Outline of Contract Law in Japan
Hiroto Dogauchi (Professor of Law, University of Tokyo)
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Part 1. Formation and Interpretation of Contracts
Chapter 1. Status of contract law within Japanese law
1. Japan is a civil law country that uses statutes for the fundamental areas of law. However, the basic rules concerning contracts are prescribed in the Civil Code together with the law of torts, law of property, law of succession, and family law. There is no separate contracts code.
Moreover, the rules concerning contracts that are contained in the Civil Code are limited to basic rules. Special rules relating to contracts between merchants are prescribed in the Commercial Code. There are also many special laws for purposes such as consumer protection. Beyond this, there are also many statutes to regulate the conduct of business operators. This includes statutes that play a very important role in relation to, for example, the process of contract formation.
2. For practical purposes contract law is the aggregate of these statutes and rules. Simply looking at the contract provisions and their application in the Civil Code would not be sufficient for understanding contract law in Japan. However, at the same time, the provisions in the Civil Code form the basis, and so we focus on these in the following discussion.
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Chapter 2. Contracting parties
Section 1. Capacity to hold rights
1. The meaning of capacity to hold rights
Article 3 (1) of the Civil Code states, “The enjoyment of private rights shall commence at birth.” This means that all natural persons qualify as entities capable of rights and obligations. Possessing such qualification is referred to as having capacity to hold rights (Rechtsfähigkeit).
This concept of capacity to hold rights no longer has any great meaning for natural persons excepting societies that deny slaves the capacity to hold rights. However, this is more important for a juridical person. Article 43 of the Civil Code states, “A juridical person shall have rights and assume duties to the extent of the purpose provided in the applicable articles of incorporation or act of endowment subject to the applicable provisions of the laws and regulations.” Applying this literally means, for example, even if a stock company enters into contract types outside the purposes provided for in its articles of incorporation such stock company would not qualify as an entity to enter into such contract so such contract may become invalid.
2. Juridical person's capacity to hold rights
These provisions are said to have been influenced by the ultra vires doctrine under English law. However, as with the abandonment of the ultra vires doctrine in England, this article has very limited application in Japan.
That is to say, a claim by a juridical person that entered a contract for profit and now asserts the contract to be invalid because it is outside the purposes provided in its articles of incorporation would not be upheld by courts. Even when it would appear at first glance to be outside the purposes in the articles of incorporation of such juridical person, these purposes in the articles of incorporation are interpreted very widely. Most actions are interpreted as corresponding to the articles of incorporation and being within the purposes specified.
However, for those juridical persons not entering into a contract for profit there have been court rulings that state a contract is invalid because the contract is outside the specified purpose1.
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Section 2. Mental capacity/ capacity to act
1. The origin of a contract's binding effect
What determines the binding effect of a contract is a matter of worldwide debate. This largely divides into whether it is grounded in the parties' intent or grounded in the parties' trust.
The same debate exists in Japan, and it should be said that current statutes are designed to strike a balance between both grounds.
When ‘the parties' intent’ is agreed as the binding force of the contract, the content of the contract must be truly satisfactory to the parties. This is because ‘being bound by desire’ first make sense as a reason for parties entering into contracts when there is true satisfaction with the contents of the contract. Consequently, statutes are used to prepare systems to ensure this ‘true satisfaction’. In short, if ‘true satisfaction’ is not present regardless of the external form of the contract, its binding power must be denied.
However, we consider the example of agreement based on an error of speech from one side. We certainly cannot have ‘true satisfaction’ at such time and this becomes a matter of the ‘other person's trust’. A soba (noodle) shop makes and delivers a tendon (tempura on rice dish). As long as ‘the other person's trust is protected’ as the grounds for the binding effect of the contract, the validity of the contract cannot be denied without reason.
How to balance the two grounds and reach an appropriate resolution becomes an important issue.
2. Mental capacity
First, in order to state there was ‘true satisfaction’ it is at a minimum necessary for each party to understand the content of the contract and the types of rights and obligations each has undertaken themselves. There are no explicit articles on this. While it is assumed to be taken for granted, it is common in cases decisions and scholarly treatises to explain this using the term ‘capacite mentale’ (mental capacity). In abstract terms, mental capacity can be referred to as the psychological capacity that enables one to determine the nature of one's own actions. Legally, manifestation of intention without this is deemed to have no effect (be invalid). Whether or not there is mental capacity is determined in light of the nature of the act. This means that even when there is the same psychological capacity there are cases where ‘mental capacity’ is inferred for simple acts and ‘no mental capacity’ for complex acts. However, no mental capacity is inferred for children under the age of 10, mentally disabled persons, and intoxicated persons with psychological capacities below such level.
However, it is very difficult to ensure ‘true satisfaction’ through the concept of mental capacity by itself. First, for a person with a particular manifestation of intention to claim “there was no mental capacity at the time so that manifestation of intention is invalid”, that person must prove there was a loss of mental capacity at that time, and this is more often than not difficult. In addition, an ordinary 12 year old child certainly might have mental capacity, but that would not be the case in relation to making a real estate transaction based on correct judgment. For persons without the capacity to understand complex transactions, in other words for persons without the capacity to determine whether or not entering into a contract is either necessary or beneficial to them, there must be protection even if there is mental capacity.
3. Capacity to act
For this reason the concept of capacity to act was included in the Civil Code.
The capacity to act is not a concept that takes issue with each individual's psychological capacity on a case by case basis. It is capacity from the perspective of formal standards. In abstract terms the validity of a juristic act is created through one's own actions conclusively belonging to oneself. The Civil Code specifies a number of types of ‘persons without the capacity to understand the transaction details and without the capacity to determine whether or not entering into a contract is either necessary or beneficial to them.’ Capacity to act is restricted for such persons in an effort to ensure protection. Specifically there are four types: minors, adult wards, persons under curatorship, and persons under assistance.
First, a minor is a person who has not reached the age of 20 (Civil Code Art.4).
A minor is not deemed to have the reasoning capacity (or competence) to participate in transactional society alone. A contract may be rescinded (Civil Code Art. 5(2)) if it is entered into without the consent of the minor's statutory agent (parent, or guardian; See Civil Code Art. 824 and Art. 181).
(2) Adult wards
Unlike the case of minors, there is no uniform measure such as age for determining who is an adult ward. The Family Court may order the commencement of guardianship at the request of the person in question, or a family member who is within a specified degree of kinship if a person constantly lacks the capacity to discern right from wrong (Civil Code Art. 7). In practice, regardless of the extent to which a person lacks the capacity to understand, a person does not become an adult ward until these procedures are undertaken.
An adult ward has a guardian appointed (Civil Code Art. 8 and Art. 843 (1)) and guardianship then commences (Civil Code Art. 838 (2)). A guardian administers the property of a ward and represents a ward in juristic acts concerning his/her property (Art. 859 (1)). The ward is thus protected from transactional society. Then, as for a minor, a juristic act performed by an adult ward may be rescinded (Art. 9). However, in relation to any act relating to daily life, such as the purchase of daily household items, the adult ward is able to continue acting alone.
(3) Persons under curatorship
A person under curatorship is a person who has become, at the request of specified persons, subject to an order of the Family Court for commencement of curatorship. While not stating that the person lacks the capacity to discern right from wrong (a ‘lack’ of capacity would mean an adult ward) this applies for persons whose capacity is deemed to be extremely insufficient (Civil Code Art.11).
A person under curatorship has a curator appointed (Civil Code Art. 876 and Art. 876-2 (1)). A major juristic act, as prescribed in article 13 (1), such as borrowing and real estate transactions undertaken by a person under curatorship without the consent of the curator is subject to the protection of it being able to be rescinded (Civil Code Art. 13 (4)). In addition the curator may rescind these actions (Civil Code Art. 120 (1)). However, unlike the aforementioned guardian, the curator is, naturally, not deemed to have power of representation. Nevertheless, on the application of the person under curatorship or specified persons (this requires the consent of the person under curatorship him or herself) the power of representation can be given concerning specified juristic acts (Civil Code Art. 876-4).
(4) Persons under assistance
Even if there is insufficient capacity for understanding, but not to the extent that would meet the criteria for an adult ward or person under curatorship this by itself would not mean there is a lack of capacity to for example, conclude contracts. However, there are still concerns about whether the contracts can be concluded properly. Nevertheless, on the application of the person or specified persons (this requires the consent of the person) the Family Court may order that the consent of an assistant be required for some of the acts prescribed in article 13 (1) of the Civil Code (the acts for which a person under curatorship must obtain the consent of his/her curator). An act which requires such consent may be rescinded if it was performed without such consent. This is referred to as an order of commencement of assistance with the person referred to as a person under assistance and the person with the power to give consent referred to as the assistant. This is a reduced version of curatorship.
In addition, as with curatorship on the application of the person or specified persons (this requires the consent of the person under assistance him or herself) power of representation is granted to the assistant concerning specified juristic acts for the person under assistance (Civil Code Art. 876-9).
4. In this way the Civil Code aims to protect minors, adult wards, persons under curatorship, and persons under assistance (collectively referred to as persons with limited capacity) who are deemed to lack sufficient capacity for understanding.
This is very beneficial for those subject to protection. However, in certain circumstances it is necessary to protect counterparties and third parties. Nevertheless, there is no denying the need to protect those without sufficient capacity to understand in relation to transactional society. The two requests need to be balanced.
Consequently, first when an order is given for commencement of guardian ship, commencement of curatorship, or commencement of assistance it shall be recorded in the guardian registration file located at the Legal Affairs Bureau. Therefore, if a person who plans to transact with another person requests the provision of that person's certificate of registration (or documentary evidence of not being registered) it is possible to know the specific details of limitations on the capacity to act. This is the same for minors. The date of birth can be clarified by requesting production of family registration or a certificate of residence.
Therefore, for important transactions documentation about the counterparty proving his or her age and proving that there is no registration of restrictions on the capacity to act is requested. For example, if a minor cleverly rewrites his or her birth date on his or her student card to make the counterparty think the minor is 20 years of age or more, the need to protect such person is denied. Consequently, article 21 of the Civil Code states that a contract may not be rescinded if a person with limited capacity employs any fraudulent means to induce a counterparty to believe that he/she is a person with capacity. The wording of this article by itself suggests a contract cannot be rescinded if a person employs any fraudulent means, but that is not the case. At least it requires the person to have defrauded the counterparty and for that counterparty to have believed the person was not a person with limited capacity to act. In addition, simply having been negligent in belief can also be deemed unacceptable. For example, in a section for recording one's age in an application for a mail order simply inserting ‘22 years of age’ is not interpreted as fraudulent. A person's protection is required against employment of fraudulent means, as well as for reasons of insufficient capacity for understanding. This means it is obviously appropriate for a counterparty to take a certain degree of care.
Next, while aiming for limitations on period of right to rescind (5-years from when a person with the right to rescind act knows about the execution of the contract; Civil Code Art. 126), a counterparty can press the statutory agent, the curator, or assistant for rescission or ratification. If such person with the right to rescind act does not respond within a specified time period it is deemed that such act has been ratified (Civil Code Art. 20).
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Chapter 3. Formation of contracts
Section 1. Principle of consensualism
1. Fundamental non-necessity of documentation
As is the case for many countries, contracts under Japanese law are formed by the manifestation of intention by way of offer and acceptance (In fact, there is no wording clearly prescribing this point. However, this is presumed in the provisions under Civil Code Art. 521.)
In various actual fact patterns it is often unclear as to what manifestation of intention there is in the ‘offer’ and what wording should be taken to mean in the ‘acceptance’. It is said that ‘An offer is a conclusive manifestation of intention for the formation of contract. An acceptance is for the formation of contract with the manifestation of intention in relation to a specific offer’. Ultimately the success or failure of a contract is determined by whether or not there is agreement on the important parts of a contract.
For Japan the formation of contracts does not require documentation in principle. Even when litigating a claim for formation of contract the evidence is not restricted to documentation. On the other hand, as in the case of a real estate transaction by a housing construction business operator there are cases when there are legal obligations for a written contract to be delivered to the client (Real Estate Business Law Art. 37). In practice it is frequently quite difficult to prove formation of contracts without documentation. However, for example even when there is a written contract for the interpretation of additional provisions and written provisions in the contract, oral agreement can be asserted with the decision being reached from various types of evidence.
In addition, there are also cases where both parties think there is no formation of contract until a written contract has been created. In such a case the absence of formation of contract until a written contract has been created is not counter to consensualism.
2. Offer and acceptance
The issue of late arrival of offer and acceptance is dealt with in article 521 and following of the Civil Code. However, many of the provisions therein assume an era when a notice might not arrive or be considerably later than scheduled even though it was dispatched. In other words, it assumes an era of offers and acceptances being dispatched by post and there being postal delivery problems.
In particular, article 526 of the Civil Code states that contracts between persons far away from each other (persons at a distance) shall be formed upon dispatch of the notice of acceptance (postal rule). Under this system a contract shall be formed even if the acceptance does not reach, or is considerably delayed in reaching, the offeror. The risk of non receipt or delayed receipt is borne by the offeror. However, offerors who do not want to bear such risk can set a period for acceptance of the offer. Under such an arrangement when a notice of acceptance does not arrive within the period the offer ceases to be effective. Therefore, the contract is not formed (Art. 521). Since the offeror has a way to avert this type of risk it means in principle that it is fair to deem the contract to be formed when the acceptance is dispatched.
Nevertheless, where postal conditions are good and in a society with very low possibility of non receipt or late receipt there is not much need to adjust the principle that the manifestation of intention first becomes effective on delivery to the counterparty (effective delivery principle). In particular, for contracts using electronic methods such as email, regardless of the distance separating the parties a notice sent is instantly received by the counterparty. Therefore, the ‘Act on Special Provisions to the Civil Code Concerning Electronic Consumer Contracts and Electronic Acceptance Notice’ was enacted in 2001. Under this Act, in cases where acceptance is made via email, online entry (such as purchases on the Internet), facsimile, telex and telephone, contracts are formed when a notice of acceptance arrives at the counterparty. It was determined that article 526 (1) of the Civil Code would not apply.
3. Battle of the forms
In relation to the so-called ‘battle of the forms’ the Civil Code does not set any precise provisions. Unless the terms of the acceptance and the offer are the same there will be no validity as an acceptance. This type of acceptance shall be deemed to constitute a new offer (Art. 528). The principle is the mirror-image rule. Nevertheless, in theory - with reference to article 19 of the UN Convention on Contracts for the International Sale of Goods - even if the ‘acceptance is modified’ when the modifications are not major the contract shall be formed with the modified terms of acceptance, unless the offeror objects.
Even if such a rule is not clearly adopted, in a situation in which both parties think a contract has been formed and act according to that assumption, notwithstanding that the offer and acceptance are not in agreement, the court can be expected to recognize the formation of contract by construing the intent of the parties to find terms consistent with fairness between the parties.
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Section 2. Manifestation of intention that is truly unsatisfactory
1. Five systems
When executing a specific contract there are cases of ‘truly unsatisfactory’ manifestation of intention. Even so, the issue is the balance of two requests that are derived from two grounds concerning the contract's binding effect. From the position of party intent a ‘truly unsatisfactory’ manifestation of intention should be denied validity, but from the position of the ‘need to protect trust’ some limitations are needed. Consequently, the Civil Code takes an approach that considers the two aspects just as in the case of persons with limited capacity; i.e., the ‘responsibility of the person in question’ and the ‘need to protect counterparties and third parties’. We classify ‘manifestation of intention that is truly unsatisfactory’ into five categories based on these two aspects. They appear in the Civil Code in the following order: concealment of true intention, fictitious manifestation of intention, mistake, fraud, and duress.
These five systemic categories can be considered from various perspectives. Here, we explain them by separating into two broad groups. One deals with situations in which the person making the manifestation knowingly makes a manifestation of intention that does not correspond to his or her ‘true intent’; the second deals with situations in which the person making the manifestation is not aware that the manifestation of intention made does not correspond to his or her ‘true intent’. The former includes manifestations of intention based on concealment of true intention, fictitious manifestation of intention and duress, whereas the latter includes manifestation of intention based on mistake and manifestation of intent based on fraud.
2. The person making the manifestation knowingly makes a manifestation of intention that does not correspond to his or her ‘true intent’.
Situations in which the person making the manifestation knowingly makes a manifestation of intention that does not correspond to his ‘true intent’ can be further classified into three categories from the perspective of responsibility of the person in question and the need to protect counterparties. First, this can be divided into ‘situations in which the person voluntarily makes such manifestation of intention’ and ‘situations in which the person was compelled to make such manifestation of intention’. Then, voluntary situations can be further separated into situations in which manifestation was made in concert with the counterparty and situations where this was not the case.
