Holding Directors to Account: What "Liabilities" Can Shareholders Sue For in Japan? A Supreme Court Clarification

Case: Action for Registration of Transfer of Ownership
Supreme Court of Japan, Third Petty Bench, Judgment of March 10, 2009
Case Number: (Ju) No. 799 of 2007

Shareholder derivative suits are a powerful tool in corporate governance, allowing shareholders to step into the company's shoes and sue directors (or other liable parties) for harm caused to the company, especially when the company itself fails to take action. In Japan, this mechanism is provided for by Article 847 of the Companies Act (and its predecessor, Article 267 of the Commercial Code). A fundamental question, however, is what exactly constitutes a "director's liability" (取締役ノ責任 - torishimariyaku no sekinin) that can be pursued through such a suit. Is it limited to breaches of fiduciary duties like the duty of care or loyalty, or can it extend to more ordinary transactional debts a director might owe to the company? The Supreme Court of Japan provided a significant clarification on this issue in a judgment delivered on March 10, 2009.

Land Held in a Director's Name: Facts of the Case

The case involved Company A and one of its directors, Y. Between 1951 and 1960, B, who was the Representative Director of Company A at the time, arranged for Company A to purchase several plots of land ("the Land") from various third parties. However, instead of registering Company A as the legal owner, the title registrations for the Land were made in the personal name of Y, who was a director of Company A during that period.

Many years later, in 2004, X, a shareholder of Company A, initiated a shareholder derivative suit against director Y. X's lawsuit presented two main claims concerning the Land:

1. Primary Claim (Based on Company A's Alleged True Ownership): X asserted that Company A was, in fact, the true beneficial owner of the Land, as it had been Company A that acquired it from the original third-party sellers through the actions of its then-Representative Director B. Based on this alleged underlying ownership by Company A, X demanded that Y be ordered to undertake the legal procedures to transfer the title registration of the Land to Company A. This was framed as a claim for "restoration of true registered ownership" (真正な登記名義の回復 - shinsei na tōki meigi no kaifuku) to Company A.
2. Alternative (Preliminary) Claim (Based on Termination of a Name-Lending Agreement): Alternatively, X argued that when Company A acquired the Land, it had effectively entered into an agreement with director Y. Under this agreement, Y was entrusted to hold the legal title to the Land in Y's name for an indefinite period, essentially acting as a nominee for Company A (a form of "name-lending agreement" or 使用貸借 - shiyō taishaku, gratuitous loan for use, in this context). X contended that this name-lending agreement was terminated, at the latest, when the formal complaint in this shareholder derivative suit was served upon Y. Therefore, X argued that upon the termination of this agreement, Y was obligated to return the property by transferring the title registration to Company A.

The Lower Courts' Narrow Interpretation of "Director's Liability"

The court of first instance (Osaka District Court) dismissed X's claims entirely. Its primary reason was that X had failed to provide sufficient proof that Company A had actually acquired true ownership of the Land in the first place.

X appealed this decision. The Osaka High Court also dismissed X's lawsuit, but on different, more fundamental grounds. The High Court ruled that the entire lawsuit was improper (f tekihō) as a shareholder derivative suit. It reasoned that the scope of "director's liability" that can be pursued through a shareholder derivative suit under the Commercial Code is limited to what it termed "strict liabilities imposed on directors based on their status as directors." This would include, for example, liability for breach of the duty of care, duty of loyalty, or for engaging in illegal acts as a director (generally, liabilities arising from provisions like Article 266 of the old Commercial Code, now Article 423 of the Companies Act).
The High Court held that any other liabilities a director might owe to the company – such as ordinary contractual debts or obligations arising from transactions not directly tied to their statutory duties as a director – were not encompassed within the scope of "director's liability" for the purposes of a derivative suit. Since both X's primary claim (based on property ownership) and alternative claim (based on terminating a name-lending contract) did not, in the High Court's view, fall into the category of "status-based" director liability, the entire derivative suit was deemed impermissible. X appealed this dismissal to the Supreme Court, and the appeal was accepted.

The Supreme Court's Broader View: Expanding the Scope of Pursuable Liabilities

The Supreme Court delivered a nuanced judgment:

• It upheld the dismissal of X's primary claim (the one based on Company A's direct assertion of true ownership).
• However, it overturned the High Court's dismissal of X's alternative claim (the one based on the termination of the name-lending agreement with director Y) and remanded this part of the case back to the Osaka High Court for a trial on its merits.

