My Japanese Business Partner Breached Our Contract. Can I Rescind the Agreement (Kaijo)?

When a contractual relationship sours due to a counterparty's failure to perform their obligations—a situation known in Japanese law as saimu furikō (債務不履行) or "non-performance of an obligation"—the aggrieved party often seeks a way to extricate themselves from the agreement and reverse its effects. In Japan, the primary remedy for achieving this is "rescission" or "termination" of the contract, known as kaijo (解除). The Japanese Civil Code (Minpō), significantly revised effective April 1, 2020, provides a framework for when and how a contract can be rescinded due to breach. A key aspect of these reforms is the general shift away from requiring the breaching party's "fault" as a prerequisite for rescission.

Understanding "Kaijo" (Rescission/Termination) in Japanese Contract Law

Kaijo is a unilateral declaration of intent by the non-breaching party to extinguish the contractual relationship because of the other party's non-performance or other legally recognized grounds. Its primary purpose is to release the non-breaching party from their own future performance obligations and, typically, to unwind the transaction by restoring both parties to their pre-contractual positions.

It is important to distinguish kaijo for breach from:

• Termination by mutual agreement (gōi kaijo - 合意解除): Where both parties consent to end the contract.
• Termination based on a contractual right to terminate for convenience (kaiyaku ken ryūho - 解約権留保): Where the contract itself grants one or both parties the right to terminate without necessarily proving a breach (often with specific conditions like notice periods or termination fees).
  This article focuses on kaijo as a remedy for a counterparty's non-performance of their obligations.

The Landmark Shift: Fault Generally Not Required for Rescission

Under the pre-2020 Japanese Civil Code, the prevailing interpretation often required that the breaching party be at "fault" (i.e., the non-performance be due to grounds attributable to them – kiseki jiyū - 帰責事由) for the non-breaching party to rescind the contract based on that non-performance.

The revised Civil Code marks a significant departure from this. As a general rule, for most types of contractual breaches, the debtor's fault is no longer a prerequisite for the creditor to exercise the right of rescission (Civil Code Articles 541, 542). This change aligns Japanese law more closely with several international contract law instruments and shifts the focus from the breaching party's culpability to the objective failure of the contractual exchange and its impact on the non-breaching party.

The underlying justification for rescission under the new law is now more squarely centered on the idea that, due to the breach, it is no longer reasonable to expect the non-breaching party to remain bound by the contract (keiyaku ni kōsoku suru koto no kitai fukanō - 契約に拘束することの期待不可能 – the impossibility of expecting to be bound by the contract). The primary concern is whether the non-breaching party is receiving the essential benefit of the bargain.

Grounds for Rescinding a Contract for Breach

The Civil Code outlines two main pathways to rescission for non-performance: rescission after giving a demand for performance, and rescission without such prior demand in more serious or definitive situations.

1. Rescission After Demand (Saikoku Kaijo - 催告解除 - Civil Code Article 541)

This is the general method for most curable breaches, particularly where performance is delayed but still possible. The procedure involves two steps:

• Demand for Performance (催告 - Saikoku): The creditor must first make a demand to the debtor, setting a "reasonable period" (sōtō na kikan - 相当な期間) within which the debtor is to perform their overdue obligation. What constitutes a "reasonable period" depends on the nature of the obligation and the circumstances.
• Failure to Perform Within the Period: If the debtor fails to perform within the period set in the demand, the creditor may then rescind the contract.

The proviso to Article 541 states that this demand is not necessary if, during the period of demand, it is clear that the debtor has no intention of performing their obligation, or if only a trivial part of the performance is outstanding and this trivial non-performance does not frustrate the overall purpose of the contract as per common commercial sense.

2. Rescission Without Demand (Musaikoku Kaijo - 無催告解除 - Civil Code Article 542)

In certain circumstances where a demand for performance would be futile or inappropriate, the creditor can rescind the contract immediately without making a prior demand. Article 542, paragraph 1, lists these situations:

• (i) Impossibility of Performance: When the whole of the performance has become impossible.
• (ii) Definitive Refusal to Perform by Debtor: When the debtor clearly and unequivocally manifests an intention not to perform their main obligation (e.g., an explicit statement of refusal).
• (iii) Partial Impossibility or Partial Refusal Frustrating Contract Purpose: If only a part of the performance has become impossible, or if the debtor clearly refuses to perform only part of their main obligation, but the purpose of the contract cannot be achieved with the remaining part of the performance.
• (iv) Failure to Perform by Fixed Deadline in "Periodic Acts" (Teiki Kōi - 定期行為): For contracts where performance at a specific time or within a specific period is an essential element for achieving the contract's purpose (e.g., delivery of flowers for a specific event, seasonal goods). If the debtor fails to perform by that critical time, the creditor can rescind without demand.
• (v) Other Cases Where Demand Would Be Futile after Breach of Demand under Art. 541: If, even after a demand for performance under Article 541 is not complied with, it is apparent that the debtor will not perform in such a way that the creditor can achieve the purpose of the contract due to a material breach by the debtor. This allows rescission without a further demand if the initial failure after demand makes the contract's purpose unattainable.

Article 542, paragraph 2, also allows for rescission without demand if the entire performance is impossible, or the debtor has definitively refused to perform the entire obligation, even if the impossibility or refusal is due to grounds not attributable to the debtor. This highlights that rescission is primarily about the failure of the exchange, not fault.

