What to Check When Reviewing Termination for Cause and Termination for Convenience Clauses

Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.

In contract review, it is important to read carefully not only the conditions for starting a transaction but also the conditions for the "exit" that ends the contract. These clauses tend to receive little attention while business is going smoothly, but when the counterparty defaults, its creditworthiness comes into doubt, or the company's own business policy changes, the quality of the termination for cause and termination for convenience clauses can decide the outcome. If the requirements for termination for cause are too strict, the company cannot easily end the contract even when there is a breach, and if the burden of termination for convenience is too heavy, it remains bound by a contract it no longer needs. Conversely, if the company is in the position of the contractor or service provider, being subject to termination by the counterparty at any time and without conditions can throw off its plans for recovering initial costs and staffing.

When checking a contract's exit, oversights are easier to prevent if you check in the following order: whether even minor breaches are grounds for termination without demand; whether the advance notice period and termination fee for termination for convenience match the realities of the business; whether settlement of unpaid amounts and delivery of deliverables at termination are clear; and whether the scope of clauses that remain in effect after termination is appropriate.

The Different Nature of Termination for Cause and Termination for Convenience, and the Rules of the Civil Code

In contract practice, "termination for cause" (kaijo) and "termination for convenience" (chuto kaiyaku) are often confused, but the legal effect is not uniformly determined by the name of the clause alone. Here, for practical purposes, a mechanism for ending the contract on grounds such as the counterparty's breach or doubts about its creditworthiness is called "termination for cause," and a mechanism that allows one party to end the contract unilaterally during the contract term even without a serious breach is called "termination for convenience."

The main text of Article 541 of the Civil Code provides that if one party does not perform its obligation, the other party may demand performance specifying a reasonable period and, if there is no performance within that period, terminate the contract. However, if the non-performance at the time the period has elapsed is minor in light of the contract and socially accepted conventions in the transaction, the contract cannot be terminated (the minor non-performance exception). In addition, under Article 543 of the Civil Code, if the non-performance is due to reasons attributable to the obligee, termination under Article 541 or 542 of the Civil Code is not permitted. Furthermore, Article 542 of the Civil Code sets out the requirements for termination without demand, under which the contract can be terminated immediately without a demand where certain grounds exist, such as performance of the entire obligation becoming impossible or a clear refusal to perform the entire obligation.

In business-to-business contracts, it is usual to take these basic Civil Code rules as the premise and to list and agree on specific grounds for termination (payment delays, material breach of contract, filing for bankruptcy proceedings, etc.) individually in the contract. Note that the validity of insolvency termination clauses based on filings for bankruptcy proceedings and the like varies depending on the applicable insolvency procedure and the nature of the contract, so they should not be assumed to be always valid, and their effect needs to be examined.

Whether a Demand Is Required and Designing the Cure Period

What greatly affects how usable a termination clause is, is whether a demand requesting cure is required. Termination after demand is a procedure under which the contract can be terminated only after notifying the counterparty to cure the breach and no improvement is made within a reasonable grace period. Termination without demand is a mechanism under which, where the requirements of law or the contract are met, a party declares its intention to terminate without first making a demand for performance. It does not mean that even notice of termination becomes unnecessary.

A clause allowing immediate termination without demand for any minor breach of contract would make the contract harsh for the contractor or provider. Conversely, if, when events that shake the foundation of the transaction occur, such as unauthorized disclosure of confidential information, leakage of personal information, serious violations of law or loss of credibility, the company could terminate only after granting a grace period and making a demand every time, it would be difficult for the company to protect itself.

In practice, therefore, minor matters such as delays in reporting are made subject to a demand and a certain cure period, while highly bad-faith serious breaches, suspension of payments and the like are made grounds for termination without demand. When checking the clause, examine whether it is designed so that the contract could be cut off suddenly for a minor breach, whether termination without demand is secured for serious breaches, and whether the cure period set is a realistic number of days that the company can actually handle internally.

Conditions for Termination for Convenience and Adjusting for Investment Recovery

A termination for convenience clause secures the flexibility to end the contract mid-term for the company's own reasons even if the counterparty has not breached the contract. From the user's or commissioning party's side, the right to end the contract in response to changes in the business environment is desirable, but from the provider's or contractor's side, termination midway raises the risk of being unable to recover development investment, equipment costs and the cost of the staff it secured.

What adjusts this conflict of interest is the choice of whether to allow termination for convenience, the advance notice period required for termination, and the design of the amount of the termination fee (penalty).

Even if the contract has no termination for convenience clause, statutory rights of discretionary termination can become an issue, such as the orderer's discretionary termination in a contract for work (Article 641 of the Civil Code) and each party's discretionary termination in a mandate contract (Article 651 of the Civil Code). Article 641 of the Civil Code provides that before the work is completed, the orderer may terminate the contract by compensating for damages. In a mandate, compensation for damages becomes an issue where the conditions of Article 651, Paragraph 2 are met, such as termination at a time unfavorable to the other party, and there is also an exception where there is an unavoidable reason. The provisions on mandate apply mutatis mutandis to a quasi-mandate. Where the contract contains special provisions restricting termination or allocating costs, their content and validity should also be checked. It is important to align with the business department on the reasonableness of the termination conditions, including whether they are set at a level that allows initial costs to be recovered.

Settlement and Return after Termination, and Survival Clauses

A safe exit design requires not only the right to end the contract but also specific provisions for the practical wrap-up that accompanies termination. When a contract is terminated for cause or for convenience, a wide range of processes arise: settlement of unpaid amounts, refund of prepayments, handling of work in progress and inventory, delivery of deliverables, return of lent items, return or destruction of confidential information, deletion of personal information, suspension of system accounts, and export of accumulated data.

Especially in transactions handling personal information or confidential data, check the scope and method of return and deletion at termination, whether a certificate is required, and the procedure for recovery from subcontractors. Make the conditions workable, including the treatment of legally required retention and backups. In SaaS, securing the minimum subscription period and a data migration period after cancellation, and in outsourced development, delivery of source code in progress and whether it can be reused, become practical points of contention. In businesses that secure equipment and staff in advance, such as logistics, contract manufacturing and maintenance contracts, sudden termination can cause large unrecovered losses.

In a sale of goods, check separately how delivery obligations and payment obligations before delivery are handled, and how return and settlement after delivery are handled. In termination on the grounds of non-conformity, the notice period, the requirements for termination and any special contractual provisions are also relevant. In a license, check whether the cessation of use and any grace period for selling off inventory are consistent with each other.

Also check the scope of "survival clauses" that remain in effect after the contract ends. It is common for confidentiality obligations, liability for damages, dispute resolution clauses and the like to continue for a certain period after termination. However, a period such as "for three years after the end of the contract" is merely an example of what is agreed in practice, not a statutory period uniformly set by law. Also take care to ensure consistency with obligations under law to retain books and transaction records (legally required retention). If non-compete obligations, audit cooperation obligations and the like are designed to survive for an excessively long period, the company will remain unfairly bound by the counterparty even after the transaction ends, so assess whether the scope and period of the survival clauses are appropriate. Even when having AI list the grounds for termination, read together the related clauses that set out return, deletion and surviving obligations, and check the output against the original text. The scope of a monthly engagement for reviewing contracts including termination clauses is explained on our Legal Outsourcing page.