First Tuesday Update is our monthly take on current issues in commercial disputes, international arbitration, and judgment enforcement.
Legal technologies promise to flourish in the coming decade, and although it is not possible to predict all the innovations that are likely to become mainstream, the use of smart contracts appears to be on the rise. A typical smart contract uses computers and code to automate performance of some or all of the parties' obligations. However, the legal terms of the contract are likely to remain in written form in a contract that people can read. If a dispute arises, the parties may prefer arbitration as an alternative to court, but arbitration doesn't happen on its own – it typically requires a properly drafted arbitration clause. Here are some tips to keep in mind when considering how to draft these clauses:
Arbitrator Appointment: Careful consideration should be given to the appointment of the arbitrator(s). This is obviously true for arbitration in general, but in the context of smart contract disputes, the pool of arbitrators who are knowledgeable regarding the technology will not be as robust as those who are generally knowledgeable regarding ordinary contract disputes. This may not matter if your business model is more or less a traditional model using smart contracts to gain efficiencies. Or it may matter a great deal if, for example, your model incorporates smart contract functionalities into the fundamental bargain struck by the parties. The bottom line is this: If you think you will need an arbitrator with unique technical knowledge, then consider how the terms of your arbitration clause can be drafted to address the need if a dispute arises.
Governing Law and Arbitral Body: These two factors will dictate the substantive and procedural laws that apply to the arbitration. In a commercial transaction, it may be perfectly reasonable to choose AAA arbitration and New York law, but there may be preferable alternatives for smart contract disputes. For example, you might consider an arbitral body that specializes in technology disputes (like the World Intellectual Property Organization). Additionally, some states like Delaware have adopted pro-smart contract policies, which may make them good options if you are looking for helpful legal precedent.
Forum Selection: Simply put, the local law of the forum can provide additional grounds for interfering with or challenging an arbitral award. If your smart contract is not "entirely domestic in scope," your arbitration may be subject to the UN Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention). The nuances of the Convention are beyond the scope of this article. Suffice it to say that the forum of the arbitration can determine the primary jurisdiction, and in turn, a court seated in a primary jurisdiction can invoke grounds under local laws to vacate an award. E.g. Yusuf Ahmed Alghanim & Sons, W.L.L. v. Toys "R" Us, Inc., 126 F.3d 15, 21 (2d Cir. 1997). The extreme hypothetical to avoid would be a jurisdiction whose local laws make smart contracts illegal. This is not an issue in US jurisdictions, but as more states grapple with legislation and policies related to smart contract technologies, a bit of forum-shopping may be in order to avoid potential pitfalls or take advantage of beneficial developments.
Summary Dispositions: Arbitral rules and practices may not provide for summary disposition of a dispute without a merits hearing. So, some thought should be given to including this option in the arbitration clause. It may be appropriate, for example, if the primary dispute involved discrete issues that can be resolved by objectively verifiable facts, such as whether the smart contract code performed as designed and agreed to. This is perhaps one benefit that will be realized in litigation as smart contracts becomes more prevalent—i.e., the automation of contract performance may reduce or eliminate the need for discovery and fact-finding regarding the conduct and intent of the parties performing under the contract.
Smart contract applications are evolving rapidly and have given entire industries reasons to rethink their ways of doing business. Dispute resolution is part of doing business and deserves some reassessment as well. Whether you currently have arbitration clauses in existing commercial agreements, or are considering this option, it will be worthwhile to spend some time anticipating adjustments that may improve the dispute resolution process when smart contracts are involved.