Overcoming the Legal Barriers to the Implementation of Smart Contracts in the Construction Industry: The Emergence of a Practice and Research Agenda

1. Introduction

The construction industry is one of the most critical sectors of the global economy, contributing significantly to economic growth and job creation. The industry has been known to be a slow adopter of technology; however, advancements in digitalization and automation are presenting new opportunities for the sector. One of the recent innovations in the construction industry is the implementation of smart contracts. Smart contracts are self-executing contracts that are executed automatically when pre-determined conditions are met [1]. They are digital programs stored on a blockchain network and are considered as legally binding agreements between parties. Smart contracts have the potential to revolutionize the construction industry by streamlining the contracting process, reducing transaction costs, and improving transparency and trust among parties [2]. However, the implementation of smart contracts in the construction industry faces significant legal barriers that need to be overcome before they can be widely adopted [3] This article will critically appraise the legal barriers to the implementation of smart contracts in the construction industry. The article starts with an overview of smart contracts, followed by a review of the literature on the benefits of smart contracts in the construction industry. The article will then cover the legal issues related to the enforceability of smart contracts, data protection, and privacy, intellectual property rights, and dispute resolution. The role of lawyers in helping construction clients overcome legal obstacles to the implementation of smart contracts and a future research agenda are proffered.

2. Overview of Smart Contracts

A smart contract for construction projects is a self-executing agreement between the parties involved in a project, including the owner, contractor, and subcontractors. The terms of the agreement are encoded in lines of code and stored on a decentralized blockchain network, allowing for automatic execution without the need for intermediaries. Smart contracts can be used in construction projects to automate various processes, including payment, progress tracking, quality assurance, contract administration, dispute resolution, material tracking, time tracking, warranty management, environmental compliance, and health and safety compliance. The use of smart contracts can help to increase efficiency, reduce costs, and increase trust in contractual relationships by automating key processes and ensuring that the terms of the agreement are automatically enforced.

3. The Use of Smart Contracts in the Construction Process

Smart contracts for construction projects can be customized to meet the specific needs of each project and can be designed to trigger automatic actions based on predetermined conditions.

Examples of smart contracts used in construction projects include:

• Payment Escrow: A payment escrow smart contract can be used to hold funds until the agreed-upon conditions of the project have been met. Once these conditions are satisfied, the funds are automatically released to the contractor.
• Progress Tracking: A smart contract can be used to track the progress of a construction project and automatically release payment to the contractor based on predetermined milestones.
• Quality Assurance: A smart contract can be used to automate the quality assurance process by incorporating quality standards into the code. If the standards are not met, the contract can automatically trigger a dispute resolution process.
• Contract Administration: A smart contract can be used to automate the contract administration process, including the distribution of contracts, the tracking of changes, and the management of approvals.
• Dispute Resolution: A smart contract can be used to automate the dispute resolution process, with disputes automatically being resolved based on the terms of the agreement without the need for manual intervention.
• Supply Chain Management: Smart contracts can be used to automate the procurement process in the construction industry. For example, a smart contract can be used to automatically trigger the release of payment to suppliers once the delivery of materials has been confirmed.
• Performance Bonds: A smart contract can be used to automate the process of posting performance bonds, which provide financial guarantees to the owner in the event of contractor default.
• Warranty Management: A smart contract can be used to automate the warranty management process by incorporating the terms of the warranty into the code. If a warranty claim is made, the contract can automatically trigger a dispute resolution process.
• Insurance: A smart contract can be used to automate the insurance process by incorporating the terms of the insurance policy into the code. If a claim is made, the contract can automatically trigger the payment of benefits to the policyholder.

These are just a few examples of the ways in which smart contracts can be used in the construction industry to automate key processes and increase efficiency, reduce costs, and increase trust in contractual relationships. However, it is important to note that the use of smart contracts is still in its early stages, and there are ongoing legal and regulatory developments that may impact the use of smart contracts in the construction industry.

4. Benefits of Smart Contracts in the Construction Industry

Several studies have investigated the benefits of smart contracts in the construction industry. A study by Guo and He [4] found that the use of smart contracts in the construction industry could produce several benefits, including improved transparency, reduced transaction costs, increased security, and improved efficiency in the execution of construction projects.

