My Japanese Debtor Isn't Paying, But Their Customer Owes Them Money. Can I Collect Directly?

Japanese Attorney at Law - Bengoshi L.L.

• 9 min read

As a creditor, one of the most frustrating situations is when your debtor defaults on their obligations, especially if you know the debtor is owed money by a third party. You might wonder if there's a way to bypass your debtor and collect directly from their customer or debtor. In Japan, a legal mechanism known as the "Creditor's Subrogation Right" (債権者代位権 - saikensha daii ken) provides a potential, albeit nuanced, pathway for such action. This article explores this unique feature of Japanese civil law, its requirements, effects, and how it compares to other debt collection methods, particularly in light of significant reforms to the Japanese Civil Code that came into effect in April 2020.

Understanding the Creditor's Subrogation Right (Saikensha Daii Ken) in Japan

The Creditor's Subrogation Right is a statutory right granted to a creditor to exercise a right belonging to their debtor when the debtor fails to do so, for the purpose of preserving the creditor's own claim. Codified in Articles 423 to 423-7 of the Japanese Civil Code, its fundamental aim is to maintain the debtor's assets, which form the basis for satisfying the creditor's claim. Instead of passively watching the debtor's assets diminish or remain uncollected due to the debtor's inaction, the creditor can step into the debtor's shoes to assert the debtor's rights against a third party.

For example, if Company A (creditor) is owed money by Company B (debtor), and Company B is, in turn, owed money by Company C (the debtor's debtor, or third-party obligor), Company A might be able to use saikensha daii ken to demand payment from Company C on behalf of Company B.

Key Requirements for Exercising Saikensha Daii Ken (Post-2020 Reforms)

The exercise of the Creditor's Subrogation Right is not automatic and is subject to several conditions, which have been clarified and refined by the 2020 Civil Code reforms:

  1. Existence of the Creditor's Claim (被保全債権 - hihozen saiken): The creditor must have a valid and enforceable claim against their debtor. This claim is known as the "claim to be preserved."
  2. Debtor's Failure to Exercise Their Right (被代位権利 - hidai ikenri): The debtor must have a right against a third party (the "subrogated right") that they are not exercising.
  3. Necessity for Preservation of the Creditor's Claim (保全の必要性 - hozen no hitsuyōsei): The creditor must demonstrate that exercising the subrogation right is necessary to preserve their claim.
    • Debtor's Insolvency (無資力 - mushiryoku): For the subrogation of a monetary claim (like collecting a debt owed to the debtor), the general rule under Article 423 of the Civil Code is that the debtor must be insolvent (i.e., their liabilities exceed their assets, or they are unable to pay their debts generally as they become due). This requirement aims to prevent creditors from unduly interfering with a solvent debtor's affairs. The Supreme Court affirmed the necessity of insolvency in a judgment dated November 29, 1974 (Showa 49), even before the recent codification.
    • Exceptions to Insolvency Requirement: The insolvency requirement may be waived in certain situations, such as when the subrogated right is not a monetary claim but, for instance, a request for registration of title to real estate, or if the subrogated right is intrinsically linked to the effective satisfaction of the creditor's claim (e.g., a security interest).
  4. The Subrogated Right Must Not Be Exclusively Personal to the Debtor (一身専属権 - isshin senzokuken): The right that the creditor seeks to exercise on behalf of the debtor must not be of a nature that it can only be exercised by the debtor personally (e.g., certain family law rights or highly personal claims).
  5. The Creditor's Claim Must Be Due: Generally, the creditor's own claim against the debtor must be due and payable, unless the subrogation is for an act of preservation (e.g., interrupting the prescription period of the debtor's claim against the third party).

The Mechanics and Effects of Saikensha Daii Ken Today

When a creditor validly exercises their subrogation right, several legal consequences follow:

Exercising in the Creditor's Own Name

The creditor exercises the debtor's right against the third-party obligor in the creditor's own name, but on behalf of the debtor. This means the creditor initiates legal action or makes demands directly to the third party.

Direct Payment to the Creditor

Historically, case law, such as a pivotal Great Court of Cassation (Daishin-in) decision on March 12, 1935 (Showa 10), allowed the subrogating creditor to demand that the third party pay the subrogated claim directly to them. This principle is now explicitly codified in Article 423-3 of the Civil Code. The third-party obligor, upon receiving such a demand from the subrogating creditor, can only discharge their obligation by paying the creditor.

