Terminating a Contract in Japan: What Are the Legal Grounds and Consequences of "Kaijo" (Rescission/Termination)?

Contracts are the lifeblood of business, designed to create certainty and enforceability. However, circumstances can arise where one party may wish to, or need to, exit a contractual relationship. In Japan, the primary legal mechanism for unilaterally ending a validly formed contract, particularly in response to a counterparty's failure to perform, is known as kaijo (解除). This term is often translated as "rescission" or "termination." Understanding the grounds for kaijo, the procedures involved, and its significant legal ramifications is crucial for any business operating under or entering into contracts governed by Japanese law.

I. Understanding Kaijo (Termination/Rescission) in Japanese Contract Law

Kaijo, as primarily regulated by the Japanese Civil Code (Articles 540 onwards), refers to the act by which a party to a contract unilaterally dissolves the contractual relationship. It is a "formative right" (keiseiken), meaning that the valid exercise of this right by one party, through a declaration of intent to the other, directly alters the legal status of the contract, bringing its primary obligations to an end.

It's important to distinguish kaijo from several related but distinct legal concepts:

• Mutual Agreement to Terminate (Gōi Kaijo or Kaijo Keiyaku): This is not a unilateral act but rather a new contract between the parties to end their original contract. Its terms and effects are governed by this new agreement.
• Resolutory Conditions (Kaijo Jōken): These are conditions agreed upon in the contract itself, the occurrence of which automatically brings the contract to an end without the need for a declaration of termination by either party.
• Termination with Prospective Effect Only (Kaiyaku Kōkoku): This form of termination, often seen in continuing contracts like leases (Civil Code Art. 620) or employment agreements, ends the contract only for the future. Past performances are generally not unwound; the contract is simply not performed going forward.
• Right of Arbitrary Termination (Nin'i Kaijo): Certain types of contracts, such as mandate agreements (agency) or some contracts for work (before completion), grant parties a special statutory right to terminate the contract at will, even without a breach, often subject to an obligation to compensate the other party for any resulting damages.
• Avoidance (Torikeshi) or Nullity (Mukō): These concepts relate to defects in the contract's formation (e.g., due to mistake, fraud, duress, or lack of capacity for torikeshi; or due to illegality or impossibility for mukō). An avoided or null contract is treated as if it never had legal effect from the outset, which differs from terminating a contract that was initially valid.

The right to kaijo can arise from two main sources:

1. Statutory Grounds (Hōtei Kaijo): These are grounds provided by law, most significantly for a breach of contract (saimu furikō) by the other party.
2. Contractual Grounds (Yakujō Kaijo): The contract itself may stipulate specific conditions or events that grant one or both parties the right to terminate.

This article will primarily focus on statutory kaijo due to breach of contract.

II. Termination for Breach of Contract (Statutory Kaijo)

The most common scenario for statutory kaijo is when a party fails to perform its contractual obligations. The Japanese Civil Code, especially after its significant amendments effective from April 1, 2020, provides a structured approach to this.

A. General Requirements for Termination: The Role of Saikoku (Demand for Performance)

Historically, and still as a general principle for many types of breach, a party wishing to terminate a contract due to the other party's delay or partial non-performance must first give the defaulting party an opportunity to rectify the breach.

• Termination due to Delay in Performance (Civil Code Art. 541, as amended):
  If an obligor fails to perform their obligation by the due date (i.e., is in delay - rikō chitai), the obligee may specify a reasonable period and make a demand for performance (saikoku) within that period. If the obligor fails to perform within that specified period, the obligee may then terminate the contract.
  • The saikoku serves as a formal warning and provides a last chance for the defaulting party to perform.
  • What constitutes a "reasonable period" depends on the nature of the obligation and the circumstances.
  • After the period expires without performance, the obligee must then make a separate declaration of termination to the defaulting party.

