Directors' Liability to Third Parties under Japanese Corporate Law: An Explanation of Article 429 of the Companies Act and Key Case Law

In the realm of corporate activities in Japan, directors play a pivotal role in management, and their execution of duties is accompanied by a wide range of responsibilities. To ensure sound corporate governance and the protection of stakeholders, the Japanese Companies Act imposes strict obligations on directors. Article 429 of the Japanese Companies Act, in particular, is a provision of utmost importance to external stakeholders surrounding a corporation. This article indicates the possibility that a director may be held personally liable for compensation if their negligence in fulfilling duties to the company results in damage to third parties.

This article will explain the legal basis, objectives, and liability requirements of Article 429 under Japanese Corporate Law. It will also introduce key court cases that have shaped the interpretation and application of this provision, and consider its legal significance and practical impact. The aim of this article is to assist foreign readers, especially English speakers learning Japanese, in understanding this complex yet indispensable legal system. Comprehending the legal remedies for damages caused by directors’ inappropriate actions to third parties is essential for risk assessment and appropriate legal measures when engaging in transactions or investments with Japanese companies.

The Legal Basis and Purpose of Article 429 of the Japanese Companies Act

Provisions and Applicable Parties of Article 429 of the Companies Act

Article 429, Paragraph 1 of the Japanese Companies Act stipulates that “When directors or similar officers perform their duties with malice or gross negligence, they are liable to compensate for any damages incurred by third parties as a result” . The term “directors or similar officers” includes directors, executive officers, corporate auditors, accounting advisors, and accounting auditors .  

Paragraph 2 of the same article imposes liability on such officers unless they can prove that they did not neglect their duty of care in specific acts such as false notifications, entries, registrations, or public announcements . This reflects the legislator’s strong demand for accuracy in information disclosure and enhances third-party protection by increasing the burden of proof on the officers .  

The Nature of “Special Statutory Liability” and the Intent to Protect Third Parties

The liability of officers under Article 429 of the Companies Act is interpreted as “special statutory liability” according to precedents and common theory . This is a responsibility specially established by the Companies Act for the protection of third parties, distinct from the breach of duty to the company by directors (Article 423 of the Companies Act) .  

The purpose of this provision is to prevent unforeseen damages to third parties, such as creditors, when the company lacks financial resources due to the negligence of directors in their duties . Considering the significant role that the execution of directors’ duties plays in the activities of corporations, which hold an important position in the economic society, the legislator’s intention to prioritize third-party protection is clearly reflected in this special statutory liability .  

The Relationship with Tort Liability Under the Civil Code

The liability under Article 429 of the Companies Act does not exclude the application of tort liability under Article 709 of the Japanese Civil Code . Third parties can still pursue tort liability under the Civil Code if the requirements are met. However, Article 429 of the Companies Act is interpreted as requiring proof of “malice or gross negligence” in the negligence of duties by officers to the company, which reduces the burden of proof compared to the Civil Code, offering a more advantageous aspect for third parties .  

Requirements for Directors’ Liability for Damages to Third Parties Under Japanese Corporate Law

To be held liable under Article 429 of the Japanese Companies Act, directors and similar officers must meet the following requirements.

Existence of Negligent Acts in the Performance of Duties

The first requirement is that there was a ‘negligent act in the performance of duties’ by the directors or similar officers. Directors are subject to the ‘duty of due care of a prudent manager’ (Article 644 of the Japanese Civil Code, Article 330 of the Japanese Companies Act) and the ‘duty of loyalty’ to perform their duties faithfully for the benefit of the company (Article 355 of the Japanese Companies Act). Breaches of these duties or violations of laws and regulations constitute negligence in the performance of duties.

Regarding business judgments, the ‘business judgment rule’ applies, and if the decision-making process and content are rational, it may not be considered negligence even if it results in damage.

Malice or Gross Negligence

The second requirement for liability is that the directors or similar officers acted with ‘malice’ or ‘gross negligence.’ ‘Malice’ refers to a state of awareness of the negligence, while ‘gross negligence’ indicates a significant lack of care or extremely reckless behavior.

In the judgment of the Tokyo District Court on April 25, 1995, in the golf course reconstruction case, the directors were found to have ‘gross negligence’ for proceeding with the business unplanned and without sufficient investigation, leading to bankruptcy. This demonstrates the high duty of care required of directors in large-scale business ventures.

