There are questions about the legally binding nature of smart contracts, such as how their terms are interpreted, how to deal with issues such as mistakes in the coding of smart contracts and the remedies that are available when a contract fails to perform as intended. Other areas of law, including tax and data protection, raise their own issues. These uncertainties risk stifling the adoption of smart contracts, particularly in heavily regulated sectors such as insurance.
Following the publication of the UKJT’s Legal Statement on cryptoassets and smart contracts in November 2019, the Government asked the Law Commission to undertake a scoping study into the law on smart contracts, to identify where reform of certain aspects of English law may be required. The Law Commission's project will continue throughout 2021 and is designed to inform public debate and seek consensus on where reform of English law might be required.
What are Smart Contracts
There is no one universal definition of a "smart contract" due to the evolving nature of this technology. At its simplest, a smart contract is a self-executing (automated) contract where instructions are turned into computer code designed to automatically execute certain tasks.
The use cases of blockchain-enabled smart contracts are growing rapidly as the technology evolves. The following are examples of use cases in the insurance sector:
- streamlining information exchange and payments between insurers and reinsurers;
- simplifying the underwriting and payments process;
- developing new products and services, such as parametric insurance products;
- automating a large part of the claims-handling process;
- facilitating the client onboarding process; and
- accessing and sharing insurance-related personal and non-personal data.
Legal and Regulatory Considerations
In the absence of international standards and a uniform legal regime governing smart contracts, legal and regulatory considerations will need to be assessed by insurers in the context of each jurisdiction in which smart contracts are used.
There are a number of matters that need to be carefully assessed when using smart contracts. Some of the most fundamental are:
- Compliance with regulatory obligations: insurance companies should ensure the computer code enabling smart contracts is programmed and functions in a manner that allows them to comply with their regulatory obligations. This includes obligations towards their customers (such as to treat customers fairly by ensuring that customer expectations when using smarts contracts are managed accordingly) or KYC and AML obligations when conducting customer due diligence;
- Data Protection: smart contracts are beginning to be used more frequently for storing, managing and transferring data, including personal data, on blockchain. This has the potential to change the status of an insurer for data protection purposes. For example, an insurer that was as a data processor could now incur additional data protection obligations if it becomes a data controller and will need to ensure its compliance with relevant data protection regulations;
- Legality and enforceability: each jurisdiction takes an individualistic approach on whether a smart contract can be enforced and recognised as a valid and legally binding agreement. Insurers should therefore carry out assessments of the legal status and enforceability of smart contracts in each jurisdiction in which they operate; and
- Human Error and Cybersecurity: blockchains supporting smart contracts make use of cryptography technology to validate, protect and record transactions and data. In anticipation of future technological development in advancing, and in other cases, undermining cryptographic protocols, insurers should be aware of and address cyber security issues and consequences caused by human error when using smart contracts.
The call for evidence
The Law Commission's project on smart contracts highlights issues with the entire lifecycle of smart contracts, including from the formation and legally binding nature of smart contracts, how they are interpreted and which remedies will be available when a smart contract fails to perform as expected or intended. Most of the issues raised apply to B2B, P2P or B2C smart contract use cases and as the technology is in its infancy, there are few test cases to provide solutions to the legal issues.
The Law Commission explores remedies in the context of smart contracts in some detail, examining the factors that render a contract void or voidable, such as mistake, misrepresentation, duress and undue influence and the effect they have on creating a binding contract and the remedies that would be available to the affected party. It also explores the practical issues with applying English law remedies to smart contracts and considers the extent to which the courts, statute, the parties, or a combination of these, should be left to choose between possible remedies.
The call for evidence is the first step in the smart contracts scoping study. By seeking views now on how smart contracts are used and examining how existing English law accommodates them, or creates issues or barriers, the UK will be in a position to create the optimal environment for encouraging innovation and the adoption of smart contracts governed by English Law. Firms that are using, or are interested in using smart contracts, will benefit from reviewing the Law Commission's Smart Contracts Call for Evidence and following the progress of the smart contracts scoping study that is due to be published later this year.
Emma Eaton, Clifford Chance Senior Associate, Financial Institutions Group.
Kristians Butins, Clifford Chance Trainee Solicitor, Financial Institutions Group.
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Please note this blog post was written by a Clifford Chance LLP employee. Clifford Chance LLP is the parent company of Clifford Chance Applied Solutions (CCAS). The content within this post does not constitute legal advice.