The misuse of company assets, known in Japanese as kaisha zaisan no fusei riyō (会社財産の不正利用), poses a significant threat to corporate integrity, shareholder value, and stakeholder trust globally. In Japan, a sophisticated legal and regulatory framework underpins corporate governance, aiming to prevent such abuses, which can range from embezzlement and unauthorized expenditures to self-dealing by directors. For international businesses operating in Japan or engaging with Japanese companies, understanding these governance mechanisms is not just a matter of compliance, but a crucial element of risk management and ensuring long-term sustainability.

Japan has, particularly over the last two decades, made substantial strides in reforming its corporate governance landscape. These reforms, driven by a desire to enhance corporate competitiveness and attract foreign investment, have placed increasing emphasis on transparency, accountability, and the effective oversight of management. This article provides an overview of the key aspects of Japanese corporate governance focused on preventing the misuse of company assets.

The Core Legal Infrastructure: The Companies Act

The cornerstone of corporate governance in Japan is the Companies Act (会社法 - Kaishahō). This comprehensive legislation outlines the structure of companies, the roles and responsibilities of corporate organs, and the duties of directors, all of which play a part in safeguarding company assets.

1. Directors' Duties: The First Line of Defense

Japanese law imposes significant duties on directors, the breach of which can lead to liability, especially in cases of asset misuse:

• Duty of Care (善管注意義務 - zenkan chūi gimu): Article 330 of the Companies Act, by referencing Article 644 of the Civil Code, establishes that directors have a duty of care of a good manager. This requires them to manage the company's affairs with the diligence expected of a reasonably prudent person in their position. Negligently allowing or failing to prevent the misuse of assets can constitute a breach of this duty.
• Duty of Loyalty (忠実義務 - chūjitsu gimu): Article 355 of the Companies Act mandates that directors must perform their duties loyally for the benefit of the company. This duty explicitly prohibits directors from prioritizing their personal interests or the interests of third parties over those of the company. Misappropriating company assets for personal gain is a clear violation of this fundamental duty.

2. Regulating Conflicts of Interest and Self-Dealing

To prevent directors from enriching themselves at the company's expense, the Companies Act has specific provisions for transactions involving conflicts of interest:

• Self-Dealing Transactions (自己取引 - jiko torihiki): Article 356, Paragraph 1, Item 1 specifies that a director intending to engage in a transaction directly with the company for their own account or for a third party's account must disclose material facts about the transaction to the board of directors and obtain its approval.
• Transactions Involving Conflicts of Interest (利益相反取引 - rieki sōhan torihiki): Article 356, Paragraph 1, Items 2 and 3 cover transactions where a director has an indirect interest that conflicts with the company's interest, or where the company guarantees a director's debt or engages in transactions with a director's close relatives or controlled entities. These also require board approval following disclosure.

The board's approval for such transactions must be properly minuted (Article 369, Paragraph 3). A director who participated in a board resolution approving a conflict-of-interest transaction that subsequently causes damage to the company may be presumed negligent in performing their duties (Article 423, Paragraph 3), and directors who engaged in self-dealing transactions are liable for damages caused to the company unless they can prove they did not breach their duties (Article 423, Article 428). These strict approval and liability rules are designed to deter and remedy the misuse of assets through conflicted dealings.

3. Criminal Liability: Special Breach of Trust by Directors (特別背任罪 - tokubetsu hainin-zai)

Beyond civil liability, directors who misuse company assets can face severe criminal penalties. Article 960 of the Companies Act defines the crime of Special Breach of Trust by Directors. This offense is committed when a director (or other specified corporate official) acts for the purpose of promoting their own interest or the interest of a third party, or for the purpose of inflicting damage on the stock company, and, in breach of their duties, causes financial harm to the company.

The penalties for Special Breach of Trust can include imprisonment for up to ten years and/or a fine of up to ten million yen. This criminal sanction underscores the gravity with which Japanese law views the abuse of directorial power for personal enrichment or to the detriment of the company. The existence of such a potent criminal deterrent plays a significant role in the overall governance framework aimed at preventing asset misuse.

Corporate Organs: Checks and Balances

The effective functioning of various corporate organs is central to preventing the misuse of company assets.

1. The Board of Directors (取締役会 - torishimariyaku-kai)

In most Japanese stock companies, particularly larger ones, the board of directors is the primary decision-making and supervisory body. Its responsibilities relevant to asset protection include:

• Supervision of Executive Directors: The board has a duty to oversee the conduct of executive directors to ensure they are managing the company appropriately and not misusing assets.
• Decision-Making on Material Matters: The board must approve significant transactions and business decisions, providing a forum for scrutiny of actions that could involve asset deployment.
• Establishment and Operation of Internal Control Systems (内部統制システム - naibu tōsei shisutemu): For large companies (as defined by the Companies Act, generally those with stated capital of ¥500 million or more, or total liabilities of ¥20 billion or more), the board is legally required to establish and maintain an internal control system (Article 362, Paragraph 4, Item 6 and Paragraph 5). These systems are crucial for, among other things, ensuring the reliability of financial reporting and the safeguarding of assets. A robust internal control system is a proactive measure against asset misuse.

