Smart Contracts: Are They Legally Backed And Applicable In India (By- Sv Karthik)
Smart
Contracts: Are They Legally Backed And Applicable In India
Authored By- Sv Karthik
Abstract:
The idea of using
Blockchain technology for the purpose of regulating the contractual
transactions is possible. The use of blockchain technology where codes can be
used to create agreements and ensure that there is automatic execution of the
contracts. Smart contracts use the blockchain technology for the purpose of
enforcing the contractual obligations and they way in which the contracts are
enforced is through the tamper free execution and by legal system. In a world
where each and every thing is regulated by the blockchain technology it will be
a innovative to step to adopt smart contracts. India has already adopted the
use of the Electronic contracts, provisions contained in the Information
Technology Act, 2000 validates the electronic contracts. The problem arises is
with the smart contracts as there are no clear legislations or regulatory
framework which guides the way in which these contracts will be governed. It’s
a complete grey area concerning the validity of the smart contract, due to lack
of the legal infrastructure. The smart contracts can be understood in the
present context of the Indian contract Act, 1872 regarding the validity and
essentials of the contract as Smart contracts have almost the same criteria as
the traditional contracts with regard to the essentials of a valid contract.
Smart contracts do fulfill the required conditions in the Section 10 of the
contract Act.
Keywords: Blockchain,
Indian Contract Act, Legal Framework, Smart Contract and Validity
Introduction:
Smart contract is a
blockchain based computer input code, the terms of the contract are already
coded and these contracts analyze and verify the transaction against the terms
and it executes them. Smart contracts are automatic computer program and once
the code in installed it cannot be altered to make any further changes new
contract has to be made. These contracts are free from any human intervention
and they are complex as they are based on the ledger-based technology. The computer
programmer behind the smart contract is Nick Szabo who defined smart contracts
as the main objective of the smart contract is to satisfy the common
contractual condition, minimize exceptions both malicious and accidental and
minimize the need for trusted intermediaries. In Indian contract Act, 1872
there is no provision which talks about the concept of the smart contract.
There are E-contracts which exists, are known as electronic contracts exists in
India and they are recognized by multiple provisions of the Information
Technology Act, 2000. Section 10A of Information Technology Act, 2000 provides
for the validity of the contracts which are formed through electronic means.
Smart contract are the part of the electronic contracts, the validity of it is
recognized in India. Section 10 of the Indian Contract Act, 1872 is important
because in order for an agreement to become contract it must fulfill the
conditions which have been laid down in this section. Indian Contract Act, 1872
expressly does not talk about the smart contracts nor are there any other
Statutory Acts which talk about the smart contracts like the Electronic
contracts. It is important to understand that smart contracts
usesblockchain technology but they are not equal to the blockchain technology
and smart contract add to the ledger functionality of blockchain technology and
many kinds of self-executing instructions.
Blockchain
Technology:
The advent of Blockchain
was done by Satoshi Nakamoto in the year 2008 when it was implemented and
became the technology behind the famous cryptocurrency Bitcoin. The idea of
this technology is not something which is new it existed as early as 1991 but only
in 2008 it became reality and was given a real life workable touch using it in
form of cryptocurrency. Earliest uses of this technology included storing
information in form of a register and enable online payments. This technology
has diverse applications not only in for regulating payment without
involving any
intermediaries but it can also be used to create Smart Contracts. Indian
company Tech Mahindra is already establishing its market by taking first
mover’s advantage of implementing blockchain technology in sectors from diverse
fields ranging from updating banks to financial sectors to upstaging technology
in the telecom sector.
In order to understand
what smart contracts are we need to understand the technology which is behind
it. The technology which is behind the smart contract is Blockchain, in simple
words it can be defined as a process in which the information is stored blocks
and these blocks subsequently lead to creation of chains. It is a data
structure which uses some ledgers where it stores and transmits the data in
packages which are cleared blocks and these blocks are connected to each other
through the chains. This technology works on the basis of distributed
ledger technology. Distributed ledger technology uses nodes which are independent
computers for the purpose of sharing and synchronize the transactions in their
respective electronic ledgers. It is a building block of internet of value, it
allows for recording of the interactions and transfer value peer to peer
without a need for centrally coordinating entity. Value implies record of
ownership of an asset such as securities, money, land titles and information
like identity, health, personal information etc.
