Intelligent Contracts—Is This the Way Forward for Enterprises?

Blockchains can be used for more than just bitcoin, but limitations on smart contracts mean they may not deliver all that is promised.

Technology is an ever-moving target. This can create a demanding work environment for law departments and corporate counsel, as every few weeks or months enterprises need to understand and account for new technologies changing the nature of their functions.

However, the benefits are that new opportunities to combine methods or technology occur almost daily. One such combination is so-called narrow artificial intelligence for contract detection and extraction of information held within physical contracts. This is brought together with “smart contracts,” the encoding and execution of contractual data and events on a programmable blockchain. It’s a technology solution that provides a public ledger of all the transactions on a network. A block is the “current” part of a blockchain that records some or all of the recent transactions, and once completed goes into the blockchain as a permanent database.

Blockchain’s current main usage is in connection with the electronic concurrency bitcoin. However this is not its only use. One of the main advantages of Blockchain is that it allows entities, people, companies, governments, etc. to store a record of events without requiring each entity to know or trust each other. One example of this is the witnessing of documents, which is when a third party is present to attest to another party’s signature (i.e., a trusted witness). With Blockchain, it is possible to remove the third party witness, due the to the trusted nature of the transaction, via consensus, and its immutable state on the chain.

However, smart contracts may not fully deliver on all that is promised to legal teams, as they face several technical limitations and challenges. The usefulness of the data or functions encoded, and how they get accurately encoded onto the smart contract, are often questioned. These doubts typically result from hacks, like the recent DAO hack. To some extent the risks have been mitigated. Microsoft, for example, provides off-chain code execution, and on-chip Enclaves (Intel) to perform the smart contracts’ execution. This is a better way by far to provide the smart contracts’ functionality, without the risk of further DAO-type hacks. But limitations still remain.

Intelligent Contracts

Intelligent contracts are (as the name suggests) far more intelligent and flexible than smart contracts, as they are currently defined. The intelligence comes from the ‘I’ in AI (artificial intelligence), where a system is taught to continually and consistently recognize and extract key information from contracts, with active learning based on users’ responses, both positive and negative, to the extractions and predictions made. This is very different from current smart contracts, but it still uses some of the underlying methods of blockchain and the extension to store immutable information or actionable events within a block. 

The Value of Intelligent Contracts

To help demonstrate the value of intelligent contracts, let’s take a sample customer of a large international company that has acquired different companies or business units over many years. Let’s say they have 15 different contracting solutions on both the buy and sell sides of their business, and in their legal teams, with no standard reporting on contracts. They continually sign master agreements in different locations or departments, and should allow all global entities access to discounts once negotiated levels are reached or exceeded. This is a very common challenge with larger organizations. 

You can immediately see where a “smart contract” could be used to encode the master agreement’s key performance indicators (KPIs) onto a blockchain, and then automatically apply the discounts across all departments. However, with all the different systems, and no single or consistent method to track and report on new contracts being created, signed or agreed to on (potentially) third-party paper, extracting the required information can be a challenge for legal teams.

Blockchain: The Single Source of the Truth

If we take this further, past just the encoding of actions, and the combination of parties and events, we can see how this solution provides organizations with a “single source of the truth” within contracts. As a contract placed onto the blockchain has been agreed to by both parties, why not share the same information between parties—as a single entity with continually updated contract terms?

Companies placing details of actual contracts onto a public blockchain might soon run into issues of security and scalability. Security because every person on the blockchain can see the transactions that occurred, and scalability because block size is limited on public blockchains for many reasons, not least of which is performance. With blockchain, the larger the blocks the longer it takes, and the more processing power is needed to reach “consensus” (e.g., the process used by a group of peers responsible for maintaining a distributed ledger to reach agreement on the ledger’s contents). To this end, it should be clear that a public blockchain or smart contracts system is unlikely to meet the requirements of many organizations for contracts.

