What are the Requirements for a Valid Set-Off ("Sōsai Tekijō") Under Japanese Law?

Japanese Attorney at Law - Bengoshi L.L.

• 11 min read

In our previous discussion, we explored how "Sōsai" (相殺 – set-off) functions as a debt settlement mechanism in Japan, highlighting its roles in simplifying payments, ensuring fairness, and providing a form of de facto security. For a party to unilaterally effect a statutory set-off by declaration, thereby extinguishing mutual obligations, the Japanese Civil Code (Minpō - 民法), primarily in Article 505, mandates that a specific set of conditions must be met. This state of mutual eligibility for set-off is known as "Sōsai Tekijō" (相殺適状 – literally, "a condition suitable for set-off"). Understanding these requirements is crucial, as their absence (unless a valid set-off agreement waives them) renders a unilateral attempt to set off ineffective.

The Core Meaning of "Sōsai Tekijō"

"Sōsai Tekijō" signifies that the respective claims held by two parties against each other have reached a point where they are legally ripe and appropriate to be offset. It is the legal gateway to exercising the unilateral right of statutory set-off. The existence of Sōsai Tekijō means that the law views the claims as being in a position for mutual cancellation up to the corresponding amount, reflecting an underlying expectation of netting.

Essential Requirements for "Sōsai Tekijō" (Article 505, Paragraph 1)

Article 505, paragraph 1 of the Civil Code outlines the primary conditions that must be satisfied for Sōsai Tekijō to exist:

A. Existence of Opposing Claims Between the Same Parties ("Dōitsu Tōjisha Kan ni Saiken no Tairitsu ga aru Koto")

  1. Mutuality of Parties: This is the cornerstone. For a set-off, Party A must have a claim against Party B, and simultaneously, Party B must have a claim against Party A. The parties must be debtors and creditors to each other in their respective capacities.
  2. Valid Existence of Both Claims: Both the claim held by the party wishing to declare set-off (the "jidō saiken" or active claim - 自動債権) and the claim against which the set-off is declared (the "judō saiken" or passive claim - 受動債権) must be validly existing and enforceable. If, for instance, the active claim is based on a void contract or has already been extinguished by other means (like prior payment or prescription that has been duly invoked), it cannot be used for set-off.
  3. General Prohibition of "Third-Party Set-Off": The requirement of mutuality generally prohibits what might be termed "third-party set-offs." This means:
    • A debtor cannot use a claim that a third party holds against their creditor to set off their own debt. (This is sometimes referred to as "tanin saiken ni yoru sōsai" - 他人債権による相殺, set-off using another's claim).
    • A debtor cannot use a claim they hold against a third party to set off a debt they owe to their creditor.
    • A party (B) cannot typically use their claim against A to set off a debt that a third party (C) owes to A. This specific scenario is often what "daisansha sōsai" (第三者相殺 - third-party set-off) refers to in more complex discussions and is generally not permitted because it lacks the direct mutuality between B and C regarding A's claim against C.
      Strict adherence to the "same parties" rule is fundamental. While there are very limited statutory exceptions where a party in a special relationship (like a guarantor under Article 457(2) of the Civil Code) may assert certain defenses or rights available to the principal debtor (including rights of set-off the principal debtor has against the creditor), these are specific exceptions and do not negate the general mutuality requirement for effecting one's own set-off.

B. Both Claims Having the Same Kind of Subject Matter ("Ryō Saiken ga Dōshu no Mokuteki o Yūsuru Koto")

For statutory set-off, the subject matter of the two obligations must be of the same kind.

  • Typical Application: Monetary Debts: The most common and straightforward application is where both claims are for the payment of money.
  • Generic Goods: Set-off is also possible if both obligations are for the delivery of generic goods of the same type and quality (e.g., Party A owes Party B 100 kilograms of Grade X rice, and Party B owes Party A 50 kilograms of Grade X rice).
  • Non-Homogeneous Claims: One cannot set off a monetary debt against an obligation to provide a unique service or deliver a specific, non-fungible item (e.g., a particular work of art).
  • Different Currencies: If both claims are monetary but denominated in different currencies (e.g., one in JPY and the other in USD), a strict interpretation might suggest they are not of the "same kind." However, the prevailing view, supported by international commercial principles and practical considerations, is that set-off is generally possible provided the currencies are freely convertible. The claims would be converted to a common currency using an appropriate exchange rate (often the rate prevailing at the time Sōsai Tekijō arose or at the time of the set-off declaration) to determine the corresponding amounts.
  • Place of Performance Need Not Be Identical: The respective places of performance for the two obligations do not need to be the same for Sōsai Tekijō to exist. However, Article 507 of the Civil Code stipulates that if effecting a set-off involving claims with different places of performance causes any loss or expense to the other party (e.g., due to costs that would have been avoided if separate performances had occurred at the originally stipulated places), the party declaring the set-off must compensate the other party for such loss.

C. Both Claims Being Due and Payable ("Ryō Saiken no Bensanki ga Tōrai shita Koto")

For Sōsai Tekijō to arise, both the active claim and the passive claim must generally be due and payable (弁済期にある - bensaiki ni aru).

