Legal Treatment of Acts Performed by Incorporators in the Name of a "Company in Formation" under Japanese Corporate Law

Establishing a company is not merely a sequence of administrative procedures. Legally, from the creation of the articles of incorporation to the completion of the company’s registration, the organization is treated as a “company in formation” in Japan. This stage is a critical period for building the foundation of future business activities, but it is also a time fraught with legal ambiguities and numerous risks. A company in formation does not yet possess full legal personality. However, there are situations where various contractual actions are necessary, such as renting an office or hiring employees for the future company. This raises a fundamental question: do the acts performed in the name of the company in formation by the promoters legally belong to the company that will be established in the future? And who ultimately bears the responsibility for the liabilities arising from those acts? For example, there is the issue of whether a costly lease agreement concluded before the establishment can be invalidated if it is deemed unsuitable for the business plan of the company after its establishment, or whether the promoters should personally bear the responsibility.

This article focuses on the complex legal status of a “company in formation” under Japanese Corporate Law. Specifically, it will provide a detailed explanation of the range of actions that a company in formation can perform and how the legal effects of these actions are treated, based on Japanese Corporate Law and related case law. Furthermore, it will delve into the legal responsibilities that promoters and related parties should bear in the event that the company’s establishment is successful, or, unfortunately, ends in failure. This includes responsibilities towards the company itself, third parties who are transaction counterparts, and the responsibilities of “quasi-promoters” who are not promoters but are deeply involved in the establishment. Understanding these issues is essential to smoothly proceed with the company establishment process and to prevent future legal disputes preemptively.

Activities of Companies Under Formation in Japan

In the process of establishing a company, from the moment the incorporators create the articles of incorporation and begin activities aimed at the common goal of establishing the company, until the company is legally established through registration, the organization is referred to as a “company under formation.” Since this company under formation does not yet possess legal personality under Japanese Corporate Law, its legal nature is interpreted as similar to that of a “non-juristic association.” A non-juristic association is an entity that has an organizational structure, operates on the principle of majority rule, continues to exist regardless of changes in its members, and has determined the method of representation, the operation of general meetings, the management of property, and other major points as an organization.

As an organ of the company under formation, the incorporators act within the necessary scope as representatives for the establishment of the company. Whether the legal effects of the actions taken by the incorporators are attributed to the company after its establishment depends on the nature of those actions. Specifically, it is questioned whether the actions are within the scope of the objectives of the company under formation. The actions of a company under formation can be broadly classified into two categories: “actions that are essential for the establishment of the company itself” and “actions related to the preparation of the company’s business operations,” with the latter further divided into “preparatory actions for opening the business” and “business actions.” In addition, there is also an act called “acceptance of assets,” which is specially regulated by Japanese Corporate Law.

Essential Actions for Company Incorporation in Japan

First and foremost, there are certain actions that are legally and factually indispensable for achieving the goal of company incorporation. These include the creation of the articles of incorporation, the contract in which the incorporators agree to subscribe to shares, the solicitation of individuals to subscribe to the initial issuance of shares, and the convening of the inaugural general meeting. These actions are directly aligned with the objectives of the company being established. Consequently, the rights and obligations arising from these actions naturally belong to the company after its establishment. For example, fees paid to a notary public for the authentication of the articles of incorporation by the incorporators, or advertising expenses incurred for soliciting share subscriptions, can be assumed by the company after it has been established. Legal disputes rarely arise regarding the attribution of the effects of these actions to the company.

Preparatory Actions for Business Startup

Next, there are necessary preparatory actions, known as business startup preparations, to smoothly commence operations after establishment. These are distinct from the actual commencement of business operations (business activities). Examples of such preparatory actions include signing lease agreements for business premises, purchasing office equipment and supplies, and concluding employment contracts with employees.

Whether the legal effects of these preparatory actions are attributed to the company after its establishment is not uniformly determined. Case law indicates that such actions are attributed to the company post-establishment only if they are “objectively necessary as preparatory actions for startup” and are conducted within the scope of the promoters’ authority. For instance, in one case (Oita District Court decision, March 24, 1986 (1986)), an employment contract made by a company in the process of being established was deemed essential for the commencement of the company’s business, and the post-establishment company was judged to inherit the contractual status.

However, the assessment of necessity is strict. For example, the purchase of real estate at an unreasonably high cost relative to the scale of the business, or the employment of a large number of employees clearly unnecessary for the start of operations, are considered acts beyond the promoters’ authority and, in principle, do not transfer to the post-establishment company. In such cases, the individual promoters who conducted the actions bear the responsibility.

Business Activities During Company Formation

Business activities during company formation refer to the act of initiating the very business that a company is supposed to conduct after its establishment, during the incorporation process itself. For instance, this could involve a manufacturing company starting the production and sale of products or a consulting firm entering into consulting contracts with clients and providing services while still in the process of being established.

A company that is still in the process of being established does not yet possess legal personality and lacks the capacity to be the subject of business activities. Consequently, any business activities carried out by a company during its formation are generally considered unauthorized acts that exceed the authority of the promoters and do not belong to the company after its establishment. Even if these business activities result in profits, the rights and obligations typically belong to the individual promoters who conducted the acts.

