When is Set-Off ("Sōsai") Prohibited Under Japanese Law?

Set-off, or "Sōsai" (相殺), as we've discussed, is a potent and practical tool in Japanese law for extinguishing mutual obligations. It allows parties to net their debts, simplifying settlements and often providing a de facto form of security. However, this right is not absolute. The Japanese Civil Code (Minpō - 民法) and other statutes delineate several important circumstances where the ability to effect a set-off is restricted or entirely prohibited. These prohibitions are generally designed to protect specific overriding interests, such as the well-being of individuals, the integrity of certain legal relationships, or fundamental public policies.

1. Explicit Statutory Prohibitions ("Hōritsu-jō no Sōsai Kinshi")

Certain Japanese statutes explicitly forbid set-off in particular contexts to achieve specific policy objectives. These are direct legislative mandates that override the general availability of set-off. Examples include:

• Labor Standards Act (労働基準法 - Rōdō Kijun Hō), Article 17: This provision prohibits employers from setting off an employee's wage claim against any monetary claim the employer might have against the employee arising from an advance payment made on the condition of future labor (e.g., a loan to be repaid by working). This is to protect the employee's right to receive their wages in full and prevent coercive labor practices.
• Partnerships (Kumiai - 組合) under the Civil Code (Old Interpretations relevant to Article 677 context): While the new Civil Code's Article 677 focuses on preventing creditors of individual partners from directly executing against partnership property, the underlying principle from older interpretations (relevant to the spirit of maintaining partnership distinctness) was that a debtor owing an obligation to a partnership could not typically set off that debt using a claim they held against an individual partner of that partnership. This maintains the distinction between the partnership as an entity (or collective) and its individual members.
• Trust Act (信託法 - Shintaku Hō), Article 22: This article contains specific rules restricting set-off when trust property is involved. For instance, a third party who owes a debt that forms part of the trust property generally cannot set off that debt using a personal claim they have against the trustee in the trustee's individual capacity. Conversely, a third party cannot set off a debt owed by the trust property using a claim the trustee personally owes to them. These rules are crucial for maintaining the segregation and integrity of trust assets, protecting them from the trustee's personal creditors and vice-versa.
• Companies Act (会社法 - Kaisha Hō), Article 208(3): This provision prohibits a person who is obligated to pay for shares upon their issuance (i.e., a subscriber) from setting off this payment obligation against any claim they might have against the company. The purpose is to ensure the actual contribution of capital to the company, which is fundamental for its financial soundness and the protection of its creditors.

These examples illustrate how specific legislative policies can limit the general right of set-off.

2. Prohibition Due to the Nature of the Claim ("Seishitsu-jō no Sōsai Kinshi")

Article 505, paragraph 1 of the Civil Code, after establishing the general conditions for set-off, contains an important proviso: "...this shall not apply if the nature of such obligation does not permit a set-off." This "prohibition by nature" is a more general category that requires interpretation based on the inherent characteristics and purpose of the claims involved. The drafting history of the Meiji Civil Code did not extensively detail this concept, but its understanding has been shaped over time, partly influenced by comparative legal theories (notably German jurisprudence).

A. Active Claim Subject to a Defense ("Jidō Saiken ni Kōbenken ga Fuchaku Shiteiru Baai")

A primary instance where the "nature of the claim" prohibits set-off is when the active claim (the jidō saiken - 自動債権, i.e., the claim held by the party wishing to declare set-off) is itself subject to a valid defense that its obligor (the other party to the set-off) could assert if sued upon it directly.

