Turkish Law Blog

A Legal Analysis on CISG’s Scope of Application from Smart Contracts’ Perspective

Emir Bayramoğlu Emir Bayramoğlu/ Forensis Law Firm
20 January, 2020

I. Introduction and Development of Smart Contract Technology

Distributed Ledger Technology (DLT) is a prominent element of today’s disruptive innovation age, and it is a fierce discussion topic especially ever since a pseudonymous person called Satoshi Nakamoto released his renowned paper and introduced a new peer to peer (P2P) electronic cash system called “Bitcoin”[1].  Nakamoto’s main idea was to create a decentralized transparent environment which eliminates any kind of financial intermediary and prevent double spending problem, which can be defined as threat of spending the same unit of value[2] more than once. Therefore, the philosophy is to create trustless trust.

DLT is an umbrella term[3] which refers to a digital system for recording the transaction of assets in which the transactions and their details are recorded in multiple places (called “node”) at the same time, without utilizing any central data storage or administration functionality. In principle, DLT consist of five different services: consensus, validity, uniqueness, immutability and authentication. 

Despite the fact that legal profession usually lagging behind technological developments, in the last decade, the legal community was not totally indifferent to DLT and blockchain. Our paper is related to “smart contracts”, which might be the most important reflection of blockchain technology on law. In 2013, a programmer called Vitalik Buterin released the Ethereum White Paper and launched his platform two years later, which is a next generation smart contract and decentralized application platform. It is not only one of the most ambitious projects that is built on blockchain; but also purportedly a real breakthrough for law[4].

Ethereum is equipped with the ability to form more complex smart contracts utilizing an “if-then algorithm”[5]. The Ethereum Virtual Machine (EVM) enables coders to generate hypothetically unlimited potential applications including but not limited to creating markets, registries of debts or promises which operates according to instructions, without needing a middleman. Furthermore, developers are not obliged to use EVM’s opcode; instead, they can use high-level and much more sophisticated programming languages such as Solidity and Serpent. For real life data input, tools called Oracle are being used.

In light of foregoing, EVM enabled developers (and in future the lawyers) to design nearly unlimited type of applications which is going to cause a lot of legal discussions. As a part of these discussions, following is going to address legal smart contracts and due to their potential use in international trade, they are going to be scrutinized under the scope of application of the United Nations Convention on Contracts for the International Sale of Goods (CISG).

II. Legal Smart Contracts and the CISG

Smart contracts are the bundle of two technological development: electronic contracting and cryptography. Thus, although theoretical idea of smart contracts exist for a long time, the smart contract idea laid dormant for many years due to the lack of technological platform which puts the idea into practice.  Therefore, publication of aforementioned white papers could be regarded as milestones for blockchain hype.

The term of “smart contract” is attributed to computer scientist and legal scholar Nick Szabo. Szabo, considering vending machines as a primitive ancestor, introduced the term with his paper released in 1994.  Acccording to Szabo, smart contracts are defined as:

A set of promises, including protocols within which the parties perform on the other promises. These protocols are usually implemented with programs on a computer network, or in other forms of digital electronics, thus these contracts are “smarter” than their paper-based ancestor. No use of artificial intelligence is implied[6]

Indeed, smart contract is a broad term encompassing different type of agreements on a wide spectrum. In the two extremes, a contract might be written entirely in code, or automation shall only be used as a payment mechanism whilst the parties use a natural language contract. The middle of-the-road approaches also exist in the same spectrum; such as, using a contract in code with a duplicated human language version or a “split” contract with encoded performance of non-human aspects.  Therefore, before making any interpretation with regards to the smart contracts- and yet there is no consensus on the terminology-  it would be accurate to give a definition. This paper embraces Clack et al.’s definition which sufficiently encompasses both smart contract codes and smart legal contracts and locate “hybrid” or “split” contracts and functionality of oracles:

A smart contract is an automatable and enforceable agreement; automatable by computer, although some parts may require human input and control. Enforceable either by legal enforcement of rights and obligations or via tamper-proof execution of computer code[7].

Since smart contracts aims at to reduce transaction costs and make it difficult to break an agreement, there is a rapidly increasing interest in practical usage of them and gradually more enterprises seek to use smart contracts in order to boost efficiency in supply chain and international trade. In parallel with that, World Trade Organization (“WTO”) published a full report on the potential of blockchain and smart contracts to transform international trade[8].

