Forming International Contracts with Japanese Entities: How Is the Governing Law Determined if Not Explicitly Chosen?

In the realm of international commerce, the choice of governing law for a contract is a pivotal decision that can significantly impact the rights and obligations of the parties. While explicitly stipulating the applicable law in the contract document is always best practice, parties sometimes overlook this, or fail to reach an agreement. When an international contract involving a Japanese entity lacks a choice of law clause, or if the choice is contested, Japan's Act on General Rules for Application of Laws (AGRAL) (Hō no Tekiyō ni Kansuru Tsūsokuhō, 法の適用に関する通則法) provides a structured framework for determining which jurisdiction's substantive law will govern the contract's formation and effect.

This article explores these Japanese private international law rules, focusing on the principle of party autonomy and the objective criteria applied when no explicit choice has been made.

Party Autonomy: The Cornerstone of Contractual Choice of Law in Japan (AGRAL Article 7)

The foundational principle in Japanese private international law for contractual obligations is party autonomy (tōjisha jichi no gensoku, 当事者自治の原則). Article 7 of AGRAL states: "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 juridical act."

Rationale and Scope of Party Autonomy:
The strong emphasis on party autonomy in Japan, as in many modern legal systems, is rooted in several considerations:

• Predictability and Certainty: Allowing parties to choose the applicable law enhances predictability and legal certainty for their transaction.
• Reflection of Private Autonomy: It extends the principle of freedom of contract from substantive law to the conflict of laws domain.
• Facilitation of International Trade: It enables parties to choose a neutral, well-developed, or familiar body of law, thereby facilitating international commerce.
• Difficulty of Objective Connection: For diverse and complex international contracts, finding a single, universally appropriate objective connecting factor can be challenging.

Japanese law interprets party autonomy broadly:

• Choice of Law with No Factual Connection: Parties are generally free to choose the law of a jurisdiction that has no factual connection to the contract or the parties. Unlike some other areas (e.g., matrimonial property under AGRAL Article 26(2)), Article 7 imposes no such restriction for general contracts.
• Explicit vs. Implied Choice of Law (Mokuji no Sentaku, 黙示の選択): While an explicit choice of law clause is clearest, Japanese law recognizes that a choice of law can be implied. An implied choice must be demonstrated with reasonable certainty from the terms of the contract or the circumstances of the case. For example, a consistent reference to specific statutory provisions of a particular legal system, or a choice of court/arbitration tribunal in a specific country coupled with other factors, might lead to a finding of an implied choice. However, courts are generally cautious in inferring such a choice.
• Timing of Choice and Subsequent Changes: Article 7 refers to the law chosen "at the time of the juridical act." However, AGRAL Article 9 allows parties to subsequently agree to change the applicable law. Such a change is generally effective from the time of the change, but parties can agree for it to have retrospective effect. Crucially, any retrospective change cannot prejudice the rights of third parties acquired under the previously applicable law.
• Partial Choice of Law (Bunkatsu Shitei, 分割指定) / Dépeçage: The prevailing view in Japan is that parties can choose different laws to govern different parts of their contract, provided the contract is divisible and the choices are consistent and workable. This allows for flexibility in complex international agreements.

When Parties Don't Choose: Objective Determination of the Governing Law (AGRAL Article 8)

If the parties have not made a valid choice of law (neither explicitly nor implicitly), AGRAL Article 8 provides the rules for objectively determining the applicable law.

1. The "Most Closely Connected" Law (AGRAL Article 8, Paragraph 1)

Article 8(1) states: "If there is no choice of law by the parties pursuant to the provision of the preceding Article, the formation and effect of a juridical act shall be governed by the law of the place with which said juridical act is most closely connected at the time of said juridical act."

This "closest connection" test (sai-missetsu kankei-chi-hō, 最密接関係地法) is a flexible standard requiring a comprehensive assessment of all relevant circumstances. Factors considered by Japanese courts and scholars in determining the place of closest connection include:

• Party-related factors: Nationality, habitual residence, place of business, or place of incorporation of the parties.
• Contract-related factors: The place of negotiation, conclusion, and performance of the contract.
• Subject matter-related factors: The location of the subject matter of the contract (especially for contracts concerning specific goods or real estate, though the latter has its own specific rule under Article 13 for proprietary aspects).
• Language of the contract and currency of payment.
• Commercial usages and practices relevant to the transaction.
• The law that would uphold the validity of the contract (favor contractus): While the primary approach is objective, some consideration may be given to the parties' presumed intent to create a valid and enforceable agreement.
• The presence of a choice of court or arbitration clause: This can be an indicator of a connection to the chosen forum's law, though it's not conclusive.