Transactions which are
conducted using the distributed ledger technology ensures transparency and
decentralization as the transaction isn’t managed by a single computer,
whenever a transaction is conducted it will be added to the blockchain and it
is validated by the multiple computers on the network. The system configured
for specific blockchain transactions forms a peer-to-peer network which ensures
that each transaction is valid before it is added to the blockchain. When a new
block is added to the blockchain it is linked to previous block by using a hash
which has a unique identity. This procedure ensures that the block has been
permanently added to the chain and the chain is solidified. There are two types
of blockchain public blockchain and private blockchain. A Public blockchain is
the type of blockchain where the information is available to public
domain and accessible by any party who can read, write data on the blockchain.
No person can exercise control over it and this ensures decentralization. Once
an entry is made on the blockchain it cannot be modified or deleted after it
has been validated and all nodes in the blockchain participate in the
validation of the transactions. All users can read the transactions but the
transactions can only be validated by predefined users this is known as
permissioned blockchain. Private blockchain can only be exercised by those
individuals who have consent to access the network. It’s an invitation
only blockchain which is
under the control and authorization of a single entity. A party requires
consent, permission to read, write or audit the blockchain. This system ensures
secrecy and confidentiality which is essential in transactions which are
concerned with finances or government transactions.
Blockchain is a data
structure which uses some ledgers where it stores and transmits the data in
packages which is called as blocks and these blocks are connected to each other
through chains. This technology uses the algorithms and cryptographic methods
for the purpose of recording data in a synchronized and immutable manner, it is
something which can be updateable only with the consensus among the peers. It
is something which records all the transactions which have taken place between
the parties, those transactions are permanent in nature the copies of it are
distributed to all relevant parties without the need of the third party to
authorize the transaction. Whenever a new transaction takes place, it records
that transaction into a block and that block is built upon the previous block
and it is in this manner that all the data is stored. It is virtually
impossible to hack or modify as the blocks are interlinked and stored on the
multitude of the nodes. The information is this technology is shared across a
network of users who hold a full and updated copy of the records, the advantage
of this technology is that it replicates, stores and updates information on a
distributed ledger which makes it transparent.
There are application of
this technology in national Interest which was mentioned in the report of
Ministry of Electronics and Information Technology, this technology is equipped
with features of safety and security it can facilitate functioning of business.
The protection which Blockchain provides is visible in the use of Crypto
currencies and this can be used in the functioning of B2b, G2C, G2G, B2G
services. It has applications in the areas of healthcare, legal energy, smart
cities, trade finance, insurance, etc.it can be used in the national interest
as well Transfer of Land Records, Digital Certificates management, e-notary
service, farm insurance, Duty payments, Microfinance for self-help groups.
ICICI, Axis bank, Yes bank have adopted blockchain in their business.
Smart
Contracts:
Smart Contracts are the
luminary functionalities of blockchain technology, Christopher D Clark defines
it as an agreement whose execution is both automated and enforceable. It is
automated by the computer and some parts of it require human control and human
input. It is enforceable by either legal enforcement of rights and obligations
or tamper proof execution. Nick Sabzo who was the pioneer in the introduction
of the concept of the smart contract has defined the vending machine as simple
form of smart contract which happens in real life. When a person makes payment
to the vending machine an irrevocable action sets forth and the machine
enforces the terms of the deal by computing and dispensing customer’s
choice of product. For complex transaction advanced programming can be used, for
contractual obligations where payment and delivery has to be made, such can be
done by setting up an algorithm-based calculation. The advantage of using smart
contract is that it removes the need for verification based on the trust for
the execution of contractual obligations. It can used in the supply chain and
trade finance documentation by automating process.
In Smart contracts the
code constitutes the necessary part of the agreement and the contracts are
executed by the codes are just tool to execute human made contract and the
parties sign the agreement via a digital signature. Blockchain helps in the
creation of the smart contracts which are self-executing contracts where the
terms and conditions of the agreement are drawn up into the codes, the code and
agreement exist along a distributed, decentralized network which controls the
execution and transaction are trackable and irreversible. Under the tradition
system of contract that under the Indian Contract Act, 1872 a contract is said
to be executed when there is meeting of the minds of the parties and there is
consideration. The contract can be oral as well as written, written contracts
includes digital contracts as well which are written by humans and they are
signed through digital means by the parties to the contract. With the help of
blockchain technology it is possible to create smart contracts. Smart contracts
are just the manifestation of the tradition contracts but the only difference
is that it is in form of codes. The transactions which are recorded in ledger
can trigger clauses in smart contract which can control the real-life assets
like real estate, insurance claims, etc.
