Abuse of Rights by Representative Directors②

Third-party protection v.s. a respect for laws and regulations

A Representative Director may not conclude the transactions on its own initiative, of the matters that are legally required to be resolved at the shareholders’ meeting or the Board of Directors such as an issuance of new shares. If such act is performed without the resolution, it is considered to have a “factor of being void” and thus might be invalidated through the filing action brought by shareholders or other officers.

On the other hand, there is a tendency of judicial precedents to judge that the issuance of new shares without necessary resolutions to be valid. This is because it is deemed inappropriate for a bona fide third party to suffer damages due to the company’s internal mismanagement.

Third-party protection v.s. a respect for Internal regulation

When the parent companies want to limit the local Representative Director’s authority of Japanese subsidiary, it is feasible to stipulate the restrictions in the Articles of Incorporation or in the internal regulations. However, those special restrictions may not be asserted against a bona fide third party.

Factors that can work against the Company in court.

In order for the company to avoid liability in cases where a Representative Director has entered into an unfair transaction, the company must prove that the counterparty was malicious (= knew or was grossly negligent in not knowing that the transaction was invalid or that the Representative Director was not authorized to do so).
However, since the legal principle in Japan inclines to protect the “third party” than the company, it is recommended that the company routinely prepare to prove its case as favorably as possible.

In particular, the following two points should be taken into consideration on a daily basis.

(1) Thoroughly manage the corporate seal.

The “seal culture” is still deeply rooted in Japanese business. Generally, if the name of the Representative Director is written and the corporate seal is affixed on the contract, the judge will assume that there was a valid business transaction between the company and a counterparty. Therefore, the corporate seal must be kept in a safe, and must not be left in a condition where anyone can use.

Also, especially large Japanese companies, where the corporate seal is more frequently used, it is common to have a “seal management regulations” which stipulates the requirement of obtaining the permission of several persons to affix the company seal.

Or, if the company rarely affixes its corporate seal, it may be advisable to entrust it to a trusted local third party such as a law firm, licensed tax accountant, or auditing firm.

(2) Update the corporate registry.

For example, if a Representative Director who has already retired from his/her position, but conducts an illegal transaction with a third party, the company may be at a disadvantage if the name of the person is still left on the registry. If the third party claims that he/she confirmed that the Representative Director’s name was on the registry at the time of the transaction, it will be difficult for the company to prove that the counterparty had a knowledge or is grossly negligent.

Conclusion

When a Representative Director conducts a transaction with a third party fraudulently or in violation of internal rules, there is a tendency to give priority to the protection of the third party over the company.

When the transaction is judged to be valid, the company is liable for performance as stated it in the terms of the contract.

In order for the company to be exempted from liability, it must be proven that the counter party knew there were an internal regulations on Representative Director’s authority, or it must be proven that the third party was grossly negligent in not knowing.

Sloppy management of the corporate seal or failure to update the registration in the corporate registry is likely to be disadvantageous in court.

MK@ 05/19/2022