Making Payments in Japan: What Are the Rules for "Appropriation of Performance" (Bensai no Juto) When Multiple Debts Exist?

In the course of business, it's common for a party to owe multiple debts to the same creditor, or for a single debt to comprise various components like principal, interest, and costs. When a payment is made that is insufficient to discharge all outstanding amounts, the question of how that payment should be applied—or "appropriated"—becomes critical. Japanese Civil Code Articles 488 through 491 provide a structured set of rules for this "Appropriation of Performance" (Bensai no Juto 弁済の充当), establishing a clear hierarchy to determine which obligations are settled first.

What is "Appropriation of Performance" (Bensai no Juto)?

Appropriation of performance refers to the legal process of determining which specific debt or part of a debt is considered discharged when a debtor makes a payment that is less than the total amount owed across multiple obligations of the same kind to the same creditor. This also applies when a single debt requires several distinct performances (like installment payments), or when a single debt involves principal, interest, and costs, and the payment doesn't cover all three.

The rules of appropriation are vital because they directly affect:

• The remaining balance of outstanding debts.
• The continued accrual of interest or default interest on specific obligations.
• The running of statutes of limitation for particular claims.
• Priorities in enforcement if further collection actions become necessary.

The Hierarchy of Appropriation Rules in Japan

Japanese law establishes a clear order of priority for determining how an insufficient payment is appropriated:

1. Agreed Appropriation (Goi Juto - Article 490): The Primacy of Party Agreement

The most fundamental principle is party autonomy. If the debtor (performer) and the creditor (recipient) have an agreement on how payments should be appropriated, that agreement will govern (Japanese Civil Code Art. 490).

• This agreement can be made at the time of payment, or it can be a pre-existing term within the underlying contract (e.g., a clause stating that payments will always be applied to the oldest outstanding invoice first).
• The agreement can even cover the appropriation of payments towards future debts.
• While parties can subsequently agree to modify a prior appropriation, such a later agreement generally cannot prejudice the rights of any third parties who may have acquired an interest relying on the initial state of affairs.

2. Designated Appropriation (Shitei Juto - Article 488): Unilateral Designation

If there is no agreement between the parties, the right to designate the appropriation falls to one of the parties, in a specific order:

(a) Designation by the Performer (Debtor) (Art. 488, Para. 1):
The party making the payment (typically the debtor) has the primary right to designate to which debt(s) the payment should be applied. This designation must be made at the time of performance.

• Example: A company owes its supplier for three separate invoices (A, B, and C). When making a partial payment, the company can specify, "This payment is for Invoice A."
• The creditor generally cannot refuse a valid designation if the payment itself is otherwise acceptable.

(b) Designation by the Recipient (Creditor) (Art. 488, Para. 2):
If the performer (debtor) does not make a designation at the time of payment, the right to designate then passes to the recipient of the payment (the creditor). The creditor can make this designation at the time of receiving the performance.

• Performer's Right to Object: However, this creditor designation is not absolute. If the performer (debtor) immediately objects to the creditor's designation, the creditor's designation becomes ineffective. In such a case, the appropriation will then be determined by the rules of statutory appropriation (see below). The immediacy of the objection is a factual determination.

Any designation, whether by the performer or recipient, must be communicated to the other party (Art. 488, Para. 3). It's important to remember that these rights of designation under Article 488 are default rules and can be altered or waived by prior agreement between the parties.

3. Statutory Appropriation (Hotei Juto - Article 488, Para. 4): When No Agreement or Valid Designation Exists

If there is no party agreement and no valid designation (or if a creditor's designation was immediately objected to), the Civil Code provides a default order of appropriation. This statutory order aims to apply the payment in a manner that is generally fair and reasonable:

