When Can You Terminate a Contract in Japan? Key Changes Under the Civil Code Reform

The right to terminate a contract (契約の解除 - keiyaku no kaijo) is a critical remedy when one party fails to uphold its end of a bargain. It allows the non-breaching party to extricate itself from the contractual relationship and seek other arrangements. Japan's comprehensive Civil Code reform, effective April 1, 2020, significantly reshaped the rules governing contract termination due to non-performance (債務不履行 - saimu furikō), introducing changes aimed at enhancing clarity, aligning with practical commercial needs, and, in some key respects, altering the fundamental prerequisites for exercising this right.

The Foundational Shift: Fault No Longer a General Prerequisite for Termination

Perhaps the most impactful change concerning contract termination is that the fault or attributability (帰責事由 - kisaku jiyū) of the defaulting party is no longer a general requirement for the aggrieved party to terminate the contract due to non-performance.

Under the old Civil Code, while subject to some academic debate, a prevailing interpretation and the implication of former Article 543 was that the party seeking termination generally needed to demonstrate that the non-performance was due to a cause attributable to the defaulting party (often understood as their intention or negligence).

The reformed Code has decisively moved away from this. The primary rationale is that the core purpose of termination is not to penalize the breaching party but to liberate the non-breaching party from their ongoing contractual obligations when the fundamental basis of the contract is undermined by non-performance. If the aggrieved party cannot achieve the main purpose of the contract due to the other party's failure to perform, they should generally be entitled to terminate the relationship, irrespective of why the default occurred (unless the breach is trivial or caused by the terminating party themselves).

It is crucial, however, to distinguish this from claims for damages. While fault is generally not a prerequisite for termination, it remains a general requirement if the aggrieved party also wishes to claim damages arising from the non-performance (as per the general rule in Reformed Civil Code, Article 415).

Termination with Prior Demand (催告解除 - Saikoku Kaijo)

The primary method for terminating a contract due to non-performance remains "termination with prior demand" (Reformed Civil Code, Article 541). The process is as follows:

1. Non-Performance: One party (the obligor) fails to perform its contractual obligation.
2. Demand (催告 - Saikoku): The other party (the obligee or aggrieved party) sets a "reasonable period" (相当の期間 - sōtō no kikan) and demands that the obligor perform the obligation within that period.
3. Failure to Perform within the Period: If the obligor does not perform within the specified reasonable period, the aggrieved party then acquires the right to terminate the contract.

A New Key Limitation: "Trivial" Non-Performance

A significant new constraint on this right is codified in the proviso to Article 541. Even if performance is not rendered after a proper demand and the lapse of a reasonable period, the aggrieved party cannot terminate the contract if the non-performance is "trivial" (軽微 - keibi) when assessed in light of the contract and common commercial practice (契約及び取引上の社会通念に照らして - keiyaku oyobi torihikijō no shakai tsūnen ni terashite).

The burden of proving that the non-performance is "trivial" rests on the defaulting party who is resisting termination. The Code does not define "trivial," meaning its interpretation will develop through case law. Factors likely to be considered include:

• The nature of the unperformed obligation (e.g., a primary obligation vs. an ancillary one).
• The quantitative extent of the non-performance (e.g., a minor shortfall in a large delivery vs. a substantial failure).
• The impact of the non-performance on the aggrieved party's ability to achieve the overall purpose of the contract.
• The possibility and ease of remedying the non-performance through other means (e.g., damages or price reduction).
• General commercial reasonableness and expectations in the specific type of transaction.

For example, if a contract requires the delivery of a complex model kit in 12 monthly installments, and 11 parts are delivered perfectly but one minor, easily replaceable accessory part is missing or slightly flawed, this might be considered trivial if it doesn't fundamentally prevent the assembly or enjoyment of the main product and can be easily rectified. Conversely, if a critical, unique component is missing, rendering the entire kit unusable, the non-performance would likely not be deemed trivial.

Termination without Prior Demand (無催告解除 - Mu-saikoku Kaijo)

The reformed Civil Code (Article 542) also consolidates and clarifies the circumstances under which an aggrieved party can terminate a contract without first making a demand for performance. This largely codifies principles that were previously recognized through judicial precedent and academic interpretation. Termination without demand is permissible in the following situations:

1. Performance is Wholly Impossible (全部の履行が不能): If it is objectively impossible for the obligor to perform the entire obligation (e.g., the unique subject matter of the contract has been destroyed).
2. Clear Refusal to Perform by the Obligor (履行を拒絶する意思を明確に表示): If the obligor unequivocally and definitively expresses their intention not to perform their main contractual obligations. This effectively recognizes a form of anticipatory breach. What constitutes a "clear manifestation" will be subject to factual determination.
3. Partial Impossibility or Partial Refusal Frustrating Contractual Purpose: If a part of the performance is impossible, or if the obligor clearly refuses to perform a part of their main obligation, and as a result, the aggrieved party cannot achieve the purpose of the contract. For instance, if a seller can only deliver some components of a machine, and the missing components render the entire machine unusable for its intended contractual purpose.
4. Failure to Perform a "Fixed-Time Act" (定期行為の不履行 - Teiki Kōi no Furikō): If performance by a specific agreed-upon time or within a specific period is an essential element of the contract (due to the nature of the contract or an explicit declaration by the parties, such as goods for a wedding or a specific dated event), and that time or period passes without performance.
5. Demand Would Be Futile: In addition to the specific grounds above, termination without demand is also allowed if, considering the circumstances, it is clear that the aggrieved party cannot achieve the purpose of the contract even if they were to make a demand for performance (i.e., the demand would be a pointless formality).