The determination involves weighing these and other relevant factors to identify the legal system that has the most significant relationship with the transaction.

2. The Presumption of Characteristic Performance (AGRAL Article 8, Paragraph 2)

To enhance predictability within the flexible "closest connection" test, Article 8(2) introduces a rebuttable presumption based on the theory of "characteristic performance" (tokuchō-teki kyūfu, 特徴的給付):

"If a juridical act is one in which only one of the parties is to render a characteristic performance, the law of the habitual residence of the party rendering said performance (or, if said party has a place of business related to said juridical act, the law of the place of said place of business; or, if said party has two or more places of business related to said juridical act that are located in places governed by different laws, the law of the place of the principal place of business) shall be presumed to be the law of the place with which said juridical act is most closely connected."

• Characteristic Performance: This refers to the performance that distinguishes the contract type, essentially the non-monetary obligation that defines its socio-economic function. For example:
  • In a sales contract, it's the seller's obligation to deliver the goods.
  • In a service contract, it's the service provider's obligation to render the service.
  • In a lease, it's the lessor's obligation to provide the use of the property.
    Payment of money is generally not considered characteristic as it is common to most types of contracts.
• Rationale: The presumption is based on the idea that the law of the country of the party performing the core non-monetary obligation is often the most relevant and that this party's legal environment warrants primary consideration. It can also reflect the idea that this party might face more complex legal and practical hurdles in performing their obligations.
• Connecting Factor: The presumption points to the habitual residence of the characteristic performer. If the performance is connected to their business, it points to their relevant place of business (or principal place of business if multiple are involved).
• Rebuttable Presumption: Importantly, this is only a presumption. If the specific circumstances of the case clearly demonstrate that another law is more closely connected to the contract, the presumption can be rebutted. For instance, if a seller (characteristic performer) from Country X delivers goods to a buyer in Japan under a long-term supply agreement heavily negotiated and documented in Japan, with all payments and dispute resolution centered in Japan, a Japanese court might find that Japan has a closer connection, rebutting the presumption in favor of Country X law.

AGRAL Article 8(3) creates a specific presumption for contracts concerning real property, pointing to the law of the situs of the property, but this is for the contractual obligations, distinct from the proprietary issues governed by Article 13.

Interaction with International Uniform Law (e.g., CISG)

When dealing with international contracts for the sale of goods, the UN Convention on Contracts for the International Sale of Goods (CISG), to which Japan is a party, must be considered.

• Treaty Supremacy: Under Article 98, paragraph 2 of the Constitution of Japan, treaties ratified by Japan form part of domestic law and are generally considered to prevail over conflicting domestic statutes like AGRAL.
• CISG Applicability: The CISG applies to contracts for the sale of goods between parties whose places of business are in different Contracting States (CISG Article 1(1)(a)). It can also apply if the rules of private international law (like AGRAL) lead to the application of the law of a Contracting State (CISG Article 1(1)(b)).
• Exclusion by Parties (CISG Article 6): Parties are free to exclude the application of the CISG or derogate from or vary the effect of any of its provisions. If a contract contains a clause explicitly excluding the CISG, then Japanese PIL rules (AGRAL Articles 7 and 8) will determine the applicable domestic law.
• Relationship between AGRAL and CISG: If the CISG is not excluded and its applicability conditions are met (e.g., under Article 1(1)(a)), it applies directly as substantive law, bypassing the need to use AGRAL to find a domestic sales law. If applicability hinges on Article 1(1)(b), AGRAL would first be used to identify the applicable domestic law; if that law is the law of a CISG Contracting State, then the CISG would apply (unless that State has made a reservation under CISG Article 95 regarding Article 1(1)(b)).

