Open Access Research Article
SMART CONTRACTS: MAKING INDEMNITY AND GUARANTEE TRUSTLESS.
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Article Details
SMART CONTRACTS: MAKING INDEMNITY AND
GUARANTEE TRUSTLESS.
BY -
ARYAMAN KUMAR
20011069.
Instructors
Professor
Pooja Singh.
Professor
Anjali Chawla.
2nd
November 2021
1.
INTRODUCTION: -
It is a popular opinion amongst many that Smart
Contracts is in its nascent stages, but many commercial companies, financial
giants and governmental organizations including the Indian government have
already started experimenting and auditing the blockchain technology to
leverage its applications, like Smart contracts into building a sound digital
infrastructure, capable of revolutionizing mortgages, loans, insurance, and
global trade.
a)
What is Blockchain?
The blockchain, simply put is a shared database, which stores
its information in sets, called blocks. These blocks once formed, are then
chained onto an existing ‘set of information’ thus, making a chain of data
called the blockchain. Unlike tables in traditional databases, the blockchain
stores data in blocks, this way of storing data makes this database immutable
i.e., once a block is formed, it is set in stone and can never be changed. The key elements of
a blockchain are immutability and decentralization.
b)
What are Smart Contracts?
A Smart Contract is a computer program which exists within a blockchain. Put simply, a Smart Contracts are just like
contracts in the real world, only they are completely digital and since Smart
Contracts exist on the blockchain, they inherit some interesting properties
i.e., they are immutable and distributed. A very successful and primitive
example of a smart contract functioning in real life is a vending machine which
releases Pepsi. The machine has been programed to search for $1 eternally. When
the machine recognizes a $1 bill, it self-executes to dispense a can of Pepsi.
This machine functions on a very simple If/Then program i.e., if recognize $1 then release
one can.
It is important to note that even though a smart contract
works on the fundamentals of an If/Then protocol, a Smart Contract is also
capable of running multiple and highly complex protocols depending on the needs
of the contract, however for simplicity’s sake, we will restrict our discussion
and examples to the If/Then protocol. The Pepsi transaction essentially got rid
of, ‘cashier the middleman’, where earlier there was a contract between the
cashier and the customer, wherein the customer trusted the cashier to
keep his end of the bargain in the transaction, now due to the introduction of
the vending machine this process was essentially made, trustless.
c)
Legal enforceability of Smart Contracts in India.
According to S. 2(h) of the Indian Contract
Act, 1872, “an agreement enforceable by law is a contract.”. Thus, Smart
Contracts are legal contracts in the sovereignty of India only if: -
i.
The agreement between two parties is the consequence of
the proposal of an offer by the offeror and the acceptance by the offeree, the
specifics of which we will discuss subsequently.
ii.
All parties entering a Smart Contract must be competent
to contract.
iii.
The consideration and object of contract must be
lawful.
iv.
The consent of all involved parties must be free.
In case
of acceptance, the submission of cryptographic
keys by the parties while entering a Smart Contract can be viewed as acceptance
or the offeree can express acceptance by their conduct, like handing over
control of a digital asset like NFT’s,
or cryptocurrency or even fiat currencies (if
RBI recognizes INR as a digital asset under S. 26 of the Reserve
Bank Of India Act, 1934). This agreement will be legally enforceable if the
agreement has lawful object and consideration, the consent of the parties was
free, and the parties are at the age of majority. Hence, a smart contract is
easily enforceable under the ambit of the Indian
Contract Act, 1872 if it follows the core principals of the act. In fact,
Smart Contracts can be deployed through the existing digital infrastructure
in India, the Courts can already start exploring the nuances of smart contract
and interpret their validity in line with the Indian Contract Act, 1872. It is
imperative to understand that commercial transactions done via email, software,
click-wrap contracts are already legally enforceable because the Indian
Contract Act is supported by the Information
Technology Act, 2000, and Smart Contracts can easily be regulated under the
same. However, the Indian legal system is slow to adapt by design, and there
are a lot of kinks to sort out while regulating Smart Contracts.
PHASES
OF THE CREATION OF A SMART CONTRACT.
(Flowchart 1)
|
Formation
|
|
Basal Contract is
made.
Clauses are
codified.
|
|
Acceptance?
|
|
Execution
|
|
Contract
rejected.
|
|
Automated
Execution
|
|
Off-chain
Execution.
|
|
Code Correction
and checking.
|
|
Modification
|
|
Data is fed manually into the Smart Contract.
|
|
Automated Data like GPS, IoT, UTS etc.
|
|
Oracle
|
|
All clauses
functioning?
|
|
Execute Contract
|
|
Deposit Digital
Asset
|
|
Fix Contract
|
|
Communicate
Resolution
|
|
End Procedure
|
|
Yes
|
|
No
|
|
No
|
|
Yes
|
2.
