30 - Julian Bajada

Julian Bajada Pacta sunt servanda and smart contracts: is code law?

Julian Bajada joined Camilleri Preziosi Advocates in 2015 and was appointed as a Junior Associate in January 2019. Julian assists across the firm’s Corporate & Finance practice groups, contributing principally to the firm’s Capital Markets, Banking, Finance, Mergers & Acquisitions, and Financial Services Regulation practices, specialising in debt and equity issues on the main market of the Malta Stock Exchange, cross-border mergers and acquisitions, private equity investments, bank financing, corporate structuring, and advises both local and international clientele on general commercial and corporate law and regulatory matters.

Julian has also assisted on a number of matters involving innovative technologies, such as distributed ledger technologies, digital banking and the wider Fintech space. During the course of his studies abroad, Julian was also engaged as an intern at the Cambridge Centre for Alternative Finance and was involved in a number of research-based and projectbased initiatives, collaborating with industry stakeholders and start-ups in the Regtech and Fintech industries. Julian was admitted to the bar in 2018, having graduated from the University of Cambridge with a Masters of Corporate Law (MCL. Cantab) (First Class), submitting a case study paper on “Legal Risk Management in Mergers & Acquisitions’. Prior to his studies abroad, Julian successfully completed the Masters in Advocacy (M.A. Adv) degree at the University of Malta, and the LL.B (Hons) degree at the same university, submitting a dissertation entitled ‘Pulling in the Crowd - Establishing regulatory framework for Equity Crowdfunding in Malta?’. He is also undergoing the final stages of his studies leading to the ACCA (Association of Chartered Certified Accountants) professional qualification. Julian was ranked as an ‘Advocate to watch’ in the Chambers & Partners Fintech Guide 2020. Outside his professional life, Julian is an avid sport enthusiast and is currently the Secretary General of the Malta Paralympic Committee, the national governing body for Paralympic Sport in Malta.

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The legal maxim ‘pacta sunt servanda’ embodies the bond between the parties to a contract, with the result that the ‘contract between the parties’ is equated to the ‘law between the parties’.

This maxim reflects the default rule. There are exceptions, however, including, most notably, the essential elements for the validity of a contract, mandatory formalities, and limitations on what terms and conditions may be stipulated in a contract.

The underlying rationale for such exceptions is rooted in socioeconomic considerations, including the objective of ensuring a level playing field in contractual bargaining as well as that of ensuring contractual terms are a true reflection of the parties’ intentions.

Over time, technological innovation has challenged some of our legal system’s core tenets, evolving from the lex mercatoria to an age of lex cryptographia. The phenomenon of ‘smart contracts’ is one such disruptive technology, which has raised unique challenges and posed novel questions. Although the term is often misconstrued, or misused, smart contracts have left legislators, judiciaries and legal professionals scrambling to crack the code as to the proper legal treatment of smart contracts. In this publication, we will attempt to map out what is so smart about smart contracts and whether smart contracts are a natural evolution of traditional contractual arrangements, or a whole new form of contractual arrangements of their own right.

The relationship between Maltese contract law and the law of smart contract code will be critically evaluated, in an attempt to answer the question: is code law?

1. Introduction: Pacta sunt servanda

T

he point of departure rests in formulating a clear delineation between ‘contracts’ and ‘smart contracts’. Whilst diverging views exist amongst legal and technologist circles as to what constitutes a ‘smart’ contract, it is possible 304

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to find common ground by breaking down the term into its constitutive elements.

The term ‘contract’ denotes a formal agreement or arrangement between two or more parties, setting out the terms and conditions which the parties agree are to regulate their relationship. Traceable as far back as biblical times, the art of negotiation owes much of its existence to the exigencies of international trade and commerce that necessitated a set of uniform and binding rules. In what later became known as the ‘lex mercatoria’, these unwritten rules and usages of commerce were moulded over time until they were formally crystallised into formal written agreements.1 Fast forward to the 21st century, and the concept of contractual rights and obligations that bond the parties thereto remains in principle, unaltered.

This bond between the parties is personified in the legal maxim ‘pacta sunt servanda’, translated into ‘agreements must be honoured’. The sanctity of contract is now a universally accepted concept,2 with Grotius asserting that it lay at the centre of the international legal order,3 and Ulpian observing that ‘what is so suitable to the good of mankind as to observe those things which parties have agreed upon’.4 This bond has been expressly recognised as a standard of conduct for society, finding its way into International Law in Article 26 of the Vienna Convention of the Law of Treaties,5 and codified in Article 1.3 of the UNIDROIT Principles of International Commercial Contracts.6 Looking at Maltese law, this maxim is enshrined in Article 992 of the Civil Code (Cap. 16 of the laws of Malta), providing that: ‘contracts legally entered into have the force of law between the parties’, and further that they ‘may only be revoked by mutual consent of the parties, or on grounds allowed by law’. This provision has been elucidated by our Courts on many occasions, 1 Leon E Trakman, ‘From the Medieval Law Merchant to E-Merchant Law’ (2003) 53 U TORONTO LJ 265 2 Paul W Gormley, ‘The Codification of Pacta Sunt Servanda by the International Law Commission: The Preservation of Classical Norms of Moral Force and Good Faith’, (1969) 14 St. Louis ULJ 367 3 De Jure Belli ac Pacis, lib. III ch. 25, sec. 1.

4 Digest 2, 14, 7, para. 7 5 Vienna Convention on the Law of Treaties (adopted 23 May 1969, entered into force 27 January 1980) 1155 UNTS 331; ME Villiger, Commentary on the 1969 Vienna Convention on the Law of Treaties, 365; ‘Pacta sunt servanda lies at the heart of the Convention. It applies without exception to every treaty’.

