Contractual Issues Arising from the Coronavirus Pandemic and the Force Majeure Clause under Japanese Law

Ⅰ. Introduction

The novel coronavirus (COVID−19), originating in China, has rapidly spread from East Asia throughout the rest of the world. The World Health Organization declared it a pandemic on March 11, 2020 and announced that the coronavirus pandemic was “accelerating” on March 23, 2020. Thereafter, on April 7, the Japanese government declared a state of emergency, which included recommendations for seven regions of Japan, including Tokyo. On April 16, its coverage was expanded to the entire country. The declaration of a state of emergency in Japan ended on May 25. However, the intense effects of the pandemic have remained and the difficult situation will likely continue for at least some time. Due to the direct or indirect effects of the coronavirus, corporations have been facing previously unforeseen new regulations introduced by governments all over the world. Many corporations have been heavily affected by the negative impact of these regulations on their businesses.

This article describes the key contractual issues that may arise under Japanese law when a party to a contract is unable to perform its contractual obligation due to the pandemic. This article also describes how the recent amendments to the Japanese Civil Code effective as of April 1, 2020 may affect contractual issues arising from the pandemic.

Ⅱ. Contractual Liability for Breach of Contract

Due to the coronavirus pandemic and the government regulations dealing with it, a corporation may be unable to perform and deliver contractually promised goods or services. In such a case, is a corporation liable for breach of contract under Japanese law? The main issue is likely to be the applicability of a force majeure clause, and whether the breach can be attributed to the alleged breaching party.

II-A. Legal Requirements to Demand Damages Due to Default

The following are the legal requirements to demand damages arising from an obligor’s failure to perform under Article 415 of the Japanese Civil Code:

　ⅰ　The obligor fails to perform consistent with the purpose of its obligation;
　ⅱ　There is legal causation between the failure and the damages;
　ⅲ　Damages exist; and
　ⅳ　The reasons for the failure are attributable to the obligor.

II-B. Force Majeure and No-Fault Defenses

Some contracts entered into by Japanese corporations include a force majeure clause that relieves a breaching party from liability for breach of the contract if the breach is caused by a natural disaster, such as an earthquake or a flood. The typical events mentioned in a force majeure clause in Japan are earthquakes and floods. The outbreak of an infectious disease is rarely included in such clause.

If a contract states that a breaching party would not be liable when the breach of contract is caused by a force majeure event, such as an earthquake or a flood, but does not mention a widespread infectious disease, would the latter be considered a force majeure event under Japanese law, including case law?

The contractual issues arising from the coronavirus pandemic can be categorized as follows.

First, the applicability of a force majeure clause is a legal issue that is related to whether or not there are “reasons attributable to the obligor” for the breach.

Under Japanese case law, reasons attributable to a party (i.e., fault) refer to negligence or intentional fault, or other circumstances that are deemed to be equivalent thereto, based on principles of fairness and equity. However, in the case of the coronavirus pandemic, since intentional fault would not come into play, “reasons attributable to the obligor” for a breach due to such pandemic would mainly refer to negligence on the part of the obligor.

The Japanese Civil Code does not provide a specific definition or interpretation of “force majeure.” Nevertheless, in general, “force majeure” means “an external circumstance which the party is unable to prevent with reasonable care or a preventive measure required under trade practice,” and “typical events of force majeure are a great earthquake, a great flood, a war and a riot.”[1] There is also no judicial precedent in Japan interpreting force majeure.

Fault or negligence is simply determined by proving whether the obligor failed to perform the contractual obligation due to a lack of reasonable care which an obligor of the same class, position and occupation should exercise under principles of equity.

Since the issue of whether or not fault (i.e., negligence) exists cannot be determined without taking into account external circumstances, the absence of fault may be insufficient to invoke force majeure. An event of force majeure must be based more on an external circumstance rather than a case of no fault alone. Thus, in theory, the force majeure defense has a narrower scope than a no-fault defense. However, the distinction between force majeure and no-fault is not clear in practice in Japan. Japanese contractual parties and courts do not make a clear distinction between them, and sometimes use the terms force majeure and no-fault interchangeably.[2] Nevertheless, since, ultimately, there is no difference as to the conclusion, namely, an obligor is not liable for breach, between the force majeure defense and the no-fault defense, focusing on discussions about force majeure would not be useful in Japan.

