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Overview On Smart Contract Indian Law Perspective And Mechanism Of Dispute Resolution

The recent decade has witnessed the rapid growth and advancement of technology. Though the concept of drafting a smart contract by blockchain technology was first proposed in the 1990s by Nick Szabo it's the last decade in which the rise of the smart contract can be seen to such a great extent. Ethereum one of the leading smart contract service providers deployed almost two million smart contracts by the year 2020.

India is not untouched by the pinnacle of smart contracts many Indian corporate giants such as Bajaj, Mahindra, Hindustan Unilever, and banks like YES Bank, HDFC Bank are already using smart contracts brilliantly for payments and other uses.

In recent years many start-ups like Signzy, InstaDapp, Matic Network, and established companies like IBM, Tech Mahindra, TCS, Accenture jumped in the race of smart contract and providing smart contract services to their clients.

The smart contract has many applications starting from real estate to medicine it has no limitation but India has a long road ahead technically and legally to overcome the obstacle in the journey. In the presented article author put focus on the legal issues faces by the smart contracts in India and the mechanism available for dispute resolution.

What is Smart Contract?

A smart contract is a type of computer programming that is made on a blockchain technology-based platform such as Ethereum, IBM, Etc. A smart contract can also be called a digital contract which is different from the traditional contract because it has minimum human interference. The term of the contract is written in codes on the blockchain platform and once these terms are met by the parties' code verifies it and executes the contract and fulfills the conditions of the contract upon which the parties agreed.

What is Blockchain Technology?

Blockchain is an improved version of DLT (Distributed Ledger Technology) somehow these two terms are used interchangeably but both work on a different principle of technology Blockchain uses a linear connected chain of blocks whereas DLT is a decentralized ledger that is not linear. Blockchain decentralizes the process and its work on peer-to-peer networks hence eliminating the middle man and helping maintain data that can't be tampered with and its sequentially arranged by the time stamp in the nodes of blockchain and hence doesn't need verification of payment by the third party and highly secured.

Legal drawbacks of smart contract:

India currently doesn't possess a dedicated legal framework to govern the blockchain or smart contract however there are certain prevailing laws in India such as Contract Act, IT Act, and Evidence Act, by which Smart Contracts can be made enforceable in India.

The Indian Contract Act, 1872:

Legitimate Offer, Proper Acceptance, Free Consent, Lawful Consideration, and Lawful Objective are the requirement which is mentioned in "The Indian Contract Act 1870" to make a legally enforceable contract. If a smart contract fulfills these conditions then it can be enforceable in India.

But there are other aspects also which should be taken into consideration like:

  • Parties get into a smart contract by using the services of the third party platform but the parties entering into contract neither ever met each other nor they knew each other's real identity and one of the parties decided to back off from the contract or not to fulfill their end of the deal there is the possibility that the platform which is providing such facility of the smart contract have their mechanism to resolve this kind of dispute but what if they fail to resolve it because they have neither the power nor the authority by which they can force the other party to meet their end of the contract in that case courts will be the last resort but at present, there is no law regarding the smart contract court might take a lot of time to resolve this issue or there is a possibility that the court won't even consider such contract as a valid contract because parties were not even aware of their real identities and lastly the doctrine of caveat emptor can also come into play.
  • Parties familiar with each other came into a smart contract but as mentioned above smart contracts are the line of codes that can't be changed once executed what if parties with mutual consent want to change the terms of the contract or if one party is unable to fulfill the condition currently but promise to fulfill if time is given and the other party agreed to that but the code is already written it can't be changed so other party has to pay the compensation for the non-fulfillment of the condition of the contract. Force Majeure provision should also be taken into the consideration.
  • Smart contracts are the computer programming that is designed by humans so there is a possibility of human errors in these contracts and also bugs in computer programming are not something new. So now the question arises who is going be responsible for such errors and how they are going to compensate. Whether the parties and the service provider together bear the monetization loss or the service provider alone going to compensate. Bugs as mentioned above are the biggest concern of the coders how they are going to tackle this problem is unclear.
  • Parties can enter into the smart contract from any part of the world so which court will have the jurisdiction in case of the breach of contract. This point needs careful consideration.
    However, there is no provision for the validity or the enforceability of the smart contract in The Indian Contract Act, 1870. So, unless the judiciary gives a verdict in case of a smart contract or the government pass an act or issue some guidelines regarding the same position on a smart contract will remain unclear.

The IT Act 2000:

  • The Information Technology Act 2000, provided that digital contracts are valid contracts and enforceable in the court. However, they should have the Digital or Electronic Signature by the Certified Authority authorized by the government.
  • The smart contract is created by using blockchain technology which generates its hash key and the same hash key is used to authenticate the validity of the contract, not by any government-controlled authority hence it is in contradiction with Section 35 of the IT Act. Though IT Act doesn't specifically bar the authentication done by the blockchain technology it only approves the digital signature of certified authorities.
  • Section 43(A) and Section 72(A) of the IT Act 2000, and the Information Technology (Reasonable security practices and procedures and sensitive personal data or information) Rules, 2011., provide safeguard against breach of privacy, sensitive data, and security however these laws are not applicable on the blockchain because of its highly decentralized nature.
  • Computer Emergency Response Team was created by the central government to tackle the cases of hacking or any other cyber security but because of the decentralized and self-regulated nature of the blockchain, such agencies find it hard to enforce their jurisdiction over such networks.

