Dual Directorships in Japan: Navigating Conflicts of Interest, Non-Compete, and Approval Requirements

Directors in Japanese corporations (Kabushiki Kaisha or K.K.) often wear multiple hats, serving on various boards or engaging in personal business ventures. While such activities can bring valuable experience and networks, they also present inherent risks of conflicts of interest and engagement in competitive activities that could potentially harm the company they serve. The Japanese Companies Act (会社法 - Kaishaho) provides a specific framework, primarily through Article 356, to manage these situations, mandating disclosure and formal approval for certain transactions. This framework is underpinned by the director's fundamental duties of loyalty and care, aiming to protect the company's interests. This article explores the intricacies of these regulations concerning competitive transactions and conflict-of-interest dealings by directors in Japan.

1. The Foundation: Directors' Fiduciary Duties

Before examining the specific transaction-based regulations, it's essential to remember that all directors in Japan operate under overarching fiduciary duties:

• Duty of Care of a Good Manager (善管注意義務 - zenkan chui gimu): As stipulated by Article 330 of the Companies Act (which incorporates Article 644 of the Civil Code by reference), directors must manage the company's affairs with the care of a prudent manager.
• Duty of Loyalty (忠実義務 - chujitsu gimu): Article 355 of the Companies Act requires directors to perform their duties loyally for the benefit of the company.

Article 356, which addresses competitive and conflict-of-interest transactions, can be seen as a specific application and clarification of these broader duties, designed to prevent directors from prioritizing their personal interests or those of third parties over the company's welfare.

2. Competitive Transactions (競業取引 - Kyogyo Torihiki) - Article 356(1)(i)

A director must obtain the approval of the board of directors (or the shareholders' meeting, if the company does not have a board) before engaging in a "competitive transaction." This applies when a director intends, for their own account or for the account of a third party, to conduct a transaction that falls within "the category of the company's business" (株式会社の事業の部類に属する取引 - kabushikigaisha no jigyo no burui ni zokusuru torihiki).

A. Rationale:
The purpose of this restriction is to prevent directors, who have access to sensitive internal company information such as know-how, customer lists, and strategic plans, from leveraging this knowledge to engage in activities that directly compete with and could thereby harm the company.

B. Defining "Category of Company's Business":
This is a critical and often fact-specific determination:

• Actual vs. Stated Business: The assessment is based on the company's actual business activities and operations, not merely the list of business purposes stated in its Articles of Incorporation. If a business purpose is listed but the company has never engaged in it, or has clearly abandoned it, transactions in that field by a director may not be considered competitive.
• Anticipated Business: However, the scope can extend to businesses that the company is actively preparing to launch, or for which a launch is reasonably anticipated or has become substantially certain based on its current trajectory and plans. Temporarily suspended business lines may also be included.
• Ancillary Transactions: The "category of business" includes transactions ancillary to the company's main operations (e.g., a manufacturing company purchasing raw materials). However, purely auxiliary acts necessary for general business operations, such as the company borrowing funds or hiring employees, are typically not considered "transactions within the category of business" for the purposes of this rule (though such acts could still raise separate duty of loyalty concerns, for example, if a director improperly poached key employees for a new venture).
• Market Competition: A key element is the potential for market competition. If a director engages in a similar type of business but in a geographically distinct market with no realistic overlap or prospect of overlap with the company's operations, it may not be deemed a regulated competitive transaction. However, if the company has concrete, demonstrable plans to expand into the director's market area, that area can be considered part of the company's competitive sphere. A Tokyo District Court decision on March 26, 1981, found a transaction to be competitive where a company had already made preparations and decided to expand into a region where one of its directors had newly established a similar business.

C. Serving as a Director in a Competing Company:
The mere act of a director of Company A becoming a director of Company B (which is in a competing business) is not, in itself, a "transaction" that requires approval under Article 356(1)(i). Similarly, establishing a new company that will compete is also not, per se, a regulated transaction by that director. However, this is a crucial distinction: the subsequent business activities conducted by that director on behalf of or for the benefit of Company B (the competing entity) would likely constitute competitive transactions requiring approval from Company A's board.

D. Usurping Corporate Opportunities:
Even if a director's actions do not neatly fit the definition of a regulated competitive transaction under Article 356(1)(i), they could still breach their broader duty of loyalty (Article 355). For example, if a director learns of a business opportunity through their position at the company and, instead of presenting it to the company, diverts it for their own benefit or for another entity they are involved with (thereby depriving the original company of a market expansion or other valuable opportunity), this could be actionable as a breach of loyalty.

E. Consequences of an Unapproved Competitive Transaction:

• Validity of the Transaction with Third Parties: The competitive transaction itself, if entered into with a third party, generally remains valid.
• Director's Liability to the Company: The director who engaged in the unapproved competitive transaction is liable to the company for any damages caused (Article 423, Paragraph 1).
• Presumption of Damages (Article 423, Paragraph 2): The amount of profit or benefit earned by the director (or the third party for whom they acted) from the unapproved competitive transaction is legally presumed to be the amount of damage suffered by the company. This significantly aids the company in proving damages.
• Effect of Board Approval: Obtaining board approval for a competitive transaction does not provide absolute immunity. If the transaction, despite approval, was still conducted in a way that breached the director's duty of care or loyalty (e.g., the terms were highly unfavorable to the approving company due to the director's influence, or the approval itself was based on misleading information), the director could still face liability.

3. Conflict-of-Interest Transactions (利益相反取引 - Rieki Sohan Torihiki) - Article 356(1)(ii) & (iii)

This category covers situations where a director's personal interests may directly or indirectly clash with the company's interests in a transaction. Such transactions also require prior board (or shareholder meeting) approval after disclosure of material facts.

A. Direct Transactions (直接取引 - chokusetsu torihiki) (Article 356(1)(ii)):
This occurs when a director intends to enter into a transaction directly with the company, either:
* For their own personal account (e.g., the director sells a piece of land they own to the company, or the company lends money to the director).
* For the account of a third party (e.g., the director acts as the representative of Company Y in a contract between Company X (where they are a director) and Company Y).

B. Indirect Transactions (間接取引 - kansetsu torihiki) (Article 356(1)(iii)):
This applies when the company engages in a transaction with a third party, but the transaction inherently creates a conflict between the company's interests and the personal interests of a director.
* The classic example is the company providing a guarantee for a director's personal debt to a financial institution. Here, the company's transaction is with the financial institution (the third party), but it primarily benefits the director and exposes the company to risk for the director's personal obligation.
* Other examples could include the company repaying a director's debt to a third party or acquiring assets from a third party in which a director has a significant hidden interest.

C. Transactions Generally Not Requiring Approval:
Certain types of transactions, even if involving a director, are typically considered outside the scope of regulated conflict-of-interest transactions because they do not pose a material risk of harm to the company or because the director has no discretion that could be abused:
* The company receiving a genuine gift from a director.
* The company receiving an interest-free, unsecured loan from a director.
* The company fulfilling a pre-existing, legitimate debt owed to a director.
* A director engaging in routine, standardized transactions with the company on the same terms available to any ordinary customer or member of the public (e.g., a director purchasing the company's widely available products at the standard retail price).

D. One-Person Company Exception:
If a director is the sole shareholder of the company (a "one-person company"), there is effectively no divergence between the director's personal interest and the company's interest. In such cases, the Supreme Court held on August 20, 1970, that transactions between the director and the company do not require formal board/shareholder approval under these conflict-of-interest rules.

E. Consequences of an Unapproved Conflict-of-Interest Transaction:

• Validity of the Transaction:
  • As between the director and the company, an unapproved conflict-of-interest transaction is generally considered void.
  • Against a third party involved in the transaction (e.g., the counterparty in an indirect transaction, or a third party for whose account a director acted in a direct transaction), the company can assert the transaction's invalidity only if it can prove that the third party was aware (or should have been aware, i.e., was not in good faith) of the lack of required approval. This is often termed "relative nullity."
• Director's Liability to the Company: The director(s) involved are liable for any damages caused to the company (Article 423, Paragraph 1).
• Presumption of Neglect of Duty (Article 423, Paragraph 3): If an approved conflict-of-interest transaction (or one that should have been approved) results in damage to the company, the director who engaged in the transaction, any director who caused the company to enter into it, and any director who voted in favor of its approval at the board meeting are legally presumed to have neglected their duties with respect to that transaction. This shifts the evidentiary burden to these directors to prove they acted properly.
• Strict Liability (Article 428, Paragraph 1): For direct conflict-of-interest transactions engaged in by a director for their own personal account (i.e., not for a third party), the director's liability for resulting damages is strict. They cannot avoid liability by claiming they were not negligent or did not intend to harm the company.

4. The Approval Process: Disclosure, Voting, and Post-Transaction Reporting

For both competitive and conflict-of-interest transactions requiring approval under Article 356(1):

• Disclosure of Material Facts: The director proposing to engage in the transaction (or whose interests are conflicted) must disclose all material facts concerning the transaction to the board of directors (or to the shareholders' meeting if the company has no board). "Material facts" would typically include the nature of the transaction, the subject matter, quantity, price, payment terms, duration, and any other information necessary for the approving body to make an informed decision.
• Comprehensive Approval for Ongoing Transactions: For transactions that are repetitive and ongoing (e.g., a series of sales between the company and another entity where a director has an interest), the board may, in some cases, provide a somewhat comprehensive approval covering a defined scope and period, rather than requiring approval for each individual instance. However, this must be within reasonable limits.
• Recusal of the Interested Director from Voting: A director who has a "special interest" in a proposed competitive or conflict-of-interest transaction cannot participate in the board vote on its approval (Article 369, Paragraph 2). Their vote would not be counted, and their presence might not count towards the quorum for that specific item.
• Post-Transaction Reporting to the Board (Article 365, Paragraph 2): After a director has engaged in an approved competitive transaction or conflict-of-interest transaction, they must, without delay, report the material facts concerning that transaction to the board of directors (this applies to companies with a board).

5. Limitations on Exoneration from Liability

While the Companies Act provides mechanisms for partially exempting directors from liability or limiting their liability (Articles 424-427, as discussed in a previous article on general director liability), a crucial exception exists. Under Article 428, Paragraph 2, these possibilities of exemption or limitation are not available to a director whose liability arises from a direct conflict-of-interest transaction undertaken by that director for their own personal account. This underscores the stricter approach taken towards directors personally profiting from self-dealing.

6. Broader Regulatory Landscape: Anti-Monopoly Considerations

Beyond the Companies Act, directors involved in multiple entities should also be aware of other regulations. For example, Article 13 of the Japanese Anti-Monopoly Act (独占禁止法 - Dokusen Kinshi Ho) restricts an officer or employee of one company from concurrently holding an officer position in another company if such interlocking directorate would result in a substantial restraint of competition in a particular field of trade. This represents an additional layer of scrutiny focused on market competition rather than internal corporate governance.

Conclusion

Navigating dual directorships and potential conflicts of interest under Japanese law requires diligent attention to the provisions of Article 356 of the Companies Act. Transparency through full disclosure of material facts and formal approval by the board of directors (or shareholders' meeting) are the cornerstones of this regulatory framework. Directors must be acutely aware of when their external business activities or personal dealings might trigger these approval requirements to avoid significant personal liability, which can sometimes be strict, and to ensure the legal validity of the transactions involved. Given the complexities and the potentially severe consequences of non-compliance, seeking timely legal advice is crucial when directors contemplate activities that might intersect with their company's business or their own personal interests.