Director Liability in Japan: Duties, the Business Judgment Rule, Derivative Suits, and D&O Insurance

Directors of a Japanese stock company (kabushiki kaisha) owe the company a duty of care and a duty of loyalty (Companies Act Art. 330; Civil Code Art. 644; Companies Act Art. 355). A director who neglects those duties and causes the company a loss is personally liable for the damage, and shareholders can pursue that liability through a derivative suit (Companies Act Arts. 423(1) and 847).

A business decision made after proper deliberation is not a breach merely because it later loses money. The most effective protection is preparation: approving conflict-of-interest transactions properly, keeping accurate board minutes, and putting liability-limitation agreements and D&O insurance in place.

• The company leases its office from the CEO's personal holding company, and there is no record of board approval.
• The board approved a large investment in a new business that has since failed. You thought you objected, but the minutes do not say so.
• Accounting irregularities or large losses have surfaced at a subsidiary, and you may be asked whether you supervised it properly as a director of the parent.
• The company has received a letter from a shareholder demanding that it sue its directors.

The relationship between a company and its directors is governed by the Civil Code rules on mandate (Companies Act Art. 330). A director must therefore perform their duties with the care of a prudent manager (Civil Code Art. 644). In practice, this means the level of care expected of someone in a director's position.

Directors must also comply with laws, the articles of incorporation, and shareholder resolutions, and must perform their duties loyally for the company (Companies Act Art. 355).

The Supreme Court has held that the loyalty provision of the former Commercial Code merely clarified the duty of care. It did not create a separate, higher duty (Supreme Court Grand Bench, June 24, 1970). In practice, you can treat the two as one obligation: put the company's interests first and act with due care.

The law does not distinguish between full-time and part-time directors. The board is responsible for supervising how directors carry out their duties (Companies Act Art. 362(2)(ii)).

If board materials raise questions, even on matters outside your remit, ask for an explanation. This matters for foreign parent-company executives who sit on the board of a Japanese subsidiary but rarely attend in person.

Business decisions involve forecasts, and some of them will fail.

In a shareholder derivative suit over the price a company paid for shares in a group company it wanted to make wholly owned, the Supreme Court set out the standard. Directors do not breach their duty of care unless the decision-making process or the substance of the decision was grossly unreasonable (Supreme Court, July 15, 2010, commonly known as the Apamanshop case). This approach is generally called the business judgment rule.

In that case, the shares had been valued at between JPY 6,561 and JPY 19,090 per share, yet the company bought them at JPY 50,000 per share. That price was the amount originally paid in when the subsidiary was founded.

The Court noted that the selling shareholders included franchisees important to the business. It also noted that unlisted shares can be valued within a wide range. Most importantly, the decision had been discussed at the group's management meeting after hearing a lawyer's opinion, so the process was not unreasonable.

Courts focus on how you reached the decision and whether its substance was reasonable, not on the result. When approving a major investment or acquisition:

• Gather and keep the materials you relied on, such as market research, financial projections, and expert advice.
• Record in the minutes the risks discussed, the mitigation measures, and the alternatives considered.
• If you oppose a resolution or support it only on conditions, ask for this to be recorded.

The last point is critical. A director who takes part in a board resolution and does not have an objection recorded in the minutes is presumed to have voted in favor (Companies Act Art. 369(5)).

Note that violating a law can in itself be a breach of duty (Companies Act Art. 355). Transactions in which a director has a personal interest are judged under separate rules, explained next.

A director must disclose the material facts and obtain shareholder approval before doing any of the following (Companies Act Art. 356(1)):

• carrying out, for themselves or a third party, a transaction in the company's line of business (a competing transaction);
• entering into a transaction with the company, for themselves or a third party (a direct transaction); or
• having the company guarantee the director's debts or enter into another transaction whose interests conflict with the director's (an indirect transaction).

In a company with a board of directors, approval comes from the board (Companies Act Art. 365(1)). The director must also report the material facts to the board without delay after the transaction (Art. 365(2)). A director with a special interest in the resolution may not vote on it (Companies Act Art. 369(2)).

These situations are routine at startups and owner-managed companies.

• The company rents an office in a building the CEO personally owns.
• It outsources work to a company run by the CEO's relatives.
• It guarantees the CEO's personal bank loan.

In a Japanese subsidiary, transactions with the parent group can raise the same issue when a director also represents the counterparty. Each of these may require approval.

If the company suffers a loss from a conflict-of-interest transaction, the following directors are presumed to have neglected their duties: the director who entered into it, the directors who decided on it, and the directors who voted to approve it (Companies Act Art. 423(3)).

If a director carries out a competing transaction without approval, the profit earned by the director or a third party is presumed to be the company's loss (Companies Act Art. 423(2)).

The board decides on the company's internal control systems (Companies Act Art. 362(4)(vi)). These cover compliance with laws and the articles, and also systems to ensure proper operations across the corporate group, including subsidiaries. For a large company with a board of directors, making this decision is mandatory (Art. 362(5)).

Suppose revenue at an overseas subsidiary turns out to have been inflated, and the parent books a large loss. The question will be whether the parent's directors had set up a system for overseeing the subsidiary and actually operated it.

Shareholders of a parent company who meet certain requirements can sue directors of a wholly owned subsidiary directly (Companies Act Art. 847-3). The plaintiff must hold at least 1% of the voting rights or issued shares of the ultimate wholly owning parent. The claim is limited to cases where, when the cause of the liability arose, the book value of the subsidiary's shares exceeded one-fifth of the parent's total assets.

Set out in writing what the subsidiary must report and when, which matters need parent approval, and how audits work. When an unusual figure is reported, record who checked what.

