Smart Contracts & Blockchains in Supply Chains & Projects, the dire need for legislation

?~ second article in a series on the use of blockchain technology in supply chain and project management

Blockchain technology has been powering the Bitcoin since its inception. It is an ingeniously simple technology that has immense potential for use in supply chains and projects. It is a public ledger to which everyone has access. However, at the same time, no single individual or entity can control it. The technology allows companies and individuals to collaborate with an unprecedented degree of trust and transparency. Despite being cryptographically secure, it is fundamentally open. Blockchain technology is a revolution that begun already and will change the world. Its impact on supply chains and projects will be unprecedented. Governments around the world need to be aware of its potential and legislation is needed to give it legitimacy.

As early as in 1994, Nick Szabo, a legal scholar and cryptographer found that decentralized nature of cryptography could be used in smart contracts. These are basically self-executing contracts and ensure the performance of virtual agreements through blockchain technology. They provide a hassle-free execution of agreements made between parties. The main property of blockchain technology is its decentralized nature. This is because it takes away the requirement of intermediaries. This, in turn, saves a lot of time and prevents any conflict that may arise due to a third party. A smart contract is a self-performing contract. The terms of the agreement that exist between a buyer and a seller are written directly into lines of code. A distributed, decentralized blockchain network contains the code, which consists of all the agreement terms. In addition to the agreements, the code also consists of information that executes the transactions and ensures that these transactions are tracked and are irreversible.?

A smart contract can therefore be termed as mainly a type of computer protocol. It digitally performs the function of facilitation, verification as well as enforcement. In other words, the performance of the contract is self-enforced and digitally recorded. Here are the key factors of smart contracts:

• The smart contract, once released, can’t be altered by anyone. No one can change its terms, not even the creator or owner
• The execution and completion of a smart contract does not require physical preparation and/or submission of documents
• Users can and may be anonymous but, the transaction details are recorded and registered
• Transactions of smart contracts can’t be revered

Smart Contracts & How They Work

The terms and conditions of a smart contract are engraved in the code itself. Typically, a smart contract interprets, verifies, and automatically executes any transaction laid down in the terms and conditions. Let us take a rental contract, for example. When it is made into a smart contract, we will see its efficacy and effectiveness. The tenant pays the rent to the house owner in cryptocurrency. As soon as the payment is made the code carries out the transactions in accordance with the terms of the contract as entered into the code. The landlord receives an advice when the transaction is successful and will issue a receipt. The first-time deposit and advance that are paid will lead to the release of the house key. The system operates on the If-Then principle. Whoever is involved in the blockchain will observe the transaction and become a witness to the contract. The record of payment and key release is visible to all concerned. One action will not be completed without the other. What could be a more efficient and effective system than this?

Smart contracts specify the rules and penalties related to an arrangement in the same manner and format as a conventional contract. They also implement those obligations automatically. The contracts are implemented using a platform, which consists of two elements, currency and contracts. Smart contracts are essentially agreements in electronic form rather than paper. So, the question is ~ what is its legal status? Can they still be regulated by the existing legal framework? Do they require a new legal system to govern them? We shall see.

Secured Transactions & their Benefits: With smart contracts transactions can be carried out and terms can be enforced seamlessly between the parties concerned. The concept of a smart contract is that while one person gains something of value in return to the second party being paid. The absence of intermediaries makes it easy to enforce. In the non-smart era, implementation wouldn’t be as seamless. Often third parties, usually in foreign countries, are part of the contract. This makes enforcement complicated. Blockchain platforms have made this possible. The networks are transparent as is the ability to determine and formulate who has priority over the funds in question. Parties can therefore easily accept or reject certain terms thus promote quicker and more efficient ways to implement contracts.

Regulation of Smart Contracts Around the World: Under contract laws applicable almost universally, a conventional contract must contain the following elements to be considered as valid:

• A legitimate offer
• A properly communicated acceptance
• Enforceability by lawful
• Consideration
• Consent of all competent parties in regards to all aspects of the contract

The?Uniform Electronic Transactions Act?(UETA) serves as a framework that states can use in order to determine the legal status of electronic signatures. It is not a federal law. As many as 47 states have passed and started enforcing it since 1999. UETA places regulations on electronic contracts, records, and signatures. It states that electronic contracts and signatures are valid. They constitute a legitimate way of providing contractual consent. In the European Union (EU), Rome I Regulation is the legislation that determines the legality of all EU civil and commercial contracts. The?Rome I Regulation governs the choice of law in the European Union.

Overview of Contract Law in India

Contracts in India are governed by the Indian Contract Act of 1872. It lays down the basic elements under which contracts are enforced and governed. Section 10?of the act states that?“all agreements are contracts if they hold the free consent of parties willing to contract, for a lawfully accepted consideration and with an object.”

For an agreement to be enforceable by law it must consist of an offer, acceptance, and consideration. By definition, it would be construed, therefore, that smart contracts are valid under the Indian Contract Act 1872. A smart contract consists of the offer, the acceptance and consideration in the form of cryptocurrency. Cryptocurrencies are not consideration as legal tender under Indian law. Therefore currently, these are not enforceable and hence don’t constitute a contract. Section 5 & 10 of the?Indian Information Technology Act?2000 states that electronic signatures are legally accepted. So, a contract is legitimate and enforceable if it is prepared and signed electronically.?Section 65B?of the Indian Evidence Act 1872 states that contracts digitally signed shall be admissible in the courts.?

