Q&A: Risk of Loss in Japanese Contracts: Who Bears the Risk When Performance Becomes Impossible Without Fault?

Japanese Attorney at Law - Bengoshi L.L.

• 10 min read

Contracts are formed with the expectation of mutual performance. But what happens when, through no direct fault of the performing party (the obligor), their promised performance becomes impossible due to unforeseen events like natural disasters, destruction of unique subject matter, or supervening illegality? A critical question then arises: does the other party (the creditor, who was to receive the performance) still have to render their own counter-performance, typically payment? This is the domain of the "bearing of risk" or risk of loss (危険負担 - kiken futan) doctrine in Japanese contract law, an area significantly clarified and restructured by the 2020 amendments to the Japanese Civil Code.

Q1: What is the "Bearing of Risk" (Kiken Futan) doctrine under the current Japanese Civil Code?

The core of the kiken futan doctrine is found in Article 536 of the Japanese Civil Code. Its primary function is to determine whether a party to a bilateral contract can refuse to perform their own counter-obligation when the other party's corresponding obligation has become impossible to perform.

General Rule (Article 536, Paragraph 1 - "Obligor Bears the Risk" in effect):
The default rule is that if an obligor's performance under a bilateral contract becomes impossible for reasons not attributable to the creditor, the creditor (the party who was to receive that now-impossible performance) may refuse to perform their own counter-obligation (e.g., make payment).

  • For example, if Company A contracts to provide a unique, custom-built machine to Company B, and the machine is destroyed by an earthquake (without fault of either party) before it can be delivered, Company B can refuse to pay the purchase price to Company A.
  • In this scenario, Company A (the obligor whose performance became impossible) effectively bears the risk of not receiving the counter-performance (payment). This outcome is often referred to as the "obligor bears the risk" principle (債務者主義 - saimusha shugi), although this specific terminology arises from the outcome rather than being the explicit name of the rule itself under the new law.
  • The refusal to perform the counter-obligation under Article 536(1) is generally considered a permanent defense concerning that specific impossible performance, which would lead to the dismissal of a claim for the counter-performance if the defense is successfully raised.
  • If the creditor had already rendered their counter-performance (e.g., paid in advance) before the obligor's performance became impossible, the creditor should generally be entitled to demand its return, often through principles of unjust enrichment or as a consequence of contract termination.

Crucial Distinction from Contract Termination (解除 - Kaijo):
It is vital to understand that the kiken futan doctrine under Article 536 is distinct from the rules on contract termination (解除 - kaijo, governed by Articles 540-548).

  • Risk of Loss (Art. 536): Determines whether a party must still perform their side despite the other's impossibility. It grants a right to refuse the counter-obligation.
  • Termination (e.g., Art. 542 for impossibility): Is the mechanism by which a party can actively extinguish their own counter-obligation and seek restitution of any performance already rendered. The creditor can terminate a contract due to the obligor's impossibility of performance even if the impossibility was not attributable to the obligor's fault.
    Under the old Civil Code, no-fault impossibility often led to the automatic extinguishment of the counter-obligation under its risk of loss provisions. The new Code separates these: impossibility gives the creditor a right to terminate (to extinguish their duty), and Article 536 gives them a right to refuse performance even if they don't immediately terminate.

Q2: What happens if the impossibility of performance is due to reasons attributable to the creditor?

The allocation of risk shifts dramatically if the impossibility is the creditor's "fault" (more accurately, due to grounds attributable to the creditor).

Creditor Bears the Risk (Article 536, Paragraph 2 - 債権者主義 - Saikensha Shugi):
If the obligor's performance becomes impossible due to grounds attributable to the creditor (債権者の責めに帰すべき事由 - saikensha no seme ni kisubeki jiyū), then the creditor cannot refuse to perform their own counter-obligation.

  • For instance, if Company B (the creditor for the machine) provides faulty specifications that cause Company A (the obligor) to build a machine that subsequently self-destructs before delivery due to those specifications, Company B must still pay the purchase price.
  • In such cases, the creditor (Company B) also loses the right to terminate the contract based on this impossibility, as Article 543 of the Civil Code prevents termination if the non-performance is due to the creditor's attributable grounds.
  • Obligor's Duty to Transfer Consequential Benefits: Although the obligor is excused from their (now impossible) performance, they must transfer to the creditor any benefits they gained as a result of being excused from their obligation (e.g., costs saved by not having to complete or deliver the machine). This rule prevents the obligor from being unjustly enriched.
  • Impossibility During Creditor's Delay in Acceptance: If performance becomes impossible (without the obligor's fault) during a period when the creditor is in delay of accepting performance (受領遅滞 - juryō chitai), this situation is generally treated as being attributable to the creditor, and thus Article 536, Paragraph 2 applies (see Civil Code Article 413-2, Paragraph 2). The creditor must still render their counter-performance.

