Increasing Cross-Border Transactions: Governing Law in International Contracts and How They Differ from Domestic Agreements

As business globalization advances, more Japanese companies are looking to expand overseas. However, those handling international transactions often do not know exactly what they should look out for when dealing with foreign companies. Some may even feel uneasy when reviewing contracts drafted in English.

International contracts differ from domestic ones in many ways. Failure to understand their nature and rules may expose your company to unexpected risks.

This article outlines important distinctions between domestic and international contracts and highlights the features specific to cross-border agreements.

About International Contracts

Transactions with overseas companies generally require international contracts.

International transactions commonly involve contracts such as:

• Sales and Purchase Agreements
• Licensing Agreements
• Distribution Agreements

These resemble typical domestic contracts.

However, when the counterpart is a foreign company, the transaction should be conducted under an international contract that reflects the applicable international rules, rather than relying solely on a standard Japanese domestic contract.

For companies expanding overseas, international contracts are essential.

Differences Between International and Domestic Contracts

International and domestic contracts differ in nature, roles, structure, and more. These differences arise from varying cultures and rules between countries. Understanding these distinctions is essential for smooth transactions.

The main differences are outlined in the following sections.

Contract Language

While contracts for domestic agreements are typically drafted in Japanese, English is often used for international contracts.

In principle, parties freely decide the contract language through mutual agreement.

For instance, in international contracts, the following scenarios might necessitate drafting the contract in various languages:

• Local language translations for dealings with authorities in an overseas subsidiary’s country
• Drafting the contract in both Japanese and the language of the counterpart
• Japanese companies drafting contracts in Japanese when dealing with their overseas subsidiaries

In practice, English remains the main contract language, so the ability to read and draft English-language contracts accurately is essential.

The Role of Contracts

In international transactions, contracts function primarily as a risk management tool.

In domestic transactions, contracts frequently serve as a record confirming that the parties have reached agreement.

However, in the context of international agreements, contracts are legal documents concerning the rights and obligations of the parties. They operate as a key mechanism to manage risks arising from disputes, force majeure events, and other contingencies.

Approaches to Contracts

International and domestic contracts reflect fundamentally different mindsets in drafting.

In the case of international contracts, there is a tendency to draft agreements on the assumption that things may go wrong, rather than relying on trust. Consequently, there is no inclination to defer problems by relying on the good faith negotiations of the parties involved. Instead, parties draft detailed clauses anticipating various scenarios for risk management.

By contrast, domestic contracts between Japanese parties tend to be drafted on the assumption of mutual trust. It is not uncommon for such contracts to lack provisions for matters that are assumed to be understood without explicit mention. Furthermore, there is a tendency to expect that any issues will be resolved through sincere discussions at a later stage.

It is crucial to understand that the basic mindset in international contract drafting is very different from that in domestic contracts.

Characteristics of International vs. Domestic Contracts

Due to the differences in roles and perspectives mentioned above, the characteristics of contracts also differ significantly.

International contracts anticipate all scenarios with detailed clauses for risk management. As a result, the number of pages tends to be considerably higher compared to domestic contracts.

On the other hand, domestic contracts may be concluded with less detailed provisions in anticipation of future discussions, or they may be kept very simple as a sign of mutual cooperation. Consequently, they tend to have fewer pages than international contracts.

These differences affect both volume and content of contract documents.

Governing Law

International contracts typically base on laws from “common law” systems, such as those in England and the United States.

On the other hand, Japanese contracts are structured under Japanese law, which is part of the “civil law” system.

One must keep in mind that the underlying legal frameworks for international and domestic contracts can be quite different.

International and domestic contracts thus apply laws with different philosophies. “Governing law” determines which country’s law interprets the contract in disputes. Proceeding with a domestic mindset despite differing rules and characteristics risks unexpected troubles.

Determining the Governing Law for International Contracts

The governing law in international contracts is generally determined through negotiations.

However, designating the law of a country that has no connection to the contract may make it difficult to understand the applicable legal framework and procedures, leading to unforeseen disadvantages. Typically, parties adopt the law of one party’s home country or the law of a third country related to the subject matter of the contract.

For example, even if the contract is between Japanese companies, if the goods are sourced from Taiwan and the delivery is received within Taiwan, the transaction is completed within Taiwan. In this case, it would be natural to choose Taiwanese law as the governing law.

Parties must also consider jurisdiction agreements when selecting governing law. A jurisdiction agreement designates which country’s courts handle disputes.

If governing law and jurisdiction countries differ, courts ay have to apply foreign law to proceed with the case, which can be legally and practically complex. In practice, the parties may be burdened with the responsibility of researching and presenting arguments about the content of foreign law.

Differing designations increase parties’ burdens. Governing law decisions thus weigh multiple factors. Companies should deliberate carefully for smooth transactions.

Rules Governing the Choice of Law in International Contracts

The choice of law in international contracts is primarily determined through negotiations between the parties involved. However, the agreement is not entirely at their discretion, as there are specific rules that must be followed.

The rules for choice of law in international contracts follow below.

Principles in Contractual Agreements

The governing law is, in principle, that of the jurisdiction designated in the choice of law agreement.

This reflects the principle of party autonomy in Article 7 of Japan’s Act on General Rules for Application of Laws (Act No. 78 of 2007).

(Choice of Governing Law by the Parties)

Article 7: The formation and effect of a juridical act are governed by the law of the place chosen by the parties at the time of the act.

