For U.S. businesses operating in Japan or appointing individuals to directorships within Japanese entities, a comprehensive understanding of the duties, responsibilities, and potential liabilities of directors is paramount. Japanese corporate governance is primarily dictated by the Companies Act (会社法 - Kaishahō), supplemented by evolving best practices outlined in instruments like Japan's Corporate Governance Code. This article delves into these obligations, offering insights particularly relevant from a U.S. perspective.

Core Duties of Directors under Japanese Law

Directors of Japanese companies, especially Kabushiki Kaisha (KK, or stock companies), are bound by fundamental duties derived from both the Civil Code and the Companies Act. These duties shape their conduct and decision-making.

1. Duty of Care of a Good Manager (Zenkan Chūi Gimu)

The foundational duty for directors in Japan is the "duty of care of a good manager" (Zenkan Chūi Gimu - 善良な管理者の注意義務). This principle originates from Article 644 of the Civil Code concerning mandate agreements and is extended to the relationship between a company and its directors (Companies Act Article 330). It requires directors to exercise the degree of care that a reasonably prudent person in a similar position, possessing ordinary skills and experience, would exercise in managing the company's affairs.

This duty is analogous to the "duty of care" in U.S. corporate law. It encompasses a broad range of responsibilities, including making informed decisions, overseeing business operations diligently, and ensuring the company complies with applicable laws and regulations.

The Business Judgment Rule (Keiei Handan no Gensoku)
While not explicitly codified in the same way as in some U.S. jurisdictions, Japanese courts have developed a doctrine similar to the business judgment rule, known as the Keiei Handan no Gensoku (経営判断の原則). Under this principle, courts generally refrain from second-guessing business decisions made by directors, provided the decisions were made:

• In good faith;
• Based on reasonably sufficient information; and
• Through a rational decision-making process, free from conflicts of interest or illegality.

If these conditions are met, directors are typically shielded from liability for breach of the duty of care, even if the decision ultimately results in losses for the company. This acknowledges that business inherently involves risk and that directors should not be unduly penalized for well-intentioned, informed decisions that turn out poorly. However, the scope and application of this rule can be nuanced and fact-dependent.

2. Duty of Loyalty (Chūjitsu Gimu)

Article 355 of the Companies Act imposes a "duty of loyalty" (Chūjitsu Gimu - 忠実義務) on directors. This requires directors to act faithfully in the best interests of the company. It is a more specific articulation of the overarching duty of care, emphasizing the fiduciary nature of the director's role.

The duty of loyalty in Japan parallels its U.S. counterpart, prohibiting directors from self-dealing or prioritizing their personal interests (or the interests of third parties) over those of the company. This duty underpins several specific prohibitions and approval requirements discussed later, such as those related to competitive transactions and conflict-of-interest transactions.

3. Other Key Duties

Derived from these core duties are several other important obligations:

• Duty to Comply with Laws, Articles of Incorporation, and Shareholder Resolutions: Directors must ensure their actions and the company's operations adhere to all applicable laws, the company's articles of incorporation (Teikan - 定款), and valid resolutions passed at shareholders' meetings (Companies Act Article 355).
• Duty to Establish and Maintain Internal Controls: While more explicitly emphasized for large companies and companies with an audit and supervisory committee or nominating committee, etc., there is a general expectation that directors will contribute to establishing and maintaining an appropriate system of internal controls (内部統制システム - naibu tōsei shisutemu) to ensure proper business operations and compliance (Companies Act Article 348(4), Article 362(4)(vi), Article 416(1)(i)(e)).
• Duty to Supervise/Monitor (Kanshi Gimu - 監視義務): Members of the board of directors have a collective responsibility to supervise the execution of duties by other directors, particularly the representative director(s) who manage daily operations (Companies Act Article 362(2)(ii)). Even individual directors who are not representative directors may have a duty to monitor activities within their purview and report concerns. Failure to adequately supervise can lead to liability.

Key Prohibitions and Approval Requirements

To uphold the duties of care and loyalty, the Companies Act imposes specific restrictions on directors' activities, particularly concerning transactions where their personal interests might diverge from the company's.

1. Prohibition of Competitive Transactions (Kyōgyō Torihiki no Seigen)

Directors are restricted from engaging in transactions that fall within the scope of the company's business for their own account or for the account of a third party without prior approval from the company (Companies Act Article 356(1)(i)).