The increasing appointment of outside directors (shagai torishimariyaku - 社外取締役) to Japanese boards, encouraged by the Corporate Governance Code, is intended to strengthen this supervisory function and reduce the likelihood of unchallenged asset misuse by management.

2. Audit Organs: The Watchdogs

Japan employs several models for corporate auditing, depending on the company's structure:

• Statutory Auditors (監査役 - kansayaku): In companies with a board of statutory auditors (kansayaku-kai setchi-gaisha - 監査役会設置会社), statutory auditors are independent officers responsible for auditing the directors' performance of their duties, including financial reporting and the management of company property. They have the power to investigate the company's affairs, request reports from directors and employees, and can take legal action in certain circumstances, such as demanding directors cease unlawful conduct.
• Audit and Supervisory Committee (監査等委員会 - kansa-tō iinkai): Companies can opt for an "Audit and Supervisory Committee" structure (kansa-tō iinkai setchi-gaisha - 監査等委員会設置会社), where this committee, composed primarily of outside directors, performs audit functions.
• Audit Committee (監査委員会 - kansa iinkai): In the "Company with Three Committees" structure (shi mei iinkai-tō setchi-gaisha - 指名委員会等設置会社), an Audit Committee, also composed of a majority of outside directors, is responsible for auditing and has significant oversight powers.

Regardless of the specific structure, these audit organs are tasked with ensuring that directors act lawfully and that company assets are properly managed and accounted for. They work in conjunction with External Auditors (会計監査人 - kaikei kansanin), typically accounting firms, who audit the company's financial statements. The findings of both internal and external auditors can be critical in uncovering and deterring asset misuse.

3. Shareholders (株主 - kabunushi): A Voice for Accountability

Shareholders also have mechanisms to hold management accountable and thereby contribute to the prevention of asset misuse:

• Right to Inspect Records: Shareholders have rights to inspect certain company records, including minutes of shareholders' meetings and, under certain conditions, accounting books and records (Article 433). This transparency can act as a deterrent.
• Shareholder Derivative Lawsuits (代表訴訟 - daihyō soshō): If directors have caused harm to the company through actions such as asset misuse, shareholders holding a certain percentage of shares (or even a single share for a specified period, depending on the claim) can demand that the company sue the directors. If the company fails to do so, shareholders can file a derivative lawsuit on behalf of the company to recover damages from the liable directors (Article 847). This is a powerful tool for enforcing directorial accountability.
• Shareholders' Meeting (株主総会 - kabunushi sōkai): The general meeting of shareholders has the ultimate authority to appoint and dismiss directors. Persistent concerns about asset management or governance can lead to challenges against incumbent directors.

The Role of Internal Control Systems

As mentioned, large companies are legally mandated to establish internal control systems. Even for smaller companies, implementing such systems is a best practice for preventing asset misuse. A well-designed internal control system typically includes:

• Clear Approval Processes: Documented procedures for authorizing expenditures, investments, and other transactions involving company assets, with appropriate levels of approval based on materiality.
• Segregation of Duties: Ensuring that no single individual has control over all aspects of a transaction (e.g., authorization, execution, recording, and reconciliation) to reduce opportunities for fraud.
• Regular Internal Audits: Independent internal audit functions that periodically review financial records, operational processes, and compliance with internal policies, specifically looking for irregularities or control weaknesses that could lead to asset misuse.
• Asset Management Policies: Clear policies regarding the use of company assets (e.g., vehicles, equipment, intellectual property) and regular inventories or checks.
• Whistleblower Systems (内部通報制度 - naibu tsūhō seido): Establishing confidential channels for employees and other stakeholders to report suspected misconduct, including asset misuse, without fear of retaliation. The Whistleblower Protection Act (公益通報者保護法 - kōeki tsūhōsha hogo-hō) provides certain protections for whistleblowers in Japan.
• Code of Conduct and Ethics Training: Promoting a strong ethical culture through a clear code of conduct and regular training for all employees and directors on their responsibilities and the importance of asset protection.

Specific Forms of Asset Misuse and Governance Responses

Corporate governance mechanisms are designed to counter various forms of asset misuse:

• Embezzlement and Fraudulent Accounting: Strong internal controls, regular audits by statutory auditors and external accountants, and the threat of criminal liability (e.g., for embezzlement - gyōmujō ōryō, or falsifying financial statements) are key deterrents.
• Excessive Executive Compensation: While not always "misuse" in a criminal sense, compensation perceived as grossly disproportionate to performance or company means can be a governance concern. In Japan, larger listed companies often have compensation committees (報酬委員会 - hōshū iinkai), frequently with outside director involvement, to ensure reasonableness and transparency. Shareholder approval is required for the aggregate amount of director compensation.
• Unjustified Expenses: Personal expenses disguised as business expenses, or lavish spending without legitimate business purpose, can be curbed by strict expense approval policies, diligent oversight by audit functions, and a culture of accountability.
• Self-Dealing and Undisclosed Related-Party Transactions: The Companies Act's strict rules on board approval for conflict-of-interest transactions are central. Transparency in disclosing such transactions is also crucial, often mandated by stock exchange rules for listed companies.

