Miran Legal

Attorney

14.11.2022

Legal Assessment On Smart Contracts And Force Majeure

A "contract" is a transaction performed in order to bear legal consequences by two or more people or organizations with mutual statements of will. Currently, some contracts are concluded in the digital media with Blockchain technology. Blockchain technology refers to a distributed database system that provides encrypted transaction tracking. Along with the development of technology, Blockchain technology has also become advanced and widespread. In Blockchain technology, contracts are automatically formed, developed and even concluded without human participation and intervention. These said contracts are called “smart contracts”.

 

Thanks to smart contracts, it is possible for written contracts to be converted into a computer code, stored, copied and altered. Additionally, they can be used in many areas such as banking, storing medical records, supplying, inventory management, finance, realty and real estate industry when they are monitored by a computer network that utilizes block chain.

 

A smart contract is a formation that makes it possible to change and realize the proceedings and costs of the contract when necessary. This automatically ensures that the terms of the contract are fulfilled and allows the contract to run smoothly by revising itself according to each new situation. However, there is still no consensus on whether smart contracts are included into the concept of lawful contracts.

 

According to some lawyers, the fact that smart contracts have the ability to solve problems on their own and other consequences that this feature will bring may have results against the rules and principles of today's contract law. According to Turkish law, a contract is “A transaction performed in order to bear legal consequences by two or more people or organizations with mutual statements of will.”. Therefore, as can be seen from the definition, it is essential that the contract bears legal consequences. Bearing legal consequences depend on the consent of the parties at the formation period of the contract. However, the contract will be executed automatically after it is established and the parties to the contract will not be able to interfere with this agreement. The principle of trust for the counterparty in traditional contracts shows itself as trust against the software algorithm in smart contracts. Therefore, it seems that smart contracts do not fully incorporate traditional contract features. This leads to different opinions in the doctrine about whether smart contracts should be legally accepted.

 

Smart contracts do not need human intervention since they are self-executing. Therefore, there is no such situation as a third party interference with smart contracts. Another consequence of the self-sufficiency of smart contracts is the provision that they cannot be unilaterally breached and terminated. The parties cannot participate in the contract after the approval they gave when the contract was formed. This, in turn, leads to the self-improvement of the smart contract. In addition, since smart contracts are protected by a complex cryptography and a cascading system of security measures, the security of backed-up and duplicated documents is at the highest level. In turn, in cases such as a virus, software error, hacking risks, the validity of the contract may be affected. It is evident that there are advantages as well as disadvantages to a smart contract.

 

Currently, there are two types of smart contracts: Off-Chain Contracts and On-Chain Contracts. 

 

In Off-Chain Contracts, there are two contracts. The first of these is the traditional contract that the parties form together. The other one is a smart contract formed for the execution of the traditional contract. In the event of a conflict between these two contracts, the provisions of the traditional contract are taken into account. 

 

In On-Chain Contracts, there is only a smart contract. A smart contract takes the lead both at the formation of the contract and at the execution of the contract. Since interference is also not possible due to the nature of smart contracts, the contract will continue to operate as in its current state and will remain binding on the parties. Therefore, it is important that On-Chain Contracts are formed neatly and clearly from the beginning.

 

Another question related to smart contracts is; Can this automatic system be able to adjust the balance of interests of the parties? How will smart contracts be implemented in situations such as motive mistakes or parties' irresponsibility? On these issues, the approach of dispersing the risk is taken in the doctrine. However, even if a risk dispersion is made in some cases, it does not seem possible to adapt it to the code in question. For example, not being able to execute the contract due to force majeure poses a risk. But it is quite difficult to determine the force majeure in advance. For example, due to the Covid-19 pandemic, it cannot be expected from anyone to foresee the changes on the execution of the contract's provisions in advance. 

 

According to the Turkish Code of Obligations, if the discharge of a debt becomes impossible for reasons for which the debtor cannot be held responsible, the debt is terminated. Here, the legislator has made the article open to interpretation by using an ambiguous expression such as “the reasons for which the debtor cannot be held responsible” and made it possible to adapt it to a concrete event. The ambiguity in the article is interpreted according to the characteristics of each concrete event by lawyers. However, in the algorithms that create smart contracts, each code must be specific and clear. Considering that it is also not possible to interfere in the smart contract after its formation, the legal problems that this situation may create are discussed in the doctrine.

 

In smart contracts, the parties write their wills with the codes such as “do this if the following condition occurs”. Therefore, since each input will have an output; it is quite difficult to foresee force majeure and include it to the code. Considering that an unforeseen force majeure cannot be made into a code, it will not be fair for the parties to continue the contract if the force majeure in question occurs after the establishment of the contract. 

 

However, if the word “force majeure” is put in the algorithm that creates the smart contract, it is possible for the algorithm to identify a future event as force majeure and analyze how the execution will be affected within the framework of the law. This is a concept that concerns engineers, not lawyers. But nowadays, when technology is developing every day and things that seem impossible are becoming possible, it is not impossible for the algorithm to detect the force majeure. For example, when all force majeure situations such as floods, tsunamis, epidemics, earthquakes, etc. that have occurred up to the present day are put in, the algorithm will be able to deduct that a situation that occurs in the future is a force majeure. However, if an unprecedented event occurs, it is difficult for the algorithm to put this event into the category of force majeure. Therefore, this situation will cause problems again in execution.

 

Another problem that may occur in execution is the issue of default. As a rule, the debtor of a due debt goes into default with the notice of the creditor. The default of the debtor is included in articles 117 to 126 of the Turkish Code of Obligations. The law also takes cases of default, balance of interests and irresponsibility into account. For example, a debtor who defaults in accordance with Article 119 is also responsible for damage caused by a contingency. However, in accordance with the second paragraph of the article, the debtor can get rid of this responsibility by proving that they have no fault in going into default, or that even if they had fulfilled their debt on time, the contingency would have caused damage to the subject of execution. As it can be seen, the second paragraph can be interpreted in different ways. In smart contracts, the use of this interpretation is not possible in today's conditions. Yet, thanks to the codes that make up smart contracts, risk distribution analysis and its integration into the dispute can be performed. However, nowadays it does not seem possible for the software algorithm to make the interpretations that are made by lawyers or judges while taking into account the interests of the parties. 

 

CONCLUSION

 Smart contracts are formations that have low cost, have a low risk of manipulation by third parties, greatly reduce paperwork, back up and store data so that there is no risk of losing it, are not open to interpretation and executed without human intervention. Although it has not yet been clearly stated that they have a legal contractual nature today, they are considered to have a contractual nature by most jurists in the doctrine. However, considering the advantages and disadvantages of smart contracts today, it is clear that it will be better to include them in the legal system after a comprehensive legislation has been issued.