Individual Guarantees for Business Debts in Japan: What Enhanced Protections Does the Reformed Civil Code Offer?

In Japan, individual guarantees (保証 - hoshō) have traditionally played a significant role in business financing, particularly for small and medium-sized enterprises (SMEs). However, this practice often placed substantial, sometimes crippling, financial burdens on individuals—friends, family members, or business associates—who acted as guarantors, often without a full appreciation of the risks involved. Recognizing these societal concerns, the comprehensive reforms to Japan's Civil Code, effective April 1, 2020, have introduced a robust suite of enhanced protections specifically aimed at safeguarding individuals who guarantee business-related debts. These changes impose new procedural and substantive requirements on creditors and principal debtors, significantly altering the landscape for such guarantees.

1. The Notarized Declaration of Intent: A Prerequisite for Most Individual Business Loan Guarantees

A cornerstone of the enhanced protections is the new requirement for a notarized declaration of intent when an individual guarantees certain business debts (Reformed Civil Code, Article 465-6).

The General Rule:
For an individual to validly guarantee a "debt incurred for business" (事業のために負担した貸金等債務 - jigyō no tame ni futan shita kashikin tō saimu), which primarily refers to loans taken for business purposes, or a revolving guarantee that includes such business debts within its scope, a critical procedural step must be followed. The individual guarantor must, within one month prior to concluding the guarantee contract, express their definite intention to provide the guarantee through a notarized deed (公正証書 - kōsei shōsho). Failure to comply with this notarization requirement renders the guarantee contract void.

The purpose of this stringent requirement is to ensure that the individual guarantor has a formal opportunity to reflect on the serious nature and potential consequences of their undertaking, with the involvement of a notary public who is expected to confirm the guarantor's genuine and informed intent. During the notarization process, the prospective guarantor is typically required to orally explain to the notary the key terms of the guarantee they are about to provide, including:

• Identification of the principal debtor and the creditor.
• Details of the principal obligation: the principal amount, applicable interest rates, potential damages for default, etc.
• A clear statement of their intent to perform the entire obligation if the principal debtor defaults.
• For revolving guarantees, this includes the scope of underlying obligations, the crucial maximum amount (極度額 - kyokudogaku) of the guarantee, and any fixed date for determining the principal amount secured.

This notarization requirement generally applies to guarantees of business loans and similar financial accommodations. It typically does not extend to guarantees for other types of business obligations, such as rental payments under a commercial lease.

Exceptions to Notarization (Article 465-9):
The notarization requirement is waived if the individual guarantor falls into specific categories of persons who are deemed to be closely connected to, and sufficiently informed about, the principal debtor's business and its risks. These exceptions include:

• Directors, executive officers, or persons in equivalent managerial positions of a corporate principal debtor.
• Individuals who, alone or with certain affiliated persons/entities, hold a majority of the voting rights in the corporate principal debtor (or in its parent company, or in a company that controls the parent company).
• An individual who jointly carries on the business with a non-corporate principal debtor.
• The spouse of a non-corporate principal debtor, provided the spouse is actually engaged in the principal debtor's business.

The rationale for these exceptions is that such individuals are presumed to possess adequate information and a direct interest in the business, mitigating the need for the formalistic protection of notarization.

2. Enhanced Information Disclosure Obligations

The reformed Code imposes significant new information disclosure obligations on both the principal debtor and the creditor to ensure prospective individual guarantors are better informed.

A. Disclosure by the Principal Debtor at the Time of Requesting the Guarantee (Article 465-10):
When a principal debtor requests an individual to provide a guarantee for a business debt (where the guarantee is provided upon the entrustment of the principal debtor), the principal debtor has a mandatory duty to provide the prospective guarantor with specific information regarding:

1. Their financial status, including assets, liabilities, income, and expenditure.
2. The existence, amount, and performance status of any other debts they owe (excluding the principal obligation to be guaranteed).
3. Whether any other security (e.g., collateral) has been or is intended to be provided for the principal obligation to be guaranteed, and details of such security.

If the principal debtor fails to provide this information or provides false information, and this failure or falsity causes the guarantor to enter into the guarantee agreement under a mistaken understanding, the guarantor may rescind the guarantee contract. However, this right of rescission is conditional: it can only be exercised if the creditor knew or could have known (i.e., was negligent in not knowing) of the principal debtor's failure to disclose or provision of false information. This places a degree of responsibility on the creditor to be vigilant.

B. Disclosure by the Creditor upon Request from the Guarantor (Article 458-2):
Once a guarantee is in place (and was provided upon entrustment from the principal debtor), if the guarantor (whether an individual or a corporation) requests information from the creditor concerning the status of the principal obligation, the creditor must promptly provide information regarding:

• Any non-payment of the principal sum, interest, default charges, damages, or other amounts related to the principal obligation.
• The outstanding balance of all such amounts.
• The portion of such amounts that is currently due and payable.

While the Code does not specify a direct penalty for a creditor's failure to comply with this request, such failure could potentially give rise to a claim for damages under general principles of contract law if the guarantor suffers loss as a result.

C. Disclosure by the Creditor upon the Principal Debtor's Default (Loss of Benefit of Time) (Article 458-3):
If the principal debtor defaults and, as a result, loses the "benefit of time" (期限の利益の喪失 - kigen no rieki no sōshitsu)—meaning the entire outstanding debt becomes immediately due and payable—and the guarantor is an individual, the creditor has a duty to notify the individual guarantor of this event. This notification must be given within two months from the time the creditor became aware that the principal debtor had lost the benefit of time.