4.1. Improved Transparency

Smart contracts provide an automated and transparent process for tracking the progress of construction projects. The use of smart contracts in the construction industry is expected to enable improved transparency, as the terms of the contract are stored on a decentralized and distributed ledger that is maintained by a network of computers. This makes it difficult for any single party to manipulate the terms of the contract or alter the data stored on the blockchain.

4.2. Reduced Transaction Costs

Smart contracts can also reduce transaction costs in the construction industry by automating the payment process. The use of smart contracts can reduce the need for intermediaries, such as lawyers and banks, in the payment process, which can significantly reduce the transaction costs involved in the execution of construction projects. By automating the payment process, smart contracts can also reduce the risk of payment disputes, which can lead to delays and increased costs in the construction project.

4.3. Increased Security

Smart contracts are designed to be tamper-proof and secure, as the terms of the contract are stored on a decentralized and distributed ledger that is maintained by a network of computers. This makes it difficult for any single party to manipulate the terms of the contract or alter the data stored on the blockchain. The use of smart contracts in the construction industry can increase the security of the contract, reducing the risk of fraud and ensuring that the terms of the contract are executed as agreed upon.

4.4. Improved Efficiency

Smart contracts can also improve the efficiency of construction projects by automating certain processes and reducing the need for intermediaries, such as lawyers and banks. By reducing the need for intermediaries, smart contracts can reduce the time required to execute the contract and ensure that the construction project is completed in a timely manner. The use of smart contracts can also improve the accuracy of the contract, reducing the risk of errors and misunderstandings between the parties involved in the construction project.

5. Legal Aspects of Smart Contracts

While Smart Contracts offer many benefits, such as reducing the need for intermediaries and increasing the speed and efficiency of transactions, there are also legal implications to consider.

• Validity: The first issue that arises is the validity of the smart contract itself. It must be legally binding and enforceable in the jurisdiction where it is used.
• Contractual Capacity: The parties to a smart contract must have the contractual capacity to enter into the agreement. This means that they must have the capacity to enter into a binding agreement and must be capable of understanding the terms and conditions of the contract.
• Choice of Law: Smart contracts may involve parties located in different jurisdictions, which can make it difficult to determine the applicable law. It is important to have a clear understanding of the choice of law and jurisdiction in the smart contract.
• Dispute Resolution: Disputes may arise in the execution of smart contracts, and it is important to have a mechanism for resolving disputes. This can be done through alternative dispute resolution methods such as arbitration or mediation, or through a court of law.
• Data Privacy: Smart contracts may store and transmit sensitive information, making it important to ensure that the contract has sufficient data privacy provisions in place.
• Security: Security is a key issue in smart contracts, as any vulnerabilities or hacks can result in significant financial losses. It is important to ensure that the contract is secure and that measures are in place to prevent unauthorized access.
• Regulatory Compliance: Smart contracts must comply with relevant laws and regulations, such as anti-money laundering (AML) and know-your-customer (KYC) laws.

Thus, it is important to ensure that the smart contract is legally binding, has clear dispute resolution mechanisms, and complies with relevant laws and regulations. In the UK, Smart Contracts are not yet specifically regulated by law. However, the existing legal framework for electronic contracts provides some guidance on the legal aspects of smart contracts.

The Electronic Communications Act 2000 (ECA 2000) provides that electronic contracts are valid and enforceable as long as they are executed in accordance with the formalities prescribed by the law. The Electronic Signatures Regulations 2002 (ESR 2002) prescribe that an electronic signature is valid if it is unique to the signatory, is under the signatory’s sole control, and is linked to the data in such a way that any subsequent change in the data is detectable.

The Electronic Commerce (EC Directive) Regulations 2002 (ECDR 2002) prescribe that electronic contracts may be concluded by means of electronic communications. The ECDR 2002 also sets out the formalities for the conclusion of electronic contracts and provides for the use of electronic signatures. The Consumer Contracts (Information, Cancellation and Additional Charges) Regulations 2013 (CCR 2013) prescribe that the consumer must be provided with certain information before entering into an electronic contract. The CCR 2013 also provide for the right of consumers to cancel an electronic contract within 14 days of conclusion.

6. Smart Contracts in the Construction Industry: A Developing Legal and Regulatory Framework

The implementation of smart contracts in the construction industry also requires a supportive legal and regulatory framework [5]. The legal and regulatory framework should provide clarity on the enforceability of smart contracts, the rights and responsibilities of the parties involved in the construction project, and the resolution of disputes. The legal and regulatory framework should also provide clarity on the status of smart contracts in the event of a dispute or a change in the terms of the contract [6].

