Board Resolutions under Japanese Corporate Law: Disposal of Significant Assets and Large-Scale Borrowing

In Japan, a representative director of a joint-stock company (kabushiki kaisha) wields extensive authority and executes the company’s operations. However, it is not appropriate to leave decisions that could significantly impact the company’s financial foundation and asset status to the discretion of a single representative director. Therefore, under Japanese Corporate Law, a system has been established that requires deliberation and resolution by the board of directors, composed of all directors, to ensure prudent decision-making and protect the company’s interests. This system forms the cornerstone of sound corporate governance. In practice, the issues that frequently arise are the “disposal and transfer of significant assets” and “incurring substantial debt.” Since these terms are not defined by specific amounts in the law, their interpretation has been left to the discretion of the courts. This article will first explain in detail what these critical resolution items mean, based on Japanese case law. It will then delve deeply into the legal consequences from two perspectives: how such actions are treated legally if carried out without a board of directors’ resolution (external effectiveness), and what responsibilities the involved directors bear (internal liability). Through this analysis, we aim to provide a comprehensive understanding of the importance of the board of directors’ decision-making process and the legal risks associated with it, which are essential for conducting business in Japan.

Key Matters Requiring Board Resolution Under Japanese Corporate Law

In Japan, the Companies Act mandates that companies with a board of directors exclusively entrust the decision-making authority for certain key matters to the board. Article 362, Paragraph 4 of the Japanese Companies Act explicitly prohibits delegating decisions on ‘important business execution’ that are fundamental to company management to individual directors. The purpose of this provision is to prevent arbitrary management decisions by specific individuals, such as the representative director, and to ensure the preservation of company assets and the soundness of management through careful deliberation by the collective body of directors.  

The same paragraph lists matters that cannot be delegated to individual directors, including, but not limited to:  

• Disposition and transfer of significant assets
• Incurrence of substantial debt
• Appointment and dismissal of managers and other key employees
• Establishment, alteration, or abolition of branches or other significant organizational structures

These matters directly affect the company’s assets, cash flow, personnel, and organizational structure, making collective judgment by the board of directors essential. This article will focus on two particularly central aspects of corporate financial activities and asset strategies: ‘Disposition and transfer of significant assets’ and ‘Incurrence of substantial debt,’ explaining their specific criteria for judgment and legal implications.

Criteria for Determining “Disposal and Transfer of Significant Assets” Under Japanese Corporate Law

The phrase “disposal and transfer of significant assets” as defined in Article 362, Paragraph 4, Item 1 of the Japanese Companies Act does not include a specific monetary threshold. Consequently, whether a transaction involving a certain asset is “significant” must be determined on a case-by-case basis, and its interpretation has long been left to the discretion of the courts.

The most authoritative guideline on this matter was established by the Supreme Court of Japan in its judgment on January 20, 1994 (1994). This judgment clarified that the determination of “significance” should not be based on a single criterion but should consider multiple factors comprehensively. The factors identified by the court are as follows:

1. The value of the asset in question: This is the absolute amount of the property being transacted.
2. The proportion of the company’s total assets: This indicates the relative value of the asset in question to the company’s financial scale, serving as a measure of quantitative significance.
3. The purpose for which the asset is held: This element assesses the qualitative aspect. For example, a factory used for the company’s primary business or a patent related to core technology may be deemed strategically “significant” compared to investment real estate of the same value.
4. The manner of the disposal: The method by which the property is disposed of is also taken into account. For instance, gratuitous disposals such as donations or gifts, which strongly represent an outflow of company assets, tend to be considered “significant” even at lower values compared to sales at market prices.
5. The company’s historical handling: The company’s internal practices regarding similar transactions in the past also contribute to the decision-making process.

What this multifaceted framework implies is that companies cannot rest easy with formalistic standards such as “it’s less than X% of total assets, so it’s not a problem.” Instead, it is crucial for companies to proactively establish rational and clear criteria within their internal rules, such as board of directors’ regulations, on what transactions should be subject to board resolutions, in order to manage governance risks effectively.

Criteria for Determining “Substantial Debt” Under Japanese Corporate Law

Similar to “significant property,” there is no clear monetary threshold defined in the law for “substantial debt” as stipulated by Article 362, Paragraph 4, Item 2 of the Japanese Companies Act. The interpretation of this has also been shaped by case law. A particularly relevant case is the judgment by the Tokyo District Court on March 17, 1997 (Heisei 9). This judgment stated that in determining whether a certain debt qualifies as “substantial,” the following factors should be comprehensively considered:

1. The amount of the debt: The absolute amount of borrowing or debt guarantee.
2. The proportion of the debt to the company’s total assets and ordinary income: Not only the size of the company’s assets but also the relative scale of the debt to its earning power is assessed.
3. The purpose of the debt: The significance of the use of funds for the company’s business operations.
4. The company’s traditional handling: The internal practices related to past fundraising and guarantees.

In the case addressed by this precedent, a dispute arose over whether a solidarity guarantee reservation of 10 billion yen made by a company (Y Co.) for an affiliated company (A Co.) constituted “substantial debt.” The court emphasized that although the guarantee amount of 10 billion yen represented only 0.51% of Y Co.’s total assets, it accounted for 7.75% of the capital stock and, notably, 24.6% of the ordinary income. Furthermore, it was pointed out that Y Co.’s own board of directors’ regulations stipulated that “guarantee obligations of 5 billion yen or more per case” should be subject to a board resolution.

