Understanding Guarantees in Japanese Business: Scope of Guarantor's Liability and Right of Reimbursement

Guarantees (保証 - hoshō) are a frequently encountered form of personal security in Japanese business transactions. They serve as a crucial credit enhancement tool, providing creditors with an additional layer of assurance that an obligation will be fulfilled, even if the principal debtor defaults. However, the rights and obligations of guarantors, principal debtors, and creditors under Japanese law are nuanced. Key aspects include the scope of the guarantor's liability, the specific rules governing revolving guarantees for ongoing transactions, and the guarantor's right to seek reimbursement from the principal debtor after making a payment.

This article delves into these critical elements of Japanese guarantee law, aiming to provide clarity for businesses and legal professionals navigating such arrangements.

1. What is a Guarantee (Hoshō) in Japanese Law?

Under the Japanese Civil Code (Article 446, paragraph 1), a guarantee is a contract whereby a guarantor promises a creditor to perform the obligation of a principal debtor if the principal debtor defaults. It is a secondary obligation, meaning its existence and validity are tied to the primary obligation it secures.

• Accessory Nature (付従性 - fujūsei):
  A fundamental characteristic of a guarantee is its accessory nature. The guarantee obligation is dependent on the principal debt. If the principal debt is invalid, extinguished (e.g., by payment, prescription, or set-off), or altered, the guarantee obligation is generally affected in a corresponding manner. For example, if the principal debt is reduced, the guarantor's liability is also typically reduced.
• Formalities (Article 446, paragraphs 2 and 3):
  To be valid, a guarantee contract must be made in writing or recorded in an electromagnetic record (e.g., an electronic document). An oral promise of guarantee is generally unenforceable. This formality requirement aims to ensure that the guarantor undertakes the obligation with due consideration and to prevent disputes by clarifying the terms of the guarantee.
  For certain types of personal revolving guarantees for business loans where the guarantor is an individual not substantially involved in the principal debtor's business (e.g., a director guaranteeing a small company's loan under specific conditions), even more stringent requirements apply, such as the need for a notarized "declaration of intent to guarantee" (保証意思宣明公正証書 - hoshō ishi senmei kōsei shōsho) executed before the guarantee contract is concluded (Civil Code, Articles 465-6 to 465-9). However, these heightened requirements do not apply to all business-related guarantees, such as a guarantee for ongoing trade credits between corporate entities.

2. Scope of the Guarantor's Liability (Hoshō Saimu no Han'i)

Unless the guarantee contract specifies otherwise, the scope of a guarantor's liability is broad.

• General Scope (Article 447, paragraph 1):
  The guarantee covers not only the principal amount of the debt but also:
  • Interest on the principal obligation.
  • Liquidated damages or default penalties (違約金 - iyakukin).
  • Damages arising from the principal debtor's non-performance.
  • All other charges that are ancillary to (従たる - jūtたる) the principal obligation.
    This means the guarantor's potential exposure can significantly exceed the original principal amount if the debtor defaults and substantial interest or damages accrue. This broad scope applies even to damages incurred by the creditor due to the principal debtor's default, irrespective of whether the underlying contract between the creditor and principal debtor is subsequently terminated (Great Court of Cassation, April 15, 1910, Minroku Vol. 16, p. 325). Furthermore, case law has established that a guarantor can be liable for the principal debtor's obligation to make restitution (e.g., return advance payments) if the main contract is terminated due to the principal debtor's default, as this is often within the contemplated risk assumed by the guarantor (Supreme Court, June 30, 1965, Minshū Vol. 19, No. 4, p. 1143).
• Simple Guarantee vs. Joint and Several Guarantee (連帯保証 - Rentai Hoshō):
  It is crucial to distinguish between a "simple" guarantee and a "joint and several" guarantee, as their effects on the guarantor's procedural rights differ significantly:
  • Simple Guarantor: A simple guarantor possesses certain procedural defenses. They can demand that the creditor first pursue the principal debtor (right of "notice" or demand for prior execution - 催告の抗弁権, saikoku no kōbenken, Article 452) and, if the principal debtor has sufficient assets and execution on those assets is feasible, demand that the creditor first execute against the principal debtor's assets (right of "search" - 検索の抗弁権, kensaku no kōbenken, Article 453).
  • Joint and Several Guarantor (連帯保証人 - rentai hoshōnin): If the guarantee is "joint and several" (which must be explicitly agreed or, in commercial guarantees, is often presumed), the guarantor does not have the rights of notice and search (Article 454). The creditor can demand full performance from the joint and several guarantor immediately upon the principal debtor's default, without first having to pursue the principal debtor. Most guarantees in Japanese business practice are structured as joint and several guarantees to provide stronger security to the creditor.

