Midterm examination report comparison of similarities and differences between traditional contracts and smart contracts

Highlight the similarities between Traditional Contracts and Smart Contracts 2.1 An overview of Traditional Contracts and Smart Contracts 2.1.1, Traditional Contracts A traditional contr

MIDTERM EXAMINATION REPORT

Comparison of Similarities and Differences Between

Traditional Contracts and Smart Contracts

Subject: Business Law

2.1.1.2 Elements of traditional contracts

2.1.1.3 The role of the legal system in enforcing traditional contracts

2.2.1.1 An overview of smart contracts

2.2.1.2 Contexts where smart contracts are used

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1 Introducfion

In today's rapidly ever-changing world, contracts are believed to be fundamental

to business and personal interactions A traditional contract 1s a legally binding agreement between two or more parties', typically documented on paper with physical signatures It shows the obligations and nghts of each party and is enforceable by law

if it meets essential legal requirements, ensuring clarity and reducing the risk of disagreement They are known for depending on legal frameworks, usually requiring physical paperwork, and often come with lengthy enforcement and dispute resolution processes However, smart contracts came into existence thanks to the advent of blockchain technology They are known as a piece of code stored on a blockchain that self-executes contract terms when certain conditions are met’ Specifically, these contracts automatically enforce clauses, such as automatically impose penalties if a party breaches the agreement As a result, there is no need of human intervention because blockchain technology has provided a decentralized and immutable transaction ledger

Understanding the differences and similarities between traditional and smart contracts is important in today’s world because it helps prevent misinterpretation and imrprove the legal process Therefore, this report aims to provide a comprehensive overview of the definition of two types of contracts as well as how they are changing, especially with the rise of smart contracts Besides, it will explore the key characteristics of smart contracts, their potential benefits and challenges, and the legal and technological while using them By understanding the impact of this technological transition, businesses, lawyers, and policymakers can better prepare for the future of

contract management

1 Alex Zhezherov, Everything you need to know about electronic vs traditional contracts, May 2023, available

at http://www.pandadoc.conyblog/difference-between-electronic-contracts-and-traditional-contracts/, accessed:

08 September 2024

2 Kenneth W Clarkson, Roger LeRoy Miller, Gaylord A Jentz, Frank B Cross, BUSINESS LAW, 11th Edition TEXT & CASES Legal, Ethical, Global, and E-Commerce Environments, Publisher South-Western, Cengage

2 Highlight the similarities between Traditional Contracts and Smart Contracts

2.1 An overview of Traditional Contracts and Smart Contracts

2.1.1, Traditional Contracts

A traditional contract’ is an agreement between two or more parties that are legally enforceable, typically documented on paper and often requiring physical signatures These contracts comprise terms and conditions that outline the obligations, rights, and responsibilities of each party involved They are legitimate under law under the condition that they meet certain crucial requirements such as agreement, consideration, contractual capacity, and legality’ Traditional contracts rely on written paperwork, which provides a tangible record of the agreement and strengthens its legal enforceability

2.1.1.1 The establishment of enforceable agreements

Traditional legal contracts are commonly used in various industries where formal, enforceable agreements are of the importance to protect the interests of all stakeholders involved’ In the field of real estate, for instance, traditional contracts are indispensable during transactions such as property sales or leases These agreements clearly outline terms such as the purchase price, property boundaries, and payment schedules, ensuring both the buyer and seller understand their obligations A real estate purchase agreement is typically highlighted in this case where the contract specifies terms like contingencies, closing dates, and financial details Without such formal agreements, real estate transactions could easily result in disputes over property

3 James Fyfe, What is an Enforceable Contract? Definition, Elements and Creation Guide, 2024, available at https://www.portant.co/post/enforceable-contract, accessed: 08 September 2024

4 The Different Types of Contracts: What You Need To Know, available at:

https://www.axiomlaw.com/guides/types-of-contracts, accessed: 10 September 2024

5 Kenneth W Clarkson, Roger LeRoy Miller, Gaylord A Jentz, Frank B Cross, BUSINESS LAW, I Ith Edition TEXT & CASES Legal, Ethical, Global, and E-Commerce Environments, Publisher South-Western, Cengage

ownership, payments, or missed deadlines, underscoring the need for clearly articulated legal contracts

Employment agreements also rely mainly on traditional contracts to protect both employers and employees These contracts formalize the terms of employment, including salary, benefits, job responsibilities, and the conditions for employment termination For example, a corporation may present a new hire with a formal employment contract that specifies work duties, remuneration, and length of employment® This contract establishes a binding agreement that sets precise expectations, and prevents potential misunderstandings or legal disputes In many cases, these are adhesion contracts, which underlines that the employer sets the terms with little room for negotiation; thus, the content must be comprehensive and fair to both sides

