Contract formation

Good faith in negotiating

Is there an obligation to use good faith when negotiating a contract?

Yes. Although a party to a contract, in principle, has full discretion whether or not to enter into the contract up until execution, even in a phase where the contract is yet to be concluded, the negotiating parties are required to act in good faith. If a party did not act in good faith and as a result the other party suffers damages, the party failing to act in good faith may be liable for such damages incurred in the following cases:

  • a contract has been concluded, but the contract is found invalid for certain reasons, such as the impossibility of performance, and the party knew or should have known of such impossibility;
  • negotiations aiming to conclude a contract had reached a final phase, but ultimately the contract was not concluded because the party did not act in good faith in failing to conclude the contract; or
  • a contract was effectively concluded, but as a result of the party’s provision of false information, the process and contents thereof were disadvantageous to the other party.

It should be noted that recovery of damages in these cases is limited to the extent of the causal relationship between the damages suffered and the reliance on the counterparty’s actions; in other words, it does not cover expectancy interest. That is to say, the harmed party will only be able to claim for direct damages suffered or incurred as a result of acting under the belief that the contract should be valid or that the contract highly likely should be concluded, and performance profits that would have been obtained if the contract were to be performed are not recoverable.

‘Battle of the forms’ disputes

How are ‘battle of the forms’ disputes resolved in your jurisdiction?

Although no definite legislation exists in Japan, and therefore Japanese law is silent on this point, if the terms of the two submitted forms are entirely different, it is likely to be considered that no contract has been formed, since it is generally understood that a contract is formed by the terms of the offer and the acceptance being the same.

Notwithstanding the foregoing, it also is generally understood that the conditions proposed by the first submitted form are evaluated as declaring an intention of that party and are rejected by the other party by its proposal of its counter form. If the party that made the initial submission does not raise any objection, it is highly likely that such counter form is considered as an acceptance and reflects the terms of the understanding.

Further, under the Commercial Code of Japan, when one party receives an offer to contract in relation to its business from another party, with which the party has regular dealings, the party must issue a notice of its acceptance or refusal of the offer to contract without delay. If the party fails to issue this notice, the party will be deemed to have accepted the offer to contract.

Language requirements

Is there a legal requirement to draft the contract in the local language?

Parties are free to draft a contract in any language they prefer.

However, since Japanese must be used in court, to enforce rights under a contract before a Japanese court, it will be necessary to have it translated into Japanese. Incidentally, if a contract is a necessary document for any registration, permission and such like, a Japanese translation will also be required.

Online contracts

Is it possible to agree a B2B contract online?

Yes, in principle, as no form of documentation is required under Japanese law for the parties to enter into a contract. Even an oral communication can constitute a contract in appropriate circumstances. Particular types of contract, however, such as contracts of guarantee, shall be made in writing or concluded by electromagnetic record.

A contractual party can avoid the obligation to pay stamp duty, which the parties are required to pay in respect of certain document types finalised in Japan. However, in order to prove the formation of a contract, it is important to maintain evidence that a contract has been validly concluded.

Traditionally, online contracts have not commonly been used in Japan and most contracts have been signed on paper, although recently the use of online contracts is being offered by more and more Japanese companies. Nevertheless, at present, the predominant method of executing contracts is still on paper.

Statutory controls and implied terms

Controls on freedom to agree terms

Are there any statutory or other controls on parties’ freedom to agree terms in contracts between commercial parties in your jurisdiction?

Under Japanese law, the principle of freedom of contract is upheld, and parties are free to draft commercial contracts without any statutory or other controls unless it is contrary to public order and morals, among others.

Standard form contracts

Are standard form contracts treated differently?

Under the current Civil Code, there are no special provisions concerning standard form contracts.

The leading case on the binding effect of a standard form contract is a Great Court of Cassation (a predecessor of the Supreme Court of Japan) ruling of 24 December 1915. In this case, with respect to a claim that the other party should not be bound by exemption clauses in a fire insurance standard form contract because it was unaware of the existence of such provisions, the court ruled that since the parties did not express any intention of excluding the application of such standard form contract, unless counter evidence is provided, it should be assumed that the parties concluded the contract intending that the standard form contract would apply. However, the evaluation of this precedent and the development of arguments based on this theory are extremely varied.