• Rationale: Allowing set-off with such an encumbered active claim would effectively permit the party declaring set-off to unilaterally bypass or nullify the legitimate defense that the other party possesses against that very claim. This would be unfair and undermine the purpose of such defenses.
• Examples of Defenses on the Active Claim that Preclude Set-Off:
  • Defense of Simultaneous Performance (同時履行の抗弁権 - dōji rikō no kōbenken, Article 533): If Party A's claim against Party B is linked to a counter-performance owed by A to B, A generally cannot use this claim for set-off without performing or tendering their own counter-performance.
  • Guarantor's Defenses: A guarantor, when sued by the creditor, has certain defenses such as the "defense of demand" (催告の抗弁権 - saikoku no kōbenken, Article 452, obliging the creditor to first demand performance from the principal debtor) and the "defense of search" (検索の抗弁権 - kensaku no kōbenken, Article 453, obliging the creditor to first execute against the principal debtor's assets if the debtor proves they have means and execution is easy). A creditor generally cannot use their claim against a guarantor as an active claim for set-off if these defenses are available to the guarantor and have not been exhausted or waived.
  • Principal Debtor's Defenses Against Guarantor's Preliminary Reimbursement Claim: Under Article 461, if a guarantor exercises a right of preliminary reimbursement against the principal debtor before actually paying the creditor, the principal debtor has certain defenses, such as demanding the guarantor provide security. The guarantor cannot use such a defeasible preliminary reimbursement claim as an active claim for set-off.
• Exception – No Prejudice to the Defense: If the set-off can be effected in a way that does not prejudice the purpose of the defense attached to the active claim, it might be permissible. For example, in construction contracts, if a customer has a claim for damages due to defects (which is in a relationship of simultaneous performance with their obligation to pay the contract price), case law (e.g., Supreme Court, March 4, 1976; Supreme Court, September 21, 1978) generally allows the customer to set off their damages claim against the contractor's claim for the price. This is because the customer is effectively "paying" the damages by reducing the price owed. However, the contractor is typically not allowed to set off their claim for the price against the customer's claim for damages if doing so would defeat the customer's right to withhold payment until the defects are rectified or compensated (i.e., their defense of simultaneous performance).
• Passive Claim Subject to a Defense: It's important to note that if the passive claim (the debt owed by the person declaring set-off) is subject to a defense, this does not prevent that person from waiving their own defense and using their (unencumbered) active claim to set off their (defensible) passive debt.

B. Set-Off Between Monetary Claims: When Does "Nature" Still Prohibit?

Generally, when both the active and passive claims are for the payment of money, they are considered homogeneous and prima facie suitable for set-off. However, even with monetary claims, the specific origin, purpose, or legal context of one of the claims can sometimes render set-off contrary to its "nature."

A notable example cited in Japanese legal discussions is a Tokyo High Court decision of October 15, 1997. In this case, a condominium unit owner attempted to set off their claim against the condominium management association (for reimbursement of expenses they personally incurred for common area maintenance, potentially a claim based on officious management of affairs) against their obligation to pay regular management fees owed to the association. The court disallowed the set-off. Its reasoning was that condominium management fees are funds collectively contributed by all unit owners for the planned, continuous, and essential maintenance of the building and its common areas. Allowing individual owners to unilaterally withhold these fees through set-off based on their individual claims against the association would disrupt this vital collective funding system, potentially impairing necessary maintenance and harming all owners, including the one attempting the set-off. The court found such a set-off to be incompatible with the owner's status as a member of the management association and the collective nature of the fee obligation. This case illustrates that even for monetary claims, the broader purpose and systemic implications can lead to a prohibition of set-off based on the "nature" of the obligation.

C. Financial Institution Bonds or Corporate Bonds as Passive Claims

Can the issuer of financial bonds (e.g., bank debentures) or corporate bonds set off a claim it holds against a bondholder (e.g., a loan made to that bondholder) against its obligation to redeem the bond when it matures (i.e., using the bond redemption obligation as the passive claim)?
Supreme Court precedents (e.g., December 18, 2001, concerning bearer bonds, and February 21, 2003, concerning registered bonds) have affirmed that such set-offs by the issuing institution are generally permissible. The Court found no inherent characteristic in these types of bonds—such as their mass issuance, public trading, or character as investment securities—that would, by their nature, prohibit their use as passive claims in a set-off by the issuer against a claim it holds against the bondholder, provided the general conditions for set-off are otherwise met. The legitimate expectation of the issuing institution to be able to set off mutual debts with a bondholder was recognized.

3. Prohibition by Declaration of Intention (Agreement) – Article 505(2)

Parties to a contract are free to agree that the claims arising from their relationship shall not be subject to set-off. Such an agreement, often called a "no set-off agreement" or "sōsai seigen tokuyaku" (相殺制限特約 – agreement restricting set-off), is generally valid and binding between the contracting parties due to the principle of freedom of contract.

However, the effect of such an agreement on third parties is limited. Article 505, paragraph 2 of the Civil Code stipulates: "The manifestation of intention [to prohibit or restrict set-off] ... may not be asserted against a third party if the third party did not know of such intention or was not grossly negligent in not knowing of such intention."

This means:

• If a claim subject to a no set-off agreement is assigned, the assignee who was unaware of the agreement and not grossly negligent in failing to discover it is not bound by that agreement. They can still set off a claim they acquire against the original creditor using the assigned claim (now their active claim) against a debt they owe to that original creditor (their passive claim), or they can be subject to set-off by the debtor of the assigned claim if that debtor was unaware of the restriction.
• The new Civil Code changed the standard for the third party from simple "good faith" (善意 - zen'i) under the old law to "not knowing and not being grossly negligent in not knowing." This aligns the rule more closely with similar provisions concerning the effect of assignment restriction agreements on third parties.
• The burden of proving that the third party knew of the no set-off agreement or was grossly negligent in not knowing it lies with the party who wishes to enforce the no set-off agreement against that third party.

