification by a third party ensures definite privity between the parties to a smart contract.

Given how similar these aspects are to the common law principles governing conventional contracts, are smart contracts a manifestation of conventional contracts? The answer is yes, with caveats. It depends on many factors. Because common law has laid down the essentials of a valid contract, smart contracts must abide by the same to achieve force under the law. There must be an offer, acceptance and consideration etc. Section 10 of the Indian Contract Act[3] says that all agreements are contracts if their object and the consideration behind the exchange are lawfully accepted. Parties willing to formulate a smart contract(s) must see to it that their consideration and object are lawful and recognized. This is to make sure that a breach of performance or terms may be appreciated by an arbitrator or a court after it has been established that the smart contract was a contract in the sense of Section 10. There may be times when the consideration, while not illegal, may not be recognized by the regulators and the law. This can pose hurdles for legal and compliance teams, as any adjudication to investigate a breach will run into the problem of whether what they are judging is in the law or not. In India, the Information and Technology Act, 2000, through its sections 5 and 10A, affirms the enforceability of contracts made using an electronic medium. The requirement is that if they are electronic, they must be recoverable for subsequent reference, a characteristic of smart contracts on the blockchain. The issue that arises is when operating on a public blockchain. This can be explained with an example. In 2017, Bajaj Electricals contracted Yes Bank (Bajaj Electricals' partner bank) to develop a financial accounting system that would automatically debit payments to suppliers (as the earlier method was not smooth and systematic). Yes Bank facilitated this by creating a closed-loop (permissioned) blockchain platform to pay all suppliers once the supplies were received. We must note, however, that this was all done within Yes Bank's framework, that is, a private blockchain. Yes Bank was the central authority governing the entire protocol, creating identifiable parties to the contract, establishing terms between them etc. What if an arrangement like this were to be done in a public manner? Say the government were to decide on integrating MGNREGA payments with a blockchain solution. By law, the government will have to create a permissioned blockchain once again, as Section 35[4] states that all electronic signatures have to be authenticated by a hash function[5] provided by a certified authority as granted by the Central Government. The Central Government has not brought any legislation as of yet to grant said authority to the major public blockchain entities like Bitcoin, Ethereum etc. In this sense, smart contracts have certain limitations. Conventional contracts enjoy the jurisdiction of the Indian Contract Act and any breaches are judged using the provisions of the same, but smart contracts involve a slew of provisions, only to interpret how a contract has been structured, any further breach is a question which the arbitrators/courts will have to decide. This is an area of concern, as blockchain technology is very promising and can-do wonders for our economy, its potential must be recognized by the laws. We need intricate laws to accept smart contracts and to regulate blockchains. Once we acknowledge the issues above, we will be on the right track, hopefully.

Inadequacies And The Regulatory Viewpoint

Smart contracts, currently, have loopholes to them. These inadequacies might hamper their recognition under the law as either too tedious to regulate or vulnerable to exploits. To be valid, the consideration behind a contract must be lawfully accepted, as stated in Section 10[6]. The problem with expanding the world of smart contracts to the public is that, at present, there exists no regulation which protects parties from frauds or scams which may arise out of a contract. This is why we can go ahead and extend the interpretation of 'lawfully accepted' to lawfully recognized as well. The Reserve Bank of India and the Central Government have declared public blockchains and their cryptocurrencies ('asset classes') to not be illegal, but unregulated. This means that in the event of a breach of performance on these platforms or any violation of contractual terms, the aggrieved party has no recourse. Conventional contracts find remedy in civil courts whenever a civil suit arises. The same cannot be said for smart contracts as no agency has the mandate to govern them. Another issue is that of consideration in unilateral contracts, an essential requirement in contract framing for Indian courts. Smart contracts can be programmed on the basis of the performance of something. That would be sufficient consideration. But, if the person on the receiving end of such promise were to achieve that benefit out of someone's loss or by fraud, that would constitute unjust enrichment[7]. This potentially means that one could backtrack on their donation/gift and seek such restoration of their loss, although the jurisprudence around the same is scant apart from the rule on unjust enrichment. Determining fraud would also be tricky in certain situations and the absence of a mechanism makes the task more demanding. This could make specific smart contracts ineligible to avail a remedy under Section 17[8], which talks about fraudulent situations which may arise during contract framing. This is problematic because the central authorities have essentially left a regulatory vacuum for blockchain technology to persist. This hesitance to lay down a charter or to meet with stakeholders to frame laws might come across as bureaucratic envy of the promises which an industry holds. Smart contracts serve the practical purpose of bridging the logistical gap between intended parties to a contract. It cuts down on the time it takes to frame contracts and to perform them. Not ensuring protections or regulations will not only have a legal drawback (for contractual jurisprudence will never develop and remain archaic) but the after-effects will be felt across disciplines, spilling over into the economy as well, coming at a time when the nation is seeing tremendous levels of innovation and growth.