Source: Act on General Rules for Application of Laws

This Act applies in Japanese lawsuits. Parties’ agreements on governing law are thus adopted.

Principles in Tort Claims

For tort claims, Article 7 of the Act on General Rules for Application of Laws does not apply.

A tort refers to an act that infringes on the interests of another person intentionally or negligently (including gross negligence).

When a breach of contractual obligations (failure to perform the contents of a contract) is in question, the governing law is determined by the principle of party autonomy, through an agreement on the governing law.

However, even if it is the same set of facts, when bringing a tort claim, Article 17 and subsequent provisions of the Act on General Rules for Application of Laws apply instead.

For example, Article 17 is stipulated as follows:

(Torts)

Article 17: The formation and effect of a claim arising from a tort is governed by the law of the place where the result of the wrongful act occurred . . .

Source: Act on General Rules for Application of Laws

As a concrete example, consider a ship carrying cargo under a contract with a US company that causes a collision due to negligence in American territorial waters. In this case, even if there was an agreement that Japanese law would be the governing law of the contract, the governing law for the damages from the collision accident would be US law.

Thus, when bringing a tort claim, the governing law is not determined by the agreement of the parties but is decided according to the provisions of the Act.

In Absence of Governing Law Agreement in Contracts

When there is no agreement on the governing law in a contract, the Act on General Rules for Application of Laws provides handling methods.

First, examine whether there is an implied agreement between the parties. This is because Article 7 of the Act covers both explicit and implied agreements, such as tacit understandings.

If no implied agreement can be confirmed, the law of the jurisdiction most closely related to the contract will be adopted as the governing law (Article 8 of the Act on General Rules for Application of Laws).

The most closely connected jurisdiction is determined by considering factors such as:

• The location where the juristic performance of the contract took place (Article 8, Paragraph 1 of the Act on General Rules for Application of Laws)
• Principal place of business of the party providing juristic performance (Article 8, Paragraph 2)
• Location of contract-subject real estate (Article 8, Paragraph 8)

Various circumstances determine implied agreements or closest connections, risking unexpected laws. Therefore, it is important to explicitly state the governing law in the contract in advance.

Exceptions to Contract Governing Law Agreements

The Act on General Rules for Application of Laws provides exceptions to the agreed governing law in consumer and employment contracts.

This is to protect consumers and workers, who are often in a weaker position compared to businesses.

In the case of consumer and employment contracts, even if there is an agreement on the governing law between the parties, mandatory provisions of another jurisdiction’s law may apply regardless of the agreement.

A mandatory provision is a legal rule that cannot be waived by contract.

When consumers or workers express their desire to use the mandatory provisions of their own country’s laws, these provisions will be applied (Articles 11 and 12).

Key Points When Entering International Contracts

Businesses face several considerations in international contracts.

International contracts differ significantly from domestic ones, and signing a contract with the same ease as a domestic one could lead to unexpected troubles.

Key points for entering international contracts follow.

Do Not Sign Without Careful Review

While reviewing the contract is crucial for any agreement, it is especially risky to sign an English contract without careful legal review.

English contracts are often based on the common law system, which is different from Japanese law, and may include concepts and clauses not typically found in Japanese contracts, such as:

• Definition clauses
• Consideration
• Recitals
• Waivers
• Indemnities
• Entire agreement

Clauses of this kind are rarely found in standard Japanese contracts.

Thus, beyond language, English contracts differ substantially from Japanese ones. Review thoroughly before signing.

Negotiate Favorable Terms

In international contracts, it is common to negotiate modifications, deletions, or additions to the contract terms presented by the other party.

This is because the contract drafted by the other party typically includes terms that are favorable to them. Therefore, it is almost unheard of to sign their contract without any revisions.

Both parties expect to create the contract through negotiation, based on the initial draft, by asserting their positions and making compromises. Engaging in reasonable negotiations generally does not harm your relationship with the other side.

Aim for contract terms that are advantageous to your company and engage in negotiations proactively.

Consult a Lawyer

Consult a lawyer before concluding international contracts.

In international contracts, if a problem arises after the contract is signed, you can only rely on the clauses in the contract. Consulting with a specialist before concluding the contract is an essential risk management strategy, as the contract governs everything.

Japanese contracts often include a clause stating that “matters not stipulated shall be resolved upon sincere consultation.” This allows for the possibility of finding a resolution through consultation with a lawyer even after a problem arises.

However, in international contracts, if you have already entered into a disadvantageous agreement, consulting a lawyer after a problem arises may not lead to a favorable resolution for your company. You may have little or no opportunity to renegotiate the terms.

We recommend consulting with a lawyer before, not after, issues arise.

Summary: Understanding the Differences Between Domestic and International Contracts is Crucial for Negotiations

Engaging in transactions with overseas companies inevitably involves international contracts, which differ from domestic contracts in various aspects. Treating international contracts like domestic agreements may expose your company to unforeseen risks.

It is essential to thoroughly understand the nature and rules of international contracts and how they differ from domestic ones to avoid entering into agreements that could be detrimental to your company.

The foremost risk mitigation involves pre-signing review and negotiation. Consulting experienced attorneys proves advisable.

Guidance on Measures by Our Firm

Monolith Law Office holds extensive experience in both IT, particularly the internet, and legal matters. As global business expands, expert legal checks grow essential. Our firm offers solutions related to international legal affairs.

Areas of practice at Monolith Law Office: International Legal Affairs & Overseas Business