Crossing Borders, Sharing Responsibility? Director Liability in Japanese Parent Companies for Overseas Subsidiary Misconduct

Japanese Attorney at Law - Bengoshi L.L.

• 7 min read

In today's interconnected global economy, multinational corporate groups are the norm. Japanese companies, like their counterparts worldwide, operate extensive networks of subsidiaries across numerous jurisdictions. This global reach, however, brings complex governance challenges, particularly concerning the accountability of directors at the Japanese parent company for wrongdoing that occurs within these overseas affiliates. For US businesses partnering with, investing in, or involved in M&A activities with Japanese corporations, understanding the scope of parent company director liability for foreign subsidiary actions under Japanese law is a critical aspect of risk assessment and due diligence.

While directors primarily owe duties to the specific company whose board they sit on, Japanese law, like that of many other jurisdictions, recognizes that parent company directors cannot completely ignore the activities of their subsidiaries. The potential for liability arises primarily through the lens of the directors' fundamental duties and the legal requirements surrounding group governance.

The foundation for director liability in Japan rests on the Companies Act (会社法 - kaishahō). Key duties include:

  1. Duty of Care of a Good Manager (善管注意義務 - zenkan chūi gimu): Article 330 of the Companies Act, referencing Article 644 of the Civil Code, requires directors to manage the company's affairs with the care of a "good manager." This is the general standard against which director performance is measured.
  2. Duty of Loyalty (忠実義務 - chūjitsu gimu): Article 355 requires directors to perform their duties faithfully for the benefit of the company.

Crucially, for companies with a board of directors, the Companies Act mandates the establishment of systems necessary to ensure the proper conduct of business. This explicitly includes:

  • Group Internal Control Systems (内部統制システム - naibu tōsei shisutemu): Article 362, Paragraph 4, Item (vi) (and related provisions in the Ordinance for Enforcement of the Companies Act) requires the board of directors of large companies (and certain others) to decide on the basic policies for establishing systems "to ensure the properness of operations of the corporate group consisting of the Stock Company and its Subsidiaries."

This legal requirement to establish and oversee systems for ensuring group-wide operational propriety is a cornerstone for potential parent director liability related to subsidiary misconduct. Failure to establish such a system, or failure to ensure its reasonable operation, can constitute a breach of the directors' duty of care.

When Can Parent Directors Be Held Liable?

The core question is under what circumstances the failure of a subsidiary, particularly an overseas one, translates into a breach of duty by the directors of the Japanese parent company. Liability is generally not automatic merely because misconduct occurred at a subsidiary level. Courts typically look for a failure in the parent board's oversight function, often linked to the internal control system duty. Liability might arise if:

  • Inadequate Group Oversight System: The parent board failed to establish a reasonably adequate system for monitoring subsidiary risks and ensuring compliance across the group. This includes inadequate reporting lines, risk assessment processes, or group-wide compliance policies.
  • Ignoring Red Flags: The parent directors were aware of specific risks or received clear warnings ("red flags") concerning potential or actual misconduct at a subsidiary but failed to take appropriate action (e.g., investigate, intervene, implement corrective measures).
  • Direct Involvement: Parent directors were directly involved in, or approved, the decisions or actions at the subsidiary level that constituted misconduct.
  • Foreseeability and Causation: The harm caused by the subsidiary's misconduct was reasonably foreseeable from the parent directors' perspective, and their failure to exercise adequate oversight was a cause of the damage (either to the parent company itself through reputational harm or financial loss, or potentially to third parties under specific circumstances).

Insights from Case Law: The Nuance of Group Structure and Duty

A Tokyo District Court decision issued on April 22, 2021, provides a valuable, albeit specific, illustration of how these principles are applied, particularly concerning the impact of group governance structures.

The Case Scenario: The case involved a director (Y2) of a large Japanese parent company (Y1). Y2 also held positions within the group's Korean operations and was convicted in South Korea for breach of trust and bribery related to activities at Korean affiliate companies. A shareholder of Y1 sued in Japan to have Y2 removed from Y1's board due to this foreign criminal conviction. Evidence showed that Y1's direct ownership stake in the specific Korean entities involved in the misconduct was minimal or non-existent at the relevant times. Furthermore, the corporate group had implemented a distinct governance structure where its extensive Korean operations were primarily managed and overseen by key Korean entities (specifically named as Hotel Lotte and Lotte Shopping in the PDF commentary), and Y1's board was not expected, under this structure, to exercise direct operational supervision over those specific Korean affiliates' daily business execution.

The Court's Findings and Reasoning: The Tokyo District Court dismissed the shareholder's claim. Its reasoning highlighted several key points relevant to parent director duties:

  1. Scope of Director's Duties: The court determined that Y2's actions leading to the Korean conviction were performed in his capacity within the Korean group structure and related to the business execution of those Korean affiliates, not directly as part of his duties or business execution (shokumu no shikkō ni kanshi) for the Japanese parent company, Y1.
  2. Impact of Governance Structure: Crucially, the court considered the established group governance model. Since Y1's board was not designed or expected to directly supervise the specific operational activities of the implicated Korean affiliates, the court found that Y1's directors (including Y2 in his capacity as a Y1 director) did not have a direct duty of care (zenkan chūi gimu) to monitor or prevent those specific acts within the Korean entities. The responsibility lay within the designated Korean governance framework.
  3. Limited Connection: The minimal shareholding relationship further supported the view that Y1 did not have the requisite control or direct supervisory obligation in this specific instance.

