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Arbitration in Smart Contracts – Code Naïve v Code-Savvy
Written by Hetal Doshi & Sankalp Udgata
Combining law, computer science and finance in unprecedented ways, “Smart Contract” is the latest addition to the unending list of Internet of Things. Unlike a traditional contract, which only lays out the terms of agreement for subsequent execution, a smart contract autonomously executes some or all of the terms of the agreement as it are usually based on Block-chain. It has the potential to reshape our understanding of contract and technology law. The shift from the code naïve to the code-savvy, has surfaced problems in dispute resolution beyond the existing legal perception which this article aims at analysing and resolving.
Working of the Smart Contract
By removing the need for direct human involvement, a smart contract is deployed on to a distributed Trustless Public Ledger. However, in order for the smart contract to work efficiently, exactly specified conditions for the execution of the contract are necessary, otherwise, it will be impossible to automate the process. Also, smart contracts receive information from outside block-chain platform through the use of Oracle programs that mediate with external databases and are entered into the block-chain technology.
A Hornet’s Nest
Smart contract come with their own sets of limitation and drawbacks. Following are few of the many problems, inevitable in resolving disputes over smart contracts. Interestingly however, although these problems may be encountered by an Arbitral Tribunal, arbitration (with requisite checks) is the most efficient mechanism to deal with such problems.
Enforceability Quandary
- A) Formal Enforcement
A very fundamental and critical impediment, Courts and Tribunals are consistently skeptical in enforcing such unconventional contracts. Although the use of automated communication or system to conclude contracts or make it binding on the parties has been long accepted by the business community, a Tribunal is often troubled with disparity in validity of smart contracts over conflicting jurisdictions.
Secondly, Article 2.1.1 of UNIDROIT (PICC) undoubtedly includes automated contracting. However, problems may arise in relation to codes meeting the in writing requirement of UNCITRAL and the New York Convention.
- B) Substantive Enforcement
The artificial nature of contracting deprives actions of the human touch. Complexities arise when there a subsequent smart contracts. For example, if there is a supplementary smart contract, consent for which is sought from the parent contract. Since it is the codes in the parent smart contract that initiate the subsequent contracts and transactions and the performance, can consent be said to have been given by a mere code and is such consent valid and enforceable against such code.
A Hitch in the Seat
Given the distributed nature of block-chain i.e. a ledger which is spread across the network among all peers in the network and the operation of Smart Contracts, it is important to agree a seat for the arbitration to avoid satellite disputes about the applicable seat and/or procedural law.
Problems in Execution- Irreversibility and Irremediability
Since they are theorized to be complete contract by focusing on ex ante rather than ex post, they eliminate the act of remediation, by admitting no possibility of breach. However, the DAO case was incomplete as it failed to anticipate the possibility that coding errors could result in unexpected wealth transfers. In addition, smart contract may deal with commercial scenarios so complex and unpredictable that the code will fail to embed all possible answers to all possible questions.
Further, if the smart contract contains a mistake, security flaw, or does not accurately capture the parties’ intent, the smart contracts will be difficult to modify or change, due to a block-chain’s resilient and tamper resistant nature. The program will continue to blindly execute its code, regardless of the intent of the parties or changed circumstances. When the transaction is more complex, involving multiple players (humans or machines), multi-component assets and diverse jurisdictions, computer code smartness may easily turn into plain dumbness.
Needless to mention, a Tribunal or a Court will encounter several problems in executing a decision vis-à-vis a smart contract such as:
- Lack of in-rem jurisdiction- Reversing a transaction on a decentralised ledger with several contributors that may not even be parties before the Tribunal.
- Excusing future performance or specific performance- Since they operate automatically and are not flexible.
The Truth about Consent
Contracting also has issues such as duress, fraud, forgery, lack of legal capacity and unconscionability which require human judgement and cannot be scrutinised by a smart contract which simply functions on a series of binary inputs. Moreover, though it provides guarantee of execution to certain extent, it cannot verify whether the contracting parties have the legal capacity to get into legal relationships or business capacity to make an agreement.
It also does not care whether there truly exists consensus as idem between contractual parties, there is no possibility for the contract to be void or voidable. However, although codes are not natural language that might be vague or ambiguous, leaving space for interpretation. For a consensual dispute resolution mechanism like arbitration, the indispensable requirement of free consent and the evaluation of intention of parties cannot be comprehended by a smart contract that stands deprived of reason and morale.