II-C. Approach to Determining the Reasons Attributable to the Alleged Breaching Party

Under Japanese law, as discussed earlier, a breach of contract can be considered attributable to a party if there was negligence or intentional fault on its part, or other circumstances deemed to be equivalent thereto based on principles of fairness and equity (i.e., reasons attributable to the obligor).

These bases for finding breach of contract are not determined solely from the party’s obligations under the contract and the circumstances of the breach. Other factors to be considered include the nature and purpose of the contract, the parties’ history in negotiating and implementing the contract, the trade relationship between the parties, and socially accepted conventions related to the transaction.[3]

Based on the above approach, whether a breach of contract due to the coronavirus outbreak is attributable to the alleged breaching party will be determined on a case-by-case basis, depending on the individual and specific circumstances of the contractual parties and the contract.

II-D. Judicial Precedents

As mentioned earlier, Japanese courts have not yet decided whether an outbreak of an infectious disease such as COVID-19 is a force majeure event. However, there are several judicial precedents that may be useful, including a case on whether or not there was negligence on the part of the alleged breaching party due to a great earthquake, which is a typical event of force majeure in Japan.

ⅰ. Tokyo District Court Decision of June 22, 1999 (Hanrei Times 1008-288)

The central issue in this case was whether a warehouse company was liable for the goods destroyed in a fire caused by the chemical materials stored there that ignited due to the Great Hanshin-Awaji Earthquake in 1995.

The court ruled that the warehouse company was not contractually liable for breach of contract because it was impossible to predict specifically such a large earthquake of an unusual force – its seismic intensity level registered 7, the strongest level of the Japanese seismic scale at the time – and thus, such event could not have been unforeseen by the parties at the time they entered into the contract. The court thus found that there was no negligence. It considered as the central issue whether the parties were able to foresee such a great earthquake, and not just a lesser, more common seismic event.

ⅱ. Fukuoka High Court Decision of March 26, 1975 (Hanrei times 326-232)

A seller failed to deliver Korean seeds to the purchaser in Japan due to the failure to pass a plant inspection in Japan. The purchaser demanded compensation for damages due to delayed delivery. The central issue in this case was whether the reason for the delay was attributable to the seller.

The court denied the claim finding that the failure to pass the plant inspection in Japan was not a reason attributable to the seller and it was impossible for the seller to foresee the same based on the following circumstances:

(i) the seller had not experienced a failure to pass the plant inspection throughout its extensive experience;

(ii) the seller obtained an inspection certificate issued by the Korean government and a certificate issued by an exporting dealer which demonstrated that it had passed an inspection stricter than the plant inspection in Japan.

ⅲ. Summary

In these two cases, the court did not hold the alleged breaching party liable for breach of contract because foreseeability is required for a finding of negligence.

Based on this approach, it is likely that the coronavirus outbreak will be considered an unusual occurrence that could not have reasonably been foreseen by the parties at the time they made a contract. Consequently, it is possible that an alleged breaching party would not be held liable for breach of contract caused by the said outbreak. However, there are examples of infectious diseases in our history: the Spanish flu of 1918-1919, the Asian flu of 1957-1958, the Hong Kong flu of 1968-1969, and SARS (Severe Acute Respiratory Syndrome) of November 2002-July 2003. Thus, the outcome in any particular case may depend on the degree of foreseeability by the parties of the specific force majeure event when they entered into the contract to establish whether there was negligence on the part of the obligor.

II-E. Defaults Arising from Governors’ Requests and Reasons Attributable to the Obligor

Based on the Act on Special Measures for Pandemic Influenza and New Infectious Diseases Preparedness and Response (Act No. 31 of 2012), in April 2020, local governors in Japan issued requests for corporations to voluntarily suspend their activities in certain businesses, and for residents to voluntarily stay at home to prevent the spread of COVID-19 infections. These requests could cause defaults in the performance of contractual obligations, such as providing services and delivering goods. In such cases, would complying with such requests constitute a reason attributable to an alleged breaching party?

The requests by governors were not mandatory. The governors do not have the power to impose any penalty for non-compliance with such requests, unlike the stay-at-home orders in some foreign countries. Therefore, it is possible that an alleged breaching party would still be held liable for breach of contract caused by complying with a governor’s request. However, despite the absence of penalties for non-compliance, such requests by the governors could result in the release of the names of corporations that do not comply therewith, so, to avoid any negative publicity, those requests may actually have power over corporations. Moreover, compliance with such requests could generate the social benefit of preventing the spread of the infectious disease. For these reasons, it is also possible that an alleged breaching party would not be held liable for breach of contract for complying with such requests.

