Blockchain: Can Smart Contracts Replace Lawyers?

Not quite yet, but their potential to do so in the future does raise many interesting questions.

So far in our discussion on blockchain, we’ve touched on a number of topics including exactly what makes blockchain transactions immutable and how blockchain technology can provide trust between parties involved in a financial transaction. What we have yet to cover is if, and how, blockchain technology could disintermediate attorneys in transactions. This is where the concept of “smart contracts” comes in.

As we start to dig into this topic, it merits stating that, despite the name, a smart contract is not a contract in the traditional sense, nor does it replace same. A smart contract is a software program that “sits” on top of the blockchain and takes actions (e.g., posts transactions) on the blockchain based on certain data conditions that are detected in the blockchain. If that definition sounds vague to you, it’s because smart contracts can potentially serve many uses.

For the purpose of this article, we will continue to look the transfer of property example that we explored in last month’s article. In order for transfer of property to occur, the following things[1] have to happen (assuming purchase terms and conditions have already been agreed to):

• The purchaser pays a portion (down payment) of the agreed upon funds for purchase.
• Assuming that the purchaser is borrowing funds, the mortgage company pays the remaining balance required for purchase.
• Purchase funds are used to clear outstanding liens (e.g., mortgages, unpaid taxes, etc.) on the property.
• Remaining purchase funds are distributed to the seller.
• Any requisite new liens (e.g., the purchaser’s mortgage) are added to the property.
• Title is transferred from the seller to the purchaser.

Given that the average purchase price of a new house in the U.S. is roughly $400K,[2] the funds associated with purchase are not insignificant — so it makes sense for each of the parties to look for a trusted intermediary, such as a closing attorney, to help facilitate the transaction. The parties typically agree on a title company to prepare and file all required paperwork and (most importantly) to hold funds in escrow while each of the above steps are taken. This ensures, among other things, that the seller doesn’t simply abscond with the purchase funds and leave the purchaser with a lien-ridden property.

So how does the blockchain and the concept of smart contracts fit into such a transaction? To start, the necessary data to complete the transaction would all have to be stored in a single blockchain system. At a minimum, a central, most likely government-owned system that includes property and lien records would have to exist. In addition, the system would need to be able to transfer payment between users through either some form of cryptocurrency or a more traditional automated clearing house-based (ACH) payment mechanism.

Assuming that all of the above were in place, then one could write a computer program (a smart contract) that would be capable of monitoring all of the data referenced above. In order to execute the transaction, the following steps would be required:

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1. Both purchaser and seller agree to the terms of sale, input those terms into the smart contract, and digitally sign their acceptance. The smart contract application writes the terms and authorizations into a blockchain transaction.

2. At closing, the purchaser transfers down payment funds through the smart contract to the smart contract’s escrow account. The smart contract application writes the new escrow balance and the payment record into the blockchain.

3. Assuming that underwriting has been completed successfully (this is performed outside the system), the purchaser’s mortgage company transfers the remaining funds through the smart contract to the smart contract’s escrow account. The smart contract application writes the new escrow balance and the payment record into the blockchain.

At this point, the smart contract can see both the terms of the transaction and that payment has been made by the seller. Assuming that the payment meets the terms of the transaction, the smart contract can begin to process the remaining transaction items:

4. The smart contract application transfers funds to each lien holder, marks each lien record as closed, reduces the escrow balance appropriately, and records all actions as a transaction on the blockchain.

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5. The smart contract application transfers the title to the purchaser, establishes a new lien for the mortgage company, transfers remaining funds to the seller, and records all actions as a transaction on the blockchain.

This hypothetical workflow illustrates the potential disintermediation of the closing attorney in a real estate transaction, but it should be noted that significant development of a property records system (most likely by a government agency) would be required to even contemplate such a workflow.

This example highlights the difference between potential and technical feasibility in a near-term scenario for blockchain technology in law… where implementing a smart contract, in terms of layering on the actual technology, is not the most complicated part. The true challenge lies in all of the other aspects of the process — and the buy-in from existing governing bodies and institutions — that would have to fall into place to make this executable.

The potential, however, does raise many interesting questions: who would write such a smart contract application? How would that provider develop trust with the market? What would happen when things go wrong (e.g., if the seller knowingly failed to disclose a material defect in the property)?

These and other topics are currently under examination within our industry. Several groups are already making significant inroads and investment in exploring blockchain technology’s role in the practice of law. More on that next month.

[1] This of course is a simplistic view of the steps required in transfer of title, and is meant to serve as a high-level example to illustrate the potential role of a smart contract.
[1] U.S. Census figures, December 2017


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Dean Sonderegger is Vice President & General Manager, Legal Markets and Innovation at Wolters Kluwer Legal & Regulatory U.S., a leading provider of information, business intelligence, regulatory and legal workflow solutions. Dean has more than two decades of experience at the cutting edge of technology across industries. He can be reached at Dean.Sonderegger@wolterskluwer.com.

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