BLOCKCHAIN AND SMART CONTRACT IN INDIA

INTRODUCTION

?

With the advent of modern technology and innovation, we are moving towards a more digitised world where automation is the name of the game. The ideas surrounding the blockchain, artificial intelligence and big data are revolutionary and are poised to change the way business and human infrastructure operates. Today, these the concepts are closer to us than one might first think and stand to indelibly change our lives.

?

This brings us to a concept of smart contracts. Put simply, a smart contract is a self-executing contract that is triggered upon the happening of certain pre-determined events. The concept of a smart contract may be traced back to a paper authored by American computer scientist Nick Szabo in 1996, titled "Smart Contracts: Building Blocks for Digital Markets."[1] In the paper, Szabo explores the idea of embedding certain kinds of contractual clauses in the hardware and software of a computer program, which are structured in a way that breach of contract would be, possibly even prohibitively, expensive for the breaching party.?He explains this concept through the analogy of a vending machine, wherein smart contracts go through the machine to dispense the desired product: to operate a vending machine you would need to input a command (offer), you would need a certain amount of money (consideration), and then the machine will dispense the product (acceptance).?Fundamentally, if you use the same inputs to operate the machine, the same outputs shall be reached each time. Intrinsically, vending machines are automated machines, and as such, smart contracts are the automation of its software.

?

WHAT ARE SMART CONTRACTS

?

Today's smart contracts are programs that operate and are stored on a blockchain, that are self-executing and run when the encapsulated code, which contains certain predetermined conditions for the execution of the agreement, are met. This process is typically done by following simple "if/when.then." commands. Following Szabo's vending machine analogy,?if/when?someone inserts money and enters a certain command on the machine,?then?the product corresponding with the command so entered will be automatically dispensed by the machine, successfully executing the contract. Modern day smart contracts operate on the blockchain, which is a public electronic ledger that creates an immutable record of transactions by way of a distributed and decentralised network of computers. Each transaction recorded on this network is entered into an encoded 'block', which is a set of information. Each block can store a certain amount of data per block, and once a block is filled it will be closed and all following data will be stored in a succeeding block. Each new block is connected to a previously filled block, forming a chain of blocks, or a blockchain. The entirety of this data stored creates the electronic ledger that we now know to be the blockchain, an immutable and transparent public record of information, which may be accessed at any time. Given that contemporary smart contracts operate on a blockchain, they imbibe some of the properties of a blockchain, including immutability, meaning they cannot be modified once they have been created.

?

Smart Contracts are a set of blockchain-based codes that execute themselves when certain conditions are met. In layman’s terms, they define a contract’s rules and regulations and automatically carry out the specified tasks when the requirements are met. They are known as ‘If’ and ‘Then’ programs in computer language. “If” something happens, “then” that should be executed. Smart Contracts are also known as “E-contracts.”?

?

The Validity of contracts formed through electronic [i.e., Smart Contracts] means in India can be derived from?Section 10A[2]?of the?Information Technology Act,2000. Smart contracts are treated the same as regular paper contracts, if they meet all of the essential conditions for the enforcement of a valid contract under the Indian Contract Act of 1872.

?

The?IT Act, 2000?overall does not apply to:?

?

1.?????????????Negotiable Instruments?

2.?????????????Power of Attorney

3.?????????????Will

4.?????????????Trust Deeds

5.?????????????Any agreement for sale or conveyance of immovable property.

?

APPLICABILITY OF INDIAN LAW

?

