What are the Methods of Contract Termination in System Development?

System development projects, due to their long-term nature, naturally anticipate situations such as “flaming” during their progress. And while it would be ideal if users and vendors could always work in sync, it’s also important to consider the possibility of contract termination at some point.

In this article, we will explain the legal option of “termination” of a contract, focusing on the points that become important in relation to system development.

The Relationship Between System Development and Cancellation

What is Cancellation under the Civil Code?

In the revised Japanese Civil Code, the general provisions regarding the “cancellation” of a contract are stipulated in Articles 540 to 548. Cancelling a contract means to nullify the effects of a contract that has been concluded.

In the relationship between a user and a vendor, once a contract is concluded, the vendor is obligated to develop the system, and the user is obligated to pay the fee. These obligations are also the “rights” of both parties. If the contract is cancelled, the obligations and rights that both parties had will return to the state before the contract was concluded. Therefore, even if there are unfulfilled obligations, not only will the obligation to fulfill them disappear, but also the obligation to return to the original state based on the state before the contract was concluded will arise. This is called the “obligation to restore the original state”.

Furthermore, if there are circumstances where damage has occurred at the same time, it is also possible to separately compensate for the damage.

The Relationship Between System Development Practice and Cancellation

For those familiar with legal practice in business, including system development, the first thing that comes to mind when it comes to “cancellation” of a contract may be a cancellation notice. However, in legal terms, even in the context of system development, the articles that serve as the basis are broadly divided into two patterns depending on the cause of the cancellation.

In Case of Non-performance (Delay in Performance)

(Example) The vendor does not deliver despite exceeding the initially promised delivery date.

Japanese Civil Code Article 541: In the event that one party does not perform its obligations, the other party may set a reasonable period and demand performance within that period, and if there is no performance within that period, the other party may cancel the contract.

In the case of a contract-based system development, the “obligation” that the vendor, who is “one party”, bears is to complete the system according to the requirements and deliver it. Therefore, if the vendor does not deliver despite exceeding the delivery date, it means that the vendor did not complete the work by the delivery date. So, what does “completion of work” mean in the context of system development? This point is explained in detail in the following article.

https://monolith.law/corporate/completion-of-work-in-system-development[ja]

In Case of Defect Warranty Liability

(Example) The system delivered by the vendor has many bugs and data inconsistencies, and it is later found to be unsuitable for practical use.

Japanese Civil Code Article 635: When there is a defect in the object of the work and the purpose of the contract cannot be achieved because of it, the orderer may cancel the contract. However, this does not apply to buildings and other land structures.

From the perspective of a system development project, it is not common for the vendor to express an intention to cancel the contract. It is usually assumed that the user will make the cancellation to the vendor.

For more details on defect warranty liability, please refer to the separate article below.

https://monolith.law/corporate/defect-warranty-liability[ja]

Termination Notice and Related Legal Issues

A termination notice is a document used to convey the intention to terminate a contract (usually from the user to the vendor). The following clause from the Japanese Civil Code can be referred to in this context:

Japanese Civil Code Article 541: If one party does not perform its obligations, the other party may, after setting a reasonable period and demanding performance within that period, terminate the contract if there is no performance within that period.

When viewed as a document related to system development, a termination notice is not intended to facilitate the smooth progress of a project, but rather to end it. It is also personalityized by its expectation to directly bring about certain legal effects.

However, as per the aforementioned clause, unlike a contract, a termination notice can be sufficient with a unilateral declaration of intent (provided certain conditions are met). When a user presents a termination notice to a vendor, the vendor’s representative who receives it may face issues such as “I read the termination notice, but I don’t understand why the contract was terminated.” So, how specific should the user be in pointing out the reasons for termination in the termination notice?

Should the Reason for Termination be Included in the Termination Notice?

Based on past court precedents, it is not necessarily essential to specify the reason for termination in the termination notice. The court case cited below involves a legal issue that arose due to a defect in the delivered system. When the user expressed their intention to terminate, the question arose as to how much they needed to understand the specifics of the defect and how specifically they needed to point it out. The court made the following statement regarding this issue.

In expressing the intention to terminate, it is not always necessary to indicate the cause of termination, and it is possible to terminate based on multiple causes with a single expression of intention. Unless there are special circumstances, such as clearly stating that termination will not be carried out for reasons other than those stated, the expression of intention to terminate is considered to be an expression of intention to terminate the contract entirely based on all reasons that existed at the time of termination.

Tokyo District Court, December 22, 2004 (Heisei 16)

The court’s view is that “it is possible to terminate based on multiple causes with a single expression of intention”. In other words, what is important is whether or not the contracting party has the intention to terminate, and there is no need to point out the detailed cause in detail.

Therefore, even if the product has been delivered, it is not necessary to question whether it should be treated as incomplete or whether it should be treated as a problem of warranty liability for defects due to serious defects at the stage of expressing the intention to terminate. Even if these subtle issues are set aside for the time being, if the intention to terminate is expressed first, it is possible to argue either performance delay or warranty liability for defects as the basis for termination, even if a lawsuit occurs later.

• If an incomplete product is delivered… → Breach of contract
• If a product with serious defects is delivered… → Warranty liability for defects

Even without specifying the cause in detail, the expression of intention to terminate is valid as an expression of intention to terminate.

However, there are also advantages to specifying the cause of termination in detail and presenting the termination notice, as it can clarify any misunderstandings or discrepancies in communication or perception with the vendor. For the recipient of the termination notice, if they can think of the cause, the worry of getting involved in a dispute later is reduced. Therefore, it is a fact that it is better to clearly state the cause of termination as much as possible.

What is the duration of a ‘reasonable period’ stipulated in a notice?

Another point to consider is the question of how long the ‘reasonable period’ mentioned in Article 541 of the Japanese Civil Code is. However, it is not necessary to be overly concerned about this. This is because even if a ‘reasonable period’ is not stipulated for the duration until the notice is given, if a reasonable period has elapsed from the notice, the contract can be terminated as a result. Also, even if the period until the notice was not a ‘reasonable period’, it has been clearly established in case law that the contract can be terminated once a reasonable period has elapsed.

In system development projects, in ‘fire’ cases where performance delays or warranty liability become an issue, it is unlikely that delivery or defect repair will be completed even if a notice is given stipulating a ‘reasonable period’. Taking these points into consideration, it is unlikely that serious disputes will arise over the ‘reasonable period’ in practice.

We explain the definition of performance delay in system development in another article.

https://monolith.law/corporate/performance-delay-in-system-development[ja]

What is the best way to notify a termination notice?

As for how to notify a termination notice, any method is acceptable as long as the notification ultimately reaches the recipient (moreover, if it can be proven later that it definitely reached them). Therefore, there is no need to be overly concerned about procedural issues.

Indeed, in practice, methods such as registered mail with return receipt are often preferred to avoid disputes over whether or not the notice was given. However, if it can be confirmed that the recipient received the notice, there is no problem with using simpler methods such as fax or email. However, if it ends up in court, you will need to prove that the notice “reached the other party”, and from this perspective, it can be said that registered mail with return receipt is safer.

Summary

In this article, we have organized information about contract termination in the context of system development. Understanding not only the practical know-how of termination but also the method of legally valid expression of intent should make this knowledge easily applicable.