Can a director in Japan be held personally liable for damages? Liability to the company and to third parties, and the mechanisms that limit it

Question

阿部国際法律事務所 · Accepted Answer

A director who fails in their duties is personally liable to the company (Companies Act, Art. 423(1)), and to third parties such as suppliers where they acted in bad faith or with gross negligence (Art. 429(1)). Shareholders can sue on the company's behalf. Partial release, liability caps and D&O insurance can reduce the exposure.

A director of a Japanese company who fails to perform their duties is personally liable to the company for the resulting loss (Companies Act, Art. 423(1)). Where a director acts in bad faith or with gross negligence in performing their duties, they are also directly liable to third parties such as suppliers and creditors (Art. 429(1)). If the company itself does not pursue a director, shareholders can sue on its behalf (Art. 847). At the same time, the Companies Act provides ways to reduce that exposure: partial release, liability limitation agreements, company indemnification and directors' and officers' (D&O) liability insurance.

Typical situations

- A large investment approved by the board has failed, and shareholders say it was the directors' fault.
- The representative director traded with another company they represent, without board approval.
- The company has gone bankrupt, and an unpaid supplier has written to a director personally demanding payment.
- You were appointed by an overseas parent to the board of its Japanese subsidiary, and the parent's instructions conflict with the subsidiary's interests.

1. The two basic duties of a director

The relationship between a company and its directors is governed by the rules on mandate (Companies Act, Art. 330). A director therefore owes a duty of care as a prudent manager (Civil Code, Art. 644): the care normally expected of someone in that position.

A director must also comply with laws and regulations, the articles of incorporation and shareholder resolutions, and perform their duties loyally for the company (Companies Act, Art. 355, the duty of loyalty). "The company" here means the company on whose board the director sits. A director sent by an overseas parent owes these duties to the Japanese subsidiary, not to the parent.

2. Liability to the company for failure to perform duties

A director who fails to perform their duties must compensate the company for the resulting loss (Art. 423(1)). Typical problem areas are breaches of law, significant transactions made without a board resolution, and inadequate oversight of other directors.

Special rules apply to competing transactions and conflict-of-interest transactions. Before a director carries out a transaction in the same line of business as the company, or enters into a transaction with the company, the director must disclose the material facts and obtain shareholder approval (Art. 356(1)). In a company with a board of directors, the board gives the approval (Art. 365(1)), and the director must report the material facts to the board without delay after the transaction (Art. 365(2)).

If a director carries out a competing transaction without approval, the profit made by the director or a third party is presumed to be the company's loss (Art. 423(2)). If a conflict-of-interest transaction causes loss to the company, the director who traded, the directors who decided on the transaction and the directors who voted for it at the board are presumed to have failed in their duties (Art. 423(3)). A director who traded directly with the company for their own benefit cannot escape liability by showing that they were not at fault (Art. 428(1)).

Unlawful dividends are another risk. If surplus is distributed beyond the distributable amount, the executive officers who carried out the distribution, among others, are jointly liable to pay the company an amount equal to the book value of what was distributed (Art. 462(1)).

3. Shareholder derivative actions

If the company does not pursue a director, a shareholder can first demand in writing (or by another prescribed method) that the company bring an action (Art. 847(1)). In a public company the shareholder must have held shares continuously for the preceding six months (or any shorter period set in the articles); in a non-public company there is no holding period requirement (Art. 847(2)).

If the company does not sue within 60 days of the demand, the shareholder may sue on the company's behalf (Art. 847(3)). Where waiting 60 days risks irreparable loss to the company, the shareholder may sue immediately (Art. 847(5)).

4. Liability to suppliers and other third parties

A director who acts in bad faith or with gross negligence in performing their duties is liable for the resulting loss to third parties (Art. 429(1)). This is the provision suppliers and creditors rely on when they pursue directors personally after a company fails.

A director is also liable where they make false statements on material matters in the financial statements or business report, or make a false registration or public notice (Art. 429(2)(i)). In those cases the director escapes liability only by proving that they did not neglect to exercise due care (proviso to Art. 429(2)).

5. Criminal liability

A director who, to benefit themselves or a third party or to harm the company, acts in breach of their duties and causes the company financial loss commits aggravated breach of trust. The penalty is imprisonment (kokin-kei) of up to 10 years, a fine of up to JPY 10 million, or both (Art. 960(1)).

