What Law Governs Smart Contracts?
Giesela Rühl - Friedrich Schiller University of Jena and Humboldt University of Berlin
-- The law applicable to smart contracts is a neglected topic. At times it is even discarded as irrelevant or unnecessary. In fact, many authors claim that smart contracts especially when stored and executed with the help of blockchain technology make contract law and, in fact, the entire legal system obsolete. A closer look, however, reveals that smart contracts are not – and should not – be independent of the law. In fact, while it might be true that smart contracts do not need a legal system to operate and to execute legal obligations, there can be little doubt that smart contracts depend on a legal system to determine whether there is any enforceable legal obligation to begin with. This is because the smart contract itself – as a piece of code – does not have the means of knowing whether an enforceable legal obligation has been validly created. It does not even have the means of knowing whether the parties who decide to make use of a smart contract have validly agreed to do so. All that a smart contract can do is to do what it has been told to do. However, the mere power to do something, does not mean that doing it is right or legal. Code is not law. And it should not be. The decisive question, therefore, is not whether smart contracts are subject to law at all, but rather to which law they are subject?
Traditionally, the question of which (private) law applies to a contract is determined by the provisions of private international law [i.e., conflict of laws rules - ed.]. As an area of law that looks back on almost 1000 years of history and that is, today, firmly anchored in the legal systems of almost all states, it assigns cases that have a connection to different states to a specific legal system with the help of choice of law rules. The interesting question, therefore, is whether private international law is able to deal with smart contracts? Are the traditional rules of private international law able to assign smart contracts to a particular contract law? Are they able to determine the applicable contract law if smart contracts are operated on different computers located in different jurisdictions with the help of blockchain technology? In an article, "Smart (Legal) Contracts, or: Which (Contract) Law for Smart Contracts?," forthcoming in Blockchain, Law and Governance, edited by Benedetta Cappiello and Gherardo Carullo (Springer), I look at this question from a European perspective and argue that the answer is “yes” because under the Rome I Regulation the law applicable to smarts contracts will either be determined through the principle of party autonomy or through the principle of the closest connection.
According to the principle of party autonomy, embodied in Article 3 Rome I Regulation, parties may submit their contract to the national law they want and without any territorial or other connection to the chosen law. The principle of party autonomy is, therefore, able to establish a connection to a particular legal system even if a smart contract operates in a completely virtual and, as the case may be, completely decentralised environment. In addition, it provides for much needed legal certainty because parties will know which law applies to their contract.
The situation looks similar when turning to the principle of the closest connection embodied in Article 4 Rome I Regulation. It comes into the picture if the parties have not chosen the applicable law and usually leads to application of the law of the habitual residence of the party required to effect the characteristic performance. Smart contracts that execute, for example, sales and service contracts will, therefore, usually be governed by the law of the country where the seller or the service provider is habitually resident. The principle of closest connection, thus, uses a connecting factor that is independent of the smart contract, its conclusion and its performance and, hence, is able to link the contract to a particular legal system. Of course, this is not to say that the principle of the closest connection will never cause any problems when applied to smart contracts. For example, it may be unclear where the relevant party is habitually resident because the smart contract is processed anonymously via a blockchain. The law of the closest connection will then have to be determined by taking into account all circumstances of the case. And, naturally, this will neither be an easy task, nor will it always lead to entirely convincing or foreseeable results. However, one may find comfort in the fact that cases of unknown habitual residence will not be too numerous because anonymity rarely means actual anonymity but mostly pseudonymity. In most cases it will, therefore, be possible to determine who is behind a transaction and where that person is habitually resident.
A completely different question is, of course, whether the contract law that applies by virtue of Article 4 Rome I Regulation offers a good legal framework for smart contracts. However, we can expect that parties will increasingly make use of their right to choose the applicable law and, hence, make a judgment about the quality of the applicable law by 'voting with their feet'. In the long run, private international law will, therefore, not only determine the law applicable to smart contracts and thereby foster legal certainty. It will also reveal which law is best equipped to meet the challenges of digitalization in the eyes of the parties. And this, in turn, may inform domestic law reform processes and eventually lead to better laws for smart contracts.
Note: An earlier version of this post appeared on the Oxford Business Law Blog. An extended (English) version is forthcoming in Blockchain, Law and Governance, edited by Benedetta Cappiello & Gherardo Carullo, Springer.