Innovation and technological advancement have been one of the significant factors that have disrupted almost every aspect of human life. Innovation in technology has had an amazing impact in improving the standards of living of humanity. Amongst the most significant benefits of technology include reducing distance, real-time communication, information storage, processing and transmission, accurate methods of diagnosis, efficiency, economise the cost of production, transportation, consumption, incredible convenience and comfort. Until a few decades ago, prior to initial successful attempt to integrate Shari’a nominate contracts (i.e. putting principles and theories of Islamic law of contracts in practice) into the mainstream economy through Islamic banking and finance, technological disruptions would not have perturbed Islamic jurists more than any informed users or beneficiaries of ever-changing trends in technology.
Outlining the Narrative on Smart Contracts
The stake of principles and theories of Islamic law of contracts in the advent of technology has never been so relevant as in our time and will continue to be more relevant in the near and far future. The theories of Islamic law of contracts laid down centuries ago – have been successfully put into practice in commercial, trade and finance cycles through Islamic banking and finance industry – are threatened to embrace a ompatibility challenge from the looming concept of digital and smart contracts regimes.
In smart contract context, the basic question is of alignment of the principles and theories of Islamic law of contracts with the technology-driven artificial intelligent concepts and methods of negotiation, formation and performance of contracts. More precisely, one has to have clarity on ‘what is a smart contract’ in a modern context and to what extent a smart contract concept conforms to the principles and theories of Islamic law of contracts.
The objective of this effort is to know more about the nature and form of smart contracts, look for the similarities within the classic principles and theories of Islamic law of contracts and differences that distinguish them from Shari’a nominate contracts. This is important so that the opinion of the Islamic jurists can be solicited at an early stage to preempt the appropriate, albeit indispensable, positioning of smart contracts in Islamic banking and finance industry. After identifying the nature and form of smart contracts and the extent of their alignment with Shari’a nominate contracts, we will assess certain imminent outcomes of smart contracts; which, in our opinion, may lead to either deviation, exception, tacit acceptance or overlooking certain forms of contracts that would otherwise not have been permissible under Shari’a.
Smart Contracts – Definition and Analysis
For a clearer view of the subject, a comparison between the definition of smart contract and contract in Islamic jurisprudence would be more relevant, to begin with. The most accurate definitions of the smart contract are as follows:
“computer code that, upon the occurrence of a specified condition or conditions, is capable of running automatically according to pre-specified functions. the code can be stored and processed on a distributed ledger and would write any resulting change into the distributed ledger.”
“computer protocol [or code] that can automatically monitor, execute and enforce a contract.”
“computer protocol intended to digitally facilitate, verify, or enforce the negotiation or performance of a contract.”
It is evident from the above definitions that the matching of predefined rule-sets or conditions will result in the automatic execution and performance of a contract. The main focus of the definitions is on how the contract will come into existence. The concept of smart contracts has combined the three most important stages of a contract in one definition: (i) contract negotiation, (ii) execution of the contract (matching the offer and acceptance); and (iii) performance (i.e. the outcome or effect of contract).
Since the very objective of smart contracts is to achieve maximum efficiency, certainty, and self-reliance in the above mentioned three stages of a contract; the description of smart contracts appears to have ensured the same. Technically, the smart contract is not a form of contract per se but a description of the phases or process of a fully consummated contract as compared to a traditional definition of a contract in law, which defines the contract as:
“an agreement between two or more parties creating an obligation that is enforceable or otherwise recognisable at law.”
1 Smart Contract Alliance of Chamber of Digital Commerce, September 2008 Publication
2 https://www.freshfields.com/en-gb/out-thinking/campaign/digital/ fintech/whats-in/whats-in-a-smart-contract/
3 Wikipedia – a common definition to highlight that there is no big difference between the technical definition and understanding of an informed individual
4 Black’s Law Dictionary
From the outset, the comparison between the definition of smart contract and the legal definition of the contract would lead to the conclusion that the concept of smart contracts is more than a definition. In fact, it has combined the second and third stages of contract that is the execution of the contract and the performance of the contract (i.e. transferring or allocating the very object of the contract).
