Kansayaku (Audit & Supervisory Board Members) and the Audit & Supervisory Board in Japan: How Do They Oversee Director Conduct?

Japanese Attorney at Law - Bengoshi L.L.

• 9 min read

Within the distinct corporate governance landscape of Japanese Kabushiki Kaisha (K.K.), or joint-stock companies, the roles of the Kansayaku (監査役 – often translated as Statutory Auditor or Audit & Supervisory Board Member) and, where established, the Kansayaku-kai (監査役会 – Audit & Supervisory Board) are pivotal. These institutions form a unique oversight mechanism, tasked primarily with auditing the execution of duties by directors and ensuring the legality and appropriateness of corporate management. Unlike the audit committees typically found within the board structure in U.S. corporations, the Kansayaku system in its traditional form operates as an independent organ, separate from the board of directors. Understanding its functions, powers, and interplay with other corporate organs is essential for anyone engaging with or analyzing the governance of Japanese companies.

The Statutory Auditor (Kansayaku): A Unique Feature of Japanese Corporate Governance

The Kansayaku is an individual officer of the K.K. whose primary responsibility is to audit the performance of duties by the company's directors. Their overarching mission is to protect the interests of shareholders by ensuring that directors manage the company lawfully and appropriately.

Distinction from Directors and Independence

A fundamental characteristic of Kansayaku is their independence from the board of directors. They are not under the command or supervision of the directors; rather, they are empowered to supervise the directors. This structural independence is considered crucial for their effectiveness. While they attend board meetings and have the right (and often the obligation) to state their opinions, they are not members of the board and do not vote on board resolutions.

Historical Development

The Kansayaku system has a long history in Japanese corporate law, evolving significantly over time. Initially introduced as an optional organ in the post-WWII Commercial Code reforms (1950), its powers were gradually strengthened through subsequent amendments (e.g., in 1974, 1993, and the current Companies Act of 2006). This evolution reflects a continuous effort to enhance corporate accountability and address shortcomings in corporate governance, often in response to corporate scandals. The development of the Kansayaku into a robust audit organ, distinct from the board, marks a key divergence from the U.S. model, which has largely relied on board committees (like the audit committee) for similar oversight functions.

Appointment, Qualifications, and Term of Office of Kansayaku

The appointment and tenure of Kansayaku are designed to bolster their independence and competence.

Appointment (Articles 329, 343)

  • Kansayaku are appointed by a resolution of the shareholders' meeting, typically an ordinary resolution (Article 329, paragraph 1). However, similar to directors, a special quorum requirement applies: the articles of incorporation cannot lower the quorum for electing Kansayaku to less than one-third of the total voting rights (Article 341).
  • Crucially, the shareholders' meeting votes separately on the appointment of directors and Kansayaku.

Qualifications (Article 335)

  • Disqualification Grounds: Individuals cannot serve as a Kansayaku if they are a director or an employee (including a manager) of the K.K. or any of its subsidiaries. This prohibition is fundamental to ensuring their independence from the management they are tasked with auditing. Other general disqualification grounds applicable to directors also apply.
  • Outside Kansayaku (Shagai Kansayaku): The concept of "outside" Kansayaku is highly significant. An outside Kansayaku is one who meets stringent independence criteria, ensuring no prior or current close ties to the company's management or controlling shareholders (Article 2, item 16). For companies with an Audit & Supervisory Board, at least half of its members must be outside Kansayaku (Article 335, paragraph 3). This requirement has been progressively strengthened to enhance objective oversight. Recent amendments to the Companies Act (related to the 2019 reforms) concerning outside directors (Article 327-2) further underscore the emphasis on external oversight, though the Kansayaku system remains distinct.
  • Number: A K.K. with a board of directors (unless it's a "Company with an Audit and Supervisory Committee" or a "Company with a Nominating Committee, etc.") must generally have at least one Kansayaku. If an Audit & Supervisory Board is established, it must consist of three or more Kansayaku (Article 335, paragraph 3).

Term of Office (Article 336)

  • The standard term of office for a Kansayaku is four years (more precisely, until the conclusion of the annual general shareholders' meeting for the last business year ending within four years from their appointment) (Article 336, paragraph 1). This is notably longer than the standard two-year term for directors.
  • Rationale for Longer Term: The longer term is intended to further enhance their independence, allowing them to perform their duties without the immediate pressure of frequent re-appointment and to accumulate expertise over time.
  • No Shortening of Term: Unlike directors' terms, the four-year term for Kansayaku cannot be shortened by the articles of incorporation or a shareholders' resolution (Article 336, paragraph 2). However, for non-public companies, the articles can extend the term up to ten years, similar to directors.