A manifestation of intention not made in collusion with the counterparty, made voluntarily and not corresponding to his or her ‘true intent’ is referred to as ‘concealment of true intention’; a manifestation of intention made in collusion with the other party, made voluntarily and not corresponding to his or her ‘true intent’ is referred to as ‘fictitious manifestation of intention’; and a manifestation of intention made as the result of fear due to the threat of harm from another person and not corresponding to his or her ‘true intent’ is referred to as a ‘manifestation of intent made under duress’.
(1) Concealment of true intention
Manifestation of intention through concealment of true intention is the manifestation of intention of a person who makes the manifestation knowing that it does not reflect his/her true intention. ‘Responsibility of the person in question’ is a clearly a big issue at such a time. In principle, such manifestation of intention is considered valid and the counterparty is protected. However, in a situation that the counterparty knows the manifestation not to be true intent or should obviously know based on the circumstances, he or she is protected because the manifestation of intention is void (Civil Code Art. 93).
(2) Fictitious manifestation of intention
Fictitious manifestation of intention is a manifestation of intention that is not true intent, made in collusion with another party. It is the same as concealment of true intention in the sense that the person who makes the manifestation knows that the manifestation is not his or her true intent. The difference is the manifestation of intention is made with the consent of the other party. This is the general definition, but in contrast, there is also the view that ‘this creates the appearance that the manifestation of intention has been in collusion with the other party, and there is no manifestation of intention called ‘fictitious manifestation of intention’.’ The latter view is probably easier to understand. Take for example the case where debtor A is faced with having his home seized by creditors if the present situation continues, so he acts in collusion with acquaintance B to pretend that the house was sold to B and transfers the title of ownership to B.
In this case too, the ‘responsibility of the person in question’ is great. However, there is no ‘need for protection of the other party’. The other party knows that this is a manifestation of intention without a corresponding true intent. Consequently, article 94 (1) of the Civil Code simply provides “Any fictitious manifestation of intention made in collusion with another party (ies) shall be void.”
However, there is the need to protect third parties who are not direct counterparties. In the above example, since the sales contract between A and B is void, there is no transfer of ownership from A to B. However, suppose that B falsely states that he is the owner of the house and sells it to a third party C. C needs to be protected from situations such as C having researched the registry to verify that B was the owner, and verified that B was listed as the owner on the registry. In addition, as already stated above, A has great responsibility.
Consequently, article 94 (2) of the Civil Code prescribes that “The nullity of the manifestation of intention pursuant to the provision of the preceding paragraph may not be asserted against a third party without knowledge.” The term ‘without knowledge’ means ‘not knowing the circumstances’ and ‘may not be asserted against’ can be thought of as ‘cannot claim’. The fictitious manifestation of intention between A and B is void, but the fact that it is void means there cannot be a claim against C (‘a third party without knowledge’) who did not know the manifestation of intention between A and B was fictitious. In other words, C acted as if the house had been validly transferred from A to B and acquired ownership of the house by concluding a sales agreement with B. Basically, C acted on the basis that the transfer of this house from A to B was valid, and entering into a sales contract with B means C can acquire ownership of this house.
(3) Manifestations of intention through duress
This is the case in which the manifestation of intent is made by a person who is subject to illegal duress by another, feels fearful, and forms intent based on such fear. In this case, the ‘responsibility of the person in question’ is minimal. In addition, in the case that the person exerting duress is the other party to the contract, there is no ‘need for protection of the other party’. Consequently, article 96 (1) of the Civil Code provides that the person making the manifestation of intent may have it rescinded if it was induced by duress.
Even where the action can be rescinded, it is completely valid until it is rescinded. However, when it is rescinded, that act is deemed void ab initio (retroactively) (Civil Code Art. 121). Therefore, after it is rescinded the situation will be the same as if it were void.
Suppose that A has not alternative but to sell a house he owns to B, due to duress from B, and transfers the title to B, whereupon B sells the house to third party C. On this occasion, C checks the registry and verifies that the owner is B, and does not know that this was the result of the sales agreement entered into under duress. C is likely to need protection. Or suppose D (a person other than B) put A under duress to cause A to sell A's house to B, but B also did not know about the duress. This case will probably require protection for B.
However, the Civil Code does not contain provisions to protect C and B in the above two examples. The code gives decisive importance to the fact that there is no ‘responsibility of the person in question’.
3. Situations in which the person making a manifestation of intention is unaware that it does not correspond to his or her ‘true intent’.
These situations can be further classified into two cases from the standpoint of the responsibility of the person in question and the need for protection of the counterparty and third parties. The issue is whether or not the ‘misunderstanding’ that caused the person making a manifestation of intention, which unconsciously does not correspond to their true intent, was intentionally brought about through the act of another person. Where this is not the case, the manifestation of intention is due to mistake; where this is the case, it is called the manifestation of intention through fraud.
(1) Manifestations of intention due to mistake
Mistake refers to cases in which there is a discrepancy between the manifestation and the true intent due to a mistake of perception or judgment by the person making a manifestation.
In cases of manifestation of intention due to mistake, the ‘misunderstanding’ that was the cause was not intentionally brought about through the act of another person. Accordingly, the ‘responsibility of the person in question’ is great. Since there was certainly no ‘true satisfaction’, such manifestation of intention cannot be simply deemed valid. At the very least, we cannot deem ‘any manifestation of intention caused by any mistake to be void’. Consequently, article 95 of the Civil Code takes a dual approach to delimiting these cases: where manifestations of intention due to mistake are void are limited to “when there is a mistake in any element of the juristic act in question”; while the person who made the manifestation of intention may not claim such nullity when “the person who made the manifestation of intention was grossly negligent.”
In terms of contract the phrase “when there is a mistake in any element of the juristic act in question” means “when there is a mistake in an important part of the contents of the contract”. Whether or not something is ‘an important part’ is determined not based on the thinking of the person making the manifestation of intention (subjective intent) but based on whether or not an ordinary person would be considered unlikely to make such a manifestation of intention if there were no mistake as to that part.
Generally, the motive for a manifestation of intention is not constituative of the contents of the contract. Therefore, when there is a mistake in the motive it generally does not fall under “when there is a mistake in any element of the juristic act in question”. However, case law has recognized “a mistake in any element of the juristic act in question”, even where there is a mistake as to motive when that motive has been declared to the other party. For example, when a customer notifies a bank that he needs cash to pay a third party and terminates a term deposit contract, then even if the contract with the third party is void and there turns out to be no need for payment of the funds, this would not be a mistake in an element of the juristic act2. However, in the situation of the distribution of property due to divorce, if it has been made clear to the other party that the person distributing the property determined the amount of property for distribution based on the perception that the distribution would not be taxed, the case would be regarded as one of “a mistake in an element of a juristic act” even though the mistake was one of motive3.
‘Manifestations of intention due to mistake’ are deemed ‘to have no effect’ under the wording of article 95 of the Civil Code. That said, the precedents hold that this invalidity can only be claimed by the person making the manifestation of intention and there is no significant difference between this and cancellation (‘rescission’).
(2) Manifestation of intention through fraud
As we have seen above, in cases of manifestation of intention due to mistake, because the other party could suffer improper loss if the person making the manifestation were simply permitted to claim invalidity, the scope of such claims is limited. However, in a case of misunderstanding by the person making a manifestation of intention due to deception by the other party, there is no ‘need for protection of the other party’. Further, even in a case in which the other party does not directly deceive the person making the manifestation of intention, if another person deceives the person making a representation with the knowledge of the counterparty, there will be no need for protection.
Consequently, article 96 (1) of the Civil Code does not impose the limit of “mistake in an element of a juristic act” but simply provides that “Manifestation of intention which is induced by any fraud [ ] may be rescinded”, and further provides in paragraph 2 even in the case that any third party commits any fraud inducing any person to make a manifestation of intention to the other party, such manifestation of intention may be rescinded if the other party knew such fact.
In a situation in which for example, as a result of a manifestation of intention made as a result of the fraud, the transfer of ownership of land from A to B is registered, there will be a need to protect C, a third party who purchases the land from B. Consequently, article 96 (3) of the Civil Code prescribes “The rescission of the manifestation of intention induced by the fraud pursuant to the provision of the preceding two paragraphs may not be asserted against a third party without knowledge.” It is important to note here that the ‘third party’ referred to here must have appeared prior to the rescission. In the above example, C's purchase of the land in question must have occurred before A rescinded his or her manifestation of intention. The result of rescission will be that the manifestation of intention is deemed void from the beginning (Civil Code Art. 121). Accordingly, from a logical standpoint, the sales agreement between A and B does not exist, so even if transfer of ownership to B is registered, such registration is void. However, because C appeared while the contract between A and B was valid, C must be protected. In contrast, we consider the purchase of land by C from B after A rescinds the manifestation of intention concerned and the contract between A and B has been deemed void from the beginning. In this case, the situation becomes one whereby C purchases from B, a person who is not the owner although he or she appears to be. This has nothing to do with the retroactive effect of a rescission. This relates to the general issue of whether or not a person who relies on appearance should be protected, and is not a problem unique to cases of fraud.
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Section 3. Agency
1. Effectiveness of agency
Agency is a system whereby a person (agent) with a stipulated relationship to the principal can, by making manifestation of intention on the principal's behalf, directly bind the principal.
Authority of agency is generally conferred by a mandate agreement between the principal and the agent. However, it is also held that authority of agency can arise from employment contracts and outsourcing contracts. Further, there are also situations in which authority of agency arises in accordance with the provisions of acts such as the guardian of an adult ward.
For an agent's act to be valid it requires that (1) the agent make a manifestation of intention after making it clear that the effect will be binding on the principal, and (2) such agent's manifestation of intention is within the scope of the validly granted authority of agency (Civil Code Art. 99). However, exceptions to (1) are prescribed in the Commercial Code. Specifically, for agents in commercial transactions, it is a general rule that the principal is bound even where an agent acts without manifesting that he acts on behalf of the principal. This is a doctrine similar to that of undisclosed principal under Anglo-American Law, but there are some minor differences. Under Japanese law, when it is known that the agent acts on behalf of the principal, demand for performance can only be made against the principal, and the only one who can demand performance of the counterparty is the principal.
2. Unauthorized agency
An issue arises in situations in which one acts as an agent although there is no valid authority of agency. In this situation, if the principal is satisfied, it is permissible to have the act of the agent bind the principal. This will prevent the counterparty's expectations from being harmed. Consequently, article 113 of the Civil Code provides for the ratification by the principal even where there was an act of unauthorized agency. Ratification has retroactive effect.
Problems arise when the ratification by the principal cannot be obtained.
In such cases, the counterparty can demand performance from the unauthorized agent in place of the principal or demand damages (Civil Code Art. 117). However, in a situation such as where the contract concluded was one for, say, the sale of land owned by the principal, it is actually impossible for the unauthorized agent to perform the contract. Further, even if payment of damages is requested, nothing can be done if the unauthorized agent does not have the capacity to pay.
However, as we have already seen, even though the general rule is that the binding effect of manifestation of intention will be denied unless there is ‘true satisfaction’ due to the ‘intent of the parties’ being demanded for the binding effect of a contract, ‘the protection of the counterparty's trust’ must also be considered. Consequently, here too the Civil Code strikes a balance between both the responsibility of the principal (i.e., ‘whether the principal has an unavoidable responsibility even if bound by a manifestation of intention that is not true intent’) and the need for protection of the other party (i.e., ‘whether the counterparty acted with care sufficient so as to deserve protection’).
First is the issue of whether or not the ‘principal is responsible’. In order to think about this, it is necessary to consider why A would confer authority of agency on B in the first place. This would be because A thought that in light of A's own available time and capacity as well as trust in B ‘it would be better to have B act, rather than acting him or herself’. In other words, A confers authority of agency on B because employing B as an agent would be beneficial to A, and A trusts B. However, B acted beyond the scope of that authority of agency. This would be a case of A's ‘slip in judgment’. A should have taken care in choosing the agent. In this case, the responsibility of A, in other words the principal, can be recognized.
However, suppose B took the liberty of counterfeiting a power of attorney without A granting B any authority of agency and acted, calling himself ‘A's agent’. In this case, because A did not entrust B, A is not responsible. However, if A created the cause of B's acting as if he were an agent although B was not granted any authority of agency at all, then A can be found responsible.
3. Apparent authority
Based on the above reasoning, the Civil Code prescribes the following three cases in which the counterparty should be protected. Such cases are called apparent authority, because, notwithstanding the actions were those of an unauthorized agent, the counterparty who believed the appearance of proper authority of agency is protected and the principal is bound by the unauthorized agent's actions.
(1) Apparent authority due to exceeding authority of agency
Even in a situation in which a person with authority of agency acts beyond the scope of such authority, ‘when a third party has reasonable grounds for believing that the agent has the authority’ the principal shall bear responsibility (Civil Code Art. 110).
What situations constitute ‘reasonable grounds’? Generally, this can be expressed as without knowledge or free of negligence (believing it to be true, and it was not negligent to so believe). However, determination of whether or not there was negligence differs according to the type of transaction and the type of agent4. For example, with respect to the purchase and sale of real estate, the counterparty cannot be called free of negligence without exerting substantial care. When a family member is the agent, it is very easy to use a personal seal to alter a power of attorney, so unless the counterparty exercises substantial care he or she will not be deemed free of negligence.
(2) Apparent authority after termination of authority of agency
This is the situation in which a person who had authority of agency for a period of time acts as an agent although the authority has terminated. When a counterparty is without knowledge or free of negligence in relation to the termination of the authority of agency the principal cannot say to the counterparty, “Don't blame me ? it was an act done after termination of the authority of agency” (Civil Code Art. 112). A had trusted B at one time, and if the authority of agency was terminated, A should have made efforts to remove the appearance that there was authority of agency.
Article 112 of the Civil Code foresees the situation in which the agent acts within the scope of the terminated authority of agency. For example, the situation in which B ? to whom A had granted authority of agency for leasing real estate ? concludes a lease agreement with C as the agent of A after the authority of agency has been terminated. So, what about the case in which B concludes a sales agreement with C as the agent of A, after termination of the authority of agency? Because this case is one of ‘exceeding authority of agency’ ‘after termination of authority of agency’, it is solved by applying both article 112 of the Civil Code and the previously explained article 109 of the Civil Code5. In other words, the counterparty shall be protected when the party is without knowledge and free of negligence with respect to the termination of the authority of agency and if the counterparty is without knowledge and free of negligence with respect to exceeding the authority of agency. It is sufficient if the requirements of these two articles are met in sequence.
(3) Apparent authority due to manifestation of grant of authority of agency
This is a situation in which a third party is protected if A has in fact not granted authority of agency on B but nevertheless makes a manifestation to a third party as if A had granted authority of agency on B and the third party enters into a transactional relationship believing this manifestation. Article 109 of the Civil Codes prescribes “A person who manifested to a third party that he/she granted certain authority of agency to other person(s) shall be liable for any act performed by such other person(s) with third parties within the scope of such authority.” This situation also requires C to be without knowledge and free of negligence.
In fact, there are many situations in which B is given a blank power of attorney and B completes the authorization fields as agreed between A and B, but B writes in actions outside the scope of the authority and acts as agent accordingly. This is because the delivery of a power attorney with blank authorization fields is taken as a ‘manifestation’ of granting authority to the agent to fill in the blank portions of the document as the agent determines6.
Further, the Commercial Code and the Companies Act contain several special rules pertaining to article 109 of the Civil Code.
First, article 14 of the Commercial Code and article 9 of the Companies Act prescribe that in a situation in which Company A permits B to conduct transactions using the name ‘Company A’, A shall be joint and severally liable for the performance of obligations from transactions conducted by B with a counterparty who mistakenly believed that the transactions were those of A.
In addition, in relation to persons referred to under article 24 of the Commercial Code as employees given “the title which holds him/her out as the approved chief of the business of the business office”; under article 13 of the Companies Act persons deemed to have authority as “Any employee with a title which holds him/her out as the chief of the business of the head office or any branch office of a Company” (for example, the branch manager), and under article 354 of the Companies Act persons with “the title of president, vice president or other title regarded as having authority to represent the Stock Company”, a third party is deemed as being ‘without knowledge’ to fulfill the requirements of protection for a counterparty to an act of unauthorized agency. Article 109 of the Civil Code interprets this as a requirement of ‘without knowing, free of negligence’, but because speed is important in commercial transactions and the fact that permitting a person to use a title is highly likely to induce trust in a counterparty, the requirements for protection are relaxed (in the case of commercial transactions).