In the Indian context, we have had a chequered past with blockchain application, starting with the 2018 ban on using virtual currencies[3],?to the quashing of this notification by the Honourable Supreme Court[4], to talks of a Central Bank Digital Currency. Under the existing legal framework for contracts, a valid contract must satisfy the fundamental criteria of contract formation, being offer, acceptance and consideration. The Indian Contract Act, 1872 ("Contract Act") necessitates the existence of a party's indication of their willingness to do or not do something, for the purpose of gaining another party's assent for that act or omission[5].?For smart contracts, the language of the self-executing code shall indicate the existence of intention to contract with another party, and the act of publishing that line of code for a single smart contract on any blockchain, would amount to the communication of an?offer. Next, the assent, of another party, to the terms outlined in an offer amount to acceptance of that offer[6].?For the execution of a smart contract, it is imperative that the other party/ies carry out certain tasks or functions that the contract necessitates. As such, any party who performs the requisite functions, as outlined by the code for the execution of the smart contract (be it by way of inputting certain commands in a vending machine), shall have?accepted?the offer. Finally, as per the Contract Act, consideration includes any act done for the benefit or interest of a party or may be qualified by some detriment or loss suffered by the other party[7]. In the context of a smart contract, given that only?if/when?the act outlined in the code is carried out, only?then?shall the contract be executed. Therefore, the performance of the conditions envisaged by the code of the smart contract shall amount to valid consideration. Further, the Contract Act states that, "all agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not hereby expressly declared to be void."[8] Given that smart contracts may only be executed when the predetermined conditions envisaged and encapsulated under the code are met, the parties seeking to enter into an agreement under that smart contract would thus have to have consented to the execution of the terms of the for the code (or smart contract) and thus would have agreed to enter into that contract.

?

Further, the Indian Evidence Act, 1872 ("Evidence Act") recognises "information stored, recorded or copied in optical or magnetic media produced by a computer" to be a document admissible as evidence[9]. While, under the Contract Act, a smart contract may be a valid contract, and the Information Technology Act, 2000 ("IT Act") additionally recognises electronic contracts as valid[10]?Indian law relating to electronic records and contracts may not apply to smart contracts. Per the Evidence Act, an electronic contract is only considered a valid agreement if it is authenticated by way of an electronic signature, as obtained in accordance with law[11].?Further, these digital signatures are only legally recognised and enforceable under the IT Act[12], if they are created in accordance with the rules made by the Central Government[13].?However, while each smart contract on any blockchain may be specifically identifiable to the contracting parties, these identifiers don't employ digital signatures in the form that Indian law requires, and thus may not enjoy the status of electronic contracts under Indian law.

?

DIFFERENCE BETWEEN SMART CONTRACTS AND TRADITIONAL CONTRACTS

?

Traditional contracts require someone to enforce them; smart contracts, on the other hand, are programs that execute exactly as they are set up (coded, programmed) by their creators. This way, all participants can be certain of the outcome right away, without the involvement of an intermediary or the loss of time. Smart Contracts can also automate a workflow by automatically triggering the next action when certain conditions are met.

?

Smart contracts are enforceable by code in the same way that traditional contracts are. In a nutshell, smart contracts allow people to transact with greater trust, speed, and security.

?

TYPES OF SMART CONTRACTS

?

There are five types of Smart Contracts, they are as follows:?

?

1.????????????Shrinkwrap agreements

?

Shrink Wrap Contracts are typically licensing agreements for software [Agreements packaged with products]. In general, the term Shrink Wrap Agreements refers to boilerplate or license agreements, as well as the terms and conditions that come with the products. The consumer’s acceptance of the contract in this sort of contract is determined by his or her use of the product.

?

2.????????????Clickwrap agreements

?

The term Click Wrap Agreements means giving consent for any purpose or for not giving consent for any purpose by clicking the button. [i.e., “Accept” or “Reject”]

?

3.????????????Browse wrap agreements

?

The term Browse Wrap Agreements means to use materials available on a website or to have access to the downloadable product. The individual can only access the contents of the web page if he agrees to the terms and conditions on the web page.

?

4.????????????E-mails

?

Emails can also be electronically signed, which is a crucial factor in determining whether an agreement becomes a contract. Smart Contracts which are executed through e-mails have been ruled in several cases, to constitute a legally binding contract.

?

For example, in the case of?Trimex International FZE vs. Vedanta Aluminium Limited[14], the Supreme Court has ruled on?the validity of an unregistered and unsigned contract discussed by email, confirming the contract’s enforceability via email.

?

5.????????????Digitally executed agreements

?

Electronic signatures are the digital and verified equivalents of traditional wet signatures. Electronic signatures are used to sign documents online in one of two methods –

?

·???????????Aadhaar-based digital signatures with an OTP?

?

