BLOCKCHAIN AND SMART CONTRACTS IN THE SHIPPING INDUSTRY: LEGAL CONSIDERATIONS

BLOCKCHAIN AND SMART CONTRACTS IN THE SHIPPING INDUSTRY: LEGAL CONSIDERATIONS

This Article was first published in the CECCA Newsletter on Maritime Law and Commerce (Issue 14) of November 2018

Introduction

This article offers a succinct overview of the potential which distributed ledger technology (DLT) has to positively disrupt a fundamental pillar of the global economy: the shipping industry. To date, more than ninety per cent (90%) of world trade is conducted by sea, with ships proving to be the most cost-effective means of transportation at our disposal to meet the insatiable demand for goods and commodities across the oceans.[1] DLT, and more specifically Blockchain applications are on the cusp of permeating the electronic and technological systems and operations which presently lie at the heart of the juggernaut that is global commercial shipping.

Although shipping is already by far the preferred and most commercially viable mode of transporting goods and raw materials worldwide, proponents of DLT and maritime experts alike agree that the technology, if harnessed and applied correctly, can enhance existing shipping procedures by improving on a number of aspects including accountability, transparency, traceability, efficiency, organisation, communication and, of course, cost.

Given shipping’s roots as one of the oldest avenues of merchant trading, it is perhaps unsurprising to note that the industry remains traditional and conservative to this day. Most shipping practices adhered to by the parties involved are long in the tooth, almost archaic. Yet the maritime sector is perhaps one of the most touted areas of business which will benefit from a bold approach, understanding and embracing of the technological revolution that is DLT.

There are a number of areas and/or processes entrenched in the sphere of shipping which may be impacted by the introduction of blockchain technology or a similar form of DLT. While it is not possible to address each of these due to the spatial constraints of this article, those of particular interest and importance will be considered after the salient features of the technology have been touched upon.

What is Distributed Ledger Technology (DLT)?

A DLT technology platform may concisely be described as a decentralised digital database of an auditable and immutable nature. Information is recorded, stored and consensually shared with a network of users (nodes) that make up the system without a controlling entity or external influence. Records are verified by consensus and then updated by the network itself in real time, meaning all users have access to an immediate display of the state of affairs of the information recorded therein.

Once information is verified, it is timestamped, stored in a “block”, and linked to the previous block in the chain. A block cannot be tampered with without affecting each subsequent block, and majority network consensus is required for any amendment to an existing record.

Against this laconic insight into the workings of the technology, we will now turn to its potential application in the world of maritime commerce.[2]

Smart Contracts

Blockchain technology serves as the ideal base for ‘smart contracts’, due to its inherent built-in features of security and decentralisation. Briefly, a smart contract is a self-executing form of computer code, the execution of which is triggered once specific pre-conditions have all been satisfied. A traditional ‘on paper’ contract is converted to computer code and is then stored, replicated, shared and overseen by the nodes on the network. No single person may exercise control over the contract. In practice, the documentation required in connection with a transaction would be uploaded onto a blockchain. As parties negotiate and execute their respective contracts, these would be approved by the system and the transaction moves on to the next stage. The result is a more efficient and secure way of dealing; such a system facilitates the reduction (or even elimination) of both human error and the need for intermediaries while simultaneously encrypting all information to provide safeguards to the transaction.

By way of simple example, let’s look at a contract for the purchase of a vessel. All agreements regarding the transaction (letter of intent, refund guarantee, shipbuilding contract etc.) would be stored on the blockchain. The builder would record progress in the shipbuilding process on the system, with the corresponding instalment of payment being made when each building milestone is reached. The buyer would receive a receipt for each such payment. If the ship, once built, successfully completes the sea trials, final payment is released once the vessel is delivered and the builder transfers ownership of the vessel to the buyer (via an electronic key). If the trials are not completed successfully or the contract is cancelled, the buyer may be refunded in accordance with the terms of the contract.[3] The blockchain may also record additional important information such as the parts used in the shipbuilding process (to ensure conformity with expected standards and contract terms) and inspection results.