Obstacles to Exercising the Right of Rescission

Even if grounds for rescission appear to exist, certain circumstances can prevent its exercise:

1. Non-Performance Due to Grounds Attributable to the Creditor (Civil Code Article 543):
   A creditor cannot rescind the contract if the debtor's non-performance is due to reasons for which the creditor themself is responsible. For example, if the creditor fails to provide necessary cooperation that is a prerequisite for the debtor's performance, they cannot then rescind for the debtor's resulting non-performance.
2. Interaction with the Defense of Simultaneous Performance (Doji Rikō no Kōbenken):
   If a party is rightfully withholding their performance because the other party has not tendered their own reciprocal due performance (i.e., they are validly asserting the defense of simultaneous performance under Article 533), their non-performance is excused and generally does not give the other party a right to rescind for delay.
3. Trivial Breaches:
   While the fault requirement has been largely removed, the underlying principle is that rescission is a remedy for significant disruptions to the contractual bargain. If a breach is extremely minor or trivial and does not substantially impair the creditor's ability to achieve the main purpose of the contract, courts may, applying principles of good faith, find that rescission is not a proportionate remedy. Article 541 proviso touches upon this when it refers to trivial non-performance after a demand.

The Effects of Rescission (Kaijo no Kōka - 解除の効果)

When a contract is validly rescinded, it has significant legal consequences, primarily governed by Article 545:

1. Extinction of Future Contractual Obligations (Art. 545(1), main part):
   Upon rescission, both parties are released from their obligations to render any further performance under the contract. The contract essentially ceases to operate prospectively.
2. Duty of Restitution (Genjō Kaifuku Gimu - 原状回復義務 - Art. 545(1)):
   This is a central effect. Each party is obligated to take necessary measures to restore the other party to the state they were in before the contract was concluded. This aims to unwind the transaction:
   • Return of Money: Any money paid must be refunded. Furthermore, if money was received, interest must be paid thereon from the time of its receipt (Article 545(2)).
   • Return of Property: Any goods or other property transferred under the contract must be returned. If the property generated "fruits" (e.g., rental income from a leased property that is now being returned), these fruits must also generally be returned (Article 545(3)).
   • Restitution by Monetary Value: If restitution in kind (e.g., returning the exact goods) has become impossible (for instance, if the goods were consumed or destroyed due to reasons not attributable to the party obliged to return them), restitution must generally be made by paying their monetary value.
3. Damages Not Precluded (Art. 545(4)):
   Crucially, the exercise of the right of rescission does not prevent the non-breaching party from also claiming damages for any losses suffered as a result of the original breach and its consequences. Rescission and damages are generally cumulative remedies in Japan. The rescission deals with unwinding the performances, while damages compensate for losses incurred.
4. Protection of Third-Party Rights (Art. 545(1), proviso):
   The retroactive effect of rescission (treating the contract as ineffective from the beginning for restitution purposes) is limited when it comes to the rights of innocent third parties. The rescission of a contract cannot be asserted against the rights of a third party who, in good faith and without negligence, acquired rights related to the subject matter of the contract before the rescission was effected, provided the third party has duly perfected their rights (e.g., through registration for real estate, or by taking possession of movables in certain circumstances).

Special Considerations for Different Contract Types

The general principles of rescission apply broadly, but specific types of contracts or breach scenarios may have nuanced applications:

• Partial Rescission (Ichibu Kaijo - 一部解除): If a contract is divisible and only part of the obligation is breached or becomes impossible, it may be possible to rescind only that part of the contract, provided the remaining part is still of value to the creditor and can be meaningfully performed independently.
• Installment Contracts (Bunkatsu Rikō Keiyaku - 分割履行契約): For contracts involving performance in installments (e.g., regular deliveries of goods), a failure to perform one installment may, depending on its materiality and the overall context, give rise to a right to rescind the entire contract or only the part relating to that installment and future installments.
• Continuous Contracts (Keizokuteki Keiyaku - 継続的契約): For ongoing contracts like long-term supply agreements, leases, or service contracts, rescission (often referred to as kaiyaku - 解約, meaning termination for the future in this context) typically has prospective effect only. This is especially true if the termination is based on a breakdown of the relationship of trust (shinrai kankei no hakai - 信頼関係の破壊) rather than a specific, quantifiable past breach. The aim is to end the relationship going forward rather than attempting to undo all past performance.

Practical Steps and Final Thoughts

• Exercising the Right: Rescission is typically effected by a clear declaration of intent to rescind, communicated to the breaching party.
• Timeliness: While the Civil Code provides statutory limitation periods for exercising rights, undue delay in rescinding after becoming aware of the grounds could, under certain circumstances, be viewed as a waiver of the right or be contrary to good faith.
• Consequences of Wrongful Rescission: If a party attempts to rescind a contract without valid grounds, their act of refusing further performance may itself be considered a breach, entitling the other party to remedies.

In conclusion, kaijo is a powerful remedy in Japanese contract law that allows a party to unwind a contractual relationship in the face of significant non-performance by the other party. The revised Civil Code has notably made this remedy more accessible by generally removing the requirement for the breaching party's fault, focusing instead on the objective disruption of the contractual exchange. This shift, coupled with the detailed rules on when and how rescission can be effected and its consequences (particularly the duty of restitution and the co-availability of damages), provides a clearer and often more creditor-friendly framework for addressing serious breaches of contract in Japan.