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Chapter 4. Interpretation, revision and supplementation of contracts
Section 1. Mandatory provisions and public policy
1. Mandatory provisions
The Civil Code and other Acts contain provisions stating that parties are not permitted to make prescriptions inconsistent therewith. These are referred to as mandatory provisions, and agreements that conflict with mandatory provisions are either invalid or are modified in accordance with the mandatory provisions.
For example, with respect to a lease of land for the purpose of owning a building, article 3 of the Land Lease and House Lease Act provides that “the duration of a land lease shall be 30 years; provided that when a longer term is prescribed by contract, the term shall be [the longer one]”. This means that ‘even if an agreement prescribes a shorter term, the term shall be 30 years’. This is further confirmed by article 9 of the Land Lease and House Lease Act that states “special agreements that violate the provisions of this section and are disadvantageous to the lessee of land shall be void.”
Therefore, with respect to a lease of land for the purpose of owning a building, the parties are not free to prescribe the term of the contract. The setting of a term of less than 30 years is not permitted, and shall be void even if the parties agree to such a term.
There are quite a few instances whereby the contents of the contract are regulated by mandatory provisions for purposes such as protecting the weaker party including consumers. More detailed explanation is provided below when various contracts are considered.
2. Void due to public policy
Thus, is it the case that any provision is valid so long as it does not violate a mandatory provision? For example, article 41-2 (1) of the Stimulants Control Law provides that “Any person who unlawfully possesses, transfers or receives stimulants …… shall be liable to penal servitude not exceeding 10 years.” However, there is no direct provision — as in the above example of the Land Lease and House Lease Act — that voids the contract. Nevertheless, this does not mean one can assert that a contract for the purchase and sale of stimulants is valid.
The contract is void based on the application of article 90 of the Civil Code. That article provides that “A juristic act with any purpose which is against public policy is void,” and the above contract is void because it breaches this provision. However, it is very difficult to determine specifically what types of contracts violate public policy.
There are also examples in which a violation of legal provision does not cause a violation of public policy. Article 52 of the Food Sanitation Act provides that any business person engaged in the sale of meat shall obtain a license from the governor of the prefecture concerned. Therefore, what will happen if a person who has not obtained a license purchases meat for the purpose of selling it? The Supreme Court of Japan held that the Food Sanitation Act “can reasonably be construed as nothing more than a simple regulatory provision, so even if Y had not obtained the license to sell meat, there is no basis for denying the validity of the transaction in question based on the above law7.”
On the other hand, article 72 of the Practicing Attorney Law provides that any person who is not a practicing attorney shall not, for a fee and as an occupation, engage in the practice of law. In addition the Supreme Court found that contracts violating this, specifically contracts where “X is mandated by A to collect claims, and appointed as an attorney to institute A's proceedings for the purposes of collecting such claims, and all other matters relating to procedures for filing petitions and settling disputes, and if the above collection of claims is successful will receive remuneration being one half of the remaining balance after litigation costs are deducted from the collected funds” were against public policy and consequently void8.
There are various other examples, but in general, the determination of validity and invalidity takes the following factors into consideration. Specifically, whether or not there is a need to suppress such acts to the extent of voiding a contract based on consideration of the interests to be harmed were the contract invalidated, and taking account of the safety of the transaction and the good faith between the parties. For example, in the above case, if the contract is invalidated due to violation of the practicing attorney law, the person who carried out legal work will simply end up working without remuneration, and a sense of unfairness between the parties shall remain. However, in order to avoid giving rise to a situation in which persons suffering with legal problems are victimized by the unqualified, the courts must always invalidate such contracts per se and create a regime whereby enter into such a contract will only result in a loss. Therefore, such contracts will be treated as invalid.
3. Violations of public policy that are not violations of laws and regulations
In the sections above we have addressed the invalidation of contracts that violate laws and regulations in terms of violation of public policy. However, where there being no violation of public policy without some form of violation of laws and regulation this is not the case.
A married man entered into a contract for future marriage with a woman who knew that he was married, under which he would pay her living expenses until they could actually be married. The contract itself did not violate any laws. However, this type of contract is based on the assumption of divorce. If a court were to recognize the woman's claim for the payment of living expenses, the court would end up promoting divorce (the only way the man could perform the contract without payment would be to divorce). Consequently, the decision is that this sort of contract disrupts the order of marriage and deemed to be void because if violates public policy9.
However, even here the decision is difficult.
In addition, lately there have been many court decisions that have found contracts for the purpose of consumer protection invalid due to them violating public policy.
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Section 2. Interpretation and supplementation of contracts
1. Interpretation of the wording of the contract
When a contract is concluded it has binding effect and the effect as if it were a statute between the parties. At that time if the contents of the contract are clear with all problematic issues provided for there is no problem. However, just as the articles of statutes require interpretation when applying contractual terms to actual cases proper interpretation is required.
Suppose A and B have an existing commercial relationship whereby they use the word ‘yellow’ to refer to ‘corn’. In addition, at this time, A and B agree to a ‘yellow transaction’.
Then, the objective meaning of the phrase ‘yellow transaction’ is certainly not ‘corn transaction’. However, if both parties give the phrase ‘yellow transaction’ the same meaning, the contract will be interpreted in accordance with that meaning. This is the first stage of contract interpretation.
The problem arises when the meanings the parties give that expression differ.
On this point, the term will be interpreted to have the meaning ‘the other party would ordinarily think’ under the circumstances (this includes the manner of dealing up to the present). In this sense, this could be thought of as ‘ascertaining the objective meaning of the expression’; however, it must be borne in mind that this does not constitute ‘the meaning found in a standard dictionary’ but ‘the objective meaning under the circumstances’. Accordingly, factors such as the customs of the business world in which A and B operate become important10.
2. Supplementation of the parties' intent
Up to this point we have been discussing the interpretation of details manifested by the use of certain words by parties. However, in actuality, when parties contract, they do not always precisely agree on every little detail. In such situations, merely interpreting their manifestations will not enable prescription of the legal relationship between the parties. There will be a need to supplement aspects not decided by the parties.
Here too, it is deemed that the parties' intent should be respected. In other words, the purpose of the contract is considered by understanding the overall manifested intent, and the intent is supplemented consistent with the direction of such agreed purpose. Further, the transactional customs, contractual negotiations and the conduct of both parties after contract formation are all significant in inferring the intent of the parties.
However, if this is taken too far, it is possible that the judges' opinion that ‘there is no mistaking that the parties thought this’ shall be imposed on the parties. Certain standards are required to prevent ‘supplementation’ from becoming whatever the judges wish. Consequently, the Civil Code contains many articles for the purpose of supplementing the intent of the parties, for each type of contract.
3. Significance of typical contract types
Civil Code Part III Claims, Chapter 2 Contracts provides 13 classical contract ‘types’, and prescribes the rights and obligations of the parties. However, almost all of the articles found here are articles to supplement situations in which the intent of the parties is not clear. In contrast to mandatory provisions, these are called voluntary provisions.
So in order for the intent of the parties to be supplemented by such voluntary provisions, it must first be made clear what type of contract is at issue as a whole. For example, suppose that under a certain contract, A delivered possessions to B. This could also arise in the situation in which B borrowed the item from A, but it could also arise in the situation in which, say, A deposits luggage with B, a for-fee luggage storage operator. Supposing that there was no agreement with respect to the payment of a fee, such that supplementation is necessary. In the former case supplementation would be required to provide for B paying a fee to A. Conversely in the latter, supplementation would be required to provide for A paying a fee to B. Consequently, unless the nature of the agreement is clarified first, the details to be supplemented cannot be determined.
Consequently, the Civil Code provides 13 contract ‘types’ and clearly prescribes the nature of the contract (ruling on nature) as the first step. Therefore, contracts provided as contract types under the Civil Code are referred to as classical contract ‘types’. The next step is to supplement the contract with voluntary provisions provided for the type of contract concerned.
There is one problem if we considering the framework of ‘ruling on nature (of contracts)’ → ‘application of contract type’ → ‘Supplementation with voluntary provisions’ as in the above. The issue is whether all of the various contracts actually in use in society can be adequately classified into 13 types.
However, the intent of the parties, including custom, is pursued even if a contract comes under the purview of a given contract type. In addition, when the actual contract does not exactly match a contract type, there will be more times when it is found that the intent of the parties differs from each article. Whatever the case, fitting a contract to one of the 13 contract types provided for in the Civil Code and supplementing with voluntary provisions will be the last step.
4. Principle of good faith and abuse of rights
In addition, when determining the rights and obligations of the parties to a contract, the principle of good faith in article 1 (2) of the Civil Code (“The exercise of rights and performance of duties must be done in good faith.”) can be used as the last step when a reasonable resolution cannot be reached using agreed supplementation through agreed interpretation and voluntary provisions. In addition,
Further, even where a right is recognized, there can be a certain restriction on the exercise thereof. Article 1 (3) of the Civil Code provides that “No abuse of rights is permitted.”
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Section 3. Expanded contractual liability
1. The classical concept of contract
The classical explanation with respect to the grounds for a contract's binding effect, i.e., the explanation that ‘the reason parties are bound by the contract is that the parties agreed based on their free intent.’ In other words, the binding effect arises from the intent of the parties' means there should be no liability without agreement. This idea is more specifically composed of the following two ideas. The first is that the parties do not have any obligations whatsoever prior to the formation of the contract, and that furthermore the parties do not have any obligation whatsoever after the contract ends. Another is that the obligations imposed by the contract exactly comply within the scope agreed to by the parties.
The former is referred to as temporal scope and the latter as quantitative scope. However, at present, different situations arise with respect to these two. That is to say, there has been a temporal expansion as well as a quantitative expansion of contractual liability.
2. Pre-contractual effect: Type 1
The temporal expansion of contractual liabilities can be further divided into two categories. Specifically, these are the affirmation of pre-contractual effect and the affirmation of post contractual effect.
First the affirmation of a liability referred to as negligence in formation of the contract can be cited as an example of an affirmation of pre-contractual effect.
The traditional thinking is that a contract is completely void if the performance of the required obligations of a party is already considered impossible when the contract is formed. For example, when a contract is formed for purchase and sale of a house and that house had already been destroyed by fire it would be impossible for the seller to perform his or her delivery obligation. So, the purchase and sale contract itself is deemed to be completely void.
However, the buyer concluded the contract thinking it to be valid, an in some cases may have borrowed funds from the bank, and may have arranged to sell the house he or she is currently living in. This means they have already incurred expenses. Even so, if the contract is deemed void due to impossibility from inception it would be hard to allow that party to suffer without a remedy. This would be particularly the case where, the seller should have known, by conducting proper inspection, at the time the contract was concluded that the house had already been destroyed by fire.
Liability for negligence in contract formation seeks to address this problem.
In other words, the parties to a contractual negotiation have imposed upon them, at the stage of contract negotiation, the duty of care so as not to cause a loss to the other party. In the above example, then, in a situation in which the seller would have known that the house had been destroyed by fire if he had used proper care, the seller would be in breach of his duty of care and would have to compensate the buyer for harm suffered thereby.
Thinking in this way about the negligence liability in concluding a contract as being the liability arising from a breach of obligation where negotiating parties to a contract are subject to duty of care not to cause the other party to incur a loss when negotiating a contract, the scope of application is not limited to cases in which concluded contracts are void. An example is the situation in which contract negotiations begin and a comfortable stage is reached where a party thinks “we still have to discuss some detailed terms, but the deal itself is not going to be broken”, but suddenly the other party says, “I am not going to contract.” Of course, each party is free to decide whether or not to conclude a contract. However, the interpretation is as follows: Because persons who have commenced a transaction and entered the stage of contract negotiation are in a close relationship subject to the principle of good faith, unlike the relationship between citizens in general, regardless of whether or not the contract is subsequently concluded, they should be subject to mutual obligations under the principle of good faith not to harm the character or property of the other party; if a party breaches this obligation and harms the other party, it is reasonable to recognize liability for damages as contractual liability even where the contract is not concluded.
There are many case decisions recognizing liability with respect to this sort of improper termination of contractual negotiations11.
3. Pre-contractual effect: Type 2
The example of negligence in concluding a contract was an example of how even where a contract is not void, liability can be imposed for breach of obligation in the negotiation process. In the same way, a breach of obligation in the negotiation process can become a problem subsequently even where the contract is formed.
An obligation for a specialist to give full explanation to a consumer is sometimes recognized in relation to the negotiation process. For example, in addition to the obligation for securities companies that sell high risk financial products to consumers to provide sufficient explanation, in the first place, it is desirable for such companies to take care in promoting investments that best conform to the client's investment experience, financial capacity and will. For persons without sufficient knowledge or financial means the act of soliciting such persons for speculative transactions itself is sometimes illegal.
4. Post contract effect
Important examples of the imposition of specified performance obligations after the contract ends are confidentiality obligations, and the obligation to refrain from competition. These are often explicitly prescribed in contracts. For example, a franchise contract may prescribe that, ‘the franchisee shall not, for a period of two years after the end or termination of this agreement, engage directly or indirectly in a business similar to the business of the X chain or a competing business in the same prefecture or a neighboring prefecture’. These sorts of confidentiality obligations and duties to refrain from competition are sometimes recognized even where there is no explicit agreement.
Further, there is a viewpoint that seeks to impose a certain duty of care on a seller of certain products after the sale. For example, there is a notion that if, after a securities company sells a certain financial product to a client, a situation arises due to economic changes whereby it is advisable to sell that financial product as soon as possible, the securities company must give appropriate advice to that client.
Further, the problem of whether or not a buyer can claim damages is also presented in a situation in which the seller of a resort condominium who made a selling point of the ‘beautiful view from the window’ soon after the sale starts to erect a building next door that blocks that view.
5. Quantitative expansion
Contractual obligations also tend to expand quantitatively.
In particular, in a contract to receive services from another party, there are obligations when receiving such services to take the necessary care to protect the other party from danger to his or her life, and health, etc. (obligation to exercise safety). There are several Supreme Court cases on this.
Such obligations of security do not mean the parties have made such an agreement in advance. Obligations of safety are not prescribed in the articles in the Civil Code concerning labor supply contracts. However, precedents are expanding the obligations imposed on the parties based on the principle of good faith (Civil Code Art 1 (2)).
The trend with respect to specified legal relationships toward imposing obligations on the parties that are broader than agreed to can also be seen as part of the realm referred to as specialists' liability.
At present, the tendency has been to consider, in a situation in which one party to a contract trusts the ability of the other party as a specialist and entrusts certain matters thereupon, that the party, as a specialist, is obligated to consider the interests of the other party beyond the scope of the agreement.
This means obligations are imposed to a broad extent necessary to comply with the trust of the other party under the scope of their respective fields of specialty. This obviously applies to specialists with public certifications such as doctors, attorneys, architects, and also applies to securities companies in relation to securities transactions and banks in relation to banking transactions.
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Decision of the Supreme Court, 4 July 1969, Vol. 23 No. 8: 1347
Decision of the Supreme Court, 19 May 1972, Vol. 26 No. 4: 723
Decision of the Supreme Court, 14 September 1989, Vol. 41 No. 11: 75
Decision of the Supreme Court, 25 June 1976, Vol. 30 No. 6: 665
Decision of the Supreme Court, 28 July 1970, Vol. 24 No. 7: 1203
Decision of the Supreme Court, 10 November 1967, Vol. 21 No. 9: 2417
Decision of the Supreme Court, 18 March 1960, Vol. 14 No. 4: 483
Decision of the Supreme Court, 13 June 1963, Vol. 17 No. 5: 744
Decision of the Great Court of Judicature, 23 October 1920, Vol. 26: 773
Decision of the Great Court of Judicature, 2 June 1921, Vol. 27: 1038
Decision of the Supreme Court, 27 February 2007
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Part 2. Specific Contracts
Chapter 5. Contracts for transfer of property
Section 1. Sale
Subsection 1. Overview
The definition of a sales contract is provided in Article 555 of the Civil Code. This states, “A sale shall become effective when one of the parties promises to transfer a certain property right to the other party and the other party promises to pay the purchase money for it.”
From this definition, a sale is ‘a bilateral contract’ that is ‘a contract for value’.
A contract for which payment is made for the value of performance is referred to as a contract for value, while other contracts are referred to as ‘contracts for no value’. One should note that under Japanese law, gifts are also contracts (contract for no value). Naturally, for example, the regulations differ in the case of a defect in performance under a gift, which is a contract for no value, and in the case of a defect in performance under a sale, which is a contract for value. However, under Japanese law, the existence of consideration or cause is not a condition for determining binding effect of a contract. This is the reason why a gift is also a contract.
Further, a contract in which both parties are obligated to pay consideration for benefits received from the other party is referred to as a bilateral contract, while a contract that obligates only one party is referred to as ‘a one-sided contract’.
Bilateral contracts for value have the most significance in economic society. Sales are a typical example of ‘a bilateral contract for value’.