Under the classic definition of contract, the contracting parties, post entering into contract; have to rely on the good faith and actual performance of the contracting parties in order to acquire the benefits (athar al aqd) of the contract or in the event of failure on the part of a contracting party (or both) seeking assistance of a competent court or authority for the enforcement and performance of the contract. However, in a smart contract regime such situation is a rare phenomenon as the smart contract contemplates an automatic and automated negotiation, verification, execution and performance of the contract (including the subject matter and transfer of mutual considerations and counter values (athar al aqd)) in a fully autonomous, remote and automated public or private distributed ledger. In essence, subject to all other legal requirements of a contract are complied with under the applicable law, a smart contract is a complete end-to-end contract rather than an agreement of the parties which is yet to be performed in respect of its subject matter or mutual considerations (athar al aqd).
From the perspective of Islamic law of contract, a contract is defined as:
“concurrence of an offer from one contracting party with the acceptance of the other in a manner that affects the subject matter of contract.”
The above definition of contract closely resembles that of the most commonly used definitions amongst the early scholars and jurists (including authors of Majallah al-Ahkam al-Adliyyah) and heavily relied upon by contemporary scholars8 except that the latter refers to concurrence of an offer from one contracting party with the acceptance of the other in a legal manner in order to affect the subject matter of the contract. However, the additional qualifications in the definitions do not change the meaning or definition much, as each Shari’a nominate contract is subject to an extensive regime of eligibility criteria including permissibility from a Shari’a-compliance perspective.
A unique distinction between the definition of contract in Islamic law of contract and contract under law is the fact that Islamic jurists have unanimously decreed, to the extent of sale contract and all contracts involving exchange of mutual considerations/counter values, that offer and acceptance must be in past tense so as to connote absolute intention of the parties, in respect of the sale contract or another Shari’a nominate contract mentioned above, at the relevant time in respect of the subject matter. The opinions of the contemporary jurists suggest that a present tense for offer and acceptance should also suffice. However, the definition of a contract in the law allows present, past and future tenses for offer and acceptance. In smart contracts the three phases of contracts (negotiation, formation (execution) and performance) will be in a sequence without time-gap or simultaneously, thereby, ensuring completion of the contract process in its entirety. In this regard, the smart contract is closer to the concept of contract in Islamic jurisprudence, particularly, in respect of spot contracts for identified assets.
Smart Contract and the Islamic Law of Contract
Surprisingly, albeit pleasant, the description of a smart contract concurs with Islamic jurisprudence on the certainty of the absolute concurrence of offer and acceptance between the contracting parties on a subject matter at the time of entering into a contract. However, the concept of smart contracts as it stands today poses a number of challenges to the Islamic law of contract. In the following paragraphs, we will analyse smart contracts in a classic Islamic law of contract context, covering the three elements of a contract:
- Parties to a contract (sqidaan)
- Offer and acceptance (sigha)
- Subject matter (mahall al aqd)
The discussion will focus on the essential requirements under each heading in Islamic law of contract and ascertain the alignment of the same with smart contracts. One more important aspect of this study is to know the effects of remoteness and automation (or artificial intelligence) in negotiation, formation and performance of a contract from an Islamic law of contract perspective. To some extent, the subject will also touch upon for scholarly discussion, one-way or two-way delegation (or agency) by contracting parties to an artificially intelligent platform for negotiation, formation and performance of contract in the context of a juridical or legal person (a concept recognised for the modern corporate, statutory and legal entities).
The concept of the smart contract is currently supported by a technology called “blockchain”, which is a specific type of distributed ledger technology that organises data into blocks that are chained together chronologically by a cryptographic hash function and confirmed by a consensus mechanism.
The more appropriate description of smart contract is ‘it is a form of conditional “if then” statement written in computer codes1\ which are prewritten software programmes that automate performance of each parties’ obligation in an “if then” statement’. Those familiar with the technology confirm that “computer codes can only tolerate precise conditional instructions “if then”, as such, there is no flexibility for the parties to incorporate terms that has one meaning at the time of execution and can be interpreted differently during the performance stage”. Contrary to smart contracts, traditional contracts and contracts in Islamic jurisprudence cover a wide range of terms and conditions such as representation, warranties, covenants, force majeure, restitutions, remedies for breach, options (inherent options such as option to rescind the contract, (khiyar al- ru’yah) in Islamic law of contract and other contractual options recognised in Islamic law of contract). Accordingly, realising the challenges, the Chamber of Digital Commerce is suggesting that there could be two models of smart contracts: external and internal model.
In external model (contract written in different languages – traditional written contract and computer codes), the computer codes do not form the entirety of the parties’ legal agreement, but merely automates the performance of some of its terms14. This model contemplates the parties may have a traditional legal contract and the performance is automated through a smart contract regime. The external model suggests a hybrid approach, which can accommodate certain contractual and boilerplate provisions in the contract that is outside the computer code. The conventional contract will be the main contract and the smart contract (computer code) merely organises, facilitates and assures performance aspect of the contract such as exchange of the subject matter of the contract (the object of the contract).
