Default, liability and remedies in shipbuilding in Japan

Default, liability and remedies

Do courts consider defective design to fall within the scope of poor workmanship for which the shipbuilder is liable under the warranty clause of the contract?

We have not found any court precedents or academic views that have dealt with this issue.

If the parties to a shipbuilding contract agree that a builder will design and construct a vessel, a Japanese court will probably consider that the defective design falls within the scope of poor workmanship for which the shipbuilder is liable under the warranty clause. If this issue is disputed, a Japanese court will carefully consider the purpose of relevant clauses in a shipbuilding contract, concrete contents of actual design, cause of defect and so on before deciding on the issue.

If the parties to a shipbuilding contract agree that the buyer will design the vessel and the builder will construct the vessel pursuant to the buyer’s design, a Japanese court would probably not consider that the defective design falls within the scope of poor workmanship for which the shipbuilder is liable under the warranty clause of the contract. However, if the shipbuilder, knowing the defectiveness of the design, failed to inform the buyer of such, a Japanese court is likely to hold that the shipbuilder has to rectify the defect in the vessel (articles 635 and 636 of the Civil Code).

Are there any remedies available to third parties against the shipbuilder for defectiveness?

Under Japanese law, a claim for compensation for damage based on article 3 of the Product Liability Law (PLL) or article 709 of the Civil Code is available to third parties against the shipbuilder for defectiveness.

The requirements of article 3 of the PLL are:

• defect in a vessel that the shipbuilder manufactured;
• harm to life, body or property of third party caused by the defect;
• occurrence of damages by the infringement; and
• owing to the defect, damage occurred to something other than the vessel.

‘Defect’ is defined as ‘a lack of safety that the product ordinarily should provide, taking into account the nature of the product, the ordinarily foreseeable manner of use of the product, the time when the manufacturer, etc, delivered the product, and other circumstances concerning the product’ (article 2, paragraph 2 of the PLL). The claim will be time-barred after three years from the time when the third party becomes aware of the damages and the identity of the party liable for the damages (the builder) or after 10 years from the time when the builder delivered the vessel (article 5, paragraph 1 of the PLL).

Pursuant to article 709 of the Civil Code, a claim requires the following elements:

• the builder’s or their employee’s negligence;
• an illegal infringement of the third party’s right;
• the occurrence of damage to the third party; and
• a causal connection between the negligence and the damage.

Where defect exists, the court is likely to assume that the builder’s negligence was involved. The claim will be time-barred after three years from the time when the third party becomes aware of the damages and the identity of the person who caused it (the builder) or after 20 years from the time when the unlawful act was committed (article 724 of the Civil Code).

If the contract contains a liquidated damages clause or a penalty provision for late delivery or not meeting guaranteed performance criteria, must the agreed level of compensation represent a genuine link with the damage suffered? Can courts mitigate liquidated damages or penalties agreed in the contract, and for what reasons?

In principle, the agreed level of compensation does not have to represent a genuine link with the damages suffered. Contractual parties may freely determine the amount of liquidated damages. However, there is a possibility that Japanese courts will hold that the liquidated damages clause is against public policy and, accordingly, void it if the agreed amount is excessively high. Under Japanese law, courts cannot increase or reduce the amount of liquidated damages. Penalty is presumed to constitute liquidated damages.

If the building contract contains a liquidated damages provision, for example, for late delivery, is the buyer then precluded from claiming proven higher damages?

The buyer is precluded from claiming proven higher damages. This is the effect of having a liquidated damages provision.

Are the parties free to design the force majeure clause of the contract?

Yes, contractual parties are free to design a force majeure clause. Japanese law recognises the principle of freedom of contract, and there are no provisions in Japanese law that prohibit the creation of a force majeure clause in a shipbuilding contract.

Is certain ‘umbrella’ insurance available in the market covering the builder and all subcontractors of a particular project for the builder’s risks?

In principle, it is possible to conclude an insurance contract to cover the builder and all subcontractors for the builder’s risk. However, in general practice, only a builder is insured and subcontractors are not included in shipbuilding insurance. However, Japanese insurance companies usually pay out if the builder’s subcontractors have caused events in the building process that satisfy the requirements for payments of insurance money. It is possible that Japanese insurance companies undertake not one vessel but multiple vessels under a particular project as insured vessels for shipbuilding insurance. Japanese insurance companies are unlikely to undertake shipbuilding insurance where Japanese companies are not involved at any point.

Will courts or arbitration tribunals in your jurisdiction be prepared to set terms if the parties are unable to reach agreement on alteration to key terms of the contract or a modification to the specification?