  1. Active Claim Must Be Due: The claim held by the person wishing to declare set-off (the jidō saiken) must have reached its maturity date. A creditor cannot use a claim that is not yet due to them to offset a debt they currently owe. This is why acceleration clauses (期限の利益喪失特約 - kigen no rieki sōshitsu tokuyaku) in loan agreements are significant; they cause the lender's claim to become due prematurely upon certain trigger events (like the borrower's default or insolvency), thereby facilitating Sōsai Tekijō with, for instance, the borrower's deposits held by the lender.
  2. Passive Claim and Waiver of "Benefit of Time": The claim against the person wishing to declare set-off (the judō saiken, i.e., their own debt) must also be due. However, the "benefit of time" (期限の利益 - kigen no rieki) associated with a future due date primarily exists for the benefit of the debtor of that claim. Under Article 136, paragraph 1 of the Civil Code, a debtor can generally waive their benefit of time. Therefore, the party wishing to declare set-off (who is the debtor of the passive claim) can unilaterally waive their own benefit of time with respect to the passive claim, making it effectively "due" for the purpose of set-off, provided their active claim against the other party is already due.
  3. Clarity from Supreme Court (February 28, 2013): A Supreme Court decision has clarified that for Sōsai Tekijō to be established, the mere potential for the debtor of the passive claim to waive the benefit of time is not sufficient. The passive claim's due date must have actually arrived, either by passage of time, by an explicit waiver of the benefit of time, or by the loss of such benefit (e.g., due to an acceleration event). This precision is important because the exact moment Sōsai Tekijō first occurs is critical for the retroactive effect of set-off (Article 506(2)) and for the application of Article 508 (permitting set-off with a claim that has become time-barred but was eligible for set-off before becoming time-barred).
  4. Claims Without a Specified Due Date: If an obligation does not have a specified due date, it is generally considered due and payable from the moment it arises. Such a claim can therefore be used as an active claim for set-off at any time by the creditor.
  5. Conditional Claims:
    • If the active claim is subject to a condition precedent (停止条件 - teishi jōken), it is not considered fully "existing" or "due" for the purpose of set-off until the condition is fulfilled (Article 127(1)). It cannot be used for set-off before then. (Insolvency law has specific provisions, such as Article 70 of the Bankruptcy Act, allowing for deposit in contemplation of future set-off with such claims).
    • If the active claim is subject to a condition subsequent (解除条件 - kaijo jōken), it is an existing and (if its maturity has passed) due claim until the condition occurs. Thus, it can be used for set-off before the condition subsequent materializes.
    • If the passive claim is subject to a condition, the party wishing to declare set-off (who is the debtor of this passive claim) can generally waive the benefit of that condition, if the condition is solely for their benefit, to create Sōsai Tekijō.

The "Present Existence" of "Sōsai Tekijō" ("Sōsai Tekijō no Genzon")

Beyond the initial establishment of Sōsai Tekijō, these conditions must generally continue to exist at the time the declaration of set-off is actually made for the set-off to be effective.

General Principle

If, after Sōsai Tekijō has arisen, one of the claims is extinguished by other means—such as payment, release, novation, or even prescription where prescription is validly invoked—before a declaration of set-off is made, the mutuality of opposing claims is lost. Consequently, set-off can no longer be effected. An old Taishō era Supreme Court of Judicature decision (February 17, 1915) supports this principle: if one debt is paid off, there's nothing left to set off against it.

Specific Scenarios Testing "Present Existence"

Several complex scenarios test this principle of "present existence":

