Conflict of Interest between Company and Officers: Restrictions on Competition

Restrictions on Competitive Transactions

I have sometime asked from our client, “If I am appointed as a representative director (or director), can I be a representative director (or director) of another company?

Going straight to the point, becoming a director of another company is permitted under the Law. However, it is also has to be well considered if the company which he/she serves engage in the same business field.【 Skip to the conclusion 】

Under the law, there is a Duty of Loyalty that states “Directors shall perform their duties for the Stock Company in a loyal manner in compliance with laws and regulations, the articles of incorporation, and resolutions of shareholders meetings(Companies Act, Article 355).” Therefore, it is considered that those who are in a position to easily obtain the company’s confidential information should avoid engaging in competing business activities that would impede the company’s profits. On the other hand, in Japanese stock companies, there are directors who do not receive remuneration or who are brought in just as a legal advisors (e.g., lawyers), and in many cases, they do not actually execute business as directors (their main duty is supervision of business management). It is also common for such directors to be engaged in management activities as officers of other companies.

Therefore, the Japanese Companies Act allow directors to serve in other competing companies if they obtain the company’s approval.

(Restrictions on Competition and Conflicting Interest Transactions)
Article 356  (1) In the following cases, a director shall disclose the material facts on the relevant transactions at a shareholders meeting and obtain approval of the shareholders meeting:

(i) If a directors intends to carry out, for himself/herself or for a third party, any transactions in the line of business of the Stock Company;

Article 365  (1) For the purpose of the application of the provisions of Article 356 to a Company with Board of Directors, “shareholders meeting” in paragraph (1) of that article shall be read as “board of directors.”

–日本法令外国語訳データベースシステム–

The scope of an “in the line of business”

The determination of whether the company to be joined is engaging in the line of business of the company you belong to,  can be based on whether the latter company is actually engaging in the business or has a concrete plan to do so.

The scope of the “Transactions”

The act of establishing a company to develop a cooperative business or the act of assuming office in such a company itself is not considered to be “transactions” and thus those are not subject to the restrictions.

Similarly, the use of a client list or the extraction of an employee during the term of office is not a “transactions” itself, and therefore does not directly subject to regulation under Article 356. However it must be noted that such actions may constitute a breach of the duty of loyalty of a director, etc. (Tokyo High Court decision H1.10.26).

A precedent case that was actually regarded as a violation of Article 356

Plaintiff: A Kabushiki-Kaisha
Defendant: X (Representative Director of A Kabushiki-Kaisha)
(Tokyo District Court decision, S56. 3. 26):

Conclusion: X was found to have violated his duty to refrain from competition because he used his position to deprive A Kabushiki-Kaisha of the opportunity to acquire B Kabushiki-Kaisha’s shares and expand its market size.

Specific Background: In order to expand the market in specific district, A Kabushiki-Kaisha has planned to acquire shares of their competing companies B Kabushiki-Kaisha. However as a time comes to conclude the share transfer transactions, X, Representative Director of A Kabushiki-Kaisha, changed the agreement so that he himself would become a shareholder of acquiree using the funds of A Kabushiki-Kaisha.* He also transferred A Kabushiki-Kaisha’s dealerships to B Kabushiki-Kaisha. on his own initiative without a approval of the company.

*X did not assume the position of Representative Director of B Kabushiki-Kaisha, but was substantially engaged in management activities.)

In addition, X established C Kabushiki-Kaisha, which was engaged in the same type of business, in the same area where A Kabushiki-Kaisha was planning to expand its market.

A non-competition obligation after resignation

In principle, a director will be released from the non-competition obligation after resignation of the position; however, there have been where a director has extracted a large number of employees was acknowledged as a breach of the duty (Tokyo High Court decision, H26.6.24).

Note: In some cases, the non-competition obligation during the term of office is stipulated in the individual mandate contract with the company, so it is recommended to re-check the contract.

Also, an agreements that impose a non-competition obligation on retired directors are considered valid as long as it is within reasonable limits. On the other hand, directors are also guaranteed the freedom to choose their profession under the Constitution of Japan, so if the company would like to make the restriction clause, it would be better to adjust the benefits of the directors (e.g., setting a time limit, higher severance pay, etc.).

Approval Resolution Authorities and Participation in Resolutions

If a director of a company intends to engage in a competing business, he/she shall disclose his/her specific plans (e.g., details of the counterparties, products and services, prices, terms, etc.) and obtain approval from the following approval authorities of the company during his/her term of office.

It is possible to grant approval in a comprehensive manner. (e.g., seeking approval for the sale of ~~~~, a transaction that is a part of the Company’s business)

It is also understood that an approval resolution itself is not required in the case of a (i) director and sole shareholder is the same person, or (ii) in the case where all shareholders (owners of the company) agree to the transactions.

Companies with a Board of Directors

Approval authority: Board of Directors

Approval shall be obtained in advance and the results shall be reported after the transaction.
The director concerned cannot participate in the resolution since he/she is a special interested party. Also, it is recommended the director in question to refrain from assuming the chairmanship of the meeting, and leave the room while the said resolution is in discussion (he/she may participate in other resolution before/ after the resolution has been made).

Companies without a Board of Directors

Approval authorities: General meeting of shareholders

Approval shall be obtained in advance (no post-event report is required).
The director concerned is allowed to participate in the resolution “as a shareholder”. It is also possible for a director to assume the position of chairman, but it is safer to have someone else assume the position to avoid the possibility of questions arising later.

Failure to Receive Approval

As a general rule, a transaction entered into by a director without the company’s approval is considered valid. This is because it is considered inappropriate to involve a counterparty in the company’s internal misconducting. On the other hand, the company can file a claim for damages against the director, and the same amount of the claim shall be considered to be the amount of economic profit gained by the director or the third party (this is based on the idea that the profit gained by the director from the violation of his/her duty to compete is the profit that the company should have gained originally).

Conclusion

• It is possible for a director in office to become a director of another company engaged in the same type of business.
• Extracting a large number of customers or employees may be considered as a violation of the non-competition obligation.
• The approval authorities are the Board of Directors if the company has a Board of Directors, or the general meeting of shareholders if the company does not have a Board of Directors.
• The director in question may not participate in the resolution and is recommended not to chair the meeting.
• No resolution is required if all shareholders have agreed to the transactions, or if the director in question is the only shareholder.
• Transactions conducted without authorization will be valid with a third party, but there is a possibility that the company will file a claim for damages against the director.

MK@ 05/22/2022