THE IMPENDING COLLISION OF SMART CONTRACTS AND THE AUTOMATIC STAY.

• Author: Wietecha, Carter D.

INTRODUCTION

A standard contract, though often complex in practice, is theoretically simple. At least two parties agree to an exchange, and they memorialize that agreement through a spoken or written promise. (1) The parties make commitments with the background knowledge that courts--or another third party empowered to make binding decisions--stand ready to interpret and enforce these commitments in the event of a dispute. This has been the paradigmatic functioning of contracts for centuries and, until recently, its basic premises were unavoidable. Rational actors have always had reasons to fear that the other parties to an agreement might not live up to their promises. (2) This demands an enforcement mechanism that goes beyond a mere trusting relationship; without it, actors are far less likely to put their faith in contracts. (3) However, the advent of high-tech computer processing now provides the tools to challenge the underlying assumptions of contract formation and execution. Digital code offers an alternative to the spoken or written word. And, in place of a third-party enforcer, blockchain technology stands ready to hold actors accountable. (4) Touted as the first trustworthy system for electronic contract enforcement, blockchain technology has the potential to transform the shape and function of covenants. (5) But the law in the United States is still built around longstanding limitations on enforcing contracts. One, especially limiting, is bankruptcy law.

A key goal of the Bankruptcy Code is to give the debtor a chance to breathe and take stock of its situation, free of creditors' collection activity. (6) The automatic stay advances that goal by preventing creditors from making a "run" on the debtor's estate and rapidly depleting it to the detriment of the debtor and other creditors. (7) If a debtor is going to be successfully rehabilitated, it must have the opportunity to construct a plan of reorganization in an environment of relative peace. However, the structure of the automatic stay relies on certain basic assumptions about the business and legal environment. Primarily, the automatic stay rules appear to be based upon an assumption that a human actor-such as a judge or a creditor--is required to enforce contested contracts, legal judgments, and the like. The need for human enforcement allows the Bankruptcy Code, through the automatic stay, to block such efforts and pause them until the resolution of the bankruptcy. But recent changes in technology now allow for contracts that execute automatically, permanently, and without the aid of enforcement efforts of a court or creditor. These so-called "smart contracts" therefore evade the basic assumptions around which the automatic stay is built. Yet, despite their novelty, smart contracts still have the potential to willfully violate the automatic stay.

This Note begins by briefly examining the nature and function of smart contracts, including how they have changed over time. Next, it evaluates the relevant language of Code provisions dealing with the automatic stay and discusses decisions treating the interaction of early generation smart contracts with the automatic stay. It concludes with a discussion of how the Supreme Court's recent decision in City of Chicago v. Fulton (8) has significantly changed the legal landscape for smart contracts and how the automatic stay will likely interact with smart contracts in the near future.

1. UNDERSTANDING SMART CONTRACTS

   1. Early Generation Smart Contracts

      Smart contracts, at least in their most primitive form, are ubiquitous. Everyday soda or snack dispensing machines technically involve smart contracts. (9) In those basic transactions, the consumer deposits money into the machine, the machine validates information about the payment and, if certain security criteria are satisfied, it automatically dispenses a product. (10) No third-party human actor is required to consummate these basic purchases, and the transaction can be final and automatic. Therefore, at their core, smart contracts involve "'a set of promises, specified in digital form, including protocols within which the parties perform on these promises.' Smart contracts self-execute upon the triggering of pre-determined conditions." (11) As the soda dispensing machine example demonstrates, smart contracts need not be excessively complicated. And, for much of the last twenty years, they were not. Some of the most common "first-generation" smart contracts include companies automatically locking a consumer's phone or vehicle in the event of bill nonpayment. (12) For years, shoppers have also benefitted from e-Bay's "bid-up" program, which is a tool programmed to "auto-bid on an item, up to a certain price, with certain parameters involving speed of bid and time interval between bids." (13) Once the consumer sets his or her preferences, the code has authority to enter into legally binding purchase agreements without further review. (14) Accordingly, smart contracts are relatively commonplace.

      Still, two interrelated issues have historically hampered the range of uses for first-generation smart contracts. First, sophisticated users were--justifiably--concerned that the contract drafter could not be entirely trusted. In the world of traditional contracts, attorneys are trained to identify risks and pitfalls in how a contract is worded. (15) Understanding the terms of a contract becomes much more difficult when they are translated into code, especially when all parties involved might not completely understand the technology. In part because of this uncertainty, first-generation smart contracts did not have a strong presence in high-value commerce. (16) Second, first-generation smart contracts suffered from difficulties with verification of real-world events. (17) To be entirely self-executing, a smart contract's code must identify when a triggering condition has occurred. This is easy to program when a machine only needs to identify how much money a customer deposited before dispensing a bag of chips. But any complexity beyond a basic transfer requires a complicated system of input processing. For example, how can a program reliably determine that a condition subsequent has been met for a property reversion? Such programming requires sophisticated computing of the type that has only recently come into existence. The invention of blockchain technology has largely put both of these concerns to rest.

   2. Blockehain-Based Smart Contracts

      "Second-generation" smart contracts differ from the first generation because they leverage blockchain technology. The central contributions of blockchain technology are its accuracy and trustworthiness. (18) Blockchain "is a type of distributed ledger that records transactions." (19) There is no master copy of the ledger, as "any participant may maintain a copy of the ledger and yet all participants have confidence that their [] [ledger] matches all other copies." (20) At a high level, all blockchain technology contains four components: "(i) a ledger, (ii) a network, and (iii) consensus, that is (iv) unalterable by feasible means." (21) Apart from a general understanding of its functioning, the details behind blockchain networks are not strictly relevant for this discussion. Instead, the consequences of blockchain technology on contract execution are what matter most.

      When paired with much stronger modern computers, blockchain allows for highly reliable, highly complex, automatic, self-executing contracts. (22) Blockchain technology is revolutionary because it is the first innovation that allows for trustworthy contract enforcement without traditional third-party recourse. (23) Unlike a first-generation smart contract, an initiated blockchain-based smart contract cannot be altered or disabled. (24) So, the parties can program the contract at the outset to have no safety hatch; this endows both parties with the rigid certainty in execution that they seek. (25) The parties to the agreement can have complete confidence that the contract will execute exactly as planned once the triggering conditions are met. (26) And yet, blockchain contracts cannot simply divorce themselves from the operation of generally applicable law. This intersection, where the automatic and unalterable function of smart contracts runs into the demands of law, has the most potential for issues. One of the most glaring points of contention is bankruptcy law's automatic stay.

      Fully autonomous second-generation smart contracts put the contracting parties at risk of willfully violating the automatic stay. This is because the second-generation smart contract's greatest feature--its tamper-proof execution--pairs poorly with the automatic stay. For example, consider a second-generation smart contract involving a lease agreement for an expensive and critical piece of machinery. (27) The lessee corporation happens upon hard times and defaults on its payments to the lessor. Instantly, the smart contract would gather the necessary data to "understand" that the lessee has not met its side of the agreement. The smart contract's interface would connect to both of the parties' banking information and identify the lessee default. Under the present model, this could unavoidably trigger a set of consequences, including disabling the machine and immediately transferring legal ownership back to the lessor.

      Of course, the contract's original programming could require human intervention before execution. (28) And a human intervention requirement would help avoid issues with the automatic stay. However, such a change would fundamentally undermine vital features of second-generation smart contracts--their uncompromising objectivity, certainty, and predictability in enforcement. Therefore, even if the hypothetical lessee had filed for bankruptcy prior to the default and notified the lessor, the parties might have no way to stop the impending equipment shut down. In the...