What are smart legal contracts? Smart contracts explained

Smart legal contracts are designed to self-execute business agreements. But is there really a place for them in scaling businesses? Let’s find out.

The global smart contracts market size is estimated to reach $345 million by 2027, fueled by the rising popularity of Blockchain technology. But can they really benefit legal counsel in scaling businesses? If so, how?

Let's discuss what smart legal contracts are, how they work and whether they are fit for use in your business in this deep dive.

If it's a more efficient contract workflow you're looking for, hit the button below to see how Juro can help. But if you're keen to learn more about smart contracts, read on.

What are smart contracts?

First coined by Nick Szabo in 1997, a smart legal contract is defined as a piece of code stored on a blockchain that self-executes contract terms when certain conditions are met. A smart contract follows a condition-based structure, and if, or when certain conditions have been met, a new action will be completed.

The code can contain as few or as many conditions as are necessary to complete a certain transaction, and this is usually built and implemented by programmers rather than conventional lawyers.

Smart legal contracts represented one of the first major developments whereby traditional contracts could be digitally automated in some way, and they empowered users to guarantee an immediate outcome with minimal human input.

But how do they work, and can they really help business and legal teams today? Let’s find out.

How do smart legal contracts work?

In a smart contract, the terms of a legal document are written directly into lines of code and stored within a distributed and decentralized blockchain network. However, the code can also be stored as part of a different distributed ledger technology, too.

This blockchain is essentially a public database, with no single owner. Instead, the transactions are automatically processed by the blockchain without the need for third-party involvement. As the transactions are stored and linked in this way, the exchange cannot be edited by either party, making them extremely secure.

It may sound confusing, but you can think of smart contracts as a piece of computer code that automatically monitors, executes, and enforces an agreement once certain events have happened. At a basic level, this could be:

• If a specific event happens (e.g when X happens, do Y)
• At a specific date (e.g on X date, do Y)

Within smart legal contracts, these conditions or events can be simple, like a payment being received or authorized, and in theory, they can be used for anything from services being delivered to exchanging money.

Vending machines work in a similar way since a vending machine automatically releases a chocolate bar once a buyer has put money into it. This is called conditional performance, because one action triggers another to execute a full transaction, but only on those conditions.

When are smart legal contracts used?

Although they have been popularised for some time, smart contracts have typically been refined to very specific use cases, such as:

1. Insurance groups

With the insurance industry plagued with inefficiency, long waiting times and fraud, some insurance groups have welcomed smart contracts to add more certainty and security to the process.  

A prime example of this use case of smart contracts is AXA’s use of blockchain smart contracts to offer insurance against delayed flights. When launched in 2017, the insurance company used smart contracts to provide automatic flight delay payments to their customers through self-executing code contained in their insurance policy.

Many aleatory contracts could be self-executed in this way.

2. Real estate

Smart contracts have also been used in real estate, since the digital ownership/management of property and documents can be tied directly to blockchain. This is a popular use case for smart contracts since real estate transactions are notoriously stressful and risky, and the features of smart contracts can minimize this risk substantially.

In real estate deals, for example, one party can feel hesitant to transfer the ownership of a property before a fee has been paid by the other, and vice versa. To resolve this, you might rely on third party involvement to ensure both parties keep to their promises. However, this can delay the process and increase costs over time.

To work around this, smart contracts can execute the terms once each condition has been met by both parties automatically instead - hence their popularity.

3. Healthcare systems

They have various different use cases in the healthcare industry, too. The main example of this is the use of smart contracts for securing and sharing patient health records in a reliable way that is free from tampering and human error.

One example of smart contracts in practice is to accurately transfer patient data between doctors and hospitals without the need to manually share and complete health record forms.

4. Voting systems

Smart legal contracts have also been recommended for use in voting systems by governments and by different groups, for example. This is because they are tamper-proof, and eliminate any risks of forgery - which ensures that voting systems are less susceptible to manipulation and mistakes.

Smart contracts present a more efficient approach to voting entries and tallying since they are digital and automated, which reduces the need for masses of paperwork and manual document completion.

