Comparison of “Lost Profit” for Damage Calculation under Japanese Law
with German and United States Law
Hideki Kojima 1
Ⅰ

Japanese Civil Code and its Origin
The samurai class in Japan emerged and captured political power in 1192 when the

Minamoto Yoritomo clan established its government in Kamakura2 and the class continued tomaintain the political power over the nation until 1868, when the Emperor was restored to
power 3 .

During the Kamakura era, Houjou Yasutoki 4 issued written laws called“Jouei-shikimoku”5 in 1232, which is to be said the first legislation promulgated by the samurai
class.
The Meiji Restoration in 1868 drastically changed the nation and eventually thesamurai not only lost political power, but disappeared as a class. The four classes, samurai,
farmer, craftsman and merchant, were declared to be “equal”6.
Prof. Gustave Boissonade7, a French professor of law, came to Japan in 1873 to advise
the Japanese government on modernization of Japan’s legal system.
drafting a Civil Code8 by 1888.

He virtually completed

But the government leaders9 started to consider the German

system10 to be superior and the “German school”11 gradually became dominant among legal
scholars. This German ascendancy occurred not only in the legal field, but also in medicine
and other various fields.

The Prussian-French War of 1870-1871 ending in Prussian victory,

influenced Japanese leaders toward German technology and ideas for the then developing nationof Japan.
Despite the completion of the Civil Code draft by Prof. Boissonade, the Japanese
Government’s Civil Code Drafting Committee was formed in 1894 and completed the current
Civil Code which took effect in 1898.
Accordingly the fundamental basis of the Japanese Civil Code was the German Civil
Code and those basic ideas still maintain.

Ⅱ
1.

Damage Claim and Lost Profit under the Japanese Civil CodeIntroduction ― Issues
The Civil Code provides two important principles for damage claim.

One

is what the contents of damage claim would be, i.e., damage claim should place theaggrieved party into the position as if a contract was fully performed.
this “filling in gap” principle12.

We can call

Another principle is that the damage claim should beto the extent of “ordinary damage”.

Ordinary damage should be within adequate1causation, which cuts off the chain of events beyond the events arising naturally.
However, if there is damage beyond ordinary damage, and if foreseeable by thebreaching party, such damage can be claimed as special damage13.
The ordinary or special damage dichotomy is a little academic.

In practiceforeseeability is the more important issue in determining the amount of damage.
Among various types of damage claims, “lost profit” is an important issue in business
contract disputes.
expected.

If the contract was fully performed, certain profit would beUpon breach by one party, the typical “lost profit” issue arises.

The loss

could be (1) resale profit anticipated from a third party (“resale profit”), (2) value ofthe contract products if duly delivered (“use merit”), or (3) lost opportunity by abusiness of the use of the contract products resulting in loss of anticipated businessprofit (“business profit”).

No special damage rule applies to lost profit discussed

above and in most cases lost profits are considered ordinary damages.
I would like to analyze and discuss the calculation of lost profits in this paper,
because breach of a commercial contract usually triggers the issue of lost profit. Lost
profits of business entities tend to be large.

The term “profit” is widely used but asingle legal definition is never attempted.

2.

Accounting Definitions
For accounting purposes, “gross profit” (or gross margin) means the profit
obtained by deducting cost of production from the sales amount.
also called turnover.

Sales amount is

In the event that a business entity is a trading company, cost of

production can be cost of purchase or acquisition.
“business operating profit”.

Secondly, there is a concept called

This is the profit after deducting SGA14 from grossmargin. SGA includes most expenses such as salaries, office rent, traveling cost and soon.

If financial costs or gains are added to the business operating profit,

is called “ordinary profit” (or loss).

the result

Other concepts of profit are “pre-tax profit” (orloss) and “after tax profit” (or loss).

This is the profit after adjusting for

extraordinary gain or loss over the ordinary profit.

For example if factory land issold and the company gained certain profit, this is considered extraordinary gain and is
not included in turnover (sales) or SGA in case of loss.

Since this transaction does

not occur in the ordinary course of business, it is classified under the heading of“extraordinary gain or loss in the profit and loss statement”.

Pre-tax profit will

become after-tax profit after deduction of taxes due.
The accounting system enables the company to calculate the tax payable to
the government, and enables the business to assess whether or not it is viable.

When

operating profits are realized, but ordinary loss results the company could be2experiencing heavy financial burdens, for example.

3.

Legal Definition of Profit
Five categories of profits according to accounting usage of the word “profit”
are shown below:(a) gross profit (margin)(b) business operating profit(c) ordinary profit(d) pre-tax profit(e) after-tax profit

When damages are claimed for lost profits, the category of profit is not necessarily
properly defined in many legal writings.

