We have suggested previously that arbitration may be a preferable alternative to court for smart contract disputes to (i) ensure a knowledgeable decision-maker handles the dispute, (ii) protect proprietary information, (iii) gain flexibility in scheduling and procedures, and (iv) pre-select the right forum. Of course, arbitration doesn’t happen on its own – it typically requires a properly drafted arbitration clause. This article provides several suggestions to consider on that point.
Notwithstanding all the hype associated with smart contracts, the real-world applications on the immediate horizon make use of distributed ledger technology (DLT) in ways that are not likely to necessitate fundamental changes in the dispute resolution procedures in those contracts. Consider the example of commercial lending. A smart contract may include protocols for the use of DLT to disburse loan proceeds and manage payments, but the inherent limits of the technology make it ill-suited to resolve a borrower’s default, leaving that circumstance to be addressed by the legal terms in the contract in the same way a default would be addressed under a traditional contract. That said, there are some aspects of the arbitration clause that should be re-considered when dealing with smart contracts:
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 DLT 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 DLT to gain efficiencies (e.g., the commercial lending example above). Or it may matter a great deal if, for example, your model incorporates DLT into the fundamental bargain struck by the parties (e.g., any smart contract system that requires its own cryptocurrency to conduct transactions). 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 WIPO). Additionally, Delaware leads the nation as the first state to implement blockchain technology in 2016, and state officials continue to pursue blockchain-friendly policies this year. Thus, Delaware law may be a good option 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 today’s blog: 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 U.S. jurisdictions, but as more states grapple with legislation and policies related to blockchain 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 DLT 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 using DLT are evolving rapidly and have given entire industries reasons to re-think their ways of doing business. Dispute resolution is part of doing business and deserves some re-assessment 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.