Limitation on Termination: Non-Performance Attributable to the Aggrieved Party

A crucial balancing provision is found in the new Article 543. This article states that the aggrieved party cannot terminate the contract (whether with or without prior demand) if the non-performance of the obligation is primarily due to a cause attributable to the aggrieved party itself (債権者の責めに帰すべき事由 - saikensha no seme ni kisu beki jiyū). This common-sense rule prevents a party from leveraging their own fault to escape contractual obligations.

Effects of Termination (解除の効果)

The legal consequences of a valid contract termination are detailed in Article 545 of the Reformed Civil Code:

• Duty of Restoration to Original State (現状回復義務 - Genjō Kaifuku Gimu): Upon termination, each party is obliged to take steps to restore the other party to the state they were in before the contract was concluded (Article 545, Paragraph 1). This primarily involves returning any money or property that has been exchanged.
• Return of Money with Interest: If money is to be returned, it must be returned with interest calculated from the date it was received (Article 545, Paragraph 2).
• Return of Property and Fruits: If property other than money is to be returned, any "fruits" (収取した果実 - shūshu shita kajitsu) derived from that property after its receipt must also be returned (Article 545, Paragraph 3). "Fruits" can include natural fruits (e.g., produce from land) or legal fruits (e.g., rental income received from a leased property that is now being returned). This paragraph clarifies an aspect that was less explicit under the old law.
• Claims for Damages Not Precluded: Importantly, the termination of a contract does not prevent the aggrieved party from also claiming damages suffered as a result of the non-performance (Article 545, Paragraph 4). However, as noted earlier, a claim for damages generally still requires that the non-performance was attributable to the defaulting party.

Interaction with Risk of Loss Rules (危険負担)

The reforms concerning contract termination align with the simultaneous revisions to the rules on "risk of loss" (kiken futan). The old, often criticized, rule that the buyer (creditor) bore the risk of accidental loss for specific goods before delivery has been abolished. Under the new framework (Article 536), if performance of an obligation becomes impossible due to a cause not attributable to either party, the party whose obligation has become impossible cannot demand counter-performance (e.g., a seller whose goods are destroyed accidentally before delivery cannot demand the price). The other party can refuse their own performance and can also terminate the contract under Article 542 (termination without demand due to impossibility) to definitively extinguish all mutual obligations.

Practical Implications for Contract Drafting and Management

The revised termination rules have several practical implications for businesses:

• No-Fault Termination as Default: The most significant change is that fault is no longer a statutory prerequisite for termination due to non-performance. If parties wish to make termination conditional on the defaulting party's fault, they would need to explicitly state this in their contract (though this would make termination harder for the aggrieved party).
• Defining "Trivial" Non-Performance: Given the new statutory limitation preventing termination for "trivial" breaches, contracts should ideally provide clarity on what constitutes a material breach versus a minor one for that specific agreement. This can be achieved by:
  • Clearly identifying essential obligations.
  • Specifying objective criteria or thresholds for performance.
  • Listing specific events of default that are agreed to be non-trivial.
• Tailoring Grounds for Termination: While the Code provides statutory grounds, parties are free to define additional or more specific grounds for termination in their contract, including events of default that might not necessarily meet the statutory thresholds for impossibility or clear refusal but are commercially significant for the parties.
• Demand Procedures: If relying on termination after demand, ensure the demand notice is clear, specifies the breach, sets a genuinely "reasonable period" for cure (what is reasonable can vary greatly depending on the context), and is properly delivered and documented.
• Evidence for No-Demand Termination: When seeking to terminate without prior demand, robust evidence supporting the chosen ground (e.g., written communications unequivocally refusing performance, independent verification of impossibility) will be essential.
• Reviewing "Boilerplate" Clauses: Standard termination clauses in existing contract templates should be reviewed. For instance, a broad clause allowing termination for "any breach" might still be challenged under the "triviality" principle unless drafted very carefully to reflect the parties' specific understanding of materiality.
• Awareness of Counterparty's Fault: Remember that if the non-performance is primarily due to the terminating party's own actions or omissions, the right to terminate is lost under Article 543.

Conclusion

The reformed rules on contract termination in Japan represent a significant modernization, bringing greater clarity and often a more commercially pragmatic approach. The removal of fault as a general prerequisite for termination due to non-performance aligns with the idea that termination is primarily a tool for releasing a party from a failed bargain. However, the introduction of the "trivial non-performance" limitation and the detailed codification of grounds for termination without demand require careful consideration by businesses. Ultimately, while the statutory framework provides a new default, well-drafted, situation-specific termination clauses that clearly delineate the parties' expectations and rights upon breach remain a cornerstone of effective contract management in Japan.