How to Establish a Kabushiki Kaisha in Japan? Differences in Procedures for Promotive vs. Subscription-Based Incorporation

Establishing a Kabushiki Kaisha (K.K., or joint-stock company) in Japan involves a series of prescribed legal steps designed to ensure the company is properly constituted, capitalized, and registered. The Japanese Companies Act (Kaisha-hō) outlines two primary methods for incorporation: Promotive Incorporation (hokki setsuritsu) and Subscription-Based Incorporation (boshū setsuritsu). While both lead to the creation of a K.K., they differ significantly in how the initial shares are subscribed and paid for, and consequently, in some of the procedural requirements. Understanding these differences is crucial for founders and legal advisors navigating the formation of a new Japanese company.

The Principle of "Normative System" for Incorporation

Unlike some jurisdictions where establishing a company might require a specific license or discretionary approval from a government authority (a "licensing system"), Japan employs a "normative system" (junsoku shugi) for the incorporation of K.K.s. This means that if the incorporators fulfill all the procedures and substantive requirements laid down in the Companies Act, the company is legally established upon registration, without needing discretionary governmental approval for its formation itself (though specific business activities may later require licenses).

The Role of Incorporators (Hokkinin)

At the heart of the incorporation process are the incorporators (hokkinin). An incorporator is a person (individual or corporation) who undertakes the procedures for establishing the company.

• They must subscribe for at least one share issued at the time of incorporation (Article 25, paragraph 2).
• They are responsible for preparing and signing (or affixing their names and seals, or electronic signatures to) the initial Articles of Incorporation (teikan) (Article 26).
• They determine various matters concerning the issuance of shares at incorporation.
• They play a key role in appointing the initial directors and other officers.

Two Methods of Incorporation: Promotive vs. Subscription-Based

The main distinction between the two incorporation methods lies in who subscribes to the shares issued at incorporation:

1. Promotive Incorporation (Hokki Setsuritsu) (Article 25, paragraph 1, item 1):
   In this method, all shares issued at the time of incorporation are subscribed for by the incorporator(s) themselves. This is often the simpler and more common method, especially for closely-held companies or wholly-owned subsidiaries where the initial capital is provided entirely by the founders or parent company.
2. Subscription-Based Incorporation (Boshū Setsuritsu) (Article 25, paragraph 1, item 2):
   In this method, the incorporator(s) subscribe for only a portion of the shares issued at incorporation, and subscriptions for the remaining shares are solicited from outside subscribers (i.e., persons other than the incorporators). This method might be used when a broader base of initial investors is sought from the outset.

While the core steps like drafting the articles of incorporation are common, the procedures diverge, particularly concerning the solicitation of subscribers and the involvement of an inaugural shareholders' meeting.

Procedures for Promotive Incorporation (Hokki Setsuritsu)

Promotive incorporation, being simpler, generally involves the following key steps:

1. Preparation and Notarization of the Articles of Incorporation (Teikan):
   • The incorporator(s) draft the Articles of Incorporation, which must include absolute mandatory clauses such as the company's purpose, trade name, head office location, value of assets to be contributed upon incorporation (or its minimum amount), and the names/addresses of the incorporators (Article 27).
   • The drafted Articles of Incorporation must then be notarized by a notary public (kōshōnin) to become effective (Article 30, paragraph 1). This notarization is a crucial step.
2. Determination of Matters Concerning Shares Issued at Incorporation (Article 28, item 1):
   The incorporator(s) decide on the details of the shares to be issued at incorporation, such as the class and number of shares and the amount to be paid in per share.
3. Subscription for All Shares by Incorporators (Article 25, paragraph 1, item 1):
   As per the definition of promotive incorporation, all shares issued at this stage are subscribed for by the incorporator(s).
4. Payment of Contribution by Incorporators (Article 34):
   Each incorporator must, without delay after subscribing for shares, pay the full amount of money for the shares they subscribed for, or deliver all non-cash assets (contribution in kind - genbutsu shusshi) they agreed to contribute.
   • Payment for shares is typically made to a designated bank account (often an account held by one of the incorporators before the company is formed, or a special "subscription payment handling bank").
   • Proof of payment (e.g., a bank certificate) is required for the registration process.
5. Appointment of Initial Directors (and other officers, if any) (Article 38):
   • The incorporator(s) appoint the initial director(s) by a majority vote (if there are multiple incorporators).
   • If the company is to have a board of directors, at least three directors must be appointed.
   • If the company is to have statutory auditors (kansayaku), accounting advisors (kaikei san-yo), or an accounting auditor (kaikei kansanin) from incorporation, these are also appointed by the incorporator(s).
6. Investigation by Directors, etc. (Article 46):
   Once appointed, the initial directors (and statutory auditors, if any) must investigate whether the contributions by incorporators have been fully paid or delivered, and whether any "promoters' special benefits" or "property to be contributed in kind" (see below) are properly stated in the articles of incorporation and have been duly executed. They must report their findings to the incorporator(s).
7. Establishment of the Company by Registration (Setsuritsu Tōki) (Article 49):
   The company legally comes into existence upon the registration of its incorporation (setsuritsu tōki) at the Legal Affairs Bureau (Hōmukyoku) having jurisdiction over its head office location. The application for registration must typically be filed within two weeks of the investigation by directors (or the conclusion of procedures for subscription-based incorporation).