6 UNIDROIT, UNIDROIT Principles of International Commercial Contracts, 2004, 2nd edn.

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pronouncing that: Il-prinċipju kardinali li jirregola l-istatut tal-kuntratti jibqa’ dejjem dak li l-vinkolu kuntrattwali għandu jiġi rispettat u li hi l-volontà tal-kontraenti kif espressa fil-konvenzjoni li kellha tipprevali u trid tiġi osservata. Pacta sunt servanda.7 …il-prinċipju jibqa’ l-istess, cioè dak tal-libertà kuntrattwali bilkorollarju tiegħu li l-eċċezzjonijiet għal dik il-libertà m’għandhomx jiġu estiżi lil hemm mil-limiti tal-liġi li tistabbilixxi l-eċċezzjoni... l-Art 992 tal-Kodiċi Ċivili li jagħti lill-kuntratti magħmulin skont illiġi s-saħħa tal-liġi stess, li hija l-aqwa liġi, cioè l-liġi tal-partijiet, il-mezz u l-miżura tal-indipendenza personali tagħhom fil-kamp kontrattwali, u li ma jistgħux jiġu mħassra ħlief bil-kunsens ta’ xulxin jew għal raġunijiet magħrufin mil-liġi.8 The message from our courts is loud and clear, the ‘contract between the parties’ is equated to the ‘law between the parties’. Moreover, our legislator has extended this notion of ‘contract is law’ to stretch beyond the execution of a contract to the performance thereof, to the effect that ‘contracts must be carried out in good faith, and shall be binding not only in regard to the matter therein expressed, but also in regard to any consequence which, by equity, custom, or law, is incidental to the obligation, according to its nature’.9

2. What makes a contract a contract?

2.1 Essential elements for the validity of a contract Apart from codifying, the cardinal principle that epitomises the binding nature of contract is stipulated in the Civil Code which sets out the parameters defining what constitutes a valid contract. Article 966 of the Civil Code prescribes four essential, and cumulative, conditions to the validity of a contract, namely: 7 Mark Calleja Urry et v Joseph Portelli et, Court of Appeal, 25/02/2011, Ref. No. 129/2006/1, citing Gloria Beacom et v Anthony Spiteri Staines, Court of Appeal, 5/10/1998.

8 Dr Giuseppe Maria Camilleri v William Parkey nomine, Court of Appeal, 07/09/1973.

9 Civil Code (Chapter 16 of the Laws of Malta), Article 993

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i. the capacity of the parties to contract; ii. the consent of the party who binds himself; iii. a certain thing which constitutes the subject-matter of the contract; and iv. a lawful consideration.

In the absence of any one of the aforementioned elements, a contract will be deemed to be void ab initio, or in other words, inexistent. Elaborating on each essential element, our Civil Code sets out the juris tantum presumption that, unless subject to a legal disability from contracting, everyone is capable of contracting.10 Broadly speaking, persons who are under such legal disability include minors, interdicted or incapacitated persons and all such other persons whom the law forbids from certain contracts.11 In order for consent to be validly granted, it must be free from error, violence, or fraud.12 Insofar as the requirement for a certain subject-matter is concerned, the Civil Code provides that every contract must have as its subject-matter a thing which one of the contracting parties binds himself to give, or to do, or to forbear from doing, provided that the thing concerned is not extra commercium.13 Finally, a contractual obligation must be founded on a lawful consideration, with the result that a contract is invalid where it is made without a consideration, or founded on a false or unlawful consideration.14 The latter requirement applies, however, to the extent not expressly otherwise provided for under the Civil Code (or any other special law), such as, for instance, a donation made pursuant to Article 1737 of the Civil Code.15

2.2 Formalities for the validity of a contract In addition, a contract may be rendered invalid ex post facto where, albeit satisfying all the essential conditions for the validity of a contract described above, it fails to satisfy the prescribed formalities for the validity of the particular contract in question, to the extent that such formalities are 10 Ibid, Article 967(1) 11 Ibid, Article 967(3) 12 Ibid, Article 974 13 Ibid, Article 982(1) and (2) 14 Ibid, Article 987. In terms of Article 990 of the Civil Code, a consideration is deemed to be unlawful if it is prohibited by law or contrary to morality or to public policy.

15 Ibid, Article 1737(2) provides that a ‘donation inter vivos is a contract whereby the donor irrevocably and gratuitously transfers a thing to the donee who accepts it’.

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imposed by law on pain of nullity.

By way of illustration, Article 1233 of the Civil Code set outs classes of transactions which, ‘shall, on pain of nullity, be expressed in a public deed or a private writing’.16 Similarly, Part III of the Notarial Profession and Notarial Archives Act (Cap. 55 of the laws of Malta, the ‘Notarial Act’) sets out the formalities relating to notarial acts, the non-satisfaction of which may render the act in question null or annullable.17 Importantly, the Notarial Act prescribes requirements relating to original notarial acts, whereby: ‘the original of every notarial act shall be written, typewritten or printed in dark, clear, easily legible and indelible characters, without blanks or spaces unless such blanks or spaces are lined, without abbreviations, corrections, alterations or additions in the body of the act and without erasures. Every original act shall have two margins, one on the right-hand side and the other on the left-hand side...’.18