In this regard, a new provision in the amended Civil Code provides that, within a standard form contract, the portion that satisfies certain requirements will be considered as a ‘fixed standard form clause’ and binding. Under this new provision, if either of the following requirements is met, then it will be deemed that the parties have agreed to each of the clauses in the fixed standard form clause:

  • the parties agreed that the fixed standard form clause will become a part of the contract; or
  • the party that prepared the fixed standard form clause expressed its intention to the other party to incorporate the fixed standard form clause into the contract.

Notwithstanding the above, a clause that limits the rights or weighs the obligation of the other party one-sidedly against the principle of good faith and fair dealing, in light of the type and nature of the transaction or the prevailing market practice, will not deemed to have been agreed upon between the parties.

The amendment is to come into force on 1 April 2020. This is likely to be referenced when determining the binding enforceability of the standard form contract. In addition to the requirements to deem that an agreement existed as described above, the amendment also intends to ensure legal stability by stipulating the rules as to how changes made to the fixed standard form clauses become effective. Further, the regulations in respect to contents and presentation of the fixed standard form clause also are included in the amendment. This principle about ‘fixed standard form clause’, however, shall not apply if either party showed an intent not to apply such principle prior to the effectiveness of the amendment.

Implied terms

What terms are implied by law into the contract? Is it possible to exclude these in a commercial relationship?

First of all, in cases where a contractual party does not perform any obligation or delays in its performance of the obligation, such party must compensate for damages arising from and on a basis of its default. In this regard, if there is a defect in the object of the sale, damages arising from such defect must be compensated on a basis of ‘defect warranty liability’ (please note that because of the amended Civil Code that shall be in force as of 1 April 2020, the scope of compensable damages shall be expanded so as to be the same as usual default liabilities on a basis of ‘non-conformity liability’), and if damages are caused due to the illegal acts of the party, damages based on the illegal acts also must be compensated.

Further, manufacturers are liable for damages incurred by a third party due to defects in manufactured goods if certain requirements are met in accordance with the Product Liability Act. The third party making the claim does not assume the burden of proof to establish negligence of the manufacturer, which is a benefit for claims made under this law.

See question 10 for the possibility of limiting responsibility.

Vienna Convention

Is your jurisdiction a signatory to the United Nations Convention on Contracts for the International Sale of Goods (the Vienna Convention)?

Yes, Japan has joined the Vienna Convention.

Good faith in entering and peforming

Is there an obligation to use good faith when entering and performing a contract?

Yes. When equitable principles or public policy under the Civil Code are violated, the exercise of rights will be restricted, and there is a possibility that a part of a contract will be determined as invalid. There is no explicit standard as to what constitutes a violation of equitable principles or public policy; reference must be made to court precedents.

Limiting liability

Prohibition on exclusions and limitations

What liabilities cannot be excluded or limited by a supplier in a contract?

In principle, a provision that limits liabilities or provides an exemption from liability for damages is valid. However, in cases where the damages were caused by a person intentionally or by gross negligence, such limitation or exemption may not apply.

For instance, the validity of a contract for outsourcing software development that included a provision specifying that ‘the upper limit of the compensation for damages shall be the contract amount specified in an individual agreement’ was reviewed by a court. In this case, the court found that ‘if this provision limits the liability for damages, even in the case where a party concerned infringes rights or interests protected by law, intentionally or by gross negligence, this will degrade equity considerably and go against the ordinary intentions of parties concerned’, and went on to rule that the provision limiting compensation for damages cannot apply to such cases.

Financial caps

Are there any statutory controls on using financial caps to limit liability for breach of contract?

See question 10.

Indemnities

Are there any statutory controls on indemnities used to cover liability risks in contracts?

See question 10.

Liquidated damages

Are liquidated damages clauses enforceable and commonly used in your jurisdiction?

Liquidated damages clauses are enforceable and commonly used in Japan. Under the Civil Code, if liquidated damages are specified in a contract, the courts have no authority to change the amount stated in such agreement as long as the scope of the damages and the amount specified in the clause are reasonable when compared with the actual damages that could result from a breach of the contract.