·???????????Digital signatures that use an asymmetric public key system and hash methodologies and allow users to sign documents with a password.

FEATURES OF SMART CONTRACTS

?

1.????????????Distributed and transparent

?

Smart contracts are maintained on a blockchain, they operate on a peer-to-peer network, which means they are dispersed among all nodes running the blockchain and anybody can read the contract’s information.

?

2.????????????Customisable

?

Before implementation, smart contracts can be programmed in a variety of ways to meet the demands of the transacting parties.

?

3.????????????Deterministic

?

No matter who executes smart contracts, the outcome is always the same depending on the actions they are designed to perform.

?

BENEFITS OF SMART CONTRACTS

?

1.????????????Automation

?

Smart Contracts can help to automate a lot of processes.

?

2.????????????Efficient

?

Since the contracts are saved on computers, they carry out the functions as soon as the prerequisites are met.

?

3.????????????Security and storage

?

The contracts are recorded digitally on a blockchain, they are protected by encryption, and the possibility of losing or misplacing them is eliminated.

?

4.????????????Immutable

?

Contracts that have been deployed cannot be modified, thereby?removing the possibility of manipulation by other parties or any of the parties participating in the agreement.

?

5.????????????Cheaper

?

Intermediaries typically charge a fee to facilitate transactions between two parties, which will be significantly reduced, if not eliminated, with smart contracts.

?

LIMITATIONS OF SMART CONTRACTS

?

1.????????????Inability to adjust

?

Smart contracts are immutable, any errors or flaws in the contract cannot be fixed after they are stored on the blockchain. Contracts can be cancelled if a ‘SELF-DESTRUCT’ function is introduced while they are being created.

?

2.????????????Software bugs

?

Since all the data is stored in computer codes, it may be prone?to software faults.

?

3.????????????Third-party

?

Smart contracts cannot completely replace third parties as some processes do require human intelligence that cannot be replaced.

?

4.????????????Vague terms

?

Since contracts include terms that are not always understood, smart contracts are not always able to handle terms and conditions that are vague.

?

VALIDITY & ENFORCEABILITY OF SMART CONTRACTS

?

As per?Section 10[15]?of?the Indian Contract Act, 1872, the following criteria must be satisfied for a legitimate contract:?

?

1.????????The parties to the contract must be?competent[16]?to contract

?

2.????????The Parties must be of Sound Mind[17]

?

3.????????????The Contract must be based on the?free consent[18]?of the parties.

?

4.????????????The Consideration and Object must be lawful[19], and

?

5.????????????The Agreement must not be expressly declared to be?void

?

The?Indian Contract Act,1872?shows no evidence of the following requirements:

?

(1)?????????A written contract unless there is a legal requirement to have a contract in writing;?

?

(2)?????????A signature either physically or electronically.

?

Thus, Smart Contracts are enforceable in India if they meet the criteria.?

?

CONCLUSION

?

There is little doubt that the real-world applications of this technology, such as in cases of maintenance of land records thereby avoiding title fraud, have the potential to automate and streamline processes and systems that are notoriously difficult to navigate, and perhaps even help lessen the burden of title disputes from our judicial system. However, smart contracts come with a plethora of regulatory and policy issues, including problems of jurisdiction and the potential of fraud arising out of the anonymity of the process of executing a smart contract. While the theoretical benefits of employing blockchain technology and automating contracting, at least in certain areas, can't be denied, concerns with such application still exist, and, at the very least, the Indian regulatory framework would need to be amended and aligned to govern smart contracts.

?

[1] Szabo, Nick, "Smart Contracts: Building Blocks for Digital Markets". 1996. Available at?https://www.fon.hum.uva.nl/rob/Courses/InformationInSpeech/CDROM/

Literature/LOTwinterschool2006/szabo.best.vwh.net/smart_contracts_2.html

[2] Section 10A of the IT Act

Validity of contracts formed through electronic means. -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.

