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

As the globalization of business progresses, 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.

Because international contracts are markedly different from domestic ones, not fully understanding their structure 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.

The contracts conducted in international transactions often include:

• Sales and Purchase Agreements
• Licensing Agreements
• Distribution Agreements

On the surface, these resemble ordinary domestic agreements.

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.

The underlying reason is that each country has its own legal framework and commercial customs.

International and domestic contracts differ in various aspects such as their nature, roles, and structure. This is due to the differences in culture and rules between countries. To ensure smooth transactions, it is crucial to understand the differences between international and domestic contracts.

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.

However, the parties are, in principle, free to choose the language of the contract.

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

• Preparing a local-language version for dealings with authorities in the country of a foreign subsidiary
• 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 tool for risk management.

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 Contractual Agreements

There is a fundamental difference in the mindset when drafting international contracts compared to domestic contracts.

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, contracts are meticulously drafted to manage risks by anticipating various scenarios.

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.

In the case of international contracts, to manage risks, they often anticipate every possible scenario and incorporate detailed contractual clauses in advance. 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.

Thus, the differences between international and domestic contracts affect not only the volume but also the content of the contract documents.

Governing Law

Many international contracts are governed by the law of common law jurisdictions.

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.

The term “governing law” refers to the determination of which country’s laws will be used to interpret the contract in the event of a dispute. Relying on assumptions from domestic contracts, without considering differences in governing law, can create unforeseen issues. It is crucial to understand this to avoid potential troubles.

Determining the Governing Law for International Contracts

The governing law in international contracts is generally determined by agreement between the parties.

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, which can work to your disadvantage. Typically, the law of one of the party’s countries of residence or the law of a third country related to the subject matter of the contract is adopted.

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.

The selection of governing law should be coordinated with any agreement on jurisdiction.

If the countries designated in the governing law agreement and the jurisdiction agreement differ, the court will 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.

It is important to consider that if the countries designated in the governing law agreement and the jurisdiction agreement differ, it could potentially increase the burden on the parties involved.

As such, the decision on the governing law for international contracts is made by considering various factors. To ensure smooth transactions, it is crucial to carefully deliberate on the governing law.

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.

Let’s take a closer look at the rules governing the choice of law in international contracts.

Principles in Contractual Agreements

The governing law in international contracts is, in principle, the law of the jurisdiction designated by the parties in their choice of law agreement.

This is based on the principle of party autonomy as stipulated in Article 7 of Japan’s Act on General Rules for Application of Laws. (平成19年(2007年)法律第78号).

(Choice of Governing Law by the Parties)

Article 7: The formation and effect of a juridical act shall be governed by the law of the jurisdiction chosen by the parties at the time of the said act.

Act on General Rules for Application of Laws｜e-Gov Law Search[ja]

If a lawsuit is conducted in Japan, this Act on General Rules for Application of Laws will be applied.

The principle is that the governing law can be freely determined by the agreement between the parties, and such agreement will be adopted.

Principles in Tort Claims

In 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 through intent or negligence (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 claim for a tort, the rules in Article 17 and subsequent provisions of the Act on General Rules for Application of Laws, rather than Article 7, apply.

For example, Article 17 of the General Principles of Civil Law is stipulated as follows:

(Torts)

Article 17: The establishment and effect of a claim arising from a tort shall be governed by the law of the place where the result of the tortious act occurred. …

General Principles of Civil Law | e-Gov Law Search[ja]

As a concrete example, consider a ship carrying cargo under a contract with an American 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 American law.

Thus, when bringing a claim for a tort, the governing law is not determined by the agreement of the parties but is decided according to the provisions of the General Principles of Civil Law.

In the Absence of an Agreement on the Governing Law in a Contract

When there is no agreement on the governing law in a contract, the General Principles of Law provide a method for dealing with such situations.

First, it is necessary to examine whether there is an implied agreement between the parties. This is because Article 7 of the General Principles of Law includes not only explicit agreements but also implied agreements, such as tacit understandings.

If no implied agreement can be confirmed, the law of the jurisdiction most closely related to the contract (the most closely connected jurisdiction) will be adopted as the governing law (Article 8 of the General Principles of Law).

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

• The location where the personalityistic performance of the contract took place (Article 8, Paragraph 1 of the General Principles of Law)
• The location of the main place of business of the party who performed the personalityistic obligation (Article 8, Paragraph 2 of the General Principles of Law)
• The location of the real estate that is the subject of the contract (Article 8, Paragraph 3 of the General Principles of Law)

However, the implied agreement and the most closely connected jurisdiction are determined by considering various circumstances. There is a possibility that the laws of an unexpected jurisdiction may apply.

Therefore, it is important to explicitly state the governing law in the contract in advance.

Exceptions to the Agreed Governing Law in Contracts

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 the law of the land may apply regardless of the agreed governing law.

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 (Japanese General Law Articles 11 and 12).

It is important to be aware that there are exceptions to the agreed governing law in contracts, even when such an agreement is in place.

Important practical points are set out below.

There are several important considerations for businesses when entering into 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.

We will explain in detail the points to consider when entering into international contracts below.

Do Not Sign Without Careful Review

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

English-language 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.

English-language contracts not only differ in language but also contain many elements that are different from Japanese contracts. It is essential to thoroughly review them before signing.

Negotiate for Terms Favorable to Your Company

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 with a Lawyer

When entering into an international contract, it is crucial to consult with a lawyer before finalizing the agreement.

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 is everything in international agreements.

Japanese contracts often include a clause stating that “matters not provided for 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, problems occur.

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.

When it comes to mitigating risks in international contracts, the most important step is the review and negotiation of the contract before signing. We strongly recommend consulting with an experienced attorney to guide you through this process.

Guidance on Measures by Our Firm

Monolith Law Office is a legal practice with extensive experience in both IT, particularly the internet, and legal matters. In recent years, global business has been expanding increasingly, and the need for legal checks by experts is growing more than ever. Our firm provides solutions related to international legal affairs.

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