The Banking Litigation Law Review: Japan
No official statistical data on the number and trend of civil litigation cases involving banks and other financial institutions exists in Japan. It is widely believed, however, that the number of lawsuits between investors and financial institutions, one of the main categories from which banking litigation is generated, has decreased compared with the number of the same immediately following the post-global financial crisis era, after the bankruptcy of Lehman Brothers in 2008. This decrease is largely owing to Japan's recent improved economic situation, which benefits many investors, likely obviating their need to seek judicial redress in many instances. Be that as it may, in recent years, some lawsuits involving the banking sector have been heard, on which Japanese courts have handed down seminal decisions. In this chapter we introduce those court decisions and recent legislative developments, specifically reforms of Japan's Civil Code, which are likely to substantially affect future commercial litigation, including banking disputes. We also explain the major causes of and procedural issues related to banking litigation in Japan.
Significant recent cases
i Financial institution's liability regarding damages incurred due to embezzlement using bank account
In its decision dated 2 February 2017,4 the Tokyo High Court did not find a defendant bank (a Shinkin bank) liable for damages incurred by the plaintiff company that had alleged that the defendant failed to properly verify the identity of a bank account holder, thereby facilitating embezzlement by the plaintiff company's employee via a fictitious bank account with the defendant. Pursuant to regulations under the laws and government notice of Japan, banks and financial institutions owe a duty to follow identity verification procedures in relation to bank account holders when opening or withdrawing money from bank accounts. In this case, the plaintiff, which incurred damages due to the embezzlement committed by its employee, alleged (1) that the employee repeatedly transferred the plaintiff's funds without any authorisation to a fictitious bank account opened in the defendant and then withdrew the transferred money from the fictitious bank account for her own purposes; (2) that the defendant failed to conduct the necessary identity verification steps, which enabled the employee in question to open the fictitious bank account and withdraw money from the account; and (3) that the defendant's failure constitutes a tortious act for which the defendant is liable to the plaintiff for the damages it incurred due to the embezzlement. The Tokyo High Court upheld the Tokyo District Court's decision, which also did not find the bank liable in this case, holding that, even if the defendant had failed to follow the necessary identity verification procedures and such failure enabled the employee who committed the embezzlement to open and withdraw funds from that account, the defendant could not have specifically been aware that the fictitious bank account was being used for the embezzlement; therefore, the defendant's failure to follow the identify verification procedures does not constitute a tortious act, and the defendant is not liable for damages incurred by the plaintiff due to the embezzlement. This decision illustrates a clear distinction between a bank's duty under the relevant regulations regarding identity verification of account holders and the bank's civil liability towards those who incur damages due to transfers to and withdrawals from a fictitious bank account.
ii Excessive selling financial products to a customer
In its decision dated 3 March 2017, the Tokyo High Court addressed the issue of a financial institution's excessive selling of financial products to a customer that ultimately resulted in the customer incurring losses.5 In this case, a plaintiff alleged, among others, (1) that the defendant, a securities company, repeatedly advised and made proposals to the plaintiff to buy financial products notwithstanding that the plaintiff had consistently incurred losses from investing in similar financial products, and (2) that the plaintiff purchased these financial products in reliance on the defendant's advice and proposals, which constituted excessive selling of financial products by the defendant to the plaintiff, significantly deviating from socially acceptable standards. In its decision at first instance, the Tokyo District Court found the defendant liable for the plaintiff's loss, accepting the plaintiff's allegation that the defendant excessively proposed and sold financial products to the plaintiff. The Tokyo High Court upheld the decision of the Tokyo District Court regarding the defendant's liability on excessive selling of financial products to the plaintiff; however, the Tokyo High Court deducted 70 per cent of the damages incurred by the plaintiff, factoring in the plaintiff's negligence through reasoning such as that the plaintiff eventually purchased those financial products of his own accord. This decision gives some insight into Japanese courts' view as to how liability should be apportioned between financial institutions, which sell financial products to their customers improperly, and the customers, who purchase the financial products in reliance on the financial institutions' advice, but nevertheless still decide to enter into such transactions of their own accord.
