Dismissing a Director in Japan: How Do You Navigate 'Justifiable Grounds' and Potential Damage Claims?

The decision to dismiss a director from a Japanese subsidiary is a significant one, fraught with legal complexities that differ notably from frameworks in other jurisdictions. While the Japanese Companies Act (会社法 - Kaishaho) grants shareholders the power to remove a director, this power is counterbalanced by the director's right to seek damages if the dismissal lacks "justifiable grounds." For multinational corporations overseeing Japanese operations, understanding this balance, particularly the nuanced concept of "justifiable grounds" (正当な理由 - seito na riyu), is critical to mitigating legal risks and financial exposure.

1. The Power to Dismiss: Procedural Mechanics

Under the Japanese Companies Act, directors can be dismissed at any time by an ordinary resolution of the shareholders' general meeting (Article 339, Paragraph 1). An ordinary resolution typically requires the presence of shareholders representing a majority of the voting rights and approval by a majority of the voting rights present, although the Articles of Incorporation (Teikan) can modify the quorum requirement.

Unlike some jurisdictions where "cause" must be explicitly stated for the dismissal resolution itself, Japanese law does not require the reason for dismissal to be part of the resolution for it to be procedurally valid. The critical factor for passing the resolution is securing the necessary majority vote. Therefore, an initial assessment of the subsidiary's shareholder composition and voting dynamics is essential.

However, the ease of passing the resolution belies the potential financial consequences that follow if the dismissal is contested.

2. The Risk of Damages: The Impact of Article 339, Paragraph 2

The primary concern for companies dismissing a director is Article 339, Paragraph 2 of the Companies Act. This provision states that a director dismissed without "justifiable grounds" is entitled to claim damages from the company for losses arising from the dismissal. This shifts the focus from the procedural act of dismissal to the substantive justification behind it.

This provision acts as a protective measure for directors, recognizing their legitimate expectation to serve their term unless serious reasons warrant premature removal.

3. Deciphering "Justifiable Grounds" (Seito na Riyu): The Core Legal Hurdle

The term "justifiable grounds" is not exhaustively defined in the statute, and its interpretation has been shaped by legal scholarship and judicial precedent. The underlying principle is to strike a balance between the company's (and its shareholders') legitimate interest in removing a director who is detrimental to the company and the director's interest in stable tenure.

Generally Accepted Categories of Justifiable Grounds:

• Acts of Misconduct or Breach of Duty: This includes clear breaches of a director's fiduciary duties, such as embezzlement, fraud, self-dealing without proper authorization, or actions taken in bad faith that harm the company.
• Violations of Laws or the Articles of Incorporation: Significant, deliberate, or repeated violations of applicable laws (including the Companies Act itself) or the company's own Articles of Incorporation can constitute justifiable grounds. For example, the Tokyo District Court, in a decision on December 18, 2014, found justifiable grounds where a director, without authorization, held a press conference and disclosed confidential personnel matters, thereby breaching their duty of care.
• Incapacity Due to Physical or Mental Illness: If a director becomes genuinely unable to perform their duties due to a severe and lasting physical or mental illness, this can be considered a justifiable ground. The Supreme Court on January 21, 1982, acknowledged a situation where a director's deteriorating health and need to focus on recovery could constitute justifiable grounds for dismissal.

More Challenging Categories:

• Gross Incompetence or Severe Lack of Ability: While many legal commentators and some court precedents suggest that a profound and demonstrable lack of competence or ability to perform directorial duties can be a justifiable ground, this is often the most difficult to establish. Mere underperformance or differences in management style are typically insufficient. The company must demonstrate a level of incompetence so severe that it objectively makes the director unfit for the role. For instance, an error in tax processing by an auditor was deemed a justifiable reason in a Tokyo High Court case on April 28, 1983. However, proving a director's gross incompetence requires substantial, objective evidence of their inability to fulfill the core functions expected of them, not just poor business results for which they might bear some responsibility.
• Judicial Interpretation: Courts tend to look for "objective circumstances where it is unavoidable for the company to judge that it cannot entrust the director with the execution of their duties." This was a definition provided by the Tokyo District Court on January 26, 2017. This implies a high threshold, requiring more than subjective dissatisfaction by shareholders or fellow board members.

Burden of Proof:

Crucially, the burden of proving the existence of "justifiable grounds" rests squarely on the company. If a dismissed director claims damages, the company must present a compelling, evidence-backed case to the court that the dismissal was indeed justified. This makes contemporaneous documentation of performance issues, misconduct, or other grounds absolutely vital. Vague assertions of "lack of ability" or "poor performance" without specific, documented examples and their impact on the company are unlikely to succeed as a defense.

4. Scope and Calculation of Potential Damages

If "justifiable grounds" cannot be proven, the company will be liable for damages. The general principle for calculating these damages is to compensate the director for the economic benefits they would have received had they completed their term of office. This typically includes:

• Remaining Remuneration: The salary or fixed fees the director would have earned for the rest of their appointed term.
• Expected Bonuses: Any bonuses the director could have reasonably expected to receive during the remainder of their term, based on past practice or contractual entitlements.
• Retirement Allowance (Taishoku Irokin): If the director would have been entitled to a retirement allowance at the end of their term (often based on internal company rules or established practice), a proportionate amount or the full expected amount might be claimable.