From an Islamic law of contract perspective, on the whole (subject to the discussion in the following paragraphs) this approach is acceptable. However, certain sensitivities in respect of certain Shari’a nominate contract will have to be taken into account. These include at par consideration and spot settlement requirement in currency exchange contract etc. or prohibition on delaying both considerations in a contract of sale of an identified asset (currency or commodities that are subject to at par consideration and spot settlement rule in Islamic law of contract).
In an internal model (the code as the main contract), this model contemplates two types of smart contracts:
- The computer code encompasses the entire agreement between the parties and supersedes other clauses written in natural language. Everything behind the computer code merely explains the terms.
- The computer code could form only the legally binding contract (rather than the entirety of the contract) and would supersede other clauses written in natural language. In this model, the contract may still utilise a natural language in a conventional contract for non-operational clauses. The computer code of this model is an integral part of the agreement and not a translation of its terms.
From an Islamic law of contract perspective (subject to the discussion in the following paragraphs), assuming all requirements of a valid contract are complied with the internal model, under (i) above, may entail certain difficulties such as excluding the inspection option (khiyar al-ru’yah), which is an inherent right in sale by description.
Smart Contract Compatibility Assessment
In light of the above two possible models of smart contracts as of now, the analysis of a smart contract in light of the Islamic law of contract would possibly entail the following discussion.
Parties to a contract
The discussion under this topic will include eligibility (ahliyyah-al-ada) of the parties; (i) at the time of negotiation and formation of the contract – in smart contract concept, particularly under the Internal model in general; and (ii) at the time of performance of the contract in particular. In both internal and external models of smart contracts, ascertaining or ensuring the eligibility (ahliyyah-al-ada) would be a challenge, more particularly, when a series of contracts and subsequent performance of the contracts would be on (or through) artificially intelligent platforms. The Islamic jurists have to consider the application of the eligibility criteria in a typical smart contract scenario based on the two models of smart contracts.
When a computer code (pre-written software programme) operates independent of the parties involvement in predefined conditions or scenarios, a party to contract (or both of them) may not satisfy the eligibility criteria or rule-sets under a relevant school of Islamic jurisprudence; hence affecting the validity of the contract. More clearly, one of the parties in contract or both may not have eligibility (ahliyyah-al-ada) at the time the contract is being negotiated, formed and performed. The question is “does it affect the underlying contract from an Islamic jurisprudence perspective?”
Needless to mention, the basis for eligibility (ahliyyah-al-ada) is the intellect (prudence) and consent (or discretion). There are various factors that affect the prudence and consent, which is a condition precedent for parties’ eligibility to enter into a contract in respect of a valid contract or a condition subsequent in respect of a suspended (Maukuf) contract. In the context, the scholarly discussion about complete and incomplete eligibility (ahliyyah-al- ada) would be very relevant for determining the validity of the relevant smart contract. This is more so, when considering the following two aspects of the smart contracts; (i) artificially intelligent platform, which organises smart contract, as an agent or delegate of the contracting parties; and (ii) eligibility of a platform as a juridical or legal person.
In respect of the agency or delegation, it would be important to understand the requirements of Islamic law of contract for agency to a natural, legal or juridical person. Like all other contracts, the agent should also satisfy the criteria of complete eligibility. A person (natural, juridical or legal) should have complete eligibility to enter into a contract for itself and others19. The artificially intelligent platform for smart contracts may not fulfil the requirements of a juridical or legal person as we see that all contracts by a juridical or legal person are executed by a natural person or persons with complete eligibility (ahliyyah-al-ada) and the owner of the juridical or legal person is either natural person or a body corporate representing a natural person or persons (in certain unique cases like public trust, body corporate owned by government or entities established for public benefits)20. The blockchain technology that supports the smart contract regime exists on a network of computers with nodes and users typically based all over the world. Particularly, in a public blockchain, ascertaining the ownership of the artificially intelligent platform for a person (natural, juridical or legal) would be a challenge, and has yet to be addressed.