This may be an issue in circumstances where the Smart Contract is entered into by a computer, is in code and/or and does not create legally binding contractual obligations under the applicable law. The solution to this can be that the Arbitration clause can become part of the Ricardian contract which like any other similar contract is a hybrid form of smart contract which is partly in human readable form.
The Catch in Imputing Liability in a Dispute
The code smart is sadly not insusceptible to security vulnerabilities and exploits like forking, which could cause a smart contract to operate unexpectedly and invalidate transactions, or worse, enable a third-party to siphon digital currency or other assets from contracting parties accounts. Scary, isn’t it?
However, since a Tribunal is only an in personam jurisdiction, it can barely inspect or issue directions against such third parties. Such vulnerabilities might also jeopardise the secrecy that arbitration aims to achieve.
It is not unjust to say that such a contract is dangerous enough to attract strict liability in case of any harm caused due to an error in coding. That, juxtaposed with the existence of foreseeable risk in execution of smart contracts poses a potentially huge hurdle to the exponentially growing use of block-chain technology.
Furthermore, disputes, to summarize, may arise:
- between the parties of a smart contract, or
- between two conflicting smart contracts.
Since the code smart is a form of artificial intelligence replacing human involvement, it is the second set of disputes where a Tribunal or Court will be troubled with the attachment of liability.
Cutting the Gordian knot – checks and suggestions
Given our shift from not so smart contracts, we must keep an eye for the following checklist while dealing with dispute resolution in smart contracts.
Formality requirements
Parties should therefore ensure the arbitration agreement meets any formality requirements under the governing law of the arbitration agreement and Smart Contract, the law of the seat and wherever the award is likely to be enforced.
Choice of seat
Parties should base check whether in their chosen seat,
- Domestic law does not render a Smart Contract illegal or unenforceable
- The disputes likely to arise are arbitrable
- The codified arbitration agreement in question will be upheld and enforced by the supervisory courts.
Tribunal with specialist technical knowledge
Some Smart Contract disputes will be fairly vanilla contract law disputes, but others will be of a highly technical nature, for example, where the code does not operate as expected. Pursuant to the novel nature of the smart contract the importance of having a tribunal familiar with the technology against the importance of having the dispute decided by experienced arbitrators becomes crucial.
Severable arbitration clause
Although the doctrine of separability protects the validity of an arbitration clause, the dispute resolution clause should always be kept independent of any smart codes.
Localised Termination Clause
Given the automated and perpetual nature of smart contracts, there should be an option to terminate the contract. Although non-amenability is an essential feature of a smart contract, the option to cede away from the distributed ledger (terminate the contract) should be sole switch available the each of the contributors. The code may prescribe conditions for pulling the plug, i.e. create joint switches. Therefore, a party shall not be able to terminate its obligations without assent from any of its debtor on the ledger. As a result, once the debt is settled either by payment of dues or by an award of a Tribunal, the parties may pull the plug.
Power of Pardon
Each party to a smart contract should be at liberty to excuse payment by a debtor in under a direction by a tribunal or a Court in case of a force majeure or any other scenario where performance is liable to be excused.
This list, although non-exhaustive, will certainly sustain best practices in arbitration until the next great invention in the sphere of technology and business will live to fight another day.
Three Tickets, One Seat – A Methodological Anatomy Of The Indian Practice Of Determination Of Seat Of Arbitration
Written by Sankalp Udgata & Hetal Doshi, National Law University (NUSRL), Ranchi
The choice of arbitration as the default system of resolution of commercial disputes, which was initially restricted to the foreign parties is now being reciprocated by even the Indian parties, thus setting the stage for India being a global hub for commercial arbitration. Surprising as it is, commercial agreements worth billions have but a succinct recording of a seat of arbitration. Sloppy as they are, these poorly drafted dispute resolution clauses open the doors to a tsunami of litigation which simply intervene and delay the entire resolution process thereby defeating the very virtue arbitrations proclaim to instil.
