Challenging the Validity of Share Issuance and Disposal of Treasury Shares

Issuing new shares is one of the most fundamental and crucial methods for a corporation to raise capital for business activities. This process is essential for the growth and development of a company, yet it can also lead to disputes over control of the company and conflicts between existing shareholders and management. Particularly when new shares are suspected to be issued with the purpose of diluting a specific shareholder’s stake or for management to maintain their position, serious disputes can arise regarding the validity of such issuance. To address such situations, Japanese Corporate Law (日本の会社法) has established clear, institutionalized legal proceedings to contest the effect of share issuances and the disposal of treasury shares. At the heart of these are the “lawsuit for the nullification of new share issuance” and the “lawsuit for confirmation of non-existence of new share issuance.” These legal proceedings are similarly applicable to the disposal of treasury shares. This article provides a detailed professional analysis of these legal procedures, including their legal basis, the requirements for filing a lawsuit, the specific grounds on which courts base their judgments, and the legal effects of the rulings, incorporating significant Japanese case law throughout.  

The Complete Picture of Legal Actions Contesting the Validity of New Share Issuance in Japan

Japanese Corporate Law provides a special litigation system for disputing the validity of fundamental corporate actions such as company establishment, mergers, and share issuance. Known as “corporate organizational disputes,” the purpose of this system is to determine the legal relationships surrounding a company in a stable and uniform manner, involving numerous stakeholders. Once shares are issued, they circulate in the market and can be acquired by many third parties. If the validity of the issuance could be contested by anyone at any time individually, it would significantly harm transaction safety and render the legal relationships surrounding the company extremely unstable.

To address this issue, Japanese Corporate Law limits the methods of contesting the validity of share issuance to specific lawsuits, and the judgments from these lawsuits affect not only the parties involved but also all third parties. This effect is known as “erga omnes effect.” This system carefully balances the need to protect the rights of existing shareholders and the need to protect third parties who have conducted transactions based on trust in the issued shares, maintaining the stability of legal relationships. This legislative balance is clearly reflected in the structure of the two different types of lawsuits provided by the Corporate Law: the “nullity action” and the “non-existence confirmation action.” The former is used when there are procedural defects that cannot be considered minor, prioritizing legal stability with strict time limitations and judgments that only have future effects. The latter is only permitted in extremely exceptional cases where the issuance act itself is deemed non-existent, functioning as a powerful remedy with effects that can retroactively apply without time limitations. Therefore, those who question the validity of share issuance must carefully decide which legal procedure to choose, depending on the nature and extent of the defects.

Challenging the Validity of New Share Issuance and Disposal of Treasury Shares Under Japanese Corporate Law

The lawsuit challenging the validity of new share issuance is the most common legal action taken when there are legal defects in the procedures of issuing shares, aiming to retroactively negate their effectiveness.

Legal Basis and Requirements for Filing a Lawsuit

The direct legal basis for this claim can be found in Article 828, Paragraph 1, Items 2 (issuance of new shares) and 3 (disposal of treasury shares) of the Japanese Companies Act. These provisions stipulate that claims regarding the invalidity of share issuance and similar actions can only be made through a lawsuit, a principle known as “the requirement to initiate legal proceedings.”

To file this lawsuit, strict requirements must be met. First, there is a designated filing period. For public companies (companies whose shares are not subject to approval by the company for transfer), a lawsuit must be filed within six months from the date the share issuance takes effect. For private companies (companies that are not public), the lawsuit must be filed within one year. This period is immutable, and once it has passed, the right to claim invalidity is permanently lost.

Furthermore, the parties eligible to file a lawsuit (plaintiffs) are limited. According to Article 828, Paragraph 2, Item 2 of the Japanese Companies Act, those who have the right to file are those who were shareholders, directors, auditors, executive officers, or liquidators of the company on the date the share issuance took effect. No one else is permitted to initiate a lawsuit. The defendant in the lawsuit will be the company in question.

Grounds for Invalidity of New Share Issuance Under Japanese Corporate Law

Japanese Corporate Law does not specifically enumerate what constitutes grounds for invalidating the issuance of new shares. Therefore, the determination of what defects constitute such grounds is left to the interpretation of the courts. Case law, considering the significance of overturning the effects of an already completed issuance, limits the grounds for invalidity to “serious violations of laws or articles of incorporation” in order to prioritize legal stability.