Damage to Third Parties and a Causal Relationship

The third requirement is that the negligent act in the performance of duties by the directors or similar officers caused ‘damage to third parties,’ and there is a ‘causal relationship’ between the negligent act and the damage.

‘Third parties’ refer to individuals other than the company and the responsible officers. Damages include ‘direct damages’ caused directly to third parties by the actions of the directors (e.g., fraudulent solicitation) and ‘indirect damages’ that occur to third parties through the company’s damages (e.g., inability to collect debts due to bankruptcy). The Supreme Court Grand Bench judgment on November 26, 1969, clarified that Article 429 of the Japanese Companies Act covers both direct and indirect damages.

Shareholders are also generally included as ‘third parties,’ but there is debate in case law regarding the direct claim of indirect damages (e.g., stock price decline). In the case of listed companies, the Tokyo High Court judgment on January 18, 2005 (the Snow Brand Food case) established shareholder representative lawsuits as the principle means of relief. However, as in the Fukuoka District Court judgment on October 28, 1987, there may be room to recognize a shareholder’s direct claim in cases where shareholder representative lawsuits are not effective due to ‘special circumstances,’ such as in closely held companies. In the Supreme Court judgment on September 9, 1997 (the advantageous issuance case), the directors’ liability based on Article 429 of the Japanese Companies Act was recognized for the damages to shareholders caused by unfair share issuance.

Scope and Joint Liability of Responsible Officers and Executives Under Japanese Corporate Law

Under Article 429 of the Japanese Companies Act, responsibility is not confined to the formal position of an officer but extends to a wide range of individuals based on the actual execution of duties or control exercised.

• Executive Directors: They are liable if there is malice or gross negligence in the execution of their duties.
• Non-Executive Directors: They have a duty to monitor the execution of business by other directors and may be held liable for any negligence in this oversight.
• Nominal Directors: Even if they are formally appointed and do not participate in actual management, they may be held liable under an analogous application of Article 908, Paragraph 2 of the Japanese Companies Act if they explicitly consented to a false registration.
• De Facto Directors: Individuals who preside over the company’s business execution without formal appointment or registration may be held liable under an analogous application of Article 429 of the Japanese Companies Act.

When multiple officers and executives are liable for the same damage, they bear “joint liability” under Article 430 of the Japanese Companies Act. This means that a third party can claim the full amount of damages from any one of them, enhancing the certainty of compensation for the third party’s losses.

Commentary on Key Case Law

The interpretation of Article 429 of the Japanese Companies Act has been concretized through the following key case law.

The Supreme Court of Japan’s Decision on the Legal Nature and Scope of Damages Under Article 429 of the Japanese Companies Act

The Grand Bench of the Supreme Court of Japan’s decision on November 26, 1969 (1969), provided a critically important judgment regarding the legal nature of Article 429 of the Japanese Companies Act (formerly Article 266-3 of the Commercial Code) and the scope of damages. The ruling established the principle that while directors have a fiduciary relationship with the company, owing duties of due care and loyalty, they do not automatically bear liability for damages caused to third parties due to breaches of these duties, as there is no direct relationship with third parties. However, considering the significant role that corporations play in the economy and society, and that their activities depend on the execution of duties by directors, the court ruled from the standpoint of third-party protection. It stated that if a director, with malice or gross negligence, violates their duties and thereby causes damage to a third party, the director is directly liable to the third party for damages, as long as there is a causal link between the dereliction of duty and the third party’s damages. This responsibility includes both indirect damages, where the company suffers damage resulting in harm to a third party, and direct damages suffered by the third party. This judgment has positioned the liability under Article 429 of the Japanese Companies Act as a ‘special statutory liability’, distinct from the tort liability under the Japanese Civil Code, with a clear intent to strengthen the protection of third parties.  

Distinguishing Management Judgments from Neglect of Duty Under Japanese Corporate Law

The Tokyo District Court’s decision on April 25, 1995 (the Golf Course Reconstruction Case) is an example that provided criteria for determining whether a director’s management judgment constitutes neglect of duty. In this case, the representative director Y2 and director Y3 of the golf course management company Y1, without sufficient investigation or a rational financial plan, forcefully proceeded to recruit new members in an attempt to reconstruct the financially distressed golf course. Y2 and Y3 promoted an unplanned reconstruction plan that relied solely on the income from new member entrance fees, despite the unclear market conditions and uncertain financial cooperation from banking institutions. As a result, the golf course’s reopening reached an impasse, and the new members, including the plaintiff X, suffered damages as they were unable to receive a refund of their deposits. The court pointed out that directors undertaking a business with a large scale and numerous stakeholders have a duty to conduct thorough prior research and establish an objective and rational funding plan. Although Y2 and Y3’s actions were not malicious, the court found them to constitute “gross negligence” for failing to fulfill this duty and recognized their liability for damages under Article 429 of the Japanese Companies Act. This judgment clearly demonstrates that directors are required to exercise a high degree of care in the process of making management decisions.  