Assuming that the blockchain platform does not have any owner, which is most likely the case; the ability of the platform to negotiate, execute and perform the contracts for and on behalf of the contracting parties would be questionable, therefore, affecting the underlying contracts. In the context, it would be important to consider and determine the basis and requirement for an artificially intelligent mind (electronic mind, minds or electronic agents) representing parties from Islamic law of contract perspective. In view of the above, is Islamic law of contract ready to consider and accept the artificially intelligent mind to represent the natural, juridical and legal parties for the purpose of negotiating, executing and performance of a contract on the blockchain or an artificially intelligent platform?
It would also be pertinent to have a look at the resolution of International Fiqh Academy (IFA) concerning the formation of a contract through electronic equipment or sale through an exchange of offer and acceptance over the electronic mode of communication. The IFA resolution was issued three decades ago, considering a limited scope, extent, use and simplicity of available information technology at that time. E-commerce was almost non-existence or had a one-way interaction, such as the current form of electronic ticketing/electronic purchase. The resolution does not take into account or seem to have addressed one-way or two-way no real-time human interaction for negotiation, formation and performance of a sale contract. Furthermore, the resolution does not appear to have the foresight of the role of artificial intelligence or artificially intelligent remote platform acting as an electronic mind or agent representing the parties.
Offer and Acceptance (Sigha)
Under the internal model of smart contracts, offer and acceptance will always be precise and definite and thus meeting the requirements of Islamic law of contract24. However, certain classical concepts of Islamic law of contract such as exchange of offer and acceptance during the session of contract (majlis al aqd), practical definition of thr session of contract, end of the session of contract, etc. need a thorough consideration of Islamic jurists. On the other hand, smart contracts contemplate the concept of evergreen offer and acceptance and flexible session of contract. It is possible that immediately before or simultaneously at the time of automatic execution, formation and performance of the contract the essential requirements, in respect of the three elements of contract, are no longer satisfied or complied with, thereby, affecting the validity of the underlying contract from Islamic law of contract perspective.
As mentioned above, most likely the computer code will use present tense for offer and acceptance or in an “if then” statement, followed by an immediate performance at the relevant time will affirm the execution and performance of a contract immediately which also seems to satisfy the Islamic law of contract requirement25. However, certain concepts such as exchange of offer and acceptance within a contract session without any time-gap in accordance with Shafi’i School of Jurisprudence, and the existence of the offer until acceptance, rejection or lapse of the time27 for the offer in accordance with the majority of scholars could not be accommodated in smart contract regime.
Under smart contracts, the assumption is that until acceptance by the other party, the offer can be amended. However, once it is accepted, the party cannot have the option to rescind the contract using the inherent option of the session of the contract29 or the contractual option of the session of contract in accordance with Hanfi and Malki School of Jurisprudence. On the whole, if all other requirements of eligibility (ahliyyah- al-ada) are complied with, the notion of meeting of minds of the contracting parties can be satisfied in a smart contract.
One challenge that we have discreetly alluded to in this discussion is the storage of offer and acceptance on an artificially intelligent platform or blockchain for future transactions. Since computer codes for smart contracts contemplate “if then” statement, which is conditional or contingent set of terms. Scholars have to evaluate the same for the purpose of the eligibility of the same as formats for offer and acceptance in the Islamic law of contract. Are these computer codes conditional offer and acceptance; in which case the discussion among the jurists about whether to treat such conditional offer and acceptance as a mutual promise from the respective parties on the same subject matter or two different conditional promises resulting in an automatic contract if the conditions are satisfied? If scholars’ inclination is towards the latter, there would be a forward contract element that needs to be considered.
Forward contracts are classified as impermissible contracts under the Islamic law of contract. Considering the automatic formation and performance of smart contract in respect of the first transaction, which is going to be spot in terms of execution and performance regardless of the language of the offer and acceptance (in past, present, or future tenses), the sale will be valid as the same will be construed as sale by mutual performance and conduct.31 On the other hand, if the smart contract entails formation and performance of a series of sale and purchase contract between the contracting parties in future on preset conditions, the same would certainly fall under a binding forward sale, which is an invalid contract.
Subject Matter
The discussion under this topic is based on the assumption that the subject matter is permissible under the rule-sets of Islamic law of contract. Accordingly, for the sale of specified assets (excluding istisna’ and salam contracts), the Islamic law of contract requires that:
- the subject matter should be in existence, ascertained and available at the time of exchange of offer and acceptance. The mere possibility of subject matter capable of being made available or ascertained at the time of exchange of offer and acceptance is not sufficient.
- existence of the subject matter in the condition, specification and description as per the offer and acceptance at the time of the contract is formed and performed.
