Finance & Banking

SMART CONTRACTS ISLAMIC JURISPRUDENCE STANDPOINT MIAN NAZIR CHIEF EXECUTIVE OFFICER, DAR AL SHARIA

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
compatibility 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.

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 ledger5. 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-Adliyyah7) 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 suffice9. 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:

(a) Parties to a contract (sqidaan)
(b) Offer and acceptance (sigha)
(c) 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 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
codes 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 alru’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:

  1. 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 terms15.
  2. 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-alada) 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 others.
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 contract.
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 the 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 requirement. 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 time 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
contract 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 (ahliyyahal-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. 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:

  1. 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.
  2. 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 Jurisprudence. 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’acompliance, 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 straight
forward.
• 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 hightech 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 takeup some of the issues highlighted above as a matter of priority on a proactive basis.

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