Computable Contracts Explained – Part 1
I had the occasion to teach “Computable Contracts” to the Stanford Class on Legal Informatics recently. Although I have written about computable contracts here, I thought I’d explain the concept in a more accessible form.
I. Overview: What is a Computable Contract?
What is a Computable Contract? In brief, a computable contract is a contract that a computer can “understand.” In some instances, computable contracting enables a computer to automatically assess whether the terms of a contract have been met.
How can computers understand contracts? Here is the short answer (a more in-depth explanation appears below). First, the concept of a computer “understanding” a contract is largely a metaphor. The computer is not understanding the contract at the same deep conceptual or symbolic level as a literate person, but in a more limited sense. Contracting parties express their contract in the language of computers – data – which allows the computer to reliably identify the contract components and subjects. The parties also provide the computer with a series of rules that allow the computer to react in a sensible way that is consistent with the underlying meaning of the contractual promises.
Aren’t contracts complex, abstract, and executed in environments of legal and factual uncertainty? Some are, but some aren’t. The short answer here is that the contracts that are made computable don’t involve the abstract, difficult or relatively uncertain legal topics that tend to occupy lawyers. Rather (for the moment at least), computers are typically given contract terms and conditions with relatively well-defined subjects and determinable criteria that tend not to involve significant legal or factual uncertainty in the average case.
For this reason, there are limits to computable contracts: only small subsets of contracting scenarios can be made computable. However, it turns out that these contexts are economically significant. Not all contracts can be made computable, but importantly, some can.
Importance of Computable Contracts
There are a few reasons to pay attention to computable contracts. For one, they have been quietly appearing in many industries, from finance to e-commerce. Over the past 10 years, for instance, many modern contracts to purchase financial instruments (e.g. equities or derivatives) have transformed from traditional contracts, to electronic, “data-oriented” computable contracts. Were you to examine a typical contract to purchase a standardized financial instrument these days, you would find that it looked more like a computer database record (i.e. computer data), and less like lawyerly writing in a Microsoft Word document.
Computable contracts also have new properties that traditional, English-language, paper contracts do not have. I will describe this in more depth in the next post, but in short, computable contracts can serve as inputs to other computer systems. These other systems can take computable contracts and do useful analysis not readily done with traditional contracts. For instance, a risk management system at a financial firm can take computable contracts as direct inputs for analysis, because, unlike traditional English contracts, computable contracts are data objects themselves.
II. Computable Contracts in More Detail
Having had a brief overview of computable contracts, the next few parts will discuss computable contracts in more detail.
A. What is a Computable Contract?
To understand computable contracts, it is helpful to start with a simple definition of a contract generally.
A contract (roughly speaking) is a promise to do something in the future, usually according to some specified terms or conditions, with legal consequences if the promise is not performed. For example, “I promise to sell you 100 shares of Apple stock for $400 per share on January 10, 2015.”
A computable contract is a contract that has been deliberately expressed by the contracting parties in such a way that a computer can:
1) understand what the contract is about;
2) determine whether or not the contract’s promises have been complied with (in some cases).
How can a computer “understand” a contract, and how can compliance with legal obligations be “computed” electronically?
To comprehend this, it is crucial to first appreciate the particular problems that computable contracts were developed to address.