7. The Enforceability of Smart Contracts

One of the critical legal barriers to the implementation of smart contracts in the construction industry is their enforceability. The enforceability of smart contracts is a matter of concern since they are not legally recognized in all jurisdictions [7]. The lack of legal recognition makes it difficult for parties to enforce smart contracts in court. In some jurisdictions, smart contracts may be considered as electronic contracts and are governed by electronic commerce laws. In other jurisdictions, smart contracts may be seen as a new form of contract and may not be recognized under existing contract laws. In these cases, parties may find it challenging to enforce smart contracts, particularly in the event of a dispute. The enforceability of smart contracts is also affected by the lack of legal certainty in blockchain technology.

Blockchain technology is still in its infancy, and the law has not caught up with the rapid pace of technological advancement. The absence of legal clarity makes it challenging for parties to know the legal consequences of using smart contracts. Additionally, smart contracts rely on the underlying code to execute automatically. The code of smart contracts is only as good as the person who wrote it. If the code is incorrect or contains bugs, it may lead to unintended consequences, making the smart contract unenforceable.

8. Data Protection and Privacy

Data protection and privacy are critical legal barriers to the implementation of smart contracts in the construction industry [7]. The construction industry generates a vast amount of data, including personal data, that needs to be protected. Smart contracts rely on the storage and sharing of data on a blockchain network, making them vulnerable to unauthorized access and data breaches. The lack of proper data protection regulations and the absence of privacy laws in some jurisdictions make it challenging to ensure the protection of personal data in smart contracts. The European Union, for instance, has stringent data protection laws, including the General Data Protection Regulation (GDPR), which apply to the processing of personal data. Failure to comply with these regulations can result in significant fines and penalties [8].

9. Intellectual Property Rights

Intellectual property rights are another legal barrier to the implementation of smart contracts in the construction industry. The use of smart contracts in the construction industry may infringe on intellectual property rights, such as patent rights and copyright. This is particularly relevant in the context of the use of smart contracts for the management of construction projects, where proprietary software and technology may be used. The protection of intellectual property rights is essential in the construction industry, and parties need to ensure that they have the necessary rights and licenses to use any proprietary software and technology. Failure to secure the necessary rights and licenses may result in infringement claims, which could lead to costly legal battles and a halt in the implementation of smart contracts. Moreover, the blockchain technology used in smart contracts is considered to be immutable, meaning that once data are recorded on the blockchain, it cannot be altered or deleted. This feature raises concerns about the protection of confidential information and trade secrets in smart contracts. For example, confidential information regarding the design and construction of a building may be recorded on the blockchain, making it available to unauthorized parties [8]

10. Dispute Resolution

Dispute resolution is another critical legal barrier to the implementation of smart contracts in the construction industry. Construction projects are known for having a high degree of complexity and risk, which often results in disputes between parties. The resolution of disputes in the construction industry is typically achieved through legal proceedings or arbitration. However, the resolution of disputes in smart contracts is a complex issue [9].

Smart contracts are designed to be self-executing and are intended to eliminate the need for intermediaries, including lawyers and judges. In the event of a dispute, it may be challenging to determine who has jurisdiction to resolve the dispute, and the enforceability of smart contract-based resolutions may be uncertain. Additionally, smart contracts are executed automatically when predetermined conditions are met. In the event of a dispute, it may be challenging to resolve the dispute if the conditions set out in the smart contract are ambiguous or unclear. This may lead to conflicting interpretations of the conditions, making it difficult to resolve disputes through smart contracts.

11. The Role of Lawyers in the Implementation of Smart Contracts in the Construction Industry

Lawyers can play a critical role in helping their clients overcome the legal obstacles to the implementation of smart contracts in the construction industry. Smart contracts are a relatively new technology and the legal framework surrounding their use is still evolving. Lawyers can provide guidance and expertise to help their clients navigate the legal and regulatory landscape [10].

One of the main legal obstacles to the implementation of smart contracts in the construction industry is the issue of enforceability. Lawyers can assist their clients in ensuring that smart contracts are legally binding and enforceable in the jurisdiction where the construction project is taking place. This can involve researching and interpreting the relevant laws and regulations, as well as drafting and negotiating the terms of the contract [11].

Another obstacle is the lack of clear legal definitions and standards for smart contracts. Lawyers can help their clients by providing guidance on the terms and conditions of the contract, including the responsibilities of each party, and ensuring that the contract is compliant with relevant laws and regulations [12].

