What Happens if a Contract is Based on a Fundamental Mistake (Sakugo) in Japan?

Entering into a contract involves a meeting of minds, where parties agree on a set of terms with a shared understanding of the underlying facts and circumstances. But what happens when one or both parties are operating under a fundamental misapprehension? In Japanese law, the doctrine of "Sakugo" (錯誤), or mistake, addresses situations where a contract is formed based on such errors, potentially allowing the mistaken party to undo the transaction. The rules surrounding Sakugo were significantly reformed in the 2020 amendments to the Japanese Civil Code (Minpō), shifting from a concept of "voidness" to "rescission" and clarifying the types of mistakes that qualify for relief.

Understanding "Sakugo" (Mistake) in the Japanese Civil Code

Sakugo generally refers to a situation where there is a discrepancy between a party's internal intention or assumption and their external declaration of intent, or a mistake concerning a circumstance that formed an essential basis of the juristic act (which includes contracts). Under the pre-2020 Civil Code, a contract based on a mistake in an "essential element" was considered void. The revised Civil Code, in Article 95, has changed this: now, a party who has made a declaration of intent based on a qualifying mistake can generally rescind (torikeshi - 取消し) that declaration of intent. Rescission renders the contract ineffective from the outset, requiring parties to restore each other to their pre-contractual positions.

Types of Mistake Qualifying for Rescission under Revised Article 95

The revised Article 95, paragraph 1, outlines two main categories of mistake that can lead to rescission:

1. Mistake in Declaration of Intent (意思表示に対応する意思を欠く錯誤 - Ishi-hyōji ni taiō suru ishi o kaku sakugo - Art. 95(1)(i)):
   This covers situations where the outward expression of intent does not match the party's actual inner will. This is often referred to as a "mistake in expression" (hyōji no sakugo - 表示の錯誤). Classic examples include:
   • Writing "100 apples" in an order form when the intention was "10 apples."
   • Orally stating a price of ¥10,000 when the intended price was ¥1,000 due to a slip of the tongue.
     The core issue here is a mismatch between the intended declaration and the actual declaration made.
2. Mistake Regarding Circumstances Forming the Basis of the Juristic Act (表意者が法律行為の基礎とした事情についてのその認識が真実に反する錯誤 - Hyōji-sha ga hōritsu-kōi no kiso to shita jijō ni tsuite no sono ninshiki ga shinjitsu ni hansuru sakugo - Art. 95(1)(ii)):
   This category is more complex and often relates to what was traditionally known as "mistake in motive" (dōki no sakugo - 動機の錯誤), but the new law provides a more structured approach. It applies when a party's understanding of a circumstance that formed the basis of their decision to enter into the contract turns out to be false. For this type of mistake to be actionable, two further conditions related to the circumstance are crucial:
   • The circumstance must have been a basis of the juristic act: The mistaken understanding about the circumstance must have been a fundamental reason why the party entered into the contract.
   • The circumstance must have been indicated (explicitly or implicitly) to the other party as forming such a basis: The mistaken party must have, in some way, communicated to the other party that this particular circumstance was foundational to their decision. An explicit statement is clearest, but an implicit indication can suffice if it's objectively recognizable from the nature of the transaction, prior negotiations, or other surrounding facts that both parties understood (or should have understood) this circumstance as an essential prerequisite for the deal. For example, buying land specifically for building a factory, where this purpose was made known to the seller, and then discovering the land is zoned strictly for residential use.

The Crucial Element: Materiality of the Mistake

Regardless of the type of mistake, for a party to rescind their declaration of intent under Article 95, paragraph 1, the mistake must be "material" or "essential" in light of the purpose of the juristic act and common sense in transactions (法律行為の目的及び取引上の社会通念に照らして重要なものであるとき - hōritsu kōi no mokuteki oyobi torihiki-jō no shakai tsūnen ni terashite jūyō na mono de aru toki).

This materiality standard generally means two things:

1. Subjective Materiality: The mistaken party would not have made that declaration of intent had they known the truth.
2. Objective Materiality: A reasonable person in the same circumstances would also not have made that declaration of intent (or would consider the mistake significant in the context of such a transaction).

This ensures that only significant mistakes that genuinely affect the core of the decision-making process can lead to the unwinding of a contract. Trivial errors or misjudgments that do not meet this threshold will not qualify.

When Rescission is Barred: Limitations on the Right

The right to rescind for mistake is not absolute. Article 95, paragraph 3, introduces a significant limitation:

Gross Negligence of the Mistaken Party (重過失 - Jūkashitsu):
A party generally cannot rescind their declaration of intent if the mistake was due to their own "gross negligence" (jūdai na kashitsu - 重大な過失). Simple negligence is not enough to bar rescission; the negligence must be of a severe degree, indicating a marked departure from the care expected of a reasonable person in managing their affairs.

However, there are two important exceptions to this gross negligence bar (Article 95, paragraph 3, items (i) and (ii)):

1. The other party was aware of (or grossly negligent in not being aware of) the mistaken party's error: If the counterparty knew the first party was mistaken, or was grossly negligent in failing to realize the mistake, the mistaken party can still rescind even if they were also grossly negligent. This prevents a party from knowingly taking advantage of another's serious blunder.
2. The other party caused the same mistake: If the counterparty shared the same mistaken understanding or was responsible for inducing the mistake in the first party, the mistaken party's gross negligence will not prevent rescission.