4. Passive Claim Arising from Tort or Breach of Obligation (Article 509)

Article 509 of the Civil Code places significant restrictions on the ability of a party who has incurred a liability for damages (the passive claim) due to their own wrongful act (a tort or certain types of breach of obligation) to use a claim they happen to hold against the victim (the active claim) to set off this liability.

Rationale for Prohibition

The primary policy reasons for this prohibition are:

1. Deterrence of Wrongful Acts: To prevent a situation where a person might be tempted to commit a tort or a malicious breach of contract against someone they owe money to (or who owes them money), with the intention of using their pre-existing claim to effectively "pay off" the resulting damage liability via set-off. It discourages self-help through wrongful means.
2. Ensuring Actual Compensation for Victims: To ensure that victims of certain wrongful acts, particularly those involving personal harm or malicious conduct, receive actual, tangible compensation for their injuries or losses, rather than having their right to damages effectively nullified by an offsetting claim held by the wrongdoer.

Specific Prohibited Cases under the (New) Article 509

The recently revised Civil Code has refined the scope of this prohibition. Under the new Article 509, set-off by the obligor (wrongdoer) is prohibited if their obligation (the passive claim):

• No. 1: Is for damages arising from a tort committed by that obligor with "malicious intent" (悪意 - akui) to cause harm to the obligee (victim).
  • The term "akui" (malicious intent) in this context is generally interpreted to mean more than simple intent (koi - 故意) to commit the act; it implies a positive desire, ill will, or intention to inflict harm on the victim (害意 - gai-i). This interpretation aligns with similar terminology used for non-dischargeable debts in bankruptcy law (e.g., Bankruptcy Act, Article 253(1)(ii)). During the legislative drafting process for the new Civil Code, it was clarified that "akui" was intended to capture this sense of "intent to cause harm," distinguishing it from the broader meaning of "knowledge" that "akui" can have in other legal contexts.
  • While the text of Article 509(1) specifically mentions torts, it's argued by legal scholars that a similar prohibition should apply by analogy if the passive claim is for damages arising from a breach of contract committed with the same "malicious intent" to harm the other party, especially if the breach is so egregious as to be akin to a tort.
• No. 2: Is for damages arising from an infringement of human life or body.
  • This prohibition applies whether the infringement of life or body resulted from a tort or from a breach of a contractual duty (e.g., a breach of a safety obligation under an employment or service contract leading to personal injury).
  • This rule underscores the high value Japanese law places on protecting personal integrity and ensuring that victims of such harm (or their survivors) receive actual monetary compensation, which should not be diluted by set-off.

It's crucial to note that these prohibitions apply when the wrongdoer (the tortfeasor or the party committing the malicious/harmful breach) attempts to use their own claim as the active claim to set off their liability for damages (which is the passive claim). The victim (the creditor of the damage claim) is not prohibited by Article 509 from using their damage claim as an active claim to set off a pre-existing, unrelated debt they might owe to the wrongdoer (Supreme Court, November 30, 1967).

Intersecting Torts ("Kōsateki Fuhō Kōi" - 交叉的不法行為)

A complex situation arises with "intersecting torts," where two parties commit torts against each other in the same incident (e.g., a traffic accident where both drivers are contributorily negligent and both suffer damage). Can they set off their mutual claims for damages?

• Older Supreme Court decisions (e.g., April 30, 1957; June 28, 1974) generally held that the former Article 509 (which had a broader wording for tort-based claims) applied even in such cases, prohibiting set-off by either party. The rationale was often rooted in ensuring actual compensation for all tort victims.
• This has been a point of significant academic criticism. Many scholars argued that in cases of truly intersecting torts arising from a single event, the policy concern about "inducing torts to collect debts" is absent. Furthermore, prohibiting set-off could lead to unfairness if one party is insolvent, as the solvent party would have to pay in full but might not be able to recover their own claim.
• More recent scholarly discourse, particularly considering the prevalence of liability insurance in contexts like traffic accidents, sometimes supports the prohibition of set-off in insured scenarios. The reasoning is that it allows both parties to claim fully from the respective insurers, aligning with the goal of ensuring actual and complete compensation for the physical damages and injuries sustained. The new Article 509(2), with its focus on claims for infringement of life or body, might directly address the personal injury aspects of many such cases, reinforcing the push for actual payment for such harms.

