Smart contract blockchain leases: vital and tricky

Smart contract leases are an important use case for distributed ledger, blockchain and internet-of-things business. It’s important that companies considering leases in blockchain commerce understand the legal context of their use cases so that in the event of a smart contract failure they may better control their fates.

Leasing is a vital economic function that allows assets to move and grow. It is also a complex body of commercial law, as courts have struggled with documents called leases that function as contracts for sale of goods. The distinction between a lease and a sale financed by a secured transaction matters. Creditors’ rights to payment for nonconforming goods, liability for maintenance of collateral and priority in bankruptcy are materially different in leases and sales. Distinct too are finance leases, held by third parties that purchase and lease collateral purely as a financial accommodation to lessees who use the collateral.

Courts are clear that the parties’ label of the transaction does not control the law. It’s the function of the contract that controls its treatment. This “function over form” approach is one of the reasons leases are commons subjects of litigation. In the U.S., uncertainty in leasing litigation prompted creation of Uniform Commercial Code (UCC) Article 2A to cover leases, a fork of Article 2, Sales. Many countries have analogous leasing rules. UNIDROIT, model international code, crystallizes functional leasing practices in plain language, allowing international lessors and lessees a reliable opt-in legal framework.

From a lawyer’s standpoint, leases are best created for specific client use cases because each relationship is different. Parties get creative with their commercial relationships, especially in leasing. By drafting a lease with no planned use, we limit our ability to foresee what might happen because of the specific nature of the deal at hand and prepare accordingly. This is a problem in all form contracts, but leases are officially tricky.

First question in drafting a smart contract lease: how do you want to use it?