Explanation of the Exemption and Limitation of Directors' Liability in Japanese Corporate Law

In Japanese stock corporations, officers such as directors and statutory auditors bear significant responsibilities towards the company. Article 423, Paragraph 1 of the Japanese Companies Act stipulates that if an officer neglects their duties (duty of care) resulting in damage to the company, they are liable to compensate for the damage . This liability for damages can potentially amount to a very high sum, posing a serious risk for individuals taking on officer roles. Recent court cases, such as the ruling ordering the former management of Tokyo Electric Power Company to pay over 13 trillion yen in compensation, highlight the magnitude of this risk .  

However, while imposing strict responsibilities on officers, the Japanese Companies Act also provides a sophisticated multi-layered system to exempt or limit their liability within reasonable bounds. This system is designed to balance two important objectives: to clarify the responsibilities of officers and protect the interests of the company and its shareholders, and to prevent capable individuals from hesitating to take on officer roles due to excessive liability or from overly cautious business judgments. Understanding this framework for mitigating responsibility is essential for achieving sound corporate governance and bold corporate management.  

This article comprehensively explains the main systems for exempting and limiting the liability for duty of care of officers as defined by the Japanese Companies Act, based on specific legal provisions and case law. Specifically, we will cover the following systems:

1. Complete exemption of liability with the consent of all shareholders (Japanese Companies Act, Article 424)
2. Partial exemption of liability by special resolution of the shareholders’ meeting (Japanese Companies Act, Article 425)
3. Partial exemption of liability by resolution of the board of directors (Japanese Companies Act, Article 426)
4. Liability limitation contracts with non-executive directors, etc. (Japanese Companies Act, Article 427)
5. Settlement in shareholder representative lawsuits (Japanese Companies Act, Article 850)

Each of these systems has different requirements, procedures, and effects. Accurately understanding these differences is extremely important for officers, executives, and investors of companies operating in Japan, from the perspectives of risk management and governance structure development.

Complete Exemption of Liability with the Consent of All Shareholders (Article 424 of the Japanese Companies Act)

One of the most fundamental and powerful methods to exempt directors from their duty of care liability is to obtain the consent of all shareholders. Article 424 of the Japanese Companies Act stipulates that “the liability referred to in the first paragraph of the preceding article cannot be exempted without the consent of all shareholders.” This means that if all shareholders, who are the owners of the company, agree, the financial compensation obligations of the directors to the company can be fully exempted.

The most significant feature of this method is that it allows for the “full” exemption of liability, in contrast to other systems that are limited to the “partial” exemption of liability. Moreover, it can cover acts of directors even if they are due to malice or gross negligence.

However, there are extremely significant practical constraints to this system. It requires the consent of “all shareholders,” literally every single shareholder. In publicly traded companies with numerous shareholders or companies with a dispersed shareholder structure, securing the consent of all shareholders is virtually impossible. Therefore, this method is only a realistic option for companies with a specific and small number of shareholders, such as sole proprietorships with only one shareholder, wholly-owned subsidiaries with 100% of the shares held by the parent company, or closely-held family businesses with very few shareholders. Additionally, this exemption is only applicable to liabilities for past acts that have already occurred and cannot be used to comprehensively exempt future liabilities in advance.

This system also encompasses important theoretical legal issues, namely the tension with the protection of company creditors. The right to claim damages from directors is part of the company’s assets. When shareholders consent to waive this claim, it is an act that reduces the company’s assets. Especially in closed companies where shareholders and managers are nearly the same individuals, a situation can arise where the manager, after causing damage to the company through high-risk transactions, exempts themselves from liability in their capacity as a shareholder, thereby reducing the company’s assets and causing external creditors to suffer the disadvantage. The Japanese Companies Act does not set general restrictions on this point and can be interpreted as prioritizing the will of the shareholders in principle. However, there are provisions that limit exemptions from the perspective of protecting company creditors, such as liability for illegal distribution of surplus funds, indicating that the legislature is aware of this issue.