Internet of things are
those devices which are installed in the sensors, software, and other
technologies whose main
objective is to connect and exchange data over the internet and these devices
can range from ordinary household tools to complex industrial devices and
they have low memory power and low processing power. There smart homes
and smart environmental applications which are being built around the
blockchain technologies and when the smart contract integrates with the
blockchain then IOT can be more autonomous. Smart contracts can be used in the
financial services such as trade clearing and settlement as it managed approval
workflows between counterparties, calculates trade settlement amounts and
transfers funds automatically, insurance claims as it automatically indemnifies
the party who suffers the damage as its contingent to happening of the damage.
It can be used in life sciences and health care as well especially the
electronic medical records whose access can be provided and maintained between
parties. It can be used in technology, media and telecom for Royalty
distribution as it calculates and distributes royalty payments on the basis of
contract among the parties.
Smart
Contracts In Other Jurisdictions:
Italy was the first
country to legally implement smart contract in its jurisdiction, it came into
force in February 2019. Italian parliament introduced the concept of the
distributed ledger technologies (DLTs) in their law. It defines DLT as
technologies and IT protocols using a shared, distributed, replicable and
simultaneously accessible ledger, decentralized and encrypted which enables the
registration, validation, updating and storage of data regardless of its
encryption. Law degree No.135/2018 defines smart contract as “It is a DLT based
computer program where both the parties to a contract are bound to execute the
contract. The legislation in Italy will allows the smart contract to fulfill
the conditions that it has to be in writing upon electronic identification of
relevant parties.
In United states Arizona
was the first state to introduce smart contracts which was followed by the
other states like Delaware, Nevada and Vermont. The state of Arizona signed the
Smart Contracts Bill in 2017, it allows the blockchain
contracts and states that the contracts which are entered on the basis of
blockchain will not be void. It amended the Arizona Electronic Transactions Act
and gave recognition to the smart contracts. In the state of Nevada it made a
legislation which traced the usage if blockchain technology and give legal
effect to the smart contracts in 2017. This legislation made amendments to the
Nevada’s Uniform Electronic Transaction Act and it included the definition of
blockchain and electronic signature under NRS 710.100
Whether
There Is Scope Of Smart Contract In India:
Section 10 defines that
all agreements are contracts which are made by free consent of the parties for
a lawful object with lawful consideration and are not expressly declared void
by the law. If we look at this definition then the smart contracts can be
allowed as they fulfill the requirements mentioned in section 10. Section 2(h)
states that agreement which is enforceable by the law is contract.India has its
information Technology Act, 200 which talks about the electronic contracts.
Electronic contracts are recognized in India under multiple provisions of the
information technology Act. Section 10A of Information Technology Act, 2000
states that where in a contract formation, the communication of proposals, the
acceptance of proposals, the revocation of proposals and acceptances as the
case may be are expressed in electronic form or by means of an electronic
record, such contract shall not be deemed to be unenforceable solely on the
ground that such electronic form or means was used for that purpose. Smart
contracts can be considered as subsets within the Electronic contracts and their
validity should be recognized. The way in which the smart contracts are signed
are different from the traditional contracts. In traditional contracts the
parties sign it physically whereas in the smart contracts the signature is done
via electronic and cryptic means. The electronic and cryptographic signatures
are recognized in India., Section2(ta) of Information Technology Act, 2000
states that Authentication of any electronic record by a subscriber by means of
electronic technique specified in the second schedule and includes digital
signature. Digital signatures takes into consideration cryptographic signatures
and these type of signatures are used in smart contracts.
If we look at the
provisions of the Indian Contract Act we can establish that a smart contract
can be entered into by fulfilling all the valid essentials which are required
for a contract. Information Technology Act also allows e contracts to exist,
Section 10A and Section 2(ta) does provide enough basis to establish the
validity of the e contracts. But there are no clear legislative frameworks or
any provisions which substantially deals with the Smart contracts which uses
blockchain technology. The paper published by NitiAyog ‘Blockchain: The India
Strategy it talks about the use of the blockchain technology but provides no
clear map for the use of Smart contracts. It questions whether in smart
contracts can legal protection be afforded or can they be used in the same
manner as the traditional contracts or in case of breach or hack who can be
held liable. The legal regimes is yet to evolve regarding the area of smart
contracts. Smart contracts still
remain a grey area and
there is no clear regulated guidelines or framework which provides a legal
point of view for smart contracts.
If we are to contemplate concerning the scope of smart contracts in India, surely there is an immense scope. Various types of contracts can be regulated by smart contracts. Lets take an example of an insurance contract which can be regulated through a smart contract. Axa Fizzy is a type of smart contract of insurance. In this if a flight gets delayed it automatically compensates the policyholders. If a flight gets delayed for 2 hours it will reimburse the money automatically. Adoption of smart contracts can be revolutionary and help in facilitating the transactions with ease as its automated, safe and efficient.
