Smart Contracts: a new field for arbitration

Article by Leonardo Feres Montino, Luiz Gustavo Lopez Mide and Thais Tenani

Breakthroughs in technology allow progress in the formation and execution of contracts. Smart Contracts were developed in this scenario. They are automated contracts, regulated by codes that dismiss supervision by third parties. Nonetheless, such contracts are not shielded from disputes. This article discusses the possibility of submitting such disputes to arbitration.

Developed in 2008, the blockchain technology became notorious particularly in connection with digital currency (or cryptocurrency). Such technology is described as a decentralized and shared network which enables electronic transactions without intermediaries^[1], such as regulatory authorities or the government itself. In addition, this system also ensures the authenticity and integrity of the transaction and, after proper verification, its registration in its system^[2].

The records are organized in a chain of blocks^[3] that can’t be altered: once the transaction is verified by the network, the information is permanently registered in the blockchain.

The increasing use of blockchain did not stop with cryptocurrency transactions. Programmers began to explore the technology for various uses, for example, to store information and perform tasks. Smart contracts resulted from this innovation. They are like “contracts”^[4] that are subject to a computational language that allows storing data and can be self-enforced^[5]. The main characteristic is that they operate in a largely autonomous manner that is translated in the following formula: “if this, then that” – that is, if a pre-selected event occurs then another event will automatically take place.

Many allege that the autonomous nature of smart contracts would eliminate the existence of disputes. This is mainly because the technology assures that the contracts are fulfilled. Such assumption seems to be extremely optimistic and perhaps far from reality. For example, as with any contract, transactions made through smart contracts are still subject to claims of nullity or defect of consent. Even the self-enforcing nature is not shielded from issues – for example, when the self-enforcement presents a problem concerning the parties or the quality of performance.

Françoise Lefèvre and Nicolas Delwaide mention the following example: (1) Individual A wants to buy a bike and enters into a smart contract with Individual B. (2) The smart contract will automatically transfer the sale price to the seller (B) and the property title of the bike to the buyer (A). The problem, in this case, is that the smart contract does not guarantee that the bike is free of defects^[6].

This is not the most appropriate example under Brazilian law since “ownership of things is not transferred by legal transaction prior to delivery” (art. 1,267 of the Brazilian Civil Code), but a simple adaptation will still lead to the same conclusion: if the same individuals A and B agree to the sale of the same bike through a smart contract and, the delivery of the bike to individual A triggers automatically the transfer of the sale price to individual B there is still no guarantee that the bike is free of defects, which will substantiate a claim for damages from individual A to individual B.

Therefore, being self-enforceable or not, disputes may still arise from smart contracts. It follows from this the importance of discussing the appropriate dispute resolution methods.

Under Brazilian law, there is little space to question whether disputes concerning smart contracts can be taken to the scrutiny of the judiciary – it is a direct consequence of the constitutional principle of access to justice (article 5, XXV of the Brazilian Federal Constitution of 1988). The possibility of arbitration, on the other hand, requires further consideration.

In a preliminary examination, there are no obstacles that prevent smart contracts disputes from being held through arbitration. Among the overall strengths of the institute, arbitration (1) is compatible with the decentralized structure of the smart contract network –keep in mind that the software and the users of the network are not necessarily based in the same country, which is a problematic aspect when defining the competent jurisdiction to rule on the dispute –, (2) allows the designation of specialized arbitrators, which is an important feature for disputes involving such technology, and (3) has other qualities, such as confidentiality and flexibility.

Nonetheless, there are challenges in arbitrating disputes related to smart contracts. From an operational aspect, within the blockchain, parties are usually identified with pseudonyms, with no further information as to their real identity. This makes it impossible – or at least considerably problematic – to initiate arbitration. Further, due to arbitration’s own characteristics and costs, the method is commonly used in complex commercial transactions that hardly fit the “if this, then that” logic of smart contracts.

Questions also arise due to the Brazilian legal framework. A smart contract with an arbitration clause expressed in a code would be in line with the requirement of written form provided for in art. 5 § 1 of the Brazilian Arbitration Act?

Also, are the restrictions to arbitration clauses in adhesion contracts applicable, by analogy, to smart contracts available in the blockchain, that are signed by parties that did not participate in developing the code?

Far from having a definitive answer, it seems that programming is effectively a form of language, so that the smart contract’s formulae can be considered a written text. And, just in case, it is ideal to comply with the other restrictions imposed to arbitration clauses, such as the rules applicable to adhesion contracts.

There are also those who suggest that arbitration should be instituted within the blockchain. For this, there would be a specific authority on the network, responsible for resolving any disputes arising from the smart contracts concluded within that network. The structure would resemble that existing in PayPal or eBay, in which disputes between the seller and the buyer are submitted to the platforms’ own dispute resolution mechanisms. It does not seem to us, however, that this method would be final and definitive. At least under Brazilian law, this structure would not prevent the right of the parties to seek the judiciary.

There are many uncertainties about the applicability of dispute resolution methods in the context of new technologies such as blockchain and smart contracts. An effort to adapt will be required, mainly due to the reasonable expectation that such technologies will be more present in our daily lives. It will not be different for arbitration. In fact, some institutions, such as JAMS, have already drafted specific rules applicable to disputes involving such technologies^[7].

Link to article on NewGen.

[1] De, Fillippi, Privamera. Blockchain and the Law: The Rule of Code, Harvard University Press, 2018. ProQuest Ebook Centra. http://ebookcentral.proquest.com/lib/uconn/detail.action?docID=5340266; p. 31.

[2] Idem, p. 21-22.

[3] Idem p. 22.

[4] There is still relevant controversy whether smart contracts are formally contracts or not, particularly by a legal point of view. This is an extensive and interesting debate which, despite not being the subject matter of this article, is not unnoticed by these authors.

[5] Idem, p. 74.

[6] Françoise Lefèvre and Nicolas Delwaide, ‘Resolving Smart Contracts’ Disputes Through Arbitration: Thoughts And Perspectives’, in Dirk De Meulemeester, Maxime Berlingin, et al. (eds), Liber Amicorum CEPANI (1969-2019): 50 Years of Solutions, (© Kluwer Law International; Wolters Kluwer 2019) pp. 223 – 237

[7] JAMS. Smart Contract Clause and Rules (DRAFT). Available at: https://www.jamsadr.com/rules-smart-contracts

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