• Scope: This applies to transactions that directly compete with the company's existing business activities.
• Approval Requirement: For a director to undertake such a transaction, they must disclose all material facts to the board of directors (or to shareholders if the company does not have a board) and obtain its approval (Companies Act Article 365(1) for board approval; similar principles apply for shareholder approval). The director concerned cannot participate in the board resolution for their own competitive transaction.
• Consequences of Breach: If a director engages in a competitive transaction without approval and causes damage to the company, they are presumed to have been negligent and can be held liable for such damages (Companies Act Article 423(2)). The profits gained by the director from the unauthorized transaction may also be deemed damages suffered by the company.

2. Regulation of Conflict of Interest Transactions (Rieki Sōhan Torihiki no Seigen)

The Companies Act also strictly regulates transactions where a director's interests may conflict with those of the company (Companies Act Article 356(1)(ii) and (iii)). These include:

• Direct Conflicts: Transactions between the director and the company (e.g., the director selling personal property to the company or buying company assets).
• Indirect Conflicts: Transactions between the company and a third party where the director has a personal interest that could conflict with the company's interest (e.g., the company providing a loan guarantee for the director's personal debt or for a company controlled by the director).

Similar to competitive transactions:

• Approval Requirement: The director must disclose all material facts about the proposed transaction to the board of directors (or shareholders) and obtain its approval (Companies Act Article 365(1)). The interested director is excluded from voting on the approval.
• Consequences of Breach: An unapproved conflict-of-interest transaction can be voided by the company. The director involved is liable for any damages caused to the company, and this liability is often considered strict unless it can be shown that the transaction was fair to the company and that the company suffered no damage. For direct transactions between a director and the company without board approval, the director is liable for damages unless they can prove they were not negligent in performing their duties concerning that transaction (Companies Act Article 423(3), Article 428).

Liabilities of Directors

Failure to fulfill these duties can expose directors to significant personal liability, both to the company and to third parties.

1. Liability to the Company (Ninmu Ketai Sekinin)

Directors are liable to the company for any damages caused by their neglect of duties (Ninmu Ketai Sekinin - 任務懈怠責任) (Companies Act Article 423(1)). This is the primary basis for internal corporate accountability.

• Grounds: This liability arises from any breach of the duty of care, duty of loyalty, or specific statutory obligations, including illegal acts or violations of the articles of incorporation.
• Damages: The director is liable for the actual damages suffered by the company as a direct result of their breach.
• Burden of Proof: Generally, the company (or shareholders in a derivative suit) bears the burden of proving the director's breach, the damages, and causation. However, as noted, in certain situations like unauthorized competitive transactions, negligence or the amount of damage may be presumed.
• Joint and Several Liability: If multiple directors are responsible for the breach, they are typically jointly and severally liable.

2. Limitations on Liability to the Company

Recognizing that the risk of extensive liability might deter qualified individuals from serving as directors, the Companies Act provides several mechanisms to limit or mitigate this liability:

• Exemption by Shareholder Resolution (Art. 424): Liability can be exempted by a resolution of a general meeting of shareholders, but only to the extent permitted by law (i.e., not for breaches involving bad faith or gross negligence, and subject to minimum liability amounts).
• Partial Exemption by Articles of Incorporation or Board Resolution (for specific types of directors, Art. 426): For directors who are not involved in business execution (e.g., outside directors), the articles of incorporation can allow the board of directors (or a majority of directors if no board exists) to exempt them from liability above certain statutory minimums, provided they acted in good faith and without gross negligence.
• Liability Limitation Agreements (Art. 427): Companies can enter into liability limitation agreements (sekinin gentei keiyaku - 責任限定契約) with non-executive directors, outside directors, statutory auditors, or accounting advisors, limiting their liability to the company to a pre-agreed amount (subject to statutory minimums), provided they acted in good faith and without gross negligence. This requires authorization in the articles of incorporation.
• Directors and Officers (D&O) Liability Insurance (Yakuin-tō Baishō Sekinin Hoken - 役員等賠償責任保険) (Art. 430-3): The Companies Act was amended in 2019 to explicitly permit companies to purchase D&O insurance for their directors and officers, covering defense costs and damages arising from liability claims. The company must obtain board (or shareholder) approval if it intends to cover certain types of claims, such as those arising from shareholder derivative suits, to avoid conflicts of interest.

3. Liability to Third Parties (Daisansha ni Taisuru Sekinin)

Directors can also be held liable to third parties (such as creditors, customers, or other stakeholders) for damages suffered due to the director's actions (Companies Act Article 429(1)).

• Grounds: This liability typically arises if directors acted in bad faith (悪意 - akui) or with gross negligence (重過失 - jūkashitsu) in the performance of their duties, causing harm to a third party.
• Liability for False Statements: Directors can also be liable to third parties for damages caused by false statements or material omissions in important corporate documents such as financial statements, share offering prospectuses, or other statutory disclosures (Companies Act Article 429(2)).