Lost profit in the context of a damage claim

does not always fit the profit concept of accounting rules.

The “lost profit” needs tobe considered and defined for application to the particular case. The lost profit
damage claim should be defined in the context of “filling in gap” principle discussed
above.

For example, when a party to the contract is in a manufacturing business, andthe other party to the contract did not deliver components of manufacturing machines
on the due date, the manufacturer may have to stop operations until the components
are delivered and installed.

The manufacturer can calculate the difference of thestatus of the company’s worth if the contract had been fully performed timely and thecondition of the manufacturer because the operations were stopped or delayed by theother party’s breach.

The aggrieved party needs to be put into the position as if thecomponent had been delivered on the due date.
to satisfy the claim for damages.

This is the “filling in gap” principle

First, we need to determine the turnover for theperiod during which operations stopped.

Usually, turnover for this period will be

fictitiously determined by using the average turnover of the period of the past year.

If

that turnover is, say, US$ one million, should the lost profit be US$ one million? No,
that would not be a proper determination for the filling in gap theory.

The company

has employees’ salary expense every month, and the company pays office rent every
month and it can not decrease salary or office rent, despite the non-operation of thefactory for the delay period.

The company may use outside contractors to transport

manufactured products to customers on a day to day basis, and when factory
operations stop because there are no products, the company may be able to avoid
hiring outside transport contractors for the period.

These are some considerations forthe calculation of damages.
The “lost profit” has to be the averaged turnover minus averaged cost of3

production, minus only variable costs such as outside contractors. The company’ssalaries and rent can not be deducted because they can not be decreased for that
default period in proportion to non-operation of manufacturing facilities of thecompany.
Duty of mitigation on the part of the aggrieved party is applicable to lost
profit damages.

Only lost profits which could be realized by exercising due care byreasonable management will be allowed.

In other words, lost profit based on “fillingin gap” is conditional on proper excise of the mitigation duty.
The profit as discussed above falls under none of the profit accounting rules
such as (a) to (e) above.

We should not over-compensate or under-compensate by

wrongly applying the concept of profit.
Profit has to be the gross profit minus variable costs.

Variable costs mean

the costs which can be promptly saved by decisions of management without breaching
contracts and without creating unreasonable difficulties.
entirely or any part of fixed costs among SGA.
among SGA.

You can not deduct SGA

You can only deduct variable costs

That is the definition of legal profit I generally apply in order todelineate the legal lost profit of a damage claim.
Ⅲ

Comparative Points
Uniform Commercial Code (“UCC”) of the United Sates reads:
U.S. UCC§2-708 Seller’s Damages for Non-acceptance or Repudiation.
The measure of damages: the difference between the market price at thetime and place for vender and the unpaid contract price……less expenses
saved in consequence of the buyer’s breach…..
If inadequate to put the seller in as good a position as performance would
have done, then the measure of damages is the profit (including reasonable
overhead) which the seller would have made from full performance by thebuyer,…….

The first paragraph stipulates the “filling in gap” theory and mitigation duty.

The

second paragraph provides a basis for lost profit claim and defines profit to becompensated as the profit including reasonable overhead.
profit or operating profit.

This does not mean grossReasonable overhead includes reasonable SGA.

“reasonable” is not defined, but it is entrusted to case law.

What isWhite and Summers 15

takes the view to the effect that gross margin deducted by variable costs should be theprofit including reasonable overhead.

4

The famous English case of Hadley vs. Baxendale, Court of Exchequer, 1854, heldthat lost profit should consider consequential damages.

Plaintiffs, who operated amill, sued defendants, who were common carriers, for breach of a contract of carriage.
The delivery of a crank shaft was delayed five (5) days.

This precedent is fully followed by United States Courts. The case is famous for
upholding “lost profit” as damage, and the court used forseeability to award the lost
profit claim to the aggrieved party. This case was cited and discussed at the time theJapanese Civil Code Drafting Committee was working.

In this damage claim theory, the British law (and the United States common law) does
not differ from Japanese law.

English courts at that time were influenced by

European Continental jurisprudence and adopted European legal theories of lost profit
to include consequential damage.

The March 1, 2001 Federal Ordinary Civil Court Judgment of Germany-Bundesgerichtshof- seems in line with the view, i.e., lost profit is gross profit minus
variable cost.

German courts also have decided cases similar to my discussion here.

In other words,

the lost profit calculations are universal and common among Japan, Germany andUnited States.

