When a business partner in Japan takes actions that appear designed to improperly shield assets from creditors, it can leave you in a precarious position. The Japanese Civil Code, particularly after its significant amendments effective April 1, 2020, provides a specific remedy for such situations: the right to demand the rescission of a fraudulent act, known as Sagō Kōi Torikeshi-ken. This right allows a creditor to effectively undo certain transactions made by a debtor that harm the creditor's ability to collect their dues. However, the amended Code has introduced important clarifications and, in some instances, stricter requirements for exercising this right.

Understanding the Fraudulent Act Rescission Right (Sagō Kōi Torikeshi-ken)

The fraudulent act rescission right is principally outlined in Article 424 of the Japanese Civil Code. It empowers a creditor to petition a court to rescind an act committed by the debtor with the knowledge that such an act would prejudice the creditor[cite: 1]. The primary purpose is to preserve the debtor's assets, which would otherwise be available to satisfy the creditor's claims.

It's crucial to understand that this is not a self-help remedy; the creditor must file a lawsuit to seek rescission[cite: 1]. The effect of a successful claim is significant: the act is undone, and the property or its value is, in principle, returned to the debtor's estate, thereby becoming available for execution by creditors.

Core Requirements for Initiating a Fraudulent Act Rescission Claim

Several conditions must be met for a creditor to successfully invoke the fraudulent act rescission right.

1. Existence and Nature of the Creditor's Claim

The creditor must have a valid monetary claim against the debtor. A significant rule, clarified under Article 424, Paragraph 3 of the amended Civil Code, is that the creditor's claim must generally have arisen from a cause that existed before the debtor committed the challenged prejudicial act[cite: 1]. This means if the debt was incurred after the asset-shielding transaction, the creditor typically cannot use this remedy for that specific transaction. Furthermore, Article 424, Paragraph 4, now explicitly states that a creditor cannot make a fraudulent act rescission claim if their claim cannot be realized through compulsory execution[cite: 1].

2. Debtor's Prejudicial Act

The debtor must have engaged in an act concerning their property that prejudices the creditor. "Prejudice" in this context generally means that the act reduces the debtor's overall assets to a point where they are insufficient to satisfy the creditor's claims (i.e., the debtor becomes insolvent or their existing insolvency worsens). This isn't limited to formal juristic acts like sales or gifts; it can also include actions like making a preferential payment to another creditor or acknowledging a statute-barred debt if done with the requisite intent and effect. However, acts that do not concern property rights are generally excluded (Article 424, Paragraph 2)[cite: 1]. Real estate sales are a common subject of fraudulent act claims.

3. Debtor's Fraudulent Intent (Sagai Ishi)

The debtor must have committed the act knowing that it would harm their creditors[cite: 1]. Proving this subjective intent can be challenging, but it is often inferred from the circumstances, such as the debtor's financial situation at the time of the act and the nature of the transaction itself (e.g., selling a significant asset for a conspicuously low price while insolvent).

4. Beneficiary's or Subsequent Acquirer's Knowledge (Bad Faith - Akui)

The person who benefited from the debtor's act (the "beneficiary") or any subsequent acquirer of the property must have known, at the time of the act or their acquisition, that the debtor's act was prejudicial to creditors[cite: 1]. If the beneficiary was unaware (in good faith), the creditor cannot rescind the act against them.

The rules for subsequent acquirers (tentokusha) are detailed in Article 424-5. For a claim to succeed against a subsequent acquirer, it must first be established that all requirements for rescission against the initial beneficiary were met[cite: 3]. If the initial beneficiary was in good faith and protected, a subsequent acquirer cannot be targeted even if they themselves were in bad faith regarding the prejudice to the original debtor's creditors[cite: 3]. This addressed a previous "reversal phenomenon" where the conditions could differ inconsistently with bankruptcy avoidance rules[cite: 3].

Stricter Requirements Introduced by the Amended Civil Code

The amended Civil Code has, in several key areas, made the requirements for the fraudulent act rescission right more stringent, often aligning them more closely with the rules for avoidance in bankruptcy proceedings. This was partly to resolve what was termed the "reversal phenomenon" (gyakuten genshō), where rescission under the Civil Code could sometimes be easier than avoidance in bankruptcy, which was considered counterintuitive given that bankruptcy typically involves a more severe deterioration of the debtor's financial state[cite: 2].