However, it is possible that liquidated damages could be violative of the principles of good faith, public order and morals, and held invalid.

For example, given the court precedents, in cases where the liquidated damage is too high (as has been found with respect to a franchise agreement), there may be a risk of violating public policy and of the agreement being deemed invalid. While there have been court precedents recognising liquidated damage of 60 months’ worth of royalties and precedents recognising a liquidated damage of three times the admission fee, in general, the courts would limit liquidated damage to approximately 30 months’ worth of royalties.

Payment terms

Statutory time limits on payments

Are there statutory time limits for paying invoices? Is it possible to agree a different payment period?

There are no general statutory time limits for paying invoices and parties may agree to the payment period that suits them best.

As for subcontract proceeds under the Act Against Delay in Payment of Subcontract Proceeds, Etc to Subcontractors (the Subcontracting Act), however, the payment period shall be fixed to be within 60 days and, moreover, within as short a time period as possible from the day on which the main contractor receives the completed work from its subcontractor. In case of a violation of the Subcontracting Act, the Japan Fair Trade Commission (JFTC) may issue a request for payment of interest for delay to the main contractor. In addition, if the main contractor does not comply with the request, a cease-and-desist order or a payment order by the JFTC based on the Anti-Monopoly Act may be issued.

Whether or not the Subcontracting Act is applicable will be determined based on the paid capital of the main contractor and of the subcontractor.

Late payment interest

Is statutory interest charged on late payments? Is it possible to agree a different rate of interest?

Yes, statutory interest is charged on late payments without any notice from the day following the payment date. The statutory interest rate for commercial transactions is 6 per cent per annum. In accordance with the amended Civil Code to be in force as of 1 April 2020, the statutory interest rate will be 3 per cent per annum and it will be automatically reviewed according to certain indications every three years.

The parties are free to agree to a different interest rate, but if such interest rate is contrary to public order and morals and such like, the statutory interest rate will apply.

Civil penalties

What are the civil penalties for failing to comply with statutory interest rate or late payment of invoices?

See question 15. The debtor must pay interest at 6 per cent per annum (in the amended Civil Code to be in force as of 1 April 2020, 3 per cent per annum) on late payments. The parties are free to agree to a different interest rate to the extent that it is not contrary to public order and morals and such like.

Termination

Implied terms

Do special rules apply to termination of a supply contract that will be implied by law into a contract? Can these terms be excluded or limited by including appropriate language in the contract?

Under the Civil Code, when a party does not perform its contractual obligations, the other party may terminate the agreement. In addition, if the agreement includes a termination clause, a party may bring an agreement to an end pursuant to such clause even if there is no breach of contract.

However, with respect to continuous contracts, such as franchise agreements, the expectation of the party (mainly the franchisee in franchise agreements) to continue being engaged in the contract should be protected. The commonly understood approach is to restrict contract cancellation to a certain degree, such as by requiring a legitimate reason for cancelling continuous agreements.

On the other hand, by focusing on the principle of freedom of contract, court rulings recognising the freedom to cancel continuing contracts have resulted. For example, in a case where the exercise of a right to terminate a special agent agreement for distribution of cosmetics was disputed, the Tokyo High Court held that an ‘inevitable reason’ was not required in exercising the right to terminate the agreement. In addition, there have been cases holding that with respect to the rejection of renewing a franchise agreement for take-home lunches, the agreements would end with the expiration of the term unless special circumstances exist, such as the rejection of renewal as being violative of public policy or the principle of good faith.

However, with respect to franchise agreements in particular, there are many court precedents that restrict cancellation. For example, in a case where the right to terminate an agreement was exercised in a franchise agreement of a convenience store, the court held that the exercise of the right to terminate would result in the destruction of a fiduciary relationship because the manager of the store likely works there full time and would lose his or her sole source of income if the contract was discontinued; the cancellation, accordingly, was deemed invalid.

