Is a shareholders' agreement legally binding in Japan? How far it reaches, and which terms belong in the articles of incorporation

Question

阿部国際法律事務所 · Accepted Answer

An SHA binds the shareholders who sign it, but not other shareholders or the company. Terms that must be honoured should also go in the articles of incorporation.

A shareholders' agreement (SHA: a contract between shareholders on how the company is run and how its shares are dealt with) is legally binding between the shareholders who sign it (Civil Code, Art. 521(2)). As a rule, however, it binds only its parties. It does not bind shareholders who did not sign it or people who become shareholders later, and unless the company itself is a party, the company is not bound either. Terms that must be honoured, such as share transfer restrictions and the appointment of directors, should be written into the articles of incorporation as well as the SHA.

When this becomes an issue

・You signed an SHA with a co-founder, and the co-founder has voted in a way that breaches it.
・An investor has sent you a draft SHA and you cannot tell which terms are acceptable.
・Your joint-venture partner is trying to sell its shares to a third party without the consent the SHA requires.
・A departing co-founder has left the company still holding shares, and you disagree on the buy-back terms.

1. Why an SHA binds its parties

The parties to a contract may freely decide its content within the limits of the law (Civil Code, Art. 521(2)). A contract can be formed without a written document (Art. 522(2)), but because an SHA is complex and lasts for years, it is normally put in writing.

Typical SHA terms include:

・Agreements on voting (voting for certain resolutions, consulting in advance)
・A right of first refusal when shares are sold
・Tag-along rights (minority shareholders may sell on the same terms when a major shareholder sells)
・Drag-along rights (a major shareholder may require minority shareholders to sell together)
・Rights to nominate directors
・Veto or prior-approval rights over important matters
・Information rights and non-compete undertakings
・Mechanisms for resolving deadlock (where the shareholders are split and nothing can be decided)

These are valid promises between the parties. Terms contrary to public policy are void (Art. 90), and the effect of terms that directly contradict the Companies Act can be called into question.

2. The effect stays between the parties

An SHA is a promise between shareholders. It operates on a separate layer from the procedures under the Companies Act (shareholder resolutions, share transfers and the appointment of directors).

Suppose a shareholder votes against a resolution in breach of the SHA. The other parties can pursue liability for breach, such as damages. But because a shareholder resolution is passed through the Companies Act procedure, it is generally considered difficult to overturn the resolution solely because of the breach.

The same applies to share transfers. As a rule, shareholders may transfer their shares freely (Companies Act, Art. 127). A promise in an SHA not to sell to third parties may, on its own, be hard to enforce against a buyer. And the SHA does not reach new shareholders who have not signed it.

3. Terms in the articles bind the company and all shareholders

The articles of incorporation of a stock company may contain any matter that does not violate the Companies Act (Art. 29). Because the articles bind the company and every shareholder, terms that must be honoured can also be placed there. Typical examples:

・Transfer restrictions: a provision that a transfer of shares requires the company's approval (Art. 107(1)(i)). Unless the articles provide otherwise, approval is decided by the shareholders' meeting, or by the board in a company with a board of directors (Art. 139(1)).
・Shares with veto rights: shares for which a resolution of the meeting of that class of shareholders is required in addition to the resolution of the shareholders' meeting or board (Art. 108(1)(viii)).
・Shares with the right to appoint officers: shares whose class meeting appoints directors or company auditors (Art. 108(1)(ix)). Public companies and companies with nominating committees may not issue them (proviso to Art. 108(1)).
・Shareholder-specific provisions: a company that is not a public company may provide in its articles for different treatment of individual shareholders regarding dividends, distribution of residual assets and voting rights (Art. 109(2)).

Amending the articles requires a resolution of the shareholders' meeting (Art. 466), which as a rule is a special resolution: shareholders holding a majority of the votes must be present, and at least two-thirds of the votes of those present must be in favour (Art. 309(2)(xi)). If the articles and the SHA say different things, there will be a dispute over which prevails. When you have both, always check that they match.

4. What to settle in the SHA in case of breach

A breach of an SHA tends to end up as a damages claim. But where the breach concerns control of the company, loss can be hard to prove. The SHA should therefore settle:

・A right to buy the breaching party's shares (call option) and how the price is set
・The amount of any agreed penalty
・How disputes are resolved (courts or arbitration, and the governing law)
・When the SHA ends (listing, sale of all shares, withdrawal of a party, etc.)