In essence, these two conditions necessitate that the seller should have actual possession of the subject matter and is ready to deliver the possession of the subject matter to the buyer at the time of exchange of offer and acceptance. An online sale and purchase contract (prevailing e-commerce) or smart contract in future, would also entail a sale or a legally binding contract on any subject matter, which may not be owned and/or in possession of the offeree (the contracting party) at the time of the contract is formed and/or performed under either of the smart contract models.
Alternatively, in e-commerce and a smart contract concept (contract or sale through artificially intelligent platform) regime would certainly be either sale by performance or conduct or sale by description. In the latter case, the sale should be with option of inspection (khiyar al-ru’yah) in accordance with the majority of scholars and an invalid sale in accordance with Shafi’i School of Jurisprudence35. Accordingly, smart contracts would certainly result in parties compromising on certain entitlements, which the Islamic law of contract secures for them as an inherent right.
Conclusion and the Way Forward
Following a brief analysis of the subject, it would be appropriate to highlight the followings:
- Smart contract framework, both external and internal models, can easily be implemented in Islamic banking and finance industry for contract management, administration, tracking and reporting performance and record-keeping in respect of all Shari’a nominate contracts. The smart contract would guarantee a greater level of Shari’a- compliance, record keeping and efficient contract management as every entry on the public distributed ledger is time-stamped, permanently stored and cannot be altered. This is the most promising and effective use of smart contracts and related technology. Perhaps, the external model of a smart contract regime would be more useful for this purpose as the same involves less complication from Islamic law of contract perspective.
- In terms of contract negotiation, execution, formation and performance; the smart contract and related technology can comfortably be used for the following Shari’a nominate contracts: unilateral, voluntary commitment, promises, contracts for security, collateral, suretyship, custody, bailment, wills, guarantees and service or maintenance contracts. These contracts do not involve the transfer of ownership in the underlying subject matter or exchange of counter values between the contracting parties as such are simple and straightforward.
Contracts involving exchange of mutual considerations (counter values), transfer of ownership and investments (such as all sale, trust, agency, service, settlement and investment contracts) would not be free of some of the challenges highlighted above. Perhaps, a full-scale framework would be required to map the smart contract into the Islamic law of contract. Over the last few decades, the Islamic jurisprudence has seen a drive towards consensus and narrowing the scope of interpretations and juristic inferences by agreeing on one acceptable opinion or interpretation (albeit minority opinion).
This is more so in Islamic banking and finance industry in the form of AAOIFI Standards and general resolutions of International Fiqh Academy. Nevertheless, the scope and extent of interpretations and inferences across various recognised schools of jurisprudence and scholars would continue to remain relevant and may exist and flourish in various jurisdictions. Maintaining an inclusive approach (as compared to a narrow uniform view on the subject) that accommodates a juristic opinion or interpretation under a particular school of jurisprudence will be preferable to keep the legacy of continuous development and improvement in Islamic jurisprudence in different times and circumstances.
The initial assessment suggests that the smart contract concept (embodying internal model) is yet to establish its compatibility with Islamic law of contracts even on generally accepted theories and principles of Islamic law of contract. For example, the contract under personal law (marriage, divorce, maintenance and nursing contracts) would require more studies to determine their alignment with the smart contract concept under the internal model. One important aspect highlighted above is the adoption of smart contracts may lead to the likelihood of acceptance of conditional, contingent and forward contracts, thereby, changing the long-standing position of Islamic law of contract on forward, conditional and contingent contracts.
Another related question for the scholars would be the Islamic law of contract position on automatic execution and performance of contracts (contracts which involve an exchange of counter values or considerations). As mentioned above, Islamic jurisprudence has to assess and properly identify the raison d’être for accepting electronic minds or electronic agents representing the contracting parties, more particularly, in the context of an orphan public distributed ledger (blockchain or artificially intelligent platforms).
The innovation in technology (which has no frontiers whatsoever) and the processes (which usually follows the technology) are the main drivers of economic development of which Islamic banking and finance industry is an integral part, at least in this part of the world. In an ever-changing high-tech environment affecting the economy, it is imperative to preempt the impact of technology and devise the alignment solutions within the limits set for the Shari’a nominate contracts in Islamic law of contract. The most imminent requirement is assessing and ascertaining the nature and function of the smart contract, the role of the electronic minds or agents, and artificially intelligent platform in negotiating, forming, executing and performing the contracts from a Shari’a-compliance perspective. Considering the importance of the topic, Islamic jurists and technical experts should take- up some of the issues highlighted above as a matter of priority on a proactive basis.
