In recent years, the landscape of corporate governance in Japan has been increasingly shaped by shareholder activism, with shareholder derivative lawsuits (kabunushi daihyō soshō - 株主代表訴訟) emerging as a significant tool for holding company directors accountable. While Japan's corporate culture has traditionally emphasized harmony and long-term relationships, a growing willingness among shareholders to challenge management decisions and pursue legal remedies marks a notable shift. High-profile cases, including one in 2022 where former directors of a major electric power company were ordered by the Tokyo District Court on July 13, 2022, to pay unprecedented sums in damages related to a nuclear accident, underscore the potential financial and reputational impact of these lawsuits.

What is a Shareholder Derivative Suit in Japan?

A shareholder derivative suit, as defined under Article 847 of Japan's Companies Act, is a lawsuit brought by a shareholder on behalf of the company against its directors (or other officers, such as statutory auditors or accounting auditors) for harm caused to the company due to their misconduct or negligence.

Key Purposes and Rationale:
The primary purpose is to recover damages for the company, not for the individual shareholder plaintiff. The underlying rationale is that the company itself—often represented by the board of directors or statutory auditors—might be reluctant to sue its own executives. This reluctance, known as teiso ketai kanōsei (提訴懈怠可能性 - the possibility of failure to sue), can stem from collegial relationships, conflicts of interest, or a desire to avoid internal strife. The derivative suit mechanism allows shareholders to step in and ensure that directors who breach their duties are held accountable, thereby protecting the company's interests.

Beyond the recovery of damages, these lawsuits serve a crucial "disciplining" function. The threat of being sued and held personally liable encourages directors to act with greater diligence and in compliance with their legal obligations.

Who Can Sue and Procedural Steps:
To initiate a derivative suit, a shareholder must typically have held shares in the company for the preceding six months. Notably, there is no minimum shareholding percentage required; owning even a single share can suffice, a feature that significantly democratizes access to this legal tool.

The process generally involves two main stages:

1. Demand on the Company (Teiso Seikyū - 提訴請求): Before filing a derivative suit, the shareholder must first demand that the company itself (usually through its statutory auditors or board of directors, depending on the company's governance structure) file a lawsuit against the responsible directors.
2. Filing the Derivative Suit: If the company fails to file the lawsuit within 60 days of the demand, the shareholder can then proceed to file the derivative suit in court.

If the derivative suit is successful, any damages awarded are paid to the company. The plaintiff shareholder does not directly receive this compensation, though they may be reimbursed for legal costs and may indirectly benefit from an increase in share value if the recovery significantly improves the company's financial position.

The Evolution of Derivative Suits in Japan: A Story of Reform and Unexpected Drivers

The shareholder derivative suit was first introduced into Japanese law in 1950 through amendments to the Commercial Code. This was part of broader post-World War II reforms, influenced by the Allied Occupation (GHQ), aimed at democratizing Japanese corporations and dismantling the power of the zaibatsu (family-controlled industrial and financial conglomerates).

Initial Dormancy and the Impact of the 1993 Reform:
Despite its early introduction, the derivative suit mechanism remained largely dormant for several decades. A key reason was the prohibitive cost of litigation. Court filing fees were calculated as a percentage of the damages claimed. Given that derivative suits often involve claims for substantial sums, the upfront filing fees could be astronomical, effectively barring most shareholders from pursuing such actions.

A pivotal moment came with the 1993 amendment to the Commercial Code. This reform fixed the court filing fee for shareholder derivative suits at a low, flat rate (¥8,200 at the time, currently ¥13,000). This seemingly minor procedural change dramatically reduced the financial barrier to entry and is widely credited with a subsequent surge in derivative litigation.

The impetus for the 1993 reform was complex. Domestically, there were growing calls for better corporate accountability in the wake of corporate scandals. Internationally, it was influenced by external pressures, particularly the US-Japan Structural Impediments Initiative (SII) talks. During these negotiations, the United States urged Japan to implement reforms that would enhance corporate transparency and shareholder rights, partly to address trade imbalances by challenging exclusionary business practices within keiretsu (alliances of companies) that were perceived as favoring group members over outsiders. Strengthening shareholder derivative suits was seen as one way to empower shareholders to challenge management decisions that might not be in the best interest of all shareholders or the company itself.