3. Contracting 2.0 – moving away from ‘dumb contracts’ to ‘smart contracts’ 3.1 Automated enforcement as the defining feature of smart contracts The term ‘smart’, when associated with a contract, does not necessarily denote any intrinsic intelligence or human-like intuition with which the contract is endowed. Rather than falling within the Oxford English Dictionary of the term ‘smart’ (defined as ‘having or showing a quick-witted intelligence’), the term ‘smart’ refers to the means of enforcement of the contract. A contract is dubbed as smart where it is automatically enforceable by means of automated execution of its pre-programmed code, without any human intervention. In this sense, a smart contract is self-executing, selfsovereign and self-sufficient. Automation enables the seamless execution, performance and enforcement of the operative terms of a contract over its life cycle. In fact, some technologists prefer to use the term ‘smart agent’ rather than ‘smart contract’ to denote this autonomous enforcement.19 16 Ibid, Article 1233(1)(a) to (g) 17 Notarial Profession and Notarial Archives Act, Chapter 55 of the Laws of Malta, Article 40(1)(c), or (e), 18 Civil Code (Chapter 16 of the Laws of Malta), Article 30 19 Gabriel Olivier Benjamin Jaccard, Smart Contracts and the Role of Law (University of Geneva Department of Private Law 10 January).

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At this juncture, it would be useful to illustrate the impact of automated enforcement by hypothesising a very simple scenario. Take the situation where the parties to a contract have agreed that in consideration for the delivery of goods by party A to party B, party B shall pay party A the sum of €100 within two business days from the delivery of the goods to party B. Where a traditional contract is utilised, the payment of the consideration is ultimately dependent not merely on the actual delivery of goods to party B, but is further subject to the action taken on the part of party B to effect the payment to party A as and when it falls due. Conversely, if a smart contract were to be deployed, it would be possible to automate the payment of the consideration by way of embedding the payment thereof into the smart contract between the parties. For instance, the parties may make use of a trusted verification device through the use of IT (for example, monitoring sensors), that would verify the delivery and receipt of the goods, which in turn would trigger-off the automated (and immediate) payment of the consideration price, therefore, eliminating human intervention at the point of enforcement.

Taking a more complex scenario, imagine a senior facilities agreement involving a syndicate of lenders, a security agent, a group of multi-national lenders and a diverse security package. With a traditional contract, there is often a delay between the default and the subsequent enforcement action taken by a security agent who is entrusted with carrying out the verification process and determining the action to be taken. On the other hand, with a smart contract, the enforcement may be expedited (or rather, made instantaneous), through the automated verification of the occurrence of the events of default and the corollary enforcement action to be taken, potentially saving significant time and expenses that would have otherwise been expended on the enforcement process.

3.2 Smart legal contracts or smart contract code?

Although it is widely recognised that the defining feature of a ‘smart contract’ is the automated enforcement (or self-execution) thereof, a schism emerges between the terms ‘smart legal contract’ and ‘smart contract code’, depending on whether the question is posed to a lawyer or to a coder:20 20 International Swaps and Derivatives Association (‘ISDA’) and Linklaters LLP, ‘Whitepaper: Smart Contracts and Distributed Ledger – A Legal Perspective’ (2017), 4 <https://www.isda.

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a. in legal circles, the term ‘smart legal contract’ is used to denote the rights and obligations agreed to between the parties by virtue of a natural language written agreement that has been embedded into the code underlying the software utilised for the purpose of the automation of a process or processes. In other words, it refers to the translation of the natural language contract (the ‘legal contract’) into the computer language code (the ‘smart legal contract’). In this way, the legal contract and the smart contract are one and the same, just written in (or translated into) natural language and code language respectively; b. on the other hand, technologists deploy the term ‘smart contract code’ to refer to the self-executing code, so that the ‘contract’ and the ‘smart contract’ are two different things altogether. In this school of thought, the smart contract is merely the code that executes certain tasks of the wider legal contract using Boolean logic (in layman’s terms, ‘If X, then Y’ logic) to determine if pre-defined conditions are satisfied, and to run or perform such tasks in such case.21 Whichever school of thought one may subscribe to, one observes that the tasks performed by the smart contract are, in either case, of contractual and legal relevance and reflect the rights and obligations, whether wholly or partially, of the parties to the natural language contract. Secondly, it is useful to bridge the schools by depicting the possible variety of smart contracts across a scale from partial automation to full automation. Posited differently, we may categorise smart contracts into: (i) the ‘external model’ or the ‘hybrid model’, which postulates the separation between the two to the effect that only certain terms and conditions of the natural language contract are embedded into the code language contract, and, thus, having two contracts running in parallel, regulating different aspects of the overall relationship between the parties, albeit with the possibility of overlap between the two; and (ii) the ‘internal model’ (sometimes referred to as the ‘integrated model’), which suggests the existence of one single contract regulating the relationship between the parties, being the code language smart contract. org/2017/08/03/smart-contracts-and-distributed-ledger-a-legal-perspective/> 21 Christopher Clack, Vikram Bakshi & Lee Braine, ‘Smart Contract Templates: foundations, design landscape and research directions’, (2017), <https://arxiv.org/abs/1608.00771>.

Boolean logic is sometimes referred to as ‘if/then’ logic or ‘if this then that’ or ‘IFTTT’ programming.

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The reality is, therefore, that there is a relationship between the ‘smart legal contract’ and the ‘smart contract code’, with the result that every smart legal contract can be said to contain one or more pieces of smart contract code, but not every piece of smart contract code necessarily constitutes a smart legal contract.

4. Smart contracts and Maltese law Having looked at the essential and formalistic elements for the validity of a contract, together with the salient aspects of smart contracts, we now consider the relationship between smart contracts and Maltese law, and examine whether the two sit well together.

