Regulation of Conferring Benefits in Japanese Company Law: From Anti-Sokaiya Measures to Ensuring Fair Corporate Operations

Japanese Attorney at Law - Bengoshi L.L.

• 8 min read

Article 120 of the Japanese Companies Act (Kaisha-hō) establishes a crucial, yet sometimes nuanced, regulation concerning the conferral of benefits by a company in relation to the exercise of shareholder rights. This provision prohibits a Kabushiki Kaisha (K.K., or joint-stock company) or its subsidiary from providing any proprietary benefit to any person "on its own account" in connection with the exercise of shareholder rights. While historically rooted in efforts to combat corporate racketeers known as sokaiya, the scope and application of this regulation today extend more broadly to ensuring the fairness of corporate operations and protecting company assets. This article will explore the origins, current legal framework, key elements, and consequences of violating this important provision of Japanese company law.

Historical Background and Original Purpose: The "Sokaiya" Problem

To understand the current regulation, it's helpful to look at its historical context. The prohibition on conferring benefits in relation to shareholder rights was largely introduced as a measure to tackle the issue of sokaiya (総会屋).

Who are/were Sokaiya?

Sokaiya were individuals or groups who would acquire a small number of shares in multiple companies, not for genuine investment purposes, but to extort money from these companies. Their primary tactic involved threatening to disrupt or prolong shareholders' meetings by asking difficult or embarrassing questions, making lengthy speeches, or otherwise causing disturbances. Conversely, they might offer to ensure a smooth and quick meeting in exchange for payments. These activities often had links to anti-social forces (hanshakaiteki seiryoku, often referring to organized crime groups). The presence and activities of sokaiya were a significant problem for Japanese corporations, hindering legitimate shareholder discourse and draining corporate assets.

Legislative Intent of the Original Prohibition

The core legislative intent behind the initial introduction of these regulations (during the Showa 56 (1981) amendment to the Commercial Code, the predecessor to the Companies Act) was to cut off the flow of funds from companies to sokaiya. By making it illegal for companies to pay off these corporate racketeers, the law aimed to undermine their business model.

However, defining "sokaiya" in a legally precise way that would only target them proved difficult. As a result, the prohibition was drafted broadly, stating that benefits could not be conferred "to any person" (nampito ni taishitemo) in relation to the exercise of shareholder rights. This broad wording meant that, from its inception, the regulation had the potential to apply to situations beyond the sokaiya context.

The Current Scope and Rationale of Article 120 of the Companies Act

Article 120, paragraph 1 of the Companies Act provides: "A Stock Company shall not, to any person, confer any proprietary benefit on the account of such Stock Company or its subsidiary in connection with the exercise of rights of a shareholder."

Paragraph 2 of the same article establishes a presumption: if a company provides a proprietary benefit to a specific shareholder without charge, or for consideration that is conspicuously small compared to the benefit provided, it is presumed that the company has conferred a benefit in relation to the exercise of shareholder rights.

While the anti-sokaiya objective remains relevant, the current rationale for Article 120 is understood more broadly to encompass:

  1. Ensuring the Fairness and Soundness of Corporate Operations: The provision aims to maintain the integrity of corporate decision-making processes, particularly those involving shareholders. The use of company assets to influence the exercise of shareholder rights is seen as inherently problematic, as it is more likely to serve the private interests of directors or specific factions rather than the efficient and profitable operation of the company as a whole.
  2. Preventing the Waste of Corporate Assets: By prohibiting undue payments or benefits related to shareholder rights, the law seeks to protect the company's financial resources from being depleted for improper purposes.

Key Elements of the Prohibition

For a violation of Article 120 to occur, several elements must be present:

1. "On the account of the company or its subsidiary" (Kaisha matawa sono kogaisha no keisan ni oite)

The benefit must be provided using the assets or resources of the company itself or its subsidiary. If, for example, a director personally pays a shareholder from their own funds to vote a certain way, this would not fall under Article 120, though it might raise other legal issues (such as breach of fiduciary duty by the director if it harms the company).

