July 10 2009
In 2006 the Ministry of Justice decided to consider a reform of the Law of Obligations, part of the Civil Code. Thus, civil law scholars established the Civil Code (Law of Obligations) Reform Commission in order to propose a draft reform, expecting that the Civil Code would be officially revised in the near future. Implementation of a revised Law of Obligations would mean drastic amendments to the Civil Code, which was enacted about 110 years ago. The draft reform was published in April 2009 and, as a result, the reform of the Civil Code is a hot topic among corporate lawyers in Japan.
Although the proposed revision is limited to the Law of Obligations, the draft reform covers a wide range of topics, including several which could have a significant impact on banking practice:
Debate on the revision has just begun and future discussion should be carefully monitored.
Set-off by third parties
The draft reform permits a third party (other than an obligor) to perform an obligation of the obligor subject to certain conditions. Further, it proposes that set-off may be effected by a third party (other than an obligor) which is a holder of claims against the obligee to the same extent as if the obligation of the obligor had been performed by such third party. For example, if a bank has made a loan to a borrower with the support of a guarantee, and at the same time the bank owes some money to the guarantor in connection with an entirely different transaction, the guarantor may offset the obligation of the bank to the guarantor against the borrower's obligations to the bank. Thus, the borrower may be relieved of his or her obligation by virtue of the guarantor offsetting the value of its own claim against the bank against the corresponding amount of the borrower's debt owed to the bank. A typical example of a third party which has an incentive to make use of set-off would be a guarantor or an assignee of collateral. However, this treatment poses a risk to the bank that an unexpected third party might seek to offset its claim against the bank against the borrower's debt, although the bank generally expects to be repaid on its loan, by making a claim against the borrower and offsetting that against the borrower's deposits with the lending bank.
Restrictions for set-off agreement
In practice, a customer and a bank enter into a set-off agreement to the effect that the obligations of both parties become due and suitable for set-off when or if a provisional seizure is filed in relation to a customer's claim against the bank (ie, deposits). Under case law, if a provisional seizure or attachment has been made with respect to the claims of the customer, the obligations of both parties become due and suitable for set-off pursuant to such agreement, and the bank may offset amounts owed by its customer against obligations owed by the bank to such customer, unless the bank obtains the claim against its customer after a provisional seizure or attachment is made. However, the draft reform provides that the bank can assert a set-off against the relevant attaching obligee which files attachment only where the obligations of the bank and its customer emerged from certain transactions which they have entered into continuously. Since the concept of continuing transactions is unclear, banks are concerned about whether bank transactions always constitute continuing transactions.
'Prescription of claims' is a newly established term under the draft reform and is similar to the extinctive prescription of claims under the current Civil Code.
The draft reform proposes that the period of claim prescription expires when 10 years(1) have passed since a claim becomes exercisable, or in case that a claimant becomes aware of the cause of the claim and an obligor before the 10-year-period passes when three, four or five years(2) have passed since the later of (i) the time that the claimant became aware of the claim, or (ii) the time that the claim became exercisable. The draft reform could be criticized in that the commencement of the period should be determined only by the time that a claim becomes exercisable. The three or four-year period is so short that banks might enter into legal proceedings to collect claims at an earlier stage rather than take the risk of a claim being deemed to be extinguished.
Agreement on prohibition of assignment of claims
The draft reform clarifies the cases in which assignment of claims shall be effective even if the parties have agreed to prohibit assignment. If a claim is assigned despite an agreement prohibiting such assignment, the obligor may assert that agreement against the assignee. However, the obligor may not assert such agreement against the assignee where:
As for a bank which has offered both investment banking services and commercial banking services, while the investment banking division dealing with securitization may agree to this proposed revision, the commercial banking division is unlikely to agree that an agreement prohibiting assignment of deposit claims can be nullified.
Perfection of assignment
The current Civil Code provides three methods to perfect assignment of claims against third parties:
However, the draft reform proposes that assignment of monetary claims may not be asserted against any other third party unless claim assignment registration is made. In addition, the assignor of monetary claims may assert being an obligee against the obligor by giving notice with or without a certificate of claim assignment registration. Since notice to the obligor or acknowledgement of the obligor is often used as a perfection method in practice, it might be inconvenient if the Civil Code provides only for the registration method in order to perfect assignment of monetary claims against third parties. In case that acknowledgment of the obligor would no longer be used for perfection.
The draft reform proposes that: (i) a request for performance made to one joint and several obligor shall not be effective with respect to other joint and several obligors; and (ii) the renewal, suspension of or extension of the expiration of prescription with respect to one joint and several obligor shall not be effective with respect to other joint and several obligors. Since the existing Civil Code provides that such a request shall be effective with respect to other joint and several obligors, and that completion of prescription with respect of one joint and several obligor shall relieve the liability of the other joint and several obligors to the extent of the portion of the obligation borne by such joint and several obligor, the proposed revision would have a significant influence on the management of claims held by financial institutions which require parties to provide joint and several obligors to support unsecured lending transactions.
For further information on this topic please contact Hiroo Atsumi or Yuri Suzuki at Atsumi & Partners by telephone (+81 3 5501 2111), fax (+81 3 5501 2211) or email (email@example.com or firstname.lastname@example.org).
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