B. Termination Without Prior Demand (Saikoku Nashi no Kaijo)

The 2020 amendments to the Civil Code consolidated and clarified situations where termination is permissible without first making a saikoku. Article 542 now provides several grounds for immediate termination:

1. Impossibility of Performance: If the whole of the performance has become impossible.
2. Clear Refusal to Perform: If the obligor explicitly and definitively expresses their intention not to perform the whole of their main obligation.
3. Partial Impossibility/Refusal Frustrating Contractual Purpose: If a part of the performance has become impossible, or the obligor explicitly refuses to perform a part of their main obligation, and as a result, the obligee cannot achieve the purpose of the contract by means of the remaining part of the performance.
4. "Periodic Acts" (Teiki Kōi): If the contract, by its nature or due to a declaration of intent by the parties, can only achieve its purpose if performed at a specific time or within a specific period, and that time or period has passed without performance (e.g., ordering a wedding cake for a specific wedding date).
5. Futility of Saikoku: In addition to the above, even if a saikoku were made, if it is clear from the circumstances that the obligor will not perform their main obligation within the reasonable period specified in the saikoku and that the purpose of the contract cannot be attained. This covers situations where a demand would be an obviously futile gesture.

C. The Role of "Attributable Cause" (Fault - Kiseki Jiyū) in Termination

A significant aspect of the 2020 Civil Code reform pertains to the role of the defaulting party's "fault" (kiseki jiyū) as a prerequisite for termination.

• Pre-2020 Law and Debate: Under the older law, there was considerable academic debate and some uncertainty as to whether the obligor's fault was strictly necessary for the obligee to exercise the right of kaijo. While fault was clearly necessary for claiming damages for breach, its role in termination itself was less clear-cut, with strong arguments for a "no-fault for termination" theory (saimusha no kiseki jiyū fuyōron).
• Post-2020 Civil Code Reform: The amended Civil Code has largely clarified that fault on the part of the defaulting party is generally NOT a requirement for terminating a contract due to their non-performance. The focus has shifted to the objective fact of non-performance and its impact on the ability to achieve the contract's fundamental purpose. This aligns Japanese domestic law more closely with international contract law principles (e.g., the UN Convention on Contracts for the International Sale of Goods - CISG, and the UNIDROIT Principles of International Commercial Contracts), which generally do not require fault for contract avoidance or termination due to fundamental non-performance. Fault, however, remains a critical element for claiming damages arising from the breach.

D. The "Materiality" of the Breach: Frustration of Contractual Purpose

While the old Civil Code did not use the common law term "material breach" explicitly, the underlying principle that a trivial or minor breach might not justify the drastic remedy of termination was often addressed through the application of the principle of good faith.

The 2020 Civil Code reforms have made this "materiality" threshold more explicit by frequently linking the right to terminate (especially without saikoku) to the condition that the "purpose of the contract cannot be achieved" due to the non-performance. This effectively means that if the breach is minor and does not fundamentally undermine the core objectives of the contract from the obligee's perspective, termination may not be available, or at least, a saikoku would still be required to give the obligor a chance to cure the defect. The concept of a "serious contractual violation" (jūdai na keiyaku ihan) reflects this idea that the breach must be significant enough to warrant ending the entire contractual relationship.

III. The Act and Process of Termination

Once the grounds for kaijo are established, certain procedural aspects must be observed:

• Declaration of Intent (Civil Code Art. 540(1)): Kaijo is effected by a clear declaration of intent from the terminating party to the other party. This is a unilateral act; the consent of the defaulting party is not required.
• Irrevocability (Civil Code Art. 540(2)): Once the right of kaijo has been validly exercised (i.e., the declaration has been made), it cannot be unilaterally revoked by the terminating party. This ensures legal certainty for the counterparty.
• Kaijo Involving Multiple Parties (Civil Code Art. 544): If one of the contracting parties consists of two or more persons, the right of termination may only be exercised by all of them jointly, or against all of them jointly. This is known as the principle of indivisibility of the right of termination (kaijoken no fukabunsei).

IV. Consequences of Kaijo (Civil Code Article 545)

The termination of a contract has significant legal consequences, primarily aimed at unwinding the transaction and compensating for losses.

