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Official Gazette

Sunday, May 22, 2022

Smart contracts prompt the need to improve the legal system

Updated: 09:00’ - 01/01/2022
Luu Huong Ly, LL.D.
Department of Civil and Economic Laws - Ministry of Justice

Introduction

In Vietnam, when it comes to blockchain, people often think of virtual currency such as Bitcoin and Ethereum. But in fact virtual currency is just the first and most popular application of blockchain technology. Blockchain technology can be applied in innumerable domains, one of which is blockchain-based smart contracts. With such advantages as transparency, reliability, certainty of execution and cost-saving, smart contracts are considered to have great development potential and are drawing great interests from the international community. Smart contracts have been developed and are used in a variety of fields such as finance, banking, supply chain, healthcare, education, transportation, etc. The questions now are: what is the legality of smart contracts, can Vietnam’s contract law be applied to smart contracts, and in the future do we need to revise the current legal system to regulate smart contracts? This article will focus on analyzing, evaluating and clarifying the above issues.

Concept and essence of smart contracts

In the world today, there is still no unified definition of smart contract. Smart contracts can be defined as agreements wherein execution is automated, usually by computers. Such contracts are designed to ensure performance without recourse to the courts by removing human discretion from contract execution[1]. Essentially, smart contract is a computer code that, upon the occurrence of a specified condition or conditions, is capable of running automatically according to pre-programmed functions. The code can be stored and processed on a distributed ledger and would write any resulting change into the distributed ledger[2]. Experts believe that the decentralization brought by blockchain technology provides the ideal infrastructure for smart contracts. Each transaction will be recorded and stored as a serial block of information and can be proven through retrieving the transaction history on the chain. It is this characteristic of blockchain that provides blockchain-based smart contracts with the potential to prevent or quickly resolve contractual disputes[3].

There are two possible scenarios for a smart contract: (i) the entire agreement between the parties is represented in encrypted commands or (ii) the smart contract is just a code to automate the enforcement of an underlying legal agreement (whether expressly written or not) between the parties. It is worthy to note that for the time being, most smart contracts fall into the latter category[4]. According to some experts, in the near future, smart contracts will likely be used only to ensure automatic execution of contractual terms that are precise enough to be encrypted[5].

Blockchain-based smart contracts have become popular__Photo: Internet
 

Vietnam’s law on smart contracts

Legality of smart contracts

As defined in Article 385 of the 2015 Civil Code, “Contract is an agreement between the parties on the establishment, change or termination of civil rights and obligations.” In order for a contract to be valid, it must satisfy certain conditions[6], including:

(i) The subjects have the civil legal capacity and civil act capacity in conformity with the established civil transaction;

(ii) The subjects participate in the civil transaction on a completely voluntary basis;

(iii) The purpose and contents of the civil transaction do neither violate prohibitory provisions of law nor contravene social morality; and,

(iv) The form of the civil transaction conforms to legal provisions thereon, if any.

Hence, in principle, a smart contract will possibly be regarded as a contract and binding on the parties as long as it meets the above conditions. If we think of smart contract as a type of electronic contract, it is worth mentioning that the legality of electronic contracts was already acknowledged in the 2005 Law on E-Transactions. Accordingly, an electronic contract is a contract established in the form of a data message in accordance with the specialized law (the 2005 Law on E-Transactions)[7] and its legality cannot be denied simply because the contract is presented in the form of a data message[8].

However, the 2005 Law on E-Transactions says nothing about the conclusion and performance of contracts via automated information systems. The Law, on the one hand, provides the concept of automatic electronic transaction, i.e., electronic transaction that is performed automatically in part or in whole through a pre-established information system[9]. But on the other hand, it fails to clarify the legality of automatic electronic transactions as well as responsibilities of the parties when entering into such transactions. Government Decree 52 of 2013 on e-commerce takes a deeper look at the possible use of automated information systems in commercial activities. Article 13 of the Decree stipulates: “The legality of a contract concluded from the interaction between an automated information system and a person or between automated information systems cannot be denied on the ground of lack of human inspection of, or intervention in, each specific action performed by the automated information system(s) or the concluded contract.” However, as Decree 52 is silent about the performance of contracts via automated information systems, the legality of smart contracts, a type of contracts that are automatically executed through computer codes, remains uncertain. 

In addition, the 2005 Law on E-Transactions contains no provision on presumption of capacity of parties to electronic transactions. Let’s look at the neighboring country of China. Article 48 of China’s 2018 Law on E-Commerce states: “Parties involved in e-commerce activities are presumed to have full civil act capacity to perform corresponding legal acts, unless there is evidence to the contrary”. This regulation has great significance to the development of electronic transactions as it conforms to the characteristics of electronic transactions that, unlike traditional transactions, do not necessitate the parties to see each other and even allow one or all of the parties to stay anonymous when participating in transactions.