Procedures for Subscription-Based Incorporation (Boshū Setsuritsu)

Subscription-based incorporation involves additional steps due to the solicitation of outside subscribers.

1. Preparation and Notarization of the Articles of Incorporation: Same as for promotive incorporation.
2. Subscription for Some Shares by Incorporators (Article 25, paragraph 1, item 2):
   The incorporator(s) must subscribe for at least one share each, but they do not subscribe for all shares to be issued at incorporation.
3. Determination of Subscription Requirements for Subscribed Shares (Boshū Jikō no Kettei) (Article 58):
   The incorporator(s) (by unanimous consent if not otherwise provided in the articles of incorporation) determine the "subscription requirements" for the shares to be offered to outside subscribers. These requirements are similar to those for a post-incorporation issuance of shares for subscription (see Article 199), including:
   • The class and number of shares to be offered.
   • The amount to be paid in per share (which must be the same as that paid by the incorporators for shares of the same class).
   • The period for payment.
   • Matters concerning contribution in kind, if any.
4. Solicitation of Subscribers (Article 57, 59, 60):
   The incorporators solicit applications from the public or targeted investors to subscribe for the remaining shares. This involves providing information about the proposed company and the subscription requirements.
5. Application and Allotment to Subscribers (Article 60, 61):
   • Prospective subscribers submit applications.
   • The incorporators allot the shares to the subscribers. They have discretion in allotment but must act fairly.
6. Payment of Contribution by Incorporators and Subscribers (Articles 34, 63):
   • Incorporators pay for the shares they subscribed for.
   • Subscribers to whom shares have been allotted must pay the full amount for their shares by the prescribed payment date or within the payment period.
7. Inaugural Shareholders' Meeting (Sōritsu Sōkai) (Article 65 et seq.):
   This is a key difference from promotive incorporation. Once subscriptions are made and payments (at least partially, as required) are completed, the incorporators must convene an "inaugural shareholders' meeting" (sōritsu sōkai).
   • Attendees: This meeting is attended by the incorporators and the subscribers to whom shares have been allotted.
   • Powers (Article 80, 87, etc.): The inaugural meeting has significant powers, including:
     • Appointing the initial directors, statutory auditors, etc. (if not already appointed by the articles of incorporation and agreed by incorporators – Article 66, 38). Even if incorporators made initial selections for themselves, if other subscribers are involved, this meeting confirms or makes new appointments.
     • Investigating the propriety of the incorporation process, including the payment of contributions and the valuation of any non-cash contributions or special benefits for incorporators.
     • If any irregularities are found, the inaugural meeting can resolve to take corrective action, including potentially dismissing improperly appointed officers or even resolving not to establish the company.
     • The inaugural meeting can also amend the articles of incorporation (Article 82), although fundamental changes might require broader consent.
8. Establishment of the Company by Registration (Article 49):
   Following the resolutions of the inaugural shareholders' meeting and completion of all other requirements, the company is established by registration, similar to promotive incorporation.