2. Fundamental elements
Purchase money under a sales contract should clearly be specified in all cases. It does not matter whether this is specified in Japanese yen or a foreign currency (CC Art 403). In addition, it is also acceptable to set as ‘twice the Nikkei 225 Average for the Tokyo stock market three months hence’.
Since the subject of sales is ‘property rights’ even if the contract is not for a transfer of ownership of ‘things’, it will be treated as a sales contract as defined under the Civil Code. For example, a contract to transfer monetary claims is a sales contract while contracts to transfer patent rights and fishing rights are also sales contracts. In addition, even when the contract involves ‘things’ this does not only mean the case of an individual item being specified. There are cases when an item is defined by type (see CC Art 401). In such a case, the obligation of the seller is referred to as ‘a fungible obligation’ and the claim of the buyer is referred to as ‘a fungible claim’. In addition, there are also sales where the seller shall provide for a claim that is to be identified by way of choice among more than one (see CC Art 406) (Similarly, this is referred to as ‘alternative obligation’, and ‘alternative claim’).
It is also acceptable for items for which ‘property rights’ do not exist at the present point in time. Contracts to transfer future obligations have important significance for financial transactions. This is also true for futures transactions.
Moreover, it can also apply to other person's things that are the subject of sale. Of course, even if seller A and buyer B enter into a contract for things owned by C, C naturally does not lose his/her ownership. However, A “shall assume an obligation to acquire the rights and transfer the same to the buyer” (CC Art 560). In other words, A is obligated to obtain the thing from C by way of sale and then transfer such thing to B. If C will not sell it to A, A will not have satisfied its obligation to B under the contract.
3. Pre-contracts of sales, basic contracts/ comprehensive type commitments
Pre-contracts of sales are prescribed in the Civil Code. It states, “A pre-contract to sell or purchase made by one party shall take the effect of a sale when the other party has manifested his/her intention to complete such sale” (CC Art 556 (1)). However, this is in fact almost never used in practice.
Take the case, for example, where a basic contract concluded between a manufacturer and a special distributor where there is a contract for the seller to sell and deliver certain products to the buyer to fulfill an order from the buyer and for the buyer to accept such delivery. This is sometimes referred to as a ‘comprehensive commitment’; an order by itself does not constitute a sales contract (a pre-contract of sale does) and means that there is only an obligation to enter into a contract with the other party. In other words, a seller who does not fulfill an order would be in breach of his/her obligation to enter into a contract, but not in breach of obligations under an established sales contract.
For this kind of continuing sale, the conditions differ from the usual one-off sale and there are specific problems such as under what circumstances a basic contract can be cancelled. Above all, the criteria for the ‘fundamental breach’ that is the condition for cancellation will be different.
Subsection 2 Seller's obligation
1. Obligation to transfer the subject matter
There is no question that the seller in a sales contract is obliged to transfer the subject matter to the buyer. In addition, when there are perfection requirements, for example, land registration, in relation to the transfer the seller must take the necessary action to satisfy the perfection requirements for the buyer.
2. Seller's warranty
So what is the situation when the promised property rights do not have the expected characteristics or qualities? This is also a breach of the seller's obligations. However, the Civil Code includes special provisions for separate treatment of ‘when the promised property rights are not the same nature as expected’ when there is a breach of seller's obligations. These are referred to as the seller's warranty. They are categorized as (1) in cases where rights partially belong to others, (2) in cases of shortage of quantity or partial loss of object, (3) in cases when third parties have right of use, and (4) in cases where there is any latent defect in the subject matter.
These provisions are also merely default rules (provisions for supplementation of intent when the parties have not specifically agreed). Therefore, special agreements with other content are possible. However, the seller may not be released from that responsibility with respect to any fact that the seller knew but did not disclose, and with respect to any right that the seller himself/herself created for or assigned to a third party (CC Art 572). In this case there is a mandatory provision.
(1) Seller's warranty where rights partially belong to others
The sale of a thing that belongs to others is also valid, and as already explained, the seller is obligated to acquire the thing from the other party and transfer it to the buyer, but this is the case when performance is not possible in part. This includes the case where part of the thing that is subject to the sale is owned by the seller but performance is not possible on the part owned by a third party, as well as the case when all of a thing is owned by a third party and only part could be acquired by the seller.
The Civil Code makes provisions for this by separating the case where all or part of the thing that is subject to the sale is owned by someone other than the seller is known by the buyer (bad faith) from where it is not known by the buyer (good faith).
In the case of bad faith the buyer should also anticipate the possibility that the seller may not be able to perform to the full extent. Here, Civil Code Article 563 (1) only provides that “the buyer may demand a reduction of the purchase money in proportion to the value of the part in shortage” from a bad faith seller. Nevertheless, there are cases such as the case of a firm commitment of transfer from the seller when this article does not apply and the contract is interpreted as a regular failure to perform.
By contrast, in the case of good faith, the buyer does not anticipate non performance by the seller. Here, the buyer can obviously demand a reduction of the purchase money - “A buyer in good faith may cancel the contract if the buyer would not have bought the rights if the rights consisted only of the remaining portion” (CC Art 563 (2)). Then, a claim for damages is also possible when damages are incurred because of the demand for the reduction in the purchase money or cancellation of the contract (CC Art 563 (3)).
Nevertheless, these rights must be exercised within one year; in the case of a good faith purchaser measured from the time the buyer knew the ‘facts’ (i.e., the facts that the seller would be unable to transfer the rights) and in the case of a bad faith purchaser from the ‘time of the contract’ (i.e., where the time for fulfilling the seller's obligation was set in the future when the contract was executed, that time) (CC Art 564). The theory is that this will quickly stabilize the relationship of parties. Case law provides that exercising the rights extra judicially within one year satisfies the above requirements. In this way, once for example there is an extra judicially demand for reduction in purchase monies the enforcement of rights can be made within the period for extinctive prescription of claim (10 years, CC Art 167 (1))1.
(2) Seller's Warranty in Cases of Shortage in Quantity or Partial Loss of Object
Civil Code Article 565 provides that, “in cases where there is any shortage in the object of a sale made for a designated quantity, or in cases where part of the object was already lost at the time of the contract, if the buyer did not know of the shortage or loss,” the same provisions will apply as in the case where part of the rights belongs to others. In other words, the buyer may demand a reduction of the purchase money from the seller in proportion to the value. The contract can be cancelled “if the buyer would not have bought the rights if the rights consisted only of the remaining portion.” Furthermore, it is also possible to claim for damages. This is limited to good faith purchase as in “if the buyer did not know of the shortage or loss”; because if the buyer was in bad faith it could be considered that the agreement was reached to purchase the object on the basis of a shortage in quantity or partial loss.
Case Law2 defines a ‘sale indicating a quantity’ as “For a party to secure the actual quantity of a specified object the seller shall specify the area, volume, weight, numbers and units of measurement in the contract and the sale shall be determined by purchase monies based on such quantity.” However, for sale of land it is usual to note the dimensions recorded in the registry indicating the specific thing in the contract. However, even if the dimensions noted in the registry for the subject land are indicated in the sales contract this should not necessarily mean the seller agreed to transfer the land of recorded dimensions since it is well known that the dimensions recorded in the registry are not always the same as the actual dimensions3.
This is also true for the restriction of ‘within one year from knowing the facts’ (pursuant to CC Art 563 in accordance with Art 565).
There are important special provisions concerning sales specifying quantity in Article 526(1) of the Commercial Code. The buyer does not have an obligation to inspect under the Civil Code, but the Commercial Code provides in the case of ‘sales between merchants’ that the buyer should make an inspection ‘without delay’ on receipt of the subject things and must give immediate notice to the seller if there is a shortage in quantity.
Nevertheless, if the seller knows there is a shortage in quantity (bad faith) the aforementioned special provision does not apply since there is no need for seller protection (Commercial Code Art 526 (2)).
(3) Seller's warranty in cases where third parties have right of use
If a third party has the right of use for the subject matter of the sale (superficies, emphyteusis, servitudes, rights of retention, pledges, right of lease) it will preclude the buyer's rights. However, if we consider the example of land ownership being the subject of the sale, even if a third party has superficies for such land (the right to use the land of others in order to own buildings. CC Art 265) the buyer will become the owner and able to enjoy rental income. This is clear when a third party has servitudes (the right to use such land for activities such as passage and drawing water. CC Art 280) and unless it obstructs such servitude the buyer can also use the land. The value of the purchased land is not reduced to zero and a proportional solution is called for. The example above refers to the case where the subject of sale is encumbered, but the same is true in the opposite case when the servitude for the benefit of the real estate that is the subject matter of a sale (turns out) not to exist.
Hence, in principle the buyer is limited to only claiming damages against the seller, but the contract can be cancelled only in the case where the purpose of the contract could not be fulfilled because of the existence/non-existence of such servitude.
This situation is also subject to the one year time limit (CC Art 566). When the buyer is in bad faith it is assumed that the agreement was made on the basis that the thing that was the subject of sale was subject to a limitation of rights and so redress is limited to when the buyer was aware of the existence/non-existence of servitude etc. (the same as for ‘Cases of Shortage in Quantity or Partial Loss of Object’).
(4) Seller's warranty in cases where there is any latent defect in the subject matter
We consider the situation where the subject matter of a sale lacks the usual quality and features that such type of thing should have. Naturally, the buyer will not be able to profit to the extent anticipated. However, even though this may be the case, the value of such subject matter will not be zero. Even in this case the Civil Code treats the subject matter in the same way as the case in which there are third party use rights. In other words, in general only a claim for damages can be made, and the contract can be cancelled only where the purpose of the contract could not be fulfilled because of such defect. In addition, there is also the same one year time limit (CC Art 570). This is referred to as ‘warranty against defects’.
Case law states that even where special statutory limitations on the subject matter exist, these are a type of ‘defect’4. An example would be where 80% of a purchased land parcel was within the area for a road subject to urban planning.
It is necessary for this to be a ‘latent defect’. Case law interprets this in abstract terms stating ‘this could not occur if an ordinary buyer in such a transaction took the usual care or there is no negligence in the buyer not knowing of its existence’. However, in reality situations where the buyer knows of the defect are exempted. When the buyer knows of the existence of a defect it can be considered that the agreement on the sale of the subject matter was for things with such defect.
As in the case of ‘shortage in quantity or partial loss of object’ there are special rules for ‘sales between merchants’. The meaning and details are the same (Commercial Code Art 526).
There is debate about whether or not the rules for sellers warranty against defects and ‘cases of shortage in quantity or partial loss of object’ apply when the subject matter of the sale is prescribed only by type (unspecified things). If applied, where there is a shortage in quantity or a defect, the obligation to the buyer has not been satisfied but the seller is not obligated to provide another proper thing, which can be fulfilled. It is argued that the warranty thus appears to be limited to the case of specified things, where the provision of another proper thing is impossible.
This is a theoretically a very difficult issue, but in the case of a shortage in quantity there are many cases determining that the rules of warranty applies to unspecified things. Furthermore, for warranty of defect the case law states that if the buyer initially accepts the performance as is then it becomes an issue of warranty5.
Subsection 3 Buyer's obligation
1. Earnest money
The buyer's obligation for purchase monies becomes a problem depending on whether or not the monies paid by the buyer to the seller are all purchase monies. When a sales contract is formed there are cases when the buyer pays the seller a certain amount of monies. Various terms are used to refer to such payment, such as ‘application money’, ‘down payment’, and ‘earnest money’ etc.
The nature of the payment is determined by the intent of the parties. However the following types of custom predate the enactment of the Civil Code. In other words, if monies referred to as ‘earnest money’ are exchanged on formation of the contract the buyer can cancel the contract by forfeiting such monies. Conversely, the seller can cancel the contract by reimbursing twice the amount to the buyer. In this case there is no need to pay any other form of damages.
Here, the Civil Code provides that a proportion of the purchase monies paid by the buyer to the seller at the time the contract is formed is inferred to evidence the parties' intention in line with this custom (CC Art 557). However, the contract can be cancelled by either the buyer forfeiting the earnest money or the seller reimbursing twice the amount “until either party commences performance of the contract”. The case law6 states that ‘the commencement of performance of a contract pursuant to Article 557 (1) of the Civil Code………indicates the case when pre-conditional action that was necessary for the performance or partial performance based on an objective external perception was undertaken’.
2. Obligation for receipt of monies for the subject matter
Can the buyer refuse delivery when the seller tries to deliver the subject matter of the sale?
Article 524 of the Commercial Code states that when the buyer refuses to receive the object that is the subject of sale between merchants the seller may sell such object at auction (sale through the courts). There is no clear wording in the Civil Code, but at present there are many scholarly views that affirm the buyer's obligation to receive the subject matter. In general when the seller is subject to storage costs for the subject matter that the buyer refused to receive, the seller may claim payment against the buyer.
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Section 2. Gifts
“Gifts shall become effective by the manifestation by one of the parties of his/her intention to give his/her property to the other party gratuitously, and the acceptance of the other party thereof.” (CC Art 549). In this way, depending on the disclosed intent agreed by the donor and the donee, gifts also form a contract under Japanese law.
Therefore, the donor has an obligation to deliver the promised property to the donee. In the case of encumbered gifts, the donee shall also be obligated to perform such encumbrance.
However, unlike a contract where there is a value relationship between the parties, in a gift contract the donee, after all, receives the property at either no cost, or with just a slight encumbrance. Consequently, the need for protection is reduced to that extent. Here, Article 550 of the Civil Code provides that a gift not in writing can be cancelled. However, any portion of a gift that was not in writing for which performance has already been completed cannot be cancelled. This is because a contract in writing or already performed partially is likely to raise definite expectations of the donee and so it is difficult to cancel, but at the stage of a verbal promise such definite expectations are unlikely. In addition, while there is no clear wording for encumbered gifts, when the donee performs the encumbrance the interpretation is that it is then too late for the donor to cancel the gift contract.
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Chapter 6. Contracts for use of property
Section 1. Loan
1. The distinction between loans for consumption contracts and lease contracts/loans for use contracts
Contracts where one party causes another party to use property can be divided into contract types where the return of borrowed goods takes the form of things that are the same in kind, quality and quantity, and contract types where there is return of the thing itself. The former is referred to as ‘loans for consumption contracts’. The latter contract can be further divided depending on whether or not there is a value paid for the borrowing (rent) into ‘loans for use contracts’ (things on which value is not paid) and ‘leases’ (things on which value is paid).
For consumer loans, the Civil Code does not distinguish between contracts for value and no value. This creates a problem that is discussed later.
2. The nature of loans for consumption contracts
The definition of loans for consumption contracts is provided in Article 587 of the Civil Code.
“A loan for consumption shall become effective when one of the parties receives money or other things from the other party by promising that he/she will return by means of things that are the same in kind, quality and quantity.”
This definition differs from the definition of a sales contract; loans for consumption contracts will not be formed just by a promise by both parties. In addition to agreement, loans for consumption contracts require the delivery of the subject matter and the effectiveness of other provisions. Compared to a sales contract that is a consensual agreement that is formed just through promises, contracts such as loans for consumption contracts are referred to as substantial contracts.
Why is this so?
In the case of loans for consumption contracts there are no regulations concerning interest to supplement the intent of the parties in Articles 587 to 592 of the Civil Code. In other words, the basic form of a loan for consumption is without interest. Consequently, whatever the agreement, there is no great need to protect the trust of the borrower in relation to the agreement. Therefore, loans for consumption contracts are not formed simply by agreement and the contract becomes effective on the actual delivery of the thing.
However, what is of major significance to current transacting companies is naturally loans for consumption contracts with interest. Consequently, the rationale that ‘loans for consumption contracts without interest are deemed to be loans for substantial contracts’ is inapplicable for most contemporary contracts. In other words, there is no rational reason to deem these to be substantial contracts.
Hence, under present doctrine there are many who perceive that at the very least a loan for consumption contract with interest is formed just by agreement. Therefore, from the principle of freedom of contract, if a party's intent is for ‘a contract to be formed just by agreement’ it would only be natural for such agreement to be formed. However, the existence of Article 587 of the Civil Code makes the courts reluctant to directly recognize the formation of consensual loans for consumption contracts. As a result, there is leaning towards dealing with cases of financial institutions breaching loan promises not as non performance of contract, but as tortious acts7.
In reality, financial institutions often enter into promises with borrowers to grant loans divided into a number of portions (loan installment contracts) and promises to lend any number of times up to a specified limit (recurrent loan contracts). A breach of these types of promises is at the very least tortious unjust refusal.