3. Revolving Guarantees (Ne-hoshō - 根保証) for Ongoing Transactions

For continuous business relationships, such as ongoing supply agreements or open account credit lines, where multiple, unspecified future obligations may arise, a revolving guarantee (根保証 - ne-hoshō) is often used. Instead of guaranteeing a single, specific debt, a revolving guarantee covers a series of future debts up to a certain limit and within a defined scope of transactions.

• Personal Revolving Guarantees (個人根保証 - kojin ne-hoshō):
  When an individual acts as a guarantor for such revolving obligations, special protective rules apply under the Civil Code (Articles 465-2 to 465-5) to prevent individuals from being exposed to unexpectedly large and indefinite liabilities.
  • Mandatory Maximum Limit (極度額 - kyokudogaku) (Article 465-2, paragraph 2): For any personal revolving guarantee to be valid, a maximum monetary limit (kyokudogaku) of the guarantor's liability must be clearly stipulated in the written guarantee contract. This limit is comprehensive, covering all principal, interest, damages, etc. A personal revolving guarantee without such a stipulated maximum limit is void.
  • Fixation of the Principal (元本確定 - ganpon kakutei): The unspecified ("floating") obligations covered by the revolving guarantee eventually become "fixed" or "determined" (元本確定 - ganpon kakutei). Once the principal is fixed, the guarantee will only cover the obligations existing at that point (plus any subsequent interest or damages arising from those fixed obligations); no new principal obligations arising after fixation will be covered by the revolving guarantee.
    • Fixed Date for Principal Determination (元本確定期日 - ganpon kakutei kijitsu): Parties may agree on a specific date for the principal to be fixed. For "personal revolving credit guarantees" (個人貸金等根保証契約 - kojin kashikin-tō ne-hoshō keiyaku), which are personal revolving guarantees securing loans or similar credit transactions, if such a date is set, it cannot be more than five years from the contract date. If no date is set for such a guarantee, the principal is deemed fixed three years after the contract date (Article 465-3, paragraphs 1 and 2). For other types of personal revolving guarantees (e.g., for continuous sales of goods, as in one of the PDF's examples), these specific time limits in Article 465-3 do not apply, though parties can still agree on a fixation date.
    • Other Fixation Events (Article 465-4, paragraph 1): Even without a pre-set date, the principal of a personal revolving guarantee becomes fixed upon the occurrence of certain events, including:
      1. The creditor initiating compulsory execution on the guarantor's assets or exercising a security interest against the guarantor's property concerning the guaranteed obligations.
      2. The guarantor becoming subject to bankruptcy proceedings.
      3. The death of the principal debtor or the guarantor.
         For example, if an individual is a revolving guarantor for a company's trade debts and the individual guarantor passes away, the guaranteed principal is fixed at the amount of the company's outstanding debts to the creditor at the time of the guarantor's death. The guarantor's heirs would then inherit the guarantee obligation only for this fixed amount, not for any new debts incurred by the company thereafter.

4. The Guarantor's Right of Reimbursement (Kyūshōken - 求償権) after Performance

When a guarantor performs the principal debtor's obligation (e.g., pays the debt to the creditor), they generally acquire a right of reimbursement (求償権 - kyūshōken) against the principal debtor. The scope and conditions of this right depend largely on whether the guarantee was undertaken at the request (with the entrustment - 委託, itaku) of the principal debtor.