Directors can also be liable to people outside the company.

Fundraising deserves special care. If the materials used to explain the business when soliciting share subscriptions contain false statements, directors are liable to third parties (Companies Act Art. 429(2)(i)(a)).

The director escapes liability only by proving that they exercised due care. The same applies to false statements on important matters in the financial statements (Art. 429(2)(i)(b)).

A derivative suit is a lawsuit in which a shareholder pursues a director's liability on the company's behalf. It generally proceeds as follows.

1. Demand: The shareholder asks the company, in writing or by another prescribed method, to sue the director (Companies Act Art. 847(1)). In a public company, only shareholders who have held shares continuously for the past six months may do this. In a non-public company, there is no holding-period requirement (Art. 847(2)). In a company with statutory auditors, the auditor represents the company in receiving the demand (Companies Act Art. 386(2)(i)).
2. Company review (60 days): The company decides whether to sue. If it does not sue within 60 days of the demand, the shareholder may sue (Art. 847(3)). If the shareholder or the director concerned asks, the company must explain in writing why it is not suing (Art. 847(4)).
3. Shareholder files suit: If waiting 60 days would cause the company irreparable harm, the shareholder may sue immediately (Art. 847(5)). For purposes of calculating the value of the claim, the suit is treated as a non-monetary claim (Companies Act Art. 847-4(1)).
4. Proceedings and intervention: The shareholder must give the company notice of the suit (Companies Act Art. 849(4)). For the company to intervene on the director's side, it generally needs the consent of each statutory auditor (Art. 849(3)). The same consent is needed for the company to settle (Companies Act Art. 849-2).

There are safeguards against abusive claims. A defendant director can ask the court to order the shareholder to post security by making a prima facie showing that the suit was brought in bad faith (Companies Act Art. 847-4(2) and (3)).

As a rule, a director's liability to the company can be waived only with the consent of all shareholders (Companies Act Art. 424). The following tools are also available.

Even after a partial exemption, a director remains liable for a minimum amount. It is based on the director's annual compensation multiplied by six for a representative director, four for other executive directors, and two for other directors (Companies Act Art. 425(1)). Exemption under Article 426 is available only to companies with statutory auditors (and at least two directors) and certain other governance structures.

The provisions on indemnification agreements and D&O insurance were added by the 2019 amendments to the Companies Act and took effect on March 1, 2021. Indemnification has limits. The company cannot cover defense costs beyond what is ordinarily required, or damages owed to third parties where the director acted in bad faith or with gross negligence (Companies Act Art. 430-2(2)).

The terms of D&O insurance are decided by board resolution or similar (Companies Act Art. 430-3(1)). The conflict-of-interest rules do not apply to this type of policy covering directors (Art. 430-3(2)). During fundraising or IPO preparation, investors or outside director candidates may ask for coverage.

Certain listed companies are required to have outside directors (Companies Act Art. 327-2), so it is sensible to consider liability-limitation agreements and D&O insurance together.

1. 1

   Check the minutes

   Check that recent board minutes record approval of conflict-of-interest and competing transactions, and the post-transaction reports (Companies Act Arts. 356(1) and 365).

2. 2

   Review related-party deals

   List all transactions with directors, their relatives, and their holding companies, and confirm each was approved.

3. 3

   Keep decision records

   For major investments or borrowings, keep the decision materials, expert advice, and a summary of the discussion.

4. 4

   Confirm recorded objections

   Where you opposed a resolution or supported it with conditions, confirm that the minutes record this (Companies Act Art. 369(5)).

5. 5

   Check the articles

   Check whether the articles provide for partial exemption (Companies Act Art. 426) and liability-limitation agreements (Art. 427).

6. 6

   Check insurance and indemnities

   Confirm whether there is D&O insurance or an indemnification agreement, what it covers, and that a board resolution approved it.

7. 7

   Check subsidiary rules

   If you have subsidiaries, confirm that reporting, approval, and audit rules are in writing.

Consider seeking advice early if any of the following applies.

• A shareholder's demand letter has arrived (the 60-day period has started).
• You realize that a transaction with a director went ahead without approval.
• Fraud or improper accounting is suspected at a subsidiary or business unit.
• You are about to make a decision, such as a large investment, an M&A deal, or exiting a business, where the outcome could lead to claims.
• Fundraising or IPO preparation requires amending the articles, putting liability-limitation agreements in place, or designing D&O coverage.
• A supplier or creditor has made a claim against a director personally.

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It is the duty to perform one's role with the care expected of someone entrusted with managing the company (Companies Act Art. 330; Civil Code Art. 644). It is understood to be essentially the same obligation as the duty of loyalty to act faithfully for the company (Companies Act Art. 355).

Not simply because a loss occurred. The Supreme Court has held that there is no breach of the duty of care unless the decision-making process or its substance was grossly unreasonable (Supreme Court, July 15, 2010). Keeping a record of the materials and discussion behind the decision is your best protection.

The shareholder first makes a written demand on the company. If the company does not sue within 60 days, the shareholder can sue on its own (Companies Act Art. 847(1) and (3)). In a public company, only shareholders who have held shares for six months can do this; a non-public company has no holding-period requirement (Art. 847(2)).

Yes. If the articles of incorporation allow it, the company can enter into a liability-limitation agreement with the director (Companies Act Art. 427).

It is available to non-executive directors who acted in good faith and without gross negligence. It is worth considering together with D&O insurance and an indemnification agreement.

A D&O policy taken out by the company is concluded after its terms are decided by board resolution (or shareholder resolution if there is no board) (Companies Act Art. 430-3(1)). The conflict-of-interest approval rules do not apply to this type of policy covering directors (Art. 430-3(2)).