Smart contracts: legal implications

Interestingly, smart contracts are actually more like business rules than conventional legal contracts. This is because at a basic level, smart contracts automate business transactions and spend little time discussing the roles, duties and responsibilities of each party, and what liability they incur if they fail to meet these.

Instead, a smart legal contract executes the business rules automatically, unlike in conventional contracts which include intricate and detailed clauses that offer protection in the event that complex legal issues occur. Smart contracts are focused solely on achieving simple outcomes, whilst other contracts are designed to offer guidance in the event that those outcomes don’t come to fruition.

However, the LawTech panel recently decided that, despite this, smart contracts could still be legally binding provided that they include the typical elements of a contract.

Although, the Law Commission still believes that there are unanswered questions surrounding the legal impact of smart contracts. For example:

• In which circumstances is a smart contract going to be legally binding?
• How should smart contracts be interpreted by the courts?
• How can factors like mistake or misrepresentation apply to smart contracts?
• What legal remedies are available for smart contracts that have not performed the terms agreed in the ways intended?

Even separately to these core legal questions, there are more specific legal issues to consider, like:

• How will the legal status of smart contracts vary between US states?
• Can you amend smart contracts in the way you can amend other contracts?
• What happens if a smart contract is subject to an attack?
• How can you avoid void transactions from a smart contract’s blockchain?

There are a wealth of legal issues surrounding smart contracts that we are yet to see the full effect of, so there is no guarantee of how transactions using smart contract technology will play out in the future when these pressing legal questions do arise. This lack of certainty can be unsettling for businesses and legal teams, which is why so many have been reluctant to adopt the intelligent, new technology.

Smart legal contracts for business

By now, you should have a good idea of what smart legal contracts are and how they work. Now, you are probably wondering whether they could bring value to your business or not. Here are some pros and cons of smart legal contracts that might help you understand how well they would fit within your business.

Advantages of smart legal contracts in business

Advocates of smart contracts say that there are many benefits of using them to execute and enforce agreements in business, including:

1. Speed and efficiency of contract execution

One of the most obvious benefits of a smart legal contract is that once a condition has been met, the contract terms will be executed immediately, rather than waiting around for a manual approval or execution process to be completed to complete the transaction.

By departing from the traditional contract process and opting for a more efficient contract workflow (like smart contracts) businesses can save valuable time and resources which can be invested elsewhere.

However, creating, testing, and deploying smart contracts is in and of itself a time-consuming process, so you may find that having a wide range of automated contract templates is a more effective way to improve the efficiency of your contract process, particularly if you are a legal team without the support of a programmer.

2. Increased accuracy

Users have praised smart contracts for being highly accurate and reliable. Since smart contracts require a high degree of detail within their contract coding, their terms and conditions will naturally need to be recorded in an explicit and comprehensive way. This is because even the smallest omission can lead to a poorly executed contract or one that fails to execute itself at all.

However, just as that is the case, any omissions or mistakes can be potentially devastating, since any mishaps could result in costly transaction errors.

3. Security

One defining feature of a smart legal contract is that the transaction records are encrypted, which makes them incredibly difficult to hack and manipulate.

This is an obvious bonus for businesses that are looking for enhanced security within their transactions, as each record is connected to the earlier and subsequent ones using a distributed ledger, meaning that if someone were to change a record or value, they would need to edit the entire chain to do so.

Although, most successful business relationships will be built upon trust, effective communication, and shared values, so this extreme level of protection will likely not be necessary, or suitable for most cases. In fact, it is possible that going overboard with security features could actually send a message of distrust to your customer or partner, weakening ties before the relationship has even started.

Smart contracts aren’t the only way to automate and create contracts in a secure way, either, as data security is a priority within most contract management systems, and can provide more than sufficient security for contracts. Unless your smart contract use cases do require an exceptionally high level of security, you may find that contract management software with strong security protocols in place will be a better option for your business.

Disadvantages of smart legal contracts in business

However, smart contracts are not without their drawbacks. In fact, there are numerous problems that the technology poses for businesses looking to improve the way they process contracts. For example:

1. Less accessible for contract parties

Smart legal contracts became popular for their properties that prevent tampering, increase transparency, and protect businesses from fraud.