2. "To any person" (Nampito ni taishitemo)

The recipient of the benefit does not have to be a shareholder. The prohibition applies if the benefit is given to any person, including non-shareholders, as long as the other conditions (particularly the connection to shareholder rights) are met. This reflects the original drafting challenge of narrowly defining sokaiya.

3. "In relation to the exercise of a shareholder's rights" (Kabunushi no kenri no kōshi ni kanshi)

This is often the most contentious element in applying Article 120. It is generally interpreted to mean that the benefit must be conferred with the intention, purpose, or aim of influencing the exercise (or non-exercise) of a shareholder's rights. Whether the benefit actually did influence the shareholder's actions is not the primary test; the company's (or its management's) intent is key.

  • Examples of Shareholder Rights: This includes a wide range of rights, such as voting at shareholders' meetings, making proposals, asking questions, or even refraining from exercising such rights.
  • Influencing Votes: A classic example would be providing a benefit to a shareholder to persuade them to vote in favor of a management proposal at a shareholders' meeting.
  • Acquiring Shares to Silence a Shareholder: The Supreme Court, in a judgment on April 10, 2006 (Minshu Vol. 60, No. 4, p. 1273), held that providing consideration to a third party to acquire shares from an "undesirable" shareholder, with the aim of preventing that shareholder from exercising their rights, could fall under this provision. The "exercise of rights" here is construed broadly to include the potential future exercise of rights by the undesirable shareholder.
  • Employee Share Ownership Plans (ESOPs): The provision of financial assistance or incentives by a company to its employee share ownership plan has been scrutinized under Article 120. A Fukui District Court judgment on March 29, 1985 (Hanrei Times No. 559, p. 275) found that where the primary purpose of such incentives was genuinely for employee welfare and not to create a bloc of "stable shareholders" who would invariably vote with management, the incentives were not "in relation to the exercise of shareholder rights."
  • Gifts to Shareholders Attending Meetings: A Tokyo District Court judgment on December 6, 2007 (Hanrei Times No. 1258, p. 69) dealt with a case where a company gave a Quo card (a type of gift card) worth JPY 500 to shareholders who exercised their voting rights at a meeting where competing proposals from management and a shareholder were being considered. The court held that while conferring benefits is generally prohibited, it may be exceptionally permissible if:
    1. It is done for a legitimate purpose not likely to improperly influence the exercise of shareholder rights;
    2. The value of the benefit provided to each shareholder is within a socially acceptable range; and
    3. The total amount does not materially affect the company's financial soundness.
      In this specific case, while conditions (2) and (3) were met, the court found that in the context of competing proposals, the provision of the Quo card was intended to secure votes for the company's proposal, thus failing condition (1). Consequently, the benefit was deemed illegal, and the shareholder resolution was rescinded.

4. "Proprietary benefit" (Zaisan-jō no rieki)

This refers to any benefit that has economic or financial value. It is not limited to cash payments and can include goods, services, forgiveness of debt, or any other transfer of economic value.

Consequences of Violating the Prohibition

A violation of Article 120 can lead to both civil liability and criminal penalties.

Civil Liability (Article 120, paragraphs 3 and 4)

  1. Recipient's Duty to Return: Any person who receives an illegal proprietary benefit must return it to the company or its subsidiary (Article 120, paragraph 3). This is a strict liability; the recipient's knowledge or intent is irrelevant for the duty to return.
  2. Liability of Directors Involved: Directors who were involved in the illegal conferral of benefits are jointly and severally liable to the company for the value of the benefit conferred (Article 120, paragraph 4; further details in Article 21 of the Companies Act Enforcement Rules).
    • This includes directors who actually executed the conferral, as well as directors who approved a board resolution authorizing such conferral.
    • Directors who executed the conferral may be held liable even without fault. Other involved directors (e.g., those who merely voted in favor of a resolution) can escape liability if they can prove they were not negligent in performing their duties.
  3. Subject to Shareholder Derivative Suits: The company's right to demand the return of the benefit from the recipient, and its right to claim damages from the involved directors, can be enforced through a shareholder derivative lawsuit if the company itself fails to take action (Article 847, paragraph 1).