Lawyers can also assist their clients in resolving disputes that may arise during the construction project. Smart contracts can automate the dispute resolution process, but lawyers can still play an important role in advising their clients on their rights and obligations, and representing their interests during the dispute resolution process.

12. An Evolving Research Agenda

The implementation of smart contracts in the construction industry involves several legal challenges, including contractual obligations, enforceability, and dispute resolution.

To ensure the successful implementation of smart contracts in the construction industry, it is essential to have a clear understanding of the legal issues involved and to develop a research agenda to address these challenges.

This research agenda should focus on the following areas:

• Legal framework for smart contracts: A legal research agenda should focus on the creation of a framework for the implementation of smart contracts in the construction industry. This would include analysing the current legal landscape and determining what changes need to be made in order to facilitate the use of smart contracts.
• Contractual obligations and liabilities: Research would need to be conducted to understand the contractual obligations and liabilities that arise from the use of smart contracts in the construction industry. This includes considering issues such as dispute resolution and the enforceability of smart contracts.
• Interoperability and compatibility: Research would need to be conducted to ensure that smart contracts are compatible with existing construction industry standards and technologies. This would include investigating how smart contracts can be integrated into existing construction management systems and how they can interact with other technologies such as building information modelling (BIM).
• Security and privacy: The security and privacy of smart contracts must be a key research focus. This would include examining the risks of hacking, data breaches, and other security issues, and developing measures to mitigate these risks.
• Regulatory compliance: Research would need to be conducted to ensure that smart contracts comply with relevant regulations and standards, such as data protection and privacy laws, anti-money laundering regulations, and consumer protection laws.
• Economic impact: An economic research agenda should focus on understanding the potential impact of smart contracts on the construction industry. This would include examining the cost savings that can be achieved through the use of smart contracts, as well as the potential for increased efficiency and improved project outcomes.

The development of a research agenda is essential to ensure the successful implementation of smart contracts in the construction industry and to address the legal challenges that arise.

13. Conclusions

In conclusion, the implementation of smart contracts in the construction industry faces significant legal barriers that need to be overcome before they can be widely adopted.

These legal barriers include the enforceability of smart contracts, data protection and privacy, intellectual property rights, and dispute resolution. The absence of legal recognition and legal clarity in some jurisdictions, the vulnerability of smart contracts to data breaches and unauthorized access, and the complexity of dispute resolution in smart contracts are among the critical legal barriers that need to be addressed. However, despite these legal barriers, the potential benefits of smart contracts in the construction industry are significant.

Smart contracts have the potential to streamline the contracting process, reduce transaction costs, and improve transparency and trust among parties. It is, therefore, crucial for the construction industry to address these legal barriers and embrace the use of smart contracts.

The construction industry needs to work together with the legal profession and technology experts to develop a legal framework for the implementation of smart contracts. This legal framework should provide legal recognition for smart contracts, ensure the protection of personal data and intellectual property rights, and provide for effective dispute resolution mechanisms. By addressing these legal barriers, the construction industry will be well positioned to reap the benefits of smart contracts and remain competitive in the rapidly evolving digital landscape.

Additionally, the construction industry needs to adopt a proactive approach in addressing the legal barriers to smart contracts. This includes investing in research and development to improve the technology behind smart contracts and to address security and privacy concerns. Industry stakeholders should also engage in public education and awareness campaigns to inform the public about the benefits of smart contracts and to dispel misconceptions.

The legal barriers to the implementation of smart contracts in the construction industry are significant, but not insurmountable. With the right approach, these barriers can be overcome, and the construction industry can reap the benefits of smart contracts, such as reduced transaction costs, improved transparency and trust, and streamlined contracting processes.

By addressing these legal barriers, the construction industry will be better equipped to navigate the rapidly evolving digital landscape and remain competitive in the global marketplace.

The implementation of smart contracts in construction has the potential to revolutionize the industry by improving efficiency and reducing disputes. However, from a legal perspective, it is important to thoroughly research and understand the implications of using smart contracts in this sector. This includes analysing the enforceability of these contracts, the potential legal issues that may arise during their use, and determining the best approach for integrating them into existing legal frameworks. Such research is crucial for ensuring that the implementation of smart contracts in construction is carried out in a manner that is legally sound and protects the interests of all parties involved.