Can a company terminate a business contract before it expires in Japan? Termination by agreement, under a termination clause and for breach, and what to check before you terminate

Question

阿部国際法律事務所 · Accepted Answer

A contract can be ended early by agreement, under its termination clause, or by statutory termination for the other party's non-performance. Termination for non-performance generally requires a prior demand and is not available where the breach is minor (Civil Code, Art. 541). Terminating without a proper basis can itself be a breach.

A business contract in Japan can be terminated early in one of three ways: by agreement with the counterparty, under a termination clause in the contract, or under the statutory right to terminate for the counterparty's non-performance. Termination for non-performance generally requires that you demand performance within a reasonable period and that the counterparty fails to perform within that period (Civil Code, Art. 541). You cannot terminate if the non-performance remaining at the end of that period is minor (proviso to Art. 541), or if the non-performance is attributable to your own company (Art. 543). Sending a "termination notice" without a proper basis can itself be treated as a breach and expose your company to a damages claim, so check the contract and the facts before you send it.

Typical situations

- A contractor has repeatedly delivered late and below the agreed quality, and you want to switch providers mid-term.
- A change of strategy means you want to end a maintenance or system development contract with two years left to run.
- A customer's finances have deteriorated and payments have stopped.
- You want to end a long-standing distribution agreement without waiting for the renewal date.

1. Termination by agreement

Parties may freely determine the content of a contract within the limits of the law (Civil Code, Art. 521(2)), so a contract can be ended mid-term if both sides agree. A termination agreement usually sets out the end date, settlement of unpaid fees and prepayments, treatment of work in progress, return of confidential information and loaned items, and a mutual release of further claims. An oral agreement alone tends to lead to disputes over the terms later. The agreement should be dated, signed or sealed by both parties, and identify which contract ends and when.

2. Termination under a contractual clause

Many commercial contracts allow termination where the other party breaches the contract and fails to cure within a set number of days after notice, or where it suspends payments or files for bankruptcy. Others allow termination for convenience on a set number of months' written notice. Where a contract grants a right of termination, it is exercised by notice to the other party, and the notice cannot be withdrawn once given (Art. 540). Check the notice period, the method of notice and any termination fee, and follow the procedure the clause sets out.

3. Statutory termination for non-performance

Even without a termination clause, you can terminate under the Civil Code if the counterparty fails to perform.

- Termination after demand: if the counterparty does not perform, you may demand performance within a reasonable period and terminate if it is not performed in that time. Termination is not available if the non-performance at the end of the period is minor in light of the contract and generally accepted views in the trade (Art. 541).
- Termination without demand: you may terminate immediately without a demand where, for example, performance has become wholly impossible, the counterparty has clearly stated that it refuses to perform, or performance by a particular date was essential to the purpose of the contract and that date has passed (Art. 542(1)). Where only part of the performance is impossible, you may terminate part of the contract (Art. 542(2)).
- Where your company is the cause: you cannot terminate if the non-performance is attributable to the party seeking to terminate (Art. 543).

4. Rules for particular types of contract

Most service contracts are mandates (entrustment of juristic acts), quasi-mandates (entrustment of other tasks, Art. 656) or contracts for work. Either party may terminate a mandate at any time (Art. 651(1)), but a party that terminates at a time unfavourable to the other, among other cases, must compensate the other party's loss unless there was an unavoidable reason (Art. 651(2)). Under a contract for work, the party ordering the work may terminate at any time before the work is completed, on compensating the contractor's loss (Art. 641).

If you engage a freelancer (an individual, or a company with a single representative and no employees) on a continuing basis, the Freelance Act (Act on Ensuring Proper Transactions Involving Specified Entrusted Business Operators) also applies. A business that uses employees, or a corporation with two or more officers (a "specified entrusting business operator", Art. 2(6)), that wishes to terminate a continuing engagement of six months or more (including by not renewing it when it expires) must, as a rule, give at least 30 days' notice (Arts. 16(1) and 13(1) of the Act; Art. 3 of its Enforcement Order). If the freelancer then asks for the reason for termination, it must as a rule be disclosed without delay (Art. 16(2)).

