Indemnification clauses are a cornerstone of risk allocation in mergers and acquisitions (M&A) agreements in Japan, as they are globally. These provisions provide a contractual remedy for a party that suffers losses due to breaches of representations and warranties (R&W), breaches of covenants, or other specified matters by the other party. However, the right to make an indemnification claim is almost invariably subject to time limitations. Understanding how these exercise periods are typically structured, the underlying statutory limitations that also apply, and the impact of recent Japanese Civil Code reforms is crucial for both buyers and sellers navigating M&A transactions.

This article explores the common structures of indemnification claim periods in Japanese M&A contracts, specific considerations for different types of breaches, the interplay with statutory extinctive prescription, and key drafting considerations.

The Core of M&A Risk Allocation: Indemnification for Breaches

In a typical M&A deal, such as a share purchase or asset purchase, the seller provides the buyer with a series of representations and warranties concerning the target company or assets. Both parties may also undertake various covenants (promises to do or not do certain things) before and after closing. If these R&Ws prove to be inaccurate, or if covenants are breached, the non-breaching party (usually the buyer) can suffer financial losses.

Indemnification clauses aim to:

• Define the circumstances under which one party (the indemnifying party, usually the seller) will compensate the other party (the indemnified party, usually the buyer) for such losses.
• Establish procedures for making and resolving indemnification claims.
• Crucially, specify the period during which such claims can be made (the "survival period" or "claim period").

These time limits are vital for both parties. For the seller, they provide eventual certainty by defining a cutoff point for potential liabilities arising from the transaction. For the buyer, they define the window within which they must identify and assert claims for losses discovered post-closing.

Contractually Stipulated Exercise Periods for "Normal" Indemnification Claims

Unlike some statutory rights which have legally prescribed time limits for their exercise, the period for making a contractual indemnification claim under an M&A agreement is primarily a matter of negotiation and agreement between the parties. These are often referred to as "survival periods" for the R&Ws and covenants.

1. The General Survival Period for Representations and Warranties:

• Common Durations: While varying based on the specifics of the deal (e.g., industry, due diligence findings, bargaining power), a common range for the survival of general R&Ws in Japanese M&A deals is one to three years from the closing date. Some transactions may see shorter periods (e.g., 6 to 18 months) or, less commonly for general R&Ws, slightly longer ones. The (now abolished) five-year commercial extinctive prescription period under the former Commercial Code often served as an informal benchmark or outer limit in negotiations for some claims.
• Starting Point (Kisan-ten): The clock for this contractual claim period typically starts running from the closing date of the M&A transaction.
• Notification Requirement: It's important to note that this contractual period usually dictates the deadline by which the indemnified party must notify the indemnifying party of a potential claim, providing reasonable details of the alleged breach and the estimated loss. It does not necessarily mean that a lawsuit must be filed or the exact quantum of loss must be definitively established and paid within this period, though the contract will specify these procedural details.

2. Carve-Outs for Longer Survival: Specific Representations and Warranties:
It is common practice to negotiate longer survival periods for certain fundamental R&Ws or those relating to areas with a higher risk of long-tail liabilities. These often include:

• Fundamental Representations: Such as the seller's due organization, authority to enter into the transaction, and capitalization and title to the shares being sold. These may sometimes survive for a longer period (e.g., until the statutory extinctive prescription of a claim challenging title) or even indefinitely, though the latter is rare.
• Tax-Related Representations (公租公課 - kōso kōka): Breaches of tax R&Ws can lead to liabilities arising long after closing, as tax authorities typically have several years to conduct audits and make reassessments. Therefore, the survival period for tax indemnification is often specifically tied to the relevant statutory assessment period (plus a buffer, e.g., 60-90 days) for the taxes in question. This ensures the buyer is protected for the duration of the tax authorities' look-back window.
• Environmental Liabilities: Due to the potential for discovery of historical contamination and long statutory periods for environmental claims, R&Ws concerning environmental matters often have extended survival periods.
• Labor and Employment Matters (労働関係 - rōdō kankei): Certain labor law claims (e.g., unpaid overtime) also have specific statutory prescription periods, and indemnification for breaches related to these areas might be negotiated for a corresponding duration.
• Intellectual Property Ownership and Infringement: R&Ws related to IP may also have longer survival periods, reflecting the ongoing nature of IP rights and potential for third-party claims.

