What are the Consequences of a Fictitious Transaction (Kyogi Hyōji) in Japan?

In the world of legal and commercial dealings, parties sometimes create an outward appearance of a transaction that does not reflect their true intentions or agreement. Such an arrangement, where a manifestation of intention is made in collusion with the other party to feign a legal act that neither genuinely intends to be binding between themselves, is known in Japanese civil law as a Kyogi Hyōji (虚偽表示) – a "Fictitious Manifestation of Intention." While these arrangements might be entered into for various reasons, including attempts to shield assets from creditors or for perceived tax advantages, Article 94 of the Japanese Civil Code provides a clear framework for their legal consequences, striking a balance between rendering such shams ineffective between the colluding parties and protecting innocent third parties who may subsequently rely on the false appearance created.

Defining Fictitious Manifestation (Kyogi Hyōji)

A fictitious manifestation of intention under Article 94 arises when the following core elements are present:

1. An Outward Manifestation of Intention: There is an objective expression of a will to engage in a particular legal act, such as a purported contract of sale, a lease, or a transfer of property rights. This could be evidenced by a written agreement, a change in property registration, or other conduct that outwardly signifies a transaction.
2. Conscious Discrepancy: The declarant (and the other party) consciously knows that this outward manifestation does not correspond to their actual, internal intentions regarding the purported legal effects between them.
3. Collusion (Tsūbō - 通謀): This is the hallmark of a fictitious manifestation. It requires a mutual understanding or agreement between the direct parties to the transaction (e.g., the purported seller and buyer) that the outward manifestation is merely a pretense and is not intended to create the legal rights and obligations it outwardly suggests as between themselves.

This element of collusion distinguishes a fictitious manifestation from a "mental reservation" (shinri ryūho), where only one party is aware of the discrepancy between their expressed and true intent. It also differs from a "mistake" (sakugo), where a party is unaware of a discrepancy.

A common example involves an individual (A) who, fearing that creditors might seize their real estate, colludes with a friend (B) to create the appearance of a sale of the property from A to B. They might execute a sale agreement and even transfer legal title (registration) to B, but with the understanding that A remains the true owner and B will not exercise ownership rights against A.

Hidden Acts (Intoku Kōi)

Sometimes, a fictitious manifestation is used to conceal a different, genuinely intended transaction between the parties. This underlying genuine transaction is referred to as a "hidden act" (intoku kōi - 隠匿行為). For instance, parties might document a transaction as a sale to minimize tax implications, when their true intention is to effect a gift. In such cases:

• The outward fictitious act (the sham sale) is void under Article 94, Paragraph 1.
• The validity of the hidden act (the genuine gift) is assessed separately based on its own merits and compliance with legal requirements applicable to that type of transaction. If the hidden gift is valid, it will be given legal effect between the parties, despite the voidness of the superficial sale.

Legal Effect Between the Colluding Parties (Article 94, Paragraph 1)

Article 94, Paragraph 1 of the Japanese Civil Code unequivocally states: "A fictitious manifestation of intention made in collusion with the other party is void."

This means that as between the parties who orchestrated the fiction, the purported legal act has no legal effect from the outset (ab initio). They cannot legally enforce the terms of the fictitious transaction against each other. In the example of the sham sale between A and B:

• A cannot demand the fictitious purchase price from B.
• B cannot demand delivery of the property from A based on the sham contract (if delivery hasn't occurred).
• If title was fictitiously transferred to B, A can generally demand that B cooperate in restoring the title (e.g., by cancelling the registration) to reflect the true ownership, as B has no valid legal basis to retain it against A.

It's noteworthy that even if the purpose of the fictitious transaction was to evade creditors (an illicit motive), Japanese courts have generally allowed the original owner to seek recovery of the property from the colluding party. This prevents the colluding party from being unjustly enriched and ensures that the property remains, in principle, accessible to the true owner's creditors. For example, the Supreme Court, in a judgment on July 28, 1966 (Minshu Vol. 20, No. 6, p. 1265), affirmed that a transferor in a fictitious transfer made to evade compulsory execution could demand the return of the property. This is because denying recovery would effectively reward the colluding transferee and could hinder the rights of the original creditors the scheme was intended to deceive.

The Crucial Protection: Innocent Third Parties (Article 94, Paragraph 2)

While a fictitious transaction is void between the colluding parties, the situation becomes more complex when third parties become involved. Article 94, Paragraph 2 provides a critical layer of protection: "The voidness of a manifestation of intention under the preceding paragraph may not be asserted against a third party in good faith."

This provision is a cornerstone of transactional security in Japanese law. Its rationale is based on balancing the interests involved:

• Culpability of the Original Parties: Those who create a fictitious appearance of a legal transaction are responsible for that false state of affairs.
• Protection of Reliance: Third parties who subsequently deal with one of the colluding parties, relying in good faith on the outward appearance created by the fiction, deserve protection. Their legitimate expectations should not be defeated by a secret, collusive arrangement to which they were not privy. This principle is often referred to as the "principle of reliance on outward appearance" (kenri gaikan hōri - 権利外観法理 or hyōken hōri - 表見法理).