[3] "Prohibition on Dealing in Virtual Currencies". Reserve Bank of India. April 26, 2018. Available at?https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11243

[4] Internet and Mobile Association of India v. Reserve Bank of India, 2020 SCC online SC 275

[5] Section 2(a) of the Contract Act

When one person signifies to another his willingness to do or to abstain from doing anything, with a view to obtaining the assent of that other to such act or abstinence, he is said to make a proposal

[6] Section 2(b) of the Contract Act

When the person to whom the proposal is made signifies his assent thereto, the proposal is said to be accepted. A proposal, when accepted, becomes a promise

[7] Section 2(d) of the Contract Act

?When, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration for the promise

[8] Section 10 of the Contract Act

What agreements are contracts

All agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not hereby expressly declared to be void.

Nothing herein contained shall affect any law in force in?1?India and not hereby expressly repealed by which any contract is required to be made in writing2?or in the presence of witnesses, or any law relating to the registration of documents.

[9] Section 65B of the Evidence Act

Admissibility of electronic records.—

(1)???????????Notwithstanding anything contained in this Act, any information contained in an electronic record which is printed on a paper, stored, recorded or copied in optical or magnetic media produced by a computer (hereinafter referred to as the computer output) shall be deemed to be also a document, if the conditions mentioned in this section are satisfied in relation to the information and computer in question and shall be admissible in any proceedings, without further proof or production of the original, as evidence of any contents of the original or of any fact stated therein of which direct evidence would be admissible.

(2)???????????The conditions referred to in sub-section (1) in respect of a computer output shall be the following, namely:—

(a)???????????the computer output containing the information was produced by the computer during the period over which the computer was used regularly to store or process information for the purposes of any activities regularly carried on over that period by the person having lawful control over the use of the computer;

(b)???????????during the said period, information of the kind contained in the electronic record or of the kind from which the information so contained is derived was regularly fed into the computer in the ordinary course of the said activities;

(c)???????????throughout the material part of the said period, the computer was operating properly or, if not, then in respect of any period in which it was not operating properly or was out of operation during that part of the period, was not such as to affect the electronic record or the accuracy of its contents; and

(d)???????????the information contained in the electronic record reproduces or is derived from such information fed into the computer in the ordinary course of the said activities.

(3)???????????Where over any period, the function of storing or processing information for the purposes of any activities regularly carried on over that period as mentioned in clause (a) of sub-section (2) was regularly performed by computers, whether—

(a)???????????by a combination of computers operating over that period; or

(b)???????????by different computers operating in succession over that period; or

(c)???????????by different combinations of computers operating in succession over that period; or

(d)???????????in any other manner involving the successive operation over that period, in whatever order, of one or more computers and one or more combinations of computers, all the computers used for that purpose during that period shall be treated for the purposes of this section as constituting a single computer; and references in this section to a computer shall be construed accordingly.

(4)???????????In any proceedings where it is desired to give a statement in evidence by virtue of this section, a certificate doing any of the following things, that is to say,—

(a)???????????identifying the electronic record containing the statement and describing the manner in which it was produced;

(b)???????????giving such particulars of any device involved in the production of that electronic record as may be appropriate for the purpose of showing that the electronic record was produced by a computer;

(c)???????????dealing with any of the matters to which the conditions mentioned in sub-section (2) relate, and purporting to be signed by a person occupying a responsible official position in relation to the operation of the relevant device or the management of the relevant activities (whichever is appropriate) shall be evidence of any matter stated in the certificate; and for the purposes of this sub-section it shall be sufficient for a matter to be stated to the best of the knowledge and belief of the person stating it.

(5)???????????For the purposes of this section,—

(a)???????????information shall be taken to be supplied to a computer if it is supplied thereto in any appropriate form and whether it is so supplied directly or (with or without human intervention) by means of any appropriate equipment;

(b)???????????whether in the course of activities carried on by any official information is supplied with a view to its being stored or processed for the purposes of those activities by a computer operated otherwise than in the course of those activities, that information, if duly supplied to that computer, shall be taken to be supplied to it in the course of those activities;

(c)???????????a computer output shall be taken to have been produced by a computer whether it was produced by it directly or (with or without human intervention) by means of any appropriate equipment.

Explanation.—For the purposes of this section any reference to information being derived from other information shall be a reference to its being derived therefrom by calculation, comparison or any other process.

