On March 31 2015 a bill to reform the law of obligations under the Civil Code was submitted to the Diet after discussions of more than five years. The reform constitutes the first major amendment to the Civil Code in 120 years. If the bill passes in the present Diet session, it is expected to come into effect around 2018. Approximately 200 items are to be amended, including provisions which will have a significant impact on banking practice in Japan. This update discusses proposed amendments to the provisions relating to guarantee obligations.
The amended provisions will apply to all guarantee contracts entered into after the effective date of the reform, while the existing Civil Code will continue to apply to guarantee contracts entered into before the effective date.(1)
It is common for individuals to agree to guarantee a principal debtor's debts based on their personal relationship with the debtor without fully understanding the details of their obligations as guarantor. There have been notable cases in which an individual guarantor was requested to make a guarantee payment for a greater-than-expected amount, which consequently destroyed the individual's livelihood. An individual's guarantee for debt owed by a principal debtor for the debtor's business is generally viewed as especially problematic, since the guaranteed amount tends to be substantial.
Protection for individual guarantors has been addressed in previous amendments to the Civil Code and in guidelines. The 2004 amendment to the Civil Code provided that, among other things, a guarantee contract which is not in writing is considered void, as is a revolving guarantee contract entered into by an individual guarantor in which the scope of the principal debt includes monetary loans and the maximum limit on the guaranteed amount is not specified.
In December 2013 the Manager Guarantee Guideline was published by a research committee established by the Japan Chamber of Commerce and Industry and the Japanese Bankers Association. In addition, the Financial Services Agency has issued a supervisory guideline which requests financial institutions to respect the Manager Guarantee Guideline. Among other things, these guidelines promote business loans which do not rely on a guarantee provided by the principal debtor's management.
In taking into account the scenario described above, the reform includes provisions restricting individual guarantees, mainly in order to protect individual guarantors.
Details of reform
Under the reformed Civil Code, the following guarantee contracts will be considered void unless, before entering into such contracts, the proposed guarantor expresses his or her intention to perform the guarantee obligations in a notarised document executed in the month before the guarantee contract is entered into:(2)
- a guarantee contract entered into by an individual guarantor in which the principal debt is the monetary loan owed by the principal debtor for the debtor's business; and
- a revolving guarantee contract entered into by an individual guarantor in which the scope of the principal debts includes the monetary loan owed by the principal debtor for the debtor's business.
Preparation of a notarised deed includes complex requirements – for example:
- the intended guarantor must orally state to the notary the basic terms of the guarantee contract;
- the notary must listen and prepare a document containing the oral statement; and
- the guarantor must sign and affix his or her seal on the document to confirm its accuracy.(3)
A guarantor's indication of his or her intention to perform the guarantee obligation through a notarised document is not required for guarantee contracts where:
- the principal debtor is a legal person such as a company or other organisation and the guarantor is a trustee, director or executive member (or equivalent) of the legal person;
- the principal debtor is a legal person and the guarantor is a controlling shareholder of the legal person; or
- the principal debtor is an individual and the guarantor is a person who jointly operates the business with the individual or the individual's spouse who also engages in the business. Such a guarantee contract is referred to as a 'guarantee provided by the principal debtor's management'.
Effect on banking practice
As document notarisation entails complex procedures as explained above and certain regions in Japan lack a sufficient number of notaries, the preparation of notarised documents is expected to require considerable administrative work.
The negative consequences of failure to prepare the required notarised documents are serious: the guarantee contract will become void. Therefore, it will be essential for banks which intend to enter into guarantee contracts with individual guarantors to ensure that the notarisation requirements can be met.
In order to avoid such failure, before entering into a guarantee contract with an individual guarantor, banks will be required to:
- carefully determine whether the principal debt is a monetary loan owed by the principal debtor for the debtor's business; and
- if so, confirm whether such guarantee is considered a guarantee provided by the principal debtor's management.
Debt 'owed by the principal debtor for such debtor's business' is generally understood to mean debt owed for a business (ie, certain similar acts which are carried out repeatedly and continuously for a specific purpose). However, in some situations it may be difficult to determine whether the relevant monetary loan is a debt owed by the principal debtor for the debtor's business, such as a loan for building an apartment complex intended for lease.
Sometimes a guarantor may enter into a guarantee contract without fully understanding the risk arising from the guarantee. There is also the danger that the guarantee burden may increase without the guarantor's awareness, because the guarantor is not necessarily in a position to grasp fully the status of the principal debtor's performance of the debt obligations. To protect guarantors from such risks, the reform establishes three obligations to disclose certain information to the guarantor.