The Unexpected Plaintiffs: Social Activism and the "Shareholder Ombudsman" Era:
While the 1993 reform made filing suits easier, it didn't entirely solve the "incentive problem" for individual shareholders. As any damages recovered go to the company, the direct financial benefit to a small shareholder is often negligible compared to the time, effort, and potential (though reduced) costs of litigation. Unlike in the United States, where plaintiff's attorneys often drive derivative litigation on a contingency fee basis, this model is not prevalent in Japan for such suits.

Interestingly, the increase in derivative suits in Japan following the 1993 reform was not primarily driven by economically motivated individual investors. Research, notably by scholars like Puchniak and Nakahigashi, has highlighted the significant role played by social activist groups, particularly organizations like the "Shareholder Ombudsman" (株主オンブズマン - kabunushi onbuzuman). This NPO, largely composed of lawyers, utilized derivative lawsuits as a tool to pursue broader social justice objectives, such as environmental protection, consumer safety, or challenging corporate misconduct like illegal payments to sōkaiya (corporate racketeers). While their primary aim might not have been shareholder value maximization in the narrow sense, their actions inadvertently fulfilled the corporate governance function of holding directors accountable and "disciplining" management. This created a unique dynamic where social activism became a key driver of a significant corporate governance mechanism.

Key Legal Principles in Derivative Suits

Derivative suits in Japan typically revolve around alleged breaches of directors' duties to the company.

Directors' Duties:

• Duty of Care (Zenkan Chūi Gimu - 善管注意義務): Derived from Article 330 of the Companies Act and Article 644 of the Civil Code, this requires directors to manage the company's affairs with the care of a prudent manager. This is a general standard of diligence and competence.
• Duty of Loyalty (Chūjitsu Gimu - 忠実義務): Article 355 of the Companies Act mandates that directors comply with laws, the articles of incorporation, and shareholder resolutions, and perform their duties faithfully for the benefit of the company. This duty specifically prohibits directors from acting in their own self-interest or in a manner that conflicts with the company's interests.
• Compliance with Laws and Articles of Incorporation: Directors are also obligated to ensure the company's operations adhere to all applicable laws and its own internal rules.

Violations of these duties that result in damage to the company can trigger director liability under Article 423 of the Companies Act.

The Business Judgment Rule (Keiei Handan Gensoku - 経営判断原則):
Japanese courts have recognized a version of the business judgment rule. While not explicitly codified in the Companies Act for all decisions, case law, such as the Supreme Court judgment of July 15, 2010 (in a case involving Apamanshop), suggests that courts will generally defer to directors' business decisions provided that:

1. The decision was made based on reasonably collected information and a rational process.
2. The substance of the decision itself was not grossly unreasonable from the perspective of an ordinary business person in that industry.

This principle acknowledges that business inherently involves risk, and directors should not be held liable simply because a well-intentioned and reasonably made decision turns out badly. However, if the decision-making process was flawed (e.g., lack of due diligence, failure to consider critical information) or if the decision was manifestly irrational or tainted by conflicts of interest, the business judgment rule may not offer protection.

Remedies:
The primary remedy sought in a successful derivative suit is monetary damages paid by the liable directors to the company. Injunctions to stop certain actions are generally sought through different types of shareholder actions, not derivative suits focused on past harm.

Landmark Cases and Their Influence (Anonymized Examples)

Several derivative lawsuits have had a significant impact on Japanese corporate governance and the understanding of director liability.

• A notable case in 2000 involving a major bank held former directors liable for substantial losses incurred from unauthorized trading by an employee and subsequent cover-ups. The court found that the directors had breached their duty of care by failing to establish and maintain an adequate internal control system. This case sent shockwaves through corporate Japan, highlighting the importance of risk management and oversight.
• The previously mentioned 2022 district court ruling concerning a major electric power company, while still subject to appeal, underscored the potential for massive liability in cases of catastrophic failure and alleged negligence in risk assessment and disaster preparedness.
• Cases involving illegal payments to sōkaiya or accounting fraud have also led to successful derivative suits, reinforcing the expectation that directors ensure legal compliance and financial integrity. For instance, a well-known case involving a major optical and medical equipment manufacturer that engaged in a long-term scheme to hide investment losses resulted in derivative litigation and scrutiny of the directors' and auditors' roles.