Traditional agreements play an important part in service contracts as well When businesses or individuals hire service providers, such as contractors or consultants, traditional contracts ensure that the scope of services, payment terms, deadlines, and responsibilities are explicitly defined A homeowner, for instance, may engage a contractor to remodel their kitchen, entering into a contract that specifies the materials

to be used, project dates, and payment terms These service agreements are critical for holding the service provider responsible to agreed-upon tasks, timetables, and quality standards, reducing the possibility of incomplete or substandard work

In complex business transactions such as mergers and acquisitions, traditional contracts are indispensable in managing the intricacies of financial arrangements, habilities, and future obligations When a company is sold, a purchase agreement defines critical elements such as the price, transferred assets, or any warranties provided by the seller Such contracts safeguard both parties, providing legal recourse

6 Kenneth W Clarkson, Roger LeRoy Miller, Gaylord A Jentz, Frank B Cross, BUSINESS LAW, 11th Edition TEXT & CASES Legal, Ethical, Global, and E-Commerce Environments, Publisher South-Western, Cengage Learning, 2009, pp 242.

if one fails to meet their obligations Given the significant financial stakes in these transactions, traditional contracts assist in mitigating risks, ensure transparency, and secure the legal enforceability of the terms

Insurance contracts represent another vital application of traditional agreements When an individual decides to purchase health or life insurance, the contract between the insured and the insurer outlines the terms of coverage, detailing what medical services are covered, claim conditions, and payment obligations These contracts ensure that both parties acknowledge their rights and responsibilities, which is essential

in an industry where disputes over claims can be common and complex For instance,

if a policyholder makes a claim, the insurance contract will dictate under what conditions the insurer is required to pay This precision can prevent misunderstandings and ensure legal accountability

Similarly, traditional loan agreements provide essential legal frameworks for both lenders and borrowers These contracts specifically state the loan amount, interest rates, repayment schedules, and penalties for default For example, when a borrower takes out a mortgage to purchase a property, the loan agreement outlines repayment terms, including the interest rate as well as the repercussion of missed payments The consistency of these agreements guarantees the clarity and enforceability of every contract term, which is utmostly important in financial transactions involving huge sums of money and long-term responsibilities

Traditional contracts also control intellectual property agreements in industries like technology, entertainment, or publishing These agreements protect intellectual property rights and establish licensing terms For example, a software company may engage into a licensing agreement with a client that allows them to use its software under specific constraints, such as time and usage limitations With such agreements, intellectual property is ensured not to be misused or unlawfully distributed, while also offering both parties legal protection and explicit guidelines for usage

In summary, traditional contracts are crucial in a variety of different contexts, from real estate transactions to intellectual property agreements, since they provide legal clarity and enforceability while safeguarding the interests of all involved stakeholders

2.1.1.2 Elements of traditional contracts

Traditional contracts are composed of several key elements, each of which plays

a crucial role in forming a legally binding agreement

The first element is the offer, which serves as the foundation of any contract An offer is a formal proposal made by one party, known as the offeror, to another party, the offeree’ In the offer, the specific terms and conditions of the proposed agreement, the details of the obligations each party will undertake are specifically outlined For example, a business offers to sell a specific quantity of goods at a set price Therefore,

to achieve the effectiveness, the offer must be clear and plain, with no ambiguity about the nature of the agreement, allowing the offeree to fully comprehend and decide whether or not to accept

Acceptance is the next essential element, which occurs when the offeree agrees

to the terms set out in the offer This can be done verbally, in writing, or with actions that announce the agreement* However, for acceptance to be valid, it must mirror the original offer without any modifications A buyer agreeing to purchase goods at a specified price is a common example of acceptance This mutual consent between both parties solidifies the contract, establishing a binding agreement Without clear acceptance, no contract can be formed, making this element essential to the process

7 Kenneth W Clarkson, Roger LeRoy Miller, Gaylord A Jentz, Frank B Cross, BUSINESS LAW, I Ith Edition TEXT & CASES Legal, Ethical, Global, and E-Commerce Environments, Publisher South-Western, Cengage Learning, 2009, pp 250

8 Terms and Conditions: Definition, Key Terms, Examples, available at:

https://www.contractscounsel.com/t/us/terms-and-conditions#:~:text=Terms%20and%20conditions%20are

%20part%20o0f%20a%20contract,important%20boundaries%o20that%20all%20contract™20principals%20must