If a third party is protected under Article 94, Paragraph 2, it means that in their relationship with the original true owner (who participated in the fiction), the fictitious transaction is treated as if it were valid. The original owner cannot claim the transaction was a sham to defeat the rights acquired by the good-faith third party. However, the good-faith third party, if they later discover the fiction and find it advantageous, may still choose to assert the voidness of the original fictitious transaction.

Who Qualifies as a "Third Party" (Daisan-sha)?

The term "third party" in Article 94, Paragraph 2 is not all-encompassing. It generally refers to individuals other than the direct parties to the fictitious manifestation and their universal successors (like heirs). Case law has further refined this, typically defining a protected third party as someone who has acquired a new, independent legal interest concerning the subject matter of the fictitious manifestation, in reliance on its apparent validity, before the voidness is asserted against them. (Daishin'in judgment, November 17, 1916, Minroku Vol. 22, p. 2089).

Examples of Protected Third Parties:

• A person who purchases the property from the fictitious transferee (e.g., if B, the fictitious owner of land from A, sells it to C, who is unaware of the A-B fiction – Supreme Court, October 1, 1953, Minshu Vol. 7, No. 10, p. 1019).
• A person who obtains a mortgage on the property from the fictitious transferee (e.g., B mortgages the fictitiously acquired land to C – Daishin'in, December 17, 1915, Minroku Vol. 21, p. 2124).
• An assignee who, in good faith, takes an assignment of a claim that was fictitiously created or transferred.
• A lessee who, in good faith, leases the property from the fictitious owner.

Examples of Parties Generally NOT Protected as "Third Parties" under Article 94(2):

• General Creditors: A general, unsecured creditor of the fictitious transferee (e.g., someone who simply lent money to B, the fictitious owner, relying on B's apparent wealth including the fictitiously held property) is usually not protected. They have not acquired a specific legal interest in the subject matter of the fictitious transaction itself.
  • Exception for Attaching Creditors: However, if such a general creditor subsequently takes legal steps to attach or seize the fictitiously transferred property in satisfaction of their claim against the fictitious transferee, they can then qualify as a protected third party if they acted in good faith regarding the original transaction (Supreme Court, June 28, 1973, Minshu Vol. 27, No. 6, p. 724). The act of attachment creates a specific legal interest in the property.
• The principal where their agent engaged in a fictitious transaction.
• A debtor of a claim that was fictitiously assigned (if they have not yet made payment to the fictitious assignee based on the false appearance).

The "Good Faith" (Zen'i) Requirement for Third Parties

To benefit from the protection of Article 94, Paragraph 2, the third party must be "in good faith" (zen'i - 善意).

• Meaning of Good Faith: In this context, good faith primarily means that the third party was unaware of the collusive and fictitious nature of the original transaction at the time they acquired their legal interest. It is not necessarily required that they positively believed the fictitious transaction to be true, but rather that they did not know it was false.
• Time of Assessment: Good faith is judged at the moment the third party acquired their interest (Supreme Court, September 11, 1980, Minshu Vol. 34, No. 5, p. 683).
• Absence of Negligence (Mukashitsu) Generally Not Required: A crucial point established by long-standing case law (e.g., Daishin'in judgment, August 10, 1937, Shinbun No. 4185, p. 9) is that for the direct application of Article 94, Paragraph 2, the good-faith third party does not need to prove that they were also free from negligence (mukashitsu - 無過失). The rationale is that the original parties who knowingly created the false appearance bear a high degree of culpability, and this outweighs considerations of minor carelessness on the part of a third party who was otherwise unaware of the fiction. While some scholars have debated this, advocating for a negligence standard for consistency with other reliance-protection rules, the non-requirement of "no negligence" for the third party under a direct application of Article 94(2) remains the dominant judicial view.

Registration (Tōki) and the Third Party

In transactions involving real estate, the role of property registration (tōki - 登記) is significant. A question arises as to whether a good-faith third party protected by Article 94, Paragraph 2 needs to have completed their own registration to assert their rights against the original true owner who participated in the fiction.

• Against the Original True Owner: The prevailing view and Supreme Court precedent (e.g., judgment of May 27, 1969, Minshu Vol. 23, No. 6, p. 998) hold that the good-faith third party does not need to have perfected their own registration to be protected against the original party to the fiction. The original true owner, having participated in creating the false appearance, cannot invoke the general rule requiring registration to defeat third parties (Article 177 of the Civil Code) against the very person Article 94, Paragraph 2 aims to protect.
• Between Multiple Third Parties: If, however, the fictitious transferee purported to create conflicting rights in the same property in favor of multiple third parties (e.g., sold the same land to X and then mortgaged it to Y, both X and Y being in good faith), the priority between these third parties would generally be determined by the usual rules governing competing claims, which for real estate often means the order of registration.

