What Are the Rules on Providing Benefits to Shareholders in Japan and Why Do They Exist?

Japanese Attorney at Law - Bengoshi L.L.

• 8 min read

Japanese company law includes a notably strict and specific prohibition against providing benefits to shareholders, or indeed any person, in connection with the exercise of shareholder rights. This rule, found in Article 120 of the Companies Act (会社法 - Kaishahō), plays a crucial role in safeguarding the integrity of corporate governance and shareholder democracy in Japan. Understanding its origins, scope, and consequences is essential for anyone involved with Japanese corporations.

The Statutory Prohibition: Article 120 of the Companies Act

Article 120, Paragraph 1 of the Companies Act states: "A Stock Company shall not, to any person, provide any property benefit in connection with the exercise of rights of a shareholder of such Stock Company or of a Registered Pledgee of Shares thereof."

This prohibition is sweeping and forms a cornerstone of regulations aimed at ensuring fair and uncorrupted corporate decision-making processes.

Purpose and Historical Context: The Shadow of Sokaiya

The primary objective of Article 120 and its predecessor in the old Commercial Code is to ensure the fairness and integrity of the exercise of shareholder rights and to maintain the soundness of company management. A significant historical driver for this stringent rule was the problem of sokaiya (総会屋). Sokaiya were corporate racketeers who would acquire a small number of shares in various companies and then extort money from management by threatening to disrupt annual shareholders' meetings with prolonged, difficult, or embarrassing questions, or, conversely, by offering to ensure a smooth meeting for a fee.

This practice became a serious issue in post-war Japan, undermining legitimate shareholder discourse and leading to corrupt payments by companies seeking to avoid trouble or manipulate meeting outcomes. Article 120 was designed as a powerful tool to cut off the flow of funds to sokaiya and to penalize both the companies providing such benefits and the recipients. While the sokaiya problem has largely diminished due to stricter enforcement and changes in corporate practices, Article 120 remains broadly applicable to any situation where benefits are improperly linked to the exercise of shareholder rights, ensuring it addresses more contemporary forms of undue influence as well.

Key Elements of the Prohibition

To understand the reach of Article 120, several key elements must be examined:

1. "To Any Person" (何人に対しても - Nannin ni Taishite mo)

The prohibition is not limited to providing benefits directly to shareholders. It applies if a property benefit is given to any person—be it a shareholder, a director, an employee, or an unrelated third party—if the benefit is provided "in connection with the exercise of rights of a shareholder." For example, paying a third party to influence a shareholder's vote would fall under this.

2. "Property Benefit" (財産上の利益 - Zaisan-jō no Rieki)

This term is interpreted broadly by courts and scholars to encompass any economic advantage, whether tangible or intangible, and is not restricted to direct cash payments. Examples include:

  • Cash payments, gifts, or entertainment.
  • Loans provided on exceptionally favorable terms (e.g., interest-free, without adequate security, or with no genuine expectation of repayment).
  • The company assuming a shareholder's debt.
  • Providing company assets or services for free or at a conspicuously low price.
  • Purchasing assets from a shareholder at an inflated price or selling company assets to a shareholder at a significantly discounted price.
  • Offering lucrative business contracts or positions.

The case study in the PDF's Problem 11 illustrates this well. A社, a listed company, is alleged to have (a) agreed to assume a 1 billion yen debt owed by Z, a major shareholder, and (b) provided Z with 5 billion yen disguised as a loan to Z's affiliated company, which Z had no intention of repaying and A社's representative director Y₁ knew this. Both scenarios clearly involve "property benefits."

3. "In Connection with the Exercise of Rights of a Shareholder" (株主の権利の行使に関し - Kabunushi no Kenri no Kōshi ni Kanshi)

This is the most crucial and often most contested element. It requires a demonstrable nexus or causal link between the provision of the property benefit and the exercise (or non-exercise, or a particular manner of exercise) of shareholder rights. Shareholder rights are diverse and include:

  • Voting rights at shareholders' meetings.
  • The right to make shareholder proposals.
  • Information and inspection rights.
  • The right to file derivative lawsuits or seek injunctions.
  • Rights related to the sale or disposition of shares, particularly in contexts affecting corporate control.