SMART CONTRACT OF INDEMNITY & GUARANTEE
a)
Applications in a Contract of Indemnity.
i. Regular
Crop Insurance: -
In the land of a 100 million farmers, the best example to put
Smart Contracts to the test is crop insurance. Let’s say a farmer wanted crop
insurance against the possibility of drought. This contract would come under S.
124 of The Indian Contract Act, 1872, where an insurance firm promises to
indemnify the farmer against the possibility of a drought. In the event of a
drought the farmer would have to go to the insurance company to claim his
insurance citing the reason of no rainfall, and the insurance company will do
their own due diligence to verify the claim before processing it.
ii. Smart
Crop Insurance: -
In this case the farmer would enter a contract of indemnity
with an insurance company, wherein the insurance company will indemnify the
farmer against the possibility of no rainfall. Here, the smart contract will be
coded into a blockchain, it will be something like.
|
Defined event:
Crop Insurance.
|
|
Payout = Full
Insurance amount.
|
|
If farmer pays regular premiums.
|
|
If Rainfall <
20mm
|
|
If Rainfall >
20mm for 3 months
|
|
Payout = Nil.
|
|
Oracle
|
|
Then
|
But how does a computer program in the blockchain know if it
rained or not? That’s where Oracles come in, both parties will mutually decide
on a trusted oracle which provides accurate weather data on the farmer’s land.
As and when all the ‘If’ conditions are met, the smart contract will
automatically self-execute the ‘Then’ conditions i.e., paying the farmer the
insured amount instantaneously.
iii. Car
insurance: -
The same way we can revolutionize car insurance. However, as
you can imagine with damage to a car being subjective, it is a far more
complicated to code a Smart Contract, in such cases one can enter a Hybrid
Smart Contract, where the insurance company can payout insurance
instantaneously for a certain cap under clearly defined terms like “IF car license
plate reported to be in a police oracle, THEN payout a predetermined lumpsum.”,
the insurance company could codify all their terms into a smart contract and
deploy it onto a blockchain, drastically reducing their companies workforce.
While the other half of the contract with a client can be a traditional
contract, where an agent assesses the damage and releases the requisite fund.
|
Defined event:
Car Insurance.
|
|
Payout = 15,000.
|
|
If car owner pays regular premiums.
|
|
If no FIR
detected
|
|
If UP15E 1360 detected in any FIR
|
|
Payout = Nil.
|
|
Oracle
|
|
Then
|
b)
Applications in a Contract of Guarantee
i Bank guarantee:
-
A bank guarantee is considered as the "life-blood"
for the purpose of trade, and thus it is imperative to have a frictionless bank
guarantee system. Today’s bank guarantee has an applicant rely on long paper
workflows, which makes issuing guarantee a tedious back and forth process
between the creditor and the bank, these paper contracts are also prone to
forgery and destruction by the elements. Also, paper contracts are extremely
cumbersome to manage and store and takes weeks to process, time which the
debtor could have used to open their business or time the creditor is on
standby for providing lease etc. Furthermore, anytime interest rates change, or
a lease has to be extended, the bank must issue a new guarantee, negotiating
each change which is a time-consuming and unpleasant procedure. All parties
i.e., banks, landlords (creditors), and renters (debtors) are at a disadvantage
with the current system of contracts.
Within the ambit of Smart Contracts all parties can come on a
single blockchain platform, and the debtor can request a guarantee online,
where the creditor can join in and set their specific terms of the contract,
and subsequently the bank can go over the credit worthiness of the applicant as
well as the terms of the creditor and get back to both parties simultaneously
saving a lot of time. This is when a Smart Contract will start being coded
(refer to flowchart 1), and here a Smart Contract also satisfies the need for a
multilateral solution with data sharing, reconciliation, and synchronization
among all parties. This tripartite conversation can now happen digitally with
no paperwork, this conversation significantly reduces the time it takes for the
contract to be enforced, as it cuts down the process from around 30 days to 1
day.
Now, let’s take the example of a principal debtor who is
looking to lease a commercial property but instead of cash deposits or rental
bonds, chooses a bank guarantee to indemnify the creditor, all parties proceed
to the bank, where the bank provides a service for the creditor to put forth his/her
terms, and then the bank may proceed to ask for collateral from the debtor,
this collateral will be codified into the contract as a NFT, as a matter
of fact, an NFT can represent any particular asset in the real world, a
diamond, a plot of land etc. An NFT can represent the title of an immovable
property off the blockchain. And if the bank agrees to being the surety, then
the terms of the agreement will be codified into the smart contract following
the procedure of flowchart 1.