Historically in Japan there has been no banning of interest itself. The Civil Code certainly refers to the principle of loans for consumption without interest, but Article 513 of the Commercial Code states that a lender can claim statutory interest (6% annually, Commercial Code Art 514) when there has been a loan of money between merchants even if there was no agreement on interest: interest arises in principle. However, limits on interest have been in place for a long time.
Currently, the Interest Rate Restriction Law prescribes the maximum amount of interest. This is 15% per annum for principal amounts of 1 million yen or more.
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Section 2. Lease
As already explained, lease contracts are lending contracts where the lender receives the return of the things lent, and the borrower pays a value (rent) for the borrowing. A typical example is a contract to live in a rented dwelling on the payment of rent.
Lease contracts are consensual contracts and a formed only by agreement of the parties (CC Art 601).
2. Borrower's obligation
It goes without saying that the most important obligation of a borrower (lessee) on a lease contract is the obligation to pay rent (obligation to pay rent). Other than that there are various regulations such as the obligation to use the subject matter in an appropriate way (obligation to adhere to method of use, mutatis mutandis application of Civil Code Art 616 to Art 594 (1)), the obligation to return the things by the period specified in the contract (obligation to return the thing, mutatis mutandis application of Civil Code Art 616 to Art 597 (1)), and the prohibition of assignment of the lessee's rights or sublease (or lend) a leased thing without the approval of the lender (lessor) (right to borrower)(prohibition of unapproved transfer of lease rights, and unapproved assignment, CC Art 612).
3.Protection for land lessees and dwelling lessees
In the domain of land and dwelling rentals the aim is to protect the land lessees and dwelling lessees through case law and special legislation.
Case law states that in land lessees and dwelling lessees, even if there is default by the lessor, unless such default causes major damage to the trust relationship between the lessee and the lessor, the lessor cannot terminate the contract8. Even if the lessee does not pay rent for about 1 to 2 months this would not allow the lessor to terminate the contract. This is referred to as the doctrine of ‘damage to the trust relationship’.
In addition, in terms of special legislation there is ‘the Land Lease and House Lease Act’. An outline of that Act is provided below.
The land lease rights applicable under the Land Lease and House Lease are the lease rights for land for the purpose of building ownership (Land Lease and House Lease Act Art 2-1). This type of land lease right first limits the minimum term (30 years) (Land Lease and House Lease Act Art 3). Further, if there is a building existing after the expiry of the contracted term the lessee of the land can request renewal of the contract (Even if there is no special intent indicated, the ongoing use of the land means a request has been made). The lessee of the land cannot be refused renewal of the contract unless there are ‘just and reasonable grounds for dismissal’ (Land Lease and House Lease Act Art 5, 6).
By contrast a minimum term for building leases is not prescribed for leases with prescribed terms of less than one year and those considered not to have a prescribed term (Land Lease and House Lease Act Art 29). However, leases with definite terms will require ‘just and reasonable grounds for dismissal’ if the lessor is to either refuse the renewal of contract or the lessor wants to submit a notice to have the lease with no prescribed term terminated (Land Lease and House Lease Act Art 28).
However, land lease rights without renewal of the contract term (fixed land lease rights) are also recognized under specific conditions (Land Lease and House Lease Act Art 22 to 24). In addition, for house leases a fixed house lease system has been introduced since 1999. In the case of a fixed term house lease the regulations concerning contract renewal (such as the need for just grounds for dismissal to reject renewal) are excluded as already explained and the house lease contract terminates with the initially contracted expiry date (Land Lease and House Lease Act Art 38 (1)). However, depending on what was written at the time of the contract, there are conditions imposed such as a reminder notice to be given to the lessee during the period of 1 year to 6 months prior to the expiry date.
(2) Perfection of lease rights
When a lessor transfers the thing to be leased to a third party the principle is that the lessee cannot assert a right to lease against the new owner. However, even on this point, the Land Lease and House Lease Act prescribes the following type of regulation to protect the lessee.
For a land lease, even if the lease rights themselves are not registered, a lessee who has entered into the land lease for the purpose of acquiring the building thereon may, if such building is registered, assert the lease rights against a third party as well (Land Lease and House Lease Act Art 10 (1)).
Even for a residential building lease, ‘a lease of a building is effective against a subsequent acquirer of the property rights when the building had been delivered, even without registration’ (Land Lease and House Lease Act Art 31 (1)).
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Chapter 7. Contracts for provision of services
1. Service types
It is impossible to live in modern society without receiving services based on contract. The Civil Code defines a number of types of contracts for some form of service to be provided by one party to another; specifically, ‘contracts for work’, ‘employment’, ‘mandates’, and ‘deposits’. However, the criteria for these four categories are actually not very clear.
Three types: contracts for work, employment and mandates are basically explained as follows. First, there is a division into whether the purpose is to provide labor itself or provide the results of labor (completion of work). The former is taken to be an employment or a mandate and the latter a contract for work. Then, amongst contracts for which the purpose is the provision of labor itself there is a breakdown into employment and mandates based on whether the provision of such labor is under the direction of the employer (employment) or whether undertaken on the basis of a specific discretion of the labor providers (mandate).
However, even if this is the case, it is not clear which will apply for a specific contract. It is preferable to consider how, under the broad concept of contracts for provision of services, those contracts are regulated by the Civil Code and whether or not there should be such regulation.
Also, amongst contracts for provision of services there are those that are subject to a number of laws referred to as labor laws that provide for the contractual relationship between employers and employees (the Labor Standards Act is at the core of these). These are referred to as labor contracts. There are various forms of employment and a special act called the ‘Labor Contract Act’ was promulgated in 2007.
Contracts for provision of services are consensual contracts and formed only through agreement (CC Art 623, 632, 643). Agreements for the provision of services for custody of things also form a contract even if there is no actual acceptance of things. However, the legal relationship pertaining to custody of things commences with the actual acceptance of things (CC Art 657).
If there is an agreement about the existence (or not) of remuneration and the payment period, such an agreement obviously prevails. The issue is when there is no precise agreement.
First we consider what happens when there is no agreement about the existence (or not) of remuneration. On this point the Civil Code states that employment contracts and contracts for work are contracts for value and remuneration is recognized in principle (CC Art 623, 632), but mandate contracts and deposit contracts are in principle contracts for no value (CC Art 648 (1), 665).
3. Service provider's duty of care
For contracts for provision of services when there is demand for completion of specific work, it is not an issue what degree of care a service provider must exercise to perform such work. The point is that the work is completed and no questions are asked about the process. Further, when a party takes action on the basis of direction by another party (the person receiving the service) it is only fair to act in accordance with such direction.
By contrast, when a service provider exercises his/her discretion, the issue is the extent to which care was taken in exercising such discretion. Here, Article 644 of the Civil Code prescribes in relation to the mandatary there be “care of a good manager” (duty of good management). In addition there is provision for necessary obligations, “if so requested by the mandatary, report the current status of the administration of the mandated business at any time” (CC Art 645). However, when things are held gratuitously a person shall “exercise care identical to that he/she exercises for his/her own property” in respect of the thing held (CC Art 659).
When there is a request for completion of a specific work there is the issue of what to do if the completed work is defective. As was explained in relation to the seller's warranty, this also calls for a proportional solution. This is prescribed in the Civil Code from Articles 634 to 640. To state it very simply, when there is a defect in the subject matter of the work the party who orders the work can demand repairs and claim for damages from the service provider (person contracted for the work) for a period of one year from delivery . In addition, when the purpose of the contract cannot be satisfied due to such defect the contract can be cancelled. This is virtually the same as for the seller's warranty.
5. End of contract
If the scheduled service has been provided and remuneration paid the end of the contract is clear. Can then a contract end by terminating it midway?
When the completion of the specified work has not been received and where there is no relationship of services being provided to the direction/instruction of the party receiving the services, there is a relationship of trust between the receiver of the service and the service provider who is providing services based on his/her discretion. In this situation the relationship of trust between the parties is important. Here, either one of the parties can cancel the mandate (CC Art 651 (1)). When remuneration is involved and the party receiving the services unilaterally cancels the mandate, the service provider will receive damages under a separate provision (CC Art 651 (2)).
Once a specific work has been accepted, the service provider is not at liberty to cease the work. By contrast, the party ordering the work can cancel the contract, but the service provider can secure due remuneration (CC Art 641).
The above two prescriptions are combined when there is a relationship of service provided based on the direction of the party receiving the service.
This is because in addition to the element of a trust relationship existing between the parties, the fact of ‘following direction’ is considered a comprehensive acceptance of completing the work. Then, “either party may request to terminate at any time” (CC 627(1)), but when a period of five years or less is specified, unrestricted cancellation during that period is precluded and when a longer period is specified, unrestricted cancellation is not possible for either party until after the expiration of five years. When a term is specified, it can be said there is agreement to act ‘in accordance with direction’ during that period. However, the thinking is that it is not appropriate to leave (a party) in a subservient relationship for a very long term.
For care of things, the party that requested the care may demand the return of the same at any time (CC Art 662). If the party requesting care specified a term of care, the thing must be cared for during that period (CC Art 663).
6. Regulations under Special Acts
There is an infinite variety of specific stances for contracts for provision of services ranging from large scale items such as the undertaking to construct a building to the level of giving an elderly person a bath. Thus, particular contracts for provision of services are subject not only to the provisions of the Civil Code, but also the Commercial Code and other various Special Acts.
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Chapter 8. Other contracts
Section 1. Contracts for formation of organizations
1. Partnership contracts
There are various organizations in society. A contract to create this type of organization is referred to as a partnership contract. Article 667 paragraph 1 of the Civil Code states that the details of a partnership contract are provided “when each of the parties promises to engage in joint business by making a contribution”. The ‘business’ referred to here can be construed as for charitable purposes, private purposes as well as neither of such purposes.
When a partnership is formed “The contributions of the partners and other partnership property shall be jointly owned by all partners” (CC Art 668). Then the partnership property is subject to organizational restraints and each partner is unable to dispose of his/her share (CC Art 676 (1)) nor seek division of the partnership property before the partnership is dissolved and liquidated (CC Art 676 (2)). By contrast, each partner owes a separate responsibility in proportion to the value of each partner's contribution. Also, the creditors against the partnership can levy the partnership property.
2. Anonymous association contract
However, although the name may be similar to partnership within the Civil Code, Article 535 of the Commercial Code provides for anonymous associations that are completely different types of entities. These are contracts where ‘a party invests in the business of another party with the promise of sharing in the profits arising from said business’. This is not a formation of an organization, and in terms of loans for consumption contracts, the lent monies are restricted to the purposes of running the business. In addition, where the amount of repayment and timing is conducted through distribution of profit this can be said to be a matter of specific agreement. Investments by anonymous association members become the property of the business owner (Commercial Code Art 536 (1)).
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Section 2. Third party beneficiary contracts and others
1. Other ‘type’ contracts
In addition to ‘type’ contracts defined in the Civil Code are life annuities (CC Art 689) and settlement contracts (CC Art 695). The Civil Code naturally anticipates their existence, but contracts not defined in ‘Part 3 Debt, Chapter 2 Contracts’ include insurance contracts and contracts establishing real rights such as mortgages.
2. Third party beneficiary contracts
Furthermore, while not a ‘type’ contract one variety of contract defined in the Civil Code is the third party beneficiary contract. This is a contract type where a third party other than the contracting party obtains rights based on a contract between other parties.
In principle a contract creates rights and obligations only between the parties to the contract, but rights can be provided to a third party by special agreement. A life insurance contract is one typical example, but for sales contracts if a buyer and the party to whom payment is to be made, or more precisely if there is agreement between the seller and the buyer for the obligee for the claim on payment to be by a third party other than the seller it becomes a sales contract that is a third party beneficiary contract.
However, no matter the extent to which rights are acquired, the intent of such third party cannot be ignored. Hence, Article 537 (2) of the Civil Code provides for this special contract type, stating that the rights of the third party shall accrue “when the third party has expressed his/her intention to the obligor to enjoy the benefit of the contract” (expression of beneficial intent). In the above sales contract example, if the third party expresses intent to the buyer by saying ‘I will receive the purchase monies for the sale’, such third party will become the obligee with a claim on the purchase monies for the sale. However, when the recipient of insurance payments is to be a third party, such third party's expression of intent to benefit is invalid (Commercial Code Art 648, 675).
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Decision of the Great Court of Judicature, 9 November 1935, Vol. 14: 1899
Decision of the Supreme Court, 20 August 1968, Vol. 22 No. 8: 1692
Decision of the Supreme Court, 20 August 1968/ previous note 2.
Decision of the Supreme Court, 14 April 1966, Vol. 20 No. 4: 649
Decision of the Great Court of Judicature, 13 March 1925, Vol. 4: 217 et al
Decision of the Supreme Court, 24 November 1965, Vol. 19 No. 8: 2019
For example, Decision of the Tokyo High Court, 1 February 1994, Hanrei-Jiho No. 1490: 87.
For example, Decision of the Supreme Court, 28 July 1964, Vol. 18 No. 6: 1220
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Part 3. Performance and non-performance of contracts
Chapter 9. Contract performance
Section 1. Fulfillment of obligations
Subsection 1. Performance
‘When and where should performance occur?’ is prescribed by the contract (Civil Code Articles 412 and 484 are provisions for supplementation when the agreement is not clear), but what can becomes an issue is ‘Which obligation has been satisfied when a specified performance has been provided?’ (allocation of performance).
This is also determined by the designation of the person tendering the performance (CC Art 488 (1)). When the person tendering the performance does not make the designation, the person who receives the performance may determine the particular obligation to which the performance applies. However, the person who tenders the performance may object (CC Art 488 (2)). When neither party makes the designation, the performance shall be governed by Article 489 of the Civil Code. Performance is allocated beginning with the earliest due obligations and that performance of obligations which would have the most benefit (such as high interest) to the obligor.
‘Which kind of performance constitutes fulfilment of obligation?’ is of course prescribed in the contract. If the obligor and the obligee agree to provision of performance other than the original performance obligated, such ‘other performance’ becomes the performance. This is referred to as ‘substitute performance’ (CC Art 482).
2. Performance for a holder of quasi-possession of claim
Against whom should the performance be provided to effect the extinguishment of the obligation? There are obviously cases where performance in respect of the obligee is acceptable, while performance in respect of an agent authorized for collection and a trustee in bankruptcy is, naturally, effective. Then, what is the case when a person not given such appropriate authorization for collection gives the appearance that he/she has such authority, and the obligor performs the obligation?
On this point Article 478 of the Civil Code states, “Any performance made vis-à-vis a holder of quasi-possession of the claim shall remain effective to the extent the person who performed such obligation acted without knowledge, and was free from any negligence.” In other words, when performance was made in respect of ‘a person who gives the appearance that he/she has the authority for collection or is seen to be the obligor from the perspective of the performer upon the standards relating to transactions generally accepted by society’ = ‘a holder of quasi-possession of claim’, where the performer was unaware that the person did not have the authority to receive such performance (= ‘good faith’), and when there was no negligence in not knowing, the effect is to extinguish the obligation. This type of performance is referred to as ‘performance for a holder of quasi-possession of claim’.
3. Repayment of bank deposits
A frequent problem arises in relation to the repayment of bank deposits. Here, case law expands the interpretation of ‘performance’ in Article 478 of the Civil Code to include prepayment of fixed-term deposits as ‘performance’. Furthermore, this article is applied by analogy to set-off in the loans secured by deposits1 as well as loans from insurance companies to insurance policy holders that are secured by the redemption value of life insurance policies2. We will consider another problem, i.e. prepayment of fixed-term deposits.
Suppose the case where a person giving the appearance of being the depositor goes to the bank before the maturity of the fixed-term deposit and requests repayment, and the bank complies with such request. In this case, we can find two actions.
(1) Consensual termination of the fixed-term deposit contract;
(2) Its performance.
Article 478 of the Civil Code is the provison relating to performance. However, in case law3 the problem is dealt with under Article 478, which treats actions (1) and (2) as a whole. In other words, if the person who requested prepayment of a fixed-term deposit is ‘a person who gives the appearance that he/she has the authority for collection or is seen to be the obligor from the perspective of the performer upon the standards relating to transactions generally accepted by society’ the ‘consensual termination + repayment’ is effected and the claim on the fixed-term deposit is extinguished.
It is normal for a bank to repay a fixed-term deposit prior to maturity (the interest rate becomes the same as an ordinary deposit). Therefore, it is not as though there is an independent juristic act of ‘consensual termination’, and the decision is based on recognition of the current practice.
4. Repayment using cash card
Further, for repayment of bank deposits there is a regulation that “as long as the bank has verified and concluded with due care that the seal used on the repayment request and other documents is the registered seal, the documents shall be treated as not false, and the bank shall not be liable for damage incurred from the use of such documents even if such documents have been counterfeited, altered or subject to other wrongful use.” It is not that verification of the seal by itself is acceptable, it also requires due care be used in all procedures (Note that signatures are not commonly used in Japan as a method for securing intent. Seals are used).