Ⅳ

Application of Theory –Variable Costs and Fixed Costs
We can apply the lost profit theory to the case of a wrongful termination of a
distributorship agreement.

The aggrieved party distributor is entitled to claim lost

profit for the period wrongfully terminated.
＜SGA items for distributor＞
1) sales promotion(D)2) sales commission(V)3) packing, transportation, storage(V)4) advertisement and publicity(D)5) allowance for bad debts(V)6) directors’ compensation(F)7) salaries and employees’ other compensation(F)58) telecommunication and traveling cost(D)9) treatment expenses(D)10) wear and tear(D)11) depreciation cost(F)12) rent(F)13) research and development(F)

In the event that a supplier wrongfully stops sales of products, and the distributor
therefore becomes unable to sell, the distributor is likely to save the costs of 2), 3), 5).
These are marked (V) above for “variable cost”.

(F) are the costs which are usually

not affected immediately by the decrease of sales and are very difficult to be decreasedby management within a year or so. The “fixed cost” are 6), 7), 11), 12) and 13).
Those above marked (D) are costs which might be or might not be decreased by the
stoppage of sales of the products.

If decreased, 1), 4), 8), 9) and 10) are notproportionately decreased in accordance with the sales volume amount.

Hypothetical example

Turnover

1,000

Manufacturing cost

500

Gross profit

500

SGA

350

1) sales promotion

52) sales commission

43) packing, transportation, storage

84) advertisement and publicity

205) allowance for bad debts

36) directors’ compensation

207) salaries and employees’ other compensation

2008) telecommunication and traveling cost29) treatment expenses

210) wear and tear111) depreciation cost512) rent

5013) research and development30

6Operating net profit (income)150―ordinary profit covering interest, dividends exchange gain and loss
and extraordinary gain and loss are omitted―

Pre-tax net profit

100Comparison
Gross profit

500

Gross profit minus variable costs 2), 3) 5)

485

Gross profit minus SGA

150

Mitigation duty on the side of the aggrieved party does not necessarily justify the full
deduction of SGA items of (D) 1), 4), 8), 9) 10) to determine damages.

Each item of

SGA has to be analyzed, so that we can reasonably decide if deduction from grossprofit is justified.

In most cases, management has discretion to reduce (D) items suchas 1), 4), 8), 9), 10).
aggrieved party.
lost profit.

485 above should be, generally speaking, the appropriate amount of

If the lack of proper termination notice is for a year period, the lost profit

should be 485.

Ⅳ

But the law should not impose unreasonable burden on theIf six months, 242.5

Conclusion
I am not explaining accounting rules or accounting analysis, but addressing what theresults of the legal outcome should be in defining “lost profit”.
area is not frequently discussed.

For lawyers and judges, thisOnce determination is made to award a damage claim, theamount to be compensated is a great concern to clients and collectively to society and the nation.
The possibility of obtaining adequate damages motivates plaintiffs to initiate lawsuits.
Attached are a summary of recent court cases in Japan which indicate that the courts are divided
on the issue of “lost profit”.

(This paper is the edited version of my speech in Dusseldorf, Germany on October, 12 2010 atGerman Japanese Jurist Association)

7

1

Attorney at law, admitted in Japan bar in 1973, admitted in New York bar in 1981, practiced law in
New York and Dusseldorf, Germany in early 1980’s, senior partner of Kojima Law Offices
2

Minamoto Yoritomo established its first samurai government in Kamakura in 1192, being thegeneralissimo (shogun) for the subjugation of barbarians. Despite changes of warlords, the samurai
class continued to maintain its political power until 1868, when the Tokugawa shogun returned politicalpower to Emperor (the “Meiji Restoration”). The Kamakura Government began in 1185 anddiscontinued in 1333.
3

Tokugawa Yoshinobu, the 15th Shogun of Tokugawa, accepted advice of Yamanouchi Youdou, lord of
Tosa, part of present Shikoku Island, and decided to return political power to the Emperor.
4

Born in 1183, died in 1242. The third Shikken (Appointed Agent to exercise the power and role of
Shogun)5

It is officially called “Goseibai-Shikimoku”, comprised of 51 articles covering the succession of land
property, punishment of crimes, statute of limitations and others.
6

Meiji Government took the policy to treat four classes as equal.

7

7 June 1825- 27 June 1910.

He lived in Japan for 21years from 1873 to 1895.

8

The Civil Code he drafted was modeled after the French Civil Code and was adopted by the Japanese
Government but was revoked before implementation. It is, therefore, called the “ Old Civil Code”.
9

Ito Hirobumi and Saionji Kinmochi were involved in legislation policy.

