Law on cryptoassets and smart contracts clarified

Out-Law News | 19 Nov 2019 | 10:41 am | 4 min. read

Smart contracts can be legally binding, and cryptoassets should be treated as property, in principle, according to a new statement prepared by a team of UK experts spanning the government, regulators, industry and judiciary.

The LawTech Delivery Panel's UK Jurisdiction Taskforce (UKJT) published the statement in an effort to clarify issues of legal uncertainty regarding cryptoassets, distributed ledger technology and smart contracts.

Litigation expert Danielle Murphy of Pinsent Masons, the law firm behind Out-Law, said the statement has been eagerly anticipated by the legal, financial and tech industries, and could have particular bearing on the use of smart contracts in future.

A smart contract is a form of digital programming code, which exists on a blockchain platform and which will self-execute. In simplest terms these coded obligations can operate to say 'if A occurs, B will follow'. Coded obligations or outcomes have different characteristics to those which ordinarily exist in natural language contracts containing legal rights and obligations. The courts in many jurisdictions are most familiar with natural language contracts being the way in which parties agree their legal obligations, whether oral or written.

The principle elements for a valid contract under English Law are that two or more parties reach an agreement; the parties intend to create a legal relationship by their agreement; and each of the parties have given something of benefit, or 'consideration', under the agreement. Whether these elements have been satisfied, will depend on whether these requirements are demonstrated by the parties’ language and conduct.

Murphy said: "The statement recognises that parties’ contractual obligations may be defined by code, or that the code may implement an agreement recorded elsewhere, such as in a natural language document," Murphy said. "The statement identifies the characteristic feature of smart contracts being their 'automaticity' and acknowledges that despite self-executing automaticity there will be a need for dispute resolution as 'there will always be a risk that performance is affected by an event external to the code, for example a system failure, or that the code operates in an unexpected or unintended way, and in such cases any dispute must be capable of adjudication'."

"It is open to the parties to agree that a smart contract is not legally binding, however this is generally not advisable. It will be interesting to see how the courts apply the principles of contract law to smart contracts when issues of uncertainty or contention arise in practice. The statement recognises the principles of contractual interpretation can apply to smart contracts or coded contracts, but the circumstances in which these principles come to be considered by the English courts in the context of blockchain is an area to watch. The key questions will be to determine what the parties actually intended and whether they intended to be bound by the behaviour of the code; the objective assessment of parties’ intentions is not a novel principle for the courts and the statement recognises that the courts do this regularly. What will be interesting is how the intentions of the parties are seen by the courts as borne out of contractual agreements that exist in code, in whole or in part, rather than in the natural language contracts that the legal community has traditionally been accustomed to," she said.

Civil fraud and asset recovery specialist Jennifer Craven of Pinsent Masons said the UKJT's conclusion, that cryptoassets are to be treated in principle as property, "has important consequences for the application of a number of legal rules such as those relating to the vesting of property in personal bankruptcy, the rights of liquidators in corporate insolvency, and in respect of tracing and breach of trust claims, in civil fraud matters".

"Although not legally binding, it will be interesting to see how and whether the English courts, renowned for their inherent flexibility, particularly in matters relating to fraud, will apply the conclusions of the UKJT, and if any legislative work will be carried out by the Law Commission," Craven said. "It is hoped, however, that trickier and challenging legal questions have now been simplified and made easy for the asset recovery practitioner, subject to how the courts will interpret matters."

Craven has previously explained that no UK court has definitively ruled on whether cryptoassets are property before, though the High Court in London said earlier this year that there was a serious issue to be tried as to whether the cryptocurrency bitcoin can be classed as property. On that basis, the court issued an asset preservation order to prevent bitcoin allegedly defrauded from a cryptocurrency trader from being dissipated.

The concept of property in the UK is typically derived from common law. Property is something considered to have inherent value, to be transferable, and to be capable of being touched, held or recognised as intangible property, such as intellectual property or, perhaps more analogous to cryptoassets, debt or shares.

In its report, the UKJT said that cryptoassets "have all the indicia of property", that "novel or distinctive features possessed by some cryptoassets – intangibility, cryptographic authentication, use of distributed transaction ledger, decentralisation, rule by consensus – do not disqualify them from being property", and that they are not "disqualified from being property as pure information or because they might not be classifiable either as things in possession or as things in action".

Financial services regulation expert Rory Copeland of Pinsent Masons said the UKJT's statement was reaffirming for the UK's reputation for innovation.

He said: "The legal statement provides a degree of clarity as to how cryptoassets products and services ought to be structured. Its application in financial services, where blockchain use cases are already being implemented, will provide comfort that UK jurisdiction continues to be a prime environment for innovation. As the report notes, however, it describes the law as it stands today and doesn’t second-guess how regulatory intervention might alter the situation."