Nowadays, repayment is often conducted using cash cards. Consequently, cash card agreements stipulate, “If cash has been dispensed after the automated teller machine has verified the card and that the personal identification number used for the operation of the automated teller machine has matched the registered personal identification number, the bank or allied banks shall not be liable for any damage that arises, even if the card or personal identification number is counterfeited, altered, misappropriated or subject to some other accident.” The Supreme Court states in relation to the effect of this contractual stipulation that “Even if a person other than the depositor receives repayment using an automatic teller machine provided by the bank, if the actual cash card provided to the depositor by the bank is used and the correct personal identification number input, and the bank repays the deposit after the automatic teller machine has verified the cash card and the personal identification number the bank will have discharged the purpose of the contract without liability, unless there are special circumstances such as unsatisfactory management of the personal identification number by the bank.4”
A point to note is the proviso “unless there are special circumstances such as unsatisfactory management of the personal identification number by the bank.” When this type of new system is implemented the person implementing the system is responsible for considering any undermining of client trust in the safety of the system. Therefore, there is a requirement for due care necessary for establishment and administration of the system. No matter how the discharge of a contract is satisfied, a person who simply provides a dangerous system is unable to assert its validity.
Thus, in a fact pattern where applying Article 478 of the Civil Code was at issue, the Supreme Court determined there were also situations when a bank is found to be grossly negligent and in applying this article, found that performance had not been discharged5. The bank's deposit in this case used a passbook and not a card (In Japan, passbooks are issued for bank deposits, then held by the depositor with the transaction history recorded therein) and when the passbook was inserted into the automatic teller machine and the personal identification number pressed, withdrawals could be made. However, this was not stipulated in the contract, nor the depositor know about it. The depositor left the passbook in his car and it was stolen; the personal identification number was the same as the car's license plate number and so a lucky thief was able to make the withdrawal.
The decision in the case was that there should be gross negligence since the explanation to the depositor was also lacking: “For a bank to be considered not grossly negligent in relation to the repayment of deposit through the method of automated payment to a holder of quasi-possession of claim, it requires not only that the machine works correctly at the time of payment, but that the bank has taken the utmost possible care in relation to the administration of the entire automated payment system, necessary to exclude payment to an authorized person. This includes informing the depositor of the ability to obtain repayment of the deposit by way of the automated payment so that depositor does not make an omission in his/her management of items such as the personal identification number.”
Subsection 2. Performance by third parties
The obligor is required to perform the obligation. However, the matter of ‘who can perform the obligation’ is not limited to the obligor. This is determined by the intention of the parties in contract. Although Article 474 (1) of the Civil Code says that “The performance of an obligation may be effected by a third part” whereas “cases where the nature of such obligation does not permit such performance or the parties have manifested their intention to the contrary”, this only restates the principle. This is referred to as ‘performance by third parties’.
A third party is separated into a person called upon by the obligor to perform the obligation as a substitute for the obligor and a person who performs the obligation even though not called upon by the obligor. A person who has not been called upon by the obligor is free to perform the obligation, if such person has no interest in whether or not the obligation is performed (for example, a third party who is providing security). By contrast, it is stated that a third party who has no interest in an obligation may not perform the obligation against the will of the obligor (CC Art 474 (2)).
A third party who performs the obligation has the right to obtain reimbursement. The wording that provides the grounds differs on whether the person was called upon by the obligor to undertake the performance (CC Art 650 (1)), the person was not called upon by the obligor to undertake the performance (CC Art 702 (1)), or the person was a provider of security (pledgor) (CC Art 351, Art 371, Art 567(2)).
Subsection 3. Relationship of claims and obligations of multiple parties
1. Joint and several obligations
An important case when there is right to obtain reimbursement is the relationship between joint and several obligations and guarantee obligations.
So far we have considered examples where there is one obligor and one obligee, but when there is a relationship of claims and obligations between multiple parties there are also cases where multiple obligors are obliged to provide performance at the same time. This type of obligation is referred to as ‘joint and several obligations’.
However, under Japanese law there is no presumption of joint and several obligations, even if there are multiple obligors. By contrast, when the provision of performance is divisible, they are in principle divisible obligations (CC Art 427).
2. Guarantee obligations
Again, in the case of the provision of the same contents by multiple obligors there are also cases where there is a principal-supplemental relationship between the obligations of each obligor. Guarantee obligations are such an example. Article 446 (1) of the Civil Code states, “A guarantor shall have the responsibility to perform the obligation of the principal obligor when the latter fails to perform such obligation.” When the guarantor has received a demand for performance from the obligee, the guarantor has the right to first demand the obligee to demand performance of the principal obligor (CC Art 452). Even where the obligee has demanded performance and the principal obligor does not perform, the guarantor may refuse to perform the guarantee obligations when the guarantor has proved that the principal obligor has the financial resources to pay his/her obligation and that the execution would be easily achieved (CC Art 453).
Consequently, guarantee obligations are supplementary. This is troublesome for the obligee. So, in actuality there makes often a relationship of joint and several obligations between the guarantee obligations of the guarantor and the principal obligation. The obligee is free to demand performance from either the guarantor or the principal obligor. The obligation incurred by the guarantee in this case is referred to as a joint and several guarantee obligation.
(Simple or joint and several) guarantee obligations are formed by contract between the obligee and the guarantor. In general, the guarantor becomes the guarantor at the request of the principal obligor, but this relationship between the parties has no direct relationship in formation of the guarantee obligations.
In addition, regulations to protect the guarantor were implemented with revisions to the Civil Code in 2004 for contracts where a natural person comprehensively guarantees a certain portion of items such as loans incurred by the principal obligor. Such contracts must specify the maximum amount of the guarantee, and also restrict the term. In addition, all guarantee contract, including the above-mentioned type of guarantee contract, have become to be required to be formed through documentation (CC Art 446(2) and (3), 465-2 to 465-5).
3. Obtaining reimbursement among joint and several obligors; the guarantor obtaining reimbursement from the principal obligor
As mentioned above, obtaining reimbursement between obligors becomes a problem when the obligation is incurred by multiple obligors.
The obligation to perform completely is incurred by the relationship between joint and several obligors and the obligee, but there should be agreement about burden ratio (equal burden when there is no agreement) in the internal relationship between joint and several obligors. The obligor who performs the obligation can obtain reimbursement from other joint and several obligors based on this agreement to the extent of the portion of the obligations which is borne by the other joint and several obligors (CC Art 442).
In the case of guarantee obligations, the relationship with the principal obligor means the proportion of obligation borne by the guarantor is zero. The guarantor can demand full reimbursement from the principal obligor (CC Art 459, 462).
Subsection 4. Subrogation by performance
If a person who has the right to obtain reimbursement from the obligor, he/she “may exercise any and all rights possessed by such obligee as the effect of, and as a security for, such right” to the extent he/she may seek reimbursement under his/her own right (CC Art 501). A person with the right to obtain reimbursement for performing the obligation takes the status of a substitute in relation to the original obligee, and this is referred to as a ‘subrogation by performance’.
Specifically, the claim performed (referred to as the original claim) is legally transferred to the performer together with the security interest and other items that secure such claim6. Accordingly, the performer is able to exercise the original claim, but the point is that when the original claim is subject to security interest such security interest can be exercised, and a demand for guarantee obligations can be made against the guarantor, when the original claim has a guarantor.
Obviously, since it should be acceptable if the performer is satisfied by the right to obtain reimbursement, the original claim or exercise of the security interest is only approved ‘to the extent he/she may seek reimbursement’. For example, even if the original claim is something that accrues interest at 10% per annum, the right to obtain reimbursement can only be for a late payment charge that is within statutory interest, which would be a late payment charge of only 5% for civil cases and only 6% for commercial cases, unless there is a special contract provision with the obligor.
However, other requirements must also be satisfied for the aforementioned type of subrogation to be validated.
When a third person who has ‘legitimate interest’ performs the obligation he/she will naturally subrogate the obligee when acquiring the right to obtain reimbursement (CC Art 500). There are two types of persons who have ‘legitimate interest’: ‘a person on whose property the attachment is levied unless he/she performs the obligation’ and ‘a person who will suffer the loss of value of his/her own rights unless he/she performs the obligation’. The former is joint and several obligors/guarantors and third party pledgors/mortgagaros. Specific examples of the latter are subordinated secured parties and general obligees. This is referred to as statutory subrogation.
A third person with ‘legitimate interest’ would be given the rights of subrogation by performance without any requirement other than performance (CC Art 500). By contrast, when a third person who does not have ‘legitimate interest’ performs the obligation it is in a sense the free choice of that person. Therefore, there is no special need for protection. However, the obligee can transfer his/her own rights to such third person. in that situation. Article 499 of the Civil Code states a performed person should ‘acquire the approval of the obligee upon such performance’ for subrogation (CC Art 499 (1)), and set up the requirements for assertion of assignment of claim (CC Art 499 (2)). This is referred to as ‘voluntary subrogation’.
In other words, voluntary subrogation is based on full consent.
Further, when there are multiple guarantors and third party pledgors/mortgagors (including third party acquirers of the thing encumbered by the security) the relationship of rights amongst such persons must be defined in relation to the subrogation.
In such case, Article 501 of the Civil Code provides the following regulations:
(1) When there are multiple guarantors the respective burdens shall be equal;
(2) When there are multiple third party pledgors/mortgagors, the proportion of the burden shall be divided according to the proportion of value of the real estate that is encumbered by security;
(3) When there are both guarantors and third party pledgors/mortgagors, first the proportion of burden is divided by the number of parties. For example, in the case of two guarantors and three third party pledgors, the proportion will be guarantor 2 to third party pledgor/mortgagor 3. Furthermore, rule (1) is applied with equal sharing of the burden between guarantees, and rule (2) is applied with the burden divided in to the proportion of the value of the real estate that is encumbered by security between third party pledgors/mortgagors.
Further analysis is required in relation to third party acquirers of the thing that is encumbered by the security, which leads to formulation of complex rules.
3. Special provisions for financial transactions
Subrogation through performance is a rational system. However, in actual financial transactions, many types of special contract provisions are concluded and the disposition often differs from the explanation given above.
First, for the aforementioned rules (1) and (3) there are provisions defining different proportions of subrogation. In particular, when a ‘credit guarantee corporation’ (Special public corporations created to make it easier for small and medium enterprises to raise funds from financial institutions by executing guarantees, located in all regions in Japan) is the guarantor, it agrees with other guarantors and third party pledgors/mortgagors that the burdon ratio of the credit guarantee corporation is zero; the entire amount in relation to the obligee from the other guarantors and third party pledgors can be subrogated if the credit guarantee corporation performs the guarantee obligation. This is a special provision relating to the proportion of subrogation. In terms of the right of the credit guarantee corporation to obtain reimbursement from the obligor this special provision is linked to a special provision of interest rate that is higher than statutory one. This is a special provision relating to the scope of right to obtain reimbursement.
In addition, banks include the following type of special provision for non-exercise of subrogation rights in contracts of guarantee executed with the guarantor.
“The rights acquired by the guarantor from the bank through subrogation when the guarantor performs the guarantee obligations will not be exercised without the consent of the bankas long as the transactional relationship between the principal obligor and the bank continues. That right or ranking shall be assigned to the bank at no charge, if there is a request from the bank.”
If any performance occurs with respect to part of a claim, there will be subrogation by the performer, but when the bank still retains a claim the bank has the right to exercise the mortgage held by the bank (CC Art 502 (1)). However, the bank wants to exercise the mortgage at a time of its own choosing, and wants to avoid exercising the mortgage at the convenience of the subrogated performer. That is why the aforementioned special provisions are agreed.
In addition, banks have included special provisions in the guarantee contract with the guarantor so that the guarantor will not assert discharge even if the bank changes or cancels another guarantee or security. This is referred to as special provision for exemption of security interest preservation, which alters the default rule is found in Article 504 of the Civil Code.
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Section 2. Lapse due to period of time
Other than the transfer resulting from the intent of parties, the relationship between claim and obligation can also transform over time. A typical example is extinctive prescription.
Article 167 (1) of the Civil Code prescribes the following in relation to the extinctive prescription of claims. Eventually, ‘an ongoing situation of a claim not being exercised’ will reach a point of extinctive prescription, then it is treated as extinct. ‘An ongoing situation of a claim not being exercised’ is the situation when the obligor does not actively take recognizable action in relation to the existence of the obligation, the obligee does not institute legal procedures based on the existence of the claim, and even a part of performance of the obligation remains unfulfilled.
In principle, extinctive prescription is 10 years (CC Art 167 (1)). However, Article 170 of the Civil Code defines various terms from 1 to 3 years by claim type. In addition, Article 522 of the Commercial Code stipulates that claims arising out of commercial transactions shall be extinguished after five years have passed unless a shorter period is defined in the Civil Code. This article applies regardless of whether either the obligee or the obligor is a merchant, because of the need for speed in determining the relationship of rights in such a case.
A particular feature of Japanese law is that extinctive prescription is only recognized when it is asserted by the party benefiting from the extinctive prescription (CC Art 145). The court cannot recognize extinctive prescription without assertion by the party.
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Chapter 10. Breach of contract and compulsory performance
Section 1. Impposibility to perform
Subsection 1. Damages due to default
1. Reasons attributable to the obligor
So far we have considered the performance of obligations that arise from a contract, but there are obviously cases when performance is also not possible.
In this situation, we can divide the scenarios into two by considering the case where performance has not occurred even though performance conformed with the contract is possible; and the case where performance conformed with the contract is not possible. For example, enforcement of performance can be considered in the former scenario, but not in the latter.
Here, we consider the case that performance conformed with the contract is no longer possible.
First, we must consider whether or not the obligor is responsible for the reason that performance is not possible.
One might think that it would be easy to determine ‘whether or not the obligor has any responsibility’. However, even where a warehouse burns down because it catches on fire from a neighborhood fire and a thing to be sold is destroyed, one cannot simply state this was not a reason attributable to the obligor. For a subject matter with a high value there are also cases where the obligor should be obliged that the thing should obviously be stored in a place that is fire proof with security provisions. Then, if the thing is stored cheaply in a wooden warehouse located in dense housing district and is burnt down because of a fire that spread from a neighboring house, such a fire should be considered a reason attributable to the obligor.
Consequently, the determination of ‘whether or not there are reasons attributable to the obligor’ ultimately depends on the content of obligation incurred by the obligor. Thus, ‘the content of obligation incurred’ is defined by the contract. This includes the duty of care when a thing is stored and the duty of care when a thing is transported. However, in order to estimate that there are ‘reasons attributable to the obligor’, we should state that ‘the performance of the obligation conformed with the contract has become no longer possible, which was caused by the fact that the obligation of the contract was not performed’. The point is what obligation has been incurred.
‘Impossibility of performance’ is considered as ‘breach of contract’ only when its reason can be attributable to the obligor, and the phrase, ‘impossibility of performance’, is used when it is considered as ‘breach of contract’. By contrast, when there are no reasons attributable to the obligor, this becomes a question of ‘risk allocation’, as explained later.
2. Obligation for damages
The rights recognized for the obligee when there is impossibility of performance is first the entitlement to demand damages from the obligor (CC Art 415, second sentence). This will be by payment of money (CC Art 417). The obligee, in principle, has no right to demand the provision of another very similar thing.
The first problem is the scope of damage that will be compensated. Article 416 of the Civil Code states that only the damage of which causal factor was normal or could have been foreseen by the obligor at the time of default should be compensated. This resembles the rules of Hadley v. Baxendale case7 in England.
However, it is not necessarily clear how to assess what causal factor was normal or could have been foreseen by the obligor. This gives wide discretion to the judge. Therefore, there are many examples where amounts of compensation for damages are agreed in the contract (liquidated damages). When there is this agreement, demand for compensation for damages can be made with only proving non-performance of a party. The courts are basically unable to increase or decrease the amount (CC Art 420 (1)). However, when the amount is excessively large the amount can be decreased because it contravenes public policy (CC Art 90).
Subsection 2. Cancellation of a contract
1. Effectiveness of cancellation
Demand for the compensation for damages discussed above can also be made even if the contract has not been cancelled. In the case of a bilateral contract, the obligation of the party that demanded damages to the other party continues to exist. We consider the example of a contract for A to sell a painting he/she owns to B, and A loses the painting or A sells the painting to a third party because A did not take due care. Then B has the right to demand damages from A, and B continues to have an obligation to pay the price agreed in the contract to A.
