"Damages in Lieu of Performance" in Japanese Contract Law: When Can a Creditor Claim This Remedy?

When a contractual obligation is not met, the aggrieved party (creditor) in Japan has several potential remedies. One significant monetary remedy, clarified and structured under the revised Japanese Civil Code (effective April 2020), is "damages in lieu of performance" (履行に代わる損害賠償 - rikō ni kawaru songai baishō). This concept, articulated in Article 415, Paragraph 2 of the Civil Code, allows a creditor to seek monetary compensation for the benefit they would have obtained had the contract been duly performed, as an alternative to receiving the actual performance itself. This article explores the meaning of this remedy and the specific circumstances under which a creditor is entitled to claim it.

Defining "Damages in Lieu of Performance"

At its core, "damages in lieu of performance" aims to place the creditor in the financial position they would have been in if the debtor had fulfilled their contractual obligations. It is a form of compensation intended to substitute for the performance that was not rendered. The scope and extent of these damages are generally determined by Article 416 of the Civil Code, which outlines the principles for calculating the range of recoverable damages (covering ordinary damages and foreseeable special damages).

It's noteworthy that the introduction of the term "damages in lieu of performance" in the revised Civil Code does not, by itself, dictate a specific theoretical approach to calculating these damages in all situations, particularly in bilateral contracts where the creditor has also made, or was due to make, a counter-performance (like payment). For instance, if a buyer has prepaid for goods that are not delivered due to the seller's fault, and the buyer then terminates the contract and claims damages, a question arises: Does the buyer have two separate monetary claims (one for the refund of the prepayment and another for damages representing lost profit – sometimes referred to as the Surrogationstheorie or "surrogation theory")? Or is there a single claim for the net loss after accounting for the saved counter-performance (the Differenztheorie or "difference theory" in a broader sense, or Saldotheorie referring to the net balance)? The legislative history suggests that the term "damages in lieu of performance" is neutral on this point, and the specific calculation method remains a matter of interpretation based on the facts of the case and established legal principles. The term essentially refers to damages claimed for non-performance that are inherently incompatible with simultaneously receiving the originally promised performance.

Grounds for Claiming Damages in Lieu of Performance (Article 415, Paragraph 2)

Article 415, Paragraph 2 of the Japanese Civil Code specifies three primary categories of situations where a creditor can claim damages in lieu of performance:

1. Impossibility of Performance (履行不能 - rikō funō) - Item 1

This is perhaps the most straightforward ground. If the performance of an obligation has become impossible, the creditor can claim damages in lieu of that impossible performance. Examples include the destruction of a unique subject matter of a contract (e.g., a specific painting) before delivery due to the seller's fault, or a contractual obligation to perform a service that can no longer be rendered.

When performance is impossible, the creditor's right to demand actual performance is naturally extinguished. The claim for damages in lieu of performance effectively replaces it. This also applies if the impossibility arises while the debtor is already in delay of performance (as per Article 413-2, Paragraph 1 of the Civil Code, which states that a debtor in delay cannot plead impossibility that arose during the delay unless it would have occurred even with timely performance).

2. Debtor's Clear Refusal to Perform (明確な履行拒絶 - meikakuna rikō kyozetsu) - Item 2

A creditor may also claim damages in lieu of performance if "the debtor has clearly manifested their intention not to perform their obligation." This refers to a situation where the debtor, through explicit statements or unequivocal conduct, makes it plain that they will not fulfill their contractual duties.

What constitutes a "clear refusal" is a matter of factual determination. It must be more than mere reluctance or a temporary inability; it implies a definitive and unambiguous repudiation of the obligation. For example, if a supplier definitively states they will not deliver the agreed goods under any circumstances, this would likely qualify.

An important aspect of this ground is that the debtor's clear refusal, while giving rise to a claim for damages in lieu of performance, does not automatically extinguish the creditor's original right to demand actual performance. The creditor may still, in principle, insist on performance if it remains objectively possible. The right to damages in lieu of performance and the right to demand actual performance can coexist in this scenario until the contract is either terminated or performance becomes truly impossible. The creditor essentially gains an additional remedial option.

3. Contract is Terminated, or a Right to Terminate Due to Non-Performance Has Arisen - Item 3

This third category is broader and encompasses two distinct situations:

• a. The Contract Has Been Terminated Due to Non-Performance:
  If the creditor has validly terminated (解除 - kaijo) the contract due to the debtor's non-performance (e.g., after a formal demand for performance goes unheeded, or in cases allowing for termination without demand like fundamental breach), they are entitled to claim damages in lieu of the performance they will no longer receive. This is a well-established consequence of termination. The damages here would aim to compensate for the loss of the contractual bargain.
• b. A Right to Terminate Due to Non-Performance Has Arisen (Even if Not Yet Exercised):
  This is a significant aspect clarified by the revised Civil Code. A creditor can claim damages in lieu of performance even if they have not yet formally terminated the contract, provided that a legal right to terminate due to the debtor's non-performance has already arisen.
  This covers scenarios where:In these situations where a right to terminate has accrued, the creditor is given the option to claim damages in lieu of performance without necessarily taking the step of termination. Similar to a clear refusal, if performance is still possible, the creditor's right to demand actual performance coexists with the right to claim damages in lieu, until the contract is actually terminated or performance becomes impossible.
  • The debtor is in delay, the creditor has made a demand (催告 - saikoku) for performance within a reasonable period, and that period has lapsed without performance (as per Article 541, unless the non-performance is trivial).
  • It's a "specific-time contract" (定期行為 - teiki kōi), where performance by a specific date or within a specific period is essential to achieve the contract's purpose, and the debtor fails to perform by that time (as per Article 542, Paragraph 1, Item 4).
  • Other situations allowing for termination without demand under Article 542 exist, such as when the contract's main objective cannot be achieved due to the non-performance (unless already covered by impossibility or clear refusal).