1. Disposal of Property for Fair Value (Article 424-2)

Previously, even if a debtor sold property (like real estate) for a fair market price, such a transaction could sometimes be considered fraudulent if other conditions were met, based on the reasoning that liquid cash is easier to conceal than real estate. The amended Article 424-2 significantly tightens the conditions for rescinding such "fair value" transactions[cite: 2]. Now, a creditor must prove all of the following:
* The act (e.g., converting real estate to cash) must have actually created a risk that the debtor would conceal, gratuitously transfer, or otherwise dispose of the received consideration in a manner prejudicial to creditors[cite: 2].
* The debtor, at the time of the act, must have intended to engage in such prejudicial disposal of the consideration[cite: 2].
* The beneficiary (the purchaser), at the time of the act, must have known of the debtor's aforementioned intent to engage in prejudicial disposal[cite: 2].
This triple requirement makes it considerably harder to challenge sales made for appropriate consideration.

2. Preferential Acts: Providing Security or Extinguishing Debt for an Existing Debt (Article 424-3)

When a debtor, while struggling financially, provides security to a specific existing creditor or pays off a specific existing debt, this can be prejudicial to other creditors by depleting the assets available for general distribution. The amended Article 424-3 imposes strict conditions for rescinding such "preferential acts"[cite: 2]:
* The act must have been carried out when the debtor was "insolvent" (defined as being unable to pay debts generally and continuously as they become due)[cite: 2].
* The act must have been carried out through collusion between the debtor and the beneficiary (the favored creditor) with the intent to harm other creditors[cite: 2].

There are additional specific rules if the provision of security or debt extinguishment was not part of the debtor's pre-existing obligation, or if its timing was not obligatory (e.g., an early repayment not required by contract). In such non-obligatory preferential acts, if they occurred within 30 days before the debtor became insolvent (or while insolvent), collusion to harm other creditors suffices for rescission, even without proving the debtor was insolvent at the time of the act, as long as they were insolvent or became so within that 30-day window[cite: 2]. This again reflects an effort to harmonize with bankruptcy law's treatment of preferential transactions.

Scope of Rescission and Nature of Recovery

If the creditor's claim is successful, the court will rescind the debtor's fraudulent act. The consequences are detailed in the amended Civil Code:

1. Return of Property or Monetary Compensation (Article 424-6)

The creditor can demand that the beneficiary return the property that was transferred through the fraudulent act[cite: 1]. If the beneficiary is unable to return the specific property (e.g., it has been consumed or substantially altered), the creditor can demand monetary compensation equivalent to its value[cite: 1]. The same applies to subsequent acquirers who are successfully sued[cite: 1].

2. Limitation to the Creditor's Claim Amount (Article 424-8)

If the object of the debtor's fraudulent act is divisible (e.g., a sum of money or a collection of fungible goods), the creditor can only demand rescission to the extent necessary to satisfy their own claim[cite: 1]. This limitation also applies when seeking monetary compensation in lieu of property return[cite: 1].

3. Direct Payment or Delivery to the Creditor (Article 424-9)

A significant provision allows the creditor, when the recovery involves money or movable property, to demand that the beneficiary or subsequent acquirer make the payment or delivery directly to the creditor themselves[cite: 3]. If such payment or delivery is made to the creditor, the beneficiary/subsequent acquirer is discharged from their obligation to return the property to the debtor[cite: 3]. This provision, at first glance, seems to enhance the creditor's ability to directly recover. However, its interplay with the new "absolute effect" of the rescission judgment (discussed below) creates complexities regarding whether this leads to a preferential recovery for the suing creditor or if the recovered assets must still be considered part of the debtor's general estate for all creditors. The commentary notes that the ability of the counterparty (beneficiary/subsequent acquirer) to choose to pay the debtor instead of the rescinding creditor under the new regime might render this direct collection function less effective[cite: 4].