Dismissal (Articles 339, 343(3), 854)

Reflecting their independent status and the importance of their oversight role, dismissing a Kansayaku is more difficult than dismissing a director.

  • Dismissal requires a special resolution of the shareholders' meeting (Article 339, paragraph 1, read with Article 309, paragraph 2, item 7). This is a higher threshold than the ordinary resolution generally required for dismissing directors.
  • A Kansayaku being considered for dismissal has the right to attend the shareholders' meeting and state their opinion on the dismissal (Article 343, paragraph 3, applying Article 345, paragraph 1 and 4 mutatis mutandis).
  • Similar to directors, if a Kansayaku is dismissed without justifiable grounds before the expiry of their term, they can claim damages from the company (Article 339, paragraph 2).
  • Shareholders can also file a lawsuit to remove a Kansayaku for misconduct or serious violations, under similar conditions as for removing directors (Article 854).

Powers and Duties of Kansayaku (The Principle of Each Kansayaku Acting Independently - Dokkisei no Gensoku)

A crucial aspect of the Kansayaku system is the "principle of each Kansayaku acting independently" (dokkisei no gensoku). Even if a company has an Audit & Supervisory Board (which is a collective body), each individual Kansayaku retains the authority to exercise their powers independently (Article 389, paragraph 1). The Audit & Supervisory Board cannot prevent an individual Kansayaku from exercising their statutory powers.

The powers and duties of Kansayaku are extensive and can be broadly categorized into operational audit and accounting audit functions.

A. Operational Audit (Gyōmu Kansa)

This involves auditing the legality and appropriateness of the directors' execution of their duties related to the company's business operations. It is not limited to financial aspects.

  • Scope: This includes examining whether directors are complying with laws, the articles of incorporation, and shareholders' resolutions, and whether their business judgments are made with due care and loyalty.
  • Key Powers:
    • Investigation of Company Affairs and Assets (Article 381, paragraph 2): Kansayaku have the right to investigate the business operations and financial condition of the company and its subsidiaries at any time. They can request reports from directors, employees, and subsidiaries.
    • Reporting to the Board of Directors (Article 382): If a Kansayaku finds that a director is engaging or is likely to engage in conduct outside the scope of the company's purposes, or in any other conduct that violates laws or the articles of incorporation, or is grossly improper, and there is a risk of substantial harm to the company, they must report this to the board of directors.
    • Reporting to Shareholders' Meetings (Article 384): Kansayaku (or the Audit & Supervisory Board) must prepare an audit report and present it to the shareholders' meeting. This report covers both operational and accounting audit findings.
    • Demanding Cessation of Director's Acts (Injunction - Sashitome Seikyūken) (Article 385): If a director is engaging in an act outside the company's purposes or in violation of laws/articles, and such act risks causing "substantial harm" (ichijirushii songai) to the company, the Kansayaku can demand that the director cease such act. If the director does not comply, the Kansayaku can seek a court injunction. This is a powerful preventative tool.
    • Representing the Company in Actions Against Directors (Article 386): In lawsuits between the company and its directors (e.g., when the company sues a director for damages, or when a director sues the company), the Kansayaku (or the Audit & Supervisory Board, if designated by it) represents the company. This is crucial for ensuring impartiality when the board of directors itself might have a conflict of interest. This role is particularly important in the context of shareholder derivative suits.
    • Other powers: Attending and stating opinions at board meetings (Article 383, paragraph 1), convening board meetings if necessary (Article 383, paragraphs 2 and 3), and initiating various legal actions related to corporate organization.

B. Accounting Audit (Kaikei Kansa)

This involves auditing the company's financial statements and related accounting records.

  • Scope: Kansayaku audit the financial statements (balance sheet, income statement, etc.) and supporting schedules prepared by the directors to ensure their compliance with laws, the articles of incorporation, and generally accepted accounting principles.
  • In Companies with an External Accounting Auditor: If the company has appointed an external accounting auditor (kaikei kansanin), the Kansayaku's role in accounting audit shifts to overseeing the external auditor. They audit the methods and results of the audit conducted by the accounting auditor to determine their appropriateness (Article 389, paragraph 1; for Audit & Supervisory Boards, Article 390, paragraph 2, item 1).
  • Key Powers Related to Accounting Auditors:
    • The Kansayaku (or Audit & Supervisory Board) have the power to decide on proposals to be submitted to the shareholders' meeting regarding the appointment, dismissal, or non-reappointment of the accounting auditor (Article 344).
    • They also have the power to consent to the remuneration of the accounting auditor (Article 399). These powers are designed to safeguard the independence of the external audit function.

