Legal Considerations in Establishing a Company in Japan: An Explanation of Incorporators' Authority, Asset Subscription, and Fictitious Payment

Establishing a company is the first step in launching a new business venture. At this crucial stage, the ‘promoter’ plays a central role. However, the authority of a promoter is not unlimited. Japanese Corporate Law sets certain boundaries on the powers of promoters to protect the company being established, future shareholders, and transaction counterparts. Particularly in the process of forming the company’s financial foundation, strict rules are in place. The company establishment process is not merely a series of administrative procedures; it is an act of constructing a legal foundation that will affect the future business’s health. To prevent potential legal risks in this process, a precise understanding of the regulations under Japanese Corporate Law is essential.

One such regulation is the ‘property subscription.’ This is a contract where the promoter promises to acquire specific assets for the company after its establishment. Due to the risk of unfairly harming the company’s assets, Japanese Corporate Law demands stringent procedures, such as inclusion in the articles of incorporation and investigation by an inspector appointed by the court. Neglecting these procedures can lead to the severe legal consequence of the contract itself being invalidated.

Another critical theme is ‘fictitious payment.’ This act creates the appearance that the capital has been paid in, falsifying the company’s financial foundation. Japanese case law states that even if such fraudulent behavior occurs, as long as there is a formal transfer of money, the payment is valid. However, the involved promoters and directors not only have the obligation to pay the money to the company again but also may be subject to criminal penalties.

This article focuses on three important themes under Japanese Corporate Law during the establishment of a company: ‘the scope of a promoter’s authority,’ ‘legal requirements for property subscription,’ and ‘legal consequences of fictitious payment.’ These regulations are indispensable for ensuring the principle of capital adequacy, which forms the foundation of a company’s sound operation.

The Authority and Scope of Incorporators Under Japanese Corporate Law

In the process of establishing a company, incorporators play a pivotal role. According to Article 25, Paragraph 1 of the Japanese Companies Act, an incorporator is defined as the person who creates the articles of incorporation, which are the fundamental rules of the company, and signs or seals them. Incorporators have the authority to perform the necessary acts to establish the company as an organ of the “company in the process of being established,” which does not yet legally exist.

This authority includes creating the articles of incorporation, deciding on the types of shares to be issued at the time of establishment, subscribing to shares to become a shareholder, appointing initial directors and auditors, and designating financial institutions to deposit the paid-in capital for shares. All these acts are essential to legally bring the company into existence and to prepare it to commence business operations.

However, the authority of incorporators is strictly limited to the purpose of “establishing the company.” Acts that deviate from this scope do not, as a principle, bind the company after its establishment. For example, starting the actual business activities that the company should undertake after its establishment, before the company is legally formed, is generally considered outside the scope of the incorporator’s authority. Specifically, this could include bulk purchasing of goods, entering into long-term lease contracts for business-use real estate, or borrowing a significant amount of funds.

The determination of whether an incorporator’s act falls within the scope of their authority is based on whether it is objectively necessary for the establishment as a “preparatory act for commencement of business.” On this point, the Supreme Court of Japan’s decision on September 18, 1973 (1973), provides an important guideline. The decision held that even acts of a company in the process of being established, if they fall within the purpose of the company and are objectively necessary as preparatory acts for commencement of business, will bind the company after its establishment. Conversely, rights and obligations arising from transactions that exceed this scope will, in principle, be attributed to the individual incorporator who performed the act, and the company after its establishment will not be bound by them. Therefore, incorporators must always be cautious to ensure that their actions remain within the scope of the company’s establishment purposes.

Stringent Requirements for Property Acceptance Under Japanese Corporate Law

To secure the financial foundation of a company, Japanese Corporate Law sets forth special regulations when property other than money is contributed or when a company’s assets are formed through specific transactions. One such regulation is “property acceptance.”

Property acceptance, as defined in Article 28, Paragraph 2 of the Japanese Companies Act, refers to a contract in which the incorporator agrees to accept certain property from a specific third party, contingent upon the establishment of the company. For example, this includes prearranged purchases of real estate or machinery equipment intended for business use after the company’s formation from a specific individual.

While property acceptance is similar to in-kind contributions (where property itself is contributed instead of cash payments), it is legally distinct. Property acceptance presupposes a two-step process where the company first receives cash payments from shareholders and then uses that cash to purchase specific property.

The reason why Japanese Corporate Law imposes strict regulations on property acceptance is to protect the principle of capital adequacy of the company. If a contract is concluded to purchase property at an unfairly high price, the company’s assets would effectively diminish, potentially harming other shareholders and creditors. To prevent such situations, property acceptance, as an “abnormal establishment item,” must meet the following stringent statutory requirements to be recognized as effective:

Firstly, the property to be accepted, its value, and the name or designation of the transferor must be described in the articles of incorporation (Article 28, Paragraph 2 of the Japanese Companies Act). A property acceptance contract lacking this description in the articles of incorporation is considered to have no legal effect.

Secondly, as a general rule, the value of the property described in the articles of incorporation must undergo an investigation by an inspector appointed by the court (Article 33, Paragraph 1 of the Japanese Companies Act). The inspector evaluates the value of the property from an objective standpoint and reports the findings to the court.

However, an investigation by the inspector is not always necessary. Article 33, Paragraph 10 of the Japanese Companies Act stipulates the following exceptions:

• If the total value of the property described in the articles of incorporation does not exceed 5 million yen.
• If the property to be accepted is marketable securities with a market price, and the value described in the articles of incorporation does not exceed that market price.
• If the value described in the articles of incorporation is certified as appropriate by professionals such as attorneys, certified public accountants, or tax accountants (including an investigation of the value).