Since arbitrations are out-of-court proceedings, they do not by themselves command the authority of the sovereign. Therefore, every arbitration must be guided and overseen by a Court that has supervisory jurisdiction over it. This Court is the Juridical Seat of the arbitration as determined by the parties and the most important concept that the territorial situs of the Seat denotes. In absence of a positive determination by the parties in the arbitration agreement, the Tribunal or a Court whose supervisory jurisdiction is sought must first determine the Seat and consequently whether it has the jurisdiction, as the Juridical Seat, to hear the matter.
However, arbitration in India has been a Hornet’s nest if not a Pandora’s box to say the least. Admittedly, the vast majority of problems associated with international commercial arbitrations taking place in India revolve around the uncertainty in the Courts’ approach to determination of the seat when the parties have failed to choose one. The Indian Courts, much rather the Supreme Court of India (“SCI”) has shown a consistent disparity in applying any particular method for determination of the Seat in such situations. This article aims to reconcile the various tests that the Supreme Court of India has applied over the years and attempts to plot their reasoning into three distinct methods for determination of a seat when the arbitration agreement fails to explicitly document one. This article also discusses the various factors relevant in each method with examples and can therefore serve as a catalogue for practitioners as well as valuable literature to the academia.
I. Seat <=> Venue Method
Representing the most widely accepted view, this method is applicable when parties have at least chosen a particular geographic location as the venue for the arbitration to take place without specifically designating a Seat. Finally, setting the clock straight and reconciling to the globally accepted rules, the SCI in Soma JV case held that the venue of arbitration shall be the default Seat in absence of any contrary indica. (¶63)
For it to be the default Seat, the venue must exist in absence of any of the following factors that, over the years, the Court has found to be contrary indications to venue being the Seat.
- Designation of an alternate place as Seat
When there is an express designation of the arbitration venue, combined with a supranational body of rules governing the arbitration the venue shall be the seat unless the parties have designated any alternative place as the seat. (Shashoua, ¶34,42)
- Existence of a national set of lex arbitri or proper law
Despite having designated London as the venue of arbitration, the SCI held Bombay to be the Seat in the 2014 Enercon Case. In making this determination, the Court was heavily swayed by the fact that the laws specifically chosen by the parties in the contract to apply to different aspects of the dispute were Indian laws.
- Existence of an alternate place of making of award
Since it is necessary for the arbitral award to be made and signed at the place of arbitration as determined by Section 20 of the 1996 Arbitration Act (“Act”), an award made at one of the two designated venues resulted in the venue where the award was not signed was not the Seat in the Soma JV case.
- Venue of an arbitration proceeding
The Court has on several occasions differentiated between the venue of arbitration proceedings from the venue of an arbitration proceeding for the later cannot be construed as anything but a convenient location for the conduction of a meeting. (2012 Enercon case)
II. Inverse Closest & Most Real Connection Method (“Inverse-CMRC”)
The globally acclaimed CMRC test is used to determine either lex arbitri or the proper law governing the arbitration agreement when the place of arbitration has been decided as the same would be the law most closely connected to the choice of place. While the English Courts in Peruvian Insurance Case applied the law of the place of arbitration as the lex arbitri, in the Sulamerica Case, applied it to the proper law governing the arbitration agreement as they had the most real connection to the place chosen by the parties. India has also used the test in a peculiar way to apply the lex arbitri to the whole of the agreement. This proximity is essentially based on the legal localisation of the place.
However, India has been applying the above test somewhat inversely based on the geographic localisation of the law instead. Bemusing everyone, the SCI in Enercon Case applied the Inverse CMRC Method to determine the Seat to be India as it was most closely and intimately connected to the lex arbitri and the proper law of the contract, both of which were Indian. The Indian model seems to presume that the parties could not have contemplated a delocalised lex arbitri or proper law. Be that as it may, where a supranational set lex arbitri or proper law exists, the first method will prevail as these laws will not be sufficient contrary indications.
III. Cause of Action Method
This is an unsuitable method of determination of seat. In this case, if the arbitration agreement does not reveal a Seat then the Courts of the place where the cause of action arose will be considered as the Juridical Seat of the arbitration. This is derived from the definition of ‘Court’ under Section 2(1)(e) of the Act which also includes the Court that would have jurisdiction over the question if it formed the subject matter of a suit.
