Nature and Legal Capacity of Companies under Japanese Corporate Law, and the Doctrine of Disregarding Corporate Personality

For international stakeholders operating a business in Japan or engaging in transactions with Japanese companies, a deep understanding of the core concepts underpinning Japanese corporate law is essential. A company is not merely an entity for economic activity; it is endowed with specific personalityistics by law and positioned as an entity with legal capacity. Furthermore, the doctrine of “piercing the corporate veil,” which exceptionally denies corporate personality, is an extremely important concept in practice from the perspectives of transactional security and equitable justice.

This article will explain the basic personalityistics of a company under Japanese corporate law: “profit-seeking nature,” “corporate personality,” and “associative nature.” These personalityistics clarify how a company functions within society and how it is distinguished from other organizations. Next, we will delve into the scope and limitations of a company’s “legal capacity” to acquire rights and assume obligations, based on Japanese statutes and case law. Finally, we will explore the doctrine of “piercing the corporate veil,” discussing its significance, application requirements, and legal effects when the formal independence of a company leads to unfair outcomes.

Accurately grasping these concepts is crucial for a deep understanding of the business environment in Japan and for making appropriate legal judgments. This article aims to explain these complex legal concepts in an understandable way, referencing specific articles of Japanese legislation and case law.

The Nature of Companies

In Japan, companies possess three essential personalityistics in their legal structure and function: “profitability,” “corporate personality,” and “associative nature.” These personalityistics define how companies operate within society and distinguish them from other organizations.

Profitability

Profitability refers to the nature of a business activity aimed at distributing the profits earned through its operations to its members, such as shareholders and employees. Companies based on Japanese Corporate Law (日本の会社法) are fundamentally purposed with this profitability.

There is a clear distinction between for-profit and non-profit entities. For-profit entities, commonly referred to as “companies,” aim to distribute the profits from business activities to specific members. For example, a joint-stock company (株式会社) seeks the economic benefit of its shareholders and aims to distribute the company’s profits to them. Other forms of for-profit entities include limited liability companies (合同会社), general partnerships (合名会社), and limited partnerships (合資会社).

On the other hand, non-profit entities are those that are thoroughly committed to not distributing profits to their members in their articles of incorporation or are aimed at communal activities. Non-profit entities are not prohibited from making profits; instead, they use the profits for social contribution activities or to achieve the organization’s goals. Examples include NPOs (特定非営利活動法人), general incorporated associations (一般社団法人), general incorporated foundations (一般財団法人), public interest incorporated associations/foundations (公益社団法人・公益財団法人), social welfare corporations (社会福祉法人), and school corporations (学校法人). General incorporated associations can engage in business activities without restrictions and can also engage in profitable activities, but they are not allowed to distribute surplus profits.

It is permissible for non-profit entities to make a profit, and they can pay salaries to their staff from the revenue of their activities. This point may differ from the image that foreign readers associate with the term “non-profit,” which suggests an absence of any commercial activities. In Japan, non-profit entities are allowed to engage in various business activities to achieve their goals and to generate revenue. What is important is that they do not distribute these earnings to members but reinvest them for the organization’s purposes. This understanding can be helpful for international companies considering partnerships with Japanese non-profit organizations or contemplating social contribution activities, as it broadens the potential scope of collaboration.

Corporate Personality Under Japanese Law

Corporate personality refers to the qualification that allows a company, based on legal provisions, to have its own rights and obligations as an independent entity. In Japan, companies are defined as “corporations” under Article 3 of the Japanese Companies Act.  

With the granting of corporate personality, a company is treated as a separate existence from natural persons (individuals). For example, a company’s debts are solely its own, and shareholders are not generally obligated to repay them. Article 104 of the Japanese Companies Act explicitly states that the liability of shareholders is limited to the amount of the stock they hold. This means that a company has the capacity to enter into contracts, own property, and be a party to litigation in its own name.