4.1 Essential elements for validity of a contract revisited: a tech-first approach 4.1.1 Identifying the parties to a smart contract and the capacity to contract The first challenge is identifying the parties to the smart contract, and whether these are capable of contracting under Maltese law.

Article 1A of the Civil Code defines the term ‘person’ as either natural persons or legal persons. In turn, Article 4 (d) of the interpretation Act (Cap. 249 of the laws of Malta), defines the term ‘person’ as including ‘a body or other association of persons whether granted legal personality, in accordance with the provisions of the Second Schedule to the Civil Code, or not’. The outcome is that, in the case of a smart contract entered into by and between one or more natural or legal persons, the smart contract may be said to have been made between parties recognised as such by Maltese law.

That being said, the law is silent on contractual arrangements entered into autonomously where two or more smart contracts interact with one another and result in the conclusion of further contracts between them.

These are sometimes referred to as ‘follow-on contracts’. Judicial doctrine 311

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on the subject is not harmonious. In England, there is authority implying that automated computer systems are incapable of binding parties through implied agency as they lack the consciousness of a human mind.22 The position is somewhat different in Australia, where section 15C of the Electronic Transactions Act 1999 provides that a contract formed by (a) the interaction of an automated message system and a natural person or (b) the interaction of automated message systems ‘is not invalid, void or unenforceable on the sole ground that no natural person reviewed or intervene’. Some international authorities suggest that the fact the parties themselves programmed the smart contract and, therefore, anticipated its capacity to enter them into follow-on contracts, means they must be taken to accept that they may be bound to those follow-on contracts.23 In the absence of an ad-hoc rule under Maltese law and, or any judicial pronouncement on the matter, it is yet to be determined whether follow-on contracts are valid and enforceable under Maltese law.

A study on smart contracts must necessarily factor in the application of blockchain technology, the most commonly applied underlying platform for the use and application of smart contracts. Although various definitions have been posited, the common denominator appears to be that the term ‘blockchain technology’ is a ‘form of distributed ledger technology that enables the storage and processing of data using cryptography, whereby each transaction is stored on a ‘block’, with each block, in turn, being linked to the immediately preceding block, forming a ‘chain’ of unalterable blocks).24 When recording transactions on the blockchain, the parties to such transaction are actually represented by an address, which, on its own, may not prove sufficient for the purpose of identifying the proper counterparty, which is merely identified by reference to a sequential number. This is potentially problematic given that the fundamental element of having parties who are capable of contracting could be lacking, or, at least, cannot be verified by mere reference to the address, particularly where the generation of the address was not dependent on the underlying identification qualities of the natural or legal person to whom it has been allocated.

22 Software Solutions Partners Ltd, R (on the application of) v HM Customs & Excise [2 May 2007] EWHC 971 23 Chwee Kin Keong v Digilandmall.com Pte Ltd [13 January 2005] 2 LRC 28 (Singapore) 24 For further details on the various permutations of ‘blockchain technology’ and other ‘distributed ledger technologies’, see Cambridge Centre for Alternative Finance, ‘Distributed Ledger Technology Systems – A Conceptual Framework’, August 2018.

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4.1.2 Manifesting consent in the context of smart contracts The three constitutive facets making up the essential element of consent need to be examined separately, namely: (i) the offer and acceptance; (ii) the external manifestation of consent; and (iii) the validity of consent.

Dealing with the first element, reference is made to Article 9 of the Electronic Commerce Directive (the ‘ECD’)25, which applies on both a B2B and B2C basis, requiring member states of the European Union to ensure that their legal systems allow contracts to be concluded by electronic means, and further that the legal requirements applicable to the contractual process neither create obstacles for the use of electronic contracts nor result in such contracts being deprived of their legal effectiveness on account of their having been made by electronic means. In this respect, the ECD defines the term ‘electronic contract’ as ‘a contract concluded wholly or partly by electronic communications or wholly or partly in an electronic form’. In turn, the term ‘electronic communication’ means ‘information generated, communicated, processed, sent, received, recorded, stored or displayed by electronic means’.

In principle, therefore, the concept of a smart contract is compatible with the term electronic contract as defined under the ECD and thus should benefit from the statutory protection afforded to the conclusion of electronic contracts under the ECD, the terms of which have been transposed into Maltese law by virtue of the Electronic Commerce Act (Cap. 426 of the laws of Malta). The fact that the ECD does not purport to prescribe a specific form in which an electronic contract must be made, or a specific form as to the offer and acceptance thereof, further supports this position. In fact, electronic mail messages (emails) have been assumed by the English courts to be capable of constituting offers and acceptance and it would be surprising if the courts were to draw conceptual distinctions between such email messages and smart contract messages. Moreover, the English courts have accepted that the parties are free to stipulate what acts will constitute acceptance.26 The author maintains, therefore, that an offer and acceptance may be exchanged by way of signing-up to a smart contract using electronic means, whether in whole or in part, as long as the parties agree in advance that it constitutes an 25 Directive 2000/31/EC of the European Parliament and of the Council of 8 June 2000 on certain legal aspects of information society services, in particular electronic commerce, in the Internal Market.

26 Vide Holwell Securities Ltd v Hughes [1974] 1 WLR 155]

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offer and acceptance.