Specific examples of grounds for invalidity recognized as “serious violations of laws or articles of incorporation” by case law include the following:

• Issuing new shares beyond the total number of shares authorized by the company’s articles of incorporation.
• Issuing a class of shares not specified in the articles of incorporation.
• In the case of a private company, issuing solicited shares by a method other than shareholder allotment without the special resolution of the shareholders’ meeting required by Articles 199(2) and 309(2)(5) of the Japanese Companies Act. The Supreme Court of Japan ruled on April 24, 2012 (Heisei 24), that the interest in maintaining the shareholding ratio of shareholders in a private company should be particularly strongly protected, and thus deemed this procedural violation as a ground for invalidity.
• Issuing shares in violation of a court’s provisional injunction order to halt the issuance. The Supreme Court of Japan, in its decision on December 16, 1993 (Heisei 5), held that recognizing the effectiveness of an issuance that violates a provisional injunction order would undermine the purpose of the claim for injunction system, and thus recognized this as a ground for invalidity.

On the other hand, mere minor procedural defects, issuance without a board of directors’ resolution in a public company, or issuance at a significantly unfair price (advantageous issuance) are generally not considered grounds for invalidity. For advantageous issuance, corrections are sought through other systems, such as the liability for damages of directors to the company (Article 212 of the Japanese Companies Act).

The Relationship Between “Grossly Unfair Methods” and Grounds for Invalidity Under Japanese Corporate Law

In litigation surrounding Japanese Corporate Law, one of the most complex and contentious issues is the treatment of new share issuances conducted by “grossly unfair methods.” Article 210, Paragraph 2 of the Japanese Companies Act stipulates that if shares are issued by a “grossly unfair method” that could disadvantage shareholders, the shareholders may demand the company to cease such issuance (injunction request).

The question arises whether this “grossly unfair method” can also be a ground for invalidity when asserting invalidity after the issuance is completed. On this point, the Supreme Court of Japan, in a landmark decision on July 14, 1994 (1994), indicated that even if an issuance is made by a “grossly unfair method,” this fact does not, in principle, constitute a ground for invalidity. The court’s decision was influenced by policy considerations that strongly protect the safety of transactions, taking into account the possibility that the issued shares may have already been transferred to third parties. In other words, shareholders who wish to stop an unfair issuance must act swiftly with an injunction request before the issuance is executed; once the issuance is completed, it becomes extremely difficult to overturn its effects—a legal consequence that was clarified.

The courts have developed a framework for determining what constitutes a “grossly unfair method,” known as the “primary purpose rule.” This involves weighing whether the main purpose of the new share issuance is for legitimate management needs such as fundraising, or for improper purposes such as maintaining the current management’s control or reducing the voting rights percentage of specific shareholders (control maintenance purpose).

A representative case that applied this rule is the Tokyo District Court decision on July 25, 1989. In this case, a new share issuance that had a significant impact on the existing shareholders’ holding ratios and was primarily aimed at maintaining the current management’s control, was deemed to be a “grossly unfair method” in a situation where there was a dispute over the company’s control.

Furthermore, the Tokyo High Court decision on March 23, 2005 (the Nippon Broadcasting System case), added an important exception to this rule. The decision stated that even if maintaining control was the primary purpose, the issuance could be exceptionally permissible if it was a necessary and appropriate countermeasure to protect the company and the overall interests of the shareholders from abusive acquirers, such as asset strippers or those aiming for scorched-earth management. These case examples demonstrate the courts’ highly nuanced judgments based on the specific circumstances of each case.

The Effect of a Nullification Judgment

When a lawsuit seeking the nullification of a new share issuance is accepted and the judgment becomes final, the judgment has effect not only on the parties involved in the lawsuit but also on third parties (erga omnes effect, under Japanese Corporate Law Article 838). This ensures that legal relationships are uniformly established.

However, the most crucial point is that the judgment only has a prospective effect. Article 839 of Japanese Corporate Law stipulates that a nullification judgment does not have retroactive effect. This means that the exercise of voting rights based on the shares deemed invalid or dividends paid before the judgment becomes final will not be overturned. This provision is extremely important for ensuring legal stability.