This third-party liability is a significant consideration, as it exposes directors to claims from outside the corporate structure.

Enforcement and Shareholder Litigation

The duties and liabilities of directors are enforced through several mechanisms.

1. Shareholder Derivative Lawsuits (Kabunushi Daihyō Soshō)

If the company fails to pursue claims against its directors for breach of duty, shareholders holding a certain percentage of shares (or a single share for a specified period, depending on the company type) can bring a derivative lawsuit on behalf of the company to recover damages from the directors (Companies Act Article 847).

• Procedure: Before filing a lawsuit, shareholders must typically demand that the company initiate legal action against the director(s) in question. If the company fails to do so within 60 days, the shareholders can proceed with the derivative suit.
• Trends: While not as frequent as in the U.S., shareholder derivative lawsuits are an established feature of Japanese corporate governance. They serve as an important tool for holding directors accountable, though the litigation costs and procedural complexities can be deterrents.

2. Dismissal of Directors

Directors can be dismissed from office at any time by a resolution of a general meeting of shareholders (Companies Act Article 339(1)). If a director is dismissed without justifiable cause before the expiration of their term, they may be entitled to claim damages from the company for losses arising from the dismissal (Article 339(2)).

Recent Trends in Japanese Corporate Governance

Japan's corporate governance landscape has been undergoing significant evolution, driven by a desire to enhance corporate value, attract foreign investment, and improve transparency and accountability.

1. Japan's Corporate Governance Code

First introduced in 2015 and subsequently revised, Japan's Corporate Governance Code (コーポレートガバナンス・コード) operates on a "comply or explain" basis. It sets forth fundamental principles for effective corporate governance, including:

• Securing the rights and equal treatment of shareholders.
• Appropriate cooperation with stakeholders other than shareholders.
• Ensuring appropriate information disclosure and transparency.
• Responsibilities of the board, including enhancing the role of independent outside directors (社外取締役 - shagai torishimariyaku).
• Constructive dialogue with shareholders.

The Code has spurred many Japanese companies to increase the number of independent directors, focus on board effectiveness evaluations, and improve their engagement with investors.

2. Stewardship Code

Complementing the Corporate Governance Code, Japan's Stewardship Code (スチュワードシップ・コード) encourages institutional investors to actively engage with investee companies to promote their sustainable growth and enhance medium- to long-term corporate value. This has led to more proactive involvement by investors in governance matters.

3. Implications for Foreign-Owned Subsidiaries

While the Corporate Governance Code primarily targets listed companies, its principles are increasingly influential for non-listed companies, including subsidiaries of foreign corporations. Foreign-owned subsidiaries may not be strictly bound by all provisions, but adopting relevant governance best practices can enhance their reputation, facilitate smoother operations in Japan, and align with the expectations of Japanese stakeholders.

Best Practices for U.S. Companies and Appointed Directors

For U.S. companies with Japanese subsidiaries and for individuals serving as directors in Japanese entities, several best practices can help navigate these duties and mitigate risks:

• Thorough Due Diligence: Conduct comprehensive due diligence when appointing individuals to directorships, ensuring they understand their obligations under Japanese law.
• Clear Mandates and Reporting: Establish clear mandates, responsibilities, and reporting lines for directors, especially within subsidiary structures.
• Robust Internal Controls: Implement and maintain effective internal control and compliance programs tailored to the Japanese legal and business environment.
• Cultural Understanding: Complement legal knowledge with an understanding of Japanese business customs, communication styles, and decision-making processes.
• Adequate D&O Insurance: Secure appropriate Directors and Officers liability insurance that provides coverage for activities in Japan, considering the recent legislative clarifications.
• Regular Training: Provide ongoing training to directors on their duties, liabilities, and the evolving corporate governance landscape in Japan.
• Informed Decision-Making: Ensure that all board decisions are made with sufficient information and proper deliberation, documenting the process where appropriate to support the application of the business judgment rule.
• Conflict Management: Implement clear procedures for identifying, disclosing, and managing potential conflicts of interest.

Conclusion

The legal framework governing directors' duties and liabilities in Japan is comprehensive and continues to evolve, particularly with the ongoing emphasis on strengthening corporate governance. Directors are expected to act with a high degree of care and unwavering loyalty to their company. Breaches can lead to significant personal liability to the company and third parties, with enforcement mechanisms like shareholder derivative suits in place.

For U.S. businesses, understanding these Japanese legal principles, how they compare with U.S. standards, and the practical implications of recent reforms is crucial for effective risk management, sound governance of Japanese operations, and fostering long-term success in the Japanese market. Proactive compliance and a commitment to governance best practices are key to navigating this complex but rewarding environment.