In so far as the external manifestation of consent is concerned, the key consideration is the validity of the signature of the person appearing on the smart contract. In this respect, Regulation (EU) No. 910/2014 of the European Parliament and of the Council of 23 July 2014 on electronic identification and trust services for electronic transactions in the internal market and repealing Directive 1999/93/EC (the ‘eIDAS Regulation’) contains the legal framework for the recognition of electronic signatures. The seminal implication of the eIDAS Regulation is the distinction made between simple electronic signatures, advanced electronic signatures and qualified electronic signatures, to the effect that only qualified electronic signatures are recognised as having the equivalent legal effect of a handwritten wet ink signature.27 A qualified electronic signature is defined under Article 2 of the eIDAS Regulation as ‘an advanced electronic signature which is additionally created by a qualified signature creation device, and is based on a qualified certificate for electronic signatures’. In turn, the following terms are defined by the eIDAS Regulation: i. qualified certificate for electronic signature means a certificate for electronic signatures, that is issued by a qualified trust service provider and meets the requirements laid down in Annex I of the eIDAS Regulation; ii. qualified signature creation device means an electronic signature creation device that meets the requirements laid down in Annex II thereof of the eIDAS Regulation; and iii. an advanced electronic signature is one meeting the following cumulative requirements: (a) it is uniquely linked to the signatory; (b) it is capable of identifying the signatory; (c) it is created using electronic signature creation data that the signatory can, with a high level of confidence, use under his sole control; and (d) it is linked to the data signed therewith in such a way that any subsequent change in the data is detectable.

In practice, smart contracts are signed-off through the use of private 27 Regulation (EU) No 910/2014 of the European Parliament and of the Council of 23 July 2014 on electronic identification and trust services for electronic transatctions in the internal market and repealing Directive 1999/93/EC (eIDAS Regulation), Article 25(2)

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key infrastructures (‘PKIs’). Accordingly, in order to be deemed to be legally equivalent to a wet ink signature, the private key through which the individual or entity ‘signs off’ on the smart contract must satisfy the criteria to classify as a qualified electronic signature, including the need to be issued by a recognised trusted service provider. Looking at the qualification requirements in Annex I and Annex II of the eIDAS Regulation, it is arguable that, in the context of blockchain-based smart contracts, a private key could well possess the necessary attributes to qualify as a qualified electronic signature and it is, therefore, possible to reconcile the two and satisfy the element of the external manifestation of consent.

Nevertheless, a difficulty may still arise when dealing with the third constitutive facet of the validity of consent, that is, in verifying that such consent is free from error, violence or fraud. It would appear that, by itself, signing-off on a smart contract by way of private keys is not a watertight solution to ensuring that consent has not been vitiated. For instance, there can be no assurance that the private key was misplaced or misappropriated and therefore, that the person signing-off on the smart contract was unauthorized to do so. Furthermore, an intrinsic challenge arises in a purely integrated or internal smart contract model. In the absence of a natural language wrap-up contract, an issue may arise with regard to the complexity and opaqueness of the code language and whether this leaves room for interpretation as to whether consent may be vitiated on the ground of error.

This challenge is best illustrated with reference to consumer contracts and the statutory protection afforded thereto under the Consumer Affairs Act (Cap. 378 of the laws of Malta), providing, at Article 47 (1) thereof, that ‘in any consumer contract, where all or some terms offered by a trader to a consumer are in writing, these terms shall be written in plain and intelligible language which can be understood by the consumers to whom the contract is directed’.

In other words, even though a smart contract purports to provide an exante solution to enforcement, it does not do away with the possibility of an ex-post examination of whether consent has been vitiated. More importantly, smart contracts are simply not the answer to ensuring unvitiated consent at all times.

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4.1.3 Certainty of object and lawful consideration - universal and technologically agnostic The authorâ&#x20AC;&#x2122;s view is that the requirements concerning the certainty of the subject matter and lawful causa would not, in principle, be adversely affected or negated by virtue of the fact that the contract is written in code language (whether in full or in part) and not in natural language. In fact, even though severely complex code may test the limits of certainty, it is equally arguable that even the best-drafted natural language contracts may sit on the edge of (un)certainty. Similarly, it is inconceivable that the technology deployed per se may give rise to an unlawful causa - it is how and for what purpose that technology is put to use which may give rise to an unlawful or illicit causa, but certainly not the technology in and of itself.

4.2 Formal requirements for validity of a contract revisited: archaic laws in need of a revamp?

The author subscribes to the view that based on our law as it stands today; it may be innately challenging to reconcile the formal requirements for the validity of legal contracts under Maltese law with the concept of smart contracts. How can one reconcile the requirements for the validity of a public deed using code language alone? How can one satisfy the requirements concerning the rendering of verbal explanations in the presence of witnesses purely through code? How can one satisfy the requirement to record transactions where the means or format of such recording is prescriptive? How can one pass the tests of plain and legible language, or more importantly, the English language test using only smart contract code?

Pausing on the latter question, our legal and regulatory framework is dotted with a variety of instances requiring documentation to be produced in a plain and easily legible format, or, going further, requiring that such document be produced in the English language. In addition to the language requirements for notarial acts as described in section II (i) above, similar requirements arise in the context of regulated financial markets. For instance, the Listing Rules issued by the Listing Authority under the Financial Markets Act (Cap. 345 of the laws of Malta) require a prospectus, which is itself a legally binding contractual document, to be drawn up in â&#x20AC;&#x2DC;Maltese or English or in 316

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a language customary in the sphere of international finance, at the choice of the issuer’. How can this requirement be compatible with the terms and conditions of a security token offering embedded purely in smart contract code without an English (or Maltese, or customary language as aforesaid) version, or translation of, that code language? If our law does not allow for unfettered freedom of choice of the contracting language, or if the definition of the term ‘language’ is not broad enough to include code language, our law may have to be revamped in order to expressly allow parties to enter into a contract written in code language.