Property acceptance contracts that do not meet any of these stringent requirements are legally invalid. This invalidity is absolute, and it cannot be validated retrospectively, even with subsequent approval at a shareholders’ meeting. For instance, the Tokyo District Court’s decision on February 27, 1991 (1991), explicitly recognized the invalidity of property acceptance lacking the necessary description in the articles of incorporation. Therefore, when planning to secure specific property at the time of company establishment, it is crucial to strictly adhere to these statutory requirements.

The Risks and Legal Consequences of Fictitious Payment in Japan

The capital of a company is the foundation of its business activities. Therefore, under Japanese Corporate Law, promoters and stock subscribers are obligated to pay in cash as consideration for the shares they have subscribed to. However, the act of ‘fictitious payment’ becomes an issue as a fraudulent means to evade this payment obligation.

Fictitious payment is a general term for acts that, while appearing to have completed the payment, do not actually secure the company’s assets. A typical method is ‘collusion,’ where the promoter conspires with the payment handling institution (such as a bank), borrows money to cover the payment, and then repays the loan immediately after the company’s registration is completed. As a result, the company’s bank account temporarily reflects the amount equivalent to the capital, but it is withdrawn soon after, leaving the company’s assets essentially unformed.

The reason such actions are problematic is that they significantly harm the principle of capital adequacy, which is the core of a company’s credit, by making the company’s financial foundation insubstantial.

Interestingly, the Japanese legal system regulates the legal effects of fictitious payments from two aspects. First, regarding the effectiveness of the payment itself, it is considered valid. Since the Supreme Court decision on December 6, 1963 (1963), Japanese case law has consistently held that, even if the payment is borrowed money intended to be repaid immediately, the payment is valid as long as there has been an actual transfer of money. This view is taken to protect the safety of transactions and is carried over into the current Japanese Corporate Law, Article 64, Paragraph 1.

However, just because the payment is valid does not mean that the promoters are exempt from responsibility. On the contrary, they are subject to strict liability. Japanese Corporate Law, Article 64, Paragraph 1, stipulates that promoters and directors at the time of establishment who are involved in fictitious payments are jointly and severally liable to pay the company the equivalent amount of the payment in reality. This provision is to compensate for the company’s lost assets due to the fictitious act and to ensure the capital is substantively secured.

Moreover, fictitious payments are subject to criminal penalties in addition to civil liabilities. Acts that cause the payment handling institution to issue a false deposit certificate may constitute a crime of falsification of official documents under Article 157, Paragraph 1 of the Japanese Penal Code. Furthermore, Japanese Corporate Law, Article 965, imposes severe penalties for acts such as collusion with the intent to disguise payments, including imprisonment for up to five years, a fine of up to 5 million yen, or both. Thus, fictitious payments are strictly regulated from both civil and criminal perspectives as serious fraudulent acts that undermine the foundation of a company.

Comparison of Property Acceptance and In-Kind Contribution Under Japanese Corporate Law

Both property acceptance and in-kind contribution are related to the financial foundation of a company and, due to the risk of impairing capital adequacy, are subject to strict regulation (special establishment matters) under Japanese Corporate Law. They share procedural similarities in that both require inclusion in the articles of incorporation and, in principle, an investigation by an inspector. However, their legal nature and purposes differ.

In-kind contribution involves founders or similar parties contributing assets such as real estate, securities, or intellectual property rights instead of cash. The purpose is to enable those with non-monetary assets to participate in company management by using those assets as capital. In return, shares commensurate with the value of the contributed property are allocated.

On the other hand, property acceptance is a contract to purchase specific property from a specific person using the funds collected through cash payments, based on the premise of monetary contribution. Its purpose is to secure specific property necessary for business operations after the company’s establishment. The consideration is not allocated shares but money paid from the contributed funds.

The difference in legal nature clearly distinguishes the relationship between the two. In-kind contribution is a contract between the contributor and the company being established, whereas property acceptance is a contract between the founders and the transferor of the property (a third party). The table below summarizes the main differences between the two.

Summary

In this article, we have explained the important aspects of company formation under Japanese Corporate Law, namely the scope of authority of the incorporators, the requirements for the acceptance of property, and the issue of fictitious payments, based on statutes and case law. These regulations form the backbone of protecting the financial foundation of a company and safeguarding the interests of shareholders and creditors. In particular, the strict procedures for the acceptance of property and the severe civil and criminal sanctions against fictitious payments demonstrate how much Japanese Corporate Law values the principle of capital adequacy. Understanding and complying with these rules can be considered the first step towards healthy and sustainable business operations. Company formation is not merely a formal procedure but a crucial process in solidifying the legal foundation.

Monolith Law Office has a wealth of experience in dealing with such complex legal issues at the company formation stage. We have provided a wide range of legal services tailored to the individual circumstances of our clients, including advice on the authority of incorporators, assistance in drafting articles of incorporation for complex formations involving property acceptance and in-kind contributions, and building compliance systems for capital contributions. Our firm employs several experts who are not only qualified as Japanese attorneys but also hold foreign legal qualifications and are English speakers, enabling us to support our clients’ businesses smoothly from an international perspective. If you have any concerns or questions about the themes explained in this article, please do not hesitate to consult with our firm.