Law and Autonomous Systems Series: Smart consumer contracts - The end of civil procedure?
Today, consumers are provided with a vast array of mandatory consumer rights, ranging from statutory warranty and cancellation rights to claims for compensation in cases of impaired performance. However, the mere existence of these rights is of limited avail for consumers. Legal practice shows that there is a huge difference between having rights and enforcing them, especially in the field of consumer law. Most consumers either do not know their rights or, if they do, shy away from enforcing them. Thus, it is essentially only a few wealthy and well-educated consumers who make use of their rights. Meanwhile, the inactive majority incurs a loss through consumer rights as they – through the pricing mechanism – have to collectively pay for the claims of the active minority.
A significant enforcement gap
These challenges in enforcing consumer rights result in misguided incentives for businesses. For example, if businesses anticipate that only 10% of their customers will eventually enforce their rights, they have little reason to voluntarily meet those claims. Sure enough, in industries where there is real competition and companies are motivated to court potential customers’ favour, companies are likely to follow a full-service strategy and try to anticipate their customers’ every wish. However, in most cases, enforcement is dependent on the initiative of every single customer to request that her claims are met.
Take the example of passenger rights in rail traffic. In December 2009, European Regulation (EC) No 1371/2007 entered into force. It entitles rail passengers to compensation amounting to 25% of the ticket price for a one-hour delay and to a 50% refund for delays of two hours or more. There are some railway companies like the Spanish Renfe who, choosing to adopt a strict customer service strategy, voluntarily comply with this Regulation and sometimes even pay compensation far beyond their legal obligations. However, many other companies, like the German Deutsche Bahn, put obstacles in their customers’ way, for example, by requiring them to fill out a paper form and physically hand it in at a customer service centre, or send it via mail.
Against this background, the European Union has adopted a number of different instruments to try to ease rights enforcement for consumers. It has created a European small claims procedure, recommended EU Member States to introduce collective redress mechanisms and, more recently, a court-like system of consumer dispute resolution bodies in order to facilitate the out-of-court settlement of low-value consumer claims. Unfortunately, none of these efforts have been very effective as, despite being specially designed for consumers, all of those procedures eventually turned out to be far too complicated for the average consumer. Every single enforcement mechanism earned some moderate market share, but a huge enforcement gap remains.
Legal technology helps to enforce consumer claims
This unfortunate situation, however, began to change a couple of years ago. The wind of change is blowing from the shores of legal technology. Legal Tech companies collect consumer claims online, bundle them and use their collective bargaining power to enforce them. They often charge the consumer a moderate enforcement commission and, in turn, take away the burden of litigation effort and risk. Especially with regard to flight passenger compensation, the expansion of these companies has multiplied the rate of rights enforcement. The enforcement companies benefit from the straightforward legal prerequisites of European compensation rights, as well as from the fact that flight tracking data is freely accessible and generally fail-safe.
Now, even with the help of those Legal Tech companies, certain responsibilities still rest with the consumer. She still has to determine if she is entitled to claim a compensation, she needs to discover that companies exist that help with claim enforcement, she needs to enter her data into an online questionnaire and, eventually, she also needs to pay a commission to the company. In many cases, these enforcement costs are not prohibitive to making a claim. However, in just as many cases, one of those aspects will keep consumers from pursuing their claims. Thus, even with the help of Legal Tech companies, a considerable enforcement gap remains. In order to close this gap, the enforcement costs would have to be close to zero.
Smart contracts: zero enforcement costs
Precisely because they are self-enforcing, this is where smart contracts can play an important role. Parties that enter into smart contracts provide access to some of their assets. The contracts are then linked to an enforcement software that can execute transactions with the available assets as soon as an impairment of performance is detected. The more comprehensive the enforcement software, the greater the number of contractual disputes that can be automatically resolved without the parties having to lift a finger. The ideal here would be the economic concept of a complete contract, in which any potential future event is anticipated and ruled on in the contract. This is, of course, an unachievable goal. However, at least the legal effects of the most typical impairments of performance can be settled by a smart contract and transferred into software rules so that, at least in case of the most frequent events of default, these effects can be automatically triggered by the smart contract itself.
The idea of smart contracts was born as early as 1995. However, it has come into fruition only today, when the Internet of Things provides plenty of data which smart contracts can use to detect contractually relevant events. Sure enough, the challenge is to properly draft such a contract and to accurately translate its rules into the programming code of the enforcement software. If effectively translated, these efforts yield the considerable benefit of close to zero enforcement costs, at least for the most common types of contractual defaults.
This concept promises to be useful for any market player who concludes contracts on a large scale and is repeatedly faced with the same enforcement efforts. It would also be useful for consumers who, as we have seen before, usually back off from pursuing their rights as soon as they have to bear any enforcement costs. Indeed, some governments have recently started thinking about making smart contracts de rigueur for consumer commerce, especially because virtually every other enforcement mechanism attempted so far has failed. For example, the new German government formed in March 2018 refers to smart consumer contract enforcement in its legislative plans for the ongoing elective period.
What would smart consumer contracts, like the ones envisioned by the German government, look like in practice? A good example here is the enforcement of European passenger rights. For example, it would appear feasible to set up smart passenger contracts for railway traffic that automatically refund money to the customer as soon as a considerable delay of the booked train is detected. The Spanish concept already approximates this vision, but does not yet perfectly comply with it as refunds are not automatically issued.
Three important questions
At the same time, there will be a number of challenges to establishing smart contracts as a reliable consumer rights enforcement mechanism. The most pressing issues relate to the businesses that should (voluntarily or mandatorily) adopt smart consumer contracts, the reliability of the enforcement software and the systemic change that comes with leaving civil procedure behind.
Given that only a few companies would be willing to voluntarily install such a system, a nation that wants smart consumer contracts to be the norm may have to mandate their adoption by law or subsidize the critical software. As it is unrealistic to impose such an obligation on every business, the state will have to choose the right addressees of such an obligation. Beyond doubt, this is a (legally) tough choice. Should one begin with businesses of a certain size? Should the first be those who are wholly or partly under state ownership?
Aside from these considerations, smart contracts derive much of their credibility from being run on a blockchain, a distributed ledger that, due to its demand for energy, storage space, and interconnectedness, might not be technically ready to host a system that has to include thousands and thousands of customers. This might call for the enforcement software to be run on a classical, centralized data management system, hosted either by a neutral third party or by the business involved. In the latter case, where the software is controlled by the contractual party that owes the compensation due, additional safeguards are necessary to make sure that the software is not prejudiced in favour of this party. Thus, which authority should be mandated to check data quality and algorithmic integrity?
Last but not least, if the state obliges private businesses to meet private law claims, this obligation will be part of public economic law. This is remarkable because so far, every attempt to effectuate private law enforcement has been made through civil procedure. If the state starts to mandate smart contracts, does that mean that, at least for low value claims, civil procedure will fall into oblivion?
A short YouTube clip on this topic can be accessed here.
Martin Fries is a post-doc researcher at the Faculty of Law of the University of Munich (LMU).
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