Special Considerations: "Exceptional Matters of Incorporation" (Hentai Setsuritsu Jikō)

Certain matters, if included in the articles of incorporation at the time of establishment, are termed "exceptional matters of incorporation" (hentai setsuritsu jikō). These are subject to special scrutiny because they have the potential to harm the company or future shareholders/creditors if not properly valued or disclosed. These include (Article 28):

1. Contribution in Kind (Genbutsu Shusshi): Non-cash assets contributed by incorporators in exchange for shares.
2. Post-Incorporation Acquisition of Property (Zaisan Hikiuke): Property that the company agrees, prior to its incorporation, to acquire after its establishment from an incorporator or a third party.
3. Special Benefits for Incorporators (Hokkinin no Tokubetsu Rieki): Any special remuneration or benefits promised to incorporators for their services in establishing the company.
4. Expenses of Incorporation Borne by the Company: Costs related to incorporation that are to be paid by the newly formed company.

Scrutiny of Exceptional Matters:

• These matters must be stated in the articles of incorporation (Article 28).
• Court-Appointed Inspector's Investigation (Article 33): Generally, for contributions in kind or post-incorporation acquisitions of property, the incorporators must petition a court to appoint an inspector (kensayaku). The inspector investigates the appropriateness of the stated value of such property and reports to the court.
  • If the court, based on the inspector's report, finds the stated value to be improper, it can order a modification. If the incorporator making the contribution in kind disagrees, they can withdraw their contribution.
  • Exceptions to Inspector's Investigation: The investigation by a court-appointed inspector can be dispensed with in certain cases, such as:
    • If the total value of such property is not more than JPY 5 million.
    • For marketable securities, if the value stated in the articles does not exceed their market price.
    • If the stated value is certified as appropriate by a qualified professional (lawyer, CPA, tax attorney, etc.) for non-cash assets other than real estate. For real estate, certification by both a real estate appraiser and a legal professional is needed.
• In subscription-based incorporation, if there is an inspector's investigation, the inspector reports to the inaugural shareholders' meeting as well.

The purpose of these strict rules is to ensure that the company is not established with overvalued non-cash assets or burdened by excessive promoters' benefits, which could dilute the value of shares for other subscribers or mislead creditors about the company's true capital base.

Legal Relationships During Incorporation and Liability

• Incorporators' Association (Hokkinin Kumiai): Before the company is legally formed, the incorporators are often considered to be acting as a type of partnership or association.
• Attribution of Incorporators' Acts to the Company: Acts performed by incorporators within the scope of establishing the company (e.g., leasing an office, entering into preliminary contracts necessary for business commencement) can become binding on the company once it is formed, if done for the company's benefit.
• Liability of Incorporators (Articles 52, 52-2, 53, 55, 56):
  • Liability for Non-Payment of Subscriptions: If shares are not fully paid for, incorporators can be liable for the unpaid amount.
  • Liability for Shortfall in Value of Contributed Property: If the actual value of property contributed in kind is significantly less than stated, incorporators can be liable for the shortfall (unless an inspector's investigation was duly conducted or professional certification obtained, and they were not negligent).
  • Liability for Neglect of Duties: Incorporators can be liable to the company or third parties for damages caused by their neglect of duties in the incorporation process.
  • Liability in Case of Failure to Incorporate: If the company is not successfully established, incorporators may be jointly and severally liable for acts done and expenses incurred in connection with the incorporation.

Conclusion

The establishment of a Kabushiki Kaisha in Japan, whether through promotive incorporation or subscription-based incorporation, is a legally structured process designed to ensure transparency, proper capitalization, and the protection of initial investors and future stakeholders. Promotive incorporation offers a more streamlined path for founders providing all initial capital, while subscription-based incorporation accommodates a broader solicitation of initial investment and involves the crucial check of an inaugural shareholders' meeting. Both methods require careful attention to the preparation and notarization of the articles of incorporation, the determination and payment of share subscriptions, and the appointment of initial officers. Furthermore, the stringent rules surrounding "exceptional matters of incorporation," such as contributions in kind, underscore the Japanese legal system's emphasis on the substantive reality of a company's initial capital base. For anyone contemplating setting up a K.K. in Japan, a thorough understanding of these procedural nuances and legal obligations is paramount for a successful and compliant incorporation.