Subsequent Acquirers (The "Absolute Construction" - Zettai-teki Kōsei)

What if a good-faith third party (let's call them TP1), who is protected by Article 94, Paragraph 2, subsequently transfers the acquired right to another person (TP2)?
Japanese case law has adopted what is known as the "absolute construction" (zettai-teki kōsei - 絶対的構成). This means that once a right has passed through the hands of a good-faith third party (TP1) and has been "cleansed" by the application of Article 94, Paragraph 2, any subsequent acquirer (TP2) from TP1 is also protected, regardless of TP2's own good faith or bad faith concerning the original fictitious transaction (e.g., Daishin'in, July 9, 1914, Keiroku Vol. 20, p. 1475). TP2 effectively inherits the protected status of TP1. This doctrine provides stability to the rights acquired by the initial good-faith third party, making those rights freely transferable. A "relative construction," which would assess each subsequent acquirer's good faith independently, has generally not been favored as it would undermine the security of TP1's "good" title.

Revocation of the Fictitious Manifestation by the Original Parties

The parties who created the fictitious manifestation can, of course, agree to undo or revoke their sham arrangement. However, if they do so merely by internal agreement but leave the false outward appearance intact (e.g., a property registration remains in the name of the fictitious transferee), they may not be able to assert this revocation against a new third party who subsequently deals with the fictitious transferee in good faith, relying on the still-existing false appearance. To effectively nullify the potential for third-party reliance, the original parties must take steps to eliminate the false outward appearance itself (e.g., by correcting the property registration).

Beyond the Letter: Analogical Application of Article 94, Paragraph 2

The protective principles of Article 94, Paragraph 2 have been significantly extended by Japanese courts through analogical application (ruisui tekiyō - 類推適用) to situations that do not strictly meet the definition of a collusive fictitious manifestation but share similar underlying elements of a false appearance of rights for which the true owner bears some responsibility, and good-faith reliance on that appearance by a third party.

The core idea behind analogical application is that if a true rights-holder, through their own actions or knowing acquiescence, creates or allows to persist a misleading appearance that another person holds certain rights, and a third party relies on this appearance in good faith to their detriment, the true rights-holder may be estopped from asserting the true state of affairs against that third party.

Key elements generally required for such analogical application include:

1. The existence of a false outward appearance of rights (e.g., a registration in someone else's name, possession of indicia of ownership or authority).
2. Culpability or responsibility on the part of the true rights-holder for the creation or persistence of this false appearance. This is a critical element and its threshold can vary.
3. Good faith reliance by the third party on this false appearance.
4. Often, particularly when the true owner's culpability is less direct or intentional than in a classic collusive fiction, the third party's good faith may need to be without negligence for protection under analogical application.

Case law provides numerous examples. For instance, if a property owner (A) allows another person (B) to register the property in B's name (or knows of such a false registration and does nothing to correct it for a significant period), and B then sells or mortgages the property to a third party (C) who is unaware of A's true ownership, A may be precluded from asserting their ownership against C by analogical application of Article 94, Paragraph 2 (e.g., Supreme Court, September 22, 1970, Minshu Vol. 24, No. 10, p. 1424).

Another line of cases involves the true owner's extreme carelessness with important documents like registered deed seals, blank powers of attorney, or personal seal certificates, enabling another person to create a false appearance of ownership or authority to transact. If a third party relies on this enabled false appearance in good faith and without negligence, the true owner might be bound (e.g., Supreme Court, February 23, 2006, Minshu Vol. 60, No. 2, p. 546, which involved applying Article 94(2) and Article 110 [apparent agency] by analogy). These cases often blur the lines between pure reliance on title and principles of apparent agency, but the underlying theme is the protection of justified reliance on an appearance for which the true owner bears some responsibility.

The degree of the true owner's culpability required can range from active participation in creating the false appearance or knowingly permitting it to persist, to very high degrees of negligence in safeguarding their affairs that directly enable the deception. The more direct and intentional the true owner's involvement in the false appearance, the more likely a third party's simple good faith will suffice for protection. If the owner's culpability is more indirect (e.g., negligence), courts are more likely to require that the third party also be free from negligence.

Conclusion: The Enduring Importance of Outward Appearance and Bona Fide Reliance

Fictitious manifestations of intention (Kyogi Hyōji) are treated as void between the colluding parties under Article 94, Paragraph 1 of the Japanese Civil Code, reflecting the principle that the law will not enforce an arrangement the parties themselves did not intend to be binding. However, the paramount concern for transactional security and the protection of innocent parties who may be misled by such shams is addressed by Article 94, Paragraph 2. This provision, and its extensive analogical application by the courts, underscores a strong policy in Japanese law: those who create or are responsible for misleading outward appearances of legal rights may be precluded from asserting the true state of affairs against third parties who have relied on such appearances in good faith (and sometimes, without negligence). This framework is vital for maintaining predictability and fairness in commercial and property dealings, ensuring that the risks associated with false appearances are, to a significant extent, borne by those who contribute to their creation rather than by unsuspecting outsiders.