However, this involves a monetary obligation for both parties so the amounts are set off and only the difference paid. By contrast, in the case of a contract between B and A to exchange paintings they respectively own, when A cannot perform his/her obligation B has the right to demand compensation for damages from A, but A has the right to demand transfer of the promised painting by B.
However, this result can be unsatisfactory for B. Here, Article 543 of the Civil Code states the contract between B and A can be cancelled by B.
The effect of cancellation is that, in a word, such contract is treated as never having existed8. Therefore, if B cancels the contract to exchange paintings with A, A does not have to deliver his own painting to B. In addition, if the painting has already been delivered, A can demand the return of such painting (CC Art 545 (1)). However, even if one says ‘such contract did not exist’, B has certainly incurred damage. Then, Article 545 (3) of the Civil Code states that even if the contract is cancelled B shall be able to assert a claim for damages against A in relation to existing damages. The scope of damage that should be compensated is determined by the rule in Article 416 of the Civil Code. Since B also does not have to perform his/her obligations he/she profits to such extent. That amount is deducted from the amount of claim of compensation for damages.
2. The importance of impossibility of performance
From the wording in Article 543 of the Civil Code, the obligee may cancel the contract at any time when there is impossibility of performance. However, in the example of a contract to sell a piano, if a wall of the purchaser is damaged when the piano is delivered, there is the question of whether or not the cancellation of the contract by the buyer to buy the piano shall be permissible. This would be based on the impossibility of performance for the reason as follows; the seller owed the associated obligation of ‘no damage to be caused to the buyer's home on delivery’ and the seller has become unable to perform this obligation because he/she has already caused damage to the buyer's home. However, there is no need to go this far. It is thought that approval of the demand for damages for the scratch on the wall is sufficient. In addition, for an example of a sales contract executed in respect of a cedar forest, when some cedar are felled following the execution of the contract, the buyer is not considered able to cancel the contract. It may be acceptable to cancel the contract if almost all the cedar has been felled, but it would also be unusual to cancel the entire sales contract because of the felling of some of the cedar. In some cases just to have compensation for damages would suffice.
When thinking about whether or not the obligee is considered to have the right to cancellation, the obligations that are impossible to perform need to be considered in relation to the level of importance of such obligations under the contract. Only when such obligations are important will cancellation be permissible based on Article 543 of the Civil Code (This obviously includes when it is impossible to perform the whole obligation). Otherwise, only the entitlement to demand damages based on the second sentence of Article 415 of the Civil Code shall apply. Actual case law also restricts the right to cancellation in this way.
Whether something is important or not is determined by the purpose set out in the contract. ‘Whether or not the impossibility to perform is important’ is ‘the extent to which the purpose of the contract can be achieved or not due to such impossibility to perform’. Each contract should be considered to determine the purpose of each contract.
Subsection 3. Allocation of risk
1. When there are no reasons attributable to the obligor
So far we have explained the situation when the obligations under the contract cannot be performed for reasons attributable to the obligor. Next we consider the case where there are no reasons attributable to the obligor.
When there are reasons attributable to the obligor, it is obvious that the loss or damage from such impossibility should be placed on the obligor. However, when there are reasons attributable to the obligee, this cannot be assessed as a default by the obligor. The obligee himself/herself should be held responsible. In addition, when there are reasons that cannot be attributed to either the obligee or the obligor such as a natural phenomenon or action of a third party, it obviously cannot be said that the responsibility should be borne by the obligor, even though the obligation cannot be performed conformed with the contract.
Here, the Civil Code provides separate regulations by way of allocation of risk in relation to situations when there are no reasons attributable to the obligor.
In principle, this is prescribed by Article 536 of the Civil Code. According to Paragraph 1, the obligor shall not have the right to receive performance in return if there are no reasons attributable to either the obligee or the obligor. In other words, the obligor does not need to perform his/her own obligation (this is obvious since it is impossible), and a claim for performance of the obligation cannot be made on the other party either.
When partial performance is impossible, as we discussed in the case of default due to the impossibility of performance, the matter is dealt with by considering ‘whether or not the purpose of the contract cannot be achieved because of the impossibility of performing a part of the contract’.
By contrast, when there are reasons attributable to the obligee, the obligor will lose his/her right to receive performance in return (CC Art 536 (2)).
2. Exceptions such as sales contracts for specified things
The above rules are considered rational. However, Article 534 prescribes some important exceptions to these.
“In cases where the purpose of a bilateral contract is the creation or transfer of real rights regarding specified things, if the things have been lost or damaged due to reasons not attributable to the obligor, such loss or damage shall fall on the obligee.”
Consequently, for a sales contract where the specified things are second hand machinery, the buyer (the ‘obligee’ for the transferred obligation) shall bear any damage when such machinery is destroyed without any reason attributable to the obligor. In other words, the buyer must pay compensation.
Similar rules can be found in the laws of other countries, and the injustice of such rule is also noted in such countries. Even in Japan this rule is considered unfair and in doctrinal terms the allocation of risk for a specified thing under the control of the obligor is often interpreted as being the burden of the obligor. In practice, it is usual to include special provisions to exclude the application of this regulation in contracts such as sales contracts. Then, the articles relating to allocation of risk are discretionary provisions, and the special contract provisions are taken to be effective as is.
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Section 2. Failure of possible performance
Subsection 1. When taken to be a default
1. Necessity of attributing the reason to the obligor
The wording of Article 415 of the Civil Code suggests there is no need for ‘cause imputable to the obligor’ when performance is not fulfilled even though it is possible. However, many scholarly writings recognize non-performance in situations where it is possible to perform as only being a ‘default’ when there are reasons attributable to the obligor.
We can view case law as also relying on this interpretation, but case law restricts the interpretation of ‘no reasons attributable to the obligor’ to situations such as force majeure.
More important is the situation where ‘there was non-performance of the obligations conformed with the contract (even though it was possible) when the contract stated a certain action should be undertaken and such action was not taken’.
We consider the example of a delay in transfer of a specified thing from seller A to buyer B due to traffic congestion. The point here is not whether or not the delay because of traffic congestions can be a reason attributable to A, but whether or not the agreement, clearly or implicitly, made by contract consents to a delay caused by something such as traffic congestion as something that cannot be helped. If there is such consent there has been no non-performance of obligation. By contrast, if there is strict promise of the timing for delivery, the seller conceivably should have prepared a risk management strategy by transporting the thing close to the point of transfer the day prior. A breach of obligation is said to have occurred in this example.
Therefore, the point is the interpretation of the contract. It depends on what types of obligations have been agreed. For a specific contract whether or not everything has been agreed will depend not only on what is clearly agreed, but by taking account of customs for such transaction types and principle of good faith. The outcome will be supplemented with the Code provisions concerning each contract type.
2. Defense for simultaneous performance
Article 533 of the Civil Code is a supplementary provision to clarify the details agreed in a bilateral contract. It states, “A party to a bilateral contract may refuse to perform his/her own obligation until the other party tenders the performance of his/her obligation”; this is referred to as ‘defense for simultaneous performance’. This a rule that can be excluded when there is agreement clearly to the contrary, but it plays an important role in relation to cancellation and compensation for damages based on default.
There is no liability of default for either party even after the period of performance when there is this type of right of defense for simultaneous performance. If one party demands performance of the other party, a so-called ‘judgment to exchange benefits’ would be made, for example, ‘A should make the transfer in exchange for payment of price by B’.
However, one should note that the wording in Article 533 of the Civil Code does not state ‘until the other party has performed his/her obligation’, but rather ‘until the other party tenders the performance of his/her obligation’. ‘Performance’ means in the case of transfer the actual transfer. By contrast, ‘tender the performance’ means ‘the act of the obligor, which would be completed as performance if the obligee cooperates for receiving the performance when performance cannot be completed without the cooperation of the obligee’.
For example, in a sale of real estate where seller A bearing the necessary documentation waits for buyer B (= obligee) at the judicial scrivener's law office that has been agreed as the place of transfer, A will be considered to have ‘tendered the performance’. Since this means A has done everything he/she can do, it only remains for action by B. In such circumstance, an assertion by B to the defense for simultaneous performance against A will not be recognized.
3. Other effects of tendering performance
Tendering performance has important significance in areas other than in relation to defense for simultaneous performance. For example, we take the case of an agreement for payment of price where A is obliged to make payment of JPY 100 million to B. Here, we consider the situation where A has tried to pay B, but B refuses to take receipt of the payment. Under such circumstances, there is clearly no right for B to cancel the contract or demand damages from A based on non-performance of fulfilling the payment obligations. This is clarified by Article 492 of the Civil Code that prescribes, “Upon tendering the performance, the relevant obligor shall be relieved from any and all responsibilities which may arise from the nonperformance of the obligation.”
In addition, by tendering the performance the risk due to factors such as the loss of the specified thing shall also transfer to the obligee.
Subsection 2. Methods for enforcing performance
1. Affirmation of enforced performance
Now, the obligor has the defense for simultaneous performance in the case that performance is possible, but it is not performed; when the obligee has refused receipt despite the tender of performance by the obligor it is recognized as a ‘default’.
At this time, the obligee has the right to enforce performance by the obligor. In principle, enforced performance is not recognized and there is a system for just being able to take compensation for damage, but Japanese law provides a system whereby the obligee can enforce performance by the obligor (CC Art 414 (1)).
Of course, there is no need for the obligee to select a system of performance by the obligor. The method for canceling the contract can also be selected, as detailed below.
Next, we consider the situation when selecting enforcement of performance. At this time, under Japanese law there is limited scope for recognition as self-help. In principle, only the courts can provide assistance; compulsory execution procedures.
2. Compulsory execution procedures
Compulsory execution first requires one's own rights to be proved publicly. This is referred to as ‘title of obligation’. Typically, the obligee sues the other party, demanding ‘perform the obligation’ and a confirmed winning decision is the public proof. In this case, such decision is a ‘title of obligation’ in relation to compulsory execution. Other than this there are a number of types of ‘title of obligation’ prescribed in Article 22 of the Civil Execution Act.
In the following, we consider the circumstances by obligation type, one at a time.
(1) Obligation to transfer a thing
Direct enforcement is employed for an obligation to transfer a thing (CC Art 414 (1))). In the case of real estate, “The enforcing officer will terminate the obligor's possession of the specified and cause its possession to be acquired by the obligee” (Civil Execution Act Art 168 (1)). In the case of movables, regardless of whether a specified thing or unspecified thing, “the enforcing officer will take it from the obligor and transfer it to the obligee” (Civil Execution Act Art 169 (1)).
(2) An obligation to act that can be performed by a substitute party
For obligations where the obligor is obligated to perform specific actions, making the obligor undertake such action by enforcement would result in forced labor that is also prohibited under Article 18 of the Constitution. First, in relation to obligations where there is no difference to the result for the obligee whether the obligor himself/herself or a third party performs (alternative obligation to act), for example an obligation such as to demolish a building, the obligation to perform can be enforced through ‘substitute execution’ (CC Art 414 (2)).
A ‘title of obligation’ with the capacity for execution is submitted to the courts applying for compulsory execution. The court receiving this submission determines that the obligee may cause a party other than the obligor to perform the specified act at the expense of the obligor. Based on this ruling, the obligee undertakes such action himself/herself or requests a third party to perform the action (See: Civil Execution Act Art 171). Here, for example the result will be the demolishing of the building, but the point is that the obligor can be held responsible for the cost involved.
(3) Obligation for an inaction
Article 414 (3) of the Civil Code prescribes, “With respect to any obligation for an inaction, a request may be made to the court at the expense of the obligor seeking the removal of the outcome of the action performed by the obligor, or an appropriate ruling against any future action.” Theoretically, through the breach of an obligation for inaction when some sort of physical situation remains, such obligation is converted to an obligation to act (to remove the outcome) and become a substitute execution.
(4) Indirect enforcement
For example, the obligation to provide data held by the obligor cannot be enforced through a substitute execution. This is because a third party cannot provide the data if the obligor possesses the data. For this type of obligation, ‘indirect enforcement’ can be used.
Indirect enforcement is “a method for determining a specified amount of money that the obligor should pay to the obligee that is equivalent to ensuring performance of the obligation when there is a period of delay or is a recognized equivalent when performance does not occur within a specified time period” (Civil Execution Act Art 172 (1)).
Indirect enforcement had been considered as supplement to other types of enforcement, but the 2003 revision of the Civil Execution Act made it possible to use indirect enforcement if there is an offer from an obligee, even for enforcement of the transfer of things, and the enforced execution of an obligation for inaction and obligations for actions which can be enforced through other types of enforcement (Civil Execution Act Art 173 (1)).
(5) Obligations for manifestation of intent
An obligor incurs obligations for a specific manifestation of intent by way of contract. For example, when agricultural land is sold to a third party the approval of an agricultural committee (in some cases, the Prefectural governor) is required (The Agricultural Land Act Art 3 (1)), but the joint application of the buyer and the seller is required for this approval. The seller is obligated to cooperate with the buyer in relation to the joint application for approval.
However, what happens if the seller will not perform such obligation? An alternative execution is not possible in this case because the act of seller him/herself is required. One could rely on indirect enforcement, but there are doubts about whether actual action (appearing before a committee) should be strictly required.
Here, the proviso in Article 414 (2) of the Civil Code prescribes “with respect to any obligation for any juristic act, the manifestation of intention of the obligor may be achieved by a judgment.” If there is a judgment to confirm an obligation for manifestation of intent, this would mean that there was a manifestation of intent (here meaning the application) (Civil Execution Act Art 173). In principle, the registration of real estate also requires the joint application by the registry title holder and the person to whom it is to be transferred, yet it is prescribed that “while the application must be submitted jointly, registrations due to firm rulings that outline the necessary registration procedures means a party other than the person who must submit such joint application can submit independently” (Real Estate Registration Act Art 63). Since there is manifestation of intent of the obligor it means the obligee can thereafter independently submit an application.
(6) Enforced performance of monetary debt
For enforced performance of monetary debt, the basic procedure is for the courts to sell assets of the obligor and reimburse the claim of the obligee through the price of such sale.
The obligee must indicate the subject of the seizure, and the procedures differ slightly for execution in relation to real estate, execution in relation to movables, and execution in relation to monetary claims and other rights.
3. Demands for compensation for damages
Even if the types of enforced execution described above are successful, performance will obviously be delayed and damage has already been incurred. For this type of damage, there can obviously be a claim against the obligor. The calculation of the amount of compensation for damages is as in accordance with Article 416 of the Civil Code that we have already explained.
Some care should be taken in relation to monetary debt.
Compensation for damage due to the delay in payment of monetary debt is subject to Article 419 of the Civil Code, with the amount of compensation for damages prescribed by statutory interest rates. Even if the obligee can prove that the delay in the performance by the obligor caused damage in excess of the statutory interest rate, he/she cannot take such compensation for damages (Case law. However, this is different in a situation where special rules have been approved. Articles 647, 665, 671, 701 et al. of the Civil Code). For compensation based on the statutory interest rate, a claim can be exerted without any proof (CC Art 419 (2)).
The statutory interest rate is the interest rate prescribed in Article 404 of the Civil Code and Article 514 of the Commercial Code. The ‘5% per annum’ prescribed in Article 404 of the Civil Code is the general rule, but under Article 514 of the Commercial Code the rate is ‘6% per annum’ for ‘obligations arising out of commercial activity’.
Furthermore, when there is a contract in relation to late payment charges, the payment shall be in accordance with such contract. In practice, late payment charges in excess of statutory interest rates are prescribed.
Subsection 3. Cancellation of contract
1. Importance of default
Article 541 of the Civil Code prescribes the following in relation to cancellation of a contract when the other party does not perform even though performance is possible:
“In cases where one of the parties does not perform his/her obligations, if the other party demands performance of the obligations, specifying a reasonable period and no performance is tendered during that period, the other party may cancel the contract.”
There are two points to note.
The first, is that as noted in relation to cancellation due to impossibility of performance, there needs to have been an important default to the extent that would warrant cancellation for the contract to be cancelled, although the wording in the article simply states ‘In cases where one of the parties does not perform his/her obligations’.
In addition, depending on the scope of non-performance there are situations when only part of the contract can be cancelled.
Second, is that the wording in the article states, ‘if the other party demands performance of the obligations, specifying a reasonable period’.
‘A reasonable period’ is interpreted as the period necessary for a person, who has already made preparations to perform, to perform. When there is non-performance of monetary debt such as obligation to pay price, about 3 days is taken to be effective. In addition, even if the period is not specified in the demand or if the demand is something along the lines of ‘please pay promptly’, in reality termination is possible if a ‘reasonable period’ has passed9. Then, if the demand states, ‘the contract will be cancelled if payment not made by X date’, the contract will automatically terminate once such date has passed, and there is no need for manifestation of intent to cancel after the period has passed10. It is acceptable if the obligor who has already made preparations is provided with the chance to perform.
