The Conundrum of Enforceability of Blockchain Arbitration: Learnings from Kleros

[This article has been authored by Varda Saxena & Harshitha Swarna, fourth-year law students at JGLS, Sonipat]


Keywords: Kleros, Smart Contracts, Blockchain Arbitration, Arbitration, Blockchain Arbitral Order.


Introduction

A blockchain is a decentralised digital ledger of accounts maintained by its users rather than by a third party and stored on a network of computers. Blockchain transactions are completely transparent and do not have a central data storage administrator. This ensures the validity and security of the data fed to it since every transaction is encrypted and so can be traced. Smart contracts on the blockchain allow for the self-enforcement of automated legal obligations without the involvement of third-party intermediaries. As it stands, the problem faced by traditional dispute resolution mechanisms is that they cannot effectively authenticate large numbers of cross-border small-value claims. To alleviate this problem, arbitrators have introduced the concept of ‘blockchain arbitration’, which seeks to utilise blockchain technology to authenticate smart contracts and automate their execution by invoking the arbitration clause contained within the contract in the case of a dispute.


This harmonious interaction between blockchain technology and arbitration seeks to fulfil the speedy, efficient, and cost-effective resolution of disputes. However, the legal recognition and enforceability of blockchain arbitration is contentious and has been discussed across various jurisdictions worldwide. Therefore, through this article, the authors argue that reading the Kleros precedent with the principle of ex aequo et bono into the Indian legal framework under Section 28 of the Arbitration and Conciliation Act could be a possible remedy for solving the procedural hurdles which might be encountered in a blockchain arbitration.


The Methodologies of Blockchain Arbitration

The involvement of intermediaries in smart contracts might hinder the immutability and automated nature of these contracts. Hence, if intermediaries would indulge in contract enforcement, such as in arbitration or judicial intervention, it might render the basis of these contracts obsolete. However, this can be avoided if the software is used for the automation of only deterministic clauses of an agreement. All non-trivial transactions might have some non-deterministic clauses, such as good faith and reasonableness, which cannot be incorporated through languages like Solidity unless technological progress allows artificial intelligence to learn human reasoning. Hence, this makes the role of human arbitrators essential for the application of legal principles.


In order to inculcate the applicability of arbitration in smart contracts and blockchain-based transactions, clause-based consequences can be referred to an Oracle.[1] For example, if a person buys a flight ticket, which is encoded in a smart contract, it will have encoded data regarding the time of arrival and departure, and the feedback received from an Oracle can determine the chain of events and itinerary compliance. Hence, if the feedback received prompts towards a delay or flight cancellation, compensation could be automatically directed to the traveller’s account. This mechanism can also be utilised while conducting arbitration through an Oracle. When a clause postulates the deferring of a dispute to the arbitrator, the determination of the dispute could be done, and the award can be uploaded on an Oracle. Hence, the external input provided by Oracle will stimulate the software script to enforce the outcome of the award. This would also avoid extra litigation and decrease judicial burden as the execution of awards would be automated.


In the case of M/s Religare Finvest Limited v. Ranjit Singh Chouhan, the High Court of Delhi relied on the decision delivered in Daelim Industrial Co. Ltd. v. Numaligarh Refinery Ltd while stating that the territorial jurisdiction for the execution of an award is determined by the place where the property or money is located as the Award itself is executable as a decree. Similarly, many other precedents have reflected the same view. However, with the adoption of an Oracle-based arbitration mechanism, such instances could be resolved without hassle and time-lapse, thus fulfilling the aim of the arbitration laws as well, which is the speedy redressal of conflict. For further discussion on risks associated with Oracle, Alexander Egberts work helps understand how placing reliance on one Oracle could also pose a credibility issue alongside security risks stemming from a singular point of failure.


Such a procedure would also uphold the already embedded ‘routine escrow mechanisms’ first theorised by Satoshi Nakamoto and could be utilised in a variety of business transactions as the translation of clauses into codes progresses. This would also evolve the manner in which arbitral proceedings are conducted during the COVID-19 era. As the arbitral mechanisms evolve beyond the restrictive bitcoin protocols, it might also encourage legislative action. Hence, it might also help in developing a normative criterion for drafting arbitral Awards so that Oracles can facilitate the stimulation of a smart contract. Additionally, blockchain-based technologies like EOSIO40 and Mattereum have already created solutions for the inculcation of arbitration within smart contract execution protocols.