Recent legislative developments
The Amendment to the Civil Code of Japan was enacted by the National Diet in May 2017 and promulgated in June 2017. Most of the amendments came into effect on 1 April 2020. Since this reform covers a wide variety of civil law issues, it is not feasible to explain it in its entirety in this chapter. Several reforms may substantially affect commercial litigation, including one involving banks. The examples of those reforms are in Section II.
i Reform on prescription
The Civil Code prior to the amendment stipulated 10-year extinctive prescription, where a claim was extinguished if not brought within 10 years of the date on which it became possible to exercise the right to do so, with some exceptions (e.g., where the period of extinctive prescription was shorter than the general rule, such as five years, for a claim arising from a commercial act). The amendment, which abolished the exceptions, introduced a new general rule: a claim is extinguished the earlier of five years after the claimant becomes aware that the right of the claim can be exercised or 10 years after the right of the claim can be exercised. In addition, the amendment introduced a new suspension on prescription, where the completion of the prescription period for a right and claim is suspended for a certain period, generally one year, if parties agree in writing to negotiate such right and claim.
ii New restrictions on personal guarantees
The Amendment imposes some restrictions on guarantee agreements entered into by individuals. One of the important restrictions is that a guarantee agreement is not effective if (1) the principal debt of such guarantee agreement is a monetary loan owed by the principal debtor for the debtor's business; or (2) such guarantee agreement is a revolving guarantee in which the scope of the principal debts includes the monetary loan owed by the principal debtor for the debtor's business, unless the individual guarantor expresses his or her intent in a notarised document to perform the guarantee obligations within one month preceding the execution date of the guarantee agreement.2 Further, if a guarantee agreement falls within the scope of (1) or (2) above, the principal debtor is required to provide certain information, such as the properties and income and expenditures of the principal debtor, to the individual guarantor when the principal debtor asks the individual guarantor to assume the guarantee obligations. A failure to undertake such obligations may cause the guarantee agreement to be subject to cancellation by the guarantor.
iii Change of statutory interest rates
The Civil Code and the Commercial Code prior to the amendment provided a fixed statutory interest rate of 5 per cent and 6 per cent per annum, respectively. The Amendment abolished those fixed statutory interest rates, and introduced a uniform floating interest rate, which is 3 per cent, but may be revised every three years in light of the average market interest rate. Most loan agreements involving banks and other financial institutions have a provision under which interest rates are prescribed; therefore, the change of statutory interest rates generally does not affect the practice in banking sector-related litigation as far as such loan agreements are concerned. However, this statutory interest applies to a tort claim, which is one of the main causes for customers to sue their banks and financial institutions, such as a claim of failure to explain, as described in Section IX. Therefore, this change may affect litigation involving financial institutions to that extent.
Privilege and professional secrecy
i Privilege and professional secrecy
While no concept exactly equivalent to attorney–client privilege exists, a similar type of protection over attorney–client communications is available under Japanese civil procedure.
Lawyers bear confidentiality obligations for information obtained from clients under professional ethics, and a breach of such obligations could subject the breaching lawyer to criminal sanctions.13 In connection with such confidentiality obligations, the facts that become known to a lawyer during the course of his or her professional engagement and that should be kept secret, are protected. Specifically, the rights of refusal (1) to give testimony on confidential information of clients14 and (2) to produce documents containing confidential information of clients15 are provided under the Code of Civil Procedure. Further, documents prepared exclusively for the internal use of document holders are protected from document production orders issued by courts.16
In connection to privilege and professional secrecy, no 'discovery' or other document or information-exchange process in the course of litigation exists in Japan. Instead, the Code of Civil Procedure provides for courts to make orders regarding document production; however, such orders are only available where a party succeeds in presenting the existence and identity of a document17 and where the necessity to produce the same as evidence exists.18 Further, several statutory exceptions exist under which the other party does not bear the obligation of document production.19 Given the general tendency that courts are prudent in granting orders on motions for document production, no substantial disclosure of documents between parties in civil litigation usually occurs.