Determining this "connection" often involves examining the company's intent and the objective circumstances surrounding the provision of the benefit. The Supreme Court of Japan, in a judgment on April 10, 2006 (Heisei 18), addressed a situation where a company made payments to a shareholder perceived as hostile, allegedly to induce that shareholder to sell their shares and cease activities deemed disruptive by management (which could be framed as refraining from exercising certain shareholder rights). The Court indicated that the "primary purpose" (主要な目的 - shuyō na mokuteki) of the payment is a key factor. If the primary purpose was to influence the shareholder's exercise of their rights, the prohibition applies.

In the Problem 11 case study:

  • The 1 billion yen debt assumption by A社 for Z was explicitly in exchange for Z (holding 19% of A社's shares) agreeing to vote in favor of management's proposals at the upcoming shareholders' meeting. This establishes a clear and direct connection to the exercise of voting rights.
  • The 5 billion yen payment, disguised as a loan, was to enable Z to buy back A社 shares that Z had previously sold to a party considered "undesirable" by A社's management. The connection here is more nuanced but still likely present. It could be argued this benefit was provided to:
    • Secure Z's ongoing cooperation and friendly stance as a major shareholder.
    • Indirectly prevent the "undesirable party" from exercising shareholder rights by facilitating the removal of their shares from such hands.
    • Influence Z's decisions regarding his significant shareholding, perhaps by ensuring he does not align with other dissident shareholders or sell his stake to another hostile entity.
      The Supreme Court's April 10, 2006, reasoning suggests that payments made to influence a shareholder's general strategic position or shareholding decisions, especially to neutralize a perceived threat to current management or corporate policy, can indeed fall under the ambit of Article 120.

4. Presumption of Illegality (Article 120, Paragraph 2)

"If a Stock Company provides a property benefit without charge, or with a charge that is conspicuously insubstantial compared to said property benefit, to a specific shareholder, such benefit shall be presumed to have been provided in connection with the exercise of rights of a shareholder."

This presumption is significant. If a company gives an economic advantage to a particular shareholder for free or for a token amount, the law presumes the illicit connection to shareholder rights. The burden then shifts to the company to prove that the benefit was provided for a legitimate business reason entirely unrelated to influencing the shareholder's exercise of their rights. This makes it harder for companies to disguise prohibited benefits under the pretext of ordinary transactions.

Consequences of Violating Article 120

Violations of Article 120 carry severe civil and criminal consequences for both the company officials involved and the recipients of the benefits.

Civil Liability

  1. Recipient's Duty to Return (Article 120, Paragraph 3): Any person who received a property benefit in violation of Paragraph 1 must return it (or its value) to the company. This obligation is designed to restore the company's assets and overrides general civil law principles that might otherwise prevent the recovery of payments made for an illegal cause (e.g., Article 708 of the Civil Code concerning fuho gen'in kyūfu - payment for an illegal cause).
  2. Directors' Liability (Article 120, Paragraph 4): Directors who were involved in (e.g., proposed, approved, or executed) the provision of the prohibited property benefit are jointly and severally liable to the company for the value of the benefit provided. This is a strict form of liability. Directors cannot escape liability by merely proving they were not negligent; their involvement is key. The only statutory defense for a director who participated in a board resolution approving such a benefit is if they expressly objected to the resolution and their objection was recorded in the minutes of the board meeting.

Criminal Liability (Article 970)

The Companies Act also imposes criminal sanctions:

  1. For Providers (Article 970, Paragraph 1 & 2): Directors, statutory auditors, executive officers, managers, or other employees who provide a prohibited property benefit in response to a request, or in relation to a promise concerning the exercise of shareholder rights, or to solicit certain actions related to shareholder rights, can face imprisonment for up to five years or a fine of up to 5 million yen.
  2. For Recipients (Article 970, Paragraph 3 & 4): Any person (including a shareholder) who, with knowledge of its illicit nature, solicits or receives such a benefit, or causes it to be provided to a third party, can also face imprisonment for up to five years or a fine of up to 5 million yen. Any illicit benefit received by the offender is confiscated.