The inclusion of arbitration mechanisms within the smart contract architecture might also cause issues related to the self-enforceability of arbitral awards. This is because automated execution might marginalise recognition procedures, which has already been noticed in bitcoin adjudication based on multi-signature addresses.[2] But this does not bolster the need to have highly restrictive regulations, as public policy would always mandate state-controlled recognition procedures to an extent. Further, there might also be other procedures that the state might follow, such as the deduction of money due to a smart contract being refunded ‘off-chain’. Hence, the usage of smart contracts for mediation would not mandate state control via technological means only. Another problem that arises is the incompatibility that exists with state-mandated arbitration frameworks. This incompatibility with conventional arbitration frameworks compounds in two ways: first, the decentralised, cryptographic mode of the arbitration agreement, and second, the lack of a seat of arbitration, given its distributed nature. However, a dystopian argument can be made regarding the automated asset circulation which could happen on technological platforms, rendering off-chain transaction reversal extremely complicated or impracticable. But such a case would only occur in an economy where smart contracts have gained paramountcy.


The Carrera Report and the Standardisation of Blockchain Arbitration

As of 28th May 2021, the discussion surrounding the enforceability of Blockchain Arbitral Awards ceased to be mere conjecture when Mexican courts enforced an arbitral award by way of incorporating it into the existing traditional arbitration framework, thereby treading a step closer towards ensuring the compatibility of blockchain arbitral orders within the framework of state control. The case concerned Kleros, a decentralised application (“Dapp”) that utilises blockchain technology to create fast and automated modes of online dispute resolution. The issue at hand was related to a rental estate leasing agreement between the two parties, whose arbitration clause prescribed a hybrid mode of arbitration, stating that the Arbitrator must draft a Procedural Order containing the executive summary of the dispute along with supporting evidence, addressed to Kleros, which would then issue its decision on a strictly objective legal basis, upon which the Arbitrator would be required to incorporate Kleros’ decision into his Arbitral Award to govern the substance of the ruling and issue it in writing. As per the clause, since this Award would contain a definitive resolution to the dispute, the parties would renounce any recourse to revoke or modify the award.[3]


However, the blockchain arbitration process and the involvement of Kleros are not adequately detailed in the Award since it is indicated that the Award is only in the name of the Arbitrator, without accounting for the automated dispute-resolution role that Kleros plays. Since the dispute arose from a rental agreement whose terms were stipulated in Mexican currency, it was entirely off-chain. However, given that the arbitration clause contained a blockchain protocol, the subsequent Blockchain Arbitral Award devised by Kleros was enforced in consonance with the traditional arbitration paradigm adopted by Mexico.


Thus, the question that arises is whether the enforcement of blockchain arbitration through traditional arbitration as envisaged by national legal orders is counterintuitive to the self-enforceable and decentralised nature of blockchain technology and its ability to trigger smart contracts as an Oracle. However, given the relative novelty of blockchain arbitration, traditional arbitration could be an extremely effective tool to standardise and enforce blockchain awards.


The Enforceability of Blockchain Arbitration in India

The paradigm adopted by Mexico in adopting an off-chain arbitrator to incorporate Kleros’ decision into the traditional arbitral award allows for the convergence of national legal orders with blockchain arbitration, thereby ensuring that the prevailing lex arbitri is not contravened. Article 19(1) of UNCITRAL’s Model Law stipulates such a protocol. Part I of the Arbitration and Conciliation Act (hereinafter “the Act”) has been enacted to mirror the Model Law in stipulating that an application for the enforcement of an arbitral award shall be accompanied by an original arbitral award. Further, Section 34 of the Act stipulates that a party aggrieved by an arbitral award may file an application for modifying or setting aside the award, keeping in mind the margin of error within traditional arbitration frameworks and the scope for allegations of fraud or procedural lapses by the tribunals. The blockchain arbitration paradigm is so meticulous that it does not require external scrutiny from experts. This is because the blockchain ensures that the award has all the necessary ingredients, including the date, place, and digital signature of the arbitrator, and further ensures that these documents are tamper-proofed and auto-linked, thereby minimising the probability of an award being set aside.