Sources of litigation
There are various types of civil litigation involving banks and other financial institutions. Most such litigation is brought by customers of banks and other financial institutions, such as investors purchasing financial products from banks and the like, and customers who deposit money in their bank accounts. Another major source of banking litigation is for banks and other financial institutions to seek repayment of money against debtors or guarantors under a loan agreement or guarantee agreement, as well as those who seek enforcement of a mortgage right over assets of debtors, etc.
i Lawsuits between investors and financial institutions
One of the major types of litigation between financial institutions, including banks, and customers is those where investors sue the institutions for selling financial products that ultimately result in the investors incurring losses. In those lawsuits, in their complaints, investors seek refunds to the extent of their losses, and their typical arguments include the following:
- failure to explain the contents and risks of financial products;
- failure to evaluate the suitability of financial products to investors; and
- the purchase of financial products by fraudulent means by financial institutions or by mistake by investors.
These arguments often overlap, and are concurrently presented to the court. Each argument's effect differs from the other, as explained in the following subsections.
Failure to explain the contents and risks of financial products
The ASFI requires financial institutions to explain to its customers certain important information about the financial products stipulated thereunder at or before the time of sale of the financial products to the customer.21 If financial institutions fail to perform such duty of explanation, they will be held liable for the damages suffered by the said customer as a result thereof.22
In addition to the ASFI, the Supreme Court has held that, if a contractual party fails to disclose to the other party information that could affect the decision of whether to enter into the agreement, the other party may claim against that party damages incurred from entering into the agreement as a general tort claim.23 On the basis of this court precedent, investors often assert that financial institutions fail to disclose necessary information to them when selling financial products, which constitutes a tortious act, and that the financial institutions are responsible for the damages that they incurred.
The fulfilment of this duty to provide an explanation is generally considered from two different aspects: the scope of explanation and the manner and extent of explanation. Under the scope of explanation, the court essentially requires the financial institutions to explain the basic structure of the financial products in issue and the risk thereof,24 which are essential for investors to make well-informed decisions on the investment of the financial products at their own risk. Concerning the manner and extent of the explanation, the courts consider those factors by referring to, among others, the nature of the financial products and knowledge and experience that the specific investors involved had when the transaction was concluded.25
Failure to evaluate suitability of financial products to investors
A financial institution is required to evaluate a customer's suitability to a financial product in issue, in light of customer knowledge, customer experience and the state of customer assets or the purpose of the transaction in issue, pursuant to the FIEA.26 This requirement is called the 'principle of suitability', and the Supreme Court addressed the relationship between this principle of suitability and the liability of the financial institution violating this principle, holding that a material violation of the principle of the suitability, such as where a sales person of a financial institution offered to sell financial products that included excessive risks to such customers, may constitute a tortious act and cause the financial institutions to owe civil liability to the investor.27 This court decision is particularly important in that it affirmed the imposition of civil liability on the financial institutions, even though the principle of suitability is originally considered as a regulatory rule and not a direct cause of civil liability being imputed to financial institutions.
Fraud or mistake by investors
An investor sometimes argues that the contract of purchasing the financial products is void or can be cancelled owing to fraud by a financial institution or an investor's mistake regarding the structure and risks of the financial products. However, courts tend to accept such arguments in only limited circumstances, where, for example, a customer did not understand an essential part of the structure and risk of the financial product in issue owing to failure of the financial institution to perform its duty of explanation.28
ii Lawsuits between a non-investor customer and bank
In addition to lawsuits between investors and banks, lawsuits between non-investor customers and banks occasionally arise. In a typical case, customers with bank deposit accounts sue banks for non-performance of their duty under deposit agreements. For example, customers assert that banks reject their requests to withdraw money from their bank accounts without just cause. A typical reason for a bank to do so is that there is a dispute as to who has the legal right to withdraw money from the account. Another example of this kind of dispute is where customers allege that banks have negligently allowed a payment of money to be made from their bank account to unauthorised persons, and therefore, the banks remain responsible for paying such money to the customers.