In the absence of such reforms, our law contains impediments to the deployment of a purely integrated smart contract model and necessarily requires the adoption, as a bare minimum, of an external or hybrid model, with the smart contract code running in parallel with the natural language contract, and the latter drawn up in compliance with the formal requirements for the validity of a contract, including but not limited to those formalities explored in this paper.

4.3 Is code law? Does dry code prevail over wet code or can the two co-exist?

The terms of the recently enacted Malta Digital Innovation Act (Cap. 591 of the laws of Malta, the ‘MDIAA’) and the Innovative Technology Arrangements and Services Act (Cap. 592 of the laws of Malta, the ‘ITASA’) are a good indication of how Maltese law treats this pressing question.

Firstly, the MDIAA defines a smart contract as: ‘a form of innovative technology arrangement consisting of: (a) a computer protocol; and, or (b) an agreement concluded wholly or partly in an electronic form, which is automatable and enforceable by execution of computer code, although some parts may require human input and control and which may be also enforceable by ordinary legal methods or by a mixture of both’. It is interesting to note that our definition encompasses the two schools of thought examined in section II (ii) above, that is, covering both smart legal contracts and smart contract codes. Perhaps the most important aspect of the definition opted for by our legislator is the flexibility as to self-execution in whole or in part, and the possibility of a combination of human intervention and traditional 317

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means of enforcement.

Moreover, Article 8(4)(e) of the ITASA, dealing with the specific requirements for the certification of innovative technology arrangements thereunder, including smart contracts and decentralised autonomous organizations (‘DAOs’), provides that ‘the specific purposes, qualities, features, attributes, limitations, conditions, terms of service and behaviors or aspects of the relevant innovative technology arrangements and on the basis of which a user is invited to participate in, rely on or use the innovative technology arrangement are stated in the English language in an easily accessible and intelligible format… in case of conflict between the English language and the underlying code of the innovative technology arrangement, the English language shall prevail. Where the applicant wishes to use multiple languages for this purpose, in case of conflict between languages, the English language shall prevail’.

Positioning Maltese law as an enabler for the hybrid smart contract solution model, where a smart contract is deployed in tandem with a natural language traditional contract (whilst still affording varying degrees of overlap between the two) is, in the author’s view, a reasonable solution to the predicament as to whether code is law. On the one hand, one might argue that this combined system inevitably eats away at the benefits and opportunities that smart contracts have to offer, reducing operational efficiencies and driving up costs.

On the other hand, this model is commendable in that it takes cognizance of the socio-economic realities in which contracts are entered into, performed and executed. More on this in the next section, wherein the author will delve into how contractual arrangements cannot be seen in a vacuum and are, instead, necessarily a construct of the socio-economic, cultural and political norms within which they exist.

By referring to the considerations of the English language requirements and ease of accessibility and legibility of contractual terms and conditions as a sine qua non requirement to the certification of innovative technology arrangements under the ITASA, the legislator appears to have been predominantly concerned with upholding consumer protectionist ideals, with the result that the dry code is deemed under Maltese law to prevail over the wet code. It is clear that the legislator’s forma mentis was preconditioned by existing consumer protection laws, including, in particular, the non-exhaustive indicative list of unfair contract terms set out in Article 318

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44(2) of the Consumer Affairs Act (Cap. 378 of the laws of Malta). In addition, consideration appears to have been given to the over-arching implications of Article 45(1) of the Consumer Affairs Act, which stipulates that when determining whether a term is unfair or otherwise, regard will be had to whether the term ‘causes the performance of the contract to be significantly different from what the consumer could reasonable expect’. In the author’s view, there is a striking resemblance between these consumer protection laws, the definition of smart contracts and the certification conditions under the ITASA. The legislator may have also been pre-occupied with the dilemma of bridging the gap between the statutory rights of enforcing precautionary warrants and executive warrants under the Code of Organization and Civil Procedure (Cap. 12 of the laws of Malta) and the concept of automatic self-execution through smart contracts. In practical terms, a kill-switch is necessary to effectively ‘freeze time’ and preserve the rights to which the claimant is prima facie entitled to preserve ex ante or to which the claimant is lawfully entitled to recover ex post facto.

In light of the above definitions and requirements, the position under Maltese law would appear to be that code is not law. Instead, Maltese law appears to favour (or rather impose) the adoption of a hybrid approach to the relationship between legal contracts and smart contracts. This approach seems to be reflective of, and in the author’s view, seeks to encourage, the ‘Ricardian model’ of smart contracts. Put simply, the Ricardian model is a smart contract model based on deploying, in the first instance, a human-readable agreement that, once executed by the parties thereto, is subsequently converted into a machine-readable agreement to implement the terms and conditions of the human-readable agreement.28 The inclusion of the combination of automation and human intervention in the definition of a smart contract, together with the dry code supremacy clause are two strong indicators of this approach. Furthermore, this position is supported by the concept of the technical administrator under the ITASA and the inclusion of a kill-switch as part of the certification regime, to the effect that the innovative technology arrangement is required to ‘have in-built technology features, to enable the technical administrator to intervene in a transparent and effective manner in the event of - (a) a material cause of loss to any user; or (b) a material breach of law, so as to ensure that the cause of loss 28 Ian Grigg, ‘The Ricardian Contract’ (1995) <https://iang.org/papers/ricardian_contract.html>