No, Japanese courts or tribunals will not be prepared to set terms in such a case. There are no provisions in Japanese law or rules for court proceedings or arbitration that empower courts or tribunals to do so. In practice, Japanese courts or tribunals often offer certain terms for the purpose of amicable settlement; however, they do not set terms in line with the offer if either or both of the parties refuse to accept them.

Does the buyer’s signature of a protocol of delivery and acceptance, stating that the buyer’s acceptance of the vessel shall be final and binding so far as conformity of the vessel to the contract and specifications is concerned, preclude a subsequent claim for breach of performance warranties or for defects latent at the time of delivery?

Although there is no case law or academic discussion of this matter, we believe that a Japanese court or tribunal is unlikely to find the buyer’s signature as precluding a subsequent claim if it finds that the buyer was unable to find the breach or defects at the time of the delivery. Normally, buyers are not aware of the actual performance or latent defects upon signing a protocol of delivery and acceptance. Signing the protocol of acceptance is not sufficient grounds to preclude subsequent claims, regardless of the terms employed in the protocol.

Can suppliers or subcontractors of the shipbuilder exercise a lien over the vessel or work or equipment ready to be incorporated in the vessel for any unpaid invoices? Is there an implied term or statutory provision that at the time of delivery the vessel shall be free from all liens, charges and encumbrances?

Article 842, item 8 of the Commercial Code of Japan provided that a person that had a claim that had arisen from the manufacture and outfitting of the vessel had a maritime lien over the vessel, her equipment and the unpaid freight. However, article 842, item 8 is deleted in the amended Commercial Code, which became effective on 1 April 2019. One of the reasons for the deletion is said to be that, in present practice, vessels are not delivered to buyers or shipowners before the shipbuilder’s payment to the suppliers. Even after article 842, item 8 of the Commercial Code is deleted, there is a possibility that suppliers may exercise a statutory lien over the vessel or the supplied equipment under article 321 of the Civil Code, while subcontractors may not. There is no implied term or statutory provision that at the time of delivery the vessel shall be free from all liens, charges and encumbrances.

Does a reservation of title by a subcontractor or supplier of materials and equipment survive affixing to or incorporation in the vessel under construction?

In principle, the reservation of title does not survive. When a builder incorporates materials or equipment to which a subcontractor or supplier has reserved title, into a vessel under construction, the builder obtains the title to the vessel under construction with incorporated materials or equipment and the subcontractor or supplier who lost the title is only entitled to a claim for compensation (articles 243 and 248 of the Civil Code).

Assuming title to the vessel under construction vests with the builder, can third-party creditors of the builder obtain a security attachment or enforcement lien over the vessel or equipment to be incorporated in the vessel to secure their claim against the builder?

In order to obtain security, third-party creditors of the builder can attach the vessel under construction, and the equipment incorporated in the vessel, by obtaining an order for provisional attachment (PAO) of the vessel under construction. In order to obtain a PAO, the creditors have to post counter security.

It is very unlikely that third-party creditors will have a lien on the vessel under construction.

The creditors cannot have possessory lien on the vessel under construction because the vessel under construction is possessed not by the creditors but by the builder.

It is very unlikely, though theoretically not impossible, for third-party creditors to have a maritime lien on the vessel under construction. Article 850 of the Commercial Code of Japan provides that article 842 of the Commercial Code, which provides for maritime lien on the vessel, should apply mutatis mutandis to vessels under construction. An academic suggested that the builder’s employees may have a maritime lien on the vessel under construction for unpaid wages. However, we have not heard of any case in which third-party creditors of the builder attached the vessel under construction to enforce their claim.

Can a subcontractor’s or manufacturer’s warranty be assigned to the buyer? Does legislation entitle the buyer to make a direct claim under the subcontractor’s or manufacturer’s warranty?

A subcontractor’s or manufacturer’s warranty can be assigned from a builder to a buyer. However, it cannot be assigned if it is agreed in a contract between subcontractor or manufacturer and the builder that claims for performance of guarantee against the subcontractor or manufacturer shall not be assigned. Under Japanese law, the buyer is not entitled to make a direct claim against the subcontractor or manufacturer under the warranty unless the claim against them has been assigned to the buyer. However, the buyer may be able to raise a claim against the subcontractor or manufacturer in tort.

Where a builder defaults in the performance of the contract, is there a legal requirement to put the builder in default by sending an official notice before the buyer’s remedies begin to accrue? What remedies will be open to the buyer?

General position concerning remedies open to the buyer

If a builder does not deliver to the buyer the agreed vessel on the agreed date in the shipbuilding contract, the buyer may:

• claim for compensation for damages;
• rescind the contract if the builder’s breach or delay is so serious as to make the buyer’s purpose of contract not achievable;
• rescind the contract in case of serious breach or delay and claim for compensation for damages;
• claim for performance of builder’s obligation (ie, obtain a court judgment against the builder for completion of construction and enforce the judgment by way of indirect compulsory execution (ie, force the builder to pay fixed amount of penalty per day during the period of delay)); or
• claim for performance of builder’s obligation and compensation for damages.