At this point, it is important to focus on the CISG’s scope of application when it comes to the smart contracts, not only due to convention’s worldwide success of governing international sale of goods in a harmonized manner[9]; but also the liberal and flexible philosophy behind it. This experience and the philosophy behind the CISG can be a useful role model for establishing standards for smart contracts.  Moreover, it is very likely to see the CISG coded as the governing law into smart contracts related to international sale of goods when smart contracts start being used in a wide scale[10]. On the other side of the coin, without filling the interpretational gap for the CISG’s applicability to smart contracts, the legal uncertainty and ambiguities may constitute a significant deterrent for development of this technology and thereby deter increasing trade flows and enhancing trade efficiency[11]. The following will attempt to examine smart contracts’ validity under relevant articles of the CISG which governs contract formation and under the definition of “sale of goods”. 

III. Formation Validity of Smart Contracts under the CISG

A. Different Theories Regarding to the CISG’s Scope of Application

Fulfilling the CISG’s provisions regarding to contract formation is a pre-requisite for a valid contract and therefore crucial in terms of whether smart contracts will be deemed valid under the convention. Article 4 of the CISG explicitly states that “This Convention governs only the formation of the contract of sale and the rights and obligations of the seller and the buyer arising from such a contract.” Same article also states that the convention “is not concerned with the validity of the contract or of any of its provisions or of any usage

Since the Article 4 or other provisions of the CISG do not define “validity”, it is consequently left to various domestic courts to decide the description of the term. While some scholars and courts contend that the issue of contractual validity must be determined exclusively by domestic law; on the other hand in a more internationalist manner, others argue that Article 4 of the CISG must be interpreted narrowly in light of Article 7, the legislative intent of the CISG’s drafters, and the “except as otherwise expressly provided” clause in Article 4(a)[12]. This paper adopts the latter and the gap will be attempted to be filled by the CISG articles and general principles. Therefore, the other theory and discussions related to domestic law are out of the context. However, in order to explore the relationship between the traditional civil and common contract law doctrine with smart contracts’ formation, you may see the study below[13] which takes the U.S and French contract laws as reference point.

B. Offer and Acceptance According to the CISG

Similar with the most traditional contract law doctrine, the envisaged contract formation of the CISG is also based on “offer” and “acceptance”. According to Article 11 of the CISG, offer and acceptance are not subject to any requirement as to form and it may be proved by any means. Pursuant to Article 14/1 of the CISG an offer is defined as below:

“A proposal for concluding a contract addressed to one or more specific persons constitutes an offer if it is sufficiently definite and indicates the intention of the offeror to be bound in case of acceptance. A proposal is sufficiently definite if it indicates the goods and expressly or implicitly fixes or makes provision for determining the quantity and the price.

Ultimately, a valid offer has to possess three main elements:

  • One or more specific offerees
  • Intention to be bound
  • Minimum content determined or determinable

The concept of acceptance is defined pursuant to Article 18/1 of the CISG:

A statement made by or other conduct of the offeree indicating assent to an offer is an acceptance. Silence or inactivity does not in itself amount to acceptance.

For the sake of simplicity, let’s proceed with a hypothetical smart contract example which is entirely coded. Company A wants to sell 100 widgets to Company B in return for lump sum 10.000 USD and promises to accomplish the delivery on 31 December, 2019. In addition, this assumption extends that the subject matter of the agreement falls within the scope of the Article 1 of the CISG and the parties have opted the CISG in as the applicable law.

Starting with the condition of existence of identifiable one or more offerees, the blockchain medium does not constitute a great obstacle. Blockchain relies on public key encryption infrastructure which consists of two keys: the public key, which identifies a participant’s account address, and the private key, which acts as participant’s electronic signature.  Unlike some argue that actual parties to a smart contract are cryptographic keys and the transaction is consummated with the exchange of messages between the machines, UNCITRAL’s legislators adopt a different approach. The UNCITRAL Model Law on Electronic Commerce with Guide to Enactment 1996 (“MLEC”) provides that data messages—defined as encompassing “all types of messages that are…in essentially paperless form” and generated automatically by computers—should be treated as “‘originating’ from the legal entity on behalf of which the computer is operated.[14]” Even though MLEC is not a binding instrument in terms of the CISG interpretation, it is important to understand the legislators’ approach towards the technology. In conclusion, it is possible to address an offer written entirely in code to a specific person via e-mail or blockchain.