The Osaka High Court’s decision on December 19, 2014, acknowledged the responsibility of directors in a case where a company, whose financial situation had severely deteriorated, issued promissory notes to purchase goods despite having no prospects of payment, and subsequently went bankrupt, causing the notes to be dishonored. This judgment suggests that when a company is insolvent or close to it, directors have a duty as part of their due diligence to prevent the expansion of damages to the company’s creditors by considering the possibility of reconstruction or bankruptcy proceedings. In such circumstances, if directors engage in borrowing or issuing promissory notes with no prospect of repayment, their actions may be deemed neglect of duty, and they could be held responsible for the damages incurred by third-party creditors.  

The Evolution of Case Law on Shareholder Damage Claims Under Japanese Corporate Law

There has been considerable debate in multiple case laws regarding whether shareholders are included as “third parties” under Article 429 of the Japanese Companies Act, and particularly whether direct claims for indirect damages are permissible .  

The Tokyo High Court’s decision on January 18, 2005 (the Snow Brand Food case) addressed situations in publicly traded companies where all shareholders suffer equally from disadvantages such as a decline in stock prices due to directors’ negligence leading to poor performance. The ruling established that such indirect damages should, in principle, be recovered by the company through shareholder representative litigation, and that this recovery would also compensate the shareholders’ damages. Therefore, unless there are special circumstances, shareholders’ direct claims for damages against directors are not recognized. The decision cited potential issues such as double liability for directors, violation of the principle of capital maintenance, and the possibility of creating inequality among shareholders. However, the ruling also suggested that in closed companies where the stock is not publicly traded, and where the director committing the illegal act and the controlling shareholder are the same or act in concert, there may be “special circumstances” that render shareholder representative litigation ineffective, leaving room for direct claims by shareholders based on Article 709 of the Japanese Civil Code.  

In contrast, the Fukuoka District Court’s decision on October 28, 1987, specifically indicated that there is room for shareholders’ direct claims in closed companies where “special circumstances” render shareholder representative litigation ineffective. In this case, considering the reality that the representative director was a major shareholder and all officers were the defendant’s relatives, it was determined that it would be difficult for minority shareholders to actually recover damages through representative litigation. The court affirmed the shareholders’ right to claim damages against the directors based on the former Commercial Code Article 266-3, Paragraph 1 (equivalent to the current Article 429 of the Japanese Companies Act).  

Furthermore, the Supreme Court’s decision on September 9, 1997, recognized the directors’ responsibility under Article 429 of the Japanese Companies Act for damages suffered by shareholders due to unfair issuance of solicited shares. The issue in this case was the dilution of existing shareholders’ stock ownership ratios and voting rights, and the decrease in the value of shares due to a third-party allotment capital increase conducted with particularly favorable payment amounts without a lawful special resolution of the shareholders’ meeting. The court ruled that such actions constituted a breach of the directors’ duties to all shareholders, including the lack of notification for the shareholders’ meeting, and recognized the directors’ responsibility for the difference between the issue price and the proper amount that should have been paid to the company as damages to the existing shareholders. This ruling is considered an important precedent for recognizing directors’ liability for direct damages to shareholders.  

Case Law on the Scope of Officers Liable Under Japanese Corporate Law

Under Article 429 of the Japanese Companies Act, liability extends beyond formal positions to various individuals based on their actual control and level of involvement.

The Supreme Court of Japan’s decision on May 22, 1973 (Showa 48), clarified the supervisory duties of non-executive directors. This ruling indicated that even ordinary directors have a duty to monitor the execution of business by the representative director through the board of directors and, if necessary, to call for the convening of the board to ensure proper business execution.