Intelligent contracts, on the other hand, use private blockchains with algorithms to ensure no single system controls the creation of the blocks, leading to immutable and distributed consensus. As the chains are private, the issue with sizes of blocks is removed, and security can be implemented at many different layers, including HASH-only and PKI key-level security for access to information encoded on the blockchain. The use of the private blockchain also allows for the system to provide know your customer (KYC) functions, as each entity within the system would be required to be known as they are a party to, or have an interest in, a contract. They can all participate in the creation of the blocks as each entity is known and trusted.

With the differences outlined above, it’s clear to see the value intelligent contracts provide to enterprises.

Intelligent Contracts: The User Experience

One of the most important aspects of technology is to make users’ daily lives simpler, and the operation and adoption of new technology as seamless as possible. One of the best ways I have found to do this, over years of working with enterprise customers, is to embed new functions into well-known existing applications or processes so users are actually unaware of the new processes and functions taking place behind the scenes. 

In the example above, I described a large company with many different contract repositories and processes across its business functions and lines of businesses. But there are many other types of use cases for intelligent contracts, where the capabilities of this new technology will provide significant value over what is currently available for in-house counsel. These include M&A and business restructuring, contract life cycle management (CLM) and regulatory compliance.

Intelligent Contracts in M&A

When ownership of an organization changes, the contracts associated with that business are divested or acquired within those transactions, and can greatly affect the accretive nature or overall outcome of the transaction. In M&A, organizations (often the in-house legal teams) need to review contracts and analyze their metadata in the due diligence phase, to ensure they know what they are buying, and then integrate contracts into the new organization post-transaction. With divestitures, they need to know which entities to assign the appropriate contracts to. 

With intelligent contracts, legal teams can immediately locate all relevant contracts as they will be in one repository. All the metadata will be associated as blocks on the relevant chains, and so full reviews will be fast and simple, in due diligence and post-transaction. For example, special indemnifications and assignment and termination rules will be identified immediately across the entire portfolio, and will be relevant to valuation. The current “deal room,” where limited subsets of contract documents are placed for manual reviews across multiple legal professionals, will no longer be needed, significantly reducing time and cost. The deep analytics embedded in intelligent contracts will mean that M&A and legal professionals can immediately, and visually, capture all types of metrics and analytics across entire contract portfolios.

Contract Life Cycle Management

A challenge often found with contract life cycle management is system ROI (return on investment), which has been elusive for most customers. The systems are heavy in workflow and document library services, and are very light in contract data management. They have proven to be overly complex, tough to implement and suffer from low adoption rates and usage with knowledge workers. They also have poor change management functionality, and the data management is primarily manual input of contract data by users, which is inconsistent and error-prone. 

Intelligent contracts will be authored in the familiar Microsoft Word user interface, and collaboration and negotiation is facilitated via workflow in the blockchain.

Contract data is captured and shared automatically on the chain, and there is never any question or confusion as to which versions and edits are being used and approved, and why. Changes can be initiated and processed in the line of business (LOB) via Word using approved language. This means that legal operations resources are used more efficiently and cost-effectively. The result is a lean, efficient, secure and scalable contracting system that finally delivers the ROI desired for contract automation. 

Regulatory Compliance 

The final user case is in regulatory compliance. With intelligent contracts, when a regulation changes, all contract data is automatically captured and presented visually, so organizations understand the size and nature of the impact of the new regulation to their business. Compliance owners can determine strategies and project plans to meet deadlines. 

When contract repapering or renegotiation is needed to achieve compliance, the business owner can initiate the process in MS Word and, using approved language, make the needed changes. Those changes are captured on the blockchain, and then can be routed to legal operations resources for final approval. This is more efficient than using legal operations resources throughout the entire process. The blockchain is available to all relevant parties, so contract changes are permanent, transparent and auditable.  

Conclusion

Technological advances through intelligent contracts empower legal teams and business users, automating much of the data review and management work, and allowing lawyers to focus on higher-value activities and decision-making. Intelligent contracts also put more capabilities in the hands of business users, allowing legal operations to use their resources more efficiently. The result overall is that organizations better reduce risk, achieve compliance, improve efficiencies and ultimately enable higher performance. 

Originally published on Corporate Counsel. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

Contributing Author

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Kevin Gidney

Kevin Gidney is the founder and chief technical officer of Seal Software Ltd.

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