Contractual disputes between main subcontracting entrepreneurs (who delegate tasks) and subcontractors (who undertake them), such as disputes regarding unjust reductions in subcontracting fees or failure to meet agreed payment deadlines, are not uncommon. In 1956, the Subcontract Act was enacted in Japan to protect subcontractors, who tend to be in a weaker position of authority than main subcontracting entrepreneurs.
Ignorance is no excuse when it comes to violations of the Act. The repercussions of a violation can extend beyond merely the risk of increased costs; they can also lead to credit issues and damage brand reputation for businesses. To help avoid these pitfalls, this article outlines the obligations of main subcontracting entrepreneurs and the actions they are prohibited from committing under the Act.
What’s in this article?
- What is the Subcontract Act?
- What sort of businesses and transactions are covered by the Subcontract Act, and what is its scope of application?
- What are the four obligations of main subcontracting entrepreneurs?
- What are the 11 prohibited actions as defined by the Subcontract Act?
- Frequently asked questions
What is the Subcontract Act?
The Subcontract Act is a law designed to curb any abusive practices by main subcontracting entrepreneurs—who often have a stronger bargaining position in transactions—and to protect subcontractors. For example, a main contracting entrepreneur reducing the subcontracting fee without a valid reason after placing an order would be deemed a violation of the Act.
What sort of businesses and transactions are covered by the Subcontract Act, and what is its scope of application?
The Act applies to a variety of transaction types, including manufacturing, repairs, creation of information-based products, and provision of services. Its applicability is determined by the amount of capital held by each of the contracting parties.
When subcontracting manufacturing, repair, creation of information-based products (programming), or service provision (transportation, warehousing of goods, and data processing):
- Transactions between main subcontracting entrepreneurs with capital of more than ¥300 million and subcontractors (including individuals) with capital of ¥300 million or less
- Transactions between main subcontracting entrepreneurs with capital of more than ¥10 million up to ¥300 million, and subcontractors (including individuals) with capital of ¥10 million or less
When subcontracting the creation of information-based products (excluding programming) and service provision (excluding transportation, warehousing of goods, and data processing):
- Transactions between main subcontracting entrepreneurs with capital of more than ¥50 million and subcontractors (including individuals) with capital of ¥50 million or less
- Transactions between main subcontracting entrepreneurs with capital of more than ¥10 million up to ¥50 million, and subcontractors (including individuals) with capital of ¥10 million or less
For more detailed information about applicable transactions, please refer to the Japan Fair Trade Commission website.
What are the four obligations of main subcontracting entrepreneurs?
The Subcontract Act lays out four key obligations for main subcontracting entrepreneurs:
The obligation to issue documentation
To prevent disputes arising from verbal orders, documents with specified content must be produced when placing an order. This documentation, often referred to as “Article 3 Documentation,” includes 12 items. Among these are the deadline for receiving the subcontractor’s deliverables, the amount of the subcontracting fees, and the payment deadline for these fees.
The obligation to set a payment deadline
Main subcontracting entrepreneurs must set as early a payment deadline as is feasible. This must be within 60 days from the date of receiving the goods or services provided, regardless of whether they have inspected the content of the deliverables within that time frame. If a payment deadline is not set, the law stipulates the following default deadlines:
- In cases where the parties have not set a payment due date, the due date defaults to the actual day the goods or services were received.
- If the payment due date is set for more than 60 days after the goods or services were received, even if there is an agreement between the parties to that effect, the deadline will be the day before the 60th day from the date of receipt.
The obligation to create and retain documents
Upon completion of a subcontracted transaction, main subcontracting entrepreneurs are required to create written records of the transaction and retain them for two years. These records must include details of the deliverables, the amount of the subcontracting fees, any changes to the amount of said fees, along with the reasons for those changes. Having been stipulated by Article 5 of the Act, this is also referred to as “Article 5 Documentation.”
The obligation to pay interest on late payments
If a main subcontracting entrepreneur fails to pay the subcontracting fees by the payment deadline, late payment interest accrues. The main subcontracting entrepreneur is obligated to pay interest on any late payments, at an annual rate of 14.6%. This interest begins accruing the day after a 60-day period has passed since the goods were received or the services provided, and it continues accruing until the date the payment is made.
