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.