What are "Representations and Warranties" (Hyomei Hosho) in Japanese M&A and Other Contracts, and What are the Consequences of a Breach?

Japanese Attorney at Law - Bengoshi L.L.

• 8 min read

In the intricate world of mergers and acquisitions (M&A), financing deals, and other significant commercial transactions, "Representations and Warranties" (R&W) have become a standard and often heavily negotiated feature. While originating in Anglo-American legal practice, these provisions, known in Japanese as Hyōmei Hoshō (表明保証), are increasingly common in contracts governed by Japanese law. However, their legal nature, interpretation, and the consequences of their breach in Japan are shaped by the Japanese Civil Code (Minpō) and domestic legal principles, which can differ from their common law counterparts. This article explores the function and legal treatment of Hyōmei Hoshō in the Japanese contractual landscape.

Understanding "Hyōmei Hoshō": An Adapted Concept

In essence, representations and warranties are statements of fact made by one party to another concerning specific past or present conditions relevant to the contract, typically about the business, assets, or financial state of a target company in an M&A context, or the subject matter of another commercial agreement. The "warranty" aspect implies a promise by the maker that these statements are true, coupled with an assumption of liability if they prove to be incorrect.

Japanese law does not have a distinct, codified statutory doctrine specifically labelled "Representations and Warranties" in the same way as, for example, the Uniform Commercial Code (UCC) in the United States might address warranties in the sale of goods. Instead, the legal effect and enforceability of Hyōmei Hoshō clauses in Japan derive primarily from their status as agreed-upon contractual terms, interpreted in accordance with general principles of Japanese contract law.

Primary Purposes in Japanese Practice:
Similar to their function elsewhere, Hyōmei Hoshō in Japanese contracts serve several key purposes:

  1. Information Disclosure: They compel the representing party to disclose material information about the subject matter of the contract.
  2. Risk Allocation: They are a crucial mechanism for allocating risks between the parties regarding the accuracy of the stated facts. If a representation turns out to be false, the risk of loss arising from that inaccuracy is typically shifted to the party who made the representation. This is particularly important where due diligence by the other party may have limitations or cannot uncover all potential issues.
  3. Basis for Recourse: They provide a contractual foundation for the recipient to seek remedies if the statements are found to be untrue.

Common Scenarios for Hyōmei Hoshō in Japan

While most prominently featured in M&A agreements (such as share purchase agreements, asset purchase agreements, and merger agreements), Hyōmei Hoshō clauses are also utilized in a variety of other sophisticated commercial contracts in Japan, including:

  • Financing agreements (e.g., syndicated loans, commitment line agreements).
  • Transfers or licensing of intellectual property rights.
  • Real estate transactions, particularly for commercial properties.
  • Complex service agreements and outsourcing contracts.
  • Lease agreements for significant assets.

Since Hyōmei Hoshō are contractual creations, their specific meaning, scope, and the consequences of their breach are, first and foremost, determined by the wording of the contract itself, interpreted according to standard Japanese contract interpretation principles. This involves looking at:

  • The precise language of the Hyōmei Hoshō clause.
  • The context of the entire agreement and other related documents.
  • The discernible intentions of the parties.
  • The overall purpose of the transaction and the specific R&W.
  • The agreed-upon allocation of information and business risks.

Japanese legal commentaries sometimes distinguish between a "narrow sense" and a "broad sense" of Hyōmei Hoshō:

  • Narrow Sense Hyōmei Hoshō: This aligns closely with the core concept where the representing party (the "representor") guarantees the truthfulness of the stated facts and agrees to compensate the other party (the "recipient") for losses if those facts are incorrect. Crucially, this liability for compensation (often structured as an indemnity) may arise irrespective of the representor's fault (i.e., whether they knew or were negligent in not knowing about the falsity). The remedy is typically a contractually defined monetary compensation.
  • Broad Sense Hyōmei Hoshō: In practice, contracts often link a wider array of consequences to a breach of Hyōmei Hoshō beyond simple monetary compensation. These can include rights to terminate the contract, suspend counter-performance, accelerate debt repayment, or trigger price adjustments, all as specifically stipulated in the agreement.

Consequences of a Breach of Hyōmei Hoshō

The primary remedies for a breach of Hyōmei Hoshō are those specified within the contract itself. This contractual determination of remedies is paramount. Common contractual remedies include:

  1. Indemnification or Compensation: This is the most typical remedy. The contract will usually oblige the breaching party to indemnify or compensate the non-breaching party for any "Loss" (as defined in the contract) arising from the inaccuracy of the representation or warranty. Contracts often detail the mechanics for claiming and calculating this indemnity, potentially including baskets (thresholds before claims can be made), caps (maximum liability), and specific calculation methodologies.
  2. Termination or Rescission Rights: The agreement may grant the non-breaching party the right to terminate or rescind the entire contract if a breach of R&W is sufficiently material or fundamental.
  3. Purchase Price Adjustments: In M&A contexts, a breach of R&W discovered post-closing might trigger a contractual purchase price adjustment mechanism.
  4. Specific Performance (Less Common for R&W Breach Itself): While specific performance of the R&W itself (i.e., forcing a fact to be true) is generally not feasible, a breach of R&W might lead to a failure of an underlying obligation for which specific performance (like conveying an asset) could be sought, or the contract might require the breaching party to take specific actions to cure the effects of the breach.

