Share Issuance in Japanese Private Companies: Why is Shareholder Approval Crucial and How Does it Differ from Public Companies?

Japanese Attorney at Law - Bengoshi L.L.

• 9 min read

When Japanese corporations decide to issue new shares, the legal path they must follow varies significantly depending on whether they are classified as "public" or "non-public" companies. While public companies often benefit from a more flexible, board-driven process under the "authorized capital system," non-public companies (非公開会社 - hikōkai kaisha), typically closely-held entities, operate under a stricter regime where shareholder approval is paramount. This distinction is fundamental to understanding corporate finance and governance in Japan.

This article delves into the regulations governing share issuances by non-public companies in Japan, exploring why such robust shareholder approval mechanisms are mandated, how these rules contrast with those for public companies, and the implications for protecting shareholder interests in these often tightly-knit corporate environments.

The Default Rule: Special Shareholder Resolution for Share Issuance

The cornerstone of share issuance regulation for non-public Japanese companies is the general requirement for a special resolution of a shareholders' meeting to approve the issuance of new shares for subscription (募集株式の発行等 - boshū kabushiki no hakkō tō). This is stipulated in Articles 199, paragraph 2, and 309, paragraph 2, item 5 of the Companies Act (会社法 - Kaisha-hō). A special resolution typically requires the approval of a two-thirds majority of the voting rights of shareholders present at a meeting where shareholders holding a majority of all voting rights are present. Unlike public companies, the "authorized capital system"—whereby a board can issue shares within pre-approved limits—does not generally apply by default to non-public companies for issuances to third parties.

The rationale behind this stringent requirement is multifaceted, primarily revolving around the heightened need to protect the unique interests of shareholders in closely-held corporations:

  1. Protecting Controlling Interests (支配的利益の保護 - Shihaiteki Rieki no Hogo):
    In non-public companies, share ownership is often not merely a passive investment but is intrinsically linked to participation in management, strategic direction, and the identity of the company. Existing shareholders typically have a strong interest in maintaining their proportionate shareholding ratio (持株比率 - mochikabu hiritsu) and, consequently, their voting power and influence over the company's affairs. Any new issuance of shares, particularly to third parties, can significantly dilute these control interests. Given that shares in non-public companies are usually not publicly traded and are subject to transfer restrictions (indeed, a company is "non-public" if all its shares have transfer restrictions requiring company approval), shareholders cannot easily buy additional shares on the open market to counteract such dilution. The mandatory shareholder vote thus serves as a critical defense of their existing control stakes.
  2. Protecting Economic Interests (経済的利益の保護 - Keizaiteki Rieki no Hogo):
    Beyond control, economic dilution is also a major concern. For public companies with actively traded shares, there is a market price that can serve as a benchmark for assessing whether a new share issuance is priced fairly. Regulations for public companies thus focus on requiring special shareholder approval mainly for "advantageous issuances" (i.e., issuances at a price significantly below fair market value). However, for non-public companies, establishing an objective "fair market value" for shares is notoriously difficult due to the lack of a public market. A general requirement for shareholder approval for most issuances therefore also acts as a safeguard against new shares being issued at an unfairly low price, which would dilute the economic value of existing shareholders' investments.
  3. Feasibility of Shareholder Meetings:
    Non-public companies typically have a smaller and more stable shareholder base. Convening a shareholders' meeting to approve a share issuance is generally less cumbersome and costly than it would be for a large public company with thousands of shareholders. Thus, the law deems it a reasonable procedural step that does not unduly hamper legitimate fundraising needs.

Nuances in Approval Requirements: Third-Party vs. Shareholder Allotments

While a special shareholder resolution is the general rule, the Companies Act provides some nuances, particularly when distinguishing between issuances to third parties and pro-rata allotments to existing shareholders.

Issuances to Third Parties (第三者割当て - Daisansha Wariate)

When a non-public company proposes to issue shares to specific third parties (i.e., not to all existing shareholders on a pro-rata basis), the determination of all subscription requirements (募集事項 - boshū jikō), such as the number of shares, the issue price, and the payment date, must be made by a special resolution of the shareholders' meeting.