3.
THE BOON AND BANE OF SMART CONTRACTS
a)
Boon of Smart Contract
i.
Self-enforceable – the SC executes the
moment the parties fulfill their conditions. Does not require any trust to execute a
contract, thus does not need court of law for it to be enforced. For example The
self-execution of the Smart contract works in everyone’s favor when it comes to
a Bank Guarantee, as Indian courts don’t interfere unless there is a fraud of a
‘shocking’
nature.
ii.
Low Cost – Smart Contracts cut out on all
intermediaries and leave only the contracting parties, this includes charges
like, drafting, due diligence, contract management etc. this also saves on the
fee charges by various govt. offices and especially gets rid of the corrupt
‘babu’ system.
iii.
Time saving – the time it takes to draft a
Smart contract which uses digital records already stored on the blockchain is
far less than the time it takes to draft a conventional contract with annexures
etc.
iv.
Certainty – due to the simplicity of
smart contract and no scope for ambiguity, or ambiguous terms. It will simply
function on the action/omission which either fulfills the pre-specified
conditions or not. This simple If/Then formulation reduces human error significantly.
v.
Security – A Smart Contract can’t be
hacked because of blockchain technology.
vi.
Guaranteed outcome – all codes are run on
a test net before launching into the real world, thus both parties can run
through all possible permutations of the outcome given the terms of the
contract. Thus, all parties know what the end goal through their acts/omissions
will be and once the Smart Contract is deployed there is no recourse to alter
it.
b)
Bane of Smart Contract
i.
Middlemen – The need for lawyers and
coders will only increase, and the availability of lawyers with knowledge in
coding are scarce, making the initial adoption cumbersome.
ii.
Certainty – Smart Contracts remain unregulated
for now, and due to their international nature; it is hard to determine
jurisdiction in case of a conflict.
iii.
Rigid – Once deployed the contract and
its terms ergo its outcome is irreversible and inevitable. The fundamental
legal concepts of ‘good faith’, ‘negligence’ and ‘reasonableness’ are also very
difficult to encode. These concepts are employed for the very reason that they
give contracting parties flexibility in respect of certain obligations by not
specifically determining in advance exactly what those obligations entail.
iv.
Non-disclosure – Since the smart
contracts resides on the block chain, it inherits all the properties of the
blockchain, resulting in fact that the contents and progress of the Smart
Contract can be viewed by anyone on the network, but can’t be altered. Thus,
Contracts with sensitive contents can’t be deployed.
v.
Popularity – The authorities of India are
surprisingly very well educated and the Indian government is already looking
into the potential use cases of smart contracts, with academic papers released
by NITI
Aayog we can expect a well-regulated space in the future, however public
knowledge still remains low.
c)
Ways to ease the transition to Smart Contracts.
i. A solution to
ease the resistance the Indian Legal system may face during the adoption of
Smart Contracts is to draft a traditional legal contract and ‘translate’ it to
code, so that the traditional legal contract acts as a ‘wrapper’ to the
automatic performance of the legal obligations executed by the smart contract.
Thus, till the courts learn to interpret the code of Smart Contracts, the
traditional contract can be used to resolve disputes among parties by
interpreting the disparity between the word of the law and the execution of the
code.
4.
CONCLUSION
Smart Contracts
has its fair share of challenges; however, it will save a considerable amount
of time, cost, and effort for all players. The legality of Smart Contract has
not been confirmed by any legal or governing body so far, but the architecture
of the Indian Contract Act, 1872 and Information Technology Act, 2000 allows
Smart Contracts to function within their ambit. Smart Contracts have made vital
trade transactions trustless and have the potential to redefine the
applications of the contract of Indemnity and Guarantee by streamlining the
contract from its inception to its execution.
Even though
India’s legal space is slow to adapt, the legal and digital Infrastructure is
‘modern enough’ to cope up with the bleeding edge the blockchain has to offer.
Article Information
SMART CONTRACTS: MAKING INDEMNITY AND GUARANTEE TRUSTLESS.
Authors: ARYAMAN KUMAR
- Journal IJLRA
- ISSN 2582-6433
- Published 2024/04/16
- Issue 7
About Journal
International Journal for Legal Research and Analysis
- Abbreviation IJLRA
- ISSN 2582-6433
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