Blockchain and commercial disputes: new Law Society guidance

17th March 2022

The Law Society recently published the second edition of its legal and regulatory guidance on blockchain, described as “a comprehensive guide to the legal and regulatory considerations that everyone in the on-chain space needs to understand”. As the Law Society explains, over the past 18 months, the Covid-19 pandemic has accelerated the use and evolution of distributed ledger technology (DLT) such as blockchain.

See our recent briefing Understanding blockchain, NFTs & smart contracts and our video What is a blockchain? for an introduction to blockchain technology. DLT describes a wide range of technologies that maintain immutable digital records across a network and is considered to have far-reaching potential across a wide range of sectors.

England and Wales is already at the forefront of developments in this area [1]. As the use of DLT becomes more prevalent, the law (and the lawyers who practise it) will need to continue to adapt in order to keep up with the opportunities and challenges it presents. The guidance suggests best practice for legal practitioners working with these new and developing technologies and covers a range of topics including smart contracts, data and governance, data protection, intellectual property rights, dispute resolution, competition, tax, and environmental, social and governance. It will also be of interest to businesses seeking to familiarise themselves with these technologies and their uses.

In this article, commercial dispute resolution experts Louise Norbury-Robinson and Jack Heward from Walker Morris’ Technology & Digital Group summarise some of the key points raised in the guidance concerning blockchain’s impact on the commercial dispute resolution process.

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Practical uses of blockchain in commercial disputes

The guidance explores ways in which DLT can assist, as well as the potential pitfalls that may be encountered. Benefits include:

• DLT/blockchain could be effectively used in the disclosure stage of litigation to make the process quicker and more cost effective than current methods that rely on specific key word searches to select documents and identify issues in the claim. By comparison a DLT platform would be coded to identify common disputes and issues, allowing for partially automated disclosure. In addition, everything uploaded to the platform would be encrypted and non-removable, giving parties certainty over the integrity of the information and the process and easing any suspicions of tampering or removal.

• The DLT platform assigns a member of the ledger/blockchain a unique access key (similar to a bank pin number) as a secure way of generating a digital signature for each transaction recorded on the ledger/blockchain. This has a clear benefit over wet (physical) signatures which can be easily subject to fraud. It also provides certainty as the signature cannot be replicated by another individual (unless stolen), thereby reducing arguments over fraud and false signatures in litigation; and improves efficiency in light of new working practices as a result of the pandemic [2].

“On-chain” dispute resolution options

The guidance notes that there is an increasing number of new DLT-based – or “on-chain” – dispute resolution offerings which aim to digitise the traditional dispute resolution process. Companies have developed systems in response to users’ appetite for speed, efficiency and automaticity. The guidance makes the point that these are in respect of what are essentially smart contracts – they have not yet sought to solve on-chain disputes centred on smart legal contracts, which are still a relatively new technology in themselves.

On-chain offerings often purport to be a form of arbitration, although the guidance notes that the term is often misused and the majority do not satisfy the requirements under domestic laws or international treaties (for example the New York Convention) to result in a valid legal decision enforceable in the off-chain world.

The current on-chain systems broadly fall into the following three categories:

• Online “arbitration” where arbitration procedures are incorporated into the code of a smart contract, generally giving parties an option to choose arbitration before disputes arise, and claiming that awards are binding and legally enforceable;

• crowdsourcing, which allows anonymous users on the network to cast their vote as to who the “winner” of a dispute should be and rewarding them accordingly; and

• AI powered “bots” – predictive analytics tools – which produce data-driven decisions on the outcome of a dispute that can then be executed automatically.

Observations and concerns

The guidance makes a number of observations and identifies various concerns around the scope, soundness and reliability of current on-chain mechanisms to resolve the full range of potential disputes. They include the following:

• Among other things, the parties can agree encoded provisions that mirror the escalation steps in a traditional dispute resolution clause, so that they are automatically notified of a breach of the agreement, the automated operation of the code is “frozen”, and decision makers can then become actively involved to assist with the resolution of the dispute via traditional routes if desired.