Another key component is the promise, which represents the commitment made

by each party to perform a specific action or refrain from a certain behavior In most contracts, both parties make reciprocal promises For instance, in a sales contract, the seller promises to deliver goods, and the buyer promises to make a payment These promises are the core of the contract's obligations, ensuring that both parties understand what they are required to do under the agreement This exchange of promises is what gives the contract its enforceability

The subject matter of a contract refers to the specific focus of the agreement, whether it involves the sale of goods, the provision of services, or the transfer of property The subject matter is critical because it defines what the contract 1s about and what each party is agreeing to For example, in a contract for the sale of goods, the subject matter might involve the delivery of a specified number of products by a certain date A well-defined subject matter ensures that both parties are on the same page regarding the nature and scope of the agreement, minimizing the msk of misunderstandings or disputes

Finally, consideration is the exchange of something of value between the parties involved in the contract’ This can be in the form of money, goods, services, or any other legally valued things In a standard sales contract, the buyer's consideration is the payment, while the seller's consideration 1s the delivery of the goods Consideration is essential because it ensures that each party is offering something of value in return for the other's promise, creating a reciprocal exchange Without consideration, there would

be no legal basis for enforcing either party to take binding responsibilities; hence, the contract would lack the foundation required for legal legitimacy

The fundamental components of traditional contracts are offer, acceptance, promise, subject matter, and consideration The perfect combination of these key elements ensures mutual consent, clarity, and enforcement Each element plays a

9 Smart Contracts vs Traditional Contracts: Bridging Automation Gap’ , available at:

distinct yet interdependent role that makes it possible to create legally binding agreements protecting the nghts and interests of all parties

2.1.1.3 The role of the legal system in enforcing traditional contracts

A legally binding contract 1s valid and enforceable by courts, ensuring that both parties adhere to their obligations Ensuring validity is the first step in this process, where the legal system examines whether the essential elements of a contract are present These elements consist of offer, acceptance, consideration, legal capacity, and

a lawful purpose Should any of these components are missing or defective, the contract can be considered void If a party lacks the legal capacity to enter into an agreement, such as in cases involving minors or imdividuals without mental competence, the courts will not enforce the contract Similarly, if the contract’s purpose is illegal or against public policy, it will not hold up in court By ensuring that these foundational elements are mtact, the legal system guarantees that only valid agreements are recognized and enforced

The courts play a crucial role in interpreting contract terms under circumstances where disputes arise over the meaning or interpretation of contract terms Contracts can sometimes contain ambiguous language or unclear obligations, leading to disagreements between the parties The courts, in these cases, step in to interpret the language, the intentions behind the contract, and the context in which the agreement was made The goal is to enforce the contract in a way that honors the original intent of the parties Specifically, if two parties disagree on the delivery date for goods, the court would examine the wording of the contract and any surrounding circumstances to determine what was originally intended By doing so, the courts ensure that the contract 1s enforced in a manner that reflects the genuine agreement, protecting both parties’ interests

When one party fails to meet their contractual obligations, known as a breach of contract, the legal system provides remedies to address the breach and compensate the

injured party One of the most common remedies is damages, where the breaching party is ordered to provide monetary compensation for any losses incurred For instance, if a contractor fails to complete a construction project, the client may be awarded damages to cover the cost of hiring a replacement In some cases, specific performance may be required, where the court orders the breaching party to fulfill their obligations, especially in situations where monetary damages are inadequate This

is often seen in real estate transactions, where the uniqueness of the property makes financial compensation insufficient Other remedies include rescission, which cancels the contract and releases both parties from their obligations, and injunctions, where the court prevents a party from engaging in behavior that violates the contract These remedies ensure that breaches of contract are addressed, and the injured party is made whole

The legal system also plays an active role in enforcing legal obligations, ensuring that court rulings in contract disputes are followed When a court rules in favor of one party, it can use legal mechanisms such as wage garnishment, property seizure, or other enforcement actions to compel the breaching party to comply with the judgment For instance, if a party fails to pay a court-ordered settlement, the court may gamish their wages or seize assets to satisfy the judgment This enforcement framework is crucial for maintaining the integrity of contracts, ensuring that parties cannot simply ignore their legal obligations without facing consequences