Risk Allocation by Contract or by Law:
The doctrine of mistake operates as a default set of rules. Parties can, through their contract, explicitly or implicitly allocate the risk of certain types of mistakes. If a contract effectively places the risk of a particular error on the party who later claims mistake, the right to rescind under Article 95 may be precluded.

• Representations and Warranties (表明保証 - Hyōmei Hoshō): As discussed in some Japanese legal commentaries, if a party provides a representation and warranty as to a particular fact, they are essentially guaranteeing its truthfulness and assuming the risk that it might be incorrect. In such cases, that party generally cannot later rescind the contract (or the representation/warranty itself) by claiming they were mistaken about that fact. The very purpose of the representation and warranty is often to allocate this risk. One legal text notes that if an agreement on representations and warranties is made, both parties intend to handle discrepancies according to that clause, so nullifying the R&W agreement due to a factual misapprehension regarding the warranted matters is generally not permissible.
• Initial Impossibility (原始的不能 - Genshi-teki Funō): Under the revised Civil Code (Article 412-2, paragraph 2), a contract is not necessarily ineffective merely because performance was impossible at the time of contracting. If such a contract is deemed valid (meaning the parties, in essence, contracted around the risk of initial impossibility or the law otherwise upholds it), a party generally cannot then rescind for mistake regarding the possibility of performance. The contract itself has, in such scenarios, dealt with or allocated the risk associated with that initial state of affairs.

The Aftermath: Effects of Rescission (取消しの効果 - Torikeshi no Kōka)

When a declaration of intent is validly rescinded for mistake, the primary effect is that the juristic act (e.g., the contract) is treated as having been void ab initio – ineffective from the very beginning (Article 121).

This leads to:

• No Enforceable Obligations: Neither party can demand performance under the rescinded contract.
• Restitution (現状回復 - Genjō Kaifuku): If any performance has already occurred (e.g., payment made, goods delivered), each party has a duty to restore the other party to the position they were in before the contract was concluded (Article 121-2). This typically involves the return of benefits received.

Protecting Innocent Third Parties

The ability to rescind for mistake can create uncertainty, especially for third parties who may have relied on the apparent validity of the contract. Article 95, paragraph 4, provides crucial protection for such individuals: "The rescission of a declaration of intent under the provisions of paragraph 1 may not be asserted against a third party who has acted in good faith and without negligence."

This means if, for example, Party A sells an item to Party B under a mistaken contract, and Party B then sells that item to Party C (who is unaware of the mistake and not negligent in being unaware), Party A cannot later rescind the contract with Party B in a way that prejudices Party C's acquired rights to the item. The third party's reliance is protected if they are bona fide and non-negligent.

Interplay with Other Doctrines Affecting Consent

The doctrine of Sakugo is one of several legal concepts in Japanese law that deal with defects in consent that can lead to rescission. Others include:

• Fraud (詐欺 - Sagi - Article 96, paragraph 1): If a party is induced to enter into a contract by the fraudulent misrepresentation of the other party or a third party.
• Duress (強迫 - Kyōhaku - Article 96, paragraph 1): If a party is coerced into a contract through threats or unlawful pressure.

While these doctrines all lead to the possibility of rescission, their specific requirements differ. For instance, fraud and duress involve wrongful conduct by the other party (or a third party in certain cases), whereas Sakugo can arise even without any wrongdoing by the counterparty, focusing instead on the mistaken party's internal state of mind and the materiality of that mistake.

Practical Implications for Businesses

For businesses, particularly those engaged in cross-border transactions with Japanese counterparts, understanding the doctrine of Sakugo is important for several reasons:

1. Due Diligence: Thorough due diligence before entering into significant contracts can help identify and clarify potential misunderstandings about key facts or circumstances that could later form the basis of a mistake claim.
2. Clarity in Drafting: Clear and unambiguous contractual language is essential. If certain assumptions or circumstances are fundamental to the deal, it may be prudent to state them explicitly in the contract to manage how the rules on mistake (particularly mistake as to the basis of the transaction) might apply.
3. Risk Allocation: Consider how risks related to underlying assumptions are allocated. Well-drafted representation and warranty clauses, for example, can clarify which party bears the risk if certain facts turn out to be untrue, potentially precluding a subsequent mistake claim regarding those facts.
4. Responding to Mistake Claims: If a counterparty claims mistake, it's important to assess whether the legal requirements for rescission under Article 95 are met, including materiality and the absence of (or exceptions to) gross negligence on the part of the mistaken party.
5. New Law Considerations: Parties should be aware that the revised Civil Code has made rescission the primary remedy for mistake, replacing the old concept of voidness, and has refined the criteria for actionable mistakes, especially regarding mistakes in motive or underlying assumptions.

Conclusion: Balancing Protection with Contractual Stability

The Japanese Civil Code's doctrine of Sakugo (mistake) aims to strike a balance. On one hand, it provides a mechanism for a party to escape the consequences of a contract entered into under a fundamental misapprehension that significantly impacts their decision. On the other hand, through requirements like materiality and the limitation related to gross negligence, it seeks to uphold contractual certainty and prevent parties from easily evading their obligations due to minor errors or careless assumptions. The 2020 revisions have further clarified these rules, particularly regarding mistakes about the basis of a transaction and the shift to rescission as the standard remedy. For businesses operating under Japanese contract law, a careful approach to understanding and documenting the foundational elements of their agreements remains key to mitigating the risks associated with potential mistakes.