In addition, in a court case where there was a dispute as to whether renewal of a franchise agreement could be rejected, it was held that from the nature of the franchise agreement, certain legal protections for franchisees would be required based on expectations of a continuous expansion of business, and consequently there are certain restrictions based on equity principles in refusing to enforce the rejection, and that it would be reasonable to interpret that a contractual relationship will only end due to the expiration of the term in instances where there are legitimate reasons to reject the renewal. This case involved the refusal of a master franchisor to renew an agreement with an area franchisor. There are differences between normal franchise agreements and area franchise agreements, and there are many cases where area franchisors are investing large amounts of capital and contributing to the growth of the franchisees. Therefore, this type of investment would make it more likely that the franchisee expected the agreement to continue.

While the analysis afforded by the Tokyo High Court decision involving the special agent agreement for cosmetics distribution described above might be reasonably consistent with the principle of freedom to contract, given some of the holdings in other cases relying on equitable principles, to minimise litigation risks when cancelling agreements it would be prudent to bear in mind having legitimate reasons for the cancellation of a continuing contract.

Notice period

If a contract does not include a notice period to terminate a contract, how is it calculated?

In case of cancelling an agreement pursuant to the termination right provided in the agreement, while it is common to specify a notice period prior to the effectiveness of the termination, if a notice period is not specified, it can be considered that the contract can be terminated immediately. On the other hand, in order to rely on the statutory right to cancel a contract in response to the other party’s failure to fulfil its performance obligations, it is necessary to formally request the non-performing party to fulfil its obligations within a reasonable period, and if the non-performing party continues its non-performance during this period, the contract may be cancelled.

According to court precedents, however, under certain circumstance, there will be some restrictions on the cancellation of a continuing agreement, as mentioned in question 17. If a relatively long notice period is not specified, there is a possibility that cancellation of a contract will not be permitted, depending on the circumstances.

For instance, in a case where a foreign wine producer tried to change distributors by cancelling its importation and distribution contract with its Japanese distributor, the court held that in order for the wine producer to cancel the contract, it should have specified a one-year notice period prior to effectiveness of the cancellation or alternatively must compensate the distributor for its loss equivalent to this period, considering the fact that the transactions between the two companies based on their contract had been continuing for 18 years and the distributor had increased the sales of wine during that period (Judgment of Tokyo District Court, 30 July 2010).

Automatic termination on insolvency

Will a commercial contract terminate automatically on insolvency of the other party?

A commercial contract will not terminate automatically on the insolvency of the other party.

Consequently, parties often include a contract clause enabling either party to terminate the agreement on the insolvency of the other party. However, it is highly likely that such a clause will be considered unenforceable.

In particular, with regard to civil rehabilitation proceedings, the Supreme Court has found that a termination clause on a petition for the commencement of civil rehabilitation proceedings is null and void because such clause is contrary to the purpose of the civil rehabilitation proceedings (Judgment of the Supreme Court, 16 December 2008). In addition, some lower court decisions also have found that termination clauses on a petition for the commencement of bankruptcy proceedings are null and void. Therefore, it should be noted that even if parties include a termination clause on insolvency, a party may not be permitted to terminate the agreement on insolvency of its counterparty.

Termination for financial distress

Are there restrictions on terminating a contract if the other party is in financial distress?

There are no general restrictions on terminating a contract if the other party is in financial distress. Therefore, the parties are able to terminate the contract in accordance with the contract.

In order to enable this right of termination, parties often include a contract provision that enables a party to terminate the contract if the other party suffers financial distress of the types described below:

  • when it suspends or is unable to make payments, or when its bills or checks are dishonoured; or
  • when there have been actions against it of seizure, provisional seizure, provisional injunctions or auction, or if it receives a disposition for failure to pay taxes or public dues.

Please note, however, that such termination rights may be limited in certain circumstances. See questions 17 and 18.

Force majeure

Is force majeure recognised in your jurisdiction? What are the consequences of a force majeure event?

Yes, force majeure is recognised under Japanese law.

The Civil Code stipulates which party bears the risk of force majeure and, in principle, this risk is assumed to be borne by the obligor. This means that the general rule is that when a force majeure event makes it impossible for the obligor to perform the obligation, while the obligor may be excused from performance, it also is not entitled to payment.

There is an exception to this, and the obligee bears the risk and the obligee must make payment even when the obligor cannot perform the obligation due to force majeure. This exception applies where:

  • the purpose of the bilateral contract is the creation or transfer of real rights regarding specified things; or
  • the subject matter of the bilateral contract with conditions precedent has been lost or damaged due to reasons not attributable to the obligor.

