Lawsuits are coming to NFTs. As both a litigator and member of the NFT community, this indisputable fact leaves me with mixed feelings. The NFT community is comprised of overwhelmingly positive people, far more likely to tweet out GM than start an internet fight (a rarity in the 2020s social media landscape). On the other hand, I love my job suing people and defending people being sued. The dichotomy of lawman.
But what about other forms of conflict resolution? Web3 smart contracts combined with an existing arbitration framework could create a solution to many disputes not just in Web3, but also in how business disputes are currently handled at large. This article will cover how existing arbitration/mediation clauses are implemented into commercial contracts, and how it could be implemented more efficiently into smart contracts.
Arbitration and Mediation Clauses in Contracts
Litigation is expensive. To take a matter to federal court and litigate it through trial generally requires each party spend ~$100,000 (minimum). State court, you are likely looking at around half that. Between attorneys fees, deposition costs, other discovery costs, and court fees, the charges quickly add up. This is exacerbated by the speed (or lack thereof) and rules of civil procedure which govern formal court proceedings. As they say, the wheel of justice turns slow, but grinds smooth.
In formal court proceedings, the governing rules are technically complex. Litigators need to obey the applicable federal or state rules, that court’s local rules, and often times additional rules individual judges have on certain issues. During this time, there is also quite a bit of motion practice done on discovery and other issues. And by “motion practice” I mean attorneys writing thoroughly cited dissertations back and forth which even the most longwinded philosophy PhDs would think is excessive wordsmithing. This takes attorney time, and attorney time costs money.
Before things get to that point, parties often place mediation provisions in their contracts. Mediation can be binding (i.e., what the mediator says goes); non-binding (i.e., a mediator will tell you what an impartial party thinks of the dispute, and you can do with that information as you will), or a combination of both (binding for minor or expected disputes, but non-binding for major disputes). There is a whole industry set up around mediation, with uniform rules and locations across the country. JAMS is a popular mediation service and many contractual mediation provisions require the mediator be JAMs certified.
The same mostly applies for arbitration. One difference being that AAA is the most commonly used provider. Another distinction is that arbitration is far more likely to be binding, and is treated more like a court case with arbitrator (judge) and a formal proceeding (trial). Mediation is typically more informal, takes place in conference rooms, and the mediator essentially plays a game of telephone, going back and forth to the parties’ separate conference rooms and trying to work out a deal to avoid costly litigation.
Both mediation and arbitration generally have less discovery and motion practice than formal court proceedings. The parties are told to put their cards on the table, and figure it out. Arbitrators and mediators are not shackled with the same procedural rules that federal and state court judges are, meaning they can create creative and effective solutions to disputes that judges cannot. Their decisions are also less easily appealed, meaning attorneys are not wasting time creating formal records which serve no purpose in the underlying proceeding but are only there as a CYA in case of appeal.
There are plenty of articles regarding the benefits and pitfalls of binding arbitration provisions in contracts. Just like most things, they can be put into contracts with pure intentions to save everybody involved time and money, or with nefarious intentions to prevent parties from seeking class relief or having their day in court. The above is just an exceedingly simplified explanation of what alternative dispute resolution is and how it works.
Web3 Alternative Dispute Resolution
I’ll be dropping an article soon on the importance of formal written contracts in NFT agreements. Keep on the lookout for that. Needless to say, right now entirely too much is done in Web3 on informal agreements. Whether it is a developer team on a new project trading NFTs with somebody on a discord server or going halfsies on an NFT buy with friends, people need to start using formal written contracts. When money is involved, things go wrong, people you thought you could trust get greedy, and the unexpected happens. The bigger the money, the more likely there is to be a dispute. Contracts save everybody time and expense if and when that dispute does happen. A well-written contract turns the uncertain into the certain, and creates a clear winner or loser to many potential disputes before those disputes ever arise.
However, even with the best written contracts, people will disagree on the meaning of terms or who is right or wrong in a given scenario. That is where litigation (or alternative dispute resolution like arbitration/mediation) steps in. However, with Web3 smart contracts and multi-signature wallets, there is a way to make binding decisions immediately payable to the winner as opposed to trying to collect against a sore loser (which can often be a difficult task).
Imagine there is a group of four friends that get together, buy a Bored Ape, and put it into a multi-sig wallet. The wallet is set up so if any 3 agree to sell, it can be sold, but what happens in the event of a deadlock? A 5th signature could be assigned which only comes into play in the event of a dispute. That could be a service (similar to JAMS or AAA) which specializes in Web3 issues. This could all be automated via smart contract, and the only time that service was paid would be in the event that third party is brought in to decide a dispute.
Where this gets even more interesting, is this can also be done in traditional contracts. Parties to an agreement set up a multi-sig wallet which is funded with USDC (or any other crypto) by those parties per their agreement. JAMS or AAA or some other dispute resolution service provider is assigned as a signatory. In the event of a dispute, the arbitrator or mediator has the power to sign over as much or as little of the funds from that wallet as they decide is equitable. It is a clean and simple solution to the problem of collecting against losing parties during contract disputes. It can be implemented in agreements regarding NFTs, or home remodeling contracts.
Just as there are burn wallets, I predict there will be wallets set up by trusted intermediaries which will act as the final decider in the event of disputes. Think how much better it would have been for the loopy donuts developers and community if that was agreed to beforehand? Whoever steps up to be the AAA or JAMS of Web3 has the opportunity to make buckets of cash and fulfill a role which is currently missing in the ecosystem.
There are going to be entire industries set up around NFTs which have nothing to do with the actual buying or sale of .jpgs. The dispute resolution industry is one I see coming soon to Web3, just as I see smart contracts coming soon to other forms of agreements. People need to be thinking about dispute resolution before disputes arise.
We are fast approaching a world where things we currently think of as uniquely Web3 (like smart contracts) or not Web3 (like formal contracts and T&C’s) are blended together and just become everyday features of society. There is a lot society can learn regarding the efficiencies of Web3 just as Web3 has a lot it can do to be more fair and accessible to its users. I think Brian Brooks said it best in his opening statement to the House Financial Services Committee:
“Shouldn’t we take seriously the possibility that algorithms and open source software that take a measure of human error, greed, negligence, fraud, and bias out of the system, might actually make the system better on net, even if there are some new risks presented that need to be understood and regulated?”YouTube Link to Speech
Wouldn’t it be nice to live in a world where there wouldn’t be scammers in your mentions any time you type “Metamask” on Twitter because there are protections in place which make those scams a thing of the past? Or where disputes among developers didn’t sink a project? I am certainly looking forward to that world.
If you have any questions, or would like me to cover anything in particular, reach out to me on either of my twitter pages. As always, I am an attorney, I am not your attorney. For legal advice, you should always consult (and pay for) an attorney.