Contributed By Baker McKenzie
Below are the key laws relevant to the construction market in Japan (three are translated into English on the website):
There are several standard contracts issued by the government and private industry groups and below are the contracts generally used in Japan:
For private employees and contractors, the Seven Associations Terms and Conditions is commonly used in the market. Small to mid-size contractors prefer using the Seven Associations Terms and Conditions without making amendments (it is possible to amend the standard contracts by agreement between the employer and the constructor, in which case, the amendment will be stipulated as a special condition).
It is not mandatory to use these contracts but major Japanese contractors prefer to use them. Recently, with the growing number of foreign developers/owners of buildings and facilities in the market, some contractors are being flexible with respect to the use of their English-language template agreements, but this is still not very common in Japan.
Especially during the first state of emergency (for Tokyo, from 7 April 2020 until 25 May 2020), some contractors voluntarily shut down their construction sites and this resulted in construction project delays.
The question of whether or not the COVID-19 pandemic constitutes a force majeure under a construction contract was the subject of vigorous discussion. To date, no court has ruled on the question but the Ministry of Land, Infrastructure, Transport and Tourism issued an official notice to the effect that the pandemic will constitute force majeure under a construction contract for public works.
Recently, construction contract parties (especially employers) have agreed to include provisions related to additional costs and extensions of time in construction contracts.
In general, the building owner will act as the employer in a construction project.
The general rights of the employer include the following.
The general obligations of the employer include the following.
The financier makes a loan to the employer mainly to support its payment obligation to the contractor, but typically does not have a direct contractual relationship with the contractor.
Also refer to 2.4 The Financiers for commentary on the considerations that apply where a financier makes a loan to a special-purpose company (SPC) as the employer.
In general, contractors need to obtain a licence under the Construction Business Act (Kensetsu Gyou Hou).
For large-scale projects, one of the big five major construction firms in Japan commonly becomes the contractor.
The general rights of the contractor include the following.
The general obligations of the contractor include the following.
As stated in 2.1 The Employer, if the contractor subcontracts the work to a subcontractor, the contractor is liable to the employer for the subcontractor's wilful misconduct or negligence, even if there is no wilful misconduct or negligence on the part of the contractor. This section also explains that the financier does not have a direct contractual relationship with the contractor.
Refer to 2.4 The Financiers for commentary on the considerations that apply where the financier makes a loan to an SPC as the employer.
Generally, small and medium-sized construction companies will become subcontractors. Under market practice in Japan, in general, the contractor selects the subcontractor at its own discretion.
The subcontractor enters into a contract with the contractor, and its rights and obligations are generally the same as those of the contractor as stated in 2.2 The Contractor.
As stated in 2.1 The Employer and 2.2 The Contractor, the subcontractor enters into a contract with the contractor and has no direct legal relationship with the employer.
In general, there is no legal relationship between the subcontractor and the financier.
Typically, banks, trust banks, and other financial institutions licensed in Japan will become the financier to extend a loan to the employer (ie, the owner of the property) as the borrower.
The financier will not directly participate in nor give instruction to the construction business, but may sometimes control the construction project through covenants imposed on the employer or approvals on certain important matters concerning the project.
There are also market players who contribute to equity finance rather than debt finance. In these cases, the right of the party that supplies equity finance is subordinated to the debt finance provider.
When the financier, a financial institution, provides debt finance to an SPC as the employer, the finance will be on a non-recourse basis for various structuring reasons (including bankruptcy remoteness, off-balance sheet lending requirements, tax reasons, etc). In these cases, the construction contract between the contractor and the employer may contain special provisions to reflect the specific non-recourse features of the lending. The key terms are as follows:
The scope of the work is usually determined among the contractual parties, ie, the employer as the owner of the property, the designer and the contractor.
Practically, the design drawings, specifications and estimates, which are separate from the construction contract, will determine the scope of the work in detail. These documents will be attached to, and form part of, the construction contract.
In Japan, in most cases, the price is a fixed amount and will be adjusted only in limited cases.
Nevertheless, it is common practice to specify scenarios in the construction contract in which the parties may modify or adjust the scope and price of the work.
Variations at the employer's request:
Variations at the contractor’s request:
The design work starts before the commencement of the construction process.
At this stage, the employer will enter into a design contract with an architect, and the architect will prepare a preliminary design (kihon sekkei) and a construction design (jisshi sekkei). Design work is separate from, and not a part of, the contractor's work in Japan.
However, major construction companies have their own in-house architects and design departments, and consequently in major projects involving a major constructions company, the same contractor takes on both the design work and subsequent construction work.
