Laws and Regulations Relating to Japanese Real Estate

Land Leases

Under Japanese law, buildings can be owned independently of the underlying land upon which they are built. It is common in Japan for the owner of a building to differ from the owner of the underlying land. Owners of buildings must obtain a perfected leasehold interest in the underlying land.

Perfection

Under the Civil Code of Japan, in order to perfect a leasehold interest in the underlying land, the lessee is required to register its leasehold interest in the real estate register. However, the Land and Building Lease Act and its precedent legislation provides that the lessee is also able to perfect its leasehold interest in the underlying land by registering the ownership of the building standing on the land if the lessee owns such building. If the lessee does not duly perfect its leasehold interest in the land, the lessee cannot assert its leasehold interest against a new purchaser of the underlying land. The leasehold interest is also subject to any mortgage over the underlying land that is registered prior to the perfection of the leasehold interest in the land. The lessee, as a general rule, loses its leasehold interest to a prior registered mortgage if and when the mortgagee becomes entitled to foreclose on the premises. The mortgagee or its successor could then require that the lessee vacate the premises prior to the end of its lease term.

Transfer and Sublease

The transferability of a lessee's interest in a land lease depends on whether the lease is of the surface right (chijō-ken) or a leasehold right (chinshaku-ken). A surface right entitles a lessee to transfer its interest to a third party (or sublease the land) without the consent of the landlord. In the case of a leasehold right, however, any transfer (or sublease) of a lessee's interest is subject to the consent of the landlord, unless otherwise agreed upon in the land lease contract. In the event that the landlord refuses to give consent when the lessee transfers or subleases its leasehold interest in the land together with the transfer of the building standing on the land, the lessee may seek judicial permission for the transfer or sublease. A court may authorize the transfer (or sublease), unless such transfer or sublease would prejudice the landlord's rights. In making its decision, a court considers the length of the remaining term of the land lease, the history of the land lease contract, the circumstances requiring such transfer of the lease rights, and any other relevant facts.

In the event the owner of a building holds a subleasehold interest in the underlying land, and the contract between the owner of the land and the leaseholder thereof is terminated, depending on the circumstances of the termination, the owner of the building may not be able to assert its subleasehold interest against the owner and may lose the property as a result.

Termination

There are three special, fixed-term land lease contracts, or teiki shakuchi-ken:

• those that have a nonrenewable term of at least 50 years and contain a waiver by the lessee of its right to demand that the landlord purchase the building owned by the lessee at the end of the term;
• those that have a nonrenewable term of at least 30 years and provide that the building owned by the lessee must be sold to the landlord for reasonable consideration at the end of the term; and
• those that are to be used for business purposes only, notarized, and have a non-renewable term of between 10 and 20 years.

Other than the three special lease contracts above, a land lease contract is subject to the following conditions in favor of the lessee:

• the initial term of the contract is for a period of at least 30 years;
• the term of the contract is subject to extension by the lessee, unless the landlord has a justifiable reason for not agreeing to such extension in light of a number of factors, including the landlord's and the lessee's needs for the land for their own use, the history of the land lease contract, the present use of the leased land, and the amount of money the landlord is offering to pay the lessee to partially compensate the lessee for vacating the land; and
• if the contract is not extended or renewed at the end of the term of the land lease contract, the lessee has the right to demand that the landlord purchase any building on the leased land that is owned by the lessee at market price.

Building Leases

Contract Period

A building lease may have either a fixed or an indefinite term. If the building lease provides for an indefinite term or a term of less than one year, then the lease may be terminated on six months' notice. However, if the lease provides for a longer notice period, then this longer period notice must be given. If the lease is for a fixed term of one year or more, then it cannot be terminated prior to the end of that term, unless the lease specifically provides otherwise. In case of termination by the lessor, the lessor's notice is subject to the conditions set forth below.

