With distributed ledger technology (such as blockchain), there is growing interest in automating routine commercial transactions. But how will these smart contracts be interpreted under existing commercial contract laws?
Although there is no federal contracts law for private commercial transactions in the United States, there is a widely adopted core of standardized state laws that provides the framework for interpreting the existence, validity, scope, breach, and remedies for contracts for the sale of goods.
How Smart Contracts Work
A smart contract (or smart agent) is a self-executing program that uses distributed ledger technology to store rules for a defined transaction, verify the request, and execute the agreed terms.
For example, imagine the SellUrBikeEZ service is formed to facilitate local sales of bicycles between private parties. Sarah Seller registers a bike on the system, describes the bike, sets a $200 sale price, and leaves the bike in a SellUrBikeEZ locker with a coded lock. SellUrBikeEZ applies a smart contract that says: “If a buyer chooses this item, transfer <sale price> from their payment account to the seller and send the locker code to the buyer.” Bonnie Buyer reviews the description and clicks the “buy” button on the SellUrBikeEZ website.
Does a Valid Contract Exist?
In general, a contract requires a meeting of the minds, an exchange of value, parties who are able to enter into a contract, and a legal purpose.
By posting the bike on SellUrBikeEZ with a sale price, Sarah made an offer of sale. By clicking “buy”, Bonnie has accepted the offer, has transferred payment, and has received delivery (the code to unlock the SellUrBikeEZ locker where the bike is stored).
How could this fail to be a valid contract? Minors and persons who have been legally adjudged to be incompetent are not considered to be legally competent to enter into contracts. If either Sarah or Bonnie are not legally competent to enter into a binding contract, they can disavow the contract in their discretion. (The age of majority varies by state.) In these cases, ratification by a parent or guardian is required to make the contract legally enforceable. Without this ratification, the legally incompetent party can disavow the contract.
If Sarah was just borrowing the bike from a friend and doesn’t have the friend’s permission to sell it (or if the bike was stolen), selling the bike could constitute theft. A contract for the sale of illegally-obtained property is void based on public policy.
In many states, a sale of goods for $500 or more requires a “signed writing for the contract to be valid or to be enforceable. As long as the service complies with the applicable laws regarding electronic signatures, the act of posting the bike for sale and clicking “buy” will satisfy the requirements for a signed writing.
If a Valid Contract Exists, What Happens if Things Go Wrong?
Perhaps Bonnie discovers that the bike doesn’t match Sarah’s description of it. Depending on the jurisdiction and the specific situation, this could give Bonnie the basis for a claim for breach of warranty, misrepresentation, fraud or deceit against Sarah (if she can learn Bonnie’s identity), and possibly against SellUrBikeEZ.
Or perhaps Bonnie is unable to open the locker or discovers that the bike has been stolen out of the locker. When Sarah placed the bike in the SellUrBikeEZ locker to be held until it was sold, this created a bailment. The bailee (SellUrBikeEZ) is expected to take reasonable care to protect the goods left in its custody and may be liable to Sarah or Bonnie for damages if Bonnie is unable to access the bike after paying for it.
This very simple example was for the sale of a good between two private parties in the same jurisdiction who are not merchants. Specific laws apply for sales between merchants, sales by a merchant to a consumer, sales to government entities, and leases or sales of intangibles, services or real estate. And of course, all of these laws vary by state and by country.
Even when the parties agree that the laws of a specific jurisdiction apply, there may be overriding public policy reasons that supersede the parties’ agreement. For example, a court in one state or country may apply consumer protection laws of that state or country to protect local consumers who purchase defective products from a merchant in another state or country.
If you’re thinking of setting up or accepting a smart contract, make sure that you understand your legal rights and your ability to enforce them in the context of the specific transaction.