Limitation of Audit Scope (for Certain Non-Public Companies)

For non-public companies that are not Large Companies (and thus not required to have an accounting auditor, and have not voluntarily appointed one), the articles of incorporation can limit the scope of the Kansayaku's audit duties solely to accounting matters (Article 389, paragraph 1). In such "accounting-only Kansayaku" (kaikei kansa gentei no kansayaku), their operational audit powers are significantly restricted. This option provides a simpler governance structure for smaller, closely-held companies where direct shareholder oversight might be stronger.

The Audit & Supervisory Board (Kansayaku-kai)

When a company has three or more Kansayaku, it must (or may choose to) establish an Audit & Supervisory Board (Kansayaku-kai).

Establishment and Composition (Articles 335(3), 390)

  • Mandatory Establishment: An Audit & Supervisory Board is generally mandatory for Large Companies that are also public companies (Article 328, paragraph 1), unless they adopt one of the newer committee-based governance models. Other companies can voluntarily establish one.
  • Composition: It must be composed of three or more Kansayaku, and at least half of its members must be outside Kansayaku.
  • Full-time Kansayaku (Jōkin Kansayaku): The Audit & Supervisory Board must select one or more full-time Kansayaku from among its members (Article 390, paragraph 3). The full-time Kansayaku plays a crucial role in day-to-day information gathering and audit activities.

Powers and Functions of the Audit & Supervisory Board (Article 390(2))

The Audit & Supervisory Board is a collective body, but it primarily functions to facilitate and coordinate the audit activities of the individual Kansayaku, rather than to supersede their individual powers. Its key statutory functions include:

  1. Preparation of the Audit Report: This is a collective report synthesized from the findings of individual Kansayaku.
  2. Selection and Dismissal of Full-time Kansayaku.
  3. Determination of Audit Policies, Investigation Methods, etc.: The Board sets the overall audit strategy and methods for investigating the company's affairs and financial condition. However, these determinations cannot unduly restrict the ability of individual Kansayaku to exercise their own powers.
  4. Approval of Execution of Duties related to Accounting Auditors: This includes approving the exercise of the board's powers regarding proposals for the appointment/dismissal/non-reappointment of the accounting auditor, and consent to their remuneration.

Operation

The Audit & Supervisory Board operates through meetings. It is convened by any Kansayaku (unless a specific convener is designated). Resolutions are generally passed by a majority vote of the Kansayaku present, with specific quorum rules. A Kansayaku with a special interest in a resolution cannot participate in the vote. Minutes of the meetings must be kept.

Comparison with Other Oversight Mechanisms

  • Board of Directors' Supervisory Duty: While the board of directors itself has a duty to supervise the execution of duties by its members, the Kansayaku audit provides an independent layer of scrutiny from outside the board structure.
  • Internal Audit Departments: Many companies have internal audit departments that report to management or the board. Kansayaku often coordinate with and utilize the findings of internal auditors but maintain their independent audit perspective.
  • Alternative Governance Models: In a "Company with Audit and Supervisory Committee" or a "Company with Nominating Committee, etc.," the functions traditionally performed by Kansayaku are largely integrated into committees within the board of directors, composed primarily of outside directors. In these models, Kansayaku and Audit & Supervisory Boards are not established.

Liability of Kansayaku

Kansayaku, like directors, owe a duty of care to the company and can be held liable for damages caused by their neglect of duties (Article 423). This includes failures in their audit responsibilities (e.g., overlooking material misstatements in financial reports or serious director misconduct). They can also face liability to third parties under Article 429 if their willful misconduct or gross negligence in performing their duties causes damage to those third parties.

Conclusion

The Kansayaku and Audit & Supervisory Board system represents a distinct and historically significant approach to corporate oversight in Japan. It aims to ensure the legality and appropriateness of director conduct and protect shareholder interests through an organ independent of the board of directors. While its structure differs from the board-centric audit committees common in the U.S., understanding its unique powers, duties, and the principle of individual Kansayaku authority is crucial for assessing the governance framework of traditional Japanese K.K.s. Although newer governance models like the Company with Audit and Supervisory Committee offer alternatives, the Kansayaku system remains a prevalent feature in many Japanese corporations, underscoring the continued emphasis on independent oversight in the Japanese corporate governance landscape.