A. Restitution of Past Performances (Genjō Kaifuku Gimu - Duty of Restitution)

The primary effect of kaijo, as stipulated in Article 545, Paragraph 1, is that each party becomes obligated to restore the other party to the state they were in before the contract was made (genjō kaifuku). This involves:

• Returning any money received: If money was paid, it must be returned with interest calculated from the date of receipt (Article 545, Paragraph 2).
• Returning any property received: If goods or other property were transferred, they must be returned. If the actual property cannot be returned (e.g., it has been consumed or destroyed), its value at the time of receipt must typically be returned.
• The mutual obligations of restitution are themselves considered to be in a relationship of simultaneous performance (Article 546), meaning one party can refuse to make restitution until the other party does so.

B. The "Retroactive Effect" of Kaijo

Historically, the dominant view in Japanese case law and legal theory (the "direct effect theory" - chokusetsu kōka setsu) has been that kaijo has a retroactive effect. This means the contract is treated as if it had never existed from its inception. Consequently, any transfer of property rights under the contract would be deemed to have never occurred, and the basis for one party holding benefits received from the other disappears, leading to restitutionary claims often framed as a specific type of unjust enrichment.

However, the practical implications of full retroactivity, particularly concerning the rights of third parties and the continued availability of damage claims, led to scholarly critiques and alternative theories (such as the gen naiyō hen'yō setsu, suggesting termination only affects the contract prospectively while transforming it into a relationship for liquidation).

The 2020 Civil Code reform, while not explicitly abandoning the terminology of retroactivity in all contexts, has focused on the practical outcomes of restitution. Regardless of the precise theoretical underpinning, the core consequence is the unwinding of performances made under the terminated contract.

C. Protection of Third-Party Rights (Civil Code Article 545, Paragraph 1, Proviso)

A crucial limitation on the effects of kaijo is that the exercise of the right of termination cannot prejudice the rights duly acquired by third parties. If a third party, acting in good faith, acquired a right related to the subject matter of the contract before the termination (e.g., purchased property from one of the contracting parties) and has perfected that right (e.g., through registration in the case of real estate), their rights are generally protected against the effects of the subsequent kaijo between the original contracting parties. The specifics of this protection, especially the requirements for the third party (such as good faith and perfection of their rights) and the timing, can be complex.

D. Coexistence with Claims for Damages (Civil Code Article 545, Paragraph 4 - formerly Paragraph 3)

Crucially, the termination of a contract does not prevent the aggrieved party from claiming damages suffered as a result of the breach that led to the termination. Article 545, Paragraph 4 (formerly Paragraph 3) explicitly states that the exercise of the right of kaijo does not affect a claim for damages.

• The aggrieved party can therefore terminate the contract to free themselves from future obligations and concurrently seek monetary compensation for losses incurred due to the counterparty's original breach.
• The basis for such a damages claim is the breach of contract itself. As distinct from the right of termination (which, under the post-2020 rules, generally does not require the defaulting party's fault), a claim for damages typically does require that the breach was due to a cause attributable to the defaulting party (kiseki jiyū).
• Damages are usually calculated to compensate for the expectation interest (i.e., to put the aggrieved party in the position they would have been in had the contract been duly performed).

V. Conclusion

Kaijo provides a vital mechanism in Japanese contract law for a party to disengage from a contractual relationship, most notably when faced with a significant breach by the counterparty. The Japanese Civil Code, particularly with its 2020 amendments, has refined the rules for termination, clarifying aspects such as the general non-requirement of fault for termination due to breach and emphasizing the impact of non-performance on the fundamental purpose of the contract. Parties must navigate the procedural requirements, such as the saikoku (demand for performance) where applicable, with care. The consequences of a valid kaijo are substantial, involving a mutual duty of restitution to unwind the transaction, alongside the preserved right to claim damages for the underlying breach. A clear understanding of these principles is indispensable for effectively managing contractual rights and remedies in Japan.