Are smart contracts legally binding? Mythbusting with Alana Kushnir

Alana Kushnir is an art lawyer, advisor and curator based in Melbourne, Australia. She works at the intersection of art, law and technology. Alana is the Founder and Director of Guest Work Agency, the first dedicated art law and advisory firm in Australia, and the Guest Club, a community of art lovers and collectors. In the first of our Mythbusting series of articles on tech, Alana debunks some of the myths surrounding smart contracts, and highlights some of the opportunities smart contracts can have for the art industry in particular…

Mythbusting

Myth 1: Smart contracts are a new thing.

This is incorrect. The first fully automated coin operated vending machines were introduced about 150 years ago in London railway stations and post offices. They conveniently offered merchandise like postcards and postage stamps. When the requisite amount of money was inserted into the machine, the product would be automatically dispensed, and a contract of sale would be automatically executed between the seller and the purchaser. These days, the contents available for purchase in vending machines has evolved into pretty much anything you could think of  (including NFT’s)! And the automated aspect of the sales transaction remains.

Myth 2: Smart contracts are blockchain based.

Yes and no. In 1986, more than a decade before the concepts of Bitcoin and blockchain were ever heard of, the computer scientist, cryptographer, and legal scholar, Nick Szabo coined the phrase smart contract in an article he wrote while completing a graduate degree in law. In this article, Szabo defined a smart contract as “a set of promises specified in digital form, including protocols within which the parties perform on these promises.” And, he expressly linked smart contracts to the humble vending machine, describing them as the “primitive ancestor” of smart contracts.

So, where does Blockchain come into it? Nowadays, one of the most exciting use cases for smart contracts is blockchain technology. So blockchains like Ethereum are powered by smart contract style protocols.

Myth 3: Smart contracts are legal contracts.

This is perhaps one of the biggest myths out there, that smart contracts are forms of legal contracts, but smarter. I kind of get this one, after all. Why else would they call them ‘smart contracts’? Right?

Computable contracts do have their limits and aren't suitable for all contractual arrangements. For example, computable contracts are not suitable for arrangements that rely on abstract concepts or require some form of discretion by the parties. So, a party might agree to try to achieve something and the contract might place an obligation on that party to take reasonable efforts to do so. I write clauses like this all the time.

How is a computer able to determine whether sufficient reasonable efforts have been taken by that party? It is a little subjective, and highly dependent on the nature of the arrangement and the parties involved. Another example of where computable smart contracts are not suitable for contractual arrangements, is in the context of intellectual property (IP) sales and transfers. If you own IP and you want to sell or transfer it to someone else. Most jurisdictions which have intellectual property legislation in place, require that transfer (what's called an ‘assignment’) to be in writing and signed by the transferor.

This type of requirement does not tend to apply to permissions to use one’s IP (what’s called a ‘license’), but in many jurisdictions, it does indeed apply to transfers or sales of IP.

To this day, the degree to which smart contracts can be legally enforceable and can even replace the need for natural language contracts is related to the ‘code is law’ concept coined by legal scholar Lawrence Lessig. It remains the domain of theorists and is yet to be tested in the context of blockchain technology in a court of law.

Opportunities

Let’s now discuss some of the main opportunities afforded to us by smart contracts.

Opportunity 1: Smart contracts can improve legal contracts.

Enforcing a legal contract can be difficult. Natural language contracts are too often burdened by a lack of access to justice for most of the world's population.

Szabo saw the potential of smart contracts to address the challenges of enforcing legally binding contracts. He challenged the need for relying on a judicial system that decides what physical steps are to be taken by an enforcement agency, if contractual arrangements were verifiable. For Szabo, contractual enforcement could become a proactive rather than a reactive process.

Opportunity 2: Smart contracts can improve art contracts.

Issues around the enforcement of contracts are particularly prevalent in the global art industry, where having contracts in natural language is a fairly recent phenomenon.

In fact, contracts in writing are often still not used and often even where they are used, they are not drafted well. I know this firsthand, having acted for, for example, dozens of artists in disputes with galleries for example where proving that a consignment arrangement  existed in the first place is made difficult where it's not documented in a single, well-drafted and signed document.

It's often said in this industry that the artist gets paid last. And sadly that is still too often the case. For example, a gallery is transferred payment for a sold artwork, but it can be weeks or even months before the artist is transferred their cut of the sale. Not only are there serious legal issues around fiduciary or agency obligations with holding such funds longer than necessary, or mixing these funds with other gallery funds, but at a very practical level, this late payment can just seriously affect an artist’s cash flow. Embedding smart contracts into the artwork sale process, where the artist is automatically paid their cut, is an absolute game changer for everyone involved in these types of transactions.

Opportunity 3: Smart contracts can improve the administration of royalties.

The use of smart contracts has huge potential for the administration of resale royalties. There are more than 80 countries  which have legislation in place that stipulates that a certain royalty percentage must be paid to an artist where their work is resold on the secondary market. These include jurisdictions like the UK, EU, Australia and Brazil. Unfortunately however, just having laws that mandate the payment of resale royalties doesn't always mean that artists are paid the royalties they are guaranteed by law.

In Australia, for example, the payment of royalties is a fairly drawn out process, and I'd presume it would be similar in other jurisdictions with resale royalty legislation. First, the law requires the art market professional involved in the secondary sale to declare the resale and the resale amount to the administering body, here the Copyright Agency. Then, the administering body needs to either already have a record of the artist who could be registered with the administering body (which would require them to know about resale royalties), or the administering body would have to try to track down that artist if they are not registered.

I am unsure how often this tracking down actually happens, because after all it is a body with limited resources. Then, the royalty needs to be transferred from the seller or art market professional to the administering body. Once it's received by the administering body, it's transferred to the artist. This means that it can often take months after a resale for an artist to receive their royalty, if at all.

I'm also aware of instances where artists works have been resold using art market professionals, and the resale is not declared, or the resale has deliberately been structured to take place in a jurisdiction in which resale royalties are not legislated for - even though the artists themselves may be a citizen of a country which does legislate for resale royalties! It’s time for positive change, and smart contracts can absolutely help bring this about.

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