The Indian Evidence Act, which may be summoned to investigate breaches, says that any electronic agreements (records) will be held as genuine when presented, but the courts will not assume the credibility of the sender of such a contract[9]. This is to say that the court will not presume whether the agency which sent, or in this case verified the digital signatures on a smart contract is a certified agency as has been laid down by the Information and Technology Act, 2000[10]. This makes matters complex, as the admission of a smart contract might be contested when a court is assessing breaches, and they might dismiss the existence of the contract if it is found to be verified by an unrecognized or certified authority. A bigger consideration here is, that these phenomena are completely at odds with the technology itself. An essential part of smart contracts and their framing on blockchains is the verification of a contract using a hash function provided by the blockchain. It seems this level of encryption is being rejected by our laws and, as a result, not permitting the submission of a smart contract as evidence, because it is inapposite to the Evidence Act.

The potential blockchain has to transform this country and its economic outlook is well known, especially after the huge adoption of cryptocurrencies by Indians in the year 2021. Despite the regulatory vacuum, many blockchain enterprises have become unicorns (more than $1 billion in value) and are being contracted by private entities to build solutions for them. Contract law has a big role to play here. The Indian Contract Act, 1872 will need to undergo amendments to acknowledge and protect electronic agreements which are smart contracts. This will need to be done to reduce the hesitance to invest and to enter into convenient smart contracts, which stems from legal uncertainty in the absence of recognition and regulation. The ease with which parties enter into contracts under the protections provided by the ICA is not seen here.

There are other hurdles as well, although not as defined, which is why reforms will need to be more perceptive of these conflicts. Smart contracts are highly technical in that they involve a computer programmer(s) who need to be privy to the terms and details of a contract, to code the same into a protocol. This means that they are contracted for their service to create the contract, a liability that may give rise to claims in case they want to enforce the contract to their benefit. Another reason why the current provisions don't support smart contracts is because of the 'off-chain' resources involved in the creation of certain smart contracts. This means, that if two contracting parties set up terms that involve entities that are off the blockchain and the digital grid itself say a farmhand or a rural warehouse then we encounter a phenomenon of nested contracts, that is, a contract within a contract. This may be fixed by creating ancillary smart contracts to a conventional paper contract by mentioning the former in the latter as pointers, but if we are to automate jobs and complex industrial processes as Bajaj Electricals did, we need to formalize the law to account for each contract within a contract. This needs to be done to ensure the lines of privity of contract don't get blurred in the process, that is, only the contracting parties can enforce a breach and not anyone else. And so, we see that our laws need to be fine-tuned to the changing times. Our laws cannot fall behind the adoption of such sophisticated technology, lest we shall fail in our vision to achieve high levels of growth.

Views are personal

[1] Information and Technology Act 2000, s 2(f)

[2] Nick Szabo, 'Smart Contracts: Building Blocks for Digital Markets' < https://www.fon.hum.uva.nl/rob/Courses/InformationInSpeech/CDROM/Literature/LOTwinterschool2006/szabo.best.vwh.net/smart_contracts_2.html> accessed 12 October 2021

[3] Indian Contract Act 1872, s 10

[4] Information and Technology Act 2000, s 35

[5] Information and Technology Act 2000, s 3(2) Explanation

[6] Supra note 3.

[7] Indian Contract Act 1872, s 68-72

[8] Indian Contract Act 1872, s 17

[9] Indian Evidence Act 1872, s 88A

[10] Information and Technology Act 2000, s 35

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