If the builder delivered the agreed vessel by the agreed date but defects in the vessel exist, the buyer may:

• claim for compensation for damages;
• rescind the contract if the defects are so serious as to make the buyer’s purpose of contract not achievable;
• rescind the contract in case the defect is serious and claim for compensation for damages;
• claim for rectification of the defect; or
• claim for rectification of the defect and compensation for damages.

Notice

With respect to rescission of contract, the buyer is required to send a notice to the builder whereby the buyer fixes a reasonable period within which the builder should perform the contract. The buyer may rescind the contract if no performance is effected within the period. As to the other remedies, the buyer is not required to send notice before the buyer’s claim for remedy.

When a shipbuilding contract contains provisions about notice, the provisions should be taken into account. For example, under article X.1 of the SAJ form, the buyer has to send notice to the builder fixing reasonable period and demanding performance and send another notice in writing or cable to the builder notifying rescission of the contract.

Are there any remedies available to the shipowner in the event of protracted failure to construct or continue construction by the shipbuilder apart from the contractual provisions?

See question 36.

Would a buyer’s contractual right to terminate for the builder’s insolvency be enforceable in your jurisdiction?

A buyer’s contractual right to terminate a shipbuilding contract for the builder’s insolvency is not enforceable under Japanese law.

What institution will most commonly be agreed on by the parties to decide disputes?

Arbitration proceedings will commonly be held in Tokyo, Japan, by the Japan Shipping Exchange, Inc.

Would a buyer’s contractual right to take possession of the vessel under construction and continue construction survive the bankruptcy or moratorium of creditors of the builder?

If a Japanese court decides to start bankruptcy proceedings for a builder, the court-appointed administrator may rescind a shipbuilding contract. If the administrator rescinds, the buyer’s contractual right to take delivery of the vessel pursuant to the contractual terms would not survive. If the administrator does not rescind, the buyer’s right would survive. As to the vessel under construction, in general, the buyer does not have contractual right to take possession of it.

The position is similar when a Japanese court decides to start civil rehabilitation proceedings or corporate rehabilitation proceedings for a builder.

Moratorium may be admitted when a debtor asks major claimants (normally financial institutions) for workout by the Guidelines for Workout and the major claimants agree to issue moratorium notice. During the moratorium period, the buyer’s contractual right to take delivery of the vessel survives. In the workout process, a rehabilitation plan is prepared. If all of the claimants agree to the plan, the claimants’ rights and obligations may be changed in accordance with the plan. Therefore, the buyer’s contractual right would survive as long as the buyer does not consent to the plan.

In your jurisdiction, do parties tend to incorporate an ADR clause in shipbuilding contracts?

No, parties do not tend to incorporate an ADR clause in shipbuilding contracts in Japan.

Where the buyer defaults in the performance of the contract, what remedies will be available to the builder? What are the consequences of the builder’s cancellation of the contract?

Remedies available to the builder depend upon relevant provisions in a shipbuilding contract.

For example, if an SAJ form is used, the builder is entitled to claim an agreed rate of interest on unpaid instalments and all charges and expenses incurred in consequence of the buyer’s default (article XI 2). When the buyer’s default continues for 15 days, the builder may rescind the shipbuilding contract by giving notice to the buyer (article XI 3). The consequences of the builder’s cancellation of the contract are that items furnished by the buyer become the builder’s property (article XI 3); the builder may have the right to complete or not to complete the vessel, sell it and obtain proceeds (article XI 4); and, for example, if the builder completed the vessel and sold it, the builder may claim against the buyer the difference between the amount of the proceeds and the total amount of expense of the sale, unpaid instalments and interests thereon (article XI 4 (b)(e)).

If there is no provision in the shipbuilding contract in relation to remedies available to the builder:

• the builder is entitled to claim for unpaid instalments and compensation for damage based upon the contract, when the builder completes a vessel, makes preparation to deliver it and sends notice thereof to the buyer. The amount of claimable damage is, in principle, 6 per cent per annum of unpaid instalments for unpaid period; or
• the builder is entitled to send notice to the buyer notifying that the builder will cancel the shipbuilding contract if the buyer does not pay unpaid instalments within a reasonable period, and cancel the shipbuilding contract after lapse of the period without the buyer’s payment. The consequences of the builder’s cancellation of the contract are that items furnished by the buyer are the builder’s property; the builder may have the right to complete or not to complete the vessel, sell it and obtain proceeds; and the builder may claim against the buyer for compensation for damage. However, the amount of claimable damage is unclear.