Smart contracts as evidence upon settlement of civil disputes at jurisdictional agencies

The 2015 Civil Procedure Code of Vietnam stipulates: “Evidence in a civil case is any matter of fact which is handed over or produced to the court by the involved parties and other agencies, organizations and individuals in the litigation process or collected by the court according to the order and procedures prescribed by this Code and used by the court as the basis for ascertaining objective circumstances of the case as well as whether the claims or protests of the involved parties are well-grounded and lawful[10].

The Code also specifies 10 sources of evidence, including: readable, audible and visible documents, electronic data; exhibits; involved parties’ testimonies; witnesses’ testimonies; expert assessment conclusions; on-site appraisal records; asset valuation and price appraisal results; written records of legal facts and acts that are made by a competent person; notarized/authenticated documents; and other sources as prescribed by law[11]. Thus, in principle, according to the 2015 Civil Procedure Code, smart contracts, as electronic data, can be fully recognized as a source of evidence when settling civil disputes at jurisdictional agencies.

Legality of cryptographic signatures and blockchain-based records

The 2005 Law on E-Transactions provides for electronic signatures as follows: “An electronic signature shall be created in the form of words, letters, numerals, symbols, sounds or other forms by electronic means, logically attached or associated with a data message and capable of certifying the person who signs the data message and his/her consent to the content of the signed data message.[12]

Compared with the above provision, cryptographic signatures completely satisfy the conditions to be treated as electronic signatures. Additionally, under the 2005 Law on E-Transactions, an electronic signature will be considered secure if it is verified by a security check process agreed upon by parties to the transaction and meets the following conditions: (i) the electronic signature-creating data is associated solely with the signer in the context in which such data is used; (ii) the electronic signature-creating data is under the control of the signer only at the time of signing; (iii) all changes to the electronic signature after the time of signing are detectable; and (iv) all changes to the contents of the data message after the time of signing are detectable[13]. The Law also stipulates that an electronic signature may be certified by an electronic signature certification service provider and the certified electronic signature will be considered having satisfied security conditions[14]. Thus, certification by electronic signature certification service providers is not a mandatory condition for electronic signatures to be recognized as secure.  However, since the adoption of the 2005 Law on E-Transactions, the Government has issued only one decree on digital signatures (Decree 130 of 2018 detailing the Law on E-Transactions regarding digital signatures and digital signature certification services) but not yet enacted any regulations to further explain about electronic signatures, leading to confusion between electronic signatures and digital signatures and even the notion that only digital signatures are regarded as safe and legally valid.

Interpretation of contracts

Article 404 of the 2015 Civil Code lays down general principles on interpretation of contracts as follows:

1. In case a contract contains ambiguous terms, the interpretation of such terms shall be based not only on the wording of the contract but also on the intentions of parties expressed before and at the time of establishment, and during the performance of the contract.

2. In case a term or wording of a contract may be understood in different ways, it shall be interpreted according to the meaning which is most appropriate to the purpose and substance of the contract.

3. In case a term or wording of a contract is difficult to understand, it shall be interpreted according to customary practices of the place where the contract is entered into.

4. The terms of a contract shall be interpreted in their interrelations, so that the meanings of such terms conform to the whole contents of the contract.

5. In case of any contradiction between the common intention of the parties and the wording used in the contract, the common intention of the parties shall be used to interpret the contract.

6. In case the contract-drafting party inserts in the contract contents which are unfavorable to the other party, the contract shall be interpreted in a manner favoring the other party.”

Nonetheless, these principles are applicable to contracts of all types, including also smart contracts. In order to facilitate the resolution of disputes in reality, legal interpretation is still needed. For example, it remains unclear which contract will take precedence if there are inconsistencies between the terms of the smart contract and those of the written contract resulting from technical errors in entering smart contract codes.

Modification of contracts

Modification of contracts is provided in Article 421 of the 2015 Civil Code which says that the parties may agree to modify their contract and the modified contract must take the form of the original contract. However, as analyzed above, with the current development level of blockchain technology, it is quite difficult to modify a smart contract right at such contract itself and the parties will likely have to negotiate outside the blockchain system or encrypt a new smart contract to change the terms of the existing smart contract.

Compliance with specialized laws

Another thing to note is that, in addition to the Civil Code, smart contracts must also comply with specialized laws. For example, a smart contract in insurance business is an insurance policy, hence subject to the insurance law, and concurrently a contract with consumers, so governed by the law on protection of consumer interests.

