Lori Wisniewski Azzara and Nicholas M Bencsics | Cohen Seglias Pallas Greenhall & Furman
As the construction industry operates within the digital era, the complexity of the sector continues to evolve. Because there are various parties and stakeholders involved on a construction project, there are competing interests with the same goal of pushing risk onto others. This risk-shifting mentality has driven innovation and created new methods of safeguarding interests over time. One concept that is gaining popularity throughout the construction industry is the use of blockchain and smart contracts. Never heard of it? Read on so that you are prepared when it is presented to you as an option for your next project.
What is Blockchain?
“Blockchain” is often associated with cryptocurrency and is the underlying technology that allows Bitcoin and other cryptocurrencies to exist. It is a technology that allows for a shared ledger that records and tracks assets across networks—essentially, Bitcoin and other cryptocurrencies are recorded along a blockchain. However, the unique benefits of blockchain technology, namely, safety, security, and efficiency, allow it to accomplish far more than a traditional ledger or document. As a result, blockchain provides a host of benefits that can propel the construction industry forward.
Initially, blockchain provided security and constant authentication of transactions. This, coupled with its “proof-of-work” technology, prevented possible losses resulting from fraud or embezzlement. Further, while traditional ledger systems were subject to cyber-attacks, blockchain’s distributed ledger technology allows each party to hold a copy of the original chain so that the system remains even if large databases along the system fail. Blockchain’s proof-of-work technology and its decentralized location make fraudulent modifications a virtual impossibility.
The efficiency of blockchain technology accelerates transactions. It removes traditional methods of facilitation, verification and enforcement, as such conditions are automatically checked and executed. The resulting algorithmic technology is particularly beneficial to those industries that frequently deal in trades and contracting because it executes conditions in a real-time “if X then Y” format. For these reasons, blockchain technology serves as the foundation for smart contracts.
Blockchain and Smart Contracts
While blockchain is generally associated with cryptocurrency, other uses have emerged in recent years, including smart contracts. With the use of blockchain technology, parties can transfer digital assets according to pre-specified contractual conditions, resulting in a real application of the “if X then Y” format for contract implementation. As the underlying technologies continue to improve and evolve, smart contracts have gone beyond simply a self-implementing contract and now encompass other functionality such as compliance checking, supply chain tracing, and providing a shared space between parties for common data viewing.
The automatic verification and enforcement technologies within blockchain allow for a self-executing agreement. Beyond the traditional contractual provisions, smart contract algorithms are recorded along the blockchain with the consent of the contracting parties. As specific conditions or events occur, the smart contract automatically enforces the terms, thereby preventing parties from wrongfully failing or refusing to fulfill their end of the bargain.
Smart legal contracts work on three core features:
- The contract is legally enforceable within the relevant jurisdiction;
- At least some of the obligations are performed automatically via algorithm; and
- The contract exists on blockchain.
The security and efficiency of blockchain technology complement other benefits of utilizing a smart contract. The autonomy of such contracts allows for cost savings on intermediaries, such as processing payment of insurance claims to escrow. The accuracy of self-executing technology circumvents the risk of errors in manually completed documents. Documents and records are saved and available to all parties in real-time, which minimizes claims and disputes, as transparency of cost, time, and scope of the project are updated.
Smart Contracts in the Construction Industry
Disputes are inevitable in the construction industry, and the terms of the contract are often at issue. Smart contracts and their underlying technology aim to avoid these disputes in a variety of ways throughout a project’s duration. Many of the following benefits are subject to pitfalls, especially in the short term. However, as technology improves, the creative solutions to everyday problems are endless.
In the age of seemingly constant supply chain delays, blockchain technology and smart contracts offer a potential reprieve. Have any of your projects been impacted due to a delay in ordering material? With smart contracting, applications operating from sensors, scales and cameras at a jobsite can collect information and monitor material supply levels. Terms within a smart contract can be automatically triggered when inventory dips below a specified level, suppliers are automatically contracted and an order is placed. This ensures that materials are ordered in a timely manner and notifies all parties of the delivery date. Unfortunately, many issues plaguing businesses today, such as improper use of or theft of materials, still remain notwithstanding this available technology.
Have any of your payments been delayed because of missing documentation or a failure of a party to process a payment application? With smart contracts, as inspections and walkthroughs occur, payments can be triggered and processed automatically. While this will increase efficiency, there are concerns regarding automatic payments in the event of later discovered defects. Such issues will necessarily require additional conditions within the smart contract and may unfortunately raise the potential for litigation before such systems are normalized.
As conditions along the blockchain of the smart contract are triggered, the contract will remain an open and consistent record for contractors, subcontractors, and owners to review and constantly evaluate project progress from the same viewpoint. This transparency reduces the potential for disputes at each phase of the project. For example, as designs are formulated and updated, all parties access changes in real time, allowing for prices and scope to be adjusted accordingly. In the tendering, bidding and contracting phase, parties can easily exchange revisions to documents and more efficiently negotiate terms. During construction, labor information can be stored and reviewed for accountability, allowing for the potential of authentication by all parties of e-verify and other required standards. Lastly, the demolition stage can benefit from the ability to track waste generation and elimination in real-time.
Potential Pitfalls
Smart contracts and the technology behind them continue to improve at a significant rate; however, there remain many issues with smart contracts. The technology is still relatively new, and users must become familiar with and understand its basics before effectively negotiating and implementing such contracts. Users must understand which terms are suitable for automation and which are not. Further, while a significant benefit of blockchain technology and smart contracts is the reduction of human error, the blockchain technology itself is still, relatively speaking, in a state of infancy, resulting in potential conflicts. Because the execution of events when certain contract conditions are met is irreversible, incorrect terms encoded within the blockchain have the potential to cause significant headaches and financial losses.
Additionally, while the automatic enforcement nature of smart contracts provides benefits, there are drawbacks. The modification process remains in development and can be challenging once the contract is set into motion. Further, while many disputes can be avoided at the onset of a project, a party’s ability to act or withhold payment for what they believe to be genuine issues can be at risk.
If your company is considering using smart contracts, human oversight to double-check all information remains a necessity. It is critical to note that while certain human involvement can be circumvented, the streamlined process does not replace employees; instead, the technology assists employees in accomplishing tasks more efficiently. For now, experienced administrators remain necessary to ensure the process and application is running as intended.
The absence of laws across states directly addressing smart contracts is a drawback. As legislation is slow to keep pace with technology, many states fail to address smart contracts at all. Some states, like Ohio, dipped its toe in the water by taking narrow measures, such as giving legal recognition to electronic records and signatures secured through blockchain technology. Other states, like Wyoming, are leading the way with a host of laws formalizing digital assets and securities and directly defining and addressing smart contracts and how they may control and transfer data. As with any contract, it is important to confirm and understand your state’s laws regarding smart contracts before proceeding.
Conclusion
Blockchain technology and smart contracts continue to evolve daily. The real-time updates and information availability of smart contracts follow the trend of having instant access to information. While it may not be a prudent time for your company to implement smart contracts into its daily business, that day will come eventually. Until then, the attorneys at Cohen Seglias will continue to follow the evolution of smart contracts and will be ready to assist on future projects.
When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 888.684.8305, or email experts@adviseandconsult.net.