10

Old Civil Code was heavily criticized by English law scholars in Japan.

11

Once the implementation of the Old Civil Code was waived, the drafting committee members used thefirst German Civil Code Draft as their main reference.
12

Damage causes the decrease of the entire assets of an aggrieved party. The portion of such decrease
has to be recovered through the operation of law. Damage claim is the amount of monetary claim to fillin such decreased portion, and not more than that.
13

Special or ordinary is a very academic distinction. Special damages are exceptionally recoverable
only when foreseeability is proved, while ordinary damage requires no foreseeability. But arguments onwhat constitutes ordinary damage would make such distinction fruitless.
14

Sales and general administration. This covers most business expenses including salaries, executive
compensation, factory operation costs, transportation, communication cost, energy cost and so forth.
15

James J. White and Roberts S. Summers “Uniform Commercial Code” Sixth Edition, (Page 366-387),
horn book of American law, widely used in the United States as Uniform Commercial Code commentary.

8

＜Exhibit＞

October, 2010

COURT CASES DEFINING LOST PROFITS IN JAPANHIDEKI KOJIMAClassification:
No. 1

Calculation based on gross profit

No. 2

Calculation based on gross profit minus variable costs

No. 3

Calculation based on net profit

No.1: Calculation based on gross profit
Court precedentabTokyo District Court
June 9, 2009
Hei 20（wa）No. 8895

Tokyo High Court
February 26, 1981
Sho 52（ne）No. 1940

Status

Facts

Plaintiff's Assertion

Defendant was a director of thePlaintiff corporation. The
Defendant resigned and began
working for a competitor of thePlaintiff. Defendant began
Plaintiff asserted that theproviding services to the Plaintiff's
Not
calculation of lost profitsclients.
appealedshould be based on grossPlaintiff claimed that the Defendant
profits.
breached the Defendant's noncompete oblifations and claimed
lost profits as damages.

Defendant supplier refused to sellgoods to the Plaintiff distributor,
because the Defendant felt that
there was a possibility that thePlaintiff would not pay for the
Plaintiff asserted that theNotgoods. Plaintiff sued for breach of calculation of lost profits
appealed contract and requested the court to should be based on grosscaluclate its lost profits based on profits.
the difference between the saleand purchase price of the
products.

Defendant's Assertion

The basis of the calculation oflost profits as determined by
the Court

Definition of the termsby the Court

The calculation of thePlaintiff's lost profits was
There is no definition of
Defendant generally denied based on the gross profits ofgross profit in thethe Plaintiff's assertions.
the immediately preceding
judgement.
fiscal year.

The calculation of thePlaintiff's lost profits was
Defendant's assertions are based on the difference
not mentioned in the
between the sales price andjudgment.
purchase price (i.e., grossprofits).

The judgment stated thatthe definition of gross profitsis the amount of profits after
the deduction of materialpurchases from the sales
amount.

No.2: Calculation based on gross profit minus variable costs
Court precedent

a

b

ｃ

d

Osaka District Court
May 21, 2009
Hei 20（wa）No. 6081

Tokyo District Court
December 12, 2006
Hei 15（wa）No. 18743

Nagoya District Court
April 28, 2005
Hei 16（wa）No. 1307

Tokyo High Court
March 7, 1989
Sho 63（ne）No. 1431

Status

Facts

Plaintiff's Assertion

Plaintiff asserted that thePlaintiff sued Defendant alleging
Notcalculation of lost profits
ingfringement of its trademark andappealedshould be based on grossclaimed lost profits as damages.
profits.

UnderappealUnder
appealDefendant's Assertion

Plaintiff sued Defendant alleging
infringement of its patent andclaimed lost profits as damages.

Plaintiff prepared to enter intobusiness with a customer.
However, the Plaintiff 's customer
was told by Defendant that Plaintiff
did not have good credit and as aresult, the customer refuse to enter Plaintiff claimed that theNotinto a business relationship withcalculation of lost profits
appealed Plaintiff.
should be based on
Plaintiff filed for a preliminary
marginal profits.
injunction to enjoin the Defendantfrom spreading rumor's about thePlaintiff's credit and claimed lost
profits as damages.

Definition of the termsby the Court

The calculation of the
Defendant asserted that
Plaintiff's lost profits was
The meaning of grossvariable costs should bebased on the amount after
profits, variable costs anddeducted from grossdeducting variable costs such fixed costs seem to be theprofits. However, theas sales commissions orsame as the meanings
Defendant did not assert
transportation costs fromascribed to them underthat fixed costs should begross profits.
accounting rules
deducted from gross profits.

