Terminating a Contract in Japan: Grounds for Rescission (Kaijo) and Its Consequences

Contracts form the backbone of business relationships, providing a framework for mutual obligations and expectations. However, situations inevitably arise where one party fails to perform as promised, or where unforeseen circumstances make continued performance untenable. In such cases, Japanese law provides a mechanism for bringing the contract to an end: termination for cause, known as "kaijo" (解除). Understanding the grounds upon which a contract can be terminated, the procedures involved, and the legal consequences that follow is crucial for any business operating under contracts governed by Japanese law.

This article explores the Japanese Civil Code's provisions on kaijo, focusing on the primary grounds for termination—default and impossibility—the distinction between termination with prior demand and termination without it, and the significant effects of termination, such as the duty of restitution and the right to claim damages. The 2020 amendments to the Civil Code have also brought important clarifications and modernizations to this area.

1. What is "Kaijo" (Termination for Cause)?

Kaijo is the right of one party to a contract to unilaterally extinguish the contractual relationship due to a specific cause, typically a breach of contract by the other party or the impossibility of performance. It is a powerful remedy that effectively dissolves the primary obligations under the contract.

The right to terminate is exercised by a manifestation of intention (意思表示 - ishi hyōji) from the terminating party to the other party (Civil Code, Article 540, paragraph 1). Once this notice is effectively communicated (generally upon arrival, per Article 97, paragraph 1), and assuming the legal grounds are met, the contract is terminated.

It's important to distinguish kaijo (termination for cause) from:

• Torikeshi (取消し), which usually refers to rescission due to defects in consent at the time of formation (e.g., fraud, duress, mistake).
• Termination by mutual agreement (gōi kaijo - 合意解除), where parties consensually decide to end their contract.

This article focuses on kaijo as a remedy for breach or impossibility.

2. Grounds for Termination – When Can a Contract Be Terminated?

The Japanese Civil Code, particularly after the 2020 amendments, provides for two main routes to termination for cause: termination with prior demand and termination without prior demand.

A. Termination with Prior Demand (催告解除 - Saikoku Kaijo) (Article 541)

This is the general rule for termination due to a party's default in performance.

• Primary Ground: The primary ground is a default by one party in performing their obligation (e.g., delay in performance – 履行遅滞, rikō chitai; or incomplete/defective performance – 不完全履行, fukanzen rikō, where a cure is possible).
• Requirement of Saikoku (催告 - Demand for Performance): The non-defaulting party must first set a reasonable period (相当の期間 - sōtō no kikan) and demand that the defaulting party perform their obligation within that period. This demand is known as saikoku. What constitutes a "reasonable period" depends on the nature of the obligation and the circumstances.
• Failure to Perform within the Period: If the defaulting party fails to perform within the specified reasonable period after the saikoku, the non-defaulting party then acquires the right to terminate the contract.
• Minor Breach Exception (Article 541 proviso): A significant clarification in the 2020 reforms is the "minor breach" or "trivial default" exception. Termination is not permitted if, at the time the reasonable period for performance (after demand) expires, the remaining default is minor (軽微 - keibi) in light of the contract as a whole and common sense in business transactions. For example, if a seller has delivered 99.9% of goods and only a tiny, inconsequential part remains undelivered, or if a party has failed to perform a very minor ancillary obligation that does not affect the main purpose of the contract (as suggested by a scenario involving a small unpaid storage fee in a larger sales contract in the provided PDF's materials), terminating the entire contract would likely be disallowed as disproportionate.
• Tendering Own Performance: If the defaulting party has a defense of simultaneous performance (同時履行の抗弁権 - dōji rikō no kōbenken; see Article 533), the party wishing to terminate must generally tender their own performance when making the saikoku to negate this defense and put the other party unequivocally in default (as affirmed by the Supreme Court, July 27, 1954, Minshū Vol. 8, No. 7, p. 1455).

B. Termination without Prior Demand (無催告解除 - Musaikoku Kaijo) (Article 542)

In certain circumstances where demanding performance would be futile or where the nature of the default is particularly severe, the non-defaulting party can terminate the contract immediately, without making a prior saikoku. Article 542, paragraph 1, lists several such grounds:

1. Impossibility of Performance (履行不能 - rikō funō) (Item (i)): If the whole of the obligor's performance has become impossible, or if a part of the performance has become impossible and the remaining part alone would not achieve the purpose of the contract. This applies regardless of whether the impossibility is due to the obligor's fault (though fault is relevant for damages). For instance, if a unique painting sold is destroyed by fire before delivery, the buyer can terminate without demand.
2. Debtor's Unequivocal Refusal to Perform (Item (ii)): If the obligor clearly and definitively manifests their intention not to perform their principal obligation.
3. Partial Impossibility or Refusal Making Contractual Purpose Unattainable (Items (iii) & (iv)): If part of an obligation becomes impossible, or a party refuses to perform part of their obligation, and the remaining performance alone is insufficient to achieve the contract's purpose.
4. Failure to Perform by a Specific Time Essential to the Contract (定期行為 - teiki kōi) (Item (v)): If the nature of the contract or a manifestation of intention by the parties indicates that the contract's purpose cannot be achieved unless performance is rendered by a specific time (e.g., delivery of a wedding cake on the wedding day), and that time passes without performance.
5. Other defaults making demand futile: In addition to the above, termination without demand is also possible under Article 541 (the main article for termination with demand) if it is clear that even if a demand for performance were made, the defaulting party would not perform within the reasonable period because their default is already so severe that the purpose of the contract cannot be achieved.