Based on the construction design prepared by the architect, the employer applies for a building permit (kenchiku kakunin) from the authority. It is common for the architect to file the application with the authority on behalf of the employer.
In general, the architect will continue to act as the administrative architect (kouji kanri sha) even after commencement of the construction work, and will be involved in the construction process to monitor and make the necessary inspections.
The contractor is obliged to carry out the construction in accordance with the construction contract, or more specifically, the construction design drawings, specifications and estimates attached to the construction contract.
The contractor must observe the requirements under the building permit issued for the construction project by the authority.
Based on the subcontracting agreement with the contractor, the subcontractor also carries out the work as instructed by the contractor. The contractor will be liable to the employer for the subcontractor's wilful misconduct or negligence.
It is a legal requirement that the architect shall supervise the ongoing construction work to check whether it is carried out in accordance with the design drawings, etc.
In general, the employer is obliged to secure and make the construction site and land for construction available for the use of the contractor during the life of the construction project. The Seven Associations Terms and Conditions also stipulate the employer’s obligations in this regard.
Typically, the employer will retain ownership of the site, while the contractor is generally deemed to be the owner of the construction work-in-progress.
Under the Seven Associations Terms and Conditions, if an unexpected situation occurs at the construction site that will obstruct the construction process, such as soil contamination, adverse underground obstructions, or the finding of cultural artefacts, the employer or administrative architect will need to instruct the contractor to take the necessary measures, and the contractor may request a change in the construction period or the contract sum.
The permits required for construction work vary depending on the area where the work is to be done, zoning restrictions and the type of building to be constructed.
Commonly, in the construction of a new building, an application must be made to the local government for a building permit (kenchiku kakunin) to ensure that the contemplated construction of the building complies with the Building Standards Law (Kenchiku Kijyun Hou), the Fire Protection Law (Shobou Hou) and other related laws and regulations.
As described in 3.3 Design, it is usual for the architect to apply for the building permit (kenchiku kakunin) on behalf of the employer.
After completion of the construction work, the employer assumes ownership of the building from the contractor, and will take care of the building as its own asset.
However, the contractor is legally liable for non-conformance (deficiencies) as described in 3.11 Defects and Defects Liability Period. In addition, as a matter of practice, the contractor will take care of the maintenance of the building after completion of the construction project.
These maintenance services are included in the construction contract as a special condition. In practice, the contractor will have standards for such maintenance services, which may differ depending on the type of services provided.
In some large-scale construction projects, in addition to the architects and contractors, the employer may retain a project manager or construction manager to manage and administer the architects, contractors, and other related parties involved in the project.
In addition, as described in 3.3 Design, the architect will continue to be the administrative architect (kouji kanri sha) of the construction work and will be involved in the construction process and make necessary inspections, such as ensuring that construction work is carried out in accordance with the design drawings.
For the tests/inspections, there are legally required inspections and contract-based inspections.
Legally Required Inspections
Legally required inspections include the completion inspection, which is held when the building is completed; the mid-term inspection, which is held when a specific milestone in the construction process is reached for a certain type of building; and the fire safety inspection, etc.
Legally required inspections are carried out by the District Construction Surveyor (kenchiku shuji) of the local government or a designated verification inspection agency (shitei kensa kikan), upon application by the employer.
Contract-based inspections are carried out by the employer (often with the architect in attendance).
If the constructed work does not pass these inspections, the employer may request that the contractor takes the necessary remedial actions regarding the constructed parts in question.
Upon completion of the constructed work, legally speaking, the building will be regarded as independent real estate owned by the contractor.
Upon delivery, the contractor will hand over the building to the employer (after it has passed all the inspections). At this point, the employer takes over ownership of the building from the contractor, and the employer pays the contract sum (typically the remaining amount of the construction fee) to the contractor.
The delivery date is the starting date for the period of non-conformity liability, etc, as described in 3.11 Defects and Defects Liability Period.
General Rules under the Civil Code
The following is a summary of the general rules under the Civil Code regarding liability of non-conformity to contract – following the recent amendment of the Civil Code (Minpou), defect liability (kashi tanpo sekinin) is now called liability for non-conformity to contract (keiyaku futekigou sekinin).
Rules under the Seven Associations Terms and Conditions
The rule under the Seven Associations Terms and Conditions is that the employer must submit a claim no later than two years from the date of delivery (except in cases where the non-conformity is caused by the contractor's wilful misconduct or gross negligence).