Moreover, courts have the authority to intervene when they find that a contract

is unfair, unconscionable, or illegal Preventing unfair contracts is a critical aspect of the legal system’s role in contract law If the terms of a contract are so one-sided that they exploit one party, or if a party was coerced into signing the agreement, the court may declare the contract void or modify its terms to make them fairer This protects individuals and businesses from entering into exploitative agreements For example, a

contract that takes advantage of a party’s lack of bargaining power by imposing unreasonable terms can be invalidated by the court to prevent unjust outcomes Finally, the legal system ensures that contracts comply with public policy If a contract involves illegal activities or violates public interest, it will not be enforced, even if both parties willingly agreed to the terms This prevents contracts from being used to facilitate unlawful behavior, ensuring that they align with societal values and legal standards For instance, a contract that requires one party to engage in criminal activity, such as smuggling goods, would be void under the law By upholding public policy, the courts ensure that contracts are not only private agreements but also instruments that promote lawful and ethical conduct

In sum, the legal system provides the structure and enforcement necessary to ensure that contracts are valid, fairly interpreted, and enforced, while also preventing the use of contracts for illegal or exploitative purposes This framework protects the rights of individuals and businesses, ensuring that contracts are both fair and aligned with public policy

2.2.1 Smart Contracts

2.2.1.1 An overview of smart contracts

First comed by Nick Szabo in 1997, a smart legal contract is defined as a piece

of code stored on a blockchain that self-executes contract terms when certain conditions are met A smart contract follows a condition-based structure, and if, or when certain conditions have been met, a new action will be completed Contractual clauses that are embedded in smart contracts will be enforced automatically when a certain condition is satisfied (e.g., one party who breaches the contract will be punished

automatically).'°

10 Roberts & Obradovic Law, The art of contract clarity: Navigating express terms and legal interpretations,

2024, https://blog.firstreference.com/the-art-of-contract-clarity-navigating-express-terms-and-legal-

The code can contain as few or as many conditions as are necessary to complete

a certain transaction, and this is usually built and implemented by programmers rather than conventional lawyers

In a smart contract, the terms of a legal document are written directly into lines

of code and stored within a distributed and decentralized blockchain network However, the code can also be stored as part of a different distributed ledger technology, too

This blockchain is essentially a public database, with no single owner Instead, the transactions are automatically processed by the blockchain without the need for third-party involvement As the transactions are stored and linked in this way, the exchange cannot be edited by either party, making them extremely secure

2.2.1.2 Contexts where smart contracts are used

With the insurance industry plagued with inefficiency, long waiting times, and fraud, some insurance groups have welcomed smart contracts to add more certainty and security to the process A prime example of this use case of smart contracts is AXA’s use of blockcham smart contracts to offer insurance against delayed flights When launched in 2017, the insurance company used smart contracts to provide automatic flight delay payments to their customers through the self-executing code contained in their insurance policy

Smart contracts have also been used in real estate since the digital ownership/management of property and documents can be tied directly to blockchain This is a popular use case for smart contracts since real estate transactions are notoriously stressful and risky, and the features of smart contracts can minimize this risk substantially In real estate deals, for example, one party can feel hesitant to transfer the ownership of a property before a fee has been paid by the other, and vice versa To resolve this, you might rely on third-party involvement to ensure both parties keep to their promises However, this can delay the process and mcrease costs over

time To work around this, smart contracts can execute the terms once each condition has been met by both parties automatically instead - hence their popularity

They have various different use cases in the healthcare industry, too The main example of this is the use of smart contracts for securing and sharing patient health records in a reliable way that is free from tampering and human error One example of smart contracts in practice is to accurately transfer patient data between doctors and hospitals without the need to manually share and complete health record forms Smart legal contracts have also been recommended for use in voting systems by governments and by different groups, for example This is because they are tamper- proof, and eliminate any risks of forgery - which ensures that voting systems are less susceptible to manipulation and mistakes Smart contracts present a more efficient approach to voting entries and tallying since they are digital and automated, which reduces the need for masses of paperwork and manual document completion

2.2.1.3 Legal implications

Interestingly, smart contracts are actually more like business rules than conventional legal contracts This is because, at a basic level, smart contracts automate business transactions and spend little time discussing the roles, duties, and responsibilities of each party, and what liability they incur if they fail to meet these Instead, a smart legal contract executes the business rules automatically, unlike

in conventional contracts which include intricate and detailed clauses that offer protection in the event that complex legal issues occur Smart contracts are focused solely on achieving simple outcomes, whilst other contracts are designed to offer guidance in the event that those outcomes don’t come to fruition However, the LawTech panel recently decided that, despite this, smart contracts could still be legally binding provided that they include the typical elements of a contract

