Technology

Why Lawyers Won’t Be Replaced By Smart Contracts

Not so fast. A smart contract is not really 'smart,' and is not really a 'contract.'

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In three years, Cyberdyne will become the largest supplier of military computer systems. All stealth bombers are upgraded with Cyberdyne computers, becoming fully unmanned. Afterwards, they fly with a perfect operational record. The Skynet Funding Bill is passed. The system goes online on August 4th, 1997. Human decisions are removed from strategic defense. Skynet begins to learn at a geometric rate. It becomes self-aware 2:14 AM, Eastern time, August 29th. In a panic, they try to pull the plug…

And then came the rest of a really great movie, followed by some so-so sequels, punctuated by a term and a half in the governor’s mansion.

What we can we learn from this?

First, this is evidence that sometimes a divided, do-nothing Congress is preferable to the alternative. Perhaps Newt Gingrich and Bill Clinton shouldn’t have been so quick to enact this Skynet Funding Bill back in 1997.

Second, “human decisions are removed.” Yikes! Was that a good idea?

Are we about to find out?

Maybe. Supposedly “smart contracts” represent “The Blockchain Technology That Will Replace Lawyers.”  Is Skynet here?

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I briefly touched on smart contracts in my column a while back on the SEC report on DAO Tokens, but in case you don’t have perfect recall like those Cyberdyne computers, here it is again: “smart contracts” are computer protocols (“protocol” in this context basically meaning a set of computer rules) on a blockchain (almost exclusively on Ethereum, though a new blockchain named Neo is gaining popularity) that facilitate the negotiation and/or performance of a contract. Since they are blockchain-based, they are decentralized, and for now we’ll leave out the key question of whether any contract really needs to be decentralized. Today, we’re just talking about whether smart contracts will make your career go up in smoke.

I’m going to go ahead and tell you the answer: No. Smart contracts are not going to replace lawyers, not in any substantive way.

For one thing, “smart contract” is a bit of a misnomer. At the ABA Business Law Section annual conference a couple of weeks ago, a panelist referred to a “smart contract” as an “automated blockchain transaction”, which is much more accurate. The smart contract carries out what it is programmed to do, and that’s it. It doesn’t think independently, nor does it provide any reasoned analysis.

Smart contracts suffer from what is termed the “oracle problem.” This refers to the fact it is extraordinarily difficult to take human reasoning out of the equation. At some point, someone (an “oracle”) is going to have to step in and say whether the terms of the contract were fulfilled or not. For example, if payment Y is released when shipment X is delivered, how is the smart contract going to know that shipment X was exactly what was specified in the contract? (And that they were delivered undamaged, etc.) Somebody needs to look inside the box and say, “Yep, those are the widgets we’re looking for.”

Matt Levine at Bloomberg has a great quote: “My immutable unforgeable cryptographically secure blockchain record proving that I have 10,000 pounds of aluminum in a warehouse is not much use to a bank if I then smuggle the aluminum out of the warehouse through the back door.”

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Also, there’s a limit to what can be automated. Reps and warranties, third-party beneficiaries, how to address mistakes, the list of topics that can’t be automated is endless. Also, how many of us have looked at a Shepardization (is that a word?) that showed a yellow flag that turned out to be perfectly fine, or a green flag that turned out to be a little questionable? Just because a computer says it doesn’t mean it’s right, though I understand the point of view that suffering through a few anomalies could be worth it in the larger picture.

Other terms perhaps can be automated, but given the nature of the term, they probably should not be. Indemnification, for example. Given that indemnification represents an enormous uncapped liability, is any client going to feel comfortable trusting that to a smart contract?

Another one is governing law. Sure, a smart contract can be set to always use Delaware law, but remember those crazy hypotheticals from the bar exam? Somebody from Pennsylvania is visiting Las Vegas and gets in a car accident with a person from Texas (who is, of course, armed with a gun made in Connecticut) in a car manufactured in Michigan. Which law applies? These parties aren’t even in a contract to begin with, so how is it no lawyers will be necessary to sort all this out?

A smart contract is best for carrying out the simple “if thens” of the agreement. Basically, the first page of the term sheet. Party A will do X, and in return Party B will do Y. Not so much for “any supplier providing goods of a significant amount to Party A prior to August 29, 1997 is entitled to rely upon this Agreement.”

Thus a smart contract is not really “smart,” and is not really a “contract.” As long as you can bring more to the table than “if/then”, then you’re safe from Skynet. For now…

Gary J. Ross is a partner at Ross & Shulga PLLC, which he co-founded in 2017 after running his own firm for four years and after several years in Biglaw and the federal government. Gary handles corporate and securities law matters for venture capital funds, startups, and other large and small businesses, as well as investors in each. You can reach Gary by email at Gary@RSglobal.law.

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