The Evidence Act 1872:

According to section 65B of the Indian Evidence Act, electronic contracts are admissible in a court of law. However, there is a condition that these contracts must have a valid digital signature from the certified authority to prove their authenticity as mentioned in section 85B of the Indian Evidence Act.

As mentioned earlier digital signature obtained by blockchain technology in smart contracts are uncertified signature hence doesn't hold any credibility. Thus, it becomes very difficult to submit these contracts as evidence in the court of law as the signature are not obtained under the IT Act 2000.

Dispute Resolution Mechanism:

There are two types of mechanisms popular to resolve the smart contract dispute. These are:
  • "On-chain" mechanism.
  • "Off-chain" mechanism.

"On-chain" Mechanism:

Similar to traditional contracts method to resolve the dispute in case any arises can be coded in the smart contracts which will execute if certain conditions are not met these methods are called the "On-chain" Mechanism. These methods include-:

Dispute Resolution by Jurors:

In this method committee of jurors (which are selected internally by the platform on which the smart contract is drafted) will sit and decide the dispute they formulate a process to resolve the dispute which is unbiased and low risk.

Jurors must adjudicate fairly because they are subject to judgment themselves. After all, jurors decided by using game theory (This theory suggests that the award should be passed based on what the majority of jurors will decide and the jurors who gave the contradictory verdict will not be paid their fees. So, the decision according to this theory is not based on the merit of the case but on the guess how other jurors will vote.).

While this method is acceptable in the low-risk dispute situation but not by the big enterprises because of the uncertainties involves in the process which decides the case not on the merit but the prediction of the jurors.

Dispute Resolution by external industry participant:

In this method help of the external industry, the participant is seeking to resolve the issue because the dispute is far complicated and the information provided by the parties involved in the issue is distorted. Some semi-private industry fora provide these kinds of services and they also specialize in drafting standardized contracts to resolve smart contract disputes.

The final decision is passed by the external reviewer this process is designed to minimize the risk and create transparency in the process.

Dispute Resolution by third-party arbitrator:

In this method, both parties agree to resolve their issue by hiring a professional and reputable arbitrator and the process of appointing the arbitrator, composition of arbitrators, jurisdiction and laws to follow, process to enforce the arbitral award, fees of arbitral procedure, Etc., mentioned in the contract.

This method is mostly used when there is a possible chance of financial recovery by the dispute resolution and the award which is granted by the arbitrator would be acceptable by the parties and legally enforceable. This method is mostly preferred because it is a speedy process and cheaper than litigation. In the case of a smart contract, it is preferred that the arbitrator knows blockchain technology.

Dispute Resolution by Litigation:

When the parties in the dispute can't reach any decision by following any of the above-mentioned methods then Litigation is the last resort left to resolve the dispute.

But this method has its drawbacks like:

If parties haven't mentioned in the contract beforehand by which court and law of the land, they want to be adjudicated then it became very problematic to decide in which court matter should be brought.

Not many countries have dedicated legislature for smart contracts and blockchain technology and India is one of them. So, it's skeptical to say the courts will consider a smart contract a valid contract and if they considered it as a valid contract will the law which they apply will be in favor of the parties.

It's not fair to assume that the judges have the technical understanding of how the blockchain works and it might affect the judgment.

Last but not least litigation is a long time consuming and costly process that's why it is avoided by the corporates.

"Off-Chain" Mechanism:

When the smart contract doesn't contain any procedure to resolve the dispute then the "Off-Chain" method is used to resolve the issue. The majority of corporates that provide the facility of smart contracts have their procedure of resolving the dispute and granting the award but these awards are not enforceable and based on the game theory.

Traditional Arbitration is an alternative to resolve such disputes but it has many technical and legal problems such as:

The appointment of random arbitrators raises a concern about their biases and their ability to understand the technicality of blockchain.

It creates a problem of jurisdiction and by which law contract should be adjudicated.

Some court may not allow adjudicating the party on the law of their choice because the law that the party choose is to avoid other law which would certainly apply to that contract, or the chosen law would affect the public policy or infringe the human rights.

According to Arbitration law in India, an arbitration agreement must be in writing so the court must find it difficult to enforce the arbitral award.

Many experts believe that smart contracts are going to change the contractual law and the traditional contracts as we know it and they are not wrong as far as the figures suggest. According to Global Opportunity Analysis and Industry Forecast, 2021-2026 market size of smart contract was 106.7 million in 2019 and it is estimated to reach 345.4 million by 2026.
However, the legality of the smart contract remains skeptical especially in India. There is no law or any agency currently in existence that can assure the enforcement of smart contracts.

Decentralization is one of the biggest problems which raise concern for data safety and privacy because there is no single entity that can assure that all the norms of Information Technology (Reasonable Security Practices and Procedures and Sensitive Personal Data or Information) Rules, 2011 are enforced.

No doubt smart contracts are the complete game changer they minimize the risk and they are fast executing, cheaper, and reduce human error but they come with their drawbacks like hacking, data leak, coding error, etc., and legal aspect of drawbacks which are discussed above.

Hence, the smart contract has a great future ahead because as time passes technology will advance and the problem of legality will also be solved. But currently, a smart contract is in the preliminary stage, and applying it blindly in every field is not an adequate option.

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