• Another option would be a digitised commercial arbitration process intended to result in a valid and binding New York Convention award. Arbitration institutions could register on the DLT platform and users of the network could refer their disputes to be resolved under pre-established procedural rules through their smart contract or smart legal contract.

• On-chain solutions can be designed to automatically enforce the outcome of a dispute without any input from the parties. This would mean that monetary compensation could be paid immediately into the winner’s digital wallet without the need for the losing party to consent to or actively take steps to make the payment. This would save time and costs for the winner who might otherwise be forced to take enforcement action against their opponent in the event of non-payment.

• While these benefits will appeal to many would-be litigants, the guidance warns that on-chain mechanisms need to be legally robust – valid, effective and final in the off-chain world – to prevent other parties challenging or otherwise undermining the outcomes. If the outcome of the on-chain dispute can be subject to further scrutiny in a court of law or arbitral tribunal then it will only serve to increase the time and costs of the parties involved.

• Other on-chain options are based around anonymous users of the DLT/blockchain network gaining the right to vote on the dispute’s outcome by placing a stake in the form of cryptocurrency. They vote from a pre-determined list of binary outcomes, with those who voted with the majority receiving compensation and those who did not losing their stake. One of the obvious issues is that parties need to have the confidence that these anonymous “decision makers” have the necessary expertise to vote on the “correct” outcome of the dispute. A further glaring issue identified by the guidance is that in certain platforms the amount of cryptocurrency a user is willing to stake often determines the likelihood of them being selected as a decision maker and it is not even clear in some cases whether the user is ultimately a human or a bot. This presents a wide range of legal and practical challenges.

• DLT/blockchain uses a decentralised network that is not strictly bound by the limits of traditional physical borders or legal systems. A very complex legal battle may ensue if parties seeking to use on-chain dispute resolution processes fail to specify which law and jurisdiction will apply to their agreement. Parties would be well advised to consider these issues at the outset to avoid costly legal proceedings – including tactical satellite litigation in multiple jurisdictions – later down the line.

• The guidance notes that while on-chain dispute resolution mechanisms may be workable for small, straightforward and predictable disputes, it is not clear (at present) how useful they will be for more complex, multi-jurisdictional and unexpected disputes that require careful consideration of detailed evidence.

• The last section of the guidance dealing with dispute resolution considers in some detail the three issues of fundamental importance to the efficient and effective governance of any DLT system – jurisdiction, applicable law and money laundering. It says experience has demonstrated the need for cryptoassets and other DLT applications to operate within traditional legal and regulatory frameworks, noting, however, that regulators have at the same time been wary of stifling technological innovation.

The future

The guidance calls for a combination of authoritative guidance and best practice standards and concludes that, going forward, certainty and consistency of outcome in dispute resolution will likely be achieved through traditional processes and the increasing use of future forms of best practice DLT/other digital platform mechanisms combined with smart legal contract data. Examples such as regulators having been compelled to bring cryptoassets within the scope of anti-money laundering due to the illicit use of cryptocurrencies to facilitate money laundering, cyber crimes and token fraud mean that a vision of entirely self-automated DLT systems – untouched by traditional law and regulation – is not feasible.

While it is currently unlikely that on-chain dispute resolution will overthrow traditional procedures entirely, what this guidance clearly shows us is that the impact of blockchain on commercial dispute resolution will continue to gather pace as these technologies, and the discussion surrounding their uses, develops. The sooner commercial parties and their advisers get to grips with the potential benefits and pitfalls, the better.

How we can help

Our Technology & Digital experts are well placed to advise on all aspects of commercial agreements, disputes involving blockchain and other technologies and any concerns from a regulatory perspective. Please contact Louise or Jack if you have any queries arising from this briefing or need any advice or assistance.

[1] See, for example, Ground-breaking Digital Dispute Resolution Rules published, English law can accommodate smart legal contracts and English court grants wide-ranging relief after cryptocurrency scam

[2] For the latest position on electronic signatures, see Electronic execution: An essential update