Written By: Shinji Itoh, Esq.
I. Concept of Foreign Direct Investment
Non-Japanese clients who are entering into a lease contract for an office space or a residence often find it difficult to understand the provisions in the contract. Some provisions of the law are mandatory despite the stipulations in a lease contract. In this article, we offer guidance on certain items in a lease which often confuse non-Japanese clients. The main sources of Japanese law on real estate lease are the Act on Land and Building Lease (shakuchi shakkka ho) (the “Act”) and the Civil Code (minpo).
Standard Lease vs. Fixed-Term Lease
A “standard lease (futsu chintaishaku)” refers to a lease with generally a term of one or two years, renewable. A “fixed-term lease (teiki chintaishaku)” refers to a lease with a fixed term, e.g., three years, non-renewable.
Under the Act, a lessor of a standard lease may not reject a renewal of the term unless the lessor has “justifiable reasons (seito jiyu)”. The justifiable reasons are determined by taking any relevant facts into consideration, such as the necessity for the lessor to use the building, current conditions of use by the lessee, and the payment of compensation by the lessor. If the lessor lacks any justifiable reason, the lease is deemed as renewed with the same conditions; provided that the term of the lease becomes “unspecified”. A standard lease with unspecified term may be terminable by notice of a lessor with a grace period of six months, but the lessor must again have justifiable reasons for the termination.
For a fixed-term lease, the Act requires a lessor to provide a written statement of non-renewable nature with a lessee when entering into a lease contract. The Act also requires the lessor to give notice of termination to the lessee one year to six months prior to the end of the term.
In general, unless otherwise specified in a lease contract, parties to a standard lease may not terminate the lease until the term expires.
Also, parties to a fixed-term lease may not terminate the lease until the term expires. Under the Act, however, a lessee of a residence of smaller than 200 square meters may terminate the fixed-term lease if he/she has unavoidable reasons such as transfer of work place, medical treatment or care of his/her relatives.
The case law has developed a “doctrine of destruction of the confidential relationship (shinraikankei hakai no hori)”. The doctrine restricts a lessor of a standard lease or a fixed-term lease from exercising its termination right for a reason of a breach of contract or any default event specified in the contract, unless such reason is tantamount to a destruction of the confidential relationship. For example, if a lessee fails to pay rent for one or two months, a lessor may not exercise its termination right under the contract. Under the doctrine, a court would not find that such failure would be tantamount to a destruction of the confidential relationship.
Parties may stipulate the rent on which they have agreed in the lease contract. Under Article 32 of the Act, a lessor or a lessee may claim increase or decrease in the rent if it becomes inappropriate due to increase/decrease in tax or other costs, changes in economic environment such as appreciation or depreciation of the asset value, or when compared with the level of the rent of the buildings of neighboring area. Typically, such a claim is settled through a court process.
If a contract of a standard lease stipulates no increase in the rent for a certain period, Article 32 of the Act does not apply to such standard lease. If a contract of a fixed-term lease stipulates provisions relating to amendment to the rent (including a provision not to increase the rent), Article 32 of the Act does not apply to such fixed-term lease.
Usually, a lessee is required to make deposit of money (shiki-kin) with a lessor to secure obligations of the lessee under the lease contract. The amount of such security deposit is typically two to three months’ rent for a residence, and six to twelve months’ rent for an office, but may vary depending on the area, the class of the building and so on. The security deposit is only returnable after the lessee has evacuated the leased space, minus any costs (such as cleaning) incurred by the lessor for the recovery. There is no legal obligation for a lessor to keep the security deposit in safe custody; so a lessee may need to confirm with a lessor whether it will cause any guarantee of a third party or any insurance to be available to secure the security deposit.
It is a standard practice that a lessee pays certain amount of money (typically in the same amount of the security deposit) to a lessor when they enter into the lease contract. This money is called a commission or “thank-you money (reikin)”, which is non-refundable.
In the downward trend in the leasing market, it appears that an increasing number of lessors would require little or no security deposit and/or commission. Usually, a licensed real estate broker acts as an intermediary between a lessor and a lessee. A lessee is required to pay a brokerage fee, which is regulated under the Building Lots and Buildings Transaction Business Act (takuchi tatemono torihikigyo ho). Under such Act, the broker must deliver an “explanation sheet of important matters (juyo jiko setsumeisho)” to a lessee, which describes detailed information on the building and the lease.