Digital and Smart Contracts

With the ever-transforming use of technology in the legal landscape, digital and smart contracts have become increasingly common in commercial transactions. When utilised correctly, they can be used to streamline processes, reduce costs and enhance legal certainty, but they also present new challenges for legal professionals to combat.

In this article, we explore the definitions of digital and smart contracts, their benefits, the negatives and important points to remember when looking to use them in a transaction.

Digital contracts are simply traditional agreements that are created, signed and stored electronically. Unlike traditional paper agreements, digital contracts are often facilitated through online platforms that allow parties to sign and execute agreements remotely.

These can be in any format – emails, online terms & conditions, or even e‑signatures on a web interface, all working the same as paper contracts, but digital.

Smart contracts are coded agreements that embed automated execution into the agreement itself.

These types of contracts are self-executing with their terms directly written into code and executed on a blockchain. They automatically carry out actions (such as payment, delivery and transfer) once certain conditions are met.

When adopting digital or smart contracts, one of the most crucial considerations is whether they are legally enforceable. In order to be recognised and enforced by the courts, they must comply with the UK’s legal framework.

Digital Contracts

In the UK, digital contracts are legally recognised under the Electronic Communications Act 2000 and the Electronic Signatures Regulations 2002 (Retained EU eIDAS Regulation), which make electronic signatures and digital contracts enforceable, provided they meet the essential elements of a contract (offer, acceptance, intention to create a legal relationship, consideration and certainty of terms).

Smart Contracts

Smart Contracts are still a developing area in the UK, but their legal recognition is gradually taking shape. In 2021, the Law Commission advised that the legal framework in the UK is clearly able to facilitate and support the use of smart legal contracts. In order to be enforceable, their code must clearly reflect the intent of all parties, and they also need to meet the essential elements of a contract. It has previously been determined in 2019 that, in principle, smart contracts can meet the necessary requirements as:

• Code can count as acceptance and performance.
• A self-executing smart contract can be binding.
• Smart contracts can form part of, or exist alongside, a traditional written contract.

This has given businesses confidence in using smart contracts in finance, logistics, supply chains and beyond.

Opting to utilise digital or smart contracts for your commercial transactions can present a range of benefits, for example:

• Faster completion – they remove the need for manual action (print, sign, scan, send back).
• Transparency – contracts are easier to access, but can also be set up with the necessary protections.
• Security – contracts use encryption and other security measures to ensure the integrity and authenticity of the document.
• Reduce costs – enhances automation and therefore reduces overheads (letters/time).
• Audit compliance – when needed, they can be easily accessed for audits, with records being digitally kept and stored.

Adopting a new type of technology or automation in any business can have its teething problems, so it’s important to do your due diligence before committing. In the instance of digital and smart contracts, certain challenges need to be considered:

• Glitches and technical failures
• Cybersecurity risks – while digital and smart contracts are generally secure, they are still vulnerable to hacking, data breaches or unauthorised access.
• Coding errors – smart contracts are only as good as the code they are built upon, and depending on how the smart contract is coded, amendments can be difficult or irreversible
• Not every legal system or jurisdiction accepts them
• GDPR Compliance

While the Law Commission’s 2021 report explained that contract law is ready for the adoption of digital and smart contracts, there is still work to be done. Whilst regulators are also encouraging its adoption to drive legal innovation, they are conscious of ensuring consumer protections remain in place.

Introducing any type of technology into a legal process, especially when dealing with personal or confidential information, should always be supported by legal experts. If you are considering introducing digital or smart contracts into your business, the Corporate and Commercial team at Backhouse are here to provide tailored legal advice. Get in touch to book a free 30-minute consultation with one of our experts.

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