Arbitrating blockchain disputes—will smart contracts require smart dispute resolution?

Arbitrating blockchain disputes—will smart contracts require smart dispute resolution?

51570977 - polygonal background with triangles vector gray illustrationThis article considers the opportunities and challenges posed by blockchain’s wider adoption. Lee Bacon, Nigel Brook and James Contos of Clyde & Co turn to the resolution of blockchain related disputes.

In February 2016, hackers compromised the Society for Worldwide Interbank Financial Telecommunication’s (SWIFT) systems and issued instructions requesting the transfer of almost USD$1bn from Bangladesh’s central bank. Approximately USD$100m worth of those transactions succeeded, the majority of which was channelled into casinos in the Philippines. It is believed that if it were not for the misspelling of the word 'Foundation' in some messages, a much larger amount would have been stolen. As Hayley Sweetland Edwards of Time Magazine noted, it was not the amount of the heist that caused a stir, 'what shook the banking community was the breach of trust'. This attack followed a similar breach in January 2015 in which approximately USD$12m was stolen through the use of SWIFT credentials to modify transaction details.

Claims will undoubtedly arise out of these SWIFT heists and insurance policies will be called upon to respond. Proponents of the use of blockchain technology in the finance sector could hardly ask for a better advertisement of its advantages vis-à-vis the current system. After all, the enabling of trustless payments and blockchain’s robust security against cyber-attacks are two of its key innovations (the attack on Ethereum discussed in our earlier article exploited a vulnerability in the coding of a smart contract, not its blockchain). In light of the inevitable claims, are current mainstream dispute resolution avenues appropriate for technology disputes, and will they be suitable to deal with the even more alien concepts of blockchain, smart contracts and decentralised autonomous organisations (DAOs)?

Drafting a dispute resolution clause

As a starting point it is vitally important for the parties to agree on how and where disputes are to be resolved, and what law is to apply. Without this consensus, there is an enormous scope for disputes on these topics, particularly where decentralised organisations run on a blockchain housed on servers in different countries.

Next, the parties should choose between court and arbitration. Technology-related matter lists in civil courts are now common. The English courts for example have both an Intellectual Property Enterprise Court and a Technology and Construction Court. Such divisions acknowledge and reflect the specialist knowledge these areas require, as well as the procedural peculiarities they may demand. The judges selected for these lists have the requisite understanding of unique concepts to apply the law correctly—however, there is of course no guarantee that a judge will be familiar with a particular issue, and parties have little say in who will adjudicate their dispute. If the parties instead opt to resolve their disputes by arbitration then they can address the problem by selecting arbitrators who have the necessary expertise.

Drafting an arbitration agreement

A suitably drafted arbitration agreement will likely make it easier to resolve a dispute in the parties’ preferred manner. To illustrate, consider the example of parametric insurance policies for drought insurance which, utilising blockchain and smart contracts, auto-execute claim payments to insureds where rainfall over a defined period drops below a certain threshold. Those payments also then self-execute as between insurer and reinsurer so as to complete payments through the risk transfer chain. Trusted data sources upon which these smart contracts rely, known as Oracles, feed information (in this case rainfall data) to the smart contract. However, if the Oracle was to provide inaccurate information, an entire bundle of policies (via their smart contracts) may incorrectly respond, causing significant loss to the insurer. Conversely the inaccurate information may fail to trigger an otherwise valid payment. Would the insurer or the insured have any recourse? Against whom?

The answer depends, of course, on the terms of the policies and those within any contract with the Oracle. Assuming there is a wrongful payment, the first option is that the insurer may recover amounts from individual insureds (on the basis of unjust enrichment for example). An arbitration agreement to resolve the disputes could be embedded in (or parallel to) the smart contract arrangement; however, that course would likely be inefficient and costly given the amount of separate actions that would need to be commenced. It would also raise regulatory restrictions in many jurisdictions.

Assuming the insurer had a contractual relationship with the Oracle, it is far more likely to pursue it for damages in negligence and/or contract. Where the insurer was, for example, incorporated in England, yet the Oracle was incorporated in the US, the cross-border advantages of arbitration would render it an ideal vehicle for the insurer to pursue its claim. An effective arbitration agreement will generally be recognised by and enforceable in the domestic courts of the parties, while attempts to instigate domestic court proceedings in those jurisdictions would likely fail. Finally, the insurer would have greater ability to enforce any arbitral award.

Despite arbitration’s suitability to technology disputes, the major arbitral institutions are yet to thoroughly adapt with unique governing rules or procedures. While specialist technology institutions exist, they generally still lack the reputation and resources to handle large-scale matters.

Certain procedural aspects of the arbitration could benefit from tailoring where an agreement or part thereof is written in code or some urgency is required for interim issues. Some of these issues could be considered in the arbitration clause itself pending procedural developments.

In regard to choice of institution, rules which cater for emergency arbitrators and accelerated tribunal formation may benefit disputes which have time-sensitive elements. Further, the need for experts and an appropriate tribunal could lend itself to holding the hearings in a hub likely to contain or at least attract such specific expertise.

As with many of the complexities surrounding blockchain technology, it is at this early stage easier to raise issues than to solve them. Clyde & Co’s arbitration team is actively investigating appropriate forums for handling blockchain-related disputes, considering effective drafting of arbitration clauses and how (if at all) to include them in smart contracts. Please contact our cyber specialists, led by our San Francisco office, with any enquiries in relation to blockchain or technology disputes generally.

This article was written by Lee Bacon, Nigel Brook and James Contos and was originally published by Clyde & Co. The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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