This dual enforcement mechanism (civil recovery for the company and criminal penalties) underscores the gravity with which Japanese law views attempts to subvert the proper exercise of shareholder rights through financial inducements.

Permissible vs. Impermissible Benefits

It is important to distinguish prohibited benefits from legitimate corporate actions:

  • Permissible:
    • Ordinary dividends paid pro-rata to all shareholders according to their shareholding, following proper procedures.
    • Reasonable shareholder perks or benefit programs (株主優待制度 - kabunushi yūtai seido) provided they are offered equitably to all shareholders (or all shareholders of a particular class) based on objective criteria like the number of shares held, are of modest value, and are not tied to the exercise of specific voting rights or other contentious rights. However, the line can be thin.
  • Impermissible (Examples):
    • Direct payments to shareholders for voting in a particular way or for abstaining from voting.
    • Payments to shareholders for not exercising proposal rights or for withdrawing proposals.
    • Excessive or non-market rate payments to acquire shares from a specific (often "problematic") shareholder to neutralize their influence or silence their opposition.
    • Disguised loans, guarantees, or assumption of debts for specific shareholders as a quid pro quo for their support or inaction.
    • Providing company assets or services at significantly below-market rates to favored shareholders to influence their stance.

The Tokyo District Court judgment of December 6, 2007 (Heisei 19), mentioned in the PDF's Problem 11 commentary, is instructive. In that case, a company provided Quo cards (prepaid gift cards of relatively small value) to all shareholders who exercised their voting rights (regardless of how they voted or by what method – in person, by mail, or electronically). The court found this to be a prohibited benefit under Article 120 because the provision of the card was directly linked to the act of exercising the right to vote. This decision suggests that even seemingly minor benefits, if directly tied to the act of exercising a shareholder right, can fall foul of the prohibition. The key is the "connection" – kanshi.

Comparison with U.S. Law

U.S. corporate law does not have a statutory prohibition as broad, specific, and historically targeted (re: sokaiya) as Japan's Article 120. However, conduct that would violate Article 120 in Japan could often be challenged in the U.S. under different legal doctrines:

  • Breach of Fiduciary Duty: Directors causing the company to make improper payments to shareholders or third parties to influence votes or other shareholder actions could be sued for breaching their duties of loyalty (acting in self-interest or for an improper purpose) or care (corporate waste if the payment lacks legitimate corporate purpose or fair consideration).
  • Corporate Waste: A transaction that is so one-sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration.
  • Anti-Bribery Laws: General anti-bribery statutes could potentially apply if payments are made to individuals to corruptly influence their actions as shareholders, though this is less common in typical corporate governance disputes.
  • Securities Regulations: U.S. federal securities laws, particularly rules governing proxy solicitations (e.g., SEC Rule 14a-9 regarding false or misleading statements in proxy materials), would be highly relevant if benefits are provided in connection with a proxy contest and are not properly and fully disclosed. Non-disclosure of material facts related to such inducements could lead to SEC enforcement or private litigation.
  • Vote-Buying: While direct, naked vote-buying is generally illegal or against public policy in the U.S., there is a more complex body of case law distinguishing impermissible vote-buying from permissible agreements that align shareholder interests with corporate goals, often requiring transparency and a legitimate corporate purpose.

The Japanese approach under Article 120 is more prophylactic and directly targets the act of providing benefits linked to shareholder rights, carrying specific civil recovery mechanisms and criminal penalties designed for this particular type of misconduct.

Conclusion

Article 120 of the Japanese Companies Act serves as a robust and stringent safeguard against the provision of property benefits intended to influence the exercise of shareholder rights. Born from a historical necessity to combat practices like those of the sokaiya, its reach extends to any situation where financial or other economic inducements are improperly linked to how shareholders exercise their legitimate prerogatives. Both the providers and recipients of such prohibited benefits face severe consequences, including the mandatory return of the benefit to the company, personal liability for directors, and potential criminal sanctions. This underscores Japan's strong commitment to ensuring that shareholder participation in corporate governance is based on fair and transparent processes, free from undue financial influence.