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Revision of Japan's Civil Code in Relation to Assignment of Accounts Receivable

Introduction

Comprehensive amendments to Japan's Civil Code have been enacted to revise the laws relating to contracts and other rights and obligations between the debtor and the creditor. These amendments cover various aspects and will take effect in April 2020. Specifically, the amended Civil Code changes the rules relating to the assignment of accounts receivable.

Validity of Assignment of Accounts Receivable Despite Transfer Restrictions

Under the current Civil Code (which was originally promulgated in the late 19th century), if the assignment of accounts receivable is prohibited or otherwise restricted, any purported assignment that is made in violation of the prohibition or restriction on the assignment ("transfer restrictions") shall be invalid. However, if the assignee is (with no gross negligence) unaware of the transfer restrictions at the time of the assignment, the assignee may validly acquire the accounts receivable. The rationale behind this old rule is to protect the interest of the account debtor who may not want the creditor to be changed (with the proviso intended to protect a good faith assignee). However, many people have come to think that accounts receivable should more easily be assignable so as to facilitate asset-based lending transactions, pursuant to which small- or medium-sized companies may raise funds.

The amended Civil Code changes the current rule such that (i) the assignment of accounts receivable with transfer restrictions shall be valid even though it is made in violation of the restrictions; however, (ii) if the assignee is aware or should have been aware of the transfer restrictions at the time of the assignment, the account debtor may refuse to pay the receivables to the assignee (Art. 4661). In the case of (ii) above, the assignee may demand that the account debtor pay to the assignor and, if the account debtor does not make such payment within a reasonable period, the account debtor shall not refuse to pay to the assignee. Anyway, the account debtor must pay either to the assignee or to the assignor.

If accounts receivable with transfer restrictions are assigned, the account debtor may discharge its payment obligation by depositing the amount payable in the official depository (Art. 466-2). Also, in the event that the assignor is declared bankrupt, the perfected assignee of accounts receivable with transfer restrictions may demand that the account debtor deposit the amount payable in the official depository (Art. 466-3). If such deposit is made, only the assignee may retrieve the deposited money.

Assignment of accounts receivable may be perfected vis-à-vis third parties in any of the following ways:

1. notice of assignment given by the assignor to the account debtor with date certification;

2. acknowledgment of assignment by the account debtor with date certification; or

3. registration of assignment at the registry office.

Under the amended Civil Code, the situation where an account receivable is assigned twice is dealt with as follows:

Example 1

Company A has an account receivable (with transfer restrictions) from Company B, an account debtor. On March 1, in violation of the transfer restrictions, Company A assigned the receivable to Company C (which knows of the restrictions), which assignment was perfected on March 5. On March 20, Company A assigned the receivable to Company D (which knows of the restrictions), which assignment was perfected on March 30.

In Example 1, as the assignment made in violation of the transfer restrictions is valid under the amended Civil Code, Company C prevails over Company D as between the assignees because the assignment to Company C is perfected earlier. Even if Company B waives the transfer restrictions and acknowledges the assignment in relation to the assignment to Company D only and pays the receivable to Company D, Company D cannot prevail over Company C. In such a case, Company D may not retain the payment made by Company B and has to surrender the payment to Company C.2

The amended Civil Code is expected to facilitate the assignment of accounts receivable to financial institutions and enable borrowers to raise funds by utilising asset-based lending. In this regard, the assignor of accounts receivable with transfer restrictions could be held liable to the account debtor for breach of the restrictions. If the account debtor (which is a customer of the assignor) is displeased with the breach, it may want to discontinue the business relation with the assignor by terminating the underlying agreement giving rise to the accounts receivable. In the context of asset-based lending, however, the assignee (secured party) is a financial institution that usually reviews the underlying agreement before entering into a loan transaction with the assignor and should, therefore, be aware of the transfer restrictions. If so, the account debtor may decline to pay the receivable to the assignee, but may pay the same to the assignor. It may be said that the account debtor would not be prejudiced by the assignment in violation of the restrictions as the account may continue to pay the receivable to the assignor, and it should not be able to terminate the underlying agreement.

Incidentally, the old rule is retained with regard to bank deposits. Any assignment of claims on bank deposits with transfer restrictions shall be invalid unless the assignee is (with no gross negligence) unaware of the restrictions (Art. 466-5). As it is widely known that assignment of bank deposits is generally prohibited, bank deposits cannot be assigned as a matter of practice. Also, transfer restrictions do not apply to a levying creditor of the person who holds an account receivable. Attachment on the account receivable shall be valid irrespective of whether the receivable is with or without transfer restrictions (Art. 466-4, para. 1).

Account Debtor's Defense and Right to Set-off

If an account receivable is assigned, the account debtor may assert against the assignee its defense that has arisen against the assignor by the time that the assignment is perfected vis-à-vis the account debtor by way of a notice to or acknowledgment by the account debtor (Art. 468, para. 1).

Also, in the case where an account receivable is assigned, the account debtor may set off its claim on the assignor against the receivable if the account debtor has acquired the claim before the assignment is perfected vis-à-vis the account debtor (Art. 469, para. 1). In addition, the account debtor may also exercise the right to set-off if its claim derives from the cause that has arisen before the assignment is perfected vis-à-vis the account debtor (Art. 469, para. 2, item 1).

Example 2

On July 1, Company S and Company P entered into a sale agreement pursuant to which Company S sells equipment to Company P for US$10,000. On July 10, Company S delivered the equipment to Company P. However, the equipment was defective and Company P acquired a damage claim against Company S in the amount of US$2,000.

On August 1, Company S assigned to Company T the account receivable (US$10,000) from Company P, which assignment was perfected by Company S giving notice thereof to Company P on August 5. Then, Company T demanded that Company P pay US$10,000.

In Example 2, Company P had acquired the damage claim before the assignment of the receivable to Company T was perfected. Therefore, Company P may set off its damage claim against the receivable assigned to Company T pursuant to Art. 469, para. 1 of the amended Civil Code.

Regarding Example 2, suppose that Company S delivered the equipment (which was defective) to Company P on August 20. In this case, Company P acquired the damage claim after the assignment of the receivable to Company T was perfected. However, the damage claim was derived from the sale agreement, which had been concluded before the perfection of the assignment. Therefore, Company P would be able to set off its damage claim against the receivable assigned to Company T pursuant to Art. 469, para. 2, item 1 of the amended Civil Code.

Acknowledgment of Account Debtor/Waiver of Defense

The pre-amended Civil Code provides that if the account debtor acknowledges the assignment without any objection, it cannot assert any available defense (which could be asserted against the assignor) against the assignee. In such a case, however, if the assignee is aware or should have been aware of the defense, the account debtor may assert the defense against the assignee.

The amended Civil Code abolishes the concept of "acknowledgment without objection". If the assignee wants the account debtor not to assert any defense that could be asserted against the assignor, it would be necessary for the account debtor to waive all available defenses.


  1. Reference to the article number hereinafter is to the amended Civil Code.
  2. Under the pre-amended Civil Code (which will be valid until the end of March 2020), if Company B waives the transfer restrictions in relation to the assignment to Company D only and pays the receivable to Company D, Company D prevails over Company C as between the assignees. This is because the assignment made in violation of the transfer restrictions is invalid, and the later assignment to Company D becomes valid due to Company B's waiver of the restrictions.