How smart legal contracts can transform supply chains

posted by Charlie Morgan
9 June 2020

For more than three decades, digital technologies have been changing how we work and how we do business in almost every part of the global economy.

Yet, despite these changes, the way businesses contract with each other has remained largely the same. Contracts are still negotiated, drafted and agreed at great length and cost, before being stowed away in hard copy and often revisited only when a dispute arises.

Smart legal contracts (SLCs) have the potential to transform contracts as we know them into a more valuable and dynamic business tool, fit for increasingly digitalised global supply chains.

They are legally enforceable agreements containing a mix of natural language and smart clauses: machine-readable expressions of contractual provisions that enable digital activities arising from, or in connection with, the contract to be automated.

As a digital record of a legal relationship, SLCs are stored and maintained on a distributed network, meaning that no party unilaterally can control, or amend, the SLC or the operative code that it contains.

Whilst this enables SLCs to become a trusted record of all contractual events accessible to all stakeholders, as required, in real time, there remain a number of technical, legal and practical hurdles to overcome before they replace existing contracts across every sector.

However, the promise of SLCs and the value they stand to create for business and the wider economy cannot be understated. A contract that can connect to external data sources to more accurately, responsively and efficiently monitor and take action in relation to parties’ rights and obligations is of wide appeal for businesses across all sectors of the global economy.

By way of example, consider a contract that contains an obligation to notify upon the delivery of goods. A weighbridge sensor, connected to the internet, feeds data to the SLC demonstrating that Party A has delivered goods at a specified time and location, satisfying the conditions of the smart clause. Other connected sensors (internet of things devices) might be located in the truck, monitoring the condition of the shipment (e.g. in relation to temperature). The weighbridge sensor automatically triggers a notification of the delivery, which is sent to Party B. The event is then recorded on the distributed ledger shared by the parties.

This example evidences, in very simple terms, how SLCs could help solve and streamline many supply chains, particularly for global businesses that source and process materials all over the world. SLCs stand to increase transparency for participants along the supply chain, with internet-connected devices transmitting real-time information to the SLCs (and recorded on the distributed ledger, as needed) on the whereabouts of goods and stock levels. This would enable parties to have a single, trusted audit trail across a supply chain, reducing the potential for fraud, miscommunication, errors and bureaucratic frustrations or redundancies.

SLCs also have the potential to improve the sustainability of supply chains and reduce barriers to entry for smaller market participants. Over time, businesses which use SLCs will also be able to run analytics on the data produced by SLCs over their entire contract portfolio to carry out risk modelling, identify trends, and drive more precise decision making.

In other words, whilst digitisation has changed the way we work, the next step will see digitisation change the way organisations develop contractual relationships. Add another decade to the three mentioned previously and by 2030, the way we do business will look rather different.

☛  Charlie Morgan is a senior associate at law firm Herbert Smith Freehills

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