  1. The So-called "Reverse Set-Off" (ぎゃくそうさい - Gyaku Sōsai) – One Application:
    Consider a situation: Party A has an active claim (α) against Party B, and Party B has an active claim (β) against Party A. Both claims are due, so Sōsai Tekijō exists between A and B. However, before A declares set-off, Party C (a creditor of B) attaches B's claim (β) against A and obtains an assignment order (転付命令 - tenpu meirei) from the court, which, upon becoming final, transfers claim β from B to C. Now, C demands payment of claim β from A. Can A still declare set-off, using its original claim (α) against B, to offset claim β which is now held by C?
    The prevailing view, supported by Supreme Court precedent (e.g., July 10, 1979), is generally no, if C perfects its rights and asserts them before A declares set-off. While Sōsai Tekijō existed between A and B, once claim β is validly transferred to C through the execution process and C asserts its rights (e.g., by demanding payment or, if applicable, by C itself initiating a set-off against A if C also owes A a debt), A typically cannot then declare set-off of its original claim α (which was against B) against claim β now held by C. The prior existence of Sōsai Tekijō between A and B does not automatically grant A's potential set-off priority over a completed execution measure like an assignment order in favor of C, unless A had already declared set-off before C's rights became perfected. The timing of the declaration of set-off versus the perfection of the third party's (C's) rights is critical.
  2. Set-Off After Contract Termination for Default ("Saimu Furikō Kaijo Go no Sōsai"):
    Suppose a lease contract between landlord B and tenant A is validly terminated by B due to A's non-payment of rent. If, before this termination, Sōsai Tekijō existed between A's claim against B (e.g., for return of a security deposit, assuming it became due) and B's claim against A for the overdue rent, can A, after the termination, declare set-off and thereby retroactively eliminate the rent default that was the basis for the termination?
    A Supreme Court decision of March 8, 1957, held that while the retroactive effect of set-off (Article 506(2)) applies to the debts themselves, it does not invalidate a contract termination that had already validly occurred before the set-off was declared. To allow a subsequent declaration of set-off to undo a prior, valid legal act like contract termination would create excessive legal instability.
    However, this doesn't mean the prior existence of Sōsai Tekijō is irrelevant. Legal scholars suggest that if landlord B terminated the lease knowing that tenant A had a valid offsetting claim and that Sōsai Tekijō existed, B's act of termination might be restricted by the principle of good faith. Alternatively, the existence of Sōsai Tekijō at the time of the alleged default might be considered a factor negating the "illegality" or severity of the tenant's non-payment, potentially preventing the landlord's right of termination from arising in the first place. Indeed, a Supreme Court case dated July 28, 1964, denied a landlord's termination where the tenant had a valid offsetting claim and there were reasonable circumstances for not having declared set-off earlier, finding that the relationship of trust had not yet been destroyed.
  3. Set-Off Using a Time-Barred Claim as the Active Claim (Article 508 – Exception to "Present Existence"):
    Article 508 of the Civil Code provides a crucial exception to the rule that both claims must be currently valid and enforceable at the time of the set-off declaration. It states: "A claim that has been extinguished by prescription may be used as an active claim (jidō saiken) for a set-off if it was suitable for set-off prior to its extinguishment by prescription."
    • Rationale: This provision is rooted in fairness and the clearing function of set-off. Once Sōsai Tekijō has arisen, the law regards the mutual debts as being in a state where they are economically netted. It would be inequitable to allow one party (the debtor of the active claim) to strategically wait for the active claim to become time-barred (by the statute of limitations), then invoke prescription as a defense to that claim, while still demanding full payment of their own claim (the passive claim) from the other party. Article 508 protects the legitimate expectation of set-off that arose when both claims were still "live" and eligible for mutual cancellation.
    • Conditions for Applying Article 508:
      1. The active claim must have become "extinguished by prescription." In modern Japanese law, this means the prescription period must have completed and the debtor of that active claim must have validly invoked (or "availed themselves of") prescription (時効の援用 - jikō no en'yō).
      2. Critically, Sōsai Tekijō (the state where both the active claim and the passive claim were mutually eligible for set-off – i.e., same kind, both due, etc.) must have existed at some point before the active claim was extinguished by prescription.
    • If Sōsai Tekijō Arose After Prescription: If Sōsai Tekijō only came into existence after the active claim had already become time-barred, Article 508 does not apply. The time-barred claim cannot be revived for set-off in such a case. The party whose claim was not yet time-barred has a legitimate interest in the extinguishment of the other (already prescribed) claim.
    • Scope of Set-Off under Article 508: When Article 508 applies, the set-off is effective up to the amount that was in Sōsai Tekijō before the active claim became prescribed. For example, if at the moment before prescription the active claim was ¥100 and the passive claim was ¥120 (both due), set-off can occur for ¥100. Any interest or default damages that might have accrued on the passive claim after the active claim became time-barred cannot be offset by the notionally revived active claim beyond its pre-prescription value in relation to the then-existing passive claim. A Supreme Court decision of February 20, 1964, supports this limitation.
    • Time-Barred Claim Acquired from a Third Party: Article 508 does not allow a party to use a time-barred active claim for set-off if they acquired that claim from a third party after it had already become time-barred. The protection is for a party who held the claim themselves when it was still valid and became eligible for set-off against their own debt.
    • Time-Barred Principal Debt and Guarantee Obligations: An old Taishō era judicial decision suggested that a creditor might be able to set off a guarantee obligation (as the passive claim) using a claim against the guarantor, even if the principal debt (which the guarantee secured) had become time-barred. However, this view is widely criticized by modern scholars. It overlooks the accessory nature of a guarantee (附従性 - fujūsei): if the principal debt is extinguished by prescription, the guarantee obligation should generally also be extinguished or at least become unenforceable. Allowing set-off in such a case could also unfairly prejudice the guarantor by preventing them from asserting the prescription of the principal debt and potentially undermining their right of reimbursement against the principal debtor (who could assert prescription against the guarantor). This older precedent is generally not considered authoritative today.

Conclusion

The establishment of "Sōsai Tekijō"—the state where mutual claims are ripe for set-off—is governed by a clear set of requirements under the Japanese Civil Code. These conditions, centering on the mutuality of claims between the same parties, homogeneity of their subject matter, and the maturity of both obligations, ensure that the powerful unilateral remedy of statutory set-off is exercised in appropriate circumstances. While these conditions generally must exist at the time the set-off is declared, Article 508 provides a vital exception for claims that have become time-barred, upholding the fairness and clearing function of set-off by protecting legitimate expectations that arose before prescription. For parties involved in transactions in Japan, a precise understanding of these prerequisites is fundamental to effectively utilizing set-off as a means of debt settlement or defending against an improperly asserted set-off.