Partial Exemption of Liability by Special Resolution at the Shareholders’ Meeting (Article 425 of the Japanese Companies Act)

In public companies where obtaining the consent of all shareholders is challenging, a more practical option is the system of partial exemption of liability through a special resolution at the shareholders’ meeting. Article 425 of the Japanese Companies Act allows for the partial exemption of directors’ liability under certain conditions through a special resolution of the shareholders’ meeting. A special resolution is generally established with the attendance of shareholders holding a majority of the voting rights and the approval of at least two-thirds of the voting rights of the attending shareholders (Article 309, Paragraph 2, Item 8 of the Japanese Companies Act).

To utilize this system, several stringent requirements must be met. Firstly, the most critical subjective requirement is that the officer in question must have acted “in good faith and without gross negligence” in the performance of their duties. In other words, exemption through this system is not permitted in cases of ‘malice’, where the officer was aware of the dereliction of duty, or ‘gross negligence’, which could have been easily recognized with minimal attention.

Secondly, the exemption is strictly limited to “partial” liability. Officers must still bear responsibility up to the “minimum liability amount” as defined by law. This minimum liability amount varies according to the officer’s position and is calculated based on the annual officer’s remuneration and other factors, in accordance with the calculation method set forth in Article 113 of the Enforcement Regulations of the Japanese Companies Act. Specifically, for a representative director, the amount is six times the annual remuneration, for an executive director it is four times, and for other non-executive directors or auditors, it is twice the amount.

Thirdly, from a procedural standpoint, when proposing a resolution for exemption of liability to the shareholders’ meeting, the company must provide sufficient information to the shareholders. Specifically, the company is obligated to explain at the shareholders’ meeting the facts that caused the liability and the amount of compensation liability, the limit of the exemption and the basis for its calculation, and the reasons for exempting the liability along with the specific amount of exemption.

Furthermore, this system includes a very important procedural safeguard from a corporate governance perspective. Before the board of directors can submit this exemption of liability proposal to the shareholders’ meeting, they must first obtain the “consent of each auditor (or the auditor, in the case of a company without an audit & supervisory board)” (Article 425, Paragraph 3 of the Japanese Companies Act). This mechanism is designed to prevent directors from easily exempting each other’s liabilities through collusion. Auditors, from their independent position of protecting the interests of the company and shareholders, play a role in rigorously examining whether the officer in question truly acted in good faith and without gross negligence, and whether exempting the liability contributes to the company’s interests. The consent of the auditors is not merely a formal procedure but serves as a substantive gatekeeper ensuring the integrity of the liability exemption process.

Partial Exemption of Liability by Board of Directors’ Resolution Under Japanese Corporate Law (Article 426)

Japanese Corporate Law provides a more agile method of exempting liability than shareholder resolutions, through a system of partial exemption by a resolution of the board of directors. Article 426 of the Japanese Corporate Law stipulates that certain types of companies can partially exempt an officer’s liability through a board resolution, provided that such a provision is set forth in the company’s articles of incorporation.  

The prerequisites for utilizing this system are strict. First, the company must establish a provision in its articles of incorporation that states, “The liability of officers for compensation can be exempted to the extent permitted by law through a resolution of the board of directors.” A special resolution at the shareholders’ meeting is required for this amendment to the articles of incorporation. Next, the companies eligible to introduce this system are limited to those with established internal control systems, such as companies with a board of corporate auditors, an audit and supervisory committee, or a nominating committee.  

The substantive requirements for exemption are similar to those for exemptions by shareholder resolutions under Article 425 of the Corporate Law. That is, the officer must have acted in good faith and without gross negligence, and the exemption is limited to amounts exceeding the minimum liability threshold.  