(Note: The court also emphasized deference to the shareholders' decision not to remove Y2 upon his reappointment, as the misconduct was known at that time. While important for the dismissal claim, this aspect is less directly related to the underlying duty of care analysis regarding subsidiary oversight.)

Implications: This decision suggests that the existence of a well-defined, potentially decentralized, group governance structure, where specific responsibilities for subsidiary oversight are clearly allocated, can influence the scope of the Japanese parent company directors' direct supervisory duty regarding specific operational misconduct within a foreign subsidiary. Liability is not automatic; it requires a link between the director's duties to the parent company and the failure that occurred at the subsidiary level. If the parent board's role regarding that specific subsidiary function was intentionally limited by the group structure (and that structure itself wasn't inherently flawed), liability for specific operational failures might be less likely.

The Counterpoint: Liability for Oversight Failures

It would be a mistake, however, to interpret the April 2021 decision as granting parent directors immunity whenever a subsidiary is involved. As noted in legal commentary surrounding the case, other court precedents exist where parent company directors have been found liable for failures related to overseas subsidiaries. A contrasting Tokyo District Court judgment from February 13, 2020, reportedly found a director liable to the parent company for breaching their duty of care concerning actions taken while serving as the representative of an overseas subsidiary.

Liability remains a distinct possibility, particularly when:

  • The parent board fails fundamentally in its duty to establish and oversee a reasonable group-wide internal control and risk management system, as mandated by the Companies Act. The April 2021 decision did not absolve the board of this general duty; it merely found that the specific actions in Korea fell outside the scope of Y1's direct supervisory duty given the specific governance structure.
  • The parent board ignores significant red flags concerning subsidiary operations that are brought to its attention through established reporting channels.
  • The subsidiary's business is so critical or integrated with the parent that the parent board inherently retains a higher degree of direct oversight responsibility, regardless of formal structures.
  • The harm caused by the subsidiary's actions (e.g., massive fines, reputational catastrophe) was reasonably foreseeable at the parent level, and inadequate oversight contributed to the failure to mitigate that risk.

Establishing Effective Group Governance and Oversight

The requirement under Article 362(4)(vi) of the Companies Act necessitates more than just paying lip service to group governance. Parent company boards must ensure the systems they establish are reasonably effective. Key elements include:

  • Clear Reporting Structures: Mechanisms for subsidiaries (especially significant ones) to report financial performance, operational risks, and compliance issues to the parent company in a timely and accurate manner.
  • Group-Wide Risk Management: Processes for identifying, assessing, and managing material risks across the entire group, not just at the parent level.
  • Compliance Programs: Implementing core compliance policies (e.g., anti-bribery, competition law) throughout the group and monitoring adherence.
  • Information Flow to the Board: Ensuring that the parent board receives sufficient information to exercise its oversight function regarding major subsidiary risks.
  • Appropriate Autonomy vs. Oversight Balance: Defining the appropriate level of operational autonomy for subsidiaries while maintaining necessary oversight from the parent.

The specific design of these systems will vary depending on the group's size, complexity, industry, and geographic spread, but the underlying obligation to establish a reasonable framework remains.

Practical Considerations for US Businesses

The nuances of Japanese group governance and director liability have several practical implications for US companies:

  • Due Diligence is Critical: When considering a joint venture, acquisition, or significant partnership with a Japanese company, conduct thorough due diligence not only on the target entity but also on the parent company's group governance structure and its approach to subsidiary oversight. How are risks in foreign operations managed? What are the reporting lines?
  • Negotiating Joint Ventures: In JVs involving international operations, clearly define governance structures, board representation, information rights, oversight responsibilities, and liability allocation in the governing agreements.
  • Serving on Japanese Boards: US executives appointed to the boards of Japanese parent companies need to be aware of their oversight responsibilities regarding the entire group under the Companies Act. Similarly, those serving on the boards of Japanese subsidiaries of US companies should understand the expectations of the Japanese parent (if applicable) and local legal requirements.
  • Post-Acquisition Integration: When a US company acquires a Japanese business with its own subsidiaries, integrating these entities into the US parent's global compliance and risk management framework is crucial, while also ensuring continued compliance with Japanese legal requirements regarding group oversight.
  • Understanding Parent Influence: Conversely, if a US company is a subsidiary of a Japanese parent, understanding the parent's governance expectations and reporting requirements is essential for smooth operations.

Conclusion: A Fact-Dependent Assessment

The liability of directors serving on the board of a Japanese parent company for misconduct within an overseas subsidiary is not a foregone conclusion under Japanese law. It hinges on a detailed, fact-specific analysis centering on the directors' duty of care, particularly their obligation to establish and maintain reasonable group-wide internal control and risk management systems.

While specific group governance structures, like the one considered in the April 2021 Tokyo District Court case, can influence the scope of direct supervisory duty for specific operational matters, they do not eliminate the fundamental oversight obligation mandated by the Companies Act. A demonstrable failure by the parent board to implement or monitor a reasonable system for managing group-wide risks remains a significant potential source of liability. For US businesses and legal professionals engaging with Japanese corporate groups, appreciating this interplay between formal structures, directorial duties, and the practical realities of oversight is key to navigating cross-border risks effectively.