If the subject of the construction work is a new residential building, the period of liability for non-conformity of the base building structure is ten years from the date of delivery, and this rule is mandatory. However, the employer must submit a claim for non-conformity no later than one year after becoming aware of the defect.
The construction price is usually a fixed amount, subject to adjustment under the construction contract. In general, the contract price includes material costs, labour costs and expenses, as well as a certain portion of health insurance, employment insurance, and welfare pension insurance for the employees of the contractor.
Milestone payments are generally used in Japan (typically, on contract execution, in the middle of the project, and upon delivery of the work).
Advance payment is not common. The contract price is usually paid in instalments, with the final payment being made on delivery of the work.
The following are typical measures to manage late or non-payment.
Also see 5.3 Remedies in the Event of Delays with respect to late payment.
In general, the employer will pay the contractor the construction price in instalments based on the milestones agreed by the parties, and in order to confirm the satisfaction of such milestones, the contractor usually issues invoices to the employer.
The contractor will prepare the construction schedule describing the work to be completed during each time period, from the commencement to the completion of the work, and the entire construction timeframe, and submit it to the employer.
Except for projects where time is of the essence, it is understood that the construction schedule is not necessarily binding.
In general, the contractor is required to provide periodical reports to the employer.
In general and under the Seven Associations Terms and Conditions, the contractor may request that the employer extend the construction schedule in the event of delay due to any of the matters described in the construction contract (eg, additional work, force majeure, other reasonable grounds, etc). As the construction contract usually does not include any provision describing detailed procedures for addressing delay, the parties sometimes execute a separate amendment agreement or add special conditions to the existing construction contract to address resolution of delay issues.
Also see 5.3 Remedies in the Event of Delays.
The Seven Associations Terms and Conditions has a provision regarding liquidated damages calculated at the annual rate of 10% of the contract price.
The Seven Associations Terms and Conditions allow the employer to terminate the construction contract if the progress of the work is materially behind the construction schedule without reasonable cause and the contractor is unlikely to complete the work within the contracted time or within a reasonable period thereafter.
Below are the key items described in the Seven Associations Terms and Conditions that allow the contractor to request that the employer extend the contract time:
In some cases, the employer and the contractor agree to limit the circumstances where the contractor may request an extension of the contract time, and the procedures that the contractor must follow (eg, issuance of a change order).
Although force majeure is recognised as a legal concept in Japan, there is no definition of "force majeure" under the Civil Code or any other laws in Japan.
The parties may agree the scope of force majeure, but under the Seven Associations Terms and Conditions, the term "force majeure" is defined as "an Act of God or other natural or artificial cause for which neither party is responsible".
Recently, there has been active negotiation of force majeure provisions between parties to construction contracts in order to address the COVID-19 pandemic issues.
Construction contracts in Japan normally address unforeseen circumstances by requiring the parties to discuss whether they constitute force majeure.
Below are the key liabilities than cannot contractually be excluded by the parties' agreement.
The concepts of wilful misconduct (koi) and gross negligence (jyu kashitsu) exist in Japan.
However, there are no clear laws or guidance as to what situations constitute wilful misconduct or gross negligence. The level and scope of negligence must be determined on a case-by-case basis (eg, if a party is a professional, then a higher duty of care will be required).
While there is no mandatory requirement for construction contracts, the party may negotiate to add "gross" negligence in order to limit the situations claims by a party.
It is possible to contractually limit a party's liability unless they are in breach of mandatory provisions. The following are some examples that are limited under a construction contract.
In Japan, the scope of indemnities is largely determined by law, including the Civil Code.
Even if the relevant contract is silent on indemnities, the party in breach of the contract must indemnify the other party for any loss or damage suffered as long as there is reasonable cause and effect under the Civil Code.
The parties may include an indemnities clause in the construction contract to cap the claim amount, and to limit the type of loss excluding consequential loss or damage, and/or loss or damage caused by wilful misconduct or gross negligence only. However, such clauses may be unenforceable if found unreasonable. For example, an indemnity clause designating a wide range of indemnified parties (officers, employees, agents, affiliates, etc) may be arguable in Japan.
The following guarantees are typically used to limit risk for the parties involved.
Guarantee to Secure the Contractor's Obligation
The employer may request that the contractor provides a guarantee before advance payment under the Construction Business Act. The guarantee will cover both monetary claims and performance of the construction work. Major contractors tend to avoid guarantees in favour of the employer.
Guarantee to Secure the Employer's Obligation
Typically, a guarantee is required to cover the construction fee payment. Performance bonds are required only in the area of public projects led by government, and are not a prevailing practice in Japan. Guarantees must be in writing under the Civil Code, otherwise, there are no detailed requirements prescribed by law. Guarantees are not a mandatory requirement for construction projects.
