Distribution of Company Property to Shareholders in Japanese K.K.s: Understanding "Distribution of Surplus" and Source Regulations

Japanese Attorney at Law - Bengoshi L.L.

• 7 min read

One of the primary motivations for investing in a Kabushiki Kaisha (K.K., or joint-stock company) in Japan is the prospect of receiving a return on that investment through distributions of the company's profits. The Japanese Companies Act (Kaisha-hō) provides a detailed framework for how companies can distribute their property to shareholders, principally through what is termed "Distribution of Surplus" (jōyokin no bumpai). Central to this framework are stringent "source regulations" (zaigen kisei), designed to protect company creditors by ensuring that distributions do not impair the company's capital base. This article explores the concept of distribution of surplus, the critical importance of source regulations, how the distributable amount is calculated, and the consequences of making improper distributions.

The Concept of "Distribution of Surplus" (Jōyokin no Bumpai)

"Distribution of Surplus" is a broad term under the Companies Act that encompasses various ways a K.K. can return company property to its shareholders. The most common forms include:

  1. Dividends from Surplus (Jōyokin no Haitō): This is the regular payment of cash (or sometimes other assets, known as dividends in kind - genbutsu haitō) to shareholders out of the company's accumulated profits.
  2. Acquisition of Treasury Stock for Consideration (Taiyūka Jiko Kabushiki Shutoku): When a company repurchases its own shares from shareholders for cash or other assets, this is also considered a form of distribution of surplus, as it involves an outflow of company property to shareholders.
  3. Other distributions of company property to shareholders that are not purely a return of capital (e.g., certain reductions of capital surplus or retained earnings that are then distributed).

The common thread is that these actions involve transferring economic value from the company to its shareholders.

Rationale for Source Regulations (Creditor Protection)

The Japanese Companies Act imposes strict "source regulations" on any distribution of surplus (Article 461). The primary rationale for these regulations is the protection of company creditors.

  • Shareholder Limited Liability: Shareholders of a K.K. enjoy limited liability, meaning their personal assets are generally shielded from the company's debts. Creditors, therefore, can only look to the company's assets for repayment.
  • Maintaining Capital Base: The company's capital (stated capital and capital reserves) serves as a crucial buffer or "guarantee fund" for creditors. If a company were allowed to freely distribute its assets to shareholders without regard to its financial health or capital levels, it could deplete the resources available to satisfy creditor claims, undermining the principle of limited liability and potentially leading to unfair outcomes for creditors if the company subsequently becomes insolvent.
  • Balancing Interests: Source regulations aim to strike a balance between the shareholders' legitimate expectation of receiving returns on their investment and the creditors' need for a degree of assurance that the company will maintain sufficient assets to meet its obligations.

Thus, the core idea is that distributions to shareholders should only be made from "surplus" – that is, from amounts exceeding the company's core capital and necessary reserves, ensuring the "maintenance of capital" (shihon iji no gensoku).

Determining the "Distributable Amount" (Bumpai Kanō Gaku)

Article 461, paragraph 2 of the Companies Act stipulates that distributions of surplus can only be made up to the "Distributable Amount" (bumpai kanō gaku) as of the effective date of the distribution. The calculation of this distributable amount is complex and is detailed in the Companies Act Calculation Rules (Kaisha Keisan Kisoku).

A simplified conceptual overview of the calculation is as follows:

Distributable Amount = (A) Net Assets - (B) Sum of Certain Non-Distributable Items

Where:

(A) Net Assets (Jun-shisan Gaku):
This is derived from the company's balance sheet and generally represents Total Assets minus Total Liabilities.

(B) Sum of Certain Non-Distributable Items:
These are amounts that must be retained by the company and cannot be distributed, primarily to protect the capital base. They typically include:

  1. Stated Capital (Shihonkin): The par value or stated amount of issued shares, representing the core capital contributed by shareholders.
  2. Capital Reserves (Shihon Junbikin): Amounts set aside from share issuance premiums (amounts paid by shareholders in excess of stated capital) and other capital transactions. The Companies Act requires that at least half of the issue price of new shares (less the portion allocated to stated capital) be credited to capital reserves.
  3. Retained Earnings Reserves (Rieki Junbikin): A portion of profits that must be set aside as a reserve until the total of capital reserves and retained earnings reserves reaches one-quarter of the stated capital (Article 445, paragraph 4). Companies must set aside one-tenth of the amount disbursed as dividends from surplus as retained earnings reserves (or as capital reserves) at each distribution until this threshold is met.
  4. Other Legally Required Reserves: Such as specific reserves mandated by the articles of incorporation or certain revaluation reserves.
  5. Goodwill and Deferred Assets (if carried on the balance sheet under certain conditions and not offset by reserves): These are often deducted as they may not represent readily distributable value.
  6. Net Unrealized Losses on Certain Assets: For example, net unrealized losses on available-for-sale securities might be deducted under certain circumstances to ensure distributions are made from realized profits or actual surplus.
  7. Treasury Stock (Jiko Kabushiki): The book value of any treasury stock held by the company is also deducted, as distributing funds while holding significant treasury stock purchased with company funds could be seen as an indirect way of impairing capital.

The precise calculation involves many detailed rules and adjustments outlined in the Companies Act Calculation Rules, considering factors like the timing of distributions (e.g., year-end dividends vs. interim dividends), and any specific capital or reserve reduction procedures the company may have undertaken.