Reasoning of the Apex Court: "Director's Liability" Includes Transactional Debts

The Supreme Court's core reasoning for this distinction lay in its interpretation of the scope of "director's liability" that can be pursued via a shareholder derivative suit:

1. Purpose of Shareholder Derivative Suits: The Court began by affirming the fundamental purpose of the shareholder derivative suit system (as established by Article 267 of the then-Commercial Code, now Article 847 of the Companies Act). This system is designed to protect the interests of the company and its shareholders when directors who are liable to the company are not pursued by the company itself. Such inaction by the company often stems from the "special relationships" that can exist among corporate officers (e.g., reluctance to sue colleagues).
2. Company Inaction Not Limited to "Status-Based" Liabilities: The Court reasoned that the risk of a company failing to pursue a claim against one of its directors is not confined solely to situations where the director's liability arises strictly from their duties as a director (e.g., breach of care, illegal acts). This risk of inaction can equally apply to other types of debts or obligations a director might owe to the company.
3. Avoiding Imbalance – The "Loan to Director" Example: The Supreme Court pointed to a specific provision in the old Commercial Code (Article 266, Paragraph 1, Item 3, concerning liability for "loans to fellow directors" – 仲間貸し責任 - nakama-gashi sekinin) to illustrate a potential imbalance if "director's liability" were too narrowly construed. Under that old rule, if a representative director arranged for the company to lend money to another director, and that loan was not repaid, the representative director (and other directors who approved the loan) could be held liable to the company. If derivative suits were restricted only to "status-based" liabilities, then these lending/approving directors could be targeted by shareholders. However, the director who received the loan and subsequently failed to repay it (whose liability would be a straightforward transactional debt) might escape the ambit of a derivative suit. The Supreme Court found this potential outcome to be "lacking in balance."
4. Directors' Duty of Loyalty Extends to Transactional Obligations: The Court also emphasized that directors who enter into transactions with their company and thereby incur debts or obligations to it (referred to as "transactional debts owed by the director to the company" – 取締役の会社に対する取引債務 - torishimariyaku no kaisha ni taisuru torihiki saimu) are under a duty to faithfully fulfill these obligations.
5. Conclusion on the Scope of "Director's Liability": Based on these considerations, the Supreme Court concluded that the term "director's liability" as used in Article 267, Paragraph 1 of the Commercial Code (governing derivative suits) includes not only liabilities arising from the director's status and statutory duties but also liability for transactional debts owed by the director to the company.

Application to X's Claims:

• Primary Claim (Ownership-Based): The Supreme Court found that X's primary claim – seeking the transfer of title registration based on Company A's alleged direct and true ownership of the Land – was neither a claim pursuing a director's status-based liability nor one pursuing a director's transactional debt liability to the company. It was framed as a direct assertion of Company A's property rights against Y as if Y were any third party holding title. Therefore, the High Court's conclusion that this claim was not a proper subject for a shareholder derivative suit was, in its result, correct.
• Alternative Claim (Contract Termination-Based): In contrast, X's alternative claim – seeking the transfer of title registration based on the termination of the alleged name-lending agreement between Company A and director Y – could indeed be characterized as a pursuit of director Y's transactional debt liability to Company A. The obligation for Y to return the property (or its title) upon the termination of such an agreement would be a liability arising from that transaction. Therefore, the Supreme Court held that this alternative claim was a proper subject for a shareholder derivative suit. The High Court had erred in dismissing this part of the claim as improper, and it was remanded for a substantive hearing.

(It is worth noting, as mentioned in the provided commentary, that on remand, the Osaka High Court in November 2009 did find in favor of X on this alternative claim. It determined that Company A was the true owner, a name-lending agreement existed with Y, and the service of the derivative suit complaint on Y effectively terminated this agreement, obligating Y to transfer the title. This judgment became final.)

Analysis and Implications: Broadening the Reach of Shareholder Oversight

This 2009 Supreme Court decision was the first by Japan's highest court to explicitly clarify that the "liability" of a director that can be pursued through a shareholder derivative suit is not narrowly confined to breaches of statutory duties (like the duty of care or loyalty, or specific liabilities under Article 423 of the Companies Act). It importantly extends to cover "transactional debts" that a director owes to the company.