Understanding this to mean that the legislature has intended to give jurisdiction to both the Court of arbitration and the Court having territorial jurisdiction over the place where the cause of action arose, concurrently, the SCI has caused tremendous controversy by in Paragraph 96 of BALCO judgment. However, when read wholly and not in isolation, BALCO judgment very distinctly states that if concurrent jurisdiction were to be the order of the day, despite the seat having been located and specifically chosen by the parties, party autonomy would suffer and therefore Courts were intended to exercise supervisory jurisdiction to the exclusion of other Courts as provided under Section 42. (Soma JV case, ¶51)
Therefore, since the application referred to under Section 42 can only be legitimately made to the Court of the Seat, this method is only useful where seat could not be determined by any of the above methods maybe owing to lack of any territorial nexus.
Conclusion
The contradictory judgments of the English and Indian Courts over the determination of Seat in the Enercon case caused a delay of two years and has painted a Medusa of how the incongruous views of Courts across jurisdictions terrorise the development of international commercial arbitration. Therefore, arbitrations anchored in India or involving Indian parties must be planned in a manner eliding with the recent set of “pro-arbitration” trends in determination of Seat.
Although there is no specific order of precedence for application of these methods, their very nature and the manner of their application till date suggest that the Seat-Venue method takes precedence over the other two owing to its strong territorial nexus. Ideally thus, upon failure of this method owing to the presence of a sufficient contrary indica, should the Inverse-CMRC method be applied followed by the Cause of Action method as the last resort in this three-fold method for determination of Seat.
‘Force majeure certificates’ issued by the Russian Chamber of Commerce and Industry
The Russian Chamber of Commerce and Industry is issuing ‘force majeure certificates’, like some of their homologues in other countries, as discussed earlier in this blog. Although this practice has existed in Russia since 1993, the number of requests for the certificates has recently increased. The requests come not only from Russian companies but also from foreign entities. While the increase is understandable in these times of the coronavirus pandemic, under Russian law, the ‘force majeure certificate’ can (only) form a part of evidence in possible future disputes, as its impact on the outcome of the dispute is ultimately defined by the (Russian or foreign) courts or arbitration tribunals.
The Russian Chamber of Commerce and Industry (CCI) is issuing ‘force majeure certificates’, like some of their homologues in other countries. Although this practice exists in Russia since 1993, the CCI has recently noticed an increase in the number of requests for the certificates, due to the coronavirus pandemic. The requests come not only from Russian companies but also from foreign entities. What could be the practical value of the certificate in a contractual dispute relating to the consequences of the pandemic?
The legal basis for the CCI’s competence to issue the ‘force majeure certificates’ is laid down in the law ‘On the chambers of commerce and industry in the Russian Federation’ of 7 July 1993. Article 1 of the law defines the CCI as a non-state non-governmental organisation created to foster business and international trade. Along with other competences, the CCI may act as an ‘independent expert’ (art. 12) and may provide information services (art. 2) in matters relating to international trade. One of the services is the issuing of ‘force majeure certificates’. The Rules for issuing the certificates are defined by the CCI’s governing council. These Rules entrust the CCI’s legal department with assessing requests and advising whether the certificate should be issued. The advice is given on the basis of the documents that a party submits to substantiate their request, following the Rules.
Notably, the list of documents includes (a copy of) the contract, ‘which contains a clause on force majeure’ (point 3.3.2 of the Rules). This requirement is not accidental; it has to do with the non-mandatory character of the legal provision on force majeure. Article 401(3) of the Russian Civil Code provides for exoneration of liability for non-performance of a contractual obligation, if the party proves that the non-performance was due to the force majeure. This provision applies by default, if ‘the law or the contract does not provide otherwise’ (art. 401(3)). The parties may provide otherwise by including a clause about unforeseen circumstances, hardship, frustration, force majeure, or similar circumstances in the contract. This is, at least, the way Russian courts have applied art. 401(3) up to the present time. The Russian CCI does not appear to deviate from this approach. More than 95% of the requests submitted to the Russian CCI for ‘force majeure certificates’ have so far been rejected, according to the head of the Russian CCI (even though some decrees deliberately label the COVID-19 pandemic ‘force majeure’ as, for example, the Decree of 14 March 2020 does, this decree is adopted by the municipality of Moscow to prevent the spread of the virus by various measures of social distancing).