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or breach of law is satisfactorily addressed to the best of his abilities and to ensure it does not occur or re-occur, and in case of unjustifiable failure by the technical administrator’.29 Another interesting ramification of the hybrid model favoured by Maltese law is the interplay between this model and the principles on the interpretation of contracts under our Civil Code. In particular, reference is made to the principle of referential interpretation under Article 1008 of the Civil Code, providing that ‘all the clauses of a contract shall be interpreted with reference to one another, giving each clause the meaning resulting from the whole instrument’. Will our Courts, in adopting such interpretation, make reference to the terms of the code language smart contract in addition to the terms of the natural language contract? In the author’s view, once it is established that the smart contract satisfies the essential and formal requirements applicable to all contracts, the proper application of the aforesaid Article 1008 would be that such principle ought to apply, mutatis mutandis, to hybrid contracts that are in part written in a natural language and in part written in code language. In addition, reference ought to be made to the principle of literal interpretation under Article 1002 of the Civil Code, providing that ‘where, by giving to the words of an agreement the meaning attached to them by usage at the time of the agreement, the terms of such agreement are clear, there shall be no room for interpretation’. The requirement to interpret code language by giving the terms such meaning as attached to them by usage may cause a fundamental shift in the skill set required by lawyers in the drafting and interpretation of contracts, moving towards hybrid lawyers who are proficient in both natural language and code language.

4.4 The relevance of the socio-economic context in which the law (and code) exists In legal theory, a divergence arises between legal purists and legal realists (or legal relationists). Under the former view, a literal approach to contractual arrangements is favoured, with strict adherence to the express terms and conditions of the contract, isolated from the realities in which they exist. By contrast, under the latter view, contractual arrangements cannot be 29 Innovative Technology Arrangements and Services Act (Chapter 592 of the Laws of Malta), Article(4)(d)(iii)

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evaluated in a vacuum and may only be fully understood within their social, economic, relational, political and cultural contexts.30 The legal realist perspective has long focused on how law unfolds in in vivo practice, highlighting how these practices may diverge significantly from ‘law on the books’ (Mertz 1999, Macneil 1978) to ‘law in motion’. This perspective is critical to understanding parties’ intentional inclusion of loosely drafted terms or wilful non-enforcement of contractual rights or claims for strategic purposes that are conducive to a stable and long-term contractual relationship. The seminal socio-legal treatise on this phenomenon is Stewart Macaulay’s 1963 study about what he termed ‘non-contractual relations’ in business.31 Macaulay interviewed businessmen about how they went about negotiating transactions and enforcing agreements. He found that his interviewees left many aspects of their contractual relationships vaguely planned, incompletely defined, or imperfectly resolved; in other words, few of the transactions in which these parties engaged were neatly rationalized in the way that the legal purist theory would foretell. Importantly, this was not for lack of sophistication among the parties.32 He observed that parties may (purposely) choose not to insist on a perfect ‘meeting of the minds’ on every term because they anticipate (and hope) that their relationship will extend beyond the contract at immediate issue. As Macaulay puts it, ‘[d] etailed negotiated contracts can get in the way of creating good exchange relationships [.] ... If one side insists on a detailed plan, there will be delay while letters are exchanged as the parties try to agree on what should happen if a remote and unlikely contingency occurs. In some cases they may not be able to agree at all on such matters and as a result a sale may be lost’.33 The key take-away of the realist theory is that there may be other means to formal enforcement of the terms and conditions of a contract, on the premise that such alternative means may, having regard to the particular facts and circumstances at hand, and assessed against the wider backdrop of the parties’ past, present and (potentially) future relations, be a more apt remedy to strict enforcement of the contract. For instance, put yourself in the position of the lead arranger and agent in the banking syndicate contemplated earlier 30 Karen E C Levy, ‘Book-Smart, Not Street-Smart: Blockchain-Based Smart Contracts and The Social Workings of Law’, Engaging Science (2017) 3 Technology and Society Journal 2 31 Stewart Macaulay, ‘Non-Contractual Relations in Business: A Preliminary Study’ (1963) 28 American Sociological Review 1 32 Ibid 7.

33 Stewart Macaulay, ‘Non-Contractual Relations in Business: A Preliminary Study’ (1963) 28 American Sociological Review 55

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in this paper. Having regard to the wider economic conditions prevailing at the time, and considering the historical and prospective relations with the lender, is it safe to say that the automatic and instantaneous enforcement of an event of default will be the best (and only) course of action at all times, without any reservations whatsoever? Will the ripple effect of calling an event of default and acceleration of the repayment of facilities have, on the balance of things, the best possible outcome? The crux of this issue is that not all circumstances lend themselves to easy translation into ‘if/then’ Boolean logic. For instance, what constitutes conduct that is undertaken in a ‘commercially reasonable manner’ or to the ‘satisfaction of the parties?’

These, and similar judgments calls, are inherently difficult to pre-program into code language and are necessarily dependent on a variety of factors and exigencies that are difficult to forecast and subsequently articulate in an all-encompassing and exhaustive manner, and translate into code language. Indeed, such judgment calls move away from the remit of smart contract technologies to the realm of artificial intelligence. The capabilities and limitations of the latter, together with its legal and ethical implications, however, falls beyond the scope of this paper. For our purposes, it will suffice to acknowledge that the realist theory sheds light on the practical drawbacks of the defining characteristic of smart contracts, that is, to the automatic selfenforcement of contracts.