Q3: How does the "bearing of risk" doctrine specifically apply to Sales Contracts (売買契約 - Baibai Keiyaku) under Japanese law?

While Article 536 provides general rules, sales contracts have a specific provision, Article 567 of the Civil Code, which acts as a lex specialis (special law) governing the transfer of risk for loss of or damage to the subject matter of the sale. This article is crucial for buyers and sellers.

Transfer of Risk upon Delivery (引渡しによる危険の移転 - Hikiwatashi ni yoru Kiken no Iten) - Article 567, Paragraph 1:

  • The core rule is that if, after specified goods (or generic goods that have been duly specified and conform to the contract) are delivered to the buyer, the goods are subsequently lost or damaged due to grounds not attributable to the seller, then:
    • The buyer cannot refuse to pay the purchase price.
    • The buyer also loses the right to terminate the contract, claim subsequent completion, request a price reduction, or seek damages for this particular post-delivery loss or damage.
      Effectively, the risk of accidental loss or damage passes from the seller to the buyer upon delivery.
  • Clarification on "Not Attributable to the Seller": The phrase "due to grounds not attributable to either party" in Article 567(1) effectively means "grounds not attributable to the seller." This is because if the loss/damage were attributable to the buyer after delivery, the buyer would naturally bear the loss. If the loss/damage after delivery is attributable to the seller (e.g., due to a latent defect caused by the seller that manifests post-delivery, or seller's faulty installation causing subsequent damage), then the buyer retains their remedies against the seller for that breach; Article 567(1) would not shield the seller.
  • Pre-existing Non-conformity: It's important to distinguish post-delivery accidental loss from pre-existing non-conformity. If the goods were already non-conforming (defective) at the time of delivery, Article 567(1) does not prevent the buyer from exercising their standard remedies for non-conformity (e.g., demanding repair, price reduction, etc.) against the seller. Article 567(1) applies to the supervening loss or damage of goods that were (or were accepted as) conforming at the point risk passed. For generic goods, if the seller delivers non-conforming goods, "specification" for the purpose of risk transfer under this article typically does not occur, and the buyer can pursue non-conformity remedies.

Risk Transfer upon Buyer's Delay in Acceptance (受領遅滞による危険の移転 - Juryō Chitai ni yoru Kiken no Iten) - Article 567, Paragraph 2:

  • If the seller tenders delivery of conforming goods to the buyer, but the buyer, without a justifiable reason, refuses or is unable to accept them (i.e., the buyer is in delay of acceptance), and the goods are subsequently lost or damaged due to grounds not attributable to the seller, the risk is deemed to have passed to the buyer from the time of the seller's proper tender.
  • In this situation, the buyer cannot refuse to pay the purchase price for the goods that were subsequently lost or damaged, nor can they assert other remedies against the seller for such loss or damage.

Q4: How does the Japanese approach to risk of loss compare with the U.S. system, particularly under the Uniform Commercial Code (UCC)?

Both Japanese law and U.S. law (particularly the UCC for sales of goods) have developed rules to allocate the risk of loss, and while the underlying goals of fairness and predictability are similar, the specific rules and doctrinal approaches have differences:

  • UCC Approach to Risk of Loss in Sales (e.g., §2-509, §2-510):
    • The UCC provides detailed rules. In the absence of breach:
      • If the contract requires or authorizes the seller to ship the goods by carrier but doesn't require delivery at a particular destination, risk passes to the buyer when the goods are duly delivered to the carrier ("shipment contract").
      • If it does require delivery at a particular destination, risk passes to the buyer when the goods are duly tendered there to enable the buyer to take delivery ("destination contract").
      • If goods are held by a bailee to be delivered without being moved, risk passes on buyer's receipt of a negotiable document of title, or acknowledgment by the bailee of the buyer's right to possession, or after buyer has had a reasonable time to present a non-negotiable document or direction.
      • In other cases (e.g., buyer picks up from seller): if the seller is a merchant, risk passes to the buyer on their receipt of the goods; if the seller is not a merchant, risk passes on tender of delivery.
    • The UCC also has rules on the effect of breach on risk of loss (UCC §2-510). For instance, where a tender or delivery of goods so fails to conform to the contract as to give a right of rejection, the risk of their loss remains on the seller until cure or acceptance. If the buyer rightfully revokes acceptance, they may treat the risk of loss as having rested on the seller from the beginning, to the extent of any deficiency in their effective insurance coverage.
  • Points of Comparison:
    • Default Rule for Non-Sales Contracts: Japan's Article 536(1) provides a broad default for all bilateral contracts: the obligor whose performance becomes impossible (without creditor's fault) generally cannot claim the counter-performance. U.S. common law for non-sale contracts (e.g., service contracts) would typically analyze such situations under doctrines like impossibility or impracticability. If neither party is at fault, these doctrines often lead to the discharge of both parties' remaining duties. The "loss" effectively stays where it falls: the service provider doesn't get paid for unrendered services, and the recipient doesn't receive the service.
    • Sales Contracts - Focus on Delivery/Tender/Receipt: Both the Japanese Civil Code (Article 567) and the UCC link the passage of risk in sales contracts closely to physical acts like delivery, tender of delivery, or the buyer's receipt of goods, rather than abstract concepts like the moment of contract formation or the passing of title (though title can be relevant under the UCC if other provisions don't apply).
    • Impact of Breach on Risk: Both systems acknowledge that a breach of contract by one party can alter the otherwise applicable risk of loss allocation. The UCC's §2-510 is quite specific on this. Japan's Article 567(1) handles it by stating its rule applies when loss is "not attributable to the seller," and also by implying that if goods were non-conforming at delivery, the non-conformity rules take precedence over risk of loss for those pre-existing issues.
    • Role of "Fault" in the Impossibility Event: The new Japanese Civil Code de-emphasizes the obligor's own fault for the impossibility itself when applying the general risk rule in Article 536(1) (it focuses on whether impossibility is attributable to the creditor). Similarly, for sales under Article 567(1), the focus is on whether the post-delivery loss is attributable to the seller. The UCC also focuses on control, tender, receipt, and breach status rather than simply "fault" for the event causing the loss. However, the creditor's attributable cause is crucial for shifting risk to them under Article 536(2) in Japan.
    • Interaction with Termination/Discharge: In Japan, the risk of loss rules (Art. 536, 567) determine if counter-performance is still due. Termination (e.g., Art. 542) is a separate step to definitively extinguish that counter-obligation and seek restitution. In the U.S., doctrines like impossibility or impracticability often lead directly to the discharge of duties for both parties, which combines the effects of risk allocation and the end of obligations.

Q5: How is the burden of proof structured regarding risk allocation in Japanese law?

Understanding who needs to prove what is key in any dispute:

  • Under the General Rule (Article 536 Civil Code):
    • If Obligor X (whose performance has become impossible) sues Creditor Y for the counter-performance (e.g., payment), Creditor Y can defend by asserting: (i) the impossibility of Obligor X's performance, and (ii) Y's refusal to render their counter-performance based on Article 536, Paragraph 1.
    • If Obligor X wishes to overcome this defense and compel Creditor Y to perform, Obligor X must then prove that the impossibility of their (X's) performance was due to grounds attributable to Creditor Y (as per Article 536, Paragraph 2).
    • The fact that Obligor X was not at fault for their own impossibility does not, by itself, entitle X to demand counter-performance from Y under the general rule; the primary question is whether Y has the right to refuse. The wording in Article 536(1) "due to grounds not attributable to either party" is interpreted not to place a burden on Y to prove this negative; rather, it describes the typical scenario where Y can refuse.
  • Under the Sales Contract Rule (Article 567 Civil Code):
    • If a Seller sues a Buyer for the price after delivered goods are lost: The Seller would prove the contract and delivery of specified (and conforming) goods. If loss occurs post-delivery, the Buyer, to avoid payment, would generally need to prove the loss was attributable to the Seller. If the loss is not attributable to the Seller (or Buyer), the Buyer must pay, as risk has passed.
    • If a Seller sues a Buyer for the price after the Buyer delayed acceptance and the tendered goods were subsequently lost: The Seller would prove the contract, tender of conforming goods, the Buyer's delay in acceptance, and the subsequent loss of goods due to grounds not attributable to the Seller. The Buyer would then be obligated to pay the price.

Conclusion

The Japanese Civil Code, especially after its 2020 revisions, provides a distinct framework for allocating the risk of loss when contractual performance becomes impossible. The general principle under Article 536 allows the party expecting the now-impossible performance to refuse their own counter-performance, effectively placing the risk on the party whose performance failed, unless the impossibility was attributable to the creditor. For sales contracts, Article 567 provides specific rules, generally passing the risk to the buyer upon delivery of conforming goods or upon the buyer's delay in accepting a proper tender. It is crucial to distinguish these risk allocation rules, which primarily determine whether counter-performance is still due, from the separate legal mechanism of contract termination, which is used to formally extinguish the parties' mutual obligations and arrange for restitution. A clear understanding of these provisions is essential for assessing rights and potential liabilities when unforeseen supervening events disrupt contractual performance in transactions governed by Japanese law.