The second condition is that the offeror has to have the intention to be bound with his offer. Parties’ intent is crucial for contract formation under the CISG. According to Article 8 of the CISG, in determining intent of a parties intent, “due consideration is to be given to all relevant circumstances of the case including the negotiations, any practices which the parties have established between themselves, usages and any subsequent conduct of the parties.” Therefore it is possible to form valid smart contracts under the CISG in several different scenarios. Returning to hypothetical example above, if the Company A is aware of or should have known the self-executing structure of smart contracts, setting a smart contract itself (without an emergency stop or another obstacle) would be a sufficient proof of Company A’s   intention to be bound. Likewise, if the parties successfully performed the same transaction of sale of widgets before, the prior transactions might constitute an evidence of Company A’s intention to be bound with similar agreements. Indeed, the same goes for if the parties have a history of contracts written in code. Consequently, second offer criterion is also might be fulfilled and an offeror can indicate his intention to be bound both in and outside of the blockchain.

Lastly, an offer should include a minimum content which is determined or at least determinable. Due to the nature of computer algorithm, a smart contract entirely written in code can include all necessary minimum information such as identity of the parties, type of goods, characteristics of the goods and delivery time and address. Turning a human language contract into code becomes a problem in case if a contract contains subjective expressions such as “reasonable time” or “best efforts”. However these are not sine qua non elements of a sales contract and therefore it is possible to design an offer written entirely in code to be sufficiently definite under the CISG.

Regarding to the acceptance, aforementioned principles apply as well. Assent might be shown in many ways such as providing private key in order to run the smart contract or just by starting to perform according to terms of the agreements. Utilizing the time-stamp feature of blockchain, the parties would be eligible to access exact time of all digital signatures and signed transactions. Therefore, when the Company B’s signature arrives to the distributed ledger, the contract will be deemed successfully formed.

Notwithstanding that the foregoing explanations, one should not overlook the fact that under the CISG, some formative contractual elements as regards capacity to enter into legal transactions, certain types of mistake and power of representation have to comply with the relevant domestic law[15].

IV. Smart Contracts from the Perspective of “Sale of Goods”

Apart from the formation validity of the smart contracts under the CISG, smart contracts’ content and type of the goods which are subject to sale is essential in order to understand the relationship between the smart contracts and the CISG. Therefore, following is going to scrutinize whether sale of cryptocurrencies and sale of tangible goods via smart contracts fall under the scope of the CISG, respectively.

A. Sale of Cryptocurrencies

The first question needed to be addressed is whether the contracts pertaining to buying cryptocurrencies with traditional currencies fall under the scope of the CISG. The CISG does not provide an exact definition of a “contract of sale”. However, Article 2 of the CISG exempts some kind of sales from the convention’s scope of application. According to paragraph (d) of this article:

This Convention does not apply to sales: … (d) of stocks, shares, investment securities, negotiable instruments or money; …

In light of this article, without any doubt, the answer is negative. Even though Ethereum and other cryptocurrencies cannot be defined as money in strict sense, they are designed to be an alternative to traditional currencies (or maybe even replace). Moreover, despite current deficiencies, virtual currencies purportedly have a goal to fulfill three functions of money: being a means of exchange, a unit of account, and store of value[16]. In line with that, in most circumstances, the courts or arbitral tribunals might regards cryptocurrencies as “money” for this particular purpose to determine the CISG’s scope of application. One example is that, in S.E.C. v. Shavers, No. 4:13-CV-416 (E.D. Tex. Aug. 6, 2013), the judge ruled that investing Bitcoin on the promise to receiving a greater amount of Bitcoin in the future, constitutes investing “money” under a very limited purpose, in terms of the Howey test (S.E.C. v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946)), which defines investment contracts[17]. An analogy could be made for purposes of the Article 2(d) of the CISG and thus contracts which related to sale of cryptocurrencies would be exempted.

