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Thursday, February 2, 2023

What are Smart Contracts and Are They Legal in India? – India Briefing

We explain how smart contracts are executed, how they differ from traditional and electronic contracts, and their treatment under current Indian laws.
A smart contract is any contract that is digitally equipped and that automatically executes the terms of an agreement by itself. The term describes computer program code that can facilitate, execute, and enforce the negotiation or performance of an agreement using blockchain technology.
To explain in layman’s terms, we can say that the smart contract is a tiny computer program that stores the terms and conditions of a contract inside a blockchain. This purely digital type of contract runs on blockchain nodes cannot be changed. So, basically any contract is a smart contract if they store rules, verify rules, and are self-executing and run in a decentralized manner.
The essential characteristics of a smart contract are as follows:
Section 10 of the Indian Contracts Act, 1872 states that a contract must satisfy basic elements – an offer, acceptance, intention, and consideration. Thus, smart contracts can be considered proper and valid contracts under Indian law.
While India does not have specific laws/statutes/regulation related to smart contracts, there are provisions under the Contracts Act, Evidence Act, and the IT Act, which can be applied to smart contracts. Yet, these create limitations for the use of smart contracts, as the legislation has not been updated to reflect technological developments
Section 107 of the Indian Contract Act, 1872 speaks about the essential nature of a contract – ‘all agreements are contracts if they hold the free consent of parties willing to contract, for a lawfully accepted consideration and with an object’. When the same is applied to smart contracts, we see that there is offer and acceptance, hence, it could be said that smart contracts are validated and enforceable under Indian law.
But offer and acceptance are basic in nature and can be proved easily. However, the consideration has to be a legal one – for example, are such contracts specifically recognized under the law.
The IT Act provides ‘that digital contracts are valid contracts and enforceable in the court. However, they should have the Digital or Electronic Signature by the Certified Authority authorized by the government.’ Here, smart contracts contradict this clause as it is decentralized in nature and there is no involvement of a government-controlled authority.
The Evidence Act provides in section 65B, ‘electronic contracts are admissible in a court of law’. However, there is a condition that these contracts must have a valid digital signature from the certified authority to prove their authenticity, which is mentioned in section 85B of the Indian Evidence Act. This again contradicts the requisites for a smart contract.
Function
Traditional contracts
Smart contracts
Nature
Physical contracts with printed documents.
Computer codes provided online. Digital in entirety.
Third-party interference
Needs third party representation for creation and enforcement of the contract.
No intermediaries are required.
Automatically executed.
Mutability
Can be misinterpreted by changing the originality of the contract.
Safe, secure and cannot be
changed after the transaction.
Time
Time consuming and may takes days to execute.
Automatically executed within minutes depending upon the contract.
Maintenance
Physical storage is another task for traditional contracts. High maintenance with safekeeping of the physical copy.
Physical storage is another task for traditional contracts. High maintenance with safekeeping of the physical copy.
Process
Manual
Automatic
Smart contracts work by following a simple “if/when…then…” statements that are written into code on a blockchain. We can briefly divide the process into three steps as stated below:
These contracts are mostly written in a programming language, Solidity (invented by Ethereum’s core contributors). It is imperative that they do precisely what the parties want them to do. The code behaves in predefined ways and doesn’t have the linguistic nuances of human languages. These codes are stored, verified, and executed on a blockchain.
As the transaction happens, a copy of the transaction is distributed to all the participants, say A, B and C, who validates the transaction in real time.
Here A, B, and C are a network of computers executing the actions by verifying them. The actions here could be anything related to sending notice, registering a plot, releasing funds, buying NFTs etc. This network of parties updates the blockchain after this transaction gets completed, which means that the transaction cannot be reversed or changed.
Parties to the contract can indeed add their own terms and satisfy their conditions before the transaction gets actioned. The parties have to agree at the ‘if, when…then’ stage and explore all the possible exceptions and define a framework for resolving disputes. All of this information is written on the blocks of a blockchain making the process fool-proof and secure.
Then this smart contract can be programmed by a developer – although increasingly, organizations that use blockchain for business provide templates, web interfaces, and other online tools to simplify structuring smart contracts.
No interference: Unlike traditional contracts, no intermediary, no broker, no third-party, not even a lawyer is required for smart contracts to be created or enforced.
Self-executing: Due to its automated nature, smart contracts have the potential to solve problems by themself.
Trust: Because of their decentralized nature, smart contracts have the tendency to facilitates trust, for example, in an international transaction between A & B, wherein A is in London and B is in Bengaluru, such contracts would be easier to use due to their automated and digital nature and encrypted records of transaction.
Speed, efficiency, and accuracy: As the contract is executed immediately after the transaction is done, there is no paperwork to process and it is done within minutes, providing a quick solution to manually filling in the documents in a traditional contract.
Transparency: As these contracts are coded, and cannot be altered, it creates transparency among the transacting parties.
Security: Due to the decentralized chain of transaction in the blockchain, wherein the records are encrypted, it is very hard to hack the contracts or personal information in the contract. A restrictive access is given to the parties only.
Savings: Unlike the traditional contracts, smart contracts remove the need for intermediaries to handle transactions and, by extension, their associated time delays and fees.
According to the Global Opportunity Analysis and Industry Forecast, 2021-2026, the market size for smart contracts was 106.7 million in 2019 and is estimated to reach 345.4 million by 2026.
Besides contract enforcement, technology can revolutionize the way contracts are performed. It is thus becoming more important for Indian government to act and frame the statutory guidelines for the use of blockchain technology and smart contracts.
Once appropriate regulation is in place, technology solutions and innovation can develop to provide highly functional and cost-effective outcomes and/or offer maximum utility – all while being secure and trustworthy and without contracting parties having to worry about legal liabilities.
For now, regulators and bureaucratic bodies within the Indian government have made some initial efforts to understand and enable the design and application of new technologies. Some of these are reflected in the table below:
Department/Board/Authority
Action
Ministry of Electronics and Information
Technology
National Policy on Software Products
(2019)
Telecom Regulatory Authority of India
In exercise of powers conferred by section
36 and section 11 of the Telecom
Regulatory Authority of India Act 1997.
Ministry of Commerce and Industry
·         Integrate to Innovate Programme for Energy Start-ups
·         Coffee Board activates blockchain based marketplace in India
Department of Banking Regulation Banking
Policy Division
Enabling Framework for Regulatory
Sandbox
(The author is an external contributor.)
About Us
India Briefing is produced by Dezan Shira & Associates. The firm assists foreign investors throughout Asia from offices across the world, including in Delhi and Mumbai. Readers may write to india@dezshira.com for more support on doing business in in India.
We also maintain offices or have alliance partners assisting foreign investors in Indonesia, Singapore, Vietnam, Philippines, Malaysia, Thailand, Italy, Germany, and the United States, in addition to practices in Bangladesh and Russia.
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