Analyzing a Scenario

Consider the following scenario, adapted from the reference material's Case 30, No. 7, Problem (1):

• Facts: Company A, a Japanese food sales company, contracts through Company B (a Japanese trading company) to purchase frozen food products from Company D, a food manufacturer in Country X (and a subsidiary of Japanese Company C). The contract is concluded in Company B's Tokyo office. The products are packaged for the Japanese market, and payment is to be made in Japanese Yen. The contract contains no choice of law clause but does include a clause explicitly excluding the application of the CISG. It also includes a clause granting exclusive jurisdiction to the Tokyo District Court. After the goods are transported to Japan, Company A inspects them and finds that 30% are defective. Company A sues Company D in Japan for damages due to breach of contract.
• Analysis:
  1. CISG Exclusion: The explicit exclusion of the CISG is effective under CISG Article 6. Therefore, the governing law must be determined by AGRAL.
  2. Party Autonomy (AGRAL Article 7): There is no explicit choice of governing law. Could an implied choice be inferred? The jurisdiction clause favoring Tokyo, combined with other Japan-centric elements (contract conclusion in Tokyo, Japanese buyer, goods for Japanese market, JPY payment), might be argued by Company A as pointing to an implied choice of Japanese law. Company D might resist this. Courts would assess if these factors demonstrate a "reasonable certainty" of a common intention to apply Japanese law.
  3. Objective Determination (AGRAL Article 8) - If no implied choice:
     • Characteristic Performance (Article 8(2)): In a sales contract, the seller (Company D) performs the characteristic non-monetary obligation (delivery of goods). Company D's relevant place of business is in Country X. Thus, the law of Country X is presumed to be the most closely connected law.
     • Rebutting the Presumption / Closest Connection (Article 8(1)): Company A would try to rebut this presumption by highlighting the numerous connections to Japan:
       • Contract concluded in Tokyo.
       • Buyer (Company A) is Japanese.
       • Goods were specifically manufactured and packaged for the Japanese market.
       • Payment in Japanese Yen.
       • Exclusive jurisdiction clause for Tokyo District Court.
         The strength of these factors combined could potentially rebut the presumption and lead a court to conclude that Japanese law is, in fact, more closely connected than the law of Country X. The court would undertake a qualitative weighing of these connecting factors.
  4. Subsequent Choice/Agreement in Court: If both parties proceed to argue the merits of the dispute in the Japanese court based on Japanese substantive law without objection, this could be construed as a subsequent agreement to apply Japanese law under AGRAL Article 9.
  5. If CISG Had Not Been Excluded: If Country X is a CISG Contracting State and AGRAL rules (after the analysis above) pointed to the law of Country X, then Country X's domestic sales law (not the CISG, if it applies via Art 1(1)(b) and Country X made an Art 95 reservation) or the CISG (if Country X is a CISG state and no Art 95 reservation, or if Art 1(1)(a) applied) would be relevant. If AGRAL rules pointed to Japanese law (Japan being a CISG Contracting State), then the CISG would apply directly as the sales law of Japan for that international transaction, unless Japan had made relevant reservations (which it generally hasn't in a way that would preclude this).

Practical Advice for Contracting with Japanese Entities

• Explicitly Choose the Governing Law: The most effective way to ensure predictability is to include a clear and unambiguous choice of law clause in your international contracts.
• Understand the Default Rules: If no choice is made, be aware that AGRAL Article 8 will apply, involving an assessment of the "closest connection" and the "characteristic performance" presumption. This can lead to uncertainty.
• Consider the CISG: For international sales of goods, be aware of the CISG's potential application and decide whether to exclude it, keep it, or modify its provisions.
• Document Connections: If you intend for a particular law to apply implicitly, ensure the contract and surrounding circumstances strongly support this inference. However, relying on implied choice is risky.
• Jurisdiction vs. Choice of Law: Remember that a choice of court (jurisdiction) clause does not automatically equate to a choice of that court's substantive law, although it can be one factor considered in an implied choice or closest connection analysis.

Conclusion

Japanese private international law prioritizes party autonomy in selecting the governing law for contracts. However, in the absence of such a choice, AGRAL Article 8 provides a detailed, albeit flexible, mechanism based on the "closest connection" test, guided by the presumption of "characteristic performance." For businesses engaging in international contracts with Japanese entities, understanding these rules is essential for anticipating the legal framework that will govern their rights and obligations and for making informed decisions when drafting their agreements. An explicit choice of law clause remains the most reliable means of achieving legal certainty.