[10] Section 10A of the IT Act

Validity of contracts formed through electronic means. -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.

[11] Section 85B of the Evidence Act

Presumption as to electronic records and electronic signatures —

(1)???????????In any proceedings involving a secure electronic record, the Court shall presume unless contrary is proved, that the secure electronic record has not been altered since the specific point of time to which the secure status relates.

(2)???????????In any proceedings, involving secure [electronic signature], the Court shall presume unless the contrary is proved that—

(a)???????????the secure [electronic signature] is affixed by subscriber with the intention of signing or approving the electronic record;

(b)???????????except in the case of a secure electronic record or a secure [electronic signature], nothing in this section shall create any presumption, relating to authenticity and integrity of the electronic record or any [electronic signature.

[12] Section 5 of the IT Act

Legal recognition of?electronic signature - Where any law provides that information or any other matter shall be authenticated by affixing the signature or any document shall be signed or bear the signature of any person, then, notwithstanding anything contained in such law, such requirement shall be deemed to have been satisfied, if such information or matter is authenticated by means of?electronic signature affixed in such manner as may be prescribed by the Central Government.

Explanation.- For the purposes of this section, "signed", with its grammatical variations and cognate expressions, shall, with reference to a person, mean affixing of his hand written signature or any mark on any document and the expression "signature" shall be construed accordingly.

[13] Section 10 of the IT Act

Power to make rules by Central Government in respect of electronic signature].—

The Central Government may, for the purposes of this Act, by rules, prescribe —

(a)???????????the type of electronic signature;

(b)???????????the manner and format in which the electronic signature shall be affixed;

(c)???????????the manner or procedure which facilitates identification of the person affixing the electronic signature;

(d)???????????control processes and procedures to ensure adequate integrity, security and confidentiality of electronic records or payments; and (e) any other matter which is necessary to give legal effect to [electronic signatures.

[14] 2010 (1) SCALE 574

[15] What agreements are contracts

All agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not hereby expressly declared to be void.

Nothing herein contained shall affect any law in force in?1?India and not hereby expressly repealed by which any contract is required to be made in writing2?or in the presence of witnesses, or any law relating to the registration of documents.

[16] Section 11 of the Indian Contract Act

Who are competent to contract.

Every person is competent to contract who is of the age of majority according to the law to which he is subject?, and who is of sound mind and is not disqualified from contracting by any law to which he is subject

[17] Section 12 of the Indian Contract Act

What is a sound mind for the purposes of contracting.

A person is said to be of sound mind for the purpose of making a contract, if, at the time when he makes it, he is capable of understanding it and of forming a rational judgment as to its effect upon his interests.

A person who is usually of unsound mind, but occasionally of sound mind, may make a contract when he is of sound mind.

A person who is usually of sound mind, but occasionally of unsound mind, may not make a contract when he is of unsound mind.

Illustrations

(a)???????????A patient in a lunatic asylum, who is at intervals of sound mind, may contract during those intervals.

(b)???????????A sane man, who is delirious from fever or who is so drunk that he cannot understand the terms of a contract, or form a rational judgment as to its effect on his interests, cannot contract whilst such delirium or drunkenness lasts.

[18] Section 14 of the Indian Contract Act

Free consent" defined.

Consent is said to be free when it is not caused by--

(1)??????coercion, as defined in section 15, or

(2)??????undue influence, as defined in section 16, or

(3)??????fraud, as defined in section 17, or

(4)??????misrepresentation, as defined in section 18, or

(5)??????mistake, subject to the provisions of sections 20, 21 and 22.

Consent is said to be so caused when it would not have been given but for the existence of such coercion, undue influence, fraud, misrepresentation or mistake.

[19] Section 24 of the Indian Contract Act

Agreements void, if considerations and objects unlawful in part.—

If any part of a single consideration for one or more objects, or any one or any part of any one of several considerations for a single object, is unlawful, the agreement is void.

Illustration A promises to superintend, on behalf of B, a legal manufacture of indigo, and an illegal traffic in other articles. B promises to pay to A a salary of 10,000 rupees a year. The agreement is void, the object of A’s promise, and the consideration for B’s promise, being in part unlawful.