The Abolition of De Facto Preferential Payment

Before the 2020 Civil Code reforms, this direct payment mechanism, combined with the creditor's ability to set off their own claim against the debtor with the funds received from the third party, led to what was known as a "de facto preferential payment" (事実上の優先弁済 - jijitsujō no yūsen bensai). The subrogating creditor would receive the funds, and while theoretically these funds belonged to the debtor's estate, the creditor could effectively keep them by offsetting their own pre-existing claim. This gave the active creditor a significant advantage over other, less active creditors, sparking considerable academic debate about whether this outcome aligned with principles of creditor equality.

Crucially, the 2020 Civil Code reforms have addressed this issue. The proviso to Article 423-3 now states that while the creditor can receive direct payment from the third-party obligor, the creditor cannot set off their own claim against the debtor with the money received through subrogation if the creditor's claim is monetary and the subrogated right is also monetary. Instead, the creditor is obligated to account for and transfer the received funds to the debtor (or the debtor's insolvency estate if applicable). This effectively abolishes the de facto preferential payment effect in most common scenarios and aligns the Creditor's Subrogation Right more closely with the principle of creditor equality. The funds recovered become part of the debtor's general assets, available to all creditors, rather than providing a backdoor priority to the subrogating creditor.

Scope of Exercise

The creditor can generally exercise the subrogated right only to the extent necessary to preserve their own claim. Article 423-2 of the Civil Code stipulates that the creditor cannot exercise the subrogated right beyond the amount of their own claim against the debtor. This was also affirmed by a Supreme Court judgment on June 24, 1969 (Showa 44).

Effect on the Debtor's Right to Dispose of the Claim

Once a creditor has initiated a subrogation action and notified the debtor, the debtor's ability to independently exercise or dispose of the subrogated right is restricted (Article 423-4). However, the debtor can still dispose of the right, and such disposal can be asserted against the subrogating creditor if the third party or acquirer was unaware of the subrogation action and not grossly negligent. If the debtor is sued by the creditor under subrogation, the debtor can intervene in the lawsuit (Article 423-5). Furthermore, if a subrogation lawsuit is pending, other creditors cannot file another subrogation lawsuit concerning the same right (Article 423-7).

Saikensha Daii Ken vs. Direct Claims Enforcement (Saiken Shikkō) – A Modern Comparison

Creditors in Japan also have the option of "direct claims enforcement" (saiken shikkō), which involves obtaining a court judgment or other title of execution (債務名義 - saimu meigi) against their debtor and then formally attaching the debtor's claim against a third party. Here's how saikensha daii ken compares:

  • Initiation:
    • Saikensha Daii Ken: Does not require a title of execution. However, as noted, the debtor's insolvency is generally a prerequisite for subrogating monetary claims.
    • Saiken Shikkō: Requires a title of execution. The debtor's insolvency is not a prerequisite for initiating enforcement.
  • Preferential Effect:
    • Saikensha Daii Ken: As discussed, the 2020 reforms largely eliminated the de facto preferential payment. The recovered funds must be passed to the debtor, benefiting the general pool of creditors.
    • Saiken Shikkō:
      • Collection Order (取立命令 - toritate meirei): If multiple creditors attach the same claim or demand distribution, the collected funds are typically paid into court and distributed proportionally among them (equality principle). No inherent preference for the first attaching creditor.
      • Assignment Order (転付命令 - tenpu meirei): The court orders the transfer of the debtor's claim against the third party to the attaching creditor at its face value in satisfaction of their own claim. This does provide a preferential effect as the claim becomes the creditor's own. However, the creditor bears the risk that the third-party obligor may be insolvent or have defenses.
  • Scope of Rights Exercisable:
    • Saikensha Daii Ken: Can be used to exercise a broader range of the debtor's rights, not just monetary claims. For instance, it could theoretically be used to exercise a debtor’s right to rescind a contract or register title, if necessary for the preservation of the creditor's claim.
    • Saiken Shikkō: Primarily designed for enforcing monetary claims by attaching the debtor's monetary claims against third parties.
  • Procedural Complexity and Cost:
    • Saikensha Daii Ken: May involve a lawsuit against the third-party obligor if they contest the debtor's underlying right or the creditor's right of subrogation.
    • Saiken Shikkō: Involves court-administered enforcement procedures which have their own formalities and costs.