These cases, among others, have contributed to a heightened awareness of director duties and the potential consequences of failing to meet them.

The Shifting Landscape of Shareholder Activism

The context for shareholder derivative suits in Japan continues to evolve.

Post-"Shareholder Ombudsman" Era:
The disbandment of the prominent "Shareholder Ombudsman" NPO in 2019 due to the aging of its core members marked the end of an era. This has raised questions about who will drive derivative litigation in the future. While the volume of lawsuits has not necessarily plummeted, the nature of the plaintiffs may be changing.

Emergence of New Actors and Focus Areas:

• Event-Driven Activism: Specific corporate scandals or major crises (like the TEPCO case) can still trigger derivative suits from ad-hoc groups of concerned shareholders or activists focused on a particular issue.
• ESG-Related Litigation: Globally, there's a rise in litigation related to Environmental, Social, and Governance (ESG) factors. While still nascent in Japan in the form of derivative suits, failures in managing climate risks, human rights issues in supply chains, or major product safety scandals could increasingly become grounds for alleging breaches of director duties. Some recent US derivative suits concerning ESG matters are being watched for potential influence.
• Institutional Investors: Traditionally, Japanese institutional investors have been hesitant to initiate litigation against companies they invest in, preferring private engagement. However, with the strengthening of Japan's Stewardship Code, there's an increasing expectation that institutional investors will actively monitor investee companies and take appropriate action to protect shareholder value. While direct derivative litigation by large institutional investors remains rare, their increased scrutiny and engagement could indirectly lead to improved governance or provide support for actions brought by others.

Implications for Directors, Including Foreign Appointees

The active use of shareholder derivative suits has significant implications for anyone serving as a director of a Japanese company, including individuals appointed by foreign parent corporations.

• Heightened Personal Liability Risk: Directors face a tangible risk of being held personally liable for substantial damages to the company.
• Importance of Diligence and Documentation: Thorough due diligence, active participation in board discussions, careful consideration of expert advice, and meticulous documentation of the decision-making process are crucial to demonstrating that duties of care and loyalty have been met.
• Robust Internal Controls and Compliance: Ensuring the company has effective internal control systems, robust compliance programs, and a culture of ethical conduct is a key directorial responsibility and a defense against liability.
• D&O Insurance: Directors and Officers (D&O) liability insurance is essential. Understanding the scope of coverage available in the Japanese market and ensuring it is adequate is critical.
• Understanding Japanese Governance Norms: Foreign-appointed directors should familiarize themselves with Japanese corporate governance practices, legal standards, and the expectations placed upon directors.

Challenges and the Future Outlook

Despite their established role, shareholder derivative suits in Japan face ongoing challenges and an uncertain future trajectory.

• The Plaintiff's Incentive Problem: The fundamental issue that individual shareholders receive little direct financial benefit from a successful suit remains. This may limit the pool of potential plaintiffs, especially if activist organizations become less prominent.
• Balancing Accountability and Risk-Taking: While crucial for accountability, an overly aggressive litigation environment could make directors excessively risk-averse, potentially stifling innovation and entrepreneurial decision-making. The application of the business judgment rule aims to strike this balance.
• Potential for Strategic or Nuisance Litigation: The low filing fee, while democratizing access, also carries a risk of suits being filed for strategic purposes unrelated to genuine corporate harm, or as nuisance claims. Courts generally scrutinize the merits, but the process itself can be a burden.

Nevertheless, shareholder derivative suits are likely to remain an important, if evolving, component of Japan's corporate governance framework. They provide a vital mechanism for shareholders to hold management accountable and ensure that directors remain focused on their duties to the company. The nature of the plaintiffs and the types of issues litigated may change, reflecting broader shifts in societal expectations and investor priorities, including a greater focus on ESG factors. For US companies and their appointed directors, vigilance, adherence to best practices in corporate governance, and a keen understanding of the Japanese legal environment are more critical than ever.