As for the specific procedures following the finalization of the judgment, the company is obligated to return the money paid by those who were shareholders at the time of the judgment’s finalization for the acquisition of the shares. This is stipulated under Japanese Corporate Law Article 840 for new share issuances and under Article 841 for the disposal of treasury shares. Additionally, the company must register the change indicating that the total number of issued shares has decreased.

Lawsuits for Confirmation of Non-Existence of New Share Issuance and Disposal of Treasury Shares Under Japanese Corporate Law

Lawsuits for confirmation of non-existence of new share issuance are even more exceptional than invalidity lawsuits, as they are brought forth when there is a fundamental flaw so severe that, legally, the act of issuing shares is deemed to have never existed.

Legal Basis and Reasons for Non-Existence

These lawsuits are based on Article 829 of the Japanese Companies Act. A lawsuit for confirmation of non-existence is only recognized when there is an extremely serious defect, not just a procedural violation, such that the ‘substance’ of the issuance act itself is considered lacking. Japanese courts are cautious about allowing the filing of these lawsuits after the period for filing an invalidity lawsuit has passed, setting a high threshold for recognizing reasons for non-existence.  

Potential cases recognized as reasons for non-existence in court precedents include:

• When there has been no payment at all for the shares, or when the payment appears to have been made in the accounting books, but in reality, no funds have been retained by the company, known as “sham payment”.
• When the representative director, who has the authority to represent the company, has not been involved at all in the procedures for issuing shares, and it cannot be legally evaluated as an act of the company.  

On the other hand, if there is only a lack of resolution by the board of directors or the general meeting of shareholders, or if there are other violations of laws, these are not considered non-existent in principle, and the issuance is deemed valid.  

The most distinctive feature of a lawsuit for confirmation of non-existence is that, unlike an invalidity lawsuit, there is no limitation on the period for filing a lawsuit.  

Effect of a Judgment Confirming Non-Existence

When a judgment confirming non-existence becomes final, it is recognized to have effects against third parties (erga omnes effect), just like an invalidity judgment (Article 838 of the Japanese Companies Act).  

However, a decisive difference from an invalidity judgment is that its effect arises retroactively. In other words, the share issuance confirmed as non-existent is treated as if it never existed from the beginning. As a result, all legal effects based on the relevant shares, such as the exercise of voting rights and dividends paid, are fundamentally overturned. Due to this powerful effect, courts take an extremely cautious stance in their recognition.

Comparison of Claims for Nullity and Non-Existence Confirmation Under Japanese Corporate Law

As we have seen, the two types of litigation procedures defined by the Japanese Companies Act are clearly distinguished in terms of their purpose and effect. The choice between which claim to pursue depends entirely on the nature and severity of the flaws in the share issuance procedures. A claim for nullity targets cases where, despite procedural defects, the act of issuance substantially exists. In contrast, a claim for confirmation of non-existence is limited to cases where the act of issuance is deemed a mere illusion from a legal standpoint, lacking any substance. The presence or absence of a filing period, and whether the judgment has a future effect only or is retroactive, are the most critical considerations in devising a litigation strategy.

To summarize these differences, the following table is presented:

Summary

Under Japanese Corporate Law, there are two distinctly separate legal proceedings provided to contest the validity of flawed stock issuance: the “action for nullification” and the “action for confirmation of nonexistence.” The choice between these mechanisms is determined by the severity of the flaw. In particular, the strict filing deadlines imposed on the action for nullification and the legal differences between a preventive injunction against unfair issuance and a post-facto action for nullification suggest that shareholders must carefully monitor the situation and act swiftly with strategic foresight to protect their rights. These systems can be seen as a sophisticated legal framework designed to balance the dual demands of shareholder rights protection and transactional security.

Monolith Law Office boasts a wealth of experience and deep expertise in litigation related to corporate law, including disputes over the validity of stock issuance as discussed in this article. Our firm is staffed with multiple English-speaking attorneys qualified in foreign jurisdictions, enabling us to provide smooth and professional legal support to international clients facing Japan’s complex legal system. If you require expert assistance with issues like those addressed in this article, please do not hesitate to consult with our office.