These grounds for termination without demand generally reflect situations where giving the defaulting party a further chance to perform via saikoku would be a pointless formality or would unfairly prejudice the non-defaulting party.

3. The Legal Consequences of Termination (Kaijo no Kōka - 解除の効果)

Termination of a contract has significant legal consequences, primarily aimed at unwinding the transaction and compensating the aggrieved party:

• Extinction of Future Obligations: Upon termination, both parties are relieved from their primary obligations to perform under the contract going forward.
• Duty of Restitution (原状回復義務 - Genjō Kaifuku Gimu) (Article 545):
  This is a core effect. Each party must take steps to restore the other party to the state they were in before the contract was made (as if the performed parts of the contract had not occurred). This generally implies a retroactive effect for typical one-off contracts like sales (though for continuous contracts like leases, termination usually only has prospective effect – see Article 620).
  • Return of Property or Money: Anything delivered or paid under the contract must be returned.
  • Restitution of Money (Article 545, paragraph 2): If money was received, it must be returned with interest calculated from the time of its receipt. The interest rate is the statutory legal rate unless otherwise agreed.
  • Restitution of Things other than Money (Article 545, paragraph 3): If an object was delivered, it must be returned. Additionally, any fruits (果実 - kajitsu, e.g., natural produce from land, or rental income from a leased property if the property itself was the subject of the terminated contract) derived from the object during the period it was held by the recipient must also be returned. Case law, such as the Supreme Court judgment of February 13, 1976 (Minshū Vol. 30, No. 1, p. 1), has established that the value of use (e.g., a rent equivalent for property that was used by the recipient) must also be restituted as part of restoring the original state.
  • If Restitution in Kind is Impossible: If the received object cannot be returned in its original state (e.g., it was destroyed or consumed), the party who received it must make monetary restitution of its value (価額償還 - kagaku shōkan). The Great Court of Cassation judgment of May 11, 1936 (Minshū Vol. 15, p. 808) supports this principle. The value is typically assessed at the time of receipt or when restitution became impossible.
  • Simultaneous Performance of Restitution Duties (Article 546): The respective restitution obligations of the parties are considered to be in a relationship of simultaneous performance, meaning one party can refuse to make restitution until the other party tenders their restitution (applying Article 533 by analogy). If both restitution obligations are monetary, they can be set off against each other.
• Claim for Damages (損害賠償請求 - Songai Baishō Seikyū) (Article 545, paragraph 4):
  Crucially, the termination of a contract does not preclude the non-defaulting party from claiming damages suffered as a result of the breach that led to the termination. This allows the party to recover losses (typically expectation damages – the profit or benefit they would have obtained had the contract been fully performed) that are not covered by mere restitution.

4. The Principle of Indivisibility of the Right to Terminate (Kaijoken no Fukabunsei - 解除権の不可分性)

Article 544 of the Civil Code lays down rules regarding the indivisibility of the right to terminate when multiple persons are involved on one side of a contract:

• Multiple Parties on One Side (Article 544, paragraph 1): If a contract involves several persons as one party (e.g., co-purchasers, co-sellers, or joint venture partners who are collectively "one party" to the contract), the right to terminate the contract can only be exercised by all of them acting jointly, or against all of them jointly. One co-party cannot unilaterally terminate their portion of the contract or terminate it on behalf of others without proper authority.
• Extinction of the Right for One Extinguishes for All (Article 544, paragraph 2): If the right to terminate is extinguished for one of these multiple parties (e.g., they waive the right, or the time limit for exercising it expires for them), it is extinguished for all the other co-parties as well.

The rationale behind this principle of indivisibility is to prevent the fragmentation of the contractual relationship where multiple parties are intended to act as a single unit on one side, and to ensure consistent legal treatment for all involved. This has practical implications for structuring and managing contracts involving multiple stakeholders, such as joint ventures or syndicated agreements, as decisions and actions regarding termination need to be coordinated among all relevant co-parties.

Conclusion: A Powerful but Regulated Remedy

Termination for cause (kaijo) is a significant remedy in Japanese contract law, providing a path to exit a contractual relationship when faced with serious breaches by the counterparty or the impossibility of performance. However, its exercise is subject to specific legal requirements, including, in many cases, a prior demand for performance (saikoku) and an allowance for a reasonable period to cure the default. The "minor breach" exception further tempers this right, preventing termination for trivial defaults.

The consequences of termination are substantial, focusing on restoring the parties to their pre-contractual positions through restitution, while still preserving the right to claim damages for losses incurred due to the breach. The 2020 Civil Code reforms have modernized and clarified many of these rules, particularly regarding the grounds for termination without prior demand. For businesses engaged in contracts under Japanese law, a clear understanding of when and how a contract can be terminated, and the full scope of the ensuing legal effects, is vital for effectively managing their contractual rights and liabilities.