Covid-19: Impact On Commercial Contracts – Japan.
Legal News & Analysis - Asia Pacific - Japan - Dispute Resolution
31 March, 2020
How is the applicable law determined by the courts in case of commercial contracts?
If the parties to a commercial contract agree on a specific governing law, the parties’ choice will be recognised and enforced under Article 7 of the Act on General Rules for the Application of Laws (Act No. 78 of 2006). While the determination of the governing law is subject to the doctrine of public policy, the courts would interfere with the parties’ agreement only in exceptional cases.
If the parties fail to agree on a specific governing law, the law of the jurisdiction that is most closely connected to the contract will be the governing law under Article 8(1) of said act.
Are there any statutory provisions relating to force majeure?
In line with the general principles of Japanese law, commercial contracts usually grant termination rights or damages if a party has performed its obligations late, only partially or not at all (“failure to perform”) if an intentional act or negligence of such party has occurred. Force majeure is usually invoked as a defence in case the failure to perform was neither an intentional act nor resulted from negligence.
Therefore, following general principles of the Civil Code, Japanese courts will examine if there was no negligence of a party in breach of its obligations, which could cover events otherwise considered as force majeure. In such cases, the party relying on a lack of negligence must prove that it did not act negligently.
There are some provisions in the Civil Code (Act No. 89 of 1896, as amended) and other laws of Japan which explicitly use the term force majeure. However, they only address very specific situations. For instance, force majeure cannot be used as a defence against a claim for damages for delayed payment (Article 419 of the Civil Code), a leaseholder can demand a reduction of the lease interest due to a decrease in profits caused by force majeure (Article 609 of the Civil Code), and special formal regulations apply to force majeure clauses in contracts for construction work (Article 19 of the Construction Business Act).
There is no statutory provision or court case that generally defines the meaning of force majeure or establishes the requirements for the application of force majeure. However, in general, force majeure is recognised as a concept to release an obligor who fails to perform an obligation or is liable for damages from such obligation or liability. In general, this will be the case where (i) the obligor experienced an event or circumstances beyond its control, (ii) the effects of which could not be avoided by taking appropriate care and measures that are reasonably necessary and available.
However, Japanese courts will only examine if there is an event considered as force majeure in accordance with the general principles of the Civil Code, if there is no force majeure clause in a contract.
How are force majeure clauses in commercial contracts applied and interpreted in practice?
Specific force majeure clauses in commercial contracts are valid under Japanese law unless such clauses conflict with certain general principles such as public policy as provided in Article 90 of the Civil Code. Where force majeure clauses have been validly agreed, Japanese courts interpret and apply such clauses on a case-by-case basis, largely depending on the wording of the clause and the specific facts of the case.
As such, the question of whether an event such as a global pandemic will qualify as force majeure will depend on the specific wording of the force majeure clause in question. If the clause does not expressly cover pandemics, a Japanese court will look at whether the event falls within the contractual definition of force majeure.
The burden of proof that a force majeure event has occurred will usually fall upon the party that invokes the force majeure clause. If the party successfully demonstrates that the failure to perform is caused by a force majeure event, the effect will depend on the content of the force majeure clause.
In the absence of statutory provisions and / or contractual arrangements on force majeure, which instruments are available to avoid the performance of contractual obligations?
The obligor may also try to resort to “the doctrine of a change of circumstances” (jijo henkou no gensoku) which Japanese courts have recognised as part of the principle of good faith under Article 1(2) of the Civil Code. According to court precedents and a majority of academic opinions, the requirements to trigger the doctrine are as follows: (i) an unforeseen change of circumstances has occurred, (ii) such change was not attributable to the parties, and (iii) a literal interpretation of a contract would result in an unfair outcome for a party under the principle of good faith. The remedies that may be available for the aggrieved party under this doctrine are mainly (i) the right to terminate a contract or (ii) the right to adjust the terms of a contract. The aggrieved party invoking the doctrine bears the burden of proof. Further information on this doctrine may be found in our cross-border guide on hardship, which includes a Japanese chapter.
A typical example where the courts have applied the doctrine has been the sale of real estate where the date of a contract and the performance are years apart and the price of the real estate has significantly increased since the execution date of the contract. We are not aware of any precedent where the doctrine was applied by a court in connection with a change of circumstances caused by an outbreak of an infectious disease, and there remains some uncertainty regarding the application of the doctrine in such cases.
What else needs to be considered by clients that are party to a contract which is affected by Covid-19?
The Civil Code does not provide for loss mitigation duties. However, Article 419 of the Civil Code provides that “[i]f the obligee is negligent regarding the failure of performance of the obligation, the court shall determine the liability for the damages and the amount thereof by taking such fact into consideration”. In other words, if the aggrieved party fails to mitigate the loss or damages caused by the other party and is found negligent, such failure will negatively affect the aggrieved party’s claim. This effectively means that parties to a contract are burdened with a mitigation duty, in the sense that failure to fulfil that duty results in a loss or reduction of the aggrieved party’s claim.
There are also no express statutory provisions which establish notification duties related to a force majeure defence. However, if a party can easily make a notification that is effective to prevent the loss or damage to the other party but fails to do so, this may be considered a breach of the mitigation duty or the principle of good faith and consequently reduce the claim of that party. Thus, in certain circumstances, even without a specific contractual agreement, notification duties can be implied by law.
For agreements governed by Japanese law, the parties should also remember that under Article 1(2) of the Civil Code there is a general principle of good faith for commercial contracts, and that the abuse of rights is prohibited under Article 1(3) of the Civil Code. In particular, parties should consider these principles during negotiations related to a delay or non-performance or the exercise of rights or performance of duties (in particular, relating to the duties to disclose information, give notice, mitigate damages, or not to terminate without good cause).
Finally, it has been reported that an amendment to the Act on Special Measures for Pandemic Influenza and New Infectious Diseases Preparedness and Response (Act No. 31 of 2012) is being discussed at present. Such amendment could provide more specific authority for the prefectural governors to take actions to restrict certain activities, such as the use of certain facilities. The amendment may lead to further restrictions on corporate activities and potentially operate in favour of applying force majeure provisions or doctrines.
For further information, please contact:
Hirofumi Taba, Partners, Linklaters