If the creditor fails to provide this timely notice, they cannot demand payment from the individual guarantor for any default interest or late payment charges that accrued during the period from when the loss of benefit of time occurred until the notice was actually given (or until the guarantor otherwise became aware of the situation). This incentivizes creditors to keep individual guarantors informed of critical defaults.

3. Stricter Rules for Revolving Guarantees by Individuals

A "revolving guarantee" (根保証 - ne-hoshō) is one that secures a series of unspecified future debts arising from ongoing transactions up to a certain limit, rather than a single, specific current debt. The reforms have significantly tightened the rules for such guarantees when provided by individuals.

Mandatory Maximum Amount (極度額 - Kyokudogaku):
Under the reformed Civil Code (Article 465-2, Paragraphs 1 and 2), any revolving guarantee contract where an individual acts as the guarantor is void unless it expressly stipulates a maximum guaranteed amount (極度額 - kyokudogaku). This requirement was previously limited primarily to revolving guarantees for loan obligations, but the reform has expanded its application to cover all types of revolving guarantees by individuals, including those for ongoing trade credit, lease obligations, or other continuous business dealings. This is a crucial protection, preventing individuals from unknowingly exposing themselves to potentially unlimited liability.

Principal Determination Events (元本確定事由 - Ganpon Kakutei Jiyū):
The events that cause the principal amount secured by an individual revolving guarantee to become fixed and no longer increase ("principal determination events") are now comprehensively applied to all individual revolving guarantees (Reformed Civil Code, Article 465-4). Such events include:

• The commencement of compulsory execution or insolvency proceedings (e.g., bankruptcy) against the guarantor.
• The death of the principal debtor or the guarantor.
  Once the principal is determined, the guarantor's liability is capped at the outstanding amount at that point, up to the agreed kyokudogaku.

4. Guarantees of Recourse Claims in Revolving Guarantees (Article 465-5)

The reforms also address complex scenarios where an individual guarantees a recourse claim that might arise under another guarantee. For example, imagine Principal Debtor D is guaranteed by Corporate Guarantor A under a revolving guarantee. Individual Guarantor B then guarantees Corporate Guarantor A's potential future recourse claim against Debtor D (should A have to pay out under its guarantee).

Even if the primary revolving guarantee provided by Corporate Guarantor A did not require a maximum amount (because A is a corporation, not an individual), the individual guarantee by B of A's recourse claim is now subject to the protective rules applicable to individual revolving guarantees (e.g., the need for a maximum amount) if the original underlying obligations secured by A's guarantee were of a type that would have required such protections had A been an individual (e.g., if they included business loans). This prevents circumvention of individual guarantor protections through multi-layered guarantee structures.

5. Impact of Creditor's Demand on a Joint and Several Guarantor

Under the reformed law, if a creditor makes a demand for performance (履行の請求 - rikō no seikyū) on one joint and several guarantor (連帯保証人 - rentai hoshōnin), this action no longer has an "absolute effect" (zettaikō) of interrupting the extinctive prescription period for the principal debtor's obligation (Reformed Civil Code, Article 458, applying mutatis mutandis Article 441). The effect is now "relative" (sōtaikō), meaning it only impacts the prescription period concerning the guarantor to whom the demand was made. Therefore, to effectively manage the statute of limitations for both the principal debt and the guarantee obligation, creditors must now ensure they make appropriate demands or take other prescription-suspending/renewing actions separately against both the principal debtor and each joint and several guarantor.

Transitional Application

These new rules enhancing guarantor protection generally apply to guarantee contracts concluded on or after April 1, 2020. The notarization requirement for individual guarantees of specified business debts also applies to guarantee contracts entered into from this date onwards. Guarantees concluded before this date generally remain subject to the rules of the old Civil Code.

Practical Considerations for Businesses, Especially Creditors

Businesses, particularly those extending credit or requiring guarantees in Japan, must adapt their practices to these new protective measures:

• Notarization Adherence: For new guarantees by individuals covering business loans (and not falling under an exception), creditors must ensure the guarantor properly completes the notarization process within one month before signing the guarantee.
• Robust Information Disclosure Protocols: Creditors should implement clear procedures to ensure that principal debtors fulfill their statutory disclosure obligations to prospective individual guarantors. Creditors themselves must be prepared to respond to information requests from existing guarantors and to provide timely notice to individual guarantors if the principal debtor defaults and loses the benefit of time. Documenting all such disclosures and notices is essential.
• Revolving Guarantees from Individuals: Always clearly stipulate a definite maximum amount (kyokudogaku) in any revolving guarantee agreement involving an individual guarantor. Existing individual revolving guarantees should be reviewed for compliance, especially if they are renewed or modified.
• Prescription Management: Creditors need to be aware that making a demand on a joint and several guarantor alone will not interrupt the prescription period for the principal debtor. Separate actions are necessary.

Conclusion

The reforms to Japan's Civil Code have significantly strengthened the legal protections afforded to individuals who guarantee business debts. By mandating notarization for certain guarantees, imposing comprehensive information disclosure duties, and requiring maximum limits for individual revolving guarantees, the law aims to prevent individuals from being subjected to unforeseen and excessive liabilities. While these changes promote fairness for individual guarantors, they also necessitate diligent adherence to new procedures by creditors and principal debtors to ensure the validity and enforceability of such guarantees in Japan's evolving legal landscape.