The potential quantum of damages can be substantial, particularly given that directors of non-public Japanese companies can have their terms extended up to ten years by the Articles of Incorporation. A director dismissed early in a long term could potentially claim several years' worth of remuneration and other benefits. This financial risk necessitates a careful cost-benefit analysis before proceeding with a dismissal that might be contested.

5. Post-Dismissal Consideration: Director Vacancies and Minimums

Dismissing a director can sometimes lead to the company having fewer directors than required by law or its own Articles of Incorporation.

• Statutory Minimums: As a reminder, a company with a board of directors must have at least three directors. A company without a board must have at least one.
• Articles of Incorporation: The Articles may stipulate a higher minimum number.
• Obligation to Appoint Successor: If a dismissal causes the number of directors to fall below these minimums, the company is obliged to take steps to appoint a new director (or directors) without delay to fill the vacancy. Failure to do so can attract a non-penal fine (過料 - karyo).

It's important to distinguish this situation from that of a "rights-and-duties director" (権利義務取締役 - kenri gimu torishimariyaku). When a director resigns or their term expires, and this results in a shortfall in the required number of directors, that director continues to hold the rights and obligations of a director until a successor is appointed (Article 346, Paragraph 1 of the Companies Act). However, this provision does not apply to a director who has been dismissed. The rationale is that it would be inappropriate for a director removed for reasons such as misconduct or unsuitability to continue exercising directorial duties. Therefore, in the event of a dismissal leading to a shortfall, the company cannot rely on the dismissed director to continue functioning; a new appointment is necessary.

A thorough review of the Articles of Incorporation concerning the number of directors is essential before any dismissal action.

6. The Lawsuit for Dismissal (Kainin no Uttae): A Shareholder's Tool

In certain circumstances, shareholders themselves can petition the court to dismiss a director. This is known as a "lawsuit for dismissal" (kainin no uttae) under Article 854 of the Companies Act.

• Triggering Conditions: This lawsuit can be initiated if:
  1. There has been misconduct or a serious violation of laws or the Articles of Incorporation in relation to the director's duties.
  2. A shareholder proposal to dismiss the director on these grounds has been rejected at a shareholders' meeting.
• Standing to Sue: The right to file such a suit is generally granted to shareholders who have held, for the preceding six months (this holding period may be shortened by the Articles of Incorporation and does not apply to non-public companies), not less than three-hundredths (3%) of the voting rights of all shareholders or of the issued shares (or a lesser proportion if stipulated in the Articles).
• Statute of Limitations: The lawsuit must be filed within thirty days from the date of the shareholders' meeting where the dismissal proposal was rejected.

This legal avenue is typically pursued in cases of clear wrongdoing or breach of duty rather than general dissatisfaction with a director's performance. It is a more confrontational path and underscores the importance of addressing serious directorial misconduct proactively within the company if possible. The PDF's case scenario mentioned a 10% shareholder contemplating action; such a shareholder would likely meet the general threshold for an Article 854 suit if the other conditions are met.

7. Strategic Alternatives and Risk Mitigation

Given the potential for damage claims and the high bar for proving "justifiable grounds," companies should consider alternatives and risk mitigation strategies:

• Negotiated Separation: Attempting to reach a mutual agreement for the director's resignation, often involving a severance package, can be a pragmatic way to avoid litigation and ensure a smoother transition.
• Waiting for Term Expiry: If the director's term is nearing its end and the issues are not critically urgent, allowing the term to expire and simply not reappointing the director is the safest way to avoid a damage claim under Article 339, Paragraph 2.
• Thorough Internal Investigation: Before any dismissal action, conduct a comprehensive and objective internal investigation to gather all relevant facts and evidence, especially if misconduct or severe incompetence is alleged.
• Legal Consultation: Seek expert legal advice early in the process to assess the strength of any "justifiable grounds," understand the potential scope of damages, and ensure procedural compliance.
• Clear Communication (with caution): While the reasons for dismissal don't need to be in the resolution, how the situation is managed internally and communicated (if necessary, to the director) requires careful handling to avoid exacerbating the situation or creating additional legal claims (e.g., defamation).

Conclusion

Dismissing a director in a Japanese subsidiary is a power available to shareholders but one that must be exercised with a keen awareness of the legal framework, particularly the director's right to claim damages for dismissal without "justifiable grounds." The ambiguity and high evidentiary threshold for "justifiable grounds," especially concerning performance issues, mean that companies face a significant risk if they cannot substantiate their reasons robustly. A proactive approach, involving careful documentation, thorough investigation, strategic consideration of alternatives, and expert legal counsel, is essential to navigate this complex area of Japanese corporate law effectively and minimize potential adverse consequences.