If the issue price is considered "especially advantageous" to the subscribers, Article 199, paragraph 3 of the Companies Act further requires the directors to explain the reasons for such necessity at the shareholders' meeting. This duty to explain is proactive and does not depend on shareholders asking questions (unlike the general duty to answer questions at shareholder meetings under Article 314).

Shareholder Allotments (株主割当て - Kabunushi Wariate)

A shareholder allotment involves offering new shares to all existing shareholders in proportion to their current shareholdings. While this method is inherently less dilutive of control for those shareholders who choose to subscribe, it still requires, as a default, a special shareholder resolution (Article 202, paragraphs 1 and 3, item 4; Article 309, paragraph 2, item 5). This resolution must determine the subscription requirements, confirm that the issuance is by way of shareholder allotment, and set the offer period for shareholders to apply for their entitlements.

The rationale for requiring shareholder approval even in pro-rata offerings is that some shareholders may be unable or unwilling to invest further capital (e.g., due to financial constraints). These non-subscribing shareholders will inevitably see their proportionate interest in the company diluted. The shareholder vote provides a forum to consider such implications.

However, recognizing that shareholder allotments are generally less prejudicial to existing shareholders' overall position compared to third-party issuances, the Companies Act offers some important relaxations:

  1. No "Advantageous Issuance" Scrutiny: The stringent rules and director explanation requirements for "advantageous issuance" pricing do not apply to shareholder allotments (Article 202, paragraph 5). This allows the company to set the subscription price for a rights offering at a level attractive to existing shareholders without triggering the additional procedural hurdles associated with advantageous pricing to third parties.
  2. Delegation by Articles of Incorporation: Crucially, a non-public company's articles of incorporation may include a provision that delegates the authority to determine the subscription requirements for future shareholder allotments to the board of directors (or to the directors if the company does not have a board) (Article 202, paragraph 3, items 1 and 2). If such a provision exists, the board can decide on the specifics of a shareholder allotment without needing a separate shareholder resolution for each instance, providing a degree of operational flexibility for routine capital increases from the existing shareholder base.

No General Requirement for Separate Public Notice of Subscription Terms

Unlike public companies, which generally must provide public notice of the subscription requirements for new share issuances (Article 201, paragraph 3), non-public companies are typically not subject to this separate public notification requirement. The rationale is that shareholders in non-public companies receive the necessary information through other means:

  • For most issuances (except shareholder allotments specifically delegated to the board by the articles), shareholders are directly involved in approving the terms at a shareholders' meeting.
  • Even in the case of shareholder allotments where the board determines the terms pursuant to a provision in the articles, the company is still obligated to provide individual notice (a "notice of allotment" - 割当通知 - wariate tsūchi) to each shareholder. This notice details the subscription requirements and the number of shares that particular shareholder is entitled to subscribe for, thereby ensuring they have the information needed to exercise their rights (Article 202, paragraph 4).

The Japanese approach to regulating share issuances in non-public companies, with its strong emphasis on ex-ante shareholder approval, is notably stricter than in some other major jurisdictions like the United States or the United Kingdom, where boards of private companies often have greater discretion to issue shares within authorized limits, especially if pre-emption rights are waived or do not apply.

This stricter Japanese stance can be partly understood as a response to historical challenges associated with effective ex-post (after the fact) remedies for shareholders in non-public companies. Before the series of Commercial Code amendments that solidified these rules (notably the 1990 amendment, which was a precursor to the current Companies Act framework), it was often difficult for shareholders in closely-held companies to successfully challenge share issuances that unfairly diluted their control or economic interests. Courts were sometimes hesitant to nullify issuances or grant injunctions based on general claims of "unfairness," especially if procedural formalities appeared to have been met. The concept of an issuance being "unfair" (不公正発行 - fukōsei hakkō), while a ground for an injunction, faced hurdles in proof and judicial application, particularly in the context of nullity.

By mandating a special shareholder resolution as the primary procedural gateway for most share issuances in non-public companies—a requirement that generally cannot be waived by the articles of incorporation (except for the specific case of shareholder allotments)—the law created a clearer, more objective basis for challenging improper issuances. The lack of such a resolution, or a resolution passed with severe procedural defects, became a more tangible ground for asserting the invalidity of the shares issued.

