Government Hands in "Private" Purses? Navigating the Legal "Distance" Between Japanese Local Governments and Their Related Entities

Japanese Attorney at Law - Bengoshi L.L.

• 8 min read

Modern governance often sees local public entities in Japan establishing or closely collaborating with a variety of "related organizations"—foundations, public corporations, third-sector companies—to deliver public services, manage facilities, or spearhead special projects. While these arrangements can offer flexibility and specialized expertise, they also create a complex web of legal and financial relationships. A critical question that frequently arises is how to maintain an appropriate legal "distance" between the local government and these entities to ensure accountability, prevent conflicts of interest, and safeguard public funds. This article explores this intricate area, focusing on the legal challenges that emerge when local governments transact with their related organizations, particularly through the lens of a key Supreme Court decision involving Nagoya City.

Local governments in Japan increasingly utilize a diverse range of associated entities to carry out their functions. These "related organizations" (kanren dantai - 関連団体) can take various legal forms, such as public interest incorporated foundations (kōeki zaidan hōjin - 公益財団法人), public interest incorporated associations (kōeki shadan hōjin - 公益社団法人), or so-called "third-sector" companies (joint ventures between public and private sectors).

The rationale behind establishing such entities is often multifaceted:

  • Operational Flexibility: They can sometimes operate with more agility than traditional government departments, free from certain bureaucratic constraints.
  • Specialized Expertise: They can attract and retain specialized skills for particular projects.
  • Leveraging Private Sector Involvement: They can facilitate public-private partnerships.
  • Ring-fencing Projects: They can manage specific large-scale projects or events with dedicated finances and governance.

However, this proximity and operational intertwining can lead to significant legal challenges, particularly concerning the transparency of financial dealings, the potential for conflicts of interest when key personnel overlap, and the overall accountability for the use of public resources.

The Nagoya World Design Exposition Case: A Study in Complexity

A landmark case that brought many of these issues to the fore was the Supreme Court (Third Petty Bench) judgment of July 13, 2004 (Minshū Vol. 58, No. 5, p. 1368). This case involved Nagoya City and the World Design Exposition Association, a foundation established by the city to prepare and manage a major international exposition for its centennial anniversary.

Facts of the Case:
Nagoya City initiated the World Design Exposition as a commemorative project. In 1986, the World Design Exposition Association (hereinafter "the Association"), a foundational juridical person (zaidan hōjin), was established with the purpose of preparing and managing the exposition. Its articles of incorporation (then kifu kōi, now teikan) stipulated a limited duration, ending in March 1990. Crucially, key Nagoya City officials held top positions in the Association: the Mayor of Nagoya served as the Chairman (and a director) of the Association, the Deputy Mayor as Vice-Chairman (and a director), and the City Treasurer as a supervisor. The Association's secretariat was also primarily staffed by city employees.

As the exposition neared its end in 1989, the Association faced a potential operating deficit. To mitigate this, the Association planned to sell off facilities and goods used during the event and approached its primary financial contributors, including Nagoya City, Aichi Prefecture, and local economic organizations, to purchase these assets. Nagoya City subsequently entered into approximately 50 contracts with the Association, purchasing various items for a total sum exceeding one billion yen.

A group of Nagoya residents filed a resident lawsuit under the Local Autonomy Act, challenging these purchase contracts. They argued, inter alia, that the contracts were invalid because they were concluded through dual representation (sōhō dairi - 双方代理) by the Mayor (who represented both the City as buyer and the Association as seller). They also contended that the City had purchased unnecessary items at unfairly high prices, constituting an abuse of discretion and causing financial loss to the City.

Dual Representation in Public Contracts: Applying Civil Code Principles

One of the central legal issues was the Mayor acting on behalf of both contracting parties. Article 108 of the Japanese Civil Code generally prohibits an agent from representing both parties in a transaction (dual representation) or from entering into a transaction between themselves and their principal (self-dealing), unless the principal consents. This rule is designed to prevent conflicts of interest and protect the principal's interests.

The Supreme Court's Stance:
The Supreme Court in the Nagoya case affirmed that the principle enshrined in Civil Code Article 108 could be applied by analogy to the representative acts of the head of a local public entity, such as a mayor. This means that when a mayor concludes a contract between the local government and another entity where the mayor also holds a representative position, the transaction is, in principle, formally flawed due to this conflict.

However, the Court also looked to another Civil Code provision, Article 116, which allows a principal to ratify (追認 - tsuinin) an unauthorized act of representation. The Court held that this principle of ratification could also be applied by analogy in the public law context. Specifically, it found that the local assembly, as the representative body of the local government, has the power to ratify contracts entered into by the mayor that might otherwise be voidable due to dual representation.

In the Nagoya case, the Supreme Court concluded that the Nagoya City Assembly, through its deliberations and approvals of budgets and financial accounts that explicitly included and acknowledged these purchase contracts with the Association (while being aware of the Mayor's dual role), had effectively given its consent and thereby ratified the transactions. This ratification, the Court held, cured the formal defect arising from the Mayor's dual representation. A concurring opinion by Justice Fujita Tokiyasu further elaborated on the rationale for applying these private law agency principles to public officials, emphasizing the need to protect the public entity's interests from potential harm arising from such conflicts.

This part of the judgment underscores that while formal conflicts of interest are taken seriously, procedural safeguards like assembly oversight and approval can validate such transactions, at least from the perspective of the formal defect of dual representation.