• Entrusted Guarantors (受託保証人 - jutaku hoshōnin):
  If the guarantor undertook the guarantee at the debtor's request (the most common scenario), their right of reimbursement is more extensive (Civil Code, Article 459, paragraph 1, applying Article 442, paragraph 2 by reference):
  • They can claim the amount they paid to discharge the debt (or the value of property if payment was made in kind, limited by the actual amount of debt extinguished – Article 459, paragraph 1, second parenthesis).
  • They can also claim legal interest on that amount from the date of discharge.
  • Additionally, they can claim any unavoidable expenses incurred and compensation for any other damages suffered.
• Un-entrusted Guarantors (委託を受けない保証人 - itaku o ukenai hoshōnin):
  If a person becomes a guarantor without the debtor's entrustment, their reimbursement right is more limited (Article 462). They can generally only claim reimbursement to the extent the debtor was enriched (benefited) by their performance at the time of reimbursement.
• The Importance of Notices for Entrusted Guarantors (Article 463):
  To ensure fairness and prevent unnecessary double payments or loss of defenses, Article 463 imposes certain notice obligations when an entrusted guarantor is involved:
  • Guarantor's Pre-Performance Notice to Debtor (Article 463, paragraph 1): If an entrusted guarantor intends to perform the obligation (e.g., pay the creditor), they should ideally notify the principal debtor beforehand. If the guarantor performs without such prior notice (and the debtor was unaware of the impending performance), and the debtor had a valid defense against the creditor (e.g., a right of set-off, or the debt had prescribed), the debtor can assert that defense against the guarantor's claim for reimbursement to the extent of their share. In such a case, the guarantor who couldn't get full reimbursement from the debtor can then try to recover that amount from the original creditor.
  • Debtor's Post-Performance Notice to Guarantor (Article 463, paragraph 2): Conversely, if the principal debtor performs the obligation (e.g., pays the creditor), they should notify the entrusted guarantor. If the debtor performs but fails to notify the guarantor, and the guarantor subsequently performs the same obligation in good faith (without knowing the debtor had already paid), the guarantor is entitled to treat their own performance as valid for the purpose of seeking reimbursement from the debtor. The debtor would then have to seek recovery of the overpayment from the creditor. The Supreme Court judgment of December 17, 1982 (Minshū Vol. 36, No. 12, p. 2399), although a case on joint and several obligors, provides analogous reasoning often applied to this guarantor-debtor notice dynamic. If, however, the guarantor also failed to give pre-performance notice to the debtor, the guarantor's reimbursement claim might be denied, as their own negligence contributed to the situation.
    These notice rules highlight the importance of communication between the debtor and an entrusted guarantor to avoid complications.
• Pre-Performance Right of Reimbursement (事前求償権 - jizen kyūshōken) (Article 460):
  In certain specific situations, an entrusted guarantor may have the right to seek reimbursement from the principal debtor before actually performing the obligation to the creditor. These situations include when the principal debtor becomes subject to bankruptcy proceedings, when the principal obligation becomes due, or other circumstances where the guarantor is likely to be called upon to perform. This pre-performance right effectively allows the guarantor to demand funds from the debtor to make the payment to the creditor.

Conclusion: Navigating Guarantees with Diligence

Guarantees play a significant role in facilitating credit and commercial transactions in Japan by providing creditors with an alternative source of recovery. However, they also impose substantial liabilities on guarantors. For all parties involved—creditors seeking security, principal debtors providing it, and individuals or entities acting as guarantors—a clear understanding of the scope of guarantee obligations, the specific rules applicable to different types of guarantees (especially the protections for individual revolving guarantors), and the mechanics of the guarantor's right of reimbursement (including the critical notice requirements) is essential. Proper drafting of guarantee agreements, awareness of the legal protections, and clear communication can help manage the rights and obligations effectively and mitigate potential disputes.