Another reason for to exclude the sale of cryptocurrencies from the CISG’s scope is that the intangible nature of the virtual currencies. With some exceptions and controversy, the CISG is only concerned with the sale of tangible goods[18]. If they can be classified as property at all, cryptocurrencies are intangible and they are incapable of being owned, as it was asserted by the District Court of Tokyo, at a case which was related to collapse of Bitcoin exchange Mt Gox[19]. Therefore, all in all, the CISG shall not govern the sale of cryptocurrencies.

B. Sale of Tangible Goods

The second question needed to be addressed is whether the CISG is applicable to contracts to buy goods with cryptocurrencies. The answer depends on whether payment with cryptocurrencies would be deemed as “payment of price” with regard to CISG Articles between 53-59.  If it is not, then these contracts would be regarded as barter contracts. A sale means an exchange of goods or money and barter contracts are not sales in that sense[20].

Legal cases to date all around the world shows that classification of cryptocurrencies depends on the context such as taxation, anti money laundering… Even though there might be other different purposes such as using cryptocurrencies as a speculative investment vehicle, from the perspective of sale of goods, cryptocurrencies do not have any other purpose other than to be a means of payment. Similarly, in terms of the taxation, the Court of Justice of the EU ruled that:

The ‘bitcoin’ virtual currency, being a contractual means of payment, cannot be regarded as a current account or a deposit account, a payment or a transfer. Moreover, unlike a debt, cheques and other negotiable instruments referred to in Article 135(1)(d) of the VAT Directive, the ‘bitcoin’ virtual currency is a direct means of payment between the operators that accept it.”

Consequently, even though the cryptocurrencies are not acknowledged as legal tender in EU, the court stated that the transactions that made via cryptocurrencies are financial transactions and the Bitcoin is a direct payment tool of these transactions. However, one should not forget that legal classifications regarding to Lex Cryptographia largely depends on the political and economic agenda of the states and the courts might have a tendency to interpret concepts case-by-case basis, especially in the burgeoning phase of this technology.

In sum, since the cryptocurrencies do not have any other purpose than being a payment tool in terms of sale of goods transactions and they do not have any intrinsic value (at least other than virtual),  sale of tangible goods in lieu of cryptocurrencies would fall into scope of the CISG.

V. Conclusion

To conclude, smart contracts which are entirely written in code can fall into CISG’s scope of application if some certain conditions are met. Blockchain infrastructure complies with the contract formation requirements regulated between Article 14-24 of the CISG. However, choice of law would also affect the validity of the contract since capacity to enter into legal transactions, certain types of mistake and power of representation have to comply with the relevant domestic law. On the other hand, when it comes to subject matter applicability of the CISG, a distinction should be made between the smart contracts related to sale of cryptocurrencies and the tangible goods. Sale of cryptocurrencies would not fall into scope of the CISG, since Article 2 of the CISG exempts. However, payment with cryptocurrencies would constitute payment of price in terms of sale of goods and thus, this paper contends that sale of tangible goods in lieu of cryptocurrencies would fall into scope of the CISG if the other conditions are met.

Even though the CISG has liberal provisions which would enable smart contracts to function like traditional contracts, the question of smart contract validity will remain ambiguous until UNCITRAL addresses this topic. Therefore, in near future, it is foreseeable to expect UNCITRAL to specifically address use of blockchain in international trade, just as they designed the Electronic Communications Convention to regulate use of e-mails.

[1] Nakamoto, S., Bitcoin: A Peer-to-Peer Electronic System, (2009).  Available at: https://bitcoin.org/bitcoin.pdf (last visit: 01.10.2019). 

[2] Transactions of value are not just monetary transactions or a narrow range of financial transactions. They may include transactions involving goods and property, the ownership of ideas, the casting of votes, or proving the existence of a document. Sherborne, A., Blockchain, Smart Contracts and Lawyers (2017). International Bar Association, p. 1. Available at: https://www.ibanet.org/Document/Default.aspx?DocumentUid=17BADEAA-072A-403B-B63C-8FBD985D198B (last visit: 01.10.2019). 

[3] Notwithstanding that there is a common wrong perpection reckons that the DLT and blockchain are interchangeable terms. However, blockchain is the most known specific form of distributed ledger is a data storage system using sequentially signed blocks. There are other kinds of  DLTs such as Hashgraph and Directed Acyclic Graph and surely more will be invented to fill deficiences of existing ones. For the difference between the DLT and the blockchain see: https://thenextweb.com/hardfork/2018/07/27/distributed-ledger-technology-blockchain/ (last visit: 01.10.2019).