Determination of applicable law and jurisdiction

This problem can be solved if the parties to a smart contract pre-program(encrypt) the applicable law and jurisdiction clause in the smart contract. In case such clause is not pre-programmed on the smart contract, there are legal provisions that may be used as grounds for determining the applicable law and the jurisdiction of Vietnamese courts. Under Article 683 of the 2015 Civil Code, parties to a contractual relation may reach agreement to select the law applicable to their contract, except some certain cases as prescribed by law. In case of the absence of such agreement, the law of the country with which the contract is most closely associated will apply. Regarding the determination of jurisdiction, Articles 469 and 470 of the 2015 Civil Procedure Code provide for the general jurisdiction of Vietnamese courts to settle civil cases involving foreign elements and exclusive jurisdiction of Vietnamese courts. Thus, when a dispute arises from a smart contract, the disputing parties may base themselves on these provisions to determine the jurisdiction of Vietnamese courts.

Recommendations

For the time being, with the current development level of blockchain technology and smart contracts, it can be temporarily concluded that Vietnam’s legal framework on contracts and electronic transactions is quite adequate to regulate smart contracts without requiring any great amendments or supplements. However, several revisions should be made to the 2005 Law on E-Transactions so as to facilitate the application of smart contracts in reality.

Firstly, in order to guarantee the legality of automatic electronic transactions in general and smart contracts in particular, regulations on use of automated information systems in e-transactions should be added. Accordingly, a contract that is concluded or performed from the interaction between an automated information system and a person or between automated information systems will not have its legality denied as a result of the lack of human inspection of, or intervention in, each specific action performed by the automated information system(s) or the concluded contract. Moreover, the parties using the automated information system will be liable for the acts performed by such system.

Secondly, lawmakers should consider adding regulations on presumption of legal capacity of parties to electronic transactions so as to lessen the parties’ duty to prove the validity of transactions upon occurrence of disputes. In other words, the party that requests declaration of transaction as null and void because of the other party’s failure to satisfy requirements on legal capacity would bear the burden of proof.

Thirdly, the 2005 Law on E-Transactions should be revised toward adopting clear and distinctive definitions of “electronic signature”, “secure electronic signature”, and “digital signature” and specifying conditions and criteria for an electronic signature to be considered secure. Once revised, the Law should clearly define secure electronic signature as either a digital signature satisfying certain conditions or a signature agreed upon by the parties and meeting law-specified conditions. Regarding the conditions for an electronic signature to be regarded as secure and reliable, lawmakers could refer to the 2001 UNCITRAL Model Law on Electronic Signatures, which highlights the principle of technological neutrality, i.e., recognizing the validity of electronic signatures regardless of the type of technology used in transactions. Although the Model Law on Electronic Signatures is designed mostly for digital signatures, which are created by public-key encryption techniques, it also mentions the use of new technologies such as biometrics and PIN authentication.

Another thing to consider is legitimization of secure electronic signatures so as to ease contractual parties from the burden to prove the authenticity and integrity of their electronic signatures, unless there is proof to the contrary.

Lastly, in the process of settlement of disputes related to such novel things as blockchain and smart contracts, it is likely that a legal provision is understood or interpreted in different ways. Hence, the Supreme People’s Court should issue a resolution or legal precedent to interpret and guide the unified application of law. However, it should be kept in mind that technology is now moving faster than ever before and blockchain and smart contracts are not exceptions, requiring authorities to keep a close eye on this issue so as to revise the legal system if necessary.-


[1] Max Raskin, “The Law and Legality of Smart Contract”, 1 GEO. L. TECH. REV. 305 (2017), available at https://georgetownlawtechreview.org/wp-content/uploads/2017/05/Raskin-1-GEO.-L.-TECH.-REV.-305-.pdf, p.306.
[2] Chamber of Digital Commerce, “Smart Contracts: Is the Law Ready?”, September 2018, available at https://digitalchamber.org/smart-contracts-paper-press/, p.10.
[3] Jack Gilcrest & Arthur Carvalho, “Smart Contracts: Legal Considerations”, available at https://www.researchgate.net/publication/330626140_Smart_Contracts_Legal_Considerations
[4] Gary Tse, “Smart contracts: a boon or bane for the legal profession?”, available at  https://www.taylorvinters.com/article/smart-contracts-a-boon-or-bane-for-the-legal-profession
[5] Primavera De Filippi and Aaron Wright, Blockchain and the Law (HUP 2018), p.195.
[6] See Articles 116, 117, 122, 407 and 408 of the 2015 Civil Code.
[7] Article 33 of the 2005 Law on E-Transactions.
[8] Article 34 of the 2005 Law on E-Transactions.
[9] Article 4.7 of the 2005 Law on E-Transactions.
[10] Article 93 of the 2015 Civil Procedure Code.
[11] Article 94 of the 2015 Civil Procedure Code.
[12] Article 21.1 of the 2005 Law on E-Transactions.
[13] Article 22.1 of the 2005 Law on E-Transactions.
[14] Clauses 2 and 3, Article 21 and Article 22.2 of the 2005 Law on E-Transactions.

 

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