The Supreme Court’s decision on March 18, 1980 (Showa 55), determined that so-called nominal directors are also subject to the same supervisory duties. The ruling clarified that even if one is nominally appointed as a director without actual involvement in management, they are still obliged to oversee the execution of business by other directors and to be vigilant against misconduct. In cases of neglecting such duties, nominal directors may be held liable under Article 429 of the Japanese Companies Act.

The Supreme Court’s decision on June 15, 1972 (Showa 47), addressed the responsibility of individuals registered as directors in the commercial registry without a board resolution for their appointment. The ruling stated that if the individual had consented to the registration, even if the appointment was nominal, they could not claim against a bona fide third party that they were not a director, by analogy with Article 908, Paragraph 2 of the Japanese Companies Act (formerly Article 14 of the Commercial Code). Consequently, individuals registered as directors could not escape liability under Article 429 of the Japanese Companies Act.

The Supreme Court’s decision on April 16, 1987 (Showa 62), considered the liability towards third parties of former directors whose resignation had not been registered. While the principle is that one does not bear responsibility after resignation, the ruling indicated that if there are “special circumstances,” such as actively acting as a director after resignation or explicitly consenting to leave a false registration uncorrected by not applying for resignation registration, they cannot avoid liability to a bona fide third party by analogy with Article 908, Paragraph 2 of the Japanese Companies Act, thus pointing towards limiting liability.

The Tokyo District Court’s decision on November 26, 1980 (Showa 55), affirmed the responsibility of a “de facto director” who, despite not being officially registered as a director, essentially presided over the company’s business execution. The ruling stated that to be liable as a de facto director, one must not only be called a director but also have authority comparable to that of a director and engage in activities akin to such. Individuals with such substantial control may be subject to liability towards third parties under Article 429 of the Japanese Companies Act by analogy, even if they do not hold a formal position.

Supreme Court of Japan’s Decision on Delay Damages

The Supreme Court of Japan’s decision on September 21, 1989 (Heisei 1), provided guidance on the starting point and interest rate for delay damages in claims for compensation based on Article 429 of the Japanese Companies Act. The ruling established that the occurrence of delay damages begins at the time of the performance request and that the delay interest should remain at the Japanese civil statutory interest rate of 5 percent per annum. This is based on the rationale that damages become definitively incurred when a company becomes unable to perform its obligations to a third party, and thereafter, there is no room for damages equivalent to the amount of statutory interest prescribed by the Bills Exchange Act to arise.  

Exemption from Liability and the Statute of Limitations in Japan

The liability of directors and similar officers for damages to third parties is treated differently from their liability to the company.

The System of Limited Liability Contracts

Under Japanese Corporate Law (such as Article 427 of the Japanese Corporate Law), there is a system that allows for the limitation of directors’ liability for damages to the company. However, these provisions for limiting or exempting liability do not generally apply to the liability for damages to third parties based on Article 429 of the Japanese Corporate Law. Since Article 429 is designed as a “special statutory liability” for the protection of third parties, it is not possible to limit the liability to external third parties through an agreement between the company and its officers.

Statute of Limitations for Claims for Damages

The statute of limitations for claims for damages based on Article 429 of the Japanese Corporate Law is understood to be 10 years, in principle, according to Article 167, Paragraph 1 of the Japanese Civil Code. This period is longer than the general statute of limitations for torts (3 years), taking into account that it may take time for third parties to identify the damage and the responsible parties.

Summary

Article 429 of the Japanese Companies Act is a crucial provision that establishes the liability of directors for damages to third parties due to malice or gross negligence. It functions as a “special statutory liability” to protect third parties in situations where a company lacks financial resources. Case law encompasses both direct and indirect damages and makes judgments regarding shareholder damages according to the personalityistics of the company. The scope of directors’ liability is broad, and liability limitation contracts generally do not apply to third parties, with a long statute of limitations set at 10 years, reflecting a strong intent to protect third parties. For foreign companies and individuals conducting business in Japan, understanding and appropriately responding to this complex legal system is of utmost importance.

Monolith Law Office boasts a wealth of experience in Japanese corporate legal affairs, particularly in supporting numerous clients with issues related to directors’ responsibilities and corporate governance. Our firm includes several English-speaking attorneys with foreign legal qualifications, enabling us to understand Japan’s complex legal regulations from an international perspective and provide practical advice. If you have any questions about Japanese corporate law or specific inquiries regarding corporate governance and directors’ responsibilities, please do not hesitate to contact Monolith Law Office. We are committed to supporting your business activities in Japan with our specialized expertise to ensure smooth operations.