Exception to Prohibition (Art. 509, proviso)

The prohibitions against set-off listed in Article 509 (both No. 1 and No. 2) do not apply if the passive claim (the claim for damages arising from the tort or breach) was acquired by the obligee (the victim) from a third party by way of assignment. If the victim has already assigned their damage claim, the direct victim-wrongdoer relationship is altered, and the specific policy reasons for ensuring direct payment to the original victim or deterring targeted wrongdoing against that specific victim are considered less compelling in the context of set-off against the assignee.

5. Passive Claim Exempt from Attachment ("Sashiosae Kinshi Saiken") (Art. 510)

Certain types of claims are designated by law as exempt from attachment or seizure (差し押え禁止債権 - sashiosae kinshi saiken) by creditors in execution proceedings. This exemption is typically granted to claims that are essential for the recipient's livelihood and basic sustenance. Examples include:

• A significant portion of wage claims (Labor Standards Act, Article 24 implies direct payment; Civil Execution Act, Article 152 details attachable portions).
• Public pensions and certain social welfare benefits (e.g., Livelihood Protection Act - 生活保護法 - Seikatsu Hogo Hō, Article 58; various pension acts).
• Certain workers' compensation benefits (e.g., Labor Standards Act, Article 83(2)).

Rationale for Set-Off Prohibition

The policy behind making these claims exempt from attachment is to ensure that the individual recipient actually receives these funds to meet their basic living needs. Allowing a debtor of such a claim (e.g., an employer owing wages, or the government owing pension benefits) to set off their own unrelated claim against the beneficiary using this exempt claim as the passive claim would effectively circumvent the purpose of the attachment exemption.

Prohibition under Article 510

Accordingly, Article 510 of the Civil Code prohibits the debtor of an attachment-exempt claim from using a claim they hold against the creditor of that exempt claim as an active claim to set off the exempt claim (which would be the passive claim). The beneficiary must receive these vital funds in actuality.

• Creditor Can Still Set Off: This prohibition is one-sided. The creditor of the attachment-exempt claim (e.g., the employee owed wages) is not prohibited by Article 510 from using that exempt claim as an active claim to set off a debt they might owe to the other party (e.g., a debt to their employer for goods purchased from the company store, subject to other labor law restrictions on wage deductions).
• Transformation of Exempt Claim into General Assets: A complex issue arises when funds from an attachment-exempt claim (e.g., a pension payment) are deposited into a general bank account. Does the deposit account balance retain the attachment-exempt character of its source? Generally, the prevailing view, supported by a Supreme Court decision of February 10, 1998, is that once such funds are deposited and commingled with other funds in a general deposit account, they lose their specific identity as an "exempt claim" and become part of an ordinary deposit claim (a claim against the bank). This ordinary deposit claim is typically not considered to automatically inherit the attachment-exempt status. Consequently, the bank (as debtor of the deposit claim) could generally set off its own claim against the depositor using this deposit as the passive claim.
  • However, if a bank account is demonstrably used exclusively for receiving such exempt funds and is clearly identifiable as such (e.g., a dedicated pension deposit account), or if a financial institution appears to be opportunistically waiting for exempt funds to be deposited merely to effect a set-off, such actions by the bank might be challenged as an abuse of right (権利の濫用 - kenri no ran'yō) or contrary to good faith, given the protective purpose of the exemption.

6. Claim Lacking Enforceability ("Kyōseiryoku o Kaku Saiken") as Active Claim

While not detailed extensively in the provided PDF snippets beyond a section title (page 295), Japanese law generally prohibits the use of a "claim lacking enforceability" (強制力を欠く債権 - kyōseiryoku o kaku saiken) as an active claim for set-off. This typically refers to what are sometimes known as "natural obligations" – claims that may have a moral or social basis but cannot be enforced through court action (e.g., debts arising from illegal gambling, or debts that are time-barred where prescription has been successfully invoked not just for the claim itself but also for the right to use it in set-off under Art. 508, or other claims deemed unenforceable by specific statutes or public policy). Allowing set-off with such an unenforceable active claim would effectively grant it a form of indirect enforcement, which would be contradictory to its nature.

Conclusion

While set-off ("Sōsai") stands as a valuable and efficient debt settlement tool in Japanese law, its application is not without limits. The Civil Code and other statutes impose important prohibitions on set-off to safeguard superior legal interests and public policies. These restrictions arise from explicit statutory mandates, the inherent nature of the claims involved (particularly when defenses are present or specific purposes would be undermined), agreements between parties, the need to protect victims of certain wrongful acts by ensuring actual compensation, and the policy of preserving funds essential for an individual's livelihood. A comprehensive understanding of these prohibitions is just as vital as knowing the conditions for effecting a set-off, as it defines the boundaries within which this powerful legal remedy can be legitimately exercised.