There are a wealth of legal issues surrounding smart contracts that we are yet to see the full effect of, so there is no guarantee of how transactions using smart contract

technology will play out in the future when these pressing legal questions do arise This lack of certainty can be unsettling for businesses and legal teams, which is why so many have been reluctant to adopt the mtelligent, new technology However, in doing

so, smart contracts can remove the more human aspect of contracts that typically help businesses foster and nurture better and longer-lasting relationships with their employees, partners, and customers

2.2 Similarities between Traditional Contracts and Smart Contracts

First, both traditional contracts and smart contracts are legally binding agreements In traditional contracts, these are agreements between parties, often in written or verbal form, that are legally binding once the mvolved parties agree to the terms Meanwhile, smart contracts also serve as legally binding agreements, but they are executed through code Once conditions are met, the contract enforces itself automatically Blockchain technology overlaps traditional contracts by including the terms of agreements between two or more parties, but surpasses them thanks to smart contracts by automating the execution of agreements in a distributed environment when

conditions are met.'!

Second, when examining the basic elements that exist in both traditional contracts and smart contracts, it becomes evident that both types of agreements share fundamental principles, despite thei differmg formats and execution methods At the core, both traditional and smart contracts rely on the concept of mutual consent, where all parties involved agree to the terms laid out in the agreement This mutual agreement

is essential for establishing the legal binding nature of the contract Additionally, both types must clearly define the obligations of each party; in traditional contracts, this is often done through detailed clauses, while smart contracts encode these obligations in code that automatically executes when certain conditions are met

11 Omri Ben Shahar, The Myth of the Opportunity to Read in Contract Law, available at:

https://home.uchicago.edu/omri/pdf/articles/The_ Myth Of Opportunity To Read.pdf, accessed: 5 September,

Third, both traditional contracts and smart contracts have the presence of consideration, as in both parties need to examine the values each party can receive during the exchange For the former type, the exchange might involve money, services,

or goods Meanwhile, smart contracts can center around cryptocurrency or digital

assets

Additionally, there needs to be a clear understanding of the terms and conditions

to ensure enforceability for both contracts In traditional contracts, this is typically achieved through legal language, while smart contracts utilize programming languages

to define and enforce conditions

Fifth, both types of contracts can be applied with the concepts of performance and breach apply Both specify how and when parties will fulfill their obligations, and what constitutes a breach should one party fail to meet their responsibilities

Moreover, legal enforceability remains a critical element, as both traditional and smart contracts aim to provide a framework that can be upheld in a court of law or through automated mechanisms in blockchamin environments These shared elements highlight the enduring principles of contract law, even as technology evolves the ways

in which agreements are formed and executed

Also, the legal system plays a crucial role in enforcing both traditional and smart contracts, ensuring that agreements are honored and disputes are resolved fairly In the realm of traditional contracts, the legal system provides a well-established framework for enforcement through courts When one party fails to fulfill their obligations, the aggrieved party can seek legal remedies, such as damages or specific performance, by presenting their case before a judge This process relies on established laws and precedents that guide the interpretation of contractual terms, ensuring consistency and predictability in outcomes

In contrast, the enforcement of smart contracts introduces new complexities, as these agreements are executed through code on a blockchain While smart contracts

can automate transactions and reduce the need for intermediaries, their enforceability still hinges on the legal system Courts are increasingly tasked with determining the validity of smart contracts, assessing whether they meet the essential legal requirements of contract formation, such as mutual consent, consideration, and lawful purpose Additionally, the unique nature of blockchain technology raises questions about jurisdiction and applicable law, as smart contracts can span multiple legal territories

Finally, the legal system must adapt to address challenges specific to smart contracts, such as identifying responsible parties in decentralized environments and resolving disputes arising from coding errors or unforeseen circumstances As the use

of blockchain technology continues to grow, there is a pressing need for legal frameworks that recognize and accommodate these innovations Ultimately, the legal system serves as a vital mechanism for upholding the integrity of both traditional and smart contracts, fostering trust and stability in commercial transactions while promoting innovation in contractual practices Blockchains assure the trust of the whole system by distributed consensus mechanisms without going through a central broker or a mediator Smart contracts stored in blockchains can be automatically triggered in a decentralized way Consequently, the administration and services costs due to the intervention from the third party can be significantly saved.”

3 Analyze the differences between Traditional Contracts and Smart Contracts 3.1 Form

a Traditional contracts

Format: Traditional contracts are normally paper-based, in written form They can be in various formats, including formal documents or mformal handwritten notes Traditional contracts can be scanned or converted into digital formats like PDFs for easier storage and sharing

12 Blockchain Smart Contracts: Implementation & Best Practices, available at: https://binariks.com/blog/smart-