The most distinctive feature of this system lies in its unique mechanism for balancing management agility with shareholder protection. While convening a shareholders’ meeting involves time and cost, a board of directors’ resolution allows for more rapid decision-making. However, this also carries the risk of abuse of authority by the board of directors. To mitigate this risk, Article 426 of the Corporate Law grants powerful veto rights to minority shareholders. Specifically, if the board of directors makes a resolution to exempt liability, the company must promptly notify or announce the content to shareholders. If, within a period of at least one month thereafter, shareholders holding at least 3% of the total voting rights object, the effect of the exemption by the board of directors is lost. This “right of objection by minority shareholders” serves as a strong check to ensure that the board of directors cannot ignore the intentions of influential minority or activist shareholders when deciding on an exemption. This ensures that while facilitating efficient decision-making by the board of directors, shareholder oversight is effectively maintained.  

Limiting Liability through Limited Liability Contracts (Article 427 of the Japanese Companies Act)

Unlike the ex post facto exemption systems we have seen before, there is a system in place that allows for the limitation of directors’ liability through contracts in advance. Article 427 of the Japanese Companies Act permits stock companies to establish in their articles of incorporation the ability to enter into contracts with specific directors to limit their liability for damages due to negligence in the performance of their duties.  

The core of this system lies in the strict limitation of the range of officers who can enter into such contracts. Limited liability contracts are only applicable to directors (excluding “executive directors, etc.”), accounting advisors, auditors, and accounting auditors. The term “executive directors, etc.” refers to representative directors or those selected by the board of directors to execute the business of the company (as defined in Article 2, Paragraph 15, Item (i) of the Japanese Companies Act). In other words, management personnel who are directly involved in daily business operations and hold significant authority are excluded from this contract.  

To utilize this system, it is necessary to first establish in the articles of incorporation, through a special resolution of the shareholders’ meeting, that a limited liability contract can be concluded, and to register this provision. Even if a contract is concluded, liability is actually limited only if the officer in question acted in good faith and without gross negligence in the performance of their duties. The amount of liability is limited to either the minimum liability amount stipulated in Article 425 of the Companies Act (twice the annual remuneration for non-executive directors, etc.) or a higher amount specified in the articles of incorporation, whichever is greater.  

Article 427 of the Companies Act is not merely a measure to mitigate liability; it is positioned as an important policy tool to strengthen corporate governance in Japan. In particular, it aims to secure high-quality independent outside directors. One of the biggest barriers for experienced professionals and executives when taking on the role of an outside director is the risk of bearing personal liability for substantial damages for a company they do not directly manage. Limited liability contracts provide an incentive by setting a cap on this financial risk, allowing talented individuals to confidently take on the roles of outside directors or auditors. The clear exclusion of executive directors reflects this policy objective. By imposing greater responsibility on those who hold the authority and responsibility for business execution and providing appropriate protection to those who are in charge of supervision and advice, the intention is to promote the separation of management and supervision and enhance the effectiveness of governance.  

An important case that demonstrates how limited liability contracts actually function is the Osaka High Court decision on May 21, 2015 (commonly known as the Sei Crest case). In this case, the liability of an outside auditor was questioned for failing to prevent fraudulent acts by the company’s representative director. A limited liability contract had been concluded between the company and the auditor in question. The court recognized the auditor’s negligence for failing to fulfill obligations such as recommending the establishment of an internal control system. However, it determined that the negligence did not constitute “gross negligence” and acknowledged the validity of the limited liability contract. As a result, the auditor’s liability for damages was limited to twice the amount of remuneration, as stipulated in the contract. This case illustrates that while the courts respect limited liability contracts, they also specifically review whether an officer’s actions constitute “gross negligence,” making it clear that an officer’s duty of care is not diminished by entering into a contract.  

Comparison of Various Exemption and Limitation Systems Under Japanese Corporate Law

The four main liability exemption and limitation systems under Japanese Corporate Law that we have explained so far each have different purposes and functions. By comparing these systems, Japanese corporations can strategically decide which system to utilize based on their own circumstances and governance policies.