Consequences of Asset Misuse

When asset misuse occurs despite preventative measures, the consequences can be severe:

• Civil Liability: Directors can be sued by the company (or by shareholders derivatively) for damages caused by their breach of duties.
• Criminal Charges: As discussed, Special Breach of Trust and embezzlement carry significant criminal penalties. Other fraud-related charges might also apply.
• Reputational Harm: Scandals involving asset misuse can severely damage a company's reputation with customers, investors, and the public, leading to loss of business and a decline in market value.
• Regulatory Scrutiny: Depending on the industry and the nature of the company (e.g., listed companies are subject to stock exchange rules and Financial Services Agency oversight), regulatory bodies may investigate and impose sanctions.
• Dismissal of Management: Shareholders or the board may move to dismiss directors or executives found responsible for or complicit in asset misuse.

Japan's Governance Evolution: Continuous Improvement

The landscape of corporate governance in Japan is not static. Prompted by both domestic needs and global investor expectations, Japan has seen significant evolution:

• Japan's Corporate Governance Code: First introduced in 2015 and subsequently revised, this "comply-or-explain" code sets out principles for effective corporate governance for listed companies. It has been instrumental in promoting the appointment of independent outside directors, enhancing board diversity, and encouraging more robust risk management and compliance frameworks – all contributing to stronger safeguards against asset misuse.
• Stewardship Code: Aimed at institutional investors, this code encourages them to engage more actively with investee companies on governance matters, thereby exerting external pressure for better practices.
• Emphasis on "Offensive" and "Defensive" Governance: There's a growing recognition that good governance is not just about preventing wrongdoing ("defensive governance") but also about enabling effective and agile decision-making for corporate growth ("offensive governance"). However, the defensive aspects, including asset protection, remain foundational.
• Increased Shareholder Engagement: Both domestic and foreign institutional investors are becoming more vocal and active in engaging with Japanese companies on governance issues, including those related to the proper stewardship of company assets.

These trends collectively push Japanese companies towards higher standards of governance, which inherently strengthens mechanisms for preventing and detecting the misuse of assets.

Practical Implications for U.S. Businesses

For U.S. companies with operations, subsidiaries, or significant investments in Japan, several practical considerations arise:

1. Robust Subsidiary Governance: When establishing or managing a Japanese subsidiary, it's crucial to implement strong corporate governance structures from the outset. This includes appointing knowledgeable directors and statutory auditors (or structuring an appropriate committee system), ensuring clear reporting lines, and embedding a culture of compliance that respects both U.S. (e.g., FCPA) and Japanese legal requirements.
2. M&A Due Diligence: In any acquisition of a Japanese company, thorough due diligence must extend to its corporate governance practices, internal controls, and any history or red flags related to asset misuse. Identifying weaknesses pre-acquisition allows for corrective measures to be planned.
3. Understanding Local Roles and Responsibilities: The roles and expectations of directors, statutory auditors, and other corporate officers in Japan can differ from those in the U.S. system. Ensure that individuals appointed to these roles (whether Japanese nationals or expatriates) fully understand their duties and potential liabilities under Japanese law.
4. Integration of Global Policies with Local Law: Multinational companies should adapt their global ethics and compliance programs to the Japanese context, ensuring they align with and reinforce local legal requirements for asset protection and director conduct.
5. Training and Communication: Provide regular training to directors and employees in Japan on company policies, ethical standards, and legal obligations related to the proper handling of company assets. Clear communication channels for reporting concerns are also essential.

Conclusion: A Commitment to Integrity

Preventing the misuse of company assets is a fundamental objective of corporate governance in Japan, supported by a comprehensive legal framework centered on the Companies Act and complemented by evolving codes and best practices. Directors bear significant duties of care and loyalty, and specific mechanisms like board oversight, independent auditing, and shareholder rights are designed to ensure accountability and protect corporate property.

While Japan's system has its unique features, the underlying principles of transparency, accountability, and diligent stewardship are universally recognized as essential for corporate success and investor confidence. For U.S. businesses engaging with the Japanese market, a proactive and informed approach to corporate governance—one that understands and respects Japanese legal and cultural nuances while upholding strong ethical standards—is critical to mitigating risks and fostering a healthy, sustainable business environment. As Japan continues to refine its governance standards, ongoing vigilance and adaptation will be key to navigating this complex but vital area of corporate management.