Even if the lease is for a fixed term with one year or more, unless the lessor or the lessee notifies its intention not to extend the lease from between six months and one year before the expiration of the term, the lease is deemed to be extended without a fixed term.

The lessor may not make such notice of termination, or intention not to extend the lease, unless the lessor has a justifiable reason, taking into account:

• the lessor and lessee's need for the building for its own use;
• the history of the building lease contract;
• the present use of the leased building;
• the current condition of the building; and
• the proposal of payment from the lessor to the lessee.

Notwithstanding the above, if the lease contract is one known as teiki tatemono chintaishaku, for which it is clearly specified in writing, such as in a notarized document, that the building lease will not be extended and the lessee is explained of this feature in writing, the building lease will be terminated without any justifiable reason upon notice of termination of the building lease between six months and one year before the expiration of the term.

Tenant Leasehold and Security Deposits

Upon execution of a building lease, the lessee is usually required to pay a tenant leasehold deposit. The tenant leasehold deposit is paid by the lessee as security for rent and other obligations. The tenant leasehold deposit does not bear interest and any outstanding amount after deduction for any charges is usually refundable after the premises are vacated. Upon execution of a building lease, the lessee may also pay a tenant security deposit, which essentially guarantees the lessee's obligations to the lessor and sometimes bears interest. The tenant security deposit is fully or partially refundable either after a specified period of time has passed under the lease or at the end of the lease depending on the terms of the lease. The amounts payable for a tenant leasehold deposit and tenant security deposit vary from location to location and from case to case in Japan.

Adjustment of Rent

Generally, either party to a building lease may demand that the rent be increased or decreased in response to market conditions, even where a properly executed lease exists. If the parties cannot come to an agreement, a court may order an adjustment after considering the following:

• whether there have been any changes in tax or other liabilities imposed on the building and/or the underlying land, the value of the building and/or the underlying land and any other relevant economic conditions; and
• the rent in comparable leases in neighboring areas.

If the court determines that the rent should be decreased, the landlord will be ordered to return any excess rent collected and pay interest at a rate of 10% per annum for the excess amount.

With respect to a special type of building lease known as teiki tatemono chintaishaku, the rent may not be subject to adjustment.

Property Subject to Co-ownership

Co-ownership refers to a type of ownership where one party owns a certain percentage interest in the whole building or property and other owners own the remaining percentage interest.

Sale of Co-ownership Interest

A co-owner of a property subject to co-ownership is entitled under the Civil Code of Japan to sell its co-ownership interest to any person or entity without the consent of the other co-owners, unless an agreement between the co-owners requires the consent or grants a right of first refusal.

Sale of Property under Co-ownership and the Right to Partition

Sale or any other disposal of a property under co-ownership may not be made without the consent of the other co-owners. A co-owner may demand that a co-owned property be partitioned, giving each co-owner a right to a specific portion of the property that each co-owner may dispose of at its discretion. If co-owners cannot agree upon a partition, a court may be asked to intervene. If partition is not practicable, or if there is a risk of significant decrease in the value of the co-owned property in the event of partition, the court may order that the property be sold by public auction. Each co-owner would then receive the proceeds of the sale of the co-owned property on a pro-rata basis. The Civil Code of Japan permits the co-owners to agree not to exercise their right to demand partition of the co-owned property, subject to the following limitations:

• the agreement must be for a period of not more than five years, and any period of renewal must be limited to not more than five years;
• the agreement is not effective against a third-party purchaser of a co-ownership interest, unless the agreement is registered; and
• the agreement is not effective against a trustee of a co-owner in relation to which bankruptcy, corporate reorganization or civil rehabilitation proceedings have been commenced, although in these cases, the other co-owner(s) may purchase the co-ownership interest of the co-owner subject to such proceedings.

Co-owners generally decide on matters relating to the administration of co-owned properties by majority vote on the basis of co-owned property interest value, unless otherwise agreed among the co-owners; provided, however, that any conduct pertaining to the preservation of the co-owned property may be performed by each co-owner without such majority approval. Accordingly, a co-owner that is not able to get a majority share of the co-owned property interests may not participate in the administration of the co-owned property.

