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Flexibility

Understanding flexibility in smart contracts vs traditional contracts

on July 8, 2021

Before digging into the lack of flexibility in smart contracts let’s see what flexibility actually is.

Traditional semantic contracts are flexible, or at least we believe so. Such flexibility operates during the negotiation phase as well as at breach.  

Flexibility allows parties to use ambiguous terms, generally defined terms, commercial customs in their agreements.

Furthermore, flexibility enables parties to shape and adapt their business relationship through modifications, amendments, sometimes arbitrarily. 

The border between flexibility and ambiguity is ephemeral and this is reflected in very unstable relations.

How can we consider flexibility?

But should we consider flexibility a bug or a feature? Maybe a source of efficiency? Or a way to hide complexity and power games? 

Last but not least are smart contracts capable to cope with flexibility? 

M. Sklaroff in his study “Smart contract and the cost of inflexibility, 2018”, affirms that flexibility creates important efficiencies in the contracting process:

  • helping parties through uncertain scenarios;
  • creating an agreement that becomes more precisely defined as parties learn more about future states of the contracts;
  • helping parties to avoid unnecessary negotiation over trade customs, which are difficult to define precisely but which strongly influence parties’ behaviour. 

The ability to easily change contract terms helps parties avoid high drafting and renegotiation costs. 

Unfortunately, smart contracts are programs running on a distributed infrastructure and are developed to automate predefined processes based on transparent and trusted data sources.

This means that smart contracts are not flexible in the traditional meaning. Their flexibility is embedded in the code and in the way they are used in the contract prose of the Smart Legal Contract.

Their flexibility is conditional! It means that they run a workflow and based on the evidence received (input data) they could apply a different pattern/rule.

Therefore, unlike semantic contracts, the lack of flexibility in smart contracts results in the loss of an important source of efficiency for parties. 

Nevertheless, based on our experience, smart contracts can enhance the drafting phase eliminating ambiguities, vagueness and redundancies which are at the basis of litigations.

Better clarity in understanding the entire agreement, duties and obligations are easily achieved. Furthermore, once the conditions described in the code are satisfied, specific actions are automatically activated: actions that no longer depend on the mere (and arbitrary) will of the parties but on objective and verified elements. 

Thanks to flexibility litigations, opportunistic behaviours and misunderstandings decrease.

Being free to shape the business relationship after an agreement is signed is not always an advantage. In most cases, there is a party with more power, trying to impose its terms and conditions, renegotiating, asking for better prices by leveraging, for example, its strong position on the market. 

Again. Flexibility entails the holdup problem: after one party has made relationship-specific investments, the other party refuses to perform unless the first one offers better terms than the original contract. 

Flexibility can “enable parties to create an enforceable agreement without requiring complete knowledge of what may happen in the future” (Smart contract and the cost of inflexibility, M. Sklaroff). Parties can accommodate their will and needs a second time.

Unfortunately, it has been proved how difficult it is to find a common ground to adjust the agreement on the new circumstances even with traditional contracts.

Flexibility is not a means to complete an agreement ex-post overcoming incompleteness. Oliver Hart highlighted the incompleteness of the traditional contracts and pointed the attention on the relational contracts to fill the gaps and reach a win-win solution. He listed six principles in this regard: loyalty, equity, autonomy, honesty, integrity and reciprocity. 

Smart contracts can’t solve those problems but can help in identifying them getting rid of the grey areas.

So is the lack of flexibility in smart contracts really an issue?

To wrap it up: 

  • If flexibility is seen as a form of ambiguity, smart contracts eliminate this problem, by requiring clean and transparent language. No more litigation costs, misunderstandings and waste of time in finding a common interpretation. 
  • If we see flexibility as a means of adjusting terms and conditions based on new circumstances, a smart contract can help parties to cope with new events with an objective and conditional approach/patterns, eliminating arbitrarily behaviours and providing an application of the relational principles. 

Terms like “best afford” or “commercially reasonable” create confusion or facilitate the parties in interpreting their agreement? 

Are we sure we cannot introduce new methods to bring transparency and efficiency by using smart contracts in this regard? 

To go deeper download our white paper on smart legal contracts. 

Dennis BuonfiglioUnderstanding flexibility in smart contracts vs traditional contracts

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