Key Concepts in Calculation:

  • "Surplus" (Jōyokin) vs. "Distributable Amount": It's important to distinguish between the accounting concept of "surplus" (which generally refers to the sum of capital surplus and retained earnings as shown on the balance sheet) and the legally defined "Distributable Amount." The Distributable Amount is the actual legal limit for distributions and is derived from the surplus after making various statutory adjustments and deductions to ensure capital maintenance.
  • Snapshot Principle: The Distributable Amount is calculated as of a specific point in time (the effective date of the distribution).

Procedures for Distribution of Surplus

The decision to distribute surplus (e.g., to pay dividends) is typically made by a resolution of the shareholders' meeting (usually an ordinary resolution) (Article 454, paragraph 1). The resolution must specify:

  • The type and book value of the property to be distributed (e.g., cash, other assets for dividends in kind).
  • The method of allotting the distributed property to shareholders (typically pro-rata to their shareholdings).
  • The effective date of the distribution.

Companies with certain qualifications (e.g., those with an external accounting auditor and a term of office for directors of one year, or Companies with Audit and Supervisory Committee) can, if authorized by their articles of incorporation, make one interim dividend distribution per business year by a resolution of the board of directors (Article 454, paragraph 5).

Consequences of Violating Source Regulations (Illegal Distributions)

Making distributions in excess of the legally permissible Distributable Amount ("illegal distributions" - ihō haitō) has serious legal consequences under the Companies Act, aimed at restoring the improperly depleted company assets and holding responsible parties accountable.

1. Liability of Recipients (Shareholders) (Article 462)

Shareholders who receive an illegal distribution are, in principle, obligated to return the monetary value of the distributed property to the company (Article 462, paragraph 1).

  • This liability is generally strict; their good faith or lack of knowledge that the distribution was illegal does not typically excuse them from the obligation to return, as the primary goal is to restore the company's capital for the benefit of creditors.
  • However, if a shareholder received the distribution in good faith and was unaware that the distribution violated the source regulations, their liability to return might be limited in certain complex factual scenarios, though the Companies Act itself does not provide a clear good faith defense for the shareholder recipient against the company's claim for return.

2. Liability of Directors and Other Responsible Persons (Article 462, Article 465)

Directors who were involved in making the illegal distribution face significant personal liability:

  • Joint and Several Liability to the Company: Directors who executed the duties related to the distribution (e.g., proposed the resolution for distribution to the shareholders' meeting or executed the board resolution for an interim dividend) are jointly and severally liable to the company for the amount of the illegal distribution (or the deficiency if the recipients do not return the full amount) (Article 462, paragraph 1).
    • This liability arises even if the directors were not negligent, unless they can prove they exercised due care in ensuring the distribution was lawful.
    • Directors who voted in favor of a shareholders' meeting resolution or a board resolution authorizing the illegal distribution are also presumed to have been involved and can be held liable.
  • Liability for "Shortfall in Net Assets" (Kesson Tenpo Sekinin) (Article 465): If, as a result of an illegal distribution, the company's net assets fall below the sum of its stated capital, capital reserves, retained earnings reserves, and other items that should constitute the minimum capital base, the directors involved are jointly and severally liable to pay the amount of this shortfall (or the amount of the illegal distribution, whichever is less), unless they can prove they were not negligent in performing their duties. This is a distinct liability aimed at directly restoring the impaired capital.

3. Liability to Creditors

While the primary liability is to the company (to restore its assets), creditors who are harmed because the company is unable to meet its obligations due to an illegal distribution may, under certain circumstances (e.g., if the company becomes bankrupt), have claims against the directors or potentially even pursue the recipients, though this is more complex and often channeled through the company's bankruptcy trustee.

Potential Voidness of the Distribution Resolution

The legal effect of a shareholders' meeting resolution or board resolution authorizing an illegal distribution has been debated.

  • One view is that such a resolution is void because it contravenes mandatory provisions of law aimed at creditor protection.
  • Another view is that the resolution itself might be valid, but the ensuing distribution gives rise to the statutory liabilities mentioned above (return by recipients, liability of directors).
    The practical consequence is that the liabilities for return and compensation are clearly stipulated, regardless of the theoretical voidness of the underlying resolution.

Importance for Companies and Stakeholders

The source regulations for distribution of surplus are fundamental to Japanese corporate finance and creditor protection.

  • For Companies: Directors must exercise extreme care in calculating the Distributable Amount before any distribution. Relying on accurate accounting and, where appropriate, legal and accounting advice is crucial. Failure to comply can lead to severe personal liability for directors and reputational damage for the company.
  • For Shareholders: While receiving distributions is a key benefit of share ownership, they should be aware that distributions made in violation of source regulations may need to be returned.
  • For Creditors: These regulations provide a vital safeguard, ensuring that the company maintains a minimum level of net assets to support its ability to meet its financial obligations.

Conclusion

The Japanese Companies Act's framework for the "Distribution of Surplus," particularly its stringent source regulations centered on the "Distributable Amount," is a critical mechanism for balancing shareholder expectations of returns with the paramount need to protect company creditors. The calculation of the Distributable Amount is a technical process requiring careful attention to accounting details and legal provisions. Directors bear significant responsibility for ensuring compliance, facing personal liability for illegal distributions. Understanding these rules is essential for the sound financial management of any Japanese K.K. and for assessing its financial health and an investor's potential returns.