One of the most important consequences of recognizing corporate personality is the principle of limited liability for shareholders. This principle plays a crucial role in promoting investment in companies and stimulating economic activity by ensuring that investors are not liable for more than the amount they have invested in the company. If shareholders were to bear unlimited liability for the company’s debts, individual investors would hesitate to expose their entire personal wealth to the business risks of the company, significantly hindering capital formation and innovation. The clear stipulation of this limited liability in the Japanese Companies Act provides significant reassurance to international investors and entrepreneurs, acting as an incentive for direct investment and business entry into the Japanese market.

Corporate Personality

Corporate personality refers to the nature of a company as an organization formed by a group of people for a specific purpose. A company operates as a collective body of its members, including employees and shareholders.

Under Japanese Corporate Law, the concept of a “sole proprietorship company,” meaning a company with only one member, is recognized for stock companies and equity companies (excluding partnerships) . Theoretically, the concept of corporate personality presupposes an association of multiple people; however, in the Japanese legal interpretation, a sole proprietorship company is considered “potentially a corporation” because it can always have multiple members .  

The allowance of “sole proprietorship companies” demonstrates that the Japanese legal system prioritizes practical business needs over pure theoretical definitions. This enables entrepreneurs to establish a company without finding multiple co-founders or shareholders and to benefit from corporate status and limited liability. This flexibility is a significant advantage for international entrepreneurs, simplifying the process of establishing sole proprietorships or wholly-owned subsidiaries in Japan.

While a company possesses legal personality, there also exist entities known as “unincorporated associations” in Japan. These are substantially groups with an organizational structure, operate on the principle of majority rule, and continue to exist despite changes in membership, but they do not have legal personality under the Japanese Civil Code or other laws. Therefore, unincorporated associations cannot be parties to contracts, and their property is considered to be collectively owned by the members. In contrast, a company with legal personality can enter into contracts and own property in its name.

Corporate Legal Capacity in Japan

The term ‘corporate legal capacity’ refers to a company’s qualification to acquire legal rights and assume obligations under the law. As a legal entity, a company in Japan possesses legal capacity within the scope of its objectives.

The Significance of Legal Capacity Under Japanese Law

Legal capacity refers to the qualification to be the subject of legal rights and obligations. Natural persons (humans) possess legal capacity by birth (Article 3, Paragraph 1 of the Japanese Civil Code), whereas legal persons (corporations) acquire legal capacity through establishment in accordance with legal provisions.

Article 34 of the Japanese Civil Code stipulates that “a legal person has rights and assumes obligations within the scope of the purposes prescribed by laws and regulations, and its articles of incorporation or other fundamental rules.” This provision is a principle that also applies to companies and serves as the foundation for determining the scope of a company’s legal actions.

While the main subject of this article is the Japanese Companies Act, it is noteworthy that the Japanese Civil Code is repeatedly referenced when explaining fundamental concepts such as a company’s legal capacity. This highlights that the Japanese Companies Act is built upon the general principles concerning legal persons established in the Civil Code. The Civil Code provides the basic framework common to all legal persons, such as the acquisition of legal personality and the scope of legal capacity, while the Companies Act further specifies detailed provisions related to the organization and operation of companies as profit-making entities. Understanding this relationship is essential for grasping the interconnectivity of the entire Japanese legal system and serves as an aid for international legal professionals to deeply comprehend Japanese corporate law.

The Scope and Limitations of Corporate Legal Capacity Under Japanese Law

While companies possess extensive legal capacities, they are subject to certain limitations due to their nature, legal regulations, or their stated purposes.

Limitations Due to Nature

As entities distinct from natural persons, companies cannot possess rights related to the body and life, such as personality rights or family law rights (for example, the right to life, parental rights, or the duty to provide support) that are unique to natural persons. However, companies are recognized to have personality rights related to their trade name and the reputation and credit of the company. If a company’s reputation or credit is damaged, it can seek legal protection.

Limitations Imposed by Laws and Regulations

Company legal capacity can be restricted by specific legal provisions. For instance, if a company is dissolved or goes bankrupt, its legal capacity is recognized only within the scope necessary for liquidation. This shift reflects the transition from business operations to the settlement of assets and repayment of debts, as stipulated in Article 476 of the Japanese Companies Act and Article 35 of the Japanese Bankruptcy Law.