Criminal Penalties (Articles 970 and 968 of the Companies Act)

The Companies Act imposes criminal sanctions for violations related to the illegal conferral of benefits, indicating the seriousness with which such conduct is viewed.

  1. Penalties for Conferring or Receiving Benefits (Article 970):
    • Directors, etc., Conferring Benefits: Directors or other relevant officers who confer an illegal benefit in violation of Article 120, paragraph 1, are subject to imprisonment of up to five years or a fine of up to JPY 5 million, or both (Article 970, paragraph 1).
    • Recipients: Any person who, with knowledge of the circumstances, receives such a benefit, or causes a third party to receive it, faces similar penalties (Article 970, paragraph 2).
    • Demanding Benefits: Even merely demanding such an illegal benefit with knowledge of the circumstances is punishable (Article 970, paragraph 3).
    • Aggravated Penalties: If the recipient or demander uses threats or intimidation against directors, etc., the penalties can be more severe (Article 970, paragraph 4).
  2. Penalties for Bribery Related to Shareholder Rights (Article 968):
    This article addresses a more direct form of bribery.
    • Receiving Bribes: Any person (including shareholders or those acting on their behalf) who, in response to an "illicit solicitation" (fusei no seitaku – meaning a request to exercise or not exercise shareholder rights in an illegal or grossly unfair manner), receives, demands, or promises to receive a proprietary benefit, is subject to imprisonment of up to five years or a fine of up to JPY 5 million, or both.
    • Giving Bribes: Similarly, any person who gives, offers, or promises such a benefit in connection with an illicit solicitation faces the same penalties.

Practical Implications and Considerations

The regulation on conferring benefits has several practical implications for companies operating in Japan:

  • Scope Beyond Sokaiya: While the anti-sokaiya roots are clear, companies must understand that Article 120 applies broadly to any situation where benefits are conferred with the intent to influence shareholder rights, not just payments to disruptive elements.
  • Identifying "Gray Areas": Certain corporate practices can fall into a gray area. Examples include:
    • Incentives for Employee Share Ownership Plans: As seen in the Fukui District Court case, these are generally permissible if their primary purpose is employee welfare, but could be problematic if structured to unduly influence ESOP voting.
    • Reimbursement of Expenses or Small Tokens for Shareholders' Meeting Attendance: Providing reasonable travel expenses or very modest tokens of appreciation is generally not considered problematic, but the line can be blurry if the amounts become substantial or are perceived as an inducement to vote in a particular way.
    • Shareholder Perk Systems (Kabunushi Yūtai): As discussed in a previous article, these are generally accepted if the perks are of modest value and serve legitimate corporate purposes like marketing or shareholder relations. However, excessively valuable or disproportionate perks could raise Article 120 concerns. The Tokyo District Court judgment involving Quo cards highlights the importance of the purpose and the context.
  • Importance for Corporate Governance: Compliance with Article 120 is an integral part of good corporate governance. A violation can also constitute a breach of a director's duty of loyalty or care to the company, leading to separate grounds for liability.
  • Due Diligence in M&A: When acquiring a Japanese company, due diligence should include an assessment of past practices related to shareholder benefits and communications to identify any potential historical violations of Article 120.

Conclusion

The Japanese Companies Act's regulation on conferring benefits in relation to the exercise of shareholder rights, encapsulated in Article 120, is a significant provision aimed at maintaining the integrity of shareholder decision-making and protecting corporate assets. Originating as a specific countermeasure against corporate racketeers, its application now extends to a broader range of conduct, emphasizing the fairness and soundness of corporate operations. Companies, their directors, and those interacting with shareholders must be acutely aware of its requirements and the potential civil and criminal consequences of non-compliance. Particularly in designing shareholder communication strategies, incentive programs, or any form of benefit distribution to shareholders, it is crucial to understand the spirit of this regulation and ensure that all actions are taken with legitimate corporate purposes and without the intent to improperly influence the exercise of shareholder rights.