The conclusion will likely be determined on a case-by-case basis, depending on the attendant circumstances, such as whether or not a contractual obligation should be performed despite such governor’s request, and the contractual parties’ intent at the time the contract was made.

II-F. Burden of Proof

Although it may depend on the wording and structure of the contract, in general, under Japanese case law,[4] a party alleged in a court action of breaching a contract has the burden to prove its force majeure defense or no-fault defense as an affirmative defense. The alleged breaching party would be held liable if it is unable to prove the same by a preponderance of the evidence.

Many corporations have been trying to resolve coronavirus outbreak-related trade issues through negotiations. They should be mindful of burden-of-proof issues while such negotiations are underway because if either party brings an action to court and does not wish to settle, the allocation of the burden of proof as described above could determine the court’s decision on a party’s liability for breach of contract.

Ⅲ. Breach of a Payment Obligation

If an obligor becomes unable to pay a supplier or a bank due to a sharp decrease of sales caused by the coronavirus outbreak, can the obligor raise a force majeure defense or a no-fault (no-negligence) defense as described in Section II above?

Under Article 419(3) of the Japanese Civil Code, an obligor cannot raise a force majeure defense for an obligation for the delivery of money. Even though this special rule concerning payment obligations is not compulsory, contracts entered into by Japanese corporations usually do not excuse the failure to deliver money caused by any force majeure event. Therefore, the obligor cannot raise a force majeure defense for a payment obligation, even if it has faced a sharp decrease of its sales due to the coronavirus pandemic.[5] Thus, to avoid a default in payment, corporations should ask for deferred payment, amend the payments terms, or obtain new financing.

Ⅳ. Legal Causation

Assuming that the coronavirus outbreak is an event of force majeure, if there was a different reason for the alleged breaching party not performing its obligation, it would still be held liable for the breach. Some corporations might raise a force majeure defense to justify not performing their obligations. However, legal causation between the coronavirus outbreak and the failure of performance is required to be exempted from liability.

Since suppliers and vendors are a part of a global supply chain, once the supply chain is disrupted, the impact could spread endlessly. Under Japanese case law,[6] reasonable causation is required between the breach of contract and the damages claimed. A contractual party should carefully determine whether there is a reasonable causation between the failure caused by the coronavirus outbreak and the damages claimed to determine if there is an available exemption from liability for breach of contract.

Ⅴ. Termination of Contract

An obligee might consider terminating a contract and seeking an alternative supplier or vendor if an obligor is unable to perform an obligation due to a force majeure event. However, under the Japanese Civil Code prior to its amendment as described below, an obligee is not entitled to terminate a contract without the obligor’s fault, unless the parties have agreed to do so. To address such inconvenience, in practice, parties often agree to a special provision that enables a party to terminate the contract if the obligor is unable to perform its obligation for any reason, regardless of the existence of a force majeure event or the obligor’s fault.

Ⅵ. Amendments to the Japanese Civil Code, Effective from April 1, 2020

The Japanese Civil Code was amended effective from April 1, 2020 (Act No. 44, 2017). Do the amendments have any impact on the contractual legal issues originating from the coronavirus outbreak discussed above?

First of all, the amended Japanese Civil Code applies to contracts entered into from April 1, 2020.

Second, as described in Section V above, under the Japanese Civil Code prior to its amendment, an obligee cannot terminate a contract unless the obligor is at fault, except when the parties agree otherwise. However, to address such inconvenience, Articles 541 to 543 of the amended Japanese Civil Code now allow an obligee to terminate the contract even absent the obligor’s fault, but only for its failure to perform an obligation, unless the obligee is in some way responsible for such non-performance.

Ⅶ. Conclusion

As the impact of the coronavirus pandemic changes quickly day by day, corporations must have a sound understanding of how force majeure and no-fault defenses may affect their contractual transactions as they attempt to resolve specific legal issues in dealing with the coronavirus outbreak.

Although there have been no court precedents in Japan interpreting a force majeure provision, corporations need to understand these trends and tendencies of Japanese courts to minimize the impact of the coronavirus outbreak on their business activities. It is the author’s hope that this article will assist readers to gain a better general understanding of how Japanese courts will approach force majeure and no-fault defenses as they confront contractual issues related to the coronavirus pandemic.

Written by So Miyamoto
Partner, Oh-Ebashi LPC & Partners