Hong Kong: Smart Contracts Definition and Legality

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.

As the technology has evolved, ‘smart contracts’ have emerged that have added further versatility to Distributed Ledger Technology(DLT). Participants are allowed to enter self-drafted agreements (i.e. smart contracts) and embed them in the records of the DLT network. Such contracts are developed in computer code, enabling DLT to execute them automatically and in precise conformity with the contract terms. Triggering events can be designed and built into the smart contracts to activate certain actions when specified events occur or certain data is received. A typical example involves a payment being triggered when a specified date is reached.

A “smart contract” is a colloquialism, and is neither legally defined by law nor a technical term. Smart contracts generally have two components: the “contract-ware” and the “DLT.” They contain immutable coding to promote transactional certainty ex ante. The “contract-ware” part of the smart contract program automates execution and exercise human discretion from performance. The contract-ware is self-interpreting and self-enforcing: it processes/interprets factual input and delivers the intended output; and it has control over, at least some of, the physical and/or digital objects needed for performance. The DLT builds in an external neutral self-help mechanism for smart contract parties. A smart contract is meant to be self-contained and obviates enforcement by judicial or arbitral intervention. “Strong” smart contracts allow for no or little room for revocation and modification (by the parties or enforcing courts/tribunals), and vice versa for “weak” ones. In this sense, “strong” smart contracts also provide no or little room for nonperformance.

With reference to the definition above, a “smart contract” has the effect of a contract, but it takes on many forms. It should not be understood as a contractual document in digital form. Referring to the vending machine example, the main legal relationship exists between the consumer and the soda can vendor and not with the machine, which is a distribution agent. This relationship includes but also exists beyond the machine. The smart contract usually contains the mechanics for execution, performance and enforcement, but it might not contain the entirety of terms forming the contract at law. The relevant question therefore is what sort of legal remedies are sought and under what claims. If a party desires to seek contractual remedies and enforce the smart contract as a contract at law, then the common law contract requirements would need to be proven to have existed contemporaneously during the purported contractual relationship between the relevant parties. The requisite elements that must be established to demonstrate the formation of a legally binding contract are: (1) offer; (2) acceptance; (3) consideration; (4) mutuality of obligation; (5) competency and capacity; and, in certain circumstances, (6) a written instrument.

It is also noteworthy that commonly a user enters into a transaction involving smart contracts by a click-wrap agreement (and there is case law in Hong Kong and overseas providing guidance on click-wrap agreements). The user, however, is agreeing to the terms of the click wrap agreement, which might or might not incorporate the terms of the smart contract (it could be simply the service terms for access a trading portal).


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