The Shift from "Transformation Theory" and the Coexistence of Remedies

The approach of the revised Civil Code marks a departure from a traditional Japanese legal theory known as the "transformation theory" (転形論 - tenkeiron). Under this older view, in certain circumstances of non-performance (like impossibility), the creditor's right to claim performance was thought to "transform" into a right to claim damages. This implied that the two rights could not generally coexist.

The new law, by allowing claims for damages in lieu of performance while the right to actual performance may still exist (as in cases of clear refusal or an accrued right to terminate where performance isn't impossible), effectively rejects a strict transformation theory. Instead, it acknowledges that a creditor might have concurrent remedies.

Implications of Coexisting Claims:

• If a creditor, entitled to both, opts to claim damages in lieu of performance, they generally retain the right to later demand actual performance if it's still feasible, until the damages are actually paid.
• Conversely, if the debtor subsequently renders full and proper performance, the creditor's claim for damages in lieu of that performance would typically be extinguished (though claims for damages due to delay up to that point might still be possible).
• Crucially, if the creditor has chosen to claim damages in lieu of performance (in a situation where performance is still possible, e.g., after a clear refusal but before termination), the debtor generally cannot defeat this claim by simply offering late performance. The creditor's choice of remedy, once validly made, is binding on the debtor, unless the creditor's insistence on damages in lieu, while refusing an offered performance, would constitute an abuse of rights or a violation of the principle of good faith and fair dealing (信義誠実の原則 - shingi seijitsu no gensoku).

Damages in Lieu of Cure or Rectification (追完に代わる損害賠償)

A related concept, though not explicitly detailed under a separate heading in Article 415, is damages in lieu of cure or rectification (追完に代わる損害賠償 - tsuikan ni kawaru songai baishō). This arises when a debtor provides defective performance, and the creditor seeks compensation instead of (or after the failure of) the debtor curing the defect.

While the Civil Code doesn't have a dedicated article for this specific scenario in the same way it details damages in lieu of primary performance, the principles of Article 415, Paragraph 2 are understood to apply by analogy. Thus, a creditor could claim damages in lieu of cure if:

1. Cure is impossible (e.g., a defect in a custom-made item is irreparable).
2. The debtor clearly refuses to cure the defect.
3. A contract concerning the cure is partially terminated, or grounds for such partial termination exist (e.g., the creditor demanded cure within a reasonable period, but the debtor failed to comply).

The Japanese Civil Code previously contained a specific provision regarding a contractor's liability for defects in completed work (former Article 634, Paragraph 2), which allowed the client to demand repair or damages in lieu of repair. This specific article was removed during the recent revisions, not to eliminate such claims, but because the legislators considered that such situations are now adequately covered by the general principles of Article 415 and related provisions on non-conformity in sales contracts (which can be applied mutatis mutandis to contracts for work).

Practical Considerations for Businesses

The provisions regarding damages in lieu of performance offer creditors flexibility but also require careful consideration:

• Identifying the Type of Non-Performance: It's crucial to accurately assess whether the situation amounts to impossibility, clear refusal, or a scenario giving rise to a right to terminate, as this determines the availability and nature of the claim.
• Strategic Choices: A creditor faced with non-performance must decide whether to:
  • Continue to demand actual performance.
  • Claim damages in lieu of performance (potentially while keeping the option of actual performance alive, if not impossible).
  • Terminate the contract and then claim damages (which would typically be damages in lieu of the lost performance).
  • The best course of action will depend on the specific facts, the nature of the contract, and the creditor's commercial objectives.
• Documentation: Clear documentation of any refusal by the debtor, demands made by the creditor (including the setting of reasonable periods for performance or cure), and notices of termination is essential to substantiate a claim.
• Impact of Termination: Claiming damages in lieu of performance after contract termination is a standard consequence. However, the ability to claim such damages before termination, merely because a right to terminate has arisen, is a powerful tool that creditors should be aware of.

Conclusion

The revised Japanese Civil Code, through Article 415, Paragraph 2, provides a more comprehensive and nuanced framework for "damages in lieu of performance." It clarifies the specific circumstances—impossibility, clear refusal by the debtor, and the accrual of a right to terminate (or actual termination)—under which a creditor can opt for monetary compensation as a substitute for the unperformed obligation. The move away from the stricter "transformation theory" and the acknowledgment of potentially coexisting rights to performance and damages in lieu offer creditors greater flexibility in seeking remedies for breach of contract, while also underscoring the importance of carefully considered actions and proper legal grounding for such claims.