So, what about smart contracts in India? ?Smart contracts basically provide a platform for contracting parties who do not know each other. Not that parties who know each other are excluded. Every contract involving the exchange of goods/services and money is prone to many risks. Smart contracts can help mitigate this problem. However, the Indian Contract Act is the law that will regulate the contract. So, to be enforceable under Indian law, due caution must be exercised. Although electronic documentation and signatures are valid, the Indian Contract Act needs to be amended to make all smart contracts legal. For example, the absence of consideration should not render the contract null and void. So, though smart contracts are legal in India, several provisions need to be added to them to make them compatible with Indian laws. For a smart contract to be valid it must fall within the boundaries of Indian contract law.

Risks of Smart Contracts: Today, Indian law allows electronic contracts and signatures. However, several Ponzi schemes which succeeded in duping many people indicate that there is a lack of desired safety in electronic documents. Will blockchain technology help in safeguarding people’s interests? As things stand, there are no well-established legal frameworks to regulate Crypto-transactions, not just in India but almost everywhere else in the world. Section 35?of the of the Information Technology Act, 2000, regulated electronic signatures. It states that “Any person may make an application to the Certifying Authority for the issue of a Digital Signature Certificate in such form as may be prescribed by the Central Government.” This raises a problem as far as smart contracts and blockchain technology are concerned. When using blockchain technology, the hash key is self-generated. It is the hash key that is used as an identifier to authenticate the smart contract. Under the Indian legal system today, there is no legal authority that regulates blockchains sanctions electronic signatures in the form of hash-tags. There is a dire need for legislation in this direction.

Section 88A?of the Indian Evidence Act 1872 states that “The Court may presume that an electronic message, forwarded by the originator through an electronic mail server to the addressee to whom the message purports to be addressed corresponds with the message as fed into his computer for transmission; but the Court shall not make any presumption as to the person by whom such message was sent.” Explanation. –– For the purposes of this section, the expressions “addressee” and “originator” shall have the same meanings respectively assigned to them in clauses (b) and (za) of sub-section (1) of section 2 of the Information Technology Act, 2000 (21 of 2000).

So, under the act, the court presumes that an electronic record produced in court is genuine. However, it does not make any presumptions about the sender of the contract. So, if a signature is obtained using blockchain technology, what will be its status? Und the act, it will only be admissible if the signature is obtained as per the provisions of the?Information Technology Act. Unfortunately, this not only vitiates the system of encryption present in the blockchain technology for smart contracts, but it also disallows their use. That is why we need legislation, maybe a brand-new evidence act, to replace the existing one. Remember, the current one is close to a century and a half old.

Despite the absence of legislation, some businesses have already started using blockchain technology and smart contracts to conduct their business. ?

One such company is Bajaj Electricals, a leading manufacturer of a wide range of electrical equipment. The company, one among the Bajaj Group of Companies, is perhaps a key player in this industry. Its business activities affect several sectors, not just channel partners and vendors internal & external, within India and abroad. One of the biggest problems for vendors, whether supplying goods or rendering services, is that payment processes are always cumbersome. Payments are forever delayed and this badly affects their cash-flows. In most cases, customers deliberately delay payments but, even if they don’t, the very act of processing documents and payments plus the money transfer mechanism leads to delays. This happens even in this day and age of electronic documentation and payments. How Bajaj Electricals dealt with this issue makes an interesting case-study. [see: https://www.livemint.com/Companies/BcqXQgey9fieFps9xVZxrK/How-Bajaj-Electricals-uses-blockchain-to-pay-suppliers.html ][also, https://www.thefuturescentre.org/signal/bajaj-electricals-in-india-uses-blockchain-to-pay-suppliers/ ]

According to the report in the Mint getting paid for the material they supplied to Bajaj Electricals Ltd was a cumbersome process for vendors. It involved several steps that included confirmation of delivery by Bajaj Electricals, raising of a physical bill of exchange by the supplier and submission of invoice and transport documents to Yes Bank Ltd, for payment.

This prompted the Bajaj Electricals management to explore a speedy and secure solution to replace its manual bill discounting process. The solution they hit upon was blockchain. In January, the company announced going live on a blockchain-based vendor-financing (also known as supplier financing) solution developed by Yes Bank. The use of blockchain technology eliminated the manual steps involved in the company’s bill discounting process and the entire transaction is now paperless. [Click on the link above for the full report]

Besides Yes Bank, the Mahindra Group and IBM are pursuing and experimenting with supplier finance blockchain. This was revealed in November 2016 that they are co-developing a cloud-based blockchain framework with the potential to reinvent supply chain finance in India. [Details available in these reports: https://cointelegraph.com/news/tech-mahindra-employs-ibm-blockchain-in-new-platform-to-combat-digital-piracy & https://mediacenter.ibm.com/media/Mahindra+Group+unlocks+the+disruptive+potential+of+IBM+Blockchain+technology/1_0qnjw112 ]

Meanwhile, the Institute for Development and Research in Banking Technology (IDRBT) has come out with a blueprint of blockchain technology for the banking sector. The institute has been working with the government, banks, and industry for building a blockchain that can serve as a common platform to launch varied applications. [see: https://www.financialexpress.com/market/idrbt-proposes-road-map-for-blockchain-technology/1451854/ ]

There is no question that the implementation and growth of smart contracts is the next step of innovation. It can lead directly to billions of overhead costs being minimized while making the whole system more efficient. Regulatory issues, however, exist, especially in India where there are no regulations regarding the finer details of a smart contract. If specific regulations are not made, a wide-ranging adoption of the technology will require the government to make amendments to the Indian Evidence At, 1872 and the IT Act. Therefore, although there is a certain amount of progress in government thinking and more businesses are adopting the smart contract concept, the law is still functioning in a grey area. Legislation is direly needed to establish an intricate framework within which to regulate the functioning of smart contracts in India.??

~ Prof Archie D'Souza