Unanimous shareholder consent (Article 424 of the Companies Act) is the only method that allows for full exemption of liability, but its application is practically limited to closely held companies with a very small number of shareholders. The special resolution of the shareholders’ meeting (Article 425 of the Companies Act) is a more widely available post-facto remedy, but it comes with subjective requirements of good faith and no gross negligence, in addition to the substantial hurdle of requiring the consent of the statutory auditor. The board of directors’ resolution (Article 426 of the Companies Act) provides a more agile procedure without going through a shareholders’ meeting, but it requires a provision in the articles of incorporation and incorporates a strong check function with the right of dissent by shareholders holding at least 3% of the shares. Lastly, the liability limitation agreement (Article 427 of the Companies Act) is the only method for managing risks in advance and is particularly aimed at securing non-executive directors, such as outside directors, although executive directors are excluded from this system.

The main features of these systems are summarized in the table below.

Settlement in Shareholder Representative Litigation Under Japanese Corporate Law (Article 850)

A typical scenario where the responsibility of officers is actually pursued is in shareholder representative litigation. This is a lawsuit filed by shareholders on behalf of the company to pursue the responsibility of its officers. During the course of this litigation, the parties involved, the shareholders and the officers, may reach a “litigation settlement.” This settlement effectively has the powerful function of limiting or exempting the officers’ responsibilities.

The legal basis for this settlement is Article 850 of the Japanese Companies Act. The most important aspect of this article is that it provides a significant exception to the principle of “consent of all shareholders” required by Article 424 of the Companies Act. If a settlement in a shareholder representative lawsuit is validly established, the officers’ responsibilities are limited to the scope of the settlement content, and the dispute is resolved, even without the consent of all shareholders.

This system reflects the pragmatic judgment of the legislature to avoid the costs and uncertainties of prolonged litigation and to enable realistic and flexible dispute resolution for the parties involved. In some cases, it is more beneficial for the overall interest of the company to negotiate a settlement that allows the company to recover a certain amount of money and regain management stability quickly, rather than contesting every lawsuit to a final judgment.

However, to prevent easy settlements between plaintiff shareholders and defendant officers that could harm the interests of the company itself, Article 850 of the Companies Act sets procedural safeguards. If the company is not directly involved in the settlement negotiations, the court must notify the company of the settlement content and give the company an opportunity to object. The company can submit a written objection within two weeks in principle after receiving the notification. If the company does not object within this period, the settlement content is deemed to have been approved. This mechanism ensures that the interests of the company are not unjustly harmed under the supervision of the court. As seen in cases involving companies like Daiwa Bank, Duskin, and Sumitomo Electric Industries, litigation settlements play an important role in the practice of corporate governance in Japan.

Conclusion

As we have seen in this article, the Japanese Companies Act is built upon a sophisticated balance that allows for the possibility of stringent accountability for directors’ negligence in their duties, while also providing a variety of mechanisms for exemption and limitation. These range from complete exemption with the unanimous consent of shareholders, to partial exemptions by the shareholders’ meeting or the board of directors, pre-arranged limitation of liability contracts, and settlements in litigation. These systems are not merely for the protection of directors; rather, they serve a greater purpose of promoting sound risk-taking in corporate management, attracting high-quality talent to executive and supervisory roles, and ultimately supporting the competitive edge and sustainable growth of companies.

Understanding these complex systems accurately and utilizing them appropriately according to one’s company situation is essential, especially for businesses operating internationally. Monolith Law Office boasts a wealth of experience and deep expertise in this field, having supported numerous domestic and international clients. Our firm is staffed not only with attorneys well-versed in Japanese corporate law but also with professionals who are qualified foreign lawyers and proficient in English. This unique structure enables us to provide seamless and high-quality legal services, from explaining the nuances of the Japanese legal system to foreign directors and parent companies, to drafting and reviewing articles of incorporation and limitation of liability contracts, guiding shareholders’ meetings, strategic advice during disputes, and litigation representation. If you are facing challenges related to Japanese corporate governance and director liability, please do not hesitate to consult with our firm.