However, in doing so, smart contracts can remove the more human aspect of contracts that typically help businesses foster and nurture better and longer-lasting relationships with their employees, partners, and customers.

In fact, by executing business deals through a complex channel that is inaccessible to most businesses and in-house legal teams, you may find yourself alienating your prospects, rather than attracting them.  

Having spoken to legal design experts, we discovered that legal documents already disengage users and that by integrating digital media such as visual interfaces within contracts and removing legal jargon, contracts would be more successful, and better understood.

However, smart contracts appear to take a different approach to contract design entirely, since contract users will now need to understand programming languages to understand and access contracts, which is a far stretch from the case for more usable contracts that’s been argued for some time.

What’s more, smart contracts are so complex that building a smart contract template to begin with can be near impossible for most stakeholders in a business, unlike with Juro’s no-code workflow builder where virtually anyone can build a contract template with ease.

2. Zero flexibility

Another problem with the business use of smart legal contracts is that they are very rigid, and they offer little to no room for mistakes, ambiguity, or changes. As many in-house lawyers know too well, the negotiation process is an important one and one which shapes your commercial relationship in the years and months ahead.

In fact, one of the biggest pain points with smart contracts is that they are notoriously difficult to manage since they are almost impossible to change once implemented - particularly since most in-house legal teams won’t have programmers on hand to adapt the code.

This lack of flexibility also means that smart contracts are quite disconnected from the real world and external events, despite the high impact external events can have on businesses and transactions.

3. Uncollaborative

Another problem with smart legal contracts is that they can often be too technical for other departments to work with, meaning that they are very uncollaborative.

Compared to other contract automation solutions, where contracts can be edited, reviewed and amended with ease by teams without contract experience, smart contracts are designed to eliminate the need for human engagement, not facilitate it.

Whilst some contract management software, like Juro, integrates with different department’s platforms (e.g Salesforce and Workday), smart contracts typically exist separately from other tools, so will not fit as seamlessly into a business’ processes.

4. Mistakes can prove costly

In-house legal teams are already aware of the costly risks associated with a poorly drafted and poorly worded contract. From gaping loopholes to inadequate legal protection, each and every mistake within the contract drafting process can prove costly to your business. Unfortunately, smart contracts are no exception to this rule. The problem is, smart contracts are immutable, so these mistakes will be permanent.

Should your legal team implement smart contracts?

Back when the concept of a smart contract was first introduced, Nick Szabo claimed that it would be more functional than paper-based contracts. He was right.

However, the truth is that smart contracts may be more complex than they need to be for most businesses to truly benefit from them, and this can prevent businesses from capturing the most value from their contracts, usually for the following reasons:

• The disconnect between contracts and lawyers: In-house legal teams will always be best placed to manage, negotiate and execute contracts. By cutting out legal counsel from the contracting process, all of the creativity, expertise, and adaptability that traditionally exists in the contract process will be lost.
• Difficulties extracting and auditing contract data: Contract data is immensely valuable for businesses, and it is incredibly hard, if not impossible, to extract these metrics from smart contracts.  
• Challenging to re-use and repurpose contracts: Smart contracts are not going to empower other departments to self-serve on business contracts. They are more likely to isolate sales and HR teams, because the code is even less accessible than legal jargon. Even if smart contract templates were available, they would be virtually impossible to edit.

To summarise: smart legal contracts are an exciting prospect, particularly for those who are already invested in the world of blockchain. But do they really have a place in businesses that need straightforward, scalable, efficient, and accessible contract processes? Probably not.

Rather, as the legal industry has developed and become increasingly collaborative, there appear to be better-placed alternatives for in-house legal experts instead - like contract automation software. Contract automation software streamlines the contract process instead of complicating it, empowering legal and business teams to collaborate securely, in one unified workspace.

With contract automation software, you can still reap the benefits of automation, such as speed and efficiency, without sacrificing the things that matter to you, like collaboration, communication, and user-centric design.

Ready to explore contract automation solutions?

Are you looking for a more human way to automate your contracts? Juro is an all-in-one contract automation platform that helps visionary legal counsel and the teams they enable to agree and manage contracts in one unified workspace, without the need for programming expertise.

To supercharge your contract workflow with Juro, hit the green button below to get in touch.