Nevertheless, there is no need to demand ‘In cases where the purpose of the contract cannot be achieved unless the performance is carried out at a specific time and date or within a certain period of time’ (CC Art 542).
2. Special contract provisions in practice
The aforementioned type of wording in the Civil Code is considered inconvenient from a practical perspective and there are various special contract provisions.
First, many actual sales contracts include wording that provides for prompt cancellation of the contract if there is evidence of deterioration in the obligor's credit such as the dishonor of a negotiable bill, seizure by another obligee, or a petition for bankruptcy. ‘Cross default provisions’ are used widely.
Next, in relation to the need to issue a demand, provisions that provide for prompt cancellation of the contract without demand are prevalent.
3. Effect of cancellation
As we have already explained briefly, the effectiveness of cancellation is that it is as though the contract had never existed.
Nevertheless, “if any monies are to be refunded, interest must accrue from the time of the receipt of those monies” (CC Art 545 (2)). In addition, it is possible to demand compensation for damages separately for damage that cannot be redressed by just returning the situation to its original state.
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Chapter 11. Realization of monetary claims
Section 1. The preservation of obligor's property
Subsection 1. The necessity of the preservation of obligor's property
When the obligor does not perform the obligation, the obligee can seize the obligor's assets on the basis of title of obligation and have the courts convert it into cash and recover his/her own claim from such. However, the distribution of the converted cash at this time is in accordance with the principle of equality of obligees.
What should obligee do if he/she wants to recover the most in relation to his/her own claim based on this system? The first thing that comes to mind is to secure the assets that can be seized. The Civil Code provides for two systems for securing the obligor's assets: obligee's subrogation right (CC Art 423) and obligee's right to demand the rescission of fraudulent act (CC Art 424). The former is subrogation by the obligee to exercise rights that the obligor does not try to exercise even though they are vested in him/her resulting in the preservation of the obligor's assets. The latter is the right of the obligee to rescind an action by the obligor when the obligor attempts to reduce to his/her assets.
Originally, these systems were for the benefit of all obligees to protect the obligor's assets. However, these are also used outside the original purpose of the system to gain the advantage in recovery of claims.
Subsection 2. Obligee's subrogation right
1. Significance of obligee's subrogation right
The obligee can exercise the rights vested in the obligor by subrogation (CC Art 423). This is referred to as the obligee's subrogation right.
We consider the following example. A has a monetary claim against B. B has sold the land he/she owned to C, but C has not paid the price even though the period for performance has already passed. If C has the financial resources, A can seize the claim on the sales price that B has on C. However, if C has not paid the sales price because he/she does not have the financial resources, it would be pointless even if the claim on the sales price were seized. At such a time, B's cancellation right for the sales contract (an event of default by C) is exercised by A on the basis of the obligee's subrogation right. This cancels the sales contract with the right of ownership returned to B. Furthermore, B's right to erase the right to registration by C is exercised by A on the basis of the obligee's subrogation right with the registered name returned to B. Then such property is seized.
By this type of obligee's subrogation right, the obligee performs the rights vested in the obligor by substitution. This is significant as preparation for enforced execution procedures. Further, rights which are exclusive and personal to the obligor cannot be exercised by way of subrogation (proviso in CC Art 423 (1)).
2. Requirements for obligee's subrogation right
Exercising the obligor's rights by way of obligee's subrogation right is an intervention in the obligor's right to manage his/her assets. Therefore it requires a state that can be in no way amended to protect the obligee's own claim. Then, Case law11 in principle recognizes the exercise of the obligee's subrogation right by taking out the claims that are subject to subrogation only when the obligor does not have assets to pay the full obligation.
However, we consider the situation where there is sequential assignment of land from A to B then B to C, but the registration is still in the name of A. C has requested a transfer of registration from B to himself/herself, but since B has not yet acquired the transfer of registration from A, B cannot institute the transfer of registration to C. At such a time, for C to realize his/her claim on B (right to demand transfer of registration) in its original form there would be no significance no matter what other assets B has. It is vital that B accurately exercises his/her right to demand transfer of registration from A.
Under this fact pattern, the general lack of financial resources is not required for C to exercise the obligee's subrogation right12. The obligee's subrogation right was originally for securing an obligor's general assets to enforce execution to realize monetary claims. However, in the transfer of registration example, the obligee's subrogation rights are not exercised to secure the obligor's general assets. Here, it can be referred to as an example of a conversion of obligee's subrogation right.
3. Prioritized recovery of claim by way of obligee's subrogation right
Obligee A with monetary claims can also exercise monetary claims against third party C based on obligee's subrogation right of monetary claims that obligor B has against C. Then, it is possible for A himself/herself to demand payment from C.
Of course, since it was A that received payment from C instead of B, the amount of money received must be transferred to B. However, A's own claim on B can be set-off by B's claim on A. Therefore, when a monetary claim that is vested in the obligor is exercised by way of subrogation due to the obligee's subrogation right, it effectively leaves other obligees making it possible to have one's own claim given priority for recovery. Since this is contrary to the original purpose of the system of obligee's subrogation right there are strong doctrinal views that this result is not appropriate, but case law has approved the effective priority performance13.
Subsection 3. Obligee's right to demand the rescission of fraudulent act
1. Definition and requirements for obligee's right to demand the rescission of fraudulent act
The obligee's right to demand the rescission of fraudulent act is a system that resembles right of avoidance under bankruptcy law.
Paragraph 1 Article 424 of the Civil Code prescribes, “An obligee may demand the court to rescind any juristic act which an obligor commits knowing that it will prejudice the obligee.”
One needs to take care in relation to the following points.
First, unlike an obligee's subrogation right, the demand for rescission must be made to the court. An obligee's subrogation right is only the performance of an action by a person instead of another who does not act even though he/she is able. The obligee's right to rescind means the rescission of another person's act so this represents a high level of intervention, and calls for careful adherence to procedures.
Second, intervention is not approved for juristic acts of which the object is not property right (CC Art 424 (2)). Even if the obligor renounces his/her inheritance, such rescission is not approved. This is because it is a matter that should be left to the obligor's own decision of the obligor, and the renouncement of inheritance only means that property will not increase and not that it will decrease. By contrast, distribution of property resulting from divorce will be subject to rescission when the amount is inappropriately large in relation to the purpose of division of assets on divorce.
Third, only acts that could unjustly reduce the obligee's portion through such action are subject to rescission, and intervention is approved only when the obligor is aware of such fact.
However, considering specific examples there are subtleties as to whether or not the above requirements are met. In Case law, the subjective elements of the obligor and the counterparty and the purpose of acts are considered synthetically.
2. Priority recovery of claims by way of obligee's right to demand the rescission of fraudulent acts
Rescission by way of obligee's right to demand the rescission of fraudulent acts is effective for all obligees against such obligor. The effect of the rescission for this purpose goes relatively well when the obligor has disposed of real estate; this real estate would come back to the obligor's assets and become subject to the seizure of all obliges.
However, if the benefits to a beneficiary due to the rescission of a juristic act are monetary (simply to consider the case of payment to just a specific obligee) the obligee who instituted the procedures for rescission can demand the transfer of such monies to himself/herself. Since there is no method of compulsion against the obligor for such receipt, the rescinding obligee must be able demand the transfer to himself/herself. Of course, the rescinding obligee who receives the monies has the obligation to transfer the received monies to the obligor. Nevertheless, at this time, the rescinding obligee can set-off his/her own claim against the obligor with the obligor's claim against the obligee (the claim for the monies that have been received to be transferred to the obligor). This effectively means there can be a priority recovery of claims.
As is the case for obligee's subrogation rights, this also goes against the original purpose of the obligee's right to demand the rescission of fraudulent acts so there are strong doctrinal views that the above result is not appropriate. However, according to case law14 there is effectively approval for priority payment to the rescinding obligee.
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Section 2. Other ways for the realization of monetary claims
1. Set-off and assignment of claim
As observed above, the obligee's subrogation right/ obligee's right to demand the rescission of fraudulent acts functioned as a system for priority recovery of a claim for a specific obligee. In the following, set-off and assignment of claim will be explained as other ways that serves to provide priority recovery of claims.
Assignment of claim is obviously not an inherent method for recovery of claims, but in effect it is often used as a method for recovery of claims.
2. Features of set-off under Japanese law
Article 505 (1) of the Civil Code prescribes “In cases where two persons mutually owe to the other any obligation with the same kind of purpose, if both obligations are due, each obligor may be relieved from his/her own obligation by setting off each value thereof against the corresponding amount of the obligation of the other obligor; provided, however, that, this shall not apply to the cases where the nature of the obligation does not permit such set-off.” The following two points need to be noted in relation to this definition.
First, even if the requirements for set-off have been met, deduction is not assumed and the set-off only happens due to a party's manifestation of intent.
Second, set-off is approved “in cases where two persons mutually owe to the other any obligation with the same kind of purpose” and there is no requirement for there to be some sort of relationship between both obligations.
3. Special contract provisions in relation to bank transactions
Set-off is often used for priority recovery of one's own claim. In particular, banks expect to recover claims through the set-off of loans and deposits. Nevertheless, this is only possible “if both obligations are due” (CC Art 505 (1)). In such situations, the following special contract provisions are often made to meet these requirements.
Specifically, we consider Article 5 (1) of the Banking Transaction Agreement that is used for transactions between a bank and its customer. Almost all banks have similar clauses in their contracts. Here, we take ‘A’ to be the bank's customer and ‘B’ to be the bank.
“If at least one of the following events occurs in relation to A, A will naturally lose all profit due for the term in relation to the debt even if there is no notice from B, and immediate repayment of the debt is required……….(text deleted)
3 When notice is issued in relation to provisional seizure, protective seizure or attachment on deposits of A or its guarantor with respect to claims against B. (abbreviated)”
The effectiveness of this clause has been contested on a number of occasions in the Supreme Court.
First, we consider an example.
A has a fixed term deposit of JPY 10 million with bank B at the same time as borrowing JPY 15 million from bank B. A has failed to make payment on an obligation to another obligee C, so C has effected a seizure over the deposits of A held with B. Consequently, bank B has asserted a set-off of the deposits A held with B for the same amount of the loan from bank B to A.
Bank B's position is as follows. Based on Article 5 (1)-3 of the Banking Transaction Agreement the seizure of A's deposits caused the lost of the term profits of A in relation to the borrowing obligations, thereby the period for repayment of the loan obligation falls due. Then, the term profits on the deposits of A with bank B were waived by bank B intentionally. Although, in the case of a fixed term deposit, the term profits are not only for the purpose of the obligor's (= bank's) profit, there is an interpretation that term profits could have been waived if the interest until the maturity of the contract had been accrued. Consequently, set-off is possible because the payment period for both obligations has fallen due.
To state the conclusion first, current Supreme Court rulings15 approve the aforementioned bank's point of view.
If set-off is seen as just a simple method for settlement, a result that provides a priority recovery of claim for just one party (in this case, the bank) should be avoided to the extent possible. In fact, previous Supreme Court rulings16 restricted the effect of the Banking Transaction Agreement. However, in subsequent Supreme Court rulings the collateral type functions of set-off have been squarely approved. Thus, bank B's arguments have been approved based on this ruling.
This type of ruling is established, but there is still much scholarly debate.
Further, in relation to netting, the ‘Law concerning Close-out Netting of Specified Financial Transactions Entered into by Financial Institutions, etc.’ was established in 1998, and the effectiveness under the bankruptcy law has been squarely approved.
4. Function of assigning claims
‘Realization of a claim’ was originally the receipt of perfect repayment. However, if there are people who will purchase such claims, their economic value can be realized. Of course, no-one will try to pay JPY 10 million to purchase a JPY 10 million claim. On the other hand, if there is a person who wants the money quickly and will satisfy with a smaller amount than the claim and another person is willing to wait a little time to acquire the benefits of investment. Consequently, this results in a sales contract with price of JPY 9 million for a claim of JPY 10 million.
Here, Article 466 (1) of the Civil Code prescribes “A claim may be assigned”. This is an assignment of claims.
However, together with the proviso that “this shall not apply to the cases where its nature does not permit the assignment” (the proviso in CC Art 466 (1)) an assignment of claims is not possible when the parties have manifested their intention to the contrary (CC Art 466 (2)).
A typical example of a contract for a claim that cannot be assigned is a bank deposit contract. In addition, for claims where the state or a local public body is the obligor, in almost all cases there are special contract provisions prohibiting assignment of claims. However, special provisions prohibiting assignment of claims are at any rate promises made between parties and a third party would not know whether or not there are special provisions prohibiting assignment of a specific claim. So there is a need to protect the recipient of an assignment of claim who had no knowledge of the existence of the special provision. Hence, the proviso in Article 466 (2) of the Civil Code states assertion against a third party without knowledge, i.e., a third party without knowledge of the existence of such special provision, is not permitted
In addition, even for claims that have special provisions prohibiting assignment of claims, the third party can seize the claims, obtain an assignment order and become the obligee. This is also the same when the third party has knowledge about the existence of the special provisions. In other words, even if there are special provisions, the compulsory assignment of claims is unhindered by the assignment order. This is because if it were not the case, assets that cannot be subject to enforced execution by way of an assignment order could be freely created by special provisions between the parties and it would not be appropriate.
5. Requirement for assertion of assignment of claim
The system of requirement for assertion is important for the assignment of claim.
On this point, Japanese law uses the obligor as an information center. Specifically, even if there is assignment of claim, an assertion of an assignment of claim cannot be made against the obligor or another third party unless notice is given to the obligor or acknowledgement obtained in relation to that matter from the obligor.
This type of notice or acknowledgement may not be asserted against a third party other than the obligor unless the notice or acknowledgement is made using an instrument bearing a fixed date (CC Art 467 (2)). An ‘instrument bearing a fixed date’ is a document bearing a date certified by a public institution. It is often the case that a notary will either stamp a date on the document or the notice or acknowledgement will be sent by content-certified mail (A service for date stamped postal items to certify the contents provided by Japan Post).
However, when multiple claims are assigned it is troublesome to have notice with an instrument bearing a fixed date or obtain the acknowledgement of the obligor for each one. Currently, the ‘Law Concerning Exceptions, Etc. to the Civil Code, Applicable to Perfection of Assignment of Claims’ was promulgated in 1998 to simplify the assertion requirements in relation to assignments of monetary claims by juridical persons (The law has now been revised as the ‘Law Concerning Special Exceptions, etc to the Civil Code with Respect to the Perfection of the Assignment of Chattel and Claims’).
Article 467 of the Civil Code, concentrates the information on the obligor to clearly indicate ownership of the claims. This is because there is no registry that indicates ownership of the claim. If that is the case, a registry should be created. Therefore, the Special Acts above state that when the assignor is a juridical person, the assignment shall be registered in the file for registry assignment of claims prepared by the Legal Affairs Bureau, and this is taken to fulfill the requirement for assertion against a third party.
Nevertheless, since it is not appropriate for the obligor to be required to take care about whether or not an assignment has been registered when undertaking performance, even if the assignment of claim is registered in the registry of assignment of claims, the assignee can assert receipt of an assignment of claim only against a third party other than the obligor. Therefore, it will be acceptable if the obligor, thinking that the original obligee (=assignor) is still the obligee, performs in relation to that person. When the assignee also wants to assert against the obligor he/she must ultimately issue a notice to the obligor.
6. Assignment of future claims
There is also the issue that to what extent the assignment of future claims are admitted. Initially there was an accumulation of lower court rulings concerning this problem that restricted the effectiveness of the assignment of future claims to within one year from assignment, and it was a major impediment to securitizing or collateralizing claims.
However, in 1999 the Supreme Court recognized the effectiveness of comprehensive assignment of claims over a long period of time extending into the future as long as the claims are specified. “Assignment of claim contracts must obviously specify the claims for the purpose of assignment by aspects such as the reason for such assignment and the amount subject to assignment. In the case where the purpose is to assign a number of claims that emerge within a specific time period or for which the term for performance should be up, the claim for the purpose of assignment should be specified by clearly stating the start and end period for the aforementioned term through some arbitrary method17”.
However, there is the restriction that ‘for an assignment of contract claims for which claims should emerge within a specified time period, the contract details such as the length of such time period should be restricted from notably departing from what would be considered within the scope of conventional wisdom for the assignor's business activities. This should take overall consideration of the state of the assignor's assets at the time the contract is executed, the anticipated transition of matters such as the assignor's operations at such time, the contract details, and the background to execution of the contract. If special conditions were to be approved that were unreasonably detrimental to other obligees, such a contract would be against public policy and the effectiveness of part or all would be negated.’
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