In a recent, interesting court case regarding a dispute between a non-investor customer and a bank, a customer filed a lawsuit against a bank for the transfer of money to an incorrect bank account, asserting that such incorrect transfer of the money caused the customer to incur a loss.29 The Tokyo High Court held that such incorrect transfer constituted a failure of performance under a money transfer agreement between the bank and the customer and that the bank was responsible for the loss incurred by the customer. A unique feature of this court case is that the court determined the amount of damages awarded by referring to Article 248 of the Code of Civil Procedure, which provides that, if damage is found to have occurred, but, owing to the nature of the damage, it is extremely difficult to prove the amount thereof, the court may reach a finding on an amount of damages that is reasonable, based on the entire import of oral arguments and the results of the examination of evidence.
iii Lawsuits between a debtor or guarantor and bank
Another typical litigation source involving financial institutions, especially banks, is litigation related to banks' collection of repayments against a debtor and guarantor under a loan agreement or guarantee agreement. Those lawsuits are usually simple because, in many cases, banks clearly have the right to demand repayment against a debtor and guarantor under the relevant agreement. However, under some circumstances, guarantors assert that they misunderstood or were unaware of material facts related to the debtor and loan agreement in issue and that the guarantee agreement is void owing to such mistake. Under limited circumstances, the courts accept such assertion by the grantor and deny the bank's claim.
Further, this type of lawsuit often concurrently occurs with bankruptcy proceedings concerning the debtor. In those cases, the debtor had typically taken out a mortgage to borrow money from the bank or has a deposit account in the bank with which it has entered into a loan agreement. Therefore, disputes frequently occur as to whether the banks' right on the mortgage and bank account has priority over the bankruptcy proceedings.
1 Hironobu Tsukamoto is a partner at Nagashima Ohno & Tsunematsu NY LLP in New York and Hiroyuki Ebisawa is a partner at Nagashima Ohno & Tsunematsu in Tokyo.
2 This restriction is not applicable if the guarantee agreement is entered into by an individual who is involved in the principal debtor's business (e.g., in the case where the individual is a director of the principal debtor if the debtor is a corporation).
3 Article 5 ASFI.
4 Tokyo High Court, 2 February 2017, Hei 28 (ne) No. 4305, 1529 KINHAN 27.
5 Tokyo High Court, 25 October 2017, Hei 29 (ne) No. 2554, 1531 KINHAN 54.
6 Article 3, Paragraph 1 ASMCCP.
8 Article 3, Paragraph 2 ASMCCP.
9 For example, Article 156-44, Paragraph 2, Item 2 FIEA.
10 For example, Article 156-44, Paragraph 2, Item 3 FIEA.
11 For example, Article 156-44, Paragraph 6 FIEA.
12 Article 20, Paragraph 1; Article 23, Paragraphs 1 and 2 Civil Provisional Remedies Act.
13 Article 134, Paragraph 1 Criminal Code.
14 Article 197, Paragraph 1, Item 2 Code of Civil Procedure.
15 Article 220, Item 4(c) Code of Civil Procedure.
16 Article 220, Item 4(d) Code of Civil Procedure.
17 Article 221, Paragraph 1 Code of Civil Procedure.
18 Article 181, Paragraph 1 Code of Civil Procedure.
19 Article 220, Item 4 Code of Civil Procedure.
20 Article 3-4, Paragraph 1; Article 3-7, Paragraph 5 Code of Civil Procedure.
21 Article 3, Paragraph 1 ASFI.
22 Article 5 ASFI.
23 Supreme Court, 22 April 2011, Hei 20 (jyu) No. 1940, 65-3 MINSHŪ 1405.
24 See, e.g., Supreme Court, 7 March 2013, Hei 23 (jyu) No. 1493, 243 SAISHŪ MINJI 51; Supreme Court, 15 March 2016, Hei 26 (jyu) No. 2454, 1648 SAIJI 1.
25 See, e.g., Tokyo High Court, 19 October 2011, Hei 23 (ne) No. 3584, 1942 KINHŌ 114.
26 Article 40, Item 1 FIEA.
27 Supreme Court, 14 July 2005, Hei 15 (jyu) No. 1284, 59-6 MINSHŪ 1323.
28 Osaka High Court, 12 October 2010, Hei 22 (ne) No. 1476, 1914 KINHŌ 68.
29 Tokyo High Court, 14 September 2016, Hei 28 (ne) No. 938, 2323 HANJI 101.
30 Article 8, Paragraph 1, Items 1 and 3 Consumer Contract Act.