Please note that in the amended Civil Code to be in force as of 1 April 2020, the above-mentioned exception shall be abandoned, and as a result thereof the risk of force majeure shall be regarded to be borne by the obligor without exception.

Notwithstanding these concepts, however, parties are free to agree to their own negotiated force majeure clause that modifies the principles in the Civil Code. Notably, parties in B2B contracts often include a force majeure clause.

Subcontracting, assignment and third-party rights

Subcontracting without consent

May a supplier subcontract its obligations under the contract without seeking consent from the other party?

It depends on the classification of the contract.

With regard to a ‘sales agreement’ (for which the purpose is to sell and purchase a product) or a ‘contract for work’, for example, constructing a building, developing a system, etc), a supplier may subcontract its obligations without seeking consent, unless otherwise stated in the contract. Liability, however, associated with delay in delivery, quality defects and the like will remain with the supplier to the party ordering the product or work notwithstanding its subcontracting. In this regard, manufacturing consignment contracts are generally considered to be classified as a ‘contract for work’.

On the other hand, the general rule for a ‘quasi-mandate agreement’ (for which the purpose is to mandate business not constituting juristic acts) is that a mandatary may not subcontract its obligations.

Quasi-mandate agreements are distinguished from contracts for work at the point where the suppliers in quasi-mandate agreements are not obliged to complete certain work; in other words, they only have to assume a duty to administer the mandated business with the care of a good manager.

Statutory rules

Are there any statutory rules that apply to subcontracting in your jurisdiction?

The Subcontracting Act referred to in question 14 may apply when subcontracting manufacturing or repairing of goods, creation of information-based products, or the provision of services. The Subcontracting Act is applicable when the paid capital of the main contractor exceeds a certain amount, and that of the subcontractor is less than a certain amount.

If the Subcontracting Act is applicable, the main contractor must (i) prepare and deliver to the subcontractor a document describing all the necessary items (‘three-section document’) when placing an order, and (ii) prepare and preserve for two years a document describing the details of the transaction (‘five-section document’). In addition, the main contractor (iii) must make payment to the subcontractor within 60 days after having received the deliverables, and (iv) is prohibited from certain acts specified in the Subcontracting Act, such as an unfair reduction of the purchase amount or price reduction.

Assignment of rights and obligations

May a party assign its rights and obligations under the contract without seeking the other party’s consent?

Receivables can be transferred between a former creditor and a new creditor without the consent of the debtor; provided, however, that this shall not apply to cases where the parties have manifested their intention to the contrary (such manifestation of intention may not be asserted against a third party without knowledge).

The assumption of obligations can be made between a creditor and an assignee without the consent of the debtor, in the case of cumulative taking of obligations (the assignee assumes the same obligations without exempting the debtor from the liabilities) (Great Court of Cassation ruling of 25 March 1926). In the case where the assumption of obligations is made between a debtor and an assignee, it is valid as the ‘contract for a third party’ as long as it is intended to provide a creditor with payables directly (Great Court of Cassation ruling of 1 November 1917).

Moreover, in the case of exempting debt assumption (an assignee assumes obligations while exempting the former debtor from the liabilities), the assumption of obligations can be made between a creditor and the assignee as long as it does not go against the intentions of the debtor, although such an assumption basically needs to involve the creditor, the debtor and the assignee (Great Court of Cassation ruling of 25 June 1937).

What statutory controls apply to the assignment of rights or obligations under a supply contract?

The assignment of receivables and assumption of obligations can be made in the manner described in question 24.

However, the assignment of receivables may not be asserted against the applicable obligor or any other party, unless the assignor gives a notice thereof to the obligor or the obligor has acknowledged the same. In addition, in order to assert such assignment against a third party other than the obligor, the said notice or acknowledgement must be made using an instrument bearing a fixed date.

A common way to use an instrument bearing a fixed date is to send out a notice of assignment of receivables or a letter of acknowledgement of such assignment by using content certified mail; or deliver the said document after receiving a fixed date stamp at the notary public office.

Enforcement by third party

How may a third party enforce a term of the contract?

