Who Bears the Loss if Goods Are Destroyed Before Delivery? Japan's Reformed 'Risk of Loss' Rules

Japanese Attorney at Law - Bengoshi L.L.

• 7 min read

In any sales transaction, a crucial question arises: what happens if the goods, the very subject matter of the contract, are lost, damaged, or destroyed before the buyer takes possession, and neither party is to blame? This issue, known in legal terms as the "risk of loss" (危険負担 - kiken futan), determines who bears the financial consequences of such an unfortunate event. Japan's Civil Code, as part of its comprehensive reforms effective April 1, 2020, fundamentally overhauled its traditional rules in this area, moving away from a principle that was often seen as counterintuitive and out of step with international commercial practices.

The Old Regime: The Controversial "Creditor Bears the Risk" Principle

Under the old Japanese Civil Code (specifically, former Article 534), for bilateral contracts concerning the creation or transfer of a real right over a specific thing (特定物 - tokuteibutsu, e.g., a particular piece of art, a specific used car, or an identified piece of real estate), a rather unique principle applied. If that specific thing was lost or damaged before delivery or transfer, due to a cause not attributable to the debtor (typically the seller in a sales context), the loss was generally borne by the creditor (the buyer). This meant that the buyer could still be obligated to pay the full purchase price even if they never received the goods, or received them in a damaged state, provided the seller was not at fault for the loss.

This "creditor-risk principle" (旧債権者主義 - kyū-saikensha-shugi) was widely criticized for being unfair to buyers, as it often ran contrary to the common understanding that payment should only be due for goods actually received in the agreed condition. While case law and sophisticated contractual drafting often sought to mitigate or contract around this default rule, its existence created a potential pitfall, especially in transactions where parties were not fully aware of its implications.

The New Order: Abolition of Creditor-Risk and Shift to Debtor-Risk

The 2020 Civil Code reform brought a decisive change by abolishing the old Article 534 and its creditor-risk principle. The new framework adopts a more debtor-centric approach for allocating the risk of accidental loss.

The Core Principle (Reformed Civil Code, Article 536, Paragraph 1):
The new general rule, found in Article 536, Paragraph 1, states that if the performance of an obligation under a bilateral contract becomes impossible due to a cause not attributable to either party, the obligor (the party who owes that performance, e.g., the seller whose obligation is to deliver the goods) cannot claim counter-performance from the obligee (the party who owes the corresponding obligation, e.g., the buyer whose obligation is to pay the price).

In the context of a sales contract, this means:

  • If the goods are accidentally lost or destroyed before the seller's delivery obligation is fulfilled or becomes impossible through other means, the seller bears the risk.
  • The seller cannot demand the purchase price from the buyer.
  • The buyer, correspondingly, can refuse to pay the price.

This principle, often termed the "debtor-risk principle" (債務者主義 - saimusha-shugi), as it places the risk on the debtor of the primary obligation that has become impossible (i.e., the seller for the delivery obligation), generally applies uniformly, whether the goods were specific or generic (though for generic goods, the issue typically arises after they have been identified or appropriated to the contract).

Interaction with Contract Termination Rights

The reformed rules on risk of loss are closely intertwined with the parties' rights to terminate the contract.
If the seller's obligation to deliver the goods becomes wholly impossible (e.g., due to their accidental destruction before risk has contractually passed to the buyer), the buyer has the right to terminate the contract without prior demand (無催告解除 - mu-saikoku kaijo) under the Reformed Civil Code, Article 542, Paragraph 1, Item 1 (which provides for termination due to impossibility of performance).

Termination effectively dissolves the contract, releasing both parties from their primary obligations: the seller is excused from the (now impossible) delivery, and the buyer is excused from paying the price. This right to terminate complements Article 536, providing the buyer with a clear mechanism to formally end the contractual relationship when the goods cannot be delivered.

Analyzing Different Scenarios of Impossibility

The allocation of risk and available remedies depend heavily on who, if anyone, is responsible for the impossibility of performance:

  1. Impossibility Attributable to the Seller (Debtor of the Delivery Obligation):
    • The buyer is not obligated to pay the price.
    • The buyer can terminate the contract.
    • The buyer can also claim damages from the seller for non-performance (under Article 415), as the seller would be unable to prove that the impossibility was not attributable to them.
  2. Impossibility Attributable to Neither Party (The Core "Risk of Loss" Scenario):
    • As per Article 536, Paragraph 1, the seller cannot demand the purchase price, and the buyer can refuse to pay.
    • The buyer can terminate the contract under Article 542, Paragraph 1, Item 1.
    • Neither party can claim damages from the other for the failure of the primary exchange, as there is no breach attributable to either side.
  3. Impossibility Attributable to the Buyer (Creditor of the Delivery Obligation):
    • In this scenario, the seller can still demand the purchase price from the buyer. The buyer cannot refuse to pay their counter-performance (Reformed Civil Code, Article 536, Paragraph 2). This rule, which protects the seller when the buyer is responsible for the impossibility, is largely carried over from the old law.
    • The buyer cannot terminate the contract based on the seller's non-delivery if the impossibility was the buyer's own fault (Reformed Civil Code, Article 543).
    • However, the seller must pass on to the buyer any benefit they gained by being excused from their own performance obligation (e.g., if the seller saved shipping costs because the goods were destroyed by the buyer before shipment) (Article 536, Paragraph 2, latter part).