Interaction with General Japanese Contract Law Remedies:
If the contract is silent or unclear on remedies for an R&W breach, or if the contractual remedies are deemed insufficient or invalid, general principles of Japanese contract law may come into play:

  • Damages for Non-Performance of an Obligation (債務不履行 - Saimu Furikō - Civil Code Art. 415): A crucial question is whether a breach of Hyōmei Hoshō can be treated as a general non-performance of a contractual obligation, giving rise to a claim for damages under Article 415.
    • This depends on how the specific Hyōmei Hoshō is interpreted. If it is construed as a promise that a certain state of affairs exists or will exist (a contractual obligation to ensure that state of affairs), then its untruth could constitute a breach of that obligation.
    • However, if the Hyōmei Hoshō is viewed primarily as a basis for a contractually agreed indemnification or compensation scheme (as in the "narrow sense" described above), then the remedy might be confined to what the contract provides, rather than general damages for breach of a primary performance obligation. Legal commentaries suggest that for "narrow sense" R&W, the primary remedy is the agreed compensation. The underlying legal thinking often frames the R&W as the representor (1) guaranteeing the truth of certain matters, thus making this guarantee part of their contractual obligations, and (2) consequently, if these matters are untrue, being obliged under a damage security promise (the warranty aspect) to provide compensation as per the contract.
  • Rescission (Kaijo - 解除 - Civil Code Arts. 541, 542): If a breach of R&W is so material that it fundamentally undermines the purpose of the contract, the non-breaching party might be able to invoke the general statutory rights of rescission, provided the contractual remedies are not stipulated as exclusive and the conditions for statutory rescission are met.

Several specific doctrines of Japanese contract law interact with Hyōmei Hoshō clauses:

  1. Mistake (Sakugo - 錯誤 - Civil Code Art. 95) and R&W:
    What if a party makes a representation and warranty while being mistaken about the very facts they are representing? Can they later seek to rescind the R&W clause or the entire contract based on the doctrine of mistake?
    • The prevailing view in Japanese legal commentary is generally no. If the Hyōmei Hoshō clause is interpreted as allocating the risk of that particular factual inaccuracy to the party making the representation, then that party has contractually assumed the risk of being mistaken. To then allow rescission for mistake would negate the risk-allocation function of the R&W. The parties, by agreeing to the R&W, are understood to have intended to address discrepancies according to the terms of that clause itself.
  2. Recipient's Knowledge of Falsity (相手方が悪意の場合 - Aitekata ga Akui no Baai):
    If the party receiving the R&W knew at the time of contracting that a particular representation was false, can they still make a claim based on its breach?
    • Generally, Japanese law, guided by the principle of good faith, would likely preclude such a claim. A party cannot reasonably claim to have relied on a statement they knew to be untrue.
    • What if the recipient was merely negligent or even grossly negligent in not discovering the falsity? The situation is more nuanced. If the representor was not fraudulent, the recipient's significant negligence in failing to recognize an obvious falsity might, by analogy to rules on mistake or under the good faith principle, weaken their ability to claim. However, if the representor themselves acted with intent to deceive, the recipient's negligence is less likely to be a bar.
  3. Relationship with Misrepresentation (不実表示 - Fujitsu Hyōji) and Fraud (詐欺 - Sagi):
    Pre-contractual misrepresentations can give rise to tort liability or, if fraudulent, allow for rescission of the contract under Article 96 of the Civil Code. Hyōmei Hoshō clauses provide a contractual basis for recourse, which can be advantageous because proving the elements of fraud (like intent to deceive) can be difficult.
    • The remedies for breach of R&W (contractual) and remedies for misrepresentation/fraud (tortious/statutory rescission) can potentially co-exist, or the contract might attempt to stipulate that the R&W remedies are exclusive for matters covered by the R&W.

Practical Tips for Drafting and Negotiating Hyōmei Hoshō under Japanese Law

Given that Hyōmei Hoshō are creatures of contract in Japan, careful drafting is paramount:

  • Clarity and Specificity: Define precisely what facts and circumstances are being represented and warranted. Ambiguities will be resolved through contract interpretation, which may not always align with a foreign party's assumptions.
  • Knowledge Qualifiers: If R&W are qualified by the representor's "knowledge," clearly define the scope of that knowledge (e.g., actual knowledge, constructive knowledge after due inquiry, knowledge of specific individuals).
  • Materiality Qualifiers: If materiality thresholds apply, define them clearly.
  • Definition of "Loss": Provide a comprehensive definition of what constitutes a compensable "Loss" for the purpose of indemnification.
  • Remedies and Procedures: Explicitly detail the remedies for breach (e.g., indemnification calculation and payment procedures, conditions for termination). Specify whether these contractual remedies are exclusive.
  • Survival Periods: Stipulate how long the R&W themselves, and the right to make a claim for their breach, will survive after the closing of the transaction. While Japanese law has general statutory prescription periods (statutes of limitation), contractual limitations on the claim period for R&W breaches are common and generally enforceable if reasonable.
  • Disclosure Schedules: These are critical. Ensure they are thorough and accurate, as information fairly disclosed in these schedules typically qualifies or limits the scope of the R&W.

Conclusion

Representations and Warranties (Hyōmei Hoshō) are playing an increasingly vital role in sophisticated Japanese commercial contracts, offering a mechanism for information disclosure and risk allocation, particularly in M&A transactions. While influenced by international practice, their legal effect in Japan is ultimately determined by their specific wording as contractual terms, interpreted within the framework of the Japanese Civil Code and its overarching principles like good faith. Unlike some common law jurisdictions, there isn't a standalone body of "R&W law"; rather, their enforcement relies on contractual promises and the remedies agreed by the parties or implied by general contract law. For businesses engaging in deals governed by Japanese law, a nuanced understanding of how these clauses function and interact with domestic legal principles, coupled with meticulous drafting, is essential for achieving the intended risk allocation and ensuring effective recourse in the event of inaccuracies.