Defendant was a director of thePlaintiff corproration andsubsequently resigned andPlaintiff asserted that theincorporated a company to"fixed expense" continues tocompete with Plaintiff. Defendantaccrue whether Plaintiff's
subsequently hired Plaintiff's
Defendant asserted thatsales decreased because of
employees and began providing
fixed expenses should not
Defendant's act or not,services to Plaintiff's clients.
be included in calcuclating
therefore such "fixed
Plaintiff claimed that the Defendantgross profits.
expense" should not cut off
was in breach of his duties as afrom the gross profit.
director and claimed lost profits
arising out of Defendant's actions.

Plaintiff claimed that thecalculation of lost profits
should be based on
marginal profits.

The basis of the calculation oflost profits as determined by
the Court

The judgment defines "fixed
expenses" as expenses,
such as depreciation or
The calculation of therent, incurred regardless of
Plaintiff's lost profit was
the Plaintiff's amount of
based on an amount after
sales .
deducting all expenses from Payroll costs of the Plaintiff
gross profits, except for fixed were not included in "fixed
expenses.
expenses". The judgement
stated that whether payroll
costs are variable depends
on the amount of sales

Defendant claimed that
The calculation of the
fixed costs should be
Plaintiff's lost profits wasdeducted from gross profits,based on marginal profits.
like variable costs.

The definition of "marginal
profit" of the judgement is
the amount after cutting off
the variable cost such as
material cost or freight costfrom the gross profit.

Defendant's assertions
were not mentioned in the
judgment..

The judgment defines"marginal profits" as theamount after cutting off thevariable cost such as
material costs or freight costfrom the gross profit.

The calculation of thePlaintiff's lost profits was
based on marginal profits.

No.3: Calculation based on net profit
Court precedent

a

b

c

Tokyo District Court
June 16, 2009
Hei 19（wa）No. 16291

Tokyo District Court
January 20, 2009
Hei 19（wa）No. 1590

Chiba District Court
Matsudo branch
July 16, 2009
Hei 20（yo）No. 6

Status

Facts

Plaintiff franchisee sued the
Defendant franchisor in breach ofcontract. Plaintiff claimed that the
Not
Plaintiff was forced to close
appealed because the Defendant used
outdated material and was inbreach of the franchise contract.

Plaintiff's assertion

Plaintiff asserted that fixed
costs should not be
deducted from gross profits
to calcurate lost profits.

Plaintiff was a shareholder ofCompany A in which the
Defendant was a director. The
Defendant resigned andincorporated a company tocompete with Company A. After
incorporating the company the
Plaintiff claimed that the
Defendant hired Company A's
Not
calculation of lost profits
employees and began providing
appealedshould be based on theservices to the clients of Company
gross profit.
A.
Plaintiff sued Defendant alleging
that Defendant breached his noncompete obligations and claimed
lost profits as damages.

UnderappealPlaintiff was s a shareholder ofCompany A in which Defendant
was a director. The Defendant
resigned and incorporated acompany to compete with
Company A. After incorporating
the company the Defendant hired
Company A's employees andbegan providing services to theclients of Company A.
The Plaintiff filed for preliminary
injunction and claimed that the
Defendant breached his duty of
non-compete obligations andclaimed lost profits as damages.

Plaintiff claimed that thecalculation of lost profits
should be based on grossprofits.

Defendant's assertion

The basis of the calculation oflost profits as determined by
the Court

Definition of the termsby the Court

The calculation of the
The meaning of grossPlaintiff's lost profits are to be
Defendant asserted thatprofits, variable costs andbased on net profits, after
fixed costs should be
fixed costs seem to be thededucting variable costs anddeducted from gross profits,
same as the meanings
fixed costs such as payroll
like variable costs.
ascribed to them undercosts, rent, depreciationaccounting rules
expenses from gross profits.

The calculation of the
The meaning of grossPlaintiff's lost profits are to be profits, variable costs andDefendant's claim is unclear based on net profits, after
fixed costs seem to be thein this judgement.
deducting fixed costs (in this same as the meanings
case, payroll costs) fromascribed to them undergross profits.
accounting rules

The calculation of the"Variable costs" is defined
Defendant asserted that
Plaintiff's lost profits are to bein the judgment as including
fixed costs should bebased on the amount after
fixed costs, such as payroll
deducted from gross profits, cutting off the variable cost
costs (e.g., thelike variable costs.
(the definition is in the right
remuneration of directors)..
block) from the gross profit.