Directors of Japanese companies are appointed by a general meeting of shareholders and are entrusted with management of the company. In a standard format company, directors also become members of the company’s board of directors, which makes decisions regarding the company’s operations.
The Board must also appoint one or more representative directors of the company, one of whom must be resident in Japan (though is not required to be a Japanese citizen).
This or these representative director(s) represent the company to third parties and conduct business activities on behalf of the company consistent with decisions of the board of directors (with day-to-day non-major business activities usually left to the representative director’s discretion).
Notwithstanding this freedom, the board of directors does have a duty to supervise the performance of the representative director. Non-executive directors too, have a duty to supervise, through the board of directors, the performance of duties by the company’s representative director(s). To enable this to occur, the representative director is legally obligated to report on the performance of duties to the Board at least quarterly (and to report on important matters of the company prior to applicable decisions being made).
The board of directors has both the authority (and the obligation) to terminate any representative director unfit for his/her position.
Duties of directors
Directors of a Japanese company have the following duties to the company:
(a) Duties of care and fiduciary duty, and of prudent management: These are based on a ‘business judgment rule’ test of whether or not the act is considered grossly unreasonable (i.e. whether or not there were careless mistakes in the recognition of facts and whether or not the choice of action based upon such recognised facts was unreasonable) in light of the knowledge and experience that a normal manager in the company’s industry should have under the circumstances surrounding the company at the time the action was taken.
Accordingly, in the performance of his/her duties, a director must pay attention to the company’s interests, must exercise sufficient care at the level generally required of a manager and must carry out his/her duties based on reasonable risk analysis. If a director has followed these guidelines no liability for damages on a personal liability basis should exist.
(b) Duty of supervision: Each director has the duty to not only supervise matters referred to the Board but also to supervise the representative director’s performance of his/her duties in general and, if necessary, convene or request convocation of a Board meeting and ensure through the Board that directors perform their duties appropriately. Depending on the size of the company, however, it is reasonable to assume that if the company is larger than a certain size it would be difficult for each director to supervise other directors in all their activities. In this case, if internal control systems have been put in place and operated in accordance with applicable rules, directors are allowed to trust that other directors have performed their duties in an appropriate manner.
(c) Duty to establish internal control systems: A director also has a duty to establish and maintain internal control systems. Accordingly, a board of directors is required to consider, decide and put in place specific systems that will effectively achieve the desired purposes, including prevention of unfair practices, risk management and appropriate performance of duties in accordance with the size, organisation and nature of the business activities of each company. Further, once such systems have been put in place, directors are required to check that the systems function effectively and ensure that they are actually operated in an appropriate manner.
Directors of a Japanese company are also subject to restrictions on competitive transactions and restrictions on transactions involving a conflict of interest.
In addition to Japan’s Corporations Law, a director must also comply with other laws relevant to his/her duties. In this respect each director is not required to have a full knowledge of all laws actually applicable to the company, but directors must, as a joint duty of the directors as a whole, establish internal control systems that enable the company to understand and comply with all laws applicable to the company (each director does have the duty to check and supervise these systems to ensure that they are functioning effectively).
Where a director has neglected his/her duties, s/he is liable to compensate the company for any damage incurred as a result of his/her neglect. Further, there are special provisions for directors’ liabilities in connection with the offering illegal profits in connection with the exercise of shareholders’ rights, illegal distributions of surplus and purchases of a company’s own shares, share purchases from dissenting shareholders, and liability for deficits following distributions of dividends and purchases of a company’s own shares.
A director’s liability to the company for damages may be exempted by the consent of all shareholders. However, liability for the illegal distribution of surplus and the purchase of a company’s own shares may be exempted, if permitted by the Articles of Incorporation of the company, up to certain limits (unless further exempted on the basis of both an absence of wilfulness and gross negligence of the director and the consent of all company auditors).
In the event a director has breached his/her duties with intent or gross negligence, s/he is liable to compensate any third party for damages incurred as a result of such breach. Further, where a director has engaged in any of the following activities, s/he is liable to compensate any third party for damages incurred as a result of such activities, unless s/he successfully proves absence of negligence (that is, a shift in the burden of proof to the director):
(i) providing false notice about any material information that needs to be notified when making an offering of shares, stock options, corporate bonds or bonds with stock options, or making false statements in explanatory documents that are used for any such offerings;
(ii) making false statements regarding any material information in a financial statement, business report or supplementary schedules attached to any of these documents, or any extraordinary financial statement; or
(iii) making a false registration or a false public announcement.
Directors’ criminal liabilities
Penal provisions of Japanese law include the crimes, among others, of special breach of trust, jeopardising company assets, using false documents, borrow-and-deposit, issuing extra shares, bribery, bribery in connection with the exercise of the rights of shareholders; and providing benefits in connection with the exercise of shareholders’ rights.
If a company fails to pursue any of the liabilities of one of its directors, a shareholder may sue the director by exercising the company’s rights on behalf of the company. In this respect a shareholder may sue: (i) any of the directors, accounting advisers, company auditors, executive officers, accounting auditors or liquidators to pursue such liabilities; (ii) any parties that received illegal benefits from the company in connection with the exercise of shareholders’ rights to demand return of such benefits; and/or (iii) any investors who subscribed for shares or stock options at unfair prices to demand payment of the difference between the unfair prices and corresponding fair prices.
In conclusion, directors of Japanese companies must maintain a normally-expected standard of care (in the context of their expertise) in performing their duties, and act in a manner consistent with their duty of care and their fiduciary duty to the company.
Directors will be liable to the company for breaches of the Articles of Incorporation of the company; acting consistent with unreasonable business judgment; failing to properly supervise others; and also where they compete with the company or engage in conflicting transactions without the prior approval of the board of directors.
A Director will be personally liable to third parties (including shareholders) for damage suffered by such third parties due to his/her wilful misconduct or gross negligence in performance of duties. Other directors who do not exercise a proper level of care in monitoring such directors may also be liable.
A director may also be held liable to third parties in tort for wilful misconduct or negligence (or for tortious wrongdoings) of company employees or corporate officers if the subject director is considered a person supervising the business of the company. A variety of criminal sanctions are also available to Japanese authorities in the most egregious circumstances.