What are the 11 prohibited actions as defined by the Subcontract Act?
The Act defines 11 prohibited actions for main subcontracting entrepreneurs.
Refusal to accept deliverables
Refusing to accept goods or services ordered where the subcontractor is not at fault. Example: A supermarket, citing excess inventory, cancels and refuses to receive a portion of the ordered goods.
Delayed payment of subcontracting fees
Failing to pay the subcontracting fees by the payment deadline, which is stipulated as being within 60 days after receiving the goods or services. Example: A business has a system of paying subcontracting fees after inspecting the deliverables, but it takes three months to do so (meaning payment is made more than 60 days after delivery).
Reduction of subcontracting fees
Reducing the predetermined subcontracting fees when the subcontractor is not at fault. Example: A video game manufacturer outsources the creation of character designs for an online game, but then later it reduces the agreed subcontracting fees, citing a decrease in production budget due to deteriorating business performance.
Returns
Returning received items when the subcontractor is not at fault. Example: An electronics manufacturer returns surplus parts due to changes in its production plans.
Abuse of bargaining power
Unjustifiably setting subcontracting fees significantly lower than the price of similar products or the going rate. Example: A building maintenance provider unilaterally sets the subcontracting fee significantly below the going rate without consulting the subcontractor, citing requests from the building owner to reduce cleaning fees.
Forced purchase or usage
Forcing the subcontractor to purchase or use specified goods or services (such as insurance or leases) without just cause. Example: During a sale campaign for its own products, a main subcontracting entrepreneur pressures subcontractors to buy products from it, setting targets for each subcontractor.
Retaliatory measures
Treating a subcontractor unfavorably for reporting the main contracting entrepreneur’s infraction to the Japan Fair Trade Commission or the Small and Medium Enterprise Agency.
Forced early payment for materials provided at a cost
When a subcontractor produces goods using materials provided for a fee by the main contracting entrepreneur, requiring payment for those materials before the subcontract fees payment deadline for the goods has elapsed. Example: A metal manufacturer requires a parts manufacturer (i.e., the subcontractor) to purchase six months' worth of materials from them, before paying the subcontractor for the products.
Issuing a promissory note that is difficult to discount
Issuing a promissory note for a subcontracting fee payment that is difficult to discount at an ordinary financial institution. Example: A clothing manufacturer issues promissory notes with a term exceeding 90 days (a term length permitted within the textile industry) as payment.
Requests for the provision of undue financial benefits
Forcing subcontractors to unfairly provide money, services, or other financial benefits. Example: As part of year-end financial closing measures, a subcontractor is asked to provide “support funds” and compelled to deposit these into a bank account designated by the main contracting entrepreneur.
Unjust changes to the content of deliverables and unfair requests for revisions
Changing the required deliverables of an order without bearing the concomitant costs, or making a subcontractor redo work after it has been delivered and accepted. Example: An industrial machinery manufacturer unilaterally changes the inspection standards for molds that had passed the previously agreed acceptance criteria, and demands a redo for no additional fee.
Frequently asked questions
What is the payment deadline under the Subcontract Act? When is the base date from which the payment deadline is calculated?
As explained in the “What are the four obligations of main subcontracting entrepreneurs?” section, main subcontracting entrepreneurs have an obligation to set a due date for payment. Main subcontracting entrepreneurs must set as early a payment deadline as is feasible. This must be within 60 days from the date of receiving the goods or services provided, regardless of whether they have inspected the content of the deliverables within that time frame.
What happens if a payment is late under the terms of the Subcontract Act? How much is the interest on late payments?
If payment is not made by the due date, it constitutes a violation of the Subcontract Act, and interest on the delayed payment will be incurred. The main subcontracting entrepreneur is obligated to pay interest on any late payments, at an annual rate of 14.6%. This interest begins accruing the day after a 60-day period has passed since the goods were received or the services provided, and it continues accruing until the date the payment is made.