3. Obligations Surviving Closing (Covenants):
For covenants that are intended to continue or be performed after the closing date (e.g., non-compete obligations, confidentiality agreements, agreements to cooperate on post-closing matters), the contractual time limit for bringing an indemnification claim for their breach may be tied to the duration of the covenant itself or a specified period after a breach of such covenant is discovered or occurs.

Special Indemnification Clauses for Known or Specific Risks

During due diligence, a buyer may uncover specific potential liabilities or risks associated with the target company or assets (e.g., a pending lawsuit, an uncertain tax position, a known environmental concern). While general R&Ws might not adequately cover these known issues (as R&Ws typically relate to unknown facts), or the buyer's knowledge could potentially undermine a claim under general R&W provisions (as suggested by a Tokyo District Court judgment, January 17, 2006, Hanrei Jihō No. 1920, p. 136, which hinted that a buyer's actual or grossly negligent ignorance of a breach might preclude a general indemnification claim), parties often address these through "special indemnification clauses" (tokubetsu hoshō jōkō).

These clauses provide a specific contractual right to indemnification for losses arising from these identified risks, often irrespective of the buyer's prior knowledge. Because these relate to pre-identified potential problems with a higher likelihood of crystallizing into actual losses, the exercise period for claims under special indemnification clauses is often negotiated to be longer than for general R&Ws, sometimes extending for many years or until the specific risk is definitively resolved.

Beyond Contractual Deadlines: The Underlying Statutory Extinctive Prescription (Shōmetsu Jikō)

It is absolutely critical for parties to understand that the contractually agreed period for notifying an indemnification claim is distinct from, and runs concurrently with, the statutory extinctive prescription period for the underlying legal right to indemnification itself. The right to indemnification under an M&A agreement is, at its core, a contractual claim for monetary compensation, and like other contractual claims in Japan, it is subject to statutory extinctive prescription.

1. Statutory Prescription Periods Applicable to Indemnification Claims:

• Pre-2020 Civil Code Reform: If the M&A agreement was considered a "commercial act" (shōkōi) – which is typically the case for transactions involving companies – the underlying indemnification claim would likely have been subject to the five-year commercial extinctive prescription under former Article 522 of the Commercial Code. If not deemed a commercial act, the general ten-year civil prescription under former Article 167(1) of the Civil Code would have applied.
• Post-2020 Civil Code Reform: The landscape has changed significantly with the April 1, 2020, amendments to the Civil Code. The separate commercial extinctive prescription was abolished. Contractual indemnification claims arising from M&A agreements executed or whose relevant starting point for prescription occurs on or after this date are now generally subject to the new dual rule under amended Civil Code Article 166(1):
  • Five years from the time the indemnified party (claimant) became aware that the right to indemnification could be exercised; OR
  • Ten years from the time the right to indemnification could objectively be exercised,
    whichever period expires earlier.

2. Determining "Awareness" and "Exercisability" for Indemnification Claims:
The application of these new statutory periods to indemnification claims presents complexities, particularly in determining the kisan-ten (starting point) for both the subjective ("awareness") and objective ("exercisability") prongs:

• When is an indemnification right "exercisable"? Does it become exercisable at the moment of the breach of R&W (even if no loss has yet materialized)? Or only when actual, quantifiable loss is suffered by the indemnified party? Or perhaps upon fulfilling contractual notice requirements?
• When does the indemnified party become "aware" that the right is exercisable? This involves awareness of the breach, the resulting (or potential) loss, and the ability to make a claim under the indemnification clause.

The PDF commentary suggests that determining this starting point can be challenging and, conservatively, one might even consider the M&A contract signing date as a potential (though likely too early for many situations) starting point for the objective 10-year period in certain analyses. More commonly, objective exercisability might be linked to the closing date (when R&Ws are deemed made or remade) or the date a specific loss attributable to a breach is actually incurred and becomes reasonably ascertainable. Awareness would then follow the discovery of these elements.