5. From the lex informatica to the lex cryptographia?

As talk of smart contracts marking a new age in the defining concepts of the law of contract gains traction, it is interesting to draw an analogy with the coming of age of the Internet and the ‘lex informatica’. The dawn of the Internet brought about an alternative normative system consisting of a particular set of rules and customary norms arising directly from the parameters imposed by the technical aspects of the network or technical infrastructure. This is what Joel Reidenberg (1992) coined as the lex informatica as a supplement to contractual norms for the regulation of online transactions through the establishment of technical norms, in addition to contractual rules. The impact of these norms is that, rather than relying on traditional law enforcement mechanisms, such as court orders or proceedings, online operators increasingly rely on technical norms as some kind of customary transnational 322

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rules applicable at the global level, in a consistent and predictable manner.34 In a similar fashion, the emergence of blockchain technology and smart contracts may cause a fundamental shift in the development of the lex informatica, moving us into an age of lex cryptographia, characterised by a set of rules administered through self-executing smart contracts that is made possible through the defining characteristics of blockchain technology, namely: cryptographically secured information, consensusbased transactions and decentralized network infrastructure.

If we were to imagine a world in which these conceptual limitations are surpassed and contractual relationships can be engineered to the extent that every single possible permutation and outcome articulated into a preprogrammed code, our legal system perhaps could take the form of a system of algorithmic governance or a state of the rule of law by code, potentially resulting in a system that is highly prescriptive and deterministic; a system where people are, indeed, free to decide the particular set of rules to which they want to abide, but once that choice has been made, no deviation from these rules is possible any longer, save for under pre-programmed circumstances and subject to any pre-programmed conditions. These are the wider socio-legal implications that we ought to bear in mind as the use and complexity of smart contract technologies gathers ground.35

6. Concluding remarks Developing a legally enforceable smart contract solution is not merely a matter of putting together the right technology stack but requires a careful consideration of the legal requisites for the essential and formal validity for a contract to be upheld as such under Maltese law. The real transformative value of smart contracting lies in bridging the gap between finding ways to preserve enforceability in the traditional legal sense of ‘enforceable by a court’ (the first meaning of enforceability) while reaping the benefits of ‘automated self-execution’ (the second meaning of enforceability).

First posited in the early 1990s by US lawyer and scientist Nick Szabo, 34 Aaron Wright & Primavera De Filippi, ‘Decentralised Blockchain Technology and the Rise of Lex Cryptographia’, 35 Ibid

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smart contracts have been heralded as ‘the technology most likely to change the next decade of business’.36 As our digital economy expands, we will increasingly rely on technology not merely as a facilitator of decisionmaking, but as a decision maker in and of itself. The deployment of smart contracts may transform various facets of our legal system. At the very basic level, the standout impact will be the shift from ex-post enforcement to ex-ante enforcement. The reality remains that a smart contract may still be challenged on the traditional grounds upon which a contract may be challenged under Maltese law and may be, therefore null ab initio or annullable. Smart legal contracts do not (and cannot) change this.37 Although Maltese law provides answers to some of the pressing questions surrounding the relationship between code and law, this paper has identified a number of gaps and illustrated how smart contracts and legal contracts are not yet wholly aligned under Maltese law. The fundamental question we should be asking ourselves is whether this merits a radical overhaul of our legal system or whether this is merely a case of tweaking our statute book to reflect the changing realities? Whichever route is opted for, the wise words of the learned judges in Chwee Kind Keon and Others vs. Digilandmail.com Pte Ltd (2005) 2 LRC 28, at paragraph 102 (High Court, Singapore) comes to mind: ‘the question is not ‘do traditional principles apply?’ but ‘how do they apply?’… continuing by stating that ‘it is axiomatic that normal contractual principles apply’. This logic should guide us in the concept of smart contracts and the next wave of contractual innovations and how this relates to our traditional concepts of law.

The subject of smart contracts also raises a number of social, normative and ethical questions. Faced with the prospect of a move towards the hybrid model of smart contracting, the legal profession may itself be in for a shake-up of its own, where legal professionals will be required to act as the intersect between natural language contracts and code language smart contracts, potentially altering legal drafting techniques or forming new hybrid languages altogether in what is referred to by some observers as a ‘controlled natural language’.38 36 Don Tapscott & Tapscott Alex, ‘The Impact of the Blockchain Goes Beyond Financial Services’ (2016) Harvard Business Review 37 ISDA & LINKLATERS, ‘Whitepaper: Smart Contracts and Distributed Ledger – A Legal Perspective’ (2017) <https://www.isda.org/a/6EKDE/smart-contracts-and-distributed-ledger-a-legal-perspective.pdf> 38 Samer Hassan and Primavera De Filippi, ‘From Code is Law to Law is Code’ (2017) 17 Field Actions Science Reports 16

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To conclude, the author wishes to stress that the point of departure is anchored in the principle that the concept of pacta sunt servanda should be capable of application regardless of the form that the contract between the parties takes. In other words, the concept ought to be technologically neutral. This basic principle is rooted in the general notion of contract law that a contract may even be a verbal, that is, a wholly unwritten agreement.

By extension, a contract may, so long as the essential requirements for the validity of a contract are duly satisfied, be written in natural language or code language, or a combination of the two. It is true, however, that a hybrid smart contract solution, which appears to be the favoured approach under Maltese law as it currently stands, may lend itself better to satisfying the requirements for the validity of a contract, whereas a pure smart contract, written wholly in code language, may face hurdles in satisfying the same requirements. That being said, where the terms of the smart contract are clear and unambiguous, and are a true and faithful manifestation of the mutual understanding of the parties, there is no reason to preclude the possibility of a smart contract qualifying as a contract in the legal sense of the term, thereby creating a bond between the parties, to the effect that the code between the parties is the ‘law between the parties’ or rather, ‘code is law’.

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