Limitations Based on Purpose

Companies are established for specific purposes as defined in their articles of incorporation, and they possess legal capacity only within the scope of these purposes. This principle is considered to protect investors and creditors. A company’s purpose is stated in its articles of incorporation and made public through registration, allowing third parties to understand the scope of the company’s activities to a certain extent.

However, Japanese case law interprets this “scope of purpose” broadly and flexibly. Acts that are necessary or beneficial for achieving the company’s purpose, even if not specified in the articles of incorporation, are deemed to be within the scope of the company’s purpose. This approach is due to concerns that strictly limiting the scope of purpose would increase the number of transactions deemed invalid when they occur outside the purpose, thereby harming transactional security.

An example of this broad interpretation is the Supreme Court decision on February 15, 1952 (Showa 27), which set a standard for determining whether an act is necessary for achieving the company’s purpose based on whether it could be objectively and abstractly necessary from the contents of the articles of incorporation. Additionally, regarding corporate political donations, the Supreme Court decision on June 24, 1970 (Showa 45) ruled that such donations are within the scope of legal capacity if they are necessary and beneficial for achieving the purposes specified in the articles of incorporation. However, if the amount of political donations is not reasonable, directors may be liable for damages based on a breach of their duty of care and loyalty.

In this way, Japanese courts emphasize the practical necessity of a company’s business activities and the safety of transactions when defining the scope of a company’s legal capacity. This judicial approach reduces the risk of transactions being invalidated as “outside the purpose” for third parties dealing with companies, providing a more predictable business environment. This allows companies to operate more flexibly, enhancing market dynamism. At the same time, this flexibility underscores the importance of proper internal governance and the duty of directors to faithfully execute their responsibilities in the interest of shareholders.

The Doctrine of Piercing the Corporate Veil Under Japanese Law

The doctrine of piercing the corporate veil is a legal principle that allows for the exceptional disregard of a company’s formal independence when it is deemed contrary to the principles of justice and equity. In such cases, the corporate entity is denied legal recognition for specific legal relations, thereby equating the company with its underlying members (shareholders or controllers) to achieve an equitable resolution of the case.

The Significance of the Doctrine of Disregarding Corporate Personality Under Japanese Law

The doctrine of disregarding corporate personality does not aim to strip away corporate status entirely, as with a company dissolution order or revocation of incorporation permission. Instead, while acknowledging the existence of the corporation, it seeks to remove the ‘veil’ of corporate personality in specific cases, attributing responsibility to the individuals or other corporations behind that veil.

The basis for this doctrine has been recognized in precedents and academic theories, and often, the legal foundation is considered to be the principle of good faith as stipulated in Article 1, Paragraph 3 of the Japanese Civil Code. The principle of good faith dictates that the exercise of rights and the fulfillment of obligations must be conducted with sincerity and in accordance with good faith.

The landmark decision that first explicitly affirmed the doctrine of disregarding corporate personality was the Supreme Court judgment on February 27, 1969 (Showa 44). This judgment stated that the granting of corporate personality is a legislative policy that evaluates the social existence of an organization and is carried out based on legal techniques when it is deemed worthy of being represented as a rights subject. It further indicated that “in cases where the corporate personality is nothing but a mere formality, or when it is abused to evade the application of law, recognizing such corporate personality should be deemed impermissible in light of the original purpose of the concept, and there arise circumstances that demand the denial of corporate personality.”

This decision by the Supreme Court of Japan clearly demonstrates that the Japanese legal system not only strictly applies the legal form of corporate personality but also pursues the ideals of justice and equity. While the independent corporate personality of a company is an essential foundation for business development, when it is used for unjust purposes or becomes nothing more than a hollow formality, it is based on the recognition that maintaining its formal independence would undermine social fairness. This doctrine serves as an important safety valve for international parties dealing with Japanese companies. It signifies that even when a company’s structure or actions appear deceptive or aimed at evading debts, the courts have the means to pursue the true responsible parties behind the corporate personality. This enhances the reliability and fairness in international transactions.

Applicability Requirements

The doctrine of piercing the corporate veil in Japan typically applies in two main scenarios.