However, it is possible for the company, after its establishment, to ratify these business activities. Ratification is the expression of intent to attribute the effects of a legal act, which would not normally be attributed, to oneself at a later time. If, after the company is established, an appropriate body such as the board of directors resolves to take on the effects of these business activities for the company, they can exceptionally be attributed to the company. Nevertheless, this is an exceptional measure, and starting business activities during the formation stage involves significant legal risks.

Property Acceptance Under Japanese Corporate Law

Finally, there is an act called “property acceptance” that is specially provided for by Japanese Corporate Law. According to Article 28, Paragraph 2 of the Japanese Companies Act, property acceptance refers to “property that a stock company has agreed to acquire after its establishment, the value of such property, and the name or designation of the transferor.” Specifically, it is a contract in which the incorporator promises the owner of certain property (for example, real estate or machinery) that the company will purchase it at a specified price after the company is established.

While property acceptance is similar to preparatory acts for starting operations, its legal treatment is significantly different. Property acceptance cannot be freely conducted based on the personal judgment of the incorporator; its contents must be described in the articles of incorporation for its effect to be recognized. This is referred to as an abnormal clause in the establishment of the articles of incorporation. By including it in the articles of incorporation, it discloses in advance to other shareholders and creditors what property the company will acquire and how much it will pay for it immediately after establishment, with the aim of preventing the impairment of company assets due to the property being unfairly overvalued.

If a contract for property acceptance is concluded without being described in the articles of incorporation, the contract is, in principle, invalid. Even if the board of directors ratifies the contract after the company’s establishment, it is not possible to validate an invalid act. On this point, the Supreme Court of Japan’s decision on December 24, 1968 (Showa 43), clearly ruled that property acceptance not described in the articles of incorporation is invalid and cannot be validated by ratification. Therefore, if it is decided to acquire specific property after establishment, it is necessary to follow the procedure of including that in the articles of incorporation.

Responsibilities Related to Company Establishment

In the process of establishing a company, various legal responsibilities may arise. These responsibilities are primarily borne by the incorporators, but they cover a wide range of subjects and content. Here, we will explain the responsibilities towards the corporation after its establishment, towards third parties who are counterparties in transactions, and the responsibilities of “de facto incorporators.”

Responsibilities Towards the Corporation After Its Establishment

Incorporators must perform their duties with the care of a prudent manager when carrying out the task of establishing a company. If they fail to fulfill this obligation, the incorporators may be held liable for damages to the company that has been established.

Article 52, Paragraph 1 of the Japanese Companies Act stipulates that if an incorporator neglects their duties in the establishment of the company, they are liable to compensate the company for any damages that arise as a result. For example, this applies if unnecessary high establishment costs are incurred or if the company is damaged due to inappropriate preparatory actions for opening the business. This liability cannot be waived without the consent of all shareholders (Japanese Companies Act, Article 54, Paragraph 1).

Furthermore, incorporators also bear special responsibility in cases of in-kind contributions (contributions of property other than money) or the aforementioned property acceptance, where the value of the property stated in the articles of incorporation is significantly less than its actual value. Article 52-2, Paragraph 1 of the Japanese Companies Act mandates that in such cases, the incorporators are jointly and severally liable to the company for the shortfall. This is a strict liability to ensure the enrichment of the company’s assets, and in principle, it cannot be avoided even if the incorporators can prove that they did not neglect their duties.

Responsibilities Towards Third Parties

Incorporators may also be held responsible for their actions related to the establishment of the company towards third parties who are the counterparties in transactions.

Firstly, if an incorporator acts with malice or gross negligence in the performance of their duties during the establishment of the company, they are liable to compensate any third party for the damages incurred (Japanese Companies Act, Article 53, Paragraph 1). For instance, this could include cases where false business plans are presented to borrow funds from third parties.

Even more critical is the responsibility in the event that the company is not established. If the establishment procedures fail and the company is not established, the incorporators are jointly and severally liable for the actions taken in relation to the establishment of the company (Japanese Companies Act, Article 56). For example, if a lease agreement for an office is concluded on the premise of the company’s establishment and the company fails to be established, all the incorporators become the contracting parties. Moreover, the costs incurred for those actions must also be borne jointly and severally by all the incorporators. This provision is designed to protect the counterparties and illustrates the heavy responsibility of becoming an incorporator.

Responsibilities of De Facto Incorporators

Finally, there are cases where individuals who are not formally incorporators but have substantially been involved in the establishment of the company may be held responsible. This is referred to as the responsibility of “de facto incorporators.”

The Japanese Companies Act, Article 55, cites two cases. The first is a person who has consented to have their name or the name of their company and their endorsement of the establishment of the corporation included or recorded in advertisements for the solicitation of shares or other documents or electronic records related to such solicitation. For example, this applies when a well-known entrepreneur allows their credibility to be used for the establishment of a company. The second case involves individuals who have not signed or sealed the articles of incorporation as incorporators.

These individuals are considered as incorporators and bear the same responsibilities as those previously explained (responsibilities towards the company and third parties). This is based on the notion that if one has created external credibility for the establishment of the company through their name or actions, they should bear the corresponding responsibility. It is essential to be aware that even if one is not officially listed as an incorporator, they may still incur significant legal responsibilities depending on their involvement in the establishment of the company.

Conclusion

Establishing a company marks a hopeful start to a new venture, but the process involves complex legal issues as explained in this article. In particular, determining the validity of actions and the location of responsibility during the transitional phase of a “company in formation” can be challenging without specialized