6. Ways to reduce liability

Liability to the company can be released entirely with the consent of all shareholders (Art. 424). Otherwise, where a director acted in good faith and without gross negligence, liability can be partly released or capped as follows:

- Partial release by shareholder resolution (Art. 425(1)). The release cannot go below the minimum liability amount: the annual equivalent of the director's remuneration multiplied by 6 for a representative director, 4 for an executive director and 2 for other directors.
- Partial release by board resolution (or similar) based on a provision in the articles (Art. 426(1)). This is available to a company with company auditors (and at least two directors), a company with an audit and supervisory committee, or a company with nominating committee, etc.
- A liability limitation agreement with a non-executive director such as an outside director (Art. 427(1)).

The company may also enter into an indemnification agreement covering, for example, a director's defence costs when liability is pursued (Art. 430-2), and may take out D&O insurance naming the directors as insureds (Art. 430-3). In a company with a board, the terms of both must be decided by board resolution.

7. Common mistakes

- Trading with a director, or with a company a director represents, without board approval.
- Board minutes that do not record the materials considered or any dissenting views.
- Acting as a nominal director and not overseeing the business at all.
- Assuming D&O insurance covers everything without checking the scope of cover and the exclusions.

What you can do now

- List all transactions with directors, with companies they represent, and guarantees of directors' debts, and check that approvals and reports are on record.
- For major investments and transactions, check that the board papers and minutes show how the decision was considered.
- Check whether the articles provide for partial release (Art. 426) or liability limitation agreements (Art. 427).
- Check who is insured under the D&O policy, what is covered and what is excluded.
- When an overseas parent appoints a director to the Japanese company, explain on appointment what duties the director owes to the Japanese company.

When to consult a lawyer

- A shareholder has written demanding that the company sue a director.
- After the company went bankrupt or stopped payments, a supplier has made a claim against a director personally.
- You have found transactions with directors that were never approved.
- Following the parent company's instructions may cause loss to the Japanese subsidiary.

Organising the records early, and checking whether missing approvals or disclosures can be dealt with, shapes everything that follows.

Frequently asked questions

Q. Is a director liable if a business decision simply turns out badly?
Liability arises where a director fails to perform their duties, that is, breaches the duty of care or the duty of loyalty (Art. 423(1)). A bad outcome alone does not decide the question; what matters is what information the decision was based on and how it was considered. Keep a record of that process in the board papers and minutes.

Q. Are outside directors and nominal directors liable too?
Every director owes the duty of care and the duty of loyalty. A non-executive director can enter into a liability limitation agreement if the articles allow it (Art. 427(1)), but the cap does not apply where the director acted in bad faith or with gross negligence.

Q. Does resigning end a director's liability?
No. Liability arising from a failure to perform duties while in office does not disappear simply because the director resigns. Releasing liability to the company requires the consent of all shareholders (Art. 424) or the procedures in Arts. 425 to 427.

Q. Is a director liable for simply following instructions from a foreign parent company?
A director of a Japanese subsidiary owes the duty of loyalty to that Japanese company (Art. 355). Even where an instruction comes from the parent, a director may be liable for failing in their duties if carrying it out harms the Japanese company. Record the instruction and the Japanese company's interests, and consider them before acting.

Q. Does a company without a board still need approval for transactions with directors?
Yes. In a company without a board of directors, a director who trades with the company, or carries out a transaction in the same line of business as the company, must disclose the material facts and obtain shareholder approval (Art. 356(1)). Even where there are few shareholders, the approval and the record of it should not be skipped.

Q. Can a director be liable to third parties even if the company has not failed?
Article 429(1) does not require the company to be insolvent. If a director acted in bad faith or with gross negligence and a third party suffered loss as a result, the director may be liable. It is the provision creditors rely on when they cannot recover from the company itself.

Q. If we have D&O insurance, will a director never have to pay personally?
The Companies Act sets out the procedure for a company to take out D&O insurance (Art. 430-3). The policy limits and the situations excluded from cover are set by the policy itself, so the terms need to be checked case by case.

Q.Can a director in Japan be held personally liable for damages? Liability to the company and to third parties, and the mechanisms that limit it

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