• The Long-Standing Debate on the Scope of "Director's Liability":
  • The "All Debts" Theory (全債務説 - zen-saimu setsu): Since the introduction of the modern shareholder derivative suit system in Japan in 1950, some influential legal scholars had argued that derivative suits should be available to pursue any and all debts or obligations a director owes to the company. Their reasoning included: (a) the 1950 reform was primarily procedural and was not intended to restrict the types of director liabilities that could already be pursued by the company itself; (b) the risk of a company failing to sue its own directors (due to internal dynamics) is not limited to breaches of fiduciary duty but can apply to any obligation; and (c) historical imbalances, like the "loan to fellow director" scenario mentioned by the Supreme Court, supported a broader scope. Even under this broad theory, however, the phrase "director's liability" implies some connection to the individual's role or dealings with the company during their tenure; it generally wouldn't extend to, for instance, purely personal debts owed to the company that are entirely unrelated to their directorship or debts incurred long after leaving office for unrelated reasons. The Supreme Court's dismissal of X's primary claim (which was essentially a property dispute not framed as Y owing a "liability" to Company A in a transactional or status-based sense) seems consistent with this implicit limitation.
  • The "Limited Liability" Theory (限定債務説 - gentei-saimu setsu): Conversely, another school of thought, which the High Court in this case adopted, argued for a more restrictive interpretation. This view held that derivative suits should primarily target liabilities for which the company's management has little legitimate discretion not to sue, or liabilities for which any waiver or release by the company is subject to very strict legal procedures (e.g., statutory duties of directors where liability is often strict or where shareholder approval for waiver is difficult to obtain). The rationale was to preserve managerial discretion in deciding whether to pursue ordinary commercial or transactional disputes against a director, which might sometimes be better resolved through negotiation or for broader business reasons. While the specific "loan to fellow director" liability that formed part of the Supreme Court's reasoning for avoiding imbalance has since been abolished under the Companies Act (being subsumed into the general rules for conflict-of-interest transactions and director's duty of care), the broader tension between shareholder oversight and managerial discretion remains. However, even under this limited view, if a director's failure to fulfill a transactional obligation causes damage to the company, it could often be re-characterized as a breach of the duty of care or loyalty, thus potentially bringing it back within the scope of a derivative suit, albeit through a more circuitous route.
  • "Intermediate" Theories: Various other theories attempted to strike a middle ground, for example, by allowing derivative suits for transactional obligations if the failure to perform them could be seen as a breach of the director's duty of loyalty, or by drawing analogies to other shareholder rights like the right to seek an injunction against illegal director conduct. The Supreme Court's 2009 decision appears to align more closely with these intermediate or moderately expanded interpretations rather than the most restrictive "status-only" view or the most expansive "all conceivable debts" view.
• Impact and Significance of the Supreme Court's 2009 Ruling:
  The decision to include "transactional debts owed by the director to the company" within the scope of pursuable liabilities via derivative suit is significant. It acknowledges that directors should not be shielded from accountability for ordinary commercial obligations owed to their company simply because the company's current management might be hesitant to sue them. It makes the derivative suit a more versatile tool for shareholders.
  However, the Supreme Court also implicitly set a boundary by dismissing the primary claim. This suggests that the claim must still be framed as one seeking to enforce a "liability" or "obligation" that the director owes to the company as a result of their dealings or status. A direct attempt by shareholders to assert, on behalf of the company, the company's underlying property rights against a director as if the director were merely an unrelated third party in a property dispute, without grounding it in a breach of duty or a transactional obligation by the director to the company, may still fall outside the intended scope of a derivative suit.
  The practical effect of this ruling is to broaden the avenues for shareholder oversight, ensuring that directors can be called to account not only for breaches of their core fiduciary duties but also for failing to meet their transactional commitments to the company they serve. It mitigates the risk that such obligations might go unenforced due to internal corporate politics.

Conclusion

The Supreme Court's judgment of March 10, 2009, provides a crucial interpretation of the term "director's liability" for the purpose of shareholder derivative suits in Japan. It clarifies that such suits are not restricted to claims arising from a director's breach of statutory duties (like the duty of care or loyalty) but can also be used to pursue "transactional debts" that a director owes to the company. By allowing shareholders to sue on behalf of the company for such transactional obligations, the Court has strengthened the mechanisms for shareholder oversight and director accountability.

However, the decision also implicitly suggests that the claim must genuinely be one to enforce a director's "liability" or "obligation" to the company. A simple property dispute, even if a director is involved on the other side, might not qualify if it's not framed in terms of the director owing a specific duty or debt back to the company related to that transaction or their role. This landmark ruling thus expands the utility of the shareholder derivative suit while still seeking to delineate its appropriate boundaries within the broader framework of corporate law.