3. Contractual Notice Period vs. Statutory Prescription:
The contractual requirement to give notice of an indemnification claim within, say, two years from closing does not typically toll, suspend, or renew the underlying statutory extinctive prescription period for the indemnification right itself. Giving timely contractual notice is a precondition to enforcing the contractual remedy, but if the statutory prescription period for the underlying claim (e.g., 5 years from awareness / 10 years from exercisability) expires before the indemnified party takes further action to enforce that claim (such as filing a lawsuit, if the claim is disputed and not paid), the claim could become time-barred by statute, even if the initial contractual notice was timely.
An exception could arise if the indemnifying party's response to the notice constitutes an "acknowledgement" (shōnin) of the indemnification debt, which would renew the statutory prescription period.

Navigating the Interplay: Contractual Claim Periods vs. Statutory Prescription

This dual system of time limits means that an indemnified party must satisfy both:

1. The contractual notice period for asserting a claim under the M&A agreement.
2. The statutory extinctive prescription period for the underlying right to receive indemnification payment.

A failure on either front can be fatal to the claim. For example, a buyer might give timely notice of a breach within the 2-year contractual period but then engage in prolonged, unresolved discussions with the seller. If, during these discussions, the 5-year statutory prescription period (from awareness of the exercisable indemnification right) expires without the seller acknowledging the debt or the buyer initiating legal proceedings, the underlying indemnification right itself could be extinguished by statute, rendering the timely contractual notice ultimately ineffective for recovery.

Practical Implications and Drafting Considerations

For Buyers (Indemnified Parties):

• Negotiate Sufficient Survival Periods: Push for survival periods that are reasonably adequate to discover potential breaches, particularly for fundamental R&Ws and areas with known long-tail risks (taxes, environmental, etc.).
• Understand Notice Requirements Precisely: The M&A agreement will detail what constitutes a valid claim notice, the information required, and the method and timing of delivery. Strict compliance is essential.
• Monitor for Breaches Diligently Post-Closing: Actively monitor the acquired business or assets for any issues that might give rise to an indemnification claim.
• Be Mindful of Statutory Prescription: Once a claim is notified, do not let it languish. If the seller disputes the claim or delays resolution, be aware of the approaching statutory extinctive prescription deadline and be prepared to take formal legal action (e.g., filing a lawsuit or initiating arbitration as per the M&A agreement's dispute resolution clause) to preserve the claim before the statutory period expires. Consider if the seller's communications constitute an "acknowledgement" that would renew the statutory period.

For Sellers (Indemnifying Parties):

• Seek to Limit Survival Periods: Negotiate for reasonable and clear cutoff dates for indemnification claims to achieve finality.
• Define Claim Procedures Clearly: Insist on precise procedures for claim notification and substantiation.
• Track Expiry of Both Contractual and Statutory Periods: Understand when potential liability truly ceases under both the contract and the overarching statutory prescription.
• Respond to Claim Notices Carefully: Be mindful that communications in response to a claim notice could inadvertently be construed as an "acknowledgement" of the debt, thereby renewing the statutory prescription period.

Clear Drafting is Key for Both Parties:
The M&A agreement should be drafted with utmost clarity regarding:

• The specific R&Ws and covenants that are subject to indemnification.
• The precise duration of the survival/claim period for different categories of breaches.
• The exact requirements for a valid claim notice.
• The procedures for resolving indemnification claims.
• Consider language that clarifies when an indemnification "right" is deemed to "arise" or become "exercisable" for the purposes of statutory prescription, although such clauses are always subject to mandatory provisions of law.

Conclusion

Time limits for indemnification claims in Japanese M&A agreements are primarily a product of contractual negotiation, establishing a window within which a party must formally notify the other of a potential claim. These contractually defined periods, however, operate within the broader framework of Japan's statutory extinctive prescription rules, which govern the ultimate enforceability of the underlying monetary claim for indemnification. The 2020 Civil Code reform, particularly the abolition of the separate commercial prescription and the introduction of a dual subjective/objective starting point for general contractual claims, has reshaped the statutory landscape for these indemnification rights. Both buyers and sellers must therefore navigate this dual system of contractual notice periods and underlying statutory prescription with diligence, ensuring their M&A agreements are drafted with precision and their post-closing actions are timed to preserve their rights and limit their liabilities effectively.