Contractual Freedom: Defining When Risk Passes

While the reformed Civil Code provides a new default rule for risk of loss in the absence of fault, parties in commercial transactions remain largely free to allocate risk differently through their contractual agreements. The statutory rules typically apply where the contract is silent or ambiguous on the point of risk transfer.

In practice, the point at which risk of loss passes from the seller to the buyer is often tied to "delivery" (引渡し - hikiwatashi) of the goods or the point at which the buyer obtains effective control. The specific definition of "delivery" can vary significantly based on the contract terms:

  • Physical handover to the buyer.
  • Making the goods available for collection at the seller's premises (ex-works).
  • Handing over the goods to the first carrier for shipment to the buyer (common in many shipment contracts).

International commercial terms, such as Incoterms®, are frequently used in cross-border transactions precisely to provide clear and standardized rules for the allocation of costs and the transfer of risk at different points in the transit process.

Once "delivery" as defined in the contract has occurred, the seller has typically fulfilled their primary obligation regarding the goods' physical transfer. Subsequent loss or damage would then usually fall on the buyer, unless it can be shown that the loss was due to a non-conformity that already existed at the time risk passed (which would then trigger the rules on liability for non-conformity).

Alignment with International Norms

The shift away from Japan's unique creditor-risk principle for specific goods brings its domestic sales law more into alignment with widely accepted international commercial standards. For example, the UN Convention on Contracts for the International Sale of Goods (CISG), to which many major trading nations are party, generally provides that risk passes to the buyer when the goods are handed over to the first carrier for transmission to the buyer in shipment contracts, or when the buyer takes over the goods in other cases, rather than at the time of contract conclusion for specific goods.

Practical Implications and Contractual Drafting Strategies

The reform of the risk of loss rules has several important practical consequences:

  • Default Risk on Seller (Pre-Delivery): Sellers of goods, especially specific or high-value items, should be aware that under the new default rule, they generally bear the risk of accidental loss or damage occurring before their delivery obligation is fulfilled or becomes impossible.
  • Importance of Explicit Risk Allocation Clauses: If parties wish to deviate from the statutory default (e.g., to have risk pass to the buyer at an earlier stage, such as upon identification of the goods to the contract or ex-works from the seller's factory), this must be clearly and unambiguously stipulated in their sales agreement.
  • Defining "Delivery" Clearly: Since the practical transfer of risk is often linked to "delivery," contracts should precisely define what acts constitute "delivery" for the purposes of their transaction.
  • Insurance Considerations: The party bearing the risk at any given stage of the transaction should ensure they have adequate insurance coverage. Under the new default rule, sellers may need to confirm their insurance covers goods up to the point of effective delivery or discharge of their delivery obligation.
  • Buyer's Termination Rights: Buyers should be aware that if goods are accidentally destroyed before the risk has passed to them, they are generally not only excused from paying the price but also have the right to terminate the contract.
  • Reinstating Creditor-Risk (Buyer-Risk) Contractually: If parties specifically wish to adopt a model where the buyer bears the risk from an earlier point (akin to the old Article 534), they can do so by contractual agreement. However, if they choose this path, they must also carefully consider how such a provision interacts with the buyer's statutory rights to terminate the contract for impossibility. To make a contractual buyer-risk provision truly effective, it may be necessary to also contractually limit or modify the buyer's termination rights that would otherwise arise from accidental loss.

Conclusion

The Japanese Civil Code's reformed rules on risk of loss represent a fundamental and welcome modernization, particularly the abolition of the often-criticized creditor-risk principle for specific goods. The new default, which generally places the risk of accidental pre-delivery loss on the seller (as the debtor of the delivery obligation), aligns Japan more closely with international standards and arguably provides a fairer baseline for sales transactions. This change relieves buyers of the burden of paying for goods they do not receive due to no fault of their own. Nevertheless, the paramount importance of clear, well-drafted contractual provisions that explicitly allocate risk, define the point of delivery, and address insurance responsibilities remains undiminished, especially in sophisticated commercial dealings.