What is noteworthy in this judgment is that the court considered not only the static indicator of total assets on the balance sheet but also the dynamic indicator of “ordinary income” on the income statement. This reflects the judiciary’s stance of emphasizing the risk to business continuity when evaluating the impact of debt, taking into account not just the size of the company but also its debt repayment capacity and the effect on profitability. Even liabilities that may seem small in terms of asset size can be deemed “substantial debt” if they significantly encroach upon the company’s profits.

Comparing Judgment Criteria

The judgment criteria used by courts for the two important decision-making matters mentioned earlier share many commonalities, yet there are also significant differences. By comparing these criteria, we can gain a clearer understanding of how Japanese courts evaluate critical corporate matters. The table below organizes the two sets of judgment criteria.

As this comparison makes clear, both frameworks of judgment are composed of three pillars: the quantitative aspect, the qualitative aspect, and the company’s internal practices, indicating that the courts have a consistent mode of thought when addressing these issues. The most significant difference lies in the evaluation of the quantitative aspect, where the case of “substantial borrowing” includes an indicator of profitability, such as “ordinary profits, etc.” This suggests that the courts accurately recognize the essential difference that while the disposition of assets is primarily a one-time act affecting the balance sheet, borrowing involves continuous interest payments and has a long-term impact on the company’s cash flow and profit structure. This flexible and context-sensitive approach reflects the maturity of judicial decisions in Japanese corporate governance.

The Validity of Transactions Lacking Board of Directors’ Resolution (External Impact) Under Japanese Corporate Law

What happens when a representative director executes significant asset disposals or incurs substantial debt without the board of directors’ resolution, which is normally required? This issue presents a conflict between the flaw in the company’s internal procedures and the protection of the counterparty’s trust in the transaction.

The basic stance of Japanese courts on this matter was established by the Supreme Court’s decision on September 22, 1965 (1965). According to this decision, transactions carried out by a representative director without a resolution are, in principle, considered valid despite lacking the internal decision-making process. This is an important principle to protect third parties who have conducted transactions believing in the legitimate authority of the representative director to represent the company, thereby ensuring the safety of transactions.

However, there are significant exceptions to this principle. If the counterparty knew that there was no board resolution (malice) or was negligent in not knowing (negligent), the transaction is deemed invalid. This legal reasoning is often explained as an analogy to Article 93 of the Japanese Civil Code and is commonly referred to as the “theory of relative invalidity.”

What this legal reasoning implies is that a certain duty of care is imposed on the counterparty, especially professional business entities such as financial institutions and real estate companies. When a transaction is objectively deemed “significant” or “substantial,” it is not sufficient for the counterparty to merely claim ignorance; they are expected to exercise due diligence, such as verifying the minutes of the board meeting, to confirm the existence of a resolution. In the Tokyo District Court decision on March 17, 1997, this very point was at issue, and the court found the bank, which had entered into a 1 billion yen guarantee reservation contract, negligent for not verifying the existence of a resolution and recognized the invalidity of the guarantee reservation.

It should be noted that, as a general rule, only the company itself can claim this invalidity, and it is not permitted for the counterparty to assert invalidity for their own benefit.

Director’s Responsibility (Internal Impact) Under Japanese Corporate Law

The legal implications of transactions conducted without a board of directors’ resolution extend beyond the validity of external transactions. More directly and severely, they pertain to the responsibilities that the involved directors bear within the company itself.

Article 423, Paragraph 1 of the Japanese Companies Act stipulates that if a director neglects their duties and causes damage to the company, they are liable to compensate for the damage. Deliberately ignoring the legally mandated procedure of a board resolution to execute significant business operations clearly constitutes such neglect of duties.

This responsibility is not limited to the representative director who actually conducted the transaction. Other directors, as members of the board, also have a duty to supervise the execution of business by their fellow directors. Therefore, other directors who were aware of, or should have been aware of, an act of authority overreach by the representative director and neglected to address it, may also be held liable for damages due to a breach of their supervisory duties.

The importance of this supervisory duty of directors has been repeatedly emphasized in Japanese jurisprudence through prominent cases such as the Daiwa Bank Shareholder Representative Lawsuit. These precedents indicate that directors have an active duty to establish and oversee an effective internal control system to ensure compliance with laws and regulations. A passive stance of merely not being involved in misconduct is insufficient, and excuses such as “I didn’t know” or “It was not my responsibility” are generally not acceptable.

Furthermore, this liability for damages is considered joint and several. This means that each director responsible can be held liable for the full amount of the damage suffered by the company, which can lead to extremely harsh consequences for the individual directors.

Summary

As explained in this article, under Japanese Corporate Law, board resolutions are legally mandated for the execution of business matters that affect the core of a company, such as the “disposition and transfer of significant assets” and “incurring substantial debt.” The interpretation of these terms is based on multifaceted standards formed by case law, requiring substantive judgment rather than formalistic decisions, tailored to individual circumstances. Failure to comply with these legal demands exposes a company to dual risks. One is the external risk that a contract may be invalidated depending on the good faith and faultlessness of the counterparty. The other, more severe, internal risk is that directors involved in illegal business execution, as well as those who overlooked such actions, may be held liable for substantial damages to the company. Properly managing these risks is an essential management issue for all companies operating in Japan.

Monolith Law Office has a proven track record of supporting numerous domestic and international clients in legal matters related to corporate governance in Japan. Our firm employs several English-speaking attorneys with foreign legal qualifications, enabling us to accurately explain the complex requirements of Japanese Corporate Law within the context of international business and provide practical advice. We offer comprehensive support to ensure that your company’s operations in Japan proceed smoothly and in compliance with the law, including board management, legal due diligence for critical decision-making, and risk management of officer liability, as discussed in this article.