The Consequence of Lacking Proper Shareholder Approval: Nullity of Issuance

If a non-public company issues shares without obtaining the requisite special shareholder resolution, or if the resolution obtained suffers from such severe defects that it is considered legally non-existent, the prevailing view in Japanese law is that the share issuance is null and void.

This position was significantly reinforced by a Supreme Court decision on April 24, 2012 (Minshu Vol. 66, No. 6, p. 2908). The Court reasoned that the Companies Act, by generally requiring a special shareholder resolution for determining subscription requirements in non-public companies and by providing a longer statutory period (one year from the date of issuance, as per Article 828, paragraph 1, item 2, compared to six months for public companies) for bringing a lawsuit to nullify a share issuance, clearly intends to prioritize the protection of existing shareholders' control-related interests. Issuances made against the will of the shareholders (as should be expressed through the formal resolution process) are therefore subject to nullification.

A Complication: Defective Shareholder Resolutions and Litigation Time Limits

A complex issue arises when a shareholder resolution approving a share issuance is passed, but that resolution itself is procedurally flawed—for example, if some shareholders were not properly notified of the meeting, or if the agenda item for the share issuance was improperly added, leading to a surprise vote. Such defects typically render a resolution "cancellable" (取り消し得る - torikeshiuru) rather than automatically void. A lawsuit to cancel a shareholder resolution must generally be filed within three months of the date of the resolution (Article 831, paragraph 1).

The interaction of this three-month cancellation period with the one-year nullity period for the share issuance itself has been a point of legal debate. Under what is known as the "absorption theory" (吸収説 - kyūshū-setsu), once the shares have been issued, a challenge to the issuance based on a defective underlying resolution is "absorbed" into a suit to nullify the share issuance. If one then applies the "restricted assertion period theory" (主張期間制限説 - shuchō kikan seigen-setsu), it would mean that the defect in the resolution could only be raised as a ground for nullifying the share issuance if the nullity suit (or the grounds related to the resolution defect) is brought within the original three-month period for challenging the resolution. This would effectively shorten the one-year period specifically provided for challenging share issuances in non-public companies, particularly in situations where shareholders might only become aware of the issuance or the resolution's defect after the three-month window has passed. Such an outcome could undermine the protective intent of the longer one-year nullity period.

Legal scholars have proposed various interpretive solutions to prevent the unfair foreclosure of shareholder challenges in such scenarios, including:

  • Arguing that particularly severe procedural flaws in a resolution might render it "non-existent" (不存在 - fusonzai), a status that can be challenged without a strict time limit.
  • Contending that the one-year statutory period for challenging the share issuance nullity should prevail even when the underlying reason for nullity is a cancellable shareholder resolution, to give full effect to the legislative intent of robust shareholder protection in the context of non-public company share issuances.

Implications for Businesses and Investors

The strict shareholder approval requirements for share issuances in Japanese non-public companies have significant practical implications:

  • For Existing Shareholders: Your rights regarding approval for new share issuances are very strong. It is crucial to understand these rights and the available remedies (including nullity suits) if these procedures are bypassed or improperly executed.
  • For Investors and Partners: When considering investing in or partnering with a Japanese non-public company, be aware that capital increases generally necessitate a high degree of shareholder consensus. This can impact transaction timelines, certainty, and the overall ease of injecting further capital. Thorough due diligence on past share issuances and the validity of shareholder meeting procedures is essential.
  • Balancing Protection and Agility: While these strict rules offer robust protection against unwanted dilution and shifts in control, they can also make agile fundraising more challenging, especially if shareholder relations within the company are complex or contentious.

Conclusion

The Japanese Companies Act draws a clear distinction in regulating share issuances by public and non-public companies. For non-public entities, the default requirement of a special shareholder resolution for nearly all issuances underscores a strong legislative policy prioritizing the protection of existing shareholders' unique control and economic interests in closely-held settings. This approach, which contrasts with the greater board-level discretion typically found in public companies (and in many private company regimes internationally), is shaped by the illiquid nature of shares in non-public companies and a historical context favoring strong ex-ante procedural safeguards.

While this system provides significant protection, complexities can arise, particularly concerning the interplay between defects in shareholder resolutions and the time limits for challenging ensuing share issuances. Navigating these intricacies requires a careful understanding of both the substantive rights of shareholders and the procedural avenues for their enforcement in the distinct environment of Japanese non-public corporations.