• (i) Due Debts First: Payments are first applied to obligations that are already due and payable, before being applied to those whose performance period has not yet arrived.
• (ii) Debt Most Beneficial to the Debtor: If there are multiple due debts (or multiple not-yet-due debts being considered as a group), the payment is appropriated to the debt(s) whose discharge provides the greatest benefit to the debtor. The law provides guidance on what constitutes "greater benefit":
  • A debt bearing interest is prioritized over a non-interest-bearing debt.
  • A debt with a higher interest rate is prioritized over one with a lower rate.
  • A secured debt (e.g., by a mortgage or pledge) is often prioritized over an unsecured debt (as its discharge frees up the collateral).
  • A debt for which the debtor is solely liable might be prioritized over a debt for which they are jointly and severally liable with others.
  • A debt for which a lawsuit has been filed against the debtor is generally prioritized over one not yet subject to litigation.
    The determination of "greatest benefit" can sometimes involve a comprehensive assessment of the debtor's overall financial situation.
• (iii) Earlier Due Date: If, after applying the "benefit to the debtor" criterion, multiple debts are still of equal priority, the payment is applied to the debt(s) with an earlier due date. If considering debts not yet due, it applies to those whose due date will arrive sooner.
• (iv) Pro Rata Application: If all the above criteria still result in a tie (e.g., multiple debts with the same due date and providing equal benefit to the debtor upon discharge), the payment is appropriated proportionally to the amount of each such debt.

These statutory appropriation rules are default provisions. They also find analogous application in determining how proceeds from compulsory execution (e.g., a court-ordered auction of a debtor's property) are distributed among multiple claims held by an execution creditor.

Appropriation When a Single Debt Involves Principal, Interest, and Costs (Article 489)

A distinct set of rules applies when a single debt has components of costs (hiyo 費用), interest (risoku 利息), and principal (ganpon 元本), and a payment is insufficient to cover all three.

1. Specific Statutory Order (Default - Art. 489, Para. 1):
   In the absence of a specific agreement on appropriation (Art. 490 allows for such agreements), Article 489, Paragraph 1 mandates a strict order:
   • 1st: Applied to Costs incurred (e.g., collection costs if chargeable to the debtor).
   • 2nd: Applied to accrued Interest (this includes default interest for late payment).
   • 3rd: Applied to the Principal amount of the debt.
     Crucially, this order (Costs → Interest → Principal) cannot be unilaterally changed by either the debtor's or the creditor's designation. It can only be varied by a mutual agreement between the parties.
2. Multiple Debts, Each with Principal, Interest, and Costs (Art. 489, Para. 2):
   If a debtor owes multiple distinct debts, and each of those debts itself comprises principal, interest, and costs, a two-step appropriation process occurs if a partial payment is made without specific agreement or designation:
   • Step 1 (Inter-Category): The payment is first applied across the debts following the Article 489(1) hierarchy: all recoverable costs across all debts are satisfied first, then all accrued interest across all debts, and finally, any remainder is applied to the principals of the debts.
   • Step 2 (Intra-Category): If the payment is insufficient to cover all items within a particular category (e.g., not enough to pay all accrued interest on all debts), then within that category, the rules of Article 488 (designation by performer, then by recipient with right of objection, then statutory appropriation based on benefit/due date/pro rata) are applied to determine which specific debt's interest (or cost, or principal) is paid first.

Appropriation for a Single Debt Requiring Multiple Performances (e.g., Installment Payments - Article 491)

If an obligation requires several distinct performances (such as installment payments for a purchased item), and a tendered payment is insufficient to cover all due installments, Article 491 dictates that the appropriation rules of Articles 488 (for choosing among due installments) and 489 (for applying a payment within a specific installment to any principal, interest, or cost components of that installment) apply mutatis mutandis (with necessary modifications).

Burden of Proof in Appropriation Disputes

In legal disputes, if a debtor raises payment as a defense to a claim, and the creditor counters that the payment received was appropriated to a different outstanding debt, the debtor generally bears the burden of proving the specific appropriation that led to the discharge of the debt in question. This involves demonstrating either an agreement on appropriation, a valid designation they made, or how the statutory rules would apply to discharge the particular debt they are claiming has been paid.

Conclusion

The rules for appropriation of performance under the Japanese Civil Code provide a structured and hierarchical approach to resolving how insufficient payments are applied to outstanding obligations. While party agreement takes precedence, the Code offers clear default rules involving designation rights and, ultimately, a statutory order of application. For businesses operating in Japan, understanding this hierarchy—Agreement > Designation by Performer > Designation by Recipient (with right of objection) > Statutory Order (considering due dates, benefit to debtor, and pro rata application), along with the specific order for costs, interest, and principal within a single debt—is essential for accurately tracking outstanding balances, managing financial obligations, and resolving payment disputes.