Smart Contracts Are Not What You Think They Are—They Are Just Code

Disruption of Private Equity by the Emergence of the Smart Contract Attorney:  A smart contract is a computer code protocol that uses blockchain distributed ledger technology to execute transactions based on pre-defined parameters. At its core, a smart contract is not an agreement between parties memorialized in a document drafted by a lawyer, but simply software code written by computer programmers. As such, smart contracts are a software coding construct first and only peripherally refer to the legal construction of the underlying transaction relationship. In other words, a smart contract is not a legally binding contract.


Smart Investment Contract Parameters and Procedural Workflows

The smart investment contract workflow, facilitated by blockchain distributed ledger technology, proceeds along these lines:

(1) Issuers and investors agree on the terms of a sale with the offering deal terms acting as variables in the templates  programmable smart investment contract.

(2) When the final terms are settled, the smart investment contract is cryptographically signed by all parties, with the final agreement terms encoded into a block on the distributed ledger.

(3) Upon closing, the smart investment contract protocol initiates the exchange of cash and transfer of securities, each of which is recorded permanently on the blockchain.

(4) Upon a conversion or liquidation event, the smart investment contract initiates the exchange of a promissory note for securities -- or facilitates the exchange of stock for cash -- for each investor, with an applicable recordation on the blockchain.

The Smart Contract Attorney Is the Key to Private Equity Disruption

A new breed of programmer-attorney will be needed to translate dates, deal terms, share prices and conversion/liquidation mechanics into effective building blocks of “if-then” -- while simultaneously generating an equivalent summary “term sheet” for establishing mutual assent to an offer. The merging of these two fields, combined with the entrepreneurship to support it, are early steps in the chain of events that will disrupt the private equity investment ecosystem. Prophecy uttered from the mouths of blockchain technologists and investors, must always be fulfilled by the believers who catch the vision and then act.

Smart Investment Contracts Have all the Earmarks of a Legally Binding Contract

However, the use of smart contracts in “initial coin offerings” (ICOs) typically meets the standard definition of both an investment contract and a legally binding written contract. In this context, a “smart investment contract” would be designed specifically to facilitate an investment agreement between a company and its investors. While there may be some variability between a traditional paper agreement and the representative digital code of the “smart investment contract,” the blackletter principles of mutual assent to a valid offer and acceptance would be met in equal measure for the following reasons:

(1) smart investment contracts could provide ample objective evidence of an existence of a legally binding contract, including plain English prose describing the terms of the investment agreement from issuance to liquidation -- similar to what is currently happening in the public investment context through the “tokenization” of debt instruments and their associated data

(2) digital signature procedures (E-SIGN Act and the Uniform Electronic Transaction Act) provide a legal basis for enforceability of digital signatures in most commercial transactions to electronic records otherwise required to be in writing

(3) immutable and verifiable recording of performance of the parameters of the transaction on blockchain distributed ledger technology

The focus therefore should not be on the regulatory framework but on the entrepreneurship and required procedural prowess needed to create the smart investment contract. States that have passed legislation defining aspects of the blockchain distributed ledger technology are largely irrelevant for purposes of private equity investment disruption.

Shoring up the enforceability and the use of smart contracts in the private equity investment context depends not on the extent to which regulatory or legislative authoritises define, but rather on the extent to which legal experts and programmers can translate legal prose into efficient coding parameters and procedures.

Topics: Blockchain, Legal