[4] Some scholars argue that widespread proliferation of decentralized technology will pave the way for a new subset of law, which was termed as Lex Cryptographia.Wright, A., De Filippi, Primavera, Decentralized Blockchain Technology and the Rise of Lex Cryptographia, (2015), p.1. Available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2580664

[5] According to Vitalik Buterin: “Ethereum does this by building what is essentially the ultimate abstract foundational layer: a blockchain (…) allowing anyone to write smart contracts and decentralized applications where they can create their own arbitrary rules for ownership, transaction formats, and state transition functions” Buterin, V., White Paper (GitHub, 2013). Available at: https://github.com/ethereum/wiki/wiki/White-Paper (last visit: 02.10.2019) 

[6] Szabo, N., Smart Contracts: Building Blocks for Digital Markets, (1996). Available at: http://www.fon.hum.uva.nl/rob/Courses/InformationInSpeech/CDROM/Literature/LOTwinterschool2006/szabo.best.vwh.net/smart_contracts_2.html (last visited: 02.10.2019)

[7] Clack, C.D., Bakshi, V.A., Braine, L., Smart Contract Templates: foundations, design landscape and research directions. arXiv: 16008.00771[cs.CY], (2016), p.2. Available at: https://arxiv.org/abs/1608.00771 (last visit: 02.10.2019).

[8]Ganne, E., Can Blockchain Revolutionize International Trade, (2018). Available at: https://www.wto.org/english/res_e/booksp_e/blockchainrev18_e.pdf (last visit: 02.10.2019).

[9] Currently, the CISG has been ratified by 89 contracting states which are the most important trading states, except for  the United Kingdom, India and South Africa. Thus, the convention is being called as lingua franca of sales due to the fact that it is applicable in every geographical region, every stage of economic development and every major legal, social and economic system  It is a real success story when taking into consideration that despite all efforts, even within the European Union there is no uniformity in terms of the contract law.

[10]For instance, Maersk, a prominent player in logistics industry,  collaborates with IBM to develop a blockchain based platform which includes the automation of various business processes such as import and export clearance via smart contracts.

[11] Duke, A., What Does the CISG Have to Say About Smart Contracts? A Legal Analysis, (2019), Chicago Journal of International Law: Vol. 20: No. 1, Article 4. Available at: https://chicagounbound.uchicago.edu/cjil/vol20/iss1/4 (last visit: 02.10.2019).

[12] Duke, A., p. 160-162.

[13] Bayramoğlu, E., Online Dispute Resolution and Direct Enforcement in the Age of Smart Contracts, (2018). Available at: http://arno.uvt.nl/show.cgi?fid=146835 (last visited: 03.10.2019)

[14]  The UNCITRAL Model Law on Electronic Commerce with Guide to Enactment 1996. Available at: https://www.uncitral.org/pdf/english/texts/electcom/05-89450_Ebook.pdf , p. 26-27 (last visited: 11.10.2019).

[15] Schlechtriem, P., Schwenzer, I, Commentary on the UN Convention on the International Sale of Goods (CISG), 3rd Ed. (2010), p. 258.

[16] European Central Bank, What is Money?, (2017). Available at: https://www.ecb.europa.eu/explainers/tell-me-more/html/what_is_money.en.html (last visited: 11.10.2019).

[17] Schroeder, J. L., Bitcoin and the Uniform Commercial Code. University of Miami Business Law Review (2016), 24(1), pp. 16-17.

[18]Munoz, E., Software Technology in CISG Contracts, Uniform Law Review (2019), 24(2), pp. 4-5.

[19] The court ruled that Bitcoin is “not subject to ownership”. Caffyn, G. (August 19, 2015). Tokyo Court: Bitcoin is Not Subject to Ownership. Available at: https://www.coindesk.com/tokyo-court-bitcoin-not-subject-to-ownership-2/ (last visit: 14.10.2019). 

[20] Schelectriem, P., Requirements of Application and Sphere of Applicability of the CISG (2005), p. 787. Available at: https://www.victoria.ac.nz/law/research/publications/vuwlr/prev-issues/vol-36-4/cisg-schlechtrieum.pdf (last visit: 14.10.2019).

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