Section 7 of the Amended Act of 2015 stipulates that a valid arbitration agreement should be in “writing”, with the clarification that an agreement would be considered having been in “writing” even if it has been communicated through “electronic means” – which is loosely defined. However, in light of the Kleros decision, it could be argued that Blockchain Arbitration Award can fall within the definition of an ‘electronic record’ under Section 10-A (Validity of Contracts formed through electronic means) of the Information Technology Act, 2000 (“IT Act”).


The Regulation of Blockchain Arbitration and its Legal Recognition Worldwide

Blockchain arbitration sets out to eliminate human error that persists within the practice of traditional arbitration by eliminating human subjectivity within disputes that involve the complex interpretation of clauses or statutes. Additionally, the blockchain system enables efficient document management by swiftly providing briefs and transcriptions of the case records. Blockchain tools like Kleros assist tribunals in preparing awards by ensuring that the preconditions required to make the award are met. This is done by crowdsourcing the decisions of a variety of jurors in order to decide the merits of the case. These decisions are then incorporated by the arbitrators and subsequently enforced as awards.

However, this approach is the main consideration that obstructs the enforceability of blockchain arbitration. This is because the blockchain “Dapp” exists entirely digitally, owing to which they are generally not considered a part of any State territory. Article I(1) of the New York Convention solely recognises the enforceability of foreign arbitral awards made in the territory of a State other than the State where the recognition and enforcement of such awards are sought. Additionally, by virtue of the guidelines set by the UNCITRAL as well as Section 31 of the Arbitration and Conciliation Act (hereinafter “the Act”), national legal orders operating within traditional arbitration frameworks act as the bridge towards achieving the enforceability of blockchain arbitration. Specifically, Section 31 of the Act requires the arbitral award to mention the seat of the arbitration in order for it to be considered enforceable. Given that blockchain awards are not localised, since the award is generated on a blockchain and circulated to the parties before the Arbitrator, they do not meet this requirement. However, ensuring the enforceability of such revolutionary technology is imperative in order to facilitate the continuous evolution of dispute resolution mechanisms. The Kleros decision must therefore be used as the governing precedent for the same. Reading this precedent with Section 28 of the Act, founded on the principle of ex aequo et bono (Latin for “according to the right and good”), which is an approach that enables party autonomy and the ability to decide the dispute in accordance with the rules of law designated by the parties as applicable to the substance of the dispute, could therefore be the key to a robust regulatory system that enables the enforcement of blockchain arbitration.


Conclusion

Blockchain technology undoubtedly allows for inexpensive, speedy, and transparent dispute resolution mechanisms, particularly within fields of real estate (as seen in the Kleros case), investments, e-commerce, and other high-volume and low-value ventures. At a time when the Indian Government is displaying palpable scepticism towards the utilisation of decentralised technology such as blockchain, as evidenced by its Virtual Digital Asset taxation policy proposed in the Union Budget, it is of paramount importance for the Indian legal system to mirror the precedent set by Kleros as well as the approaches taken in jurisdictions such as Mexico and Hong Kong. The authors suggest that this can be done by integrating the same into the Courts’ interpretation of Section 28 of the Act, which would, in turn, aid the development of a robust dispute resolution framework that allows for the efficient enforcement of hybrid arbitral awards. The usage of blockchain technology in the procedural enforcement of pre-determined smart contracts would eliminate procedural shortcomings; inculcated with a human intervention-based interpretation regime, the hybrid model of dispute resolution would insulate arbitral awards from enforceability hurdles faced by parties undertaking cross-border disputes.




[1] Primavera de Filippi and Aaron Wright, Blockchain and the Law: The Rule of Code (HUP, Cambridge 2018) 75.

[2] Electronic Platforms and Networks, in The Cambridge Handbook of Smart Contracts, Blockchain Technology and Digital Platforms (2019) 141-210.

[3] ANNEX-1 (Original Arbitration Agreement).

0 comments

Recent Posts

See All