Blockchain and smart contracts: how does it work in the oil and gas sector?
Tags: Finance, Gas, Smart Contracts, Blockchain, Oil

M. Lang and M. Müller, in relation to energy, ask the question whether smart contracts are contracts in the legal sense, or are they automated computer protocols that fulfill the obligations contained in this contract, based on the conditions stipulated in it and agreed outside computer code. While the answer to the question will depend on the jurisdiction concerned, even if smart contracts do not qualify as contracts by themselves, there is no doubt that classical contract law applies to the underlying transaction and that smart contracts expressed in computer code should comply with certain applicable law.

Without interfering with the debate about the legal nature of smart contracts, the following should be considered for conflict of laws purposes. The use of computer algorithms does not create a new contract. This is purely a matter of the form of the deal. The parties conclude a cross-border oil and gas deal in the traditional form, where part of the obligations that can be automated is written in a programming language. Some experts believe that we are talking about “an element of the contract, which is concluded in electronic form with automated execution of the obligation arisen using a computer program.” In their opinion, “the essential characteristics of such agreements are reduced to their electronic form, as well as to the automated fulfillment of obligations under them by performing digital transactions in the sequence specified by the relevant agreements and upon the occurrence of appropriate circumstances (predetermined transaction parameters).”

Determining the applicable law in cross-border oil and gas transactions presents a certain difficulty. The use of blockchain platforms and smart contracts in this case leads to an aggravation of the collision problem. The reasons seem to be as follows.

First, the lack of a wide range of unified material and legal sources makes the collision method of regulating cross-border oil and gas transactions actually dominant.

The question of the application of the 1980 Vienna Convention to contracts for the international sale of hydrocarbons is still being resolved ambiguously. If by virtue of clause f of Art. 2 electricity is directly excluded from the scope of the Convention, there is uncertainty with regard to oil and gas. According to A.V. Asoskova, the Vienna Convention of 1980 still applies to energy trade. This should be accepted, given the absence of an explicit prohibition in the Convention. This view is sometimes shared by national courts**. The 1994 Energy Charter Treaty and bilateral international treaties on the encouragement and protection of foreign investment, often applied to cross-border oil and gas transactions, are investment instruments that limit their scope to a state-foreign investor relationship.

** The Austrian Supreme Court, by decision in case 10Ob518 / 95 (Propane case) of February 6, 1996, recognized natural gas as a material thing within the meaning of the Vienna Convention of 1980, regardless of its state — liquid or gaseous.

Second, the unprecedented growth of sources of non-state regulation and the broadly interpreted concept of “rules of law” forces us to look at the lex voluntatis principle in private international law in a new way. The autonomous “transnational oil and gas law” — lex petrolea, is spreading, based on the philosophy of legal pluralism, according to which qualification as “applicable law” does not depend on its authorization by the state, but on whether it has been approved by the professional community in a particular sector of the economy. Risks of a conflict of law and “wrong” are increasing.

Thirdly, the very existence of smart contracts and blockchain technology catches lawyers by surprise, creating uncertainty about applicable law and conflict of laws regulation. The latter needs some comments.

III. Reflections on the law applicable to smart contracts

For centuries, philosophers, economists, and lawyers have sought an answer to the question of how people can trade with each other regardless of national laws and government control. In recent years, the discussion has been fueled by the digitalization phenomenon, in particular the emergence of blockchain and smart contracts. Initial hopes that smart contracts would free the exchange of goods and services from national laws did not seem to materialize. Classic contract law not only has not outlived its usefulness but also continues to actively develop in new conditions. Like all other contracts, smart contracts require the law to react to them. Thus, the decisive question is not whether smart contracts are subject to the law, but which law they are subject to.

To date, the states of Delaware, Arizona, Nebraska, Tennessee, Wyoming, Illinois, and California have adopted special legislation to recognize the legal consequences of smart contracts. These states recognize automated smart contracts even if they are not matched by a traditional written contract. Thus, the parties can be confident that their transaction will be valid if they choose the law of any jurisdiction that recognizes the legal consequences of smart contracts as the applicable law. However, one should bear in mind the general rule of US conflicts of law, according to which the autonomy of the will of the parties is limited by the law of the state having a “substantial connection” with the contract (§ 187 Restatement (Second) of Conflict of Laws).

In the European Union, the law applicable to contractual obligations is determined, as is known, in accordance with the Rome I Regulation. By virtue of Art. 1, this Regulation applies in situations of conflict of law to contractual obligations in the civil and commercial fields. As a consequence, there can be no doubt that the scope of its application also encompasses smart contracts. However, subject to one important caveat: the Rome I Regulation applies to contractual obligations in the legal sense. A smart contract, as noted earlier, is a piece of software code that can be reduced to a form that automates the fulfillment of obligations. From this, we can conclude that the provisions of the Rome I Regulation do not apply to the smart contract as such, but only to the contract that it helps to execute (to the main transaction). However, the direct application of the Regulation to a smart contract will be possible if it is legally valid under applicable law (for example, the law of the states of Delaware or Nebraska). Thus, a smart contract operating in a virtual and decentralized environment is “legalized” due to the autonomy of the will of the parties (Article 3 of the Rome I Regulation), which provides much-needed legal certainty. The final opinion on this issue could be formulated by the Court of Justice of the European Union, but so far this has not been done.

If the parties have not chosen the applicable law, the judges or arbitrators will do so on the basis of Art. 4 of the Rome I Regulation. In this case, it is of paramount importance to answer the question of what kind of transaction is executed using a smart contract (clauses “a” — “h”, paragraph 1, article 4 of the Rome I Regulation). The choice of law governing a smart contract should take into account the form and substance of the underlying transaction, its business case, technical complexity, number of participants, and jurisdictional coverage. If the contract does not fall within the scope of § 1, then a conflict of laws binding about the right of the party performing the performance that is decisive for the contract is included. Finally, if the applicable law cannot be determined taking into account the above rules, then the contract is governed by the law determined by the principle of closest connection (§ 4 Article 4 of the Rome I Regulation).

There are some general factors that judges and arbitrators take into account when determining the law that is most closely related to a cross-border oil and gas transaction (most often it is in the nature of a mixed contract). These include the place of conclusion of the contract; place of negotiations; location of a natural resource or oil and gas reservoir that is the subject of the contract; place of residence of the parties; location of the insurer; the language of the contract; the law governing any related relationship; the form of the transaction and the legal concepts that make up the contract; the currency used for contractual obligations.

To solve the conflict problem, it is proposed to use the theory of splitting the contractual statute (Dépeçage).

With regard to cross-border oil and gas transactions, characterized by a complex structure, when one applicable law cannot cover all the constituent parts of one contract, the use of Dépeçage is updated. One such transaction can be divided into parts for operation, design, construction, installation, international transport, insurance, dispute resolution, safety, and environmental aspects. Despite their logical separability, they must work as a single organism for the contract to be effective. Subordination of parts of such a transaction to different legal orders simplifies its execution, which is in the interests of the parties.

In addition, in cross-border oil and gas transactions, clauses regarding the implementation of “good practice in the development of oil and gas fields”, “best practice”, “best international practice”, “leading practice of the oil industry”, etc. are spreading. These provisions can be seen as a practical embodiment of the Dépeçage theory. In other words, the principles of “good oilfield practice”, which are widely used by multinational oil and gas companies, will apply to the relevant parts of the contract, while the main applicable law will govern the rest of the contract.

In conclusion, it should be noted that the existing conflict of laws regulation is quite applicable to smart contracts executing cross-border oil and gas transactions. The question is whether the law, applicable by virtue of a conflict of laws rule, offers a suitable legal basis for smart contracts. In the future, parties will increasingly use autonomy of will (lex voluntatis) to choose jurisdictions with developed legislation. As G. Ruehl correctly notes, in the long term, private international law will not only determine the law applicable to smart contracts, and thereby contribute to legal certainty, but also demonstrate which law is best suited to solve digitalization problems from the point of view of the parties.

This, in turn, will affect the processes of harmonization and reform of national law, which will lead to improved legislation for smart contracts in different countries.