In principle, a contract will not be effective with respect to a third party that is not a contracting party, and the third party may not assert rights under the contract.

However, with regard to a ‘contract for third parties’ - that is, a contract where a party agrees to make a certain benefit to a third party and the said third party expresses an intention to enjoy the benefit against the obligor - the said third party acquires a right to enjoy the said benefit, which is enforceable.

Disputes

Limitation periods

What are the limitation periods for breach of contract claims? Is it possible to agree a shorter limitation period?

For commercial transactions, the general principle is that breach of contract claims shall be extinguished if not exercised after five years from when it became possible to exercise the right.

Although an agreement to shorten the period is considered valid, an agreement to extend the period is considered invalid.

Choice-of-law clauses

Do your courts recognise and respect choice-of-law clauses stipulating a foreign law?

The principle is that the formation and effect of a juridical act shall be governed by the law of the place chosen by the parties at the time of the act. However, in cases where foreign law shall govern, if the application of the foreign law is against public policy in Japan, the relevant provisions shall not apply.

Do your courts recognise and respect choice-of-jurisdiction clauses stipulating a foreign jurisdiction?

Yes, the Code of Civil Procedure provides that the parties may establish, by agreement, the country in which they are permitted to file an action with the courts, provided, however, that such an agreement must be evidenced by an executed paper document. The Code further provides that if the agreement is executed by electronic means (email and the like), then the agreement is deemed to have been executed by means of a paper document.

Additionally, the Arbitration Act provides that arbitration agreements shall be enforced if they are in writing, which includes electronic forms such as email.

Japanese courts generally recognise and enforce choice-of-jurisdiction clauses and arbitration clauses in agreements as long as they fulfil statutory requirements.

Efficiency of local legal system

How efficient and cost-effective is the local legal system in dealing with commercial disputes?

Japan has a capable and independent judiciary as well as significant past precedent to draw upon. Consequently, results are generally predictable and reasonable. However, litigating in Japan can be expensive and time consuming. One factor is that when filing a lawsuit the plaintiff must pay an upfront fee, which is calculated based on the claimed amount. This makes it difficult for plaintiffs to seek high damages, and plaintiffs sometimes reduce their claimed damages to reduce the initial filing fee. Moreover, in the case of damages based on default, plaintiffs are not able to recover their attorneys’ fees from defendants. Additionally, during litigation the hearing system can be time consuming as out-of-court negotiations are uncommon once the proceedings begin. If the litigating parties seem to be amenable to reaching a compromise settlement, the court usually fosters settlement discussions; and in such cases, much of the negotiation will take place on a non-public, off-the-record basis, among the parties’ counsel and the judge. Translation costs will be incurred for translating documents into Japanese, and the lack of discovery can make it difficult for plaintiffs to gather evidence.

There have been similar issues in arbitration in Japan. In the past, foreign attorneys were not permitted to represent their clients in arbitral proceedings, which necessitated the hire of local Japanese counsel. However, the current arbitration law is based on the UNCITRAL Model Law and has facilitated convenient arbitration. Nevertheless, Japan is still not commonly selected as an arbitral forum (see question 31).

New York Convention

Is your jurisdiction a signatory to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards? Which arbitration rules are commonly used in your jurisdiction?

Yes, Japan has been a signatory to the New York Convention since 1961 and, pursuant to its Arbitration Act, Japanese courts recognise and enforce foreign arbitral awards. The most common arbitration rules used in Japan are the Commercial Arbitration Rules of the Japan Commercial Arbitration Association (JCAA), the most popular arbitration association in Japan. However, Japan is not often the seat of arbitration in cross-border commercial disputes, with the JCAA only seeing about 30 cases per year.

Remedies

Available remedies

What remedies may a court or other adjudicator grant? Are punitive damages awarded for a breach of contract claim in your jurisdiction?

In general, courts and adjudicators can order the performance of obligations, compensation for damages or injunctions on the parties. Punitive damages are not permitted for breach of contract claims in Japan, as they are against public policy. Additionally, Japanese courts will not enforce punitive damages awarded in foreign judgments.

Update and trends

Recent developments

Are there any other current developments or emerging trends that should be noted?

No updates at this time.