Details of obligation to disclose certain information
Disclosure as of execution of guarantee contract
Under the reformed Civil Code,(4) in cases where an individual is entrusted by a principal debtor to become a guarantor for debt arising from the debtor's business (or a revolving guarantee contract is entered into whereby the individual guarantees a certain specified scope of debts which include debt owed by the principal debtor's business), the principal debtor will be required to disclose the following information to the guarantor:
- the status of its assets, income and expenditure;
- the existence of any debts other than the principal debt, the amount of such debt and the repayment status of such debt; and
- the existence and details of any collateral which was provided or will be provided to secure the principal debt.
If the principal debtor breaches this obligation by failing to disclose the above information or providing false information to the guarantor and the guarantor thus enters into a guarantee contract without a correct understanding of the information, the guarantor will be able to rescind the guarantee contract if the creditor knew or could have known of such breach.
Disclosure of payment status of principal debt
Upon request from a guarantor entrusted by a principal debtor to act as such, the creditor will be required to disclose the following information to the guarantor:
- the existence of delinquent payments of the principal debt, interest, penalties, compensation for damages and other related obligations; and
- any remaining amounts and the amount of such obligations for which payment is already due.(5)
If the guarantor suffers damages due to the creditor's breach of this obligation, the creditor may be required to compensate for such damages. The position of guarantor, which is entitled to receive such information, is not limited to individuals and the principal guaranteed debt is not limited to debt arising from the debtor's business.
Disclosure upon debt acceleration
In the event of acceleration of a principal debt, the creditor will be required to notify the guarantor in this regard within two months of the date on which the creditor becomes aware of the acceleration.(6) If the creditor fails to notify the guarantor within this timeframe, it will lose the right to bring a claim against the guarantor for any late payment charge which accrued between the time of acceleration and the date on which the guarantor was notified. The position of guarantor, which is entitled to receive such notice, is limited to individuals in this case, but the guaranteed principal debt is not limited to debt arising from the principal debtor's business.
Effect on banking practice
Banks have already been performing the abovementioned disclosure obligations relating to the payment status of principal debt and debt acceleration to a certain extent; but as such obligations will be clearly stipulated in the reformed Civil Code, banks will need to develop a clear framework under which they can consciously disclose the abovementioned information to guarantors.
Unlike the disclosure obligations relating to the payment status of principal debt and debt acceleration, the obligation to provide the guarantor with the necessary information before execution of the guarantee contract rests with the principal debtor. If the principal debtor breaches this obligation and the creditor knew or could have known of the breach, there will be significant consequences for the creditor, as the guarantor may rescind the guarantee contract. Therefore, banks should consider developing a framework under which they can confirm that the principal debtor has complied with its disclosure obligations, including by way of written confirmation from the guarantor that the guarantor received the necessary information from the principal debtor.
Details of reform
Under the existing Civil Code, a creditor's claim against a joint and several guarantor for the performance of a guarantee obligation affects the principal debtor. For example, when the creditor brings such a claim against the joint and several guarantor, extinctive prescriptions on monetary loans owed by the principal debtor will be suspended.
Under the reformed Civil Code, however, a creditor's claim against a joint and several guarantor for the performance of a guarantee obligation will generally have no effect on the principal debtor. Therefore, even if the creditor brings a claim only against a joint and several guarantor, the statute of limitations on monetary loans owed by the principal debtor will continue to run. However, the reformed Civil Code will also contain a provision whereby the creditor's claim against the joint and several guarantor for the performance of guarantee obligations can affect the principal debtor if an agreement has been concluded between the relevant parties.(7)
Effect on banking practice
Due to the above, when banks enter into a guarantee contract, they will need to include a provision in the guarantee contract which stipulates that the creditor's claim against the joint and several guarantor for the performance of a guarantee obligation will have an effect on the principal debtor.
For further information on this topic please contact Izuru Goto or Gen Takizawa at City-Yuwa Partners by telephone (+81 3 6212 5500) or email (firstname.lastname@example.org or email@example.com). The City-Yuwa Partners website can be accessed at www.city-yuwa.com.
(1) The proposed amendments to the Civil Code relating to guarantee obligations are not limited to those discussed in this update.
(2) Article 465-6(1) of the reformed Civil Code.
(3) Article 465-6(2) of the reformed Civil Code.
(4) Article 465-10 of the reformed Civil Code.
(5) Article 458-2 of the reformed Civil Code.
(6) Article 458-3 of the reformed Civil Code.
(7) Proviso to Article 441 of the reformed Civil Code.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.