Hollowing Out of Corporate Personality

When a corporation is nothing more than a shell, it means that, although the company formally exists, it has lost its independence in substance and is considered as one with the individuals or other corporations behind it. Specific examples include the non-holding of shareholder meetings or board meetings, illegal non-issuance of stock certificates, lack of bookkeeping or accounting categories, and the mixing of business and assets. For instance, a case where the sole shareholder is also the president, and the president confuses the company’s assets with personal assets, falls under this category.  

An example of this hollowing out is the Tokyo District Court decision on October 29, 1990 (1990). In this case, the doctrine of piercing the corporate veil was applied to a hollowed-out corporation, and a claim for accounts receivable was recognized against the actual owner. This resulted from the determination that behind the formal corporate personality, there was a substantial individual enterprise, and the separation was deemed substantively meaningless.  

Abuse of Corporate Personality

This refers to cases where the corporate personality is used to evade the application of the law or for unjust purposes. It involves situations where a company arbitrarily uses its independent corporate personality to escape contractual or legal obligations.  

A typical example is when a company with substantial debts establishes a new company to avoid enforcement by creditors and diverts the old company’s business and assets to the new company. In such cases, there is a possibility that both the old and new companies may be deemed to share the same liabilities.  

Relevant case law includes the Supreme Court decision on March 9, 1972 (1972), which applied the doctrine of piercing the corporate veil to transfers of company assets by shareholders who were not company representatives, deeming them valid. Furthermore, the Osaka High Court decision on July 28, 2000 (2000), suggested the possibility that both the old and new companies could be held liable if it was determined that the business transfer from a heavily indebted company to a newly established company was done to avoid enforcement by creditors. Additionally, the Tokyo District Court decision on December 10, 2009 (2009), applied the doctrine of piercing the corporate veil in a case where an old company went bankrupt to avoid unpaid wage liabilities, and the new company that took over the business rights was held responsible for the unpaid wages.  

While “hollowing out” and “abuse” are explained as different types, in actual case law, the boundaries between them can become blurred. For example, the abuse of corporate personality with the intent to escape debt often accompanies signs of hollowing out, such as the mixing of assets or the non-holding of meetings. Courts in Japan base their decisions on the principles of justice and equity, taking into account the specific facts of each individual case. This underscores the importance for international businesses and their legal departments to maintain strict corporate governance and clear separation of assets in both the formal legal structure and the actual operation of Japanese companies. Particularly during mergers and acquisitions or business reorganizations, transparent procedures are required to avoid the appearance of intending to transfer or evade liabilities.

Legal Effects

When the doctrine of piercing the corporate veil is applied in Japan, the separation between a corporation and its controlling parties (individuals or other corporations) is negated within a specific legal relationship. As a result, counterparties to the company can deny the corporate personality of the company, even in transactions made in the company’s name, and hold the individuals behind it responsible for those actions. Conversely, it also becomes possible to extend the effects of contracts and other agreements made with the controllers to the corporation itself. This doctrine plays a crucial role in securing transactional safety and preventing unjust outcomes.

Summary

Understanding the nature of companies under Japanese Corporate Law (profit-seeking, corporate personality, and association), their capacity to have rights, and the doctrine of piercing the corporate veil forms an essential legal foundation for conducting business in Japan. Grasping these concepts deeply is crucial for managing legal risks and formulating appropriate business strategies. Comprehending the significance of a company’s independent legal personality, the scope and limitations of its capacity to have rights, and the requirements and effects when the corporate veil is exceptionally pierced is indispensable for avoiding unforeseen legal disputes and ensuring the stability of a business.

Monolith Law Office is a legal corporation with a wealth of experience in Japanese Corporate Law, having supported the corporate legal affairs of numerous clients, ranging from listed companies to startups within Japan. With a track record of supporting over 1639 companies, we have particular strengths in corporate legal affairs in the IT and venture business sectors. Our firm also boasts several attorneys who are native English speakers with qualifications from jurisdictions such as California, forming a team with high expertise that leverages an international network to provide high-quality legal services to clients around the world. We are ready to offer practical and strategic support for any legal challenges you may face in expanding your business in Japan, including consultations on the legal nature of companies, their capacity to have rights, and the doctrine of piercing the corporate veil, as discussed in this article. Please feel free to contact us.