Smart contracts and the "internet of things" can revolutionise the handling of disputes relating to goods in transit.

Around 90% of world trade is carried by sea. International law governing the carriage of goods has evolved over centuries. Today, international treaties, conventions, the common law and national statutes all play a part. Whilst their application and nuances have been explored by courts and tribunals around the world, issues of legal principle, as well as of commercial, practical significance remain unresolved.

A recent decision of the English Court of Appeal suggests that those areas of doubt and controversy are also areas of significant opportunity for "smart contracts" and the "internet of things" (IoT).

Shifting burden of proof

In Volcafe v CSAV [2016] EWCA Civ 1103 the Court of Appeal considered where the burden of proof lies when cargo is damaged in transit. The cargo in question comprised 20 unventilated containers each holding 275 hessian 70kg bags of Columbian coffee. On shipment, the goods were in good order and condition. On outturn, the coffee in the majority of containers had suffered condensation damage. All parties were aware that coffee is susceptible to condensation damage, so the key question was whether the carrier could be held liable for the damage.

The Court of Appeal clarified the relationship between common law and the Hague Rules.

Article III rule (2) of the Hague Rules provides that the carrier must "properly and carefully load, handle, stow, carry, keep, care for and discharge the goods carried". This obligation is subject to exceptions set out in Article IV. One such exception is if damage arises from an "inherent defect, quality or vice" of the goods (Article IV rule (2)(m)).

The Claimant argued that mere delivery of damaged goods creates an inference that the carrier is in breach of its obligation to properly care for the goods and that it is then for the carrier to prove it was not negligent or that one of the Article IV exceptions applies.

The Court of Appeal held otherwise, stating that it was:

  • for the claimant to show that the goods had been damaged
  • for the carrier to show, prima facie, that an exception such as "inherent vice" applied
  • for the claimant to prove, on balance of probabilities, that the exception should not apply due to negligence on the part of the carrier.

This shifting of the burden of proof was favoured by the Court of Appeal as being consistent with the weight of authorities and with the principle that "he who alleges must prove".

The evidential gap

The dispute in Volcafe involved a relatively small amount of money ($62,500), far less than the cost of litigation, and just 2.6% of the total value of the consignments. The parties and their underwriters seem to have regarded the matter as a test case to resolve historic legal uncertainty. This suggests the allocation of loss where perishable cargoes are damaged in transit, whilst individually low value, is a sufficiently widespread problem to justify the litigation.

The significance of where the burden of proof lies in these circumstances is practical. Claimants have access to only limited evidence as to shipment conditions. They rely on the bill of lading as to the condition of the goods at the time of loading and on the physical condition on arrival, if any formal survey is undertaken.

Whilst minor damage to coffee in bags carried in unventilated containers was, according to the Court of Appeal inevitable, the expert evidence in Volcafe was that underwriters only consider it cost-effective to conduct a physical survey of containers if at least a third of the cargo is found, on outturn, to have been damaged.

When a physical survey is carried out, as it was in Volcafe, survey evidence is not conclusive as to the cause of the damage. In Volcafe, evidence included photographs of questionable quality and some sketchy oral evidence. Relying on recent Supreme Court guidance , the Court of Appeal considered it permissible to overturn several findings of fact made by the High Court judge. Those findings included critical points such as the quality and number of layers of kraft paper used to line the containers to absorb moisture and protect the cargo. Overturning those findings allowed the Court of Appeal to reverse the ruling on liability, allowing the carrier to rely on the defences that had been rejected in the initial ruling.

With access to little definitive evidence, it is unlikely that claimants would in most cases be able to justify the costs and uncertainty of a claim. IoT could help plug this evidential gap.

How can IoT help?

In October 2016, eighty-eight bales of cotton were traded and shipped using a blockchain-based smart contract. A GPS device is tracking the geographic location of the goods in transit; on arrival at the final destination the smart contract will automatically trigger the release of funds.

Equipping containers with IoT sensors allows the real-time collection and transmission of data concerning not just geographic location, speed and direction of travel but also internal conditions of the container. Analysis of that data – including, critically, moisture levels – would allow a reasonably accurate assessment of the extent of condensation damage while in transit.

Access to such real-time detailed data about conditions during transit could provide opportunities to mitigate the impact on the cargo. Where that is not practicable, because containers are sealed, the same data would allow the parties to avoid the costs and evidential uncertainties of Volcafe-type litigation.

How can smart contracts help?

With commodities, such as coffee, which remain saleable despite some damage, data from IoT sensors can be used to support a more flexible contract structure. In Volcafe the effect of the damage was to require the claimant to sell it at a discount of approximately 10% to market rates.

The availability of real-time or near real-time data concerning the cargo's condition would allow the parties to move from a paper-trail of contractual documents, incorporated rules and conventions and bills of lading and instead adopt "smart contracts" in which the price is dynamically adjusted to reflect the cargo's condition throughout the voyage. Data concerning conditions within a shipping container can readily be combined with GPS data to determine the probable date of arrival and the likely impact of the reported conditions on the cargo's condition. It would also allow the parties to agree in advance the point (if any) at which condensation damage would have such an adverse impact on the cargo's value that the outcome should be termination rather than price adjustment.

Who gains?

Smart contracts would certainly benefit cargo owners and underwriters. The elimination of evidential problems would also save the carriers considerable time and expense in responding to actual or potential claims.

As well as providing evidential benefits in individual cases, data derived from IoT-equipped containers could also inform and improve market understanding and practice. In Volcafe, the carrier suggested that some damage was inevitable given the nature of the cargo. The Court of Appeal accepted that even where general container trade practice was followed there would inevitably be some (probably low level) condensation damage to coffee in bags carried in unventilated containers. However, there was insufficient evidence to establish anything like an industry-wide consensus on the "normal" or objectively "acceptable" level of damage. Detailed data from a statistically-significant number of consignments would allow a better understanding of the effect of conditions on goods. From there, it would be possible to develop a more consistent approach to questions such as the appropriate thickness and the number of layers of the kraft paper used to line shipping containers and to absorb condensation while in transit. Industry-wide use of such data would support the development of best practice. Greater understanding of those practical issues would also allow the parties to assess how far mitigation measures in unventilated containers can be relied upon to justify a commercial decision not to use more expensive ventilated containers, which do not carry the risk of condensation damage.

Ultimately, contract disputes are about identifying, pricing and allocating risk between the parties (and their insurers). Unless the claim relates to a fundamental breach or non-performance, the key issue is the effect on price. Harnessing technology and advanced analytics would allow parties to more accurately allocate risk, in advance, both case-by-case and across each relevant sector.

Attributed to Kizzie Fenner, Trainee Solicitor

This article is for general information only and reflects the position at the date of publication. It does not constitute legal advice.