A smart contract utilises the basic ‘if/then’ principle; in the above example, if the builder delivers the vessel (in accordance with the contract terms as evidenced by performance during sea trials), then payment is automatically released. Nobody can control or alter the contract once programmed, and it is an entirely transparent process. The result is a smoother-faster transaction which saves time and costs and which is safe, secure and certain.

Legal Considerations

Several noteworthy projects and partnerships have been created with the aim of harnessing and adapting the technology to positively impact the maritime sector.[4] In spite of this, a number of concerns remain prevalent with respect to the widespread adoption of the technology and smart contracts, including the lack of regulation at a legal (government) level and the traditionally cautious approach of the shipping industry. While these issues are beyond the scope of this article, simpler concerns are prevalent.

First and foremost, as previously stated, a smart contract is based on a traditional paper contract. The importance of having a solid legal agreement which is to be converted into code is therefore self-evident. Regardless, even if the agreement is correctly drafted on paper, issues will undoubtedly arise if errors are made when coding the agreement. As has been stated, a smart-contract will self-execute and cannot be stopped if the pre-programmed conditions are met. From a legal perspective, a contractual party which has been wronged by a bug in the system would have to take action not only against the counterparty which has benefitted from such error (possibly through no fault of its own)[5] as well as the programmer of the contract which erred during the coding process.

More specific matters also surface. If one goes back to the earlier example of a smart contract regulating the purchase of a vessel, one immediate matter which merits consideration is an instance in which a vessel, although certified as seaworthy and which performs admirably during the sea trials, sinks shortly after successful delivery to the buyer (at which time payment in full would have been made). Suppose the cause of this is identified as a latent defect which was not discovered during the trials. The buyer would undoubtedly seek damages from the builder, however, it is difficult to envisage that this can be catered for utilising a smart contract. One argument that could be put forward is for the purchase price to be held in escrow and frozen for a period of time (for example the time allowed in the contract for claims to be brought against the shipbuilder), in order to allow automatic restitution of the price (or a portion thereof) to the buyer if such event were to take place. This is simply not feasible in practice, however, because in an industry as capital intensive as shipbuilding, a builder will need the funds for its business; it cannot be expected to freeze such funds. Moreover, a latent defect is not a simple fact which can be unilaterally verified by the buyer or its appointed inspectors. The outcome would likely be that the parties would have to turn to an appropriate forum to resolve their dispute through the traditional legal channels, i.e. litigation or arbitration.

Conclusion

While blockchain technology and smart contracts undoubtedly have the potential to positively disrupt and impact the maritime industry, uncertainties and limitations remain prevalent with respect to their practical application. Leaving aside matters of regulation at government level, which are beyond the scope of this article, the genesis of a smart contract is unquestionably rooted in traditional legal documents. The importance of having a strong legal team to offer support to interested parties, from the drafting of the contract to be converted to code to providing assistance in relation to the amicable or perhaps contentious resolution of issues should disagreements arise, should, therefore, remain at the forefront of the minds of contracting parties.

About Fortior Law

Fortior law is a boutique firm situated at the heart of Europe in Geneva, Switzerland. The firm offers comprehensive legal services, particularly in the fields of shipping and commodity trading, and works closely with esteemed clients based in Europe and Central Asia. Our lawyers are qualified in a number of jurisdictions and are fluent in several languages. We also specialise in dispute resolution, and more specifically in arbitration and litigation subject to English law and before English courts and tribunals. If you feel that we may be of assistance to your business, we invite you to get in touch with us at [email protected]. We would be more than happy to be of service.

[1] International Maritime Organization (IMO) Profile Page on the UN-Business Action Hub Website: <https://business.un.org/en/entities/13> accessed 7 September 2018.

[2] For simplicity, we will refer to the technology as “Blockchain” throughout this article, as the most widely-known form of DLT.

[3] This is of course a simplified example of a successful build and is provided for ease of reference, as shipbuilding contracts are complex creatures by nature.

[4] See for example Maersk and IBM’s venture, Tradelens, aimed at improving the field of container shipping and Maritime Blockchain Labs’ consortium with a number of key players which is testing the application of the technology in the bunker industry.

[5] Unless of course such party agrees voluntarily to remedy the issue, and here the question arises as to how this would be done.

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