Thus, the legal basis of the CCI’s competence to issue a ‘force majeure certificate’ implies that the certificate is the result of a service provided by a non-state non-governmental organisation. The application of Article 401(3) implies the need to interpret the contract, more specifically, the provision on force majeure it possibly includes. If the parties disagree on the interpretation, a dispute may arise. The competence to resolve the dispute lies with the courts or arbitration tribunals. In this way, the ICC’s decision (taken upon the advice of the CCI’s legal department) to confirm by issuing a certificate that a particular event represents a force majeure in the context of the execution of a specific contract can have persuasive authority in the context of the application of Art. 401 (3). However, it remains the competence of the courts or arbitration tribunals to apply art. 401(3) to the possible dispute and to establish the ultimate impact of the relevant events on the outcome of the dispute. Under Russian law, one would treat the ‘force majeure certificates’ issued by the CCI (and possibly a refusal to issue the certificate) as a part of evidence in possible future disputes. A (Russian or foreign) court or arbitration tribunal considering this evidence is free to make a different conclusion than that of the Russian CCI or may consider other evidence.
News
Conference Sustaining Access to Justice, 19-20 Oct 2023 – registration open
On 19-20 October 2023 the Conference Sustaining Access to Justice in Europe: New Avenues for Costs and Funding will take place at Erasmus University Rotterdam. Speakers from academia, policy, business and consumer associations from Europe, the US and Asia will discuss developments in funding, including third-party litigation funding and crowdfunding, collective actions, public interest litigation, ADR and ODR and entrepreneurial lawyering.
Description
Access to civil justice is of paramount importance for enforcing citizens’ rights. At the heart access to civil justice lies litigation funding and cost management. Yet, over the past decades, access to justice has been increasingly put under pressure due to retrenching governments, high costs of procedure, and inefficiency of courts and justice systems. Within this context, the funding of litigation in Europe seems to be shifting from public to private sources. Private actors and innovative business models have emerged to provide new solutions to the old problem of financial barriers to access to justice.
With the participation of academics, policymakers, practitioners, academics and representatives of civil society from all over Europe and beyond, the conference seeks to delve deeper into the financial implications of access to justice and the different ways to achieve sustainable civil justice systems in Europe. The topics addressed in this international academic conference include different methods of financing dispute resolution and regulating costs, such as third-party funding, crowdfunding, blockchain technologies, public interest litigation, developments in ADR/ODR, new business models of legal professionals as well as law and economics perspectives on litigation funding.
Program, registration and call for papers
The full program is available here and further information and registration is available here.
A call for papers for early career researchers is available here; deadline is 7 July 2023.
This conference is organised by Erasmus School of Law in the context of the NWO Vici Project: ‘Affordable Access to Justice’, funded by the Dutch Research Council.
Private International Law and the Voices of Children
Written by Christina Shin, University of Sydney Law School
On 1 June 2023, International Children’s Day, an online webinar discussing the issue of children’s protection in private international law (PIL) was organized in collaboration with conflictoflaw.net and American Society of International Law Private International Interest Group at the Sydney Law School Centre for Asian and Pacific Law (CAPLUS). In the first part of the webinar, five experts were invited to share their views on the status quo, challenges, and potential solutions to protect the welfare of children in the international and transnational context. The second part of the webinar involved a roundtable discussion among the experts. This event was moderated by Dr. Jeanne Huang, Associate Professor at the Sydney Law School and CAPLUS co-director. The guest speakers were as follows:
Today the Mexican National Code of Civil and Family Procedure has been published in the Official Gazette
On 6 June 2023, the Mexican National Code of Civil and Family Procedure has been passed by decree issued by the Mexican president Andrés Manuel López Obrador. Indeed, after many years of stagnation, the National Code has finally been published today in the Mexican Federal Official Gazette. See here. It will enter into force tomorrow (see article 1 of the transitory articles).
This is a groundbreaking development because it will gradually replace the states codes of civil and family procedure in Mexico, harmonising procedural law in all 32 Mexican states. A specific procedure has been foreseen for the way in which it will be adopted in the Mexican states (see article 2 of the transitory articles).
There are many interesting provisions for Private International Law lawyers, we will be preparing a brief summary, which will be published here. By way of example, see the provisions on international child abduction: articles 1150-1161.