Procedural Aspects: Defendants and Litigation Notice

1. Identifying the Defendant (Article 424-7, Paragraph 1)

The lawsuit for fraudulent act rescission must be filed against the beneficiary of the act or, if the property has been transferred further, against the subsequent acquirer who is the target of the rescission claim[cite: 1]. The debtor is not named as a defendant in this specific action, although their actions and intent are central to the case[cite: 1].

2. Obligation of Litigation Notice to the Debtor (Article 424-7, Paragraph 2)

The creditor, upon filing a fraudulent act rescission lawsuit, is obligated to give litigation notice to the debtor without delay[cite: 1]. This ensures the debtor is aware of the proceedings that affect their past actions and property status.

The Effect of a Favorable Rescission Judgment (Article 425)

This is one of the most significant changes in the amended law. Previously, case law generally held that a judgment rescinding a fraudulent act had only a "relative effect," meaning it was effective primarily between the suing creditor and the defendant (beneficiary/subsequent acquirer).

The amended Article 425 now stipulates that a final and binding judgment upholding a fraudulent act rescission claim has an "absolute effect." This means the judgment is effective not only against the defendant but also against the debtor and all other creditors of the debtor[cite: 1].

Theoretically, this "absolute effect" should mean that the rescinded act is nullified for all purposes, and the recovered property unequivocally returns to the debtor's estate, making it available for satisfaction of claims by all creditors. This aligns the fraudulent act rescission more closely with the effects of avoidance actions in bankruptcy.

However, practical challenges remain, especially concerning real estate. Even if a transfer of real estate is rescinded and the judgment has absolute effect, the property registration must be corrected to reflect the debtor as the owner. The PDF commentary raises concerns that, even with the absolute effect, if the property is returned to the debtor's name or control, the debtor might attempt to dispose of it again before creditors can successfully execute their claims[cite: 4]. The effectiveness of pre-judgment or post-judgment provisional measures to secure the asset (like a provisional disposition prohibiting transfer) based on the rescission right itself is also debated under the new framework, given that the judgment's effect now extends to the debtor[cite: 4].

Time Limits for Exercising the Right (Article 426)

Creditors must act within specific time frames to exercise their fraudulent act rescission right:

• The right must be exercised within two years from the time the creditor became aware of the cause for rescission (i.e., became aware of the fraudulent act and the debtor's intent).
• Regardless of the creditor's awareness, the right is extinguished if not exercised within ten years from the time of the debtor's act. This latter period was shortened from the previous 20 years.

Implications for Real Estate Transactions

The fraudulent act rescission right frequently comes into play in real estate transactions:

• Sale of Real Estate as a Fraudulent Act: If a debtor sells real estate to hinder creditors, this can be a target for rescission. The stricter rules under Article 424-2 for sales made at fair value are particularly relevant here, making it harder to challenge such sales unless the specific intents regarding the proceeds can be proven.
• Recovery of Real Estate: A successful rescission typically involves a court order to cancel the fraudulent registration of transfer and restore the registration to the debtor's name. The shift to the "absolute effect" of the judgment under Article 425 should, in principle, make it clearer that the property returns to the debtor's estate for the benefit of all creditors. However, as noted, practical issues of preventing further disposition by the debtor before execution can occur remain a concern for creditors. The commentary questions whether provisional measures like a disposition prohibition against the beneficiary, based on the rescission right, will effectively secure the property for the creditor, especially since the new law emphasizes the return of the effect to the debtor[cite: 4].

Conclusion

The amended Japanese Civil Code has refined the fraudulent act rescission right, clarifying many aspects and, in some cases, imposing stricter conditions for its exercise, particularly for transactions made at fair value or certain preferential acts. The codification of the "absolute effect" of a rescission judgment is a major theoretical shift, intended to benefit the general body of creditors. However, creditors and their legal counsel must be aware of the heightened evidentiary burdens for certain types of transactions and the continuing practical challenges in securing recovered assets, especially real estate. Swift action within the prescribed time limits and a thorough understanding of the nuanced requirements are essential for creditors seeking to utilize this remedy against debtors attempting to improperly shield their assets in Japan.