5. Practical points

・Making the company a party: if the company also signs, it can take on obligations such as providing information or seeking prior approval. Check that these do not conflict with the directors' duties.
・New shareholders: include a clause requiring new shareholders to join the SHA (for example by signing a deed of adherence) on a capital increase or share transfer.
・Departing founders: if the SHA does not say who buys a departing founder's shares and at what price, the dispute can drag on.
・English-language agreements: agreements with overseas investors are often drafted in English and may contain terms that do not fit Japanese company law. Review them together with the design of the articles and any class shares.

6. Which terms matter most depends on the situation

The central terms of an SHA change depending on who signs it.

・Between co-founders: how shares are dealt with when a founder leaves matters most. Set out vesting (a founder gives up shares unless they stay for a certain period) and how the buy-back price is calculated. Where holdings are equal, a deadlock mechanism is essential.
・With investors: investors often ask for prior approval over important matters, information rights, the right to nominate a director and drag-along rights. The company should check that the prior-approval list does not reach into day-to-day management decisions.
・Joint ventures: the focus is on director nomination in proportion to each party's stake, veto rights over important matters, deadlock resolution and how shares are bought out when the joint venture ends.

7. Preparing for deadlock

In a company held 50:50, neither side may be able to obtain a majority at the shareholders' meeting, so directors cannot be appointed and important decisions cannot be made. An SHA should set out how deadlock is resolved, for example:

・A set period for the representatives to negotiate, moving to the next step if that fails.
・One party names a price and the other chooses whether to buy or sell at that price.
・A buy-out at a value set by an independent third party.
・As a last resort, dissolving the company.

The method chosen affects which side has the advantage, depending on which side has more funds. Choose the method that suits your company's position.

What you can do now

1. Put your SHA and articles side by side and check that transfer restrictions, officer appointments and veto rights match.
2. Check that every current shareholder is a party to the SHA.
3. Check that the SHA sets out how new shareholders join on a capital increase or share transfer.
4. Check that there is a buy-out clause for breach and a method for setting the price.
5. Decide how shares will be dealt with when a founder or officer leaves.
6. Check the dispute-resolution method (courts or arbitration, and which country's law applies).

When to consult a lawyer

・When an investor or joint-venture partner sends you a draft SHA and asks you to sign.
・When another shareholder is about to vote or transfer shares in breach of the SHA.
・When a co-founder's departure or a falling-out means you need to negotiate buy-back terms.
・When you are considering issuing class shares or amending the articles.

Frequently asked questions

Q. If a shareholder votes in breach of the SHA, is the resolution void?
Because a resolution is passed through the Companies Act procedure, it is generally considered difficult to overturn it solely on the ground of a breach of the SHA. The remedy is to claim damages or a buy-out from the breaching shareholder under the SHA. Important matters can also be secured in the articles, for example through shares with veto rights.

Q. Does an SHA bind people who become shareholders later?
As a rule, no, because they are not parties to it. The SHA should set out a procedure for new shareholders to join.

Q. Should a term go in the SHA or in the articles?
Matters that should bind the company and all shareholders (transfer restrictions, officer appointments, veto rights, etc.) should also be placed in the articles. Matters that cannot go in the articles, or that the parties want to keep between themselves (such as how a buy-out price is calculated, or non-compete undertakings), go in the SHA. Where a matter appears in both, make the wording consistent.

Q. Is an SHA invalid unless it is in writing?
A contract can be formed without a written document (Civil Code, Art. 522(2)). But an SHA is complex and long-lasting, and without a written document you will not be able to prove its content later. Always put it in writing and have every party sign it.

Q. Can any company issue class shares?
To issue different classes of shares, the company must set out their content and the total number of each class it may issue in its articles of incorporation (Companies Act, Art. 108(2)). Public companies and companies with nominating committees may not issue shares carrying the right to appoint officers (proviso to Art. 108(1)). Amending the articles requires a special resolution of the shareholders' meeting, so plan with your shareholder base in mind.

Q.Is a shareholders' agreement legally binding in Japan? How far it reaches, and which terms belong in the articles of incorporation

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