Before the 2020 reforms, saikensha daii ken was often seen as a more advantageous route due to the de facto preference. With the abolition of this preference, its strategic advantages have shifted. It remains a valuable tool when a title of execution is not yet available or when the right to be subrogated is non-monetary and crucial for preserving the creditor's ultimate ability to recover.

Saikensha Daii Ken in Collective Debt Scenarios (Current Perspective)

The utility and implications of the Creditor's Subrogation Right also differ depending on whether the debtor is involved in informal workout negotiations or formal insolvency proceedings.

When a debtor is in financial distress and creditors are attempting a "private workout" (shiteki seiri) – an out-of-court restructuring or debt settlement process – the exercise of saikensha daii ken by an individual creditor can be complex.

Before the 2020 reforms, an individual creditor using subrogation to achieve a de facto preference could significantly disrupt the collective negotiation efforts aimed at an equitable solution for all creditors. Now, with the abolition of the preferential effect, exercising saikensha daii ken primarily serves to bring assets into the debtor's estate for the benefit of all participating creditors (or according to the terms of the workout plan).

The "necessity for preservation" requirement might still be interpreted in light of the ongoing workout. If a workout plan is being fairly negotiated and implemented, a court might be less inclined to find "necessity" for an individual creditor to act unilaterally, especially if it doesn't align with the collective strategy. Conversely, if the debtor is dissipating assets and the private workout is stalled or ineffective, the necessity for an individual creditor to use subrogation to secure assets for the debtor's estate might be more readily acknowledged.

The End of the Road in Formal Insolvency (Tōsan Tetsuzuki)

Once formal insolvency proceedings (such as bankruptcy - 破産 hasan, or civil rehabilitation - 民事再生 minji saisei) are commenced against the debtor, the right of individual creditors to exercise saikensha daii ken is generally suspended.

In such proceedings, an insolvency trustee (管財人 - kanzainin) or supervisor is appointed. The trustee assumes control over the debtor's assets and is empowered to exercise the debtor's rights (including claims against third parties) for the collective benefit of all creditors, according to the priority rules of the specific insolvency statute. The individual creditor's subrogation right is effectively absorbed into the broader powers of the insolvency administrator, ensuring an orderly and equitable distribution of the debtor's assets.

The Creditor's Subrogation Right in Japan has a rich history, and its most debated aspect was undoubtedly the de facto preferential payment it afforded. For decades, Japanese courts upheld the creditor's ability to collect directly and then offset, effectively "jumping the queue." This was often justified by arguments that it rewarded the diligent creditor or was necessary to incentivize creditors to pursue assets that the debtor neglected.

However, this outcome was in constant tension with the principle of creditor equality, a cornerstone of insolvency law. Academics frequently criticized this preferential effect, arguing that it could undermine fairness, especially as a debtor approached insolvency.

The 2020 amendments to the Japanese Civil Code represent a significant policy shift in this area. By explicitly allowing direct payment to the subrogating creditor but simultaneously prohibiting the set-off that created the preference (for monetary claims), the legislature has recalibrated this tool. The reformed saikensha daii ken still allows a creditor to proactively pursue the debtor's neglected claims, but the fruits of that action are now clearly channeled back to the debtor's estate for a more equitable distribution among all creditors. This reform reflects a considered response to the long-standing debate, aiming to strike a better balance between incentivizing individual creditor action and upholding the principles of fairness in debt collection.

Conclusion

The Japanese Creditor's Subrogation Right (saikensha daii ken) is a distinctive and potent legal remedy. While the 2020 Civil Code reforms have fundamentally altered its character by removing the de facto preferential payment effect for monetary claims, it remains a valuable instrument. Creditors can still use it to ensure that their debtor's assets are not lost due to inaction, thereby preserving the pool of assets available for eventual recovery. However, its strategic use now requires careful consideration of its non-preferential nature and how it fits within the broader context of the debtor's financial situation, including any ongoing private workouts or the looming prospect of formal insolvency proceedings. Understanding this refined mechanism is crucial for any party involved in cross-border credit and collection involving Japanese counterparts.