The Seven Associations Terms and Conditions generally require the following insurances:
There are other types of insurances available including insurance for transportation, contractor's liability insurance, worker accident insurance, etc.
In general, damage to the construction site beyond both parties' control will be covered by insurance. Insurance brokers are familiar with the scope, insured amount and market trends and will advise the parties accordingly.
With respect to the consequences of the insolvency of a party, construction contracts often include contractual provisions which entitle the non-insolvent entity to terminate the construction contract.
However, such contractual provisions do not specify the legal consequences in detail, and instead, the Civil Code and insolvency-related laws (such as the Bankruptcy Act) prescribe the rules which have a mandatory effect, and these cannot be displaced by contract. In general, power shifts from the parties to the construction contract to the court or court-appointed trustee (kanzai-nin).
Generally, the court-appointed trustee may either:
The contractor or court-appointed trustee may terminate the agreement. The contractor's claim for payment will rank equally with the other creditors' claims.
Sharing of responsibility for risks between the contractor and the employer is a common practice under construction contracts in Japan. The Seven Associations Terms and Conditions provisions with respect to risk-sharing generally favour the contractor.
Risk-sharing issues often arise where a party suffers loss or damage due to force majeure. Please refer to 5.5 Force Majeure for further commentary on this particular kind of risk-sharing.
The Seven Associations Terms and Conditions has certain provisions regarding specific key personnel, ie, chief engineer, supervising engineer and site agent, and their respective roles.
In some cases, the construction contract may have general provisions requiring the contractor to comply with labour safety and sanitary arrangements (roudou anzen eisei kanri) at the construction site. In addition, certain legally mandatory requirements apply if the number of workers is 50 or more, even if the relevant construction contract is silent on that point.
Contracts between contractors and subcontractors are similar in nature to construction contracts between employers and contractors.
Full delegation by a contractor to a subcontractor is prohibited without the prior written consent of the employer.
The Act against Delay in Payment of Subcontract Proceeds, Etc to Subcontractors (Shitauke Daikin Shiharai Chien Boushi Hou, so-called shitauke hou) or certain compliance-related laws may apply to a contractor who is dealing with a subcontractor. This law imposes restrictions on unreasonable delay in payment of the subcontractor's fee, and unreasonable pressure by the contractor on the subcontractor's price, etc.
The Seven Associations Terms and Conditions has a general provision regarding the use of instruments and/or construction processes which are subject to third-party patents or other intellectual property (IP) rights, and in general, the contractor is responsible for the use of such IP rights.
It is not common to include detailed intellectual property provisions in construction contracts in Japan. IP rights may be more relevant to design contracts which generally include provisions in favour of architects.
With respect to remedies available to the employer and the contractor in Japan, both the employer and contractor may resort to the following:
In some cases, the construction contract may include a remedial provision which entitles the employer to request substitution of a third-party contractor to continue remedial work in whole or in part, in the event that the initial contractor suspends construction work.
It is common practice in Japan for a construction contract to limit the remedies available to a party. The following are examples of such limitations:
Sole remedy clauses are not common in Japan. Such provisions (if any) may be unenforceable as they may unreasonably deprive a party of flexibility to explore available remedies.
The scope of the remedy of compensation for loss or damage is limited by the requirement to establish reasonable cause and effect.
The Civil Code refers to ordinary loss caused by breach of contract and special loss incurred based on special circumstances foreseeable to the parties. However, it is not common for construction contracts to prescribe what these kinds of loss include in detail.
Retention rights are given to the contractor by the operation of the law in Japan, and it is not common practice to exclude such rights in the construction contract.
Rather, it is common practice for both parties to have the right to suspend (or request suspension of) the construction work under certain circumstances.
All district courts in Japan are generally competent to adjudicate construction contract disputes.
The Tokyo District Court is a popular choice in construction contracts because it has a special department comprised of judges who are expert in adjudicating construction disputes.
The Seven Associations Terms and Conditions prescribe mediation or arbitration at the Committee for Resolution of Construction Work Disputes (kensetsu kouji funsou shinsa kai) as an alternative method of dispute resolution.
Other alternative means of dispute resolution include conciliation under the Civil Conciliation Act, arbitration under the Arbitration Act, mediation or arbitration by the Housing Dispute Resolution Body (shitei jutaku funsou shori kikan).
These alternative means are commonly used and they are regulated by the applicable laws.