Claims and Obligations Relating to Properties under Co-ownership

When a co-owned underlying property is leased to tenants, the obligation of the co-owners to hold and refund the tenant leasehold deposits is generally considered to be joint and several, and the rents receivable by the co-owners are also deemed to be joint and several.

Property Subject to Stratified Ownership

Stratified ownership refers to a type of ownership recognized under the Law for Unit Ownership, Etc. of Buildings in Japan, or the Unit Ownership Law, whereby the building is divided into different portions, the majority of which are owned separately. The separate individual portions may be used for a variety of purposes, such as for a private dwelling, shop, office or warehouse. Properties subject to stratified ownership have two parts:

• private-use portions of the building, which a unit owner owns exclusively and can independently transfer; and
• common-use portions, which all, or several of, the unit owners of the building own together and are able to use jointly (such as the entrance area).

Owners of stratified ownership interests are entitled to sell their interests at their discretion. The consent of the other unitholders is not necessary, unless the rules of the unit owners provide otherwise. The Unit Ownership Law prohibits the separation of a unit owner's right to sell its stratified ownership interest in the building from its right to use the underlying building site, except as otherwise set forth in the rules of the unit owners.

Real Estate Registration System

There is a real estate registration system in Japan under which ownership of real estate, as well as certain other real estate-related rights, such as the right to use real estate or security rights over real estate, is registered. An owner of an unregistered real estate property or a holder of other unregistered rights cannot assert its title or rights against a third party.

The real estate register, however, does not necessarily reflect the true holder of the title or right. In practice, parties who plan to enter into a real estate transaction usually rely upon the register, as it is generally the best indication of the true owner of the real estate-related title or right. However, a party has no recourse to anyone but the seller if, relying on the register, it purchases real estate or a related right from a seller, and the information contained in the register turns out to be incorrect. The purchaser may seek reimbursement from the seller pursuant to statutory warranties or contractual warranties, but, in general, the purchaser cannot acquire the ownership of or title to the real estate.

Liabilities of the Owner of Real Estate Properties

Under Japanese law, if any damage has been caused to another person by reason of any defect in the construction or maintenance of a structure on land, the person in possession of the structure is liable to compensate the injured person for damages it suffers; provided, however, that if the person in possession has exercised due care in order to prevent the occurrence of such damage, the owner of the structure is liable for such damage.

It is customary to obtain third-party liability insurance over real property. However, in certain circumstances, insurance may not be available, or even if obtained, the insurance may not cover a liability in relation to the property.

A purchaser of real estate may in some instances seek reimbursement from the seller pursuant to statutory or contract-based warranties for liability to a third party that was caused by a defect in the property existing at the time of the sale. However, these warranties are sometimes limited or excluded or may prove insufficient if the seller lacks funds to compensate the purchaser for its loss.

Warranty Obligations

Unless contractually excluded, a seller of real estate property owes statutory warranty obligations to a purchaser for any latent defect in the real estate property. Statutory warranties are effective generally for one year from the date on which the purchaser becomes aware of the existence of the latent defect and can be enforced during this period by a cancellation of the underlying sale or by requesting damages from the seller. These statutory warranty obligations may be contractually excluded or substantially reduced in the sale and purchase agreement under which the real property is purchased.

Soil Contamination Control Law of Japan

Under the Soil Contamination Control Law of Japan, effective as of February 15, 2003, a current owner of real property may be held strictly liable for the removal or remediation of hazardous or toxic substances on or under such property, whether or not the current owner knew of, or was responsible for, the presence of such hazardous or toxic substances. In addition, the presence of hazardous or toxic substances, or the failure to properly remediate such substances, may adversely affect the owner's ability to dispose of the real property or borrow using the real property as collateral.