5. Settlement after termination

When a right of termination is exercised, each party must restore the other to its original position (Civil Code, Art. 545(1)). Money returned must carry interest from the date it was received (Art. 545(2)), and items other than money must be returned together with any fruits arising after receipt (Art. 545(3)). Termination does not prevent a claim for damages caused by the counterparty's non-performance (Art. 545(4); Art. 415). Contracts for continuing services often state that termination takes effect only for the future, so check the wording.

6. Check termination fee and automatic renewal clauses

Where a contract provides for a termination fee or penalty, it is presumed to be a pre-agreed amount of damages (Civil Code, Art. 420(3)). Agreeing an amount of damages does not prevent a claim for performance or the exercise of a right to terminate (Art. 420(2)). If you are terminating for your own reasons, the amount and calculation of the fee bear directly on the decision.

Where a contract renews automatically for another year unless either party objects a set number of months before expiry, missing that deadline means the contract continues for the next term. Ending the contract by not renewing it can be less costly than terminating mid-term, so check the renewal date and notice deadline first.

7. Common mistakes

- A demand gives too short a period, or is vague about what must be done, so it does not meet the requirements for termination after demand.
- You terminate for the counterparty's breach, but your own company was also late with payments or with providing materials, which invites a counter-argument.
- You stop paying at the same time as you send the termination notice, and the counterparty alleges that you are the one in breach.
- Notice is given only in a chat between staff, and the date of receipt or its content is disputed later.

What you can do now

- Check the contract's termination clause, termination-for-convenience clause, notice periods and any provisions on termination fees or damages.
- If you rely on the counterparty's non-performance, set out the dates and details of late deliveries or defects in chronological order, backed by emails and acceptance records.
- When demanding performance, state what must be done and a reasonable deadline, and send the demand by a method that proves the date of delivery (such as content-certified mail).
- Check whether the contractor is a freelancer (an individual or a one-person company) and whether the engagement has lasted six months or more; if so, prepare to give 30 days' notice.
- Plan the transition to a new provider, the return of data and loaned items, and settlement of outstanding payments.

When to consult a lawyer

- The counterparty denies any breach and says the termination is invalid or demands a termination fee.
- The contract has no termination clause, or you and the counterparty read the clause differently.
- You are terminating for your own business reasons and expect a large damages claim, including for lost profits.
- A customer has stopped paying, insolvency looks possible, and you need to consider recovering payment and terminating at the same time.
- The contract is with an overseas party and the governing law or dispute resolution method is in question.

Frequently asked questions

Q. If the contract has no early termination clause, can we terminate for our own reasons?
You can if the counterparty agrees. Without agreement, statutory termination is not available unless the counterparty has failed to perform. However, a mandate or quasi-mandate can be terminated at any time (Civil Code, Art. 651(1)), and a contract for work can be terminated before completion on compensating the contractor (Art. 641). Damages may be payable in either case.

Q. How long is a "reasonable period" for a demand to perform?
The law sets no number of days. It depends on whether the period is enough to prepare and carry out performance, given the nature of the obligation. If the contract sets a cure period (for example, 14 days after notice), that period is the benchmark.

Q. Can we terminate because of a minor defect in a deliverable?
Termination after demand is not available where the non-performance at the end of the period is minor in light of the contract and generally accepted views in the trade (proviso to Art. 541). The usual first step is to ask for repair or other performance and check whether the purpose of the contract can still be achieved.

Q. Can a termination notice be sent by email?
Termination is made by notice to the other party (Art. 540(1)). If the contract requires written notice, follow that requirement. To avoid disputes later over delivery or content, it is common to use a method that leaves a record, such as content-certified mail.

Q. Do we get back an advance payment if we terminate?
On termination, each party must restore the other to its original position, so you can ask for the advance to be returned (Civil Code, Art. 545(1)). Money returned must carry interest from the date it was received (Art. 545(2)). How work the counterparty has already done is paid for depends on the contract and the nature of the work.

Q. Can we end a long-standing relationship simply by not renewing the contract?
A fixed-term contract ends when the term expires, as a rule, and any deadline in the contract for giving notice of non-renewal must be followed. If the counterparty is a freelancer (an individual or a one-person company) and the engagement is a continuing one of six months or more, at least 30 days' notice is generally required even for non-renewal (Freelance Act, Art. 16(1)).

Q.Can a company terminate a business contract before it expires in Japan? Termination by agreement, under a termination clause and for breach, and what to check before you terminate

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