Smart contracts in order
to be of any worth must be legally enforceable and they way in which they can
be enforced is through a legislation that is drafted and adopted by the state
with reference to it. The way in which smart contracts can be enforced is
through the legal enforcement or tamper-proof execution. A smart contract
should have binding in the court of law, it should be something which is recognized
by the state for enforcement of legal rights. Example lender can approach the
court for performance of the contract and the court can order the borrower to
fulfill his obligations, this will only be possible when it is recognized by
the state and courts have competent jurisdiction over it. another way in which
smart contracts are enforced is through the tamper-proof code but this is quite
complex when it comes to dealing with the real-life complex situations where
the delivery of the physical asset is required.
The use of Blockchain
technology is prevalent in India as NitiAyog has executed various use cases in
Blockchain technology and piloted them with various Government departments and
Private agencies. This shows the willingness of the Government to adopt this
technology and it’s a healthy indication towards the growth of smart contracts
in the country. The adoption of smart contract for functioning in Governance
has been mentioned in the Ministry of electronics and Information Technology,
where it has been mentioned that Inter-departmental processes can be tracked
using Smart Contract enabled workflows and shared ledgers which will increase
the transparency and accountability in the system. Blockchain technology can be
used for the purpose of making smart
contracts, supply chains
for various government processes, trusted inter-departmental communication and
tamper evident storage.
Recommendation has been
made for the need of National Level of Blockchain framework for the building
infrastructure which is spread across multiple zones to meet the requirements
of different application domains of the country, the proposed infrastructure
can help in hosting multiple blockchain platforms. Domain specific chains can
be used in health sector, Property chain and education as these chains would be
a shared ledger and can be controlled using smart contracts.
Conclusion:
India is a
developing country which has tremendous potential to grow especially in
the field of the technology, as we have witnessed, in the field of the
technology we should be able to adopt blockchain technology. This
technology is beneficial in several areas and we can also see that this can be
used in the legal world in relation to the contracts. Contracts can be
completed through the blockchain technology. while there are provisions which
allow for the execution of the contracts which are made electronically but
there is no clarity on the contracts which are made through blockchain
technology. Smart contracts are something which we are not aware of and we
exactly don’t know how it will function and how to settle disputes related to
it or what to do when it is hacked. In smart contracts the parties have no role
to play after their agreements has been codified then the codes will regulate
the execution of the contract. India can adopt these smart contracts for this
it needs clarify its stance in a coherent manner and determine what impediments
it will face, it is necessary to develop guidelines related to it. Several
jurisdictions around the world have adopted the smart contracts which uses the
distributed ledger technology and regulates the transaction. Italy was the
first country to adopt and recognize these types of contracts into its legal
system and seven states in the United States of America have adopted the
approach of smart contracts.
The use of smart
contracts will align with the policies which are being pursued by the
government which is aimed at making India a digitally advanced country. There
is a need for executive and legislative steps for recognize the importance of
the smart contract and to formulate the environment which will allow it to
exist and conduct its transactions. The benefits of the small contracts in the
fields of insurance, healthcare sector, supply chain, real estate, education,
automobile, etc. will allow them to work more efficiently by reducing the
transaction costs. Government should research on the legislations, in Italy and
those in seven USA states who have adopted these contracts. Understand its
advantages and disadvantages and find out solutions to issues which it would
face and then implement smart contracts in India as it will be a great step for
the citizens who can regulate their contractual transactions with ease as they
are automatically regulated via codes and also help in attracting foreign
investments. India is a country which is aligning itself with digitalization,
various programs and schemes have been launched by the Government to make India
a digital economy and the future of technology is Blockchain. If we want to
adopt to changing technologies, we must develop legislations which are able to
cater to the
blockchain technology.
There is no clear indication made in any legislations regarding the legitimacy
of smart contracts nor are there any other sources which points out its
legality or usage or illegality it’s a grey area. Research in this area has to
be done and Government can look into places where it is being applied and look
at the literature of smart contracts and frame rules and regulations to
implement in India. Although suggestions have been made for the creation of
National Level Blockchain framework for regulating various uses of Blockchain
including the use of Smart Contracts. It has to conduct research and identify
the issues which it will face in the performance, applicability, usage, privacy
and management of Smart Contracts. As Smart Contract is able to fulfill the
essentials which are required under the Indian Contract Act, it can be treated
as a contract and its in accordance with the Section10. Hence there is need for
more clarity on smart contract from the Government.