The answer for this question is still debated within the related work groups of the Hong Kong government agencies. There are two white papers released by the Hong Kong Monetary Authority on November 11th, 2016 and October 25th 2017 in which they explain the progress in regulations related to Distributed Ledgers. I will refer to these papers when answering this question.

Where a distributed ledger technology has a central administering authority with the power to insert arbitrary or remedial transactions into that ledger (a permissioned ledger might provide for this), the parties might, for example, agree that this authority has the power to determine any disputes. This agreement might be contained in a particular smart contract, or it could be part of the terms and conditions accepted by the participant when it acquires an identity or otherwise participates in the particular ledger. The authority would need protection from disputes arising from its exercise of these powers. Again, that could be a term of a smart contract or the terms and conditions of the permissioned ledger.

Where: (a) a distributed ledger has no central administering authority (whether the distributed ledger is permissioned or permissionless); or (b) the parties do not wish to delegate dispute resolution to it; or (c) it is logically impossible to unwind a transaction without the participation of a quorum of all of the participants, then the problems are more acute: it may be impossible to unwind a transaction even if clearly desired by the direct parties. A dispute resolution mechanism built into the smart contract itself could provide a solution.

Such a mechanism would need the following characteristics:

• a provision in the contract code that causes delegation to an arbitrator, which would be triggered under rules encoded in the smart contract: for example by both parties asserting a defect and nominating the arbitrating entity;
• a provision in the contract natural language version agreeing to submit disputes to arbitration: this assumes that there is - a natural language version of the contract and that it matches the delegation mechanism in the contract code
• a forum for arbitration, which could be administered centrally, or via a relevant ledger, or by use of one of the many existing and experienced fora.

The forum would identify these essential components:

• a body of rules for the arbitration
• pool of possible arbitrators who could vary from persons able to provide expert determination at a low fee to high-value arbitrators capable of overseeing complex disputes
• an administration capable of managing the cases as they are led and decided.

A dispute resolution mechanism embedded in a smart contract reflects the advantages of a smart contract over a traditional contract: enforcement of the dispute resolution process and the consequent decision could be made automatic and integrated into the ledger. Not only would smart contracts deliver finality of agreed actions in performance, but also those actions and events that generate discord for whatever reason -disagreement over intent, bugs in the code, external exigencies- could also achieve finality through a formal process.

Such a mechanism might also provide a partial solution to the complexities of cross-jurisdictional trade. By using a common body of rules, the parties can agree to a rule base that is aligned across borders and legally acceptable within both jurisdictions.

Sources

• Can smart contracts be legally binding contracts? An R3 and Norton Rose Fulbright White Paper