Beyond Formalities: Scrutinizing the Substance and Discretion

Even if a contract is formally validated through assembly ratification, its substantive legality can still be challenged. The fact that the dual representation issue was resolved did not end the inquiry. The core question remained: did Nagoya City exercise its discretion properly when deciding to purchase the assets from the Association, particularly concerning the necessity of the purchases, the fairness of the prices, and the overall benefit to the citizens?

This involves a review for potential abuse of discretion (裁量権の逸脱・濫用 - sairyōken no itsudatsu ran'yō). The residents argued that many of anpoitems purchased were unnecessary for the City or were acquired at inflated prices, essentially amounting to an improper subsidy to bail out the Association.

The "Quasi-Mandate" Relationship: A Key Factor in Assessing Discretion

In remanding the case to the High Court for further examination of the abuse of discretion claim, the Supreme Court introduced a significant concept: the possibility of a "quasi-mandate" relationship (jun-inin-teki na kankei - 準委任的な関係) existing between Nagoya City and the Exposition Association.

The Court suggested that because the World Design Exposition was fundamentally a Nagoya City project, and the Association was specifically established to execute this project under the City's overarching plan and with its primary backing, the relationship could be viewed as analogous to a mandate (inin) under the Civil Code. In a mandate relationship, the mandator (the City) entrusts the mandatary (the Association) with certain tasks.

Implications of a Quasi-Mandate:
If such a quasi-mandate relationship was found to exist, it would have important legal consequences, particularly concerning the City's potential obligations towards the Association. Under Civil Code Article 650, a mandator is generally obliged to reimburse the mandatary for necessary expenses incurred in carrying out the mandated affairs.

The Supreme Court directed the High Court to consider that, if the Association was acting as a quasi-mandatary for the City, the City might have had a legal or at least a strong moral obligation to cover the Association's legitimate operational deficits incurred in fulfilling the public purpose of the exposition. This potential obligation, the Court reasoned, would be a crucial factor in assessing whether the City's decision to purchase assets from the Association (which had the effect of covering its potential shortfall) was an abuse of discretion or a reasonable exercise of it. The High Court's initial assessment had not sufficiently explored this quasi-mandate aspect and its bearing on the City's potential financial responsibilities towards the Association. The necessity and pricing of the purchased assets would then need to be evaluated in light of this underlying relationship and the City's possible pre-existing obligations.

Maintaining "Distance" and Ensuring Accountability

The Nagoya World Design Exposition case vividly illustrates the challenges in maintaining an appropriate legal and operational "distance" between a local government and its related entities, especially when there is an overlap in key personnel.

  • Conflicts of Interest: The most obvious challenge is the conflict of interest when a single individual, like the Mayor, formally represents both sides of a transaction. While assembly ratification can address the formal legal defect, it doesn't automatically resolve underlying concerns about whether the public entity's interests were truly prioritized.
  • Ensuring Value for Public Money: There's an inherent risk that transactions between a local government and a closely related entity might be structured to benefit the entity (e.g., covering its debts or providing an indirect subsidy) rather than achieving the best economic value for the local government and its taxpayers. This necessitates careful scrutiny of the terms of such transactions, including the necessity of the expenditure and the fairness of the price.
  • Effectiveness of Assembly Oversight: The Supreme Court relied on the local assembly's ratification to cure the dual representation defect. However, the practical effectiveness of assembly oversight in such situations is a continuing concern. Assemblies must be fully informed and exercise diligent scrutiny to ensure that such ratifications are not mere formalities but represent a genuine endorsement of substantively sound transactions.
  • Defining "Relatedness" and its Consequences: The Local Autonomy Act itself contains provisions aimed at preventing certain conflicts of interest, for example, by prohibiting mayors or other key officials from being parties to contracts with their own municipality or from holding executive positions in companies that do significant business with the municipality (e.g., Article 142). However, the application of these rules to the myriad forms of "related organizations" can be complex, often depending on factors like the degree of financial contribution by the local government (e.g., the "over 50% capital contribution" threshold mentioned in some conflict-of-interest rules). The PDF commentary notes that in the Nagoya case, the city's direct capital contribution to the Association was less than 50%, which might have implications for the applicability of some of these stricter statutory prohibitions on officials' concurrent positions, further highlighting the need for case-by-case analysis of the "distance."

Conclusion: The Ongoing Quest for Transparent Public-Private Interfaces

The intricate legal relationships between Japanese local governments and the various entities they create or partner with for public purposes demand careful navigation to ensure good governance, accountability, and the prudent use of taxpayer money. The Supreme Court's 2004 decision in the Nagoya World Design Exposition case provides important guidance on several fronts.

It confirms that fundamental private law principles, such as the prohibition of dual representation, are applicable by analogy to public officials. However, it also acknowledges that democratic mechanisms like local assembly ratification can cure formal defects arising from such situations. More profoundly, the Court's introduction of the "quasi-mandate" concept encourages a deeper examination of the substantive relationship between a local government and its related entities. This requires assessing whether transactions, even if formally valid, are a reasonable exercise of discretion in light of the underlying purposes and potential pre-existing obligations of the local government towards the entity it established or supports.

Ultimately, maintaining a proper legal and operational "distance," while fostering effective collaboration, remains a key challenge. This necessitates robust transparency, clear rules for engagement, diligent oversight by local assemblies, and a willingness by the judiciary to scrutinize not just the form but also the substance of dealings between local governments and their associated organizations to ensure they genuinely serve the public interest.