Blockchain Technology in the Practice of Law and Insurance

The potential and actual application of blockchain technology in the legal and insurance industries, as well as best practice tips and areas for future focus for attorneys as the technology expends, served as a topic for panelists at the ABA’s Fall 2018 Legal Malpractice Conference in Las Vegas.

The panel made plain that the use of blockchain technology in these fields is now a reality.

The panel included Susan Joseph, the founder and CEO of Susan Joseph LLC, Bonnie Thompson, an associate at Wiley Rein LLP, Jolene Negre, a partner at Jenner & Block, and was moderated by Reshma Kamath, the 2017-2018 Fellow at the ABA Center of Innovation. The panel began with a primer regarding the beneficial aspects of blockchain technology that have continued to fuel the desire to harness the benefits of the potentially transformative and disruptive technology.

Blockchain technology, first seen in action as the driving force behind Bitcoin, generally refers to an open distributed ledger maintained by networked computers and linked through cryptography. Blockchain technology makes use of the various networked computers (“nodes”) participating in the chain to record and validate transactions. Because the “blocks” on the blockchain are linked and the data is decentralized, information stored on the blockchain is extremely resistant to manipulation—changing one block in the chain would require changing all subsequent blocks as well. This resistance to manipulation or alteration means that blockchain technology offers transparency, security, and the opportunity to reduce administrative costs through self-authentication procedures.

The panel then addressed two applications of blockchain: cryptocurrency and smart contracts. The panel also touched upon other notable legal questions and quandaries that arise from the use of blockchain: jurisdictional and choice-of-law issues and antitrust and anticompetitive concerns.

Recurring Areas of Interest

Cryptocurrency has, to date, been the primary outlet for blockchain, as the distributed open ledger is critical to the functioning of cryptocurrency and the use of a built-in reward system, through the mining of cryptocurrency, has provided the necessary incentive to introduce sufficient computing capacity to power a blockchain.

In particular, Ms. Negre discussed some of the latest developments with respect to the regulation of cryptocurrency, a keen area of interest for attorneys representing companies interested in marketing or investing in cryptocurrency. The proper characterization of cryptocurrency—i.e., whether it is an asset or a security—remains a hot-button issue with the regulatory agencies. There is continuing confusion on this front, with different regulatory agencies offering competing views. The Internal Revenue Service, for instance, tends to view cryptocurrency as property, rather than currency, and the Securities and Exchange Commission has become more aggressive in policing cryptocurrency as a security with the advent of initial coin offerings (“ICOs”).

Ms. Negre noted that although some cryptocurrency, such as Bitcoin, does not seem to share some of the quintessential characteristics of a security, many ICOs appear likely to qualify as securities. The benchmark remains whether the transaction qualifies as an investment contract under the Howey test first announced by the Supreme Court in SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

Consequently, attorneys advising companies that may be considering issuing, marketing, selling, or investing cryptocurrency through an ICO should be cognizant of the potential applicability of federal and/or Blue Sky securities laws to the transaction. These rules can create unexpected exposure for material misrepresentations (for instance, SEC Rule 10b-5) and could require the registration of securities or, alternatively, a potential seller to seek to qualify for an exemption for the sale of securities.

The potential application of these rules poses a dual risk for attorneys, raising the specter of potential claims of negligence from a client sued for failing to comply with securities laws as well as the possibility for an aiding and abetting claim against an attorney by an aggrieved investor. Of course, even where securities laws do not apply, other theories of liability, like common law fraud or consumer protection statutes, may remain applicable. An attorney should remain mindful of such if involved in the marketing or sale of cryptocurrency, particularly as many people may not fully understand the technology.

Furthermore, attorneys may need to educate themselves about cryptocurrency in the event a client wishes to transact with an attorney in cryptocurrency. The panel discussed an opinion published by the Nebraska Lawyers’ Advisory Committee regarding whether an attorney could receive and accept cryptocurrency as payment for legal services. See Neb. Ethics Adv. Op. 17-03.

The opinion concluded that attorneys could accept cryptocurrency as payment, but that Nebraska’s rules of professional conduct required an attorney to immediately convert the cryptocurrency into U.S. Dollars. It seems likely that similar ethics opinions will ultimately be forthcoming in other jurisdictions as well, as dealing in cryptocurrency raises potential issues such as the reasonableness of fees and preserving attorney-client confidentiality.

Smart Contracts Provide New Opportunities (And New Risks)

The panel then turned to “smart” contracts, a potential application for blockchain technology which would employ blockchain’s information-storing and self-authenticating features. A smart contract is essentially a self-executing contract keyed to a quantitative event. In a smart contract, the terms have been coded into the blockchain so that when a condition for performance is satisfied, the performance is delivered automatically.

The panel noted that smart contracts are presently most suitable for simple transactions where an “if-then” parameter can be programmed (i.e., if product is delivered, then payment is made). Smart contracts help reduce transactional costs through automation and reliance on blockchain’s security and validation processes. As the panel noted, the notion of using smart contracts is steadily growing, with states such as Tennessee and Arizona already passing legislation recognizing smart contracts.

The panel described how smart contracts present an opportunity for transactional attorneys to grow their business, as smart contracts will require attorneys to help prepare the contractual language in a manner that allows it to be converted to the code that will ultimately drive the smart contract. As the use of smart contracts increase, the need for attorneys to develop ways to translate contractual terms and conditions into code will likewise increase.

These increased opportunities, though, come with interesting questions about an attorney’s requisite level of expertise in the area, as well as the potential for increased risk and exposure. For instance, Model Rule of Professional Conduct 1.1 requires that an attorney provide “competent representation,” which requires “the legal knowledge, skill, thoroughness and preparation reasonably necessary for the representation.”

So, does this require an attorney preparing contractual terms to be coded have expertise in coding? The panel opined that expertise is probably not necessary—lawyers will not also have to be software engineers—but an understanding of coding or, at the very minimum, careful vetting of the engineers employed to build out the code would likely be prudent for an attorney participating in the preparation of the coding of a smart contract.

Indeed, the nature of the blockchain means that a mistake in coding a smart contract could pose serious problems. As the smart contract is meant to be self-executing, an error with the parameters and conditions meant to trigger performance could result in a major mistake that could become quite difficult to correct. Attorneys involved in the preparation of the code that will power a smart contract should understand this risk, and probably need to ensure that clients fully understand the nature of a smart contract.

Ms. Joseph discussed recent developments relating to the adoption of blockchain technology by Blockchain Insurance Industry Initiative (“B3i”), a collaborative effort by insurers and reinsurers to implement smart contracts into the claims handling and risk management fields. Ms. Joseph described B3i’s adoption of the R3 Corda platform, also used in the financial sector, for its products. B3i’s has worked to develop and implement products aimed at automating processes associated with reinsurance for catastrophic events, and provides a concrete example regarding the application of this emerging technology.

Jurisdiction and Choice-Of-Law Questions Persist

As to the questions of jurisdiction and choice-of-law, the decentralization which makes a distributed open ledger so attractive also means that a blockchain may be built on nodes in numerous jurisdictions, each of which may have their own local laws and regulations. This begs the question of what law will apply if something goes awry, such as with a smart contract.

It also raises interesting concerns with respect to data privacy. Ms. Thompson mentioned that one of the blockchain’s key components—the security and therefore permanence of the data recorded on the chain—raises interesting questions given recent legislation aimed at protecting data privacy rights. There is, of course, the European Union’s General Data Protection Regulation (“GDPR”) to note, but Ms. Thompson also noted that California recently followed the GDPR in recognizing a right to erasure. The interplay between these privacy rights and the type of data hosted by a blockchain warrants consideration by an attorney counseling or considering the use of the technology.

Antitrust Issues

The panel also mentioned the antitrust issues that may be lurking in the implementation of blockchain products. A reality of the blockchain is that applying it to a certain industry or sector would require a substantial amount of resources and buy-in from a particularly industry.

A particular industry’s establishment of a blockchain-related product carries concerns about consortiums and the potential exclusion of market entrants. Furthermore, the existence of a blockchain may raise price-fixing concerns given the control and advantages that may flow to entities part of any such blockchain effort.

Conclusion

The panel concluded by noting that with blockchain’s emergence as a reality, there is a definite need to involve and educate regulators about these issues. The manner in which regulatory agencies weigh in on these issues—e.g., jurisdiction and choice of law, antitrust, and securities questions—will no doubt bear upon the growth of the industry and the obligations and responsibilities of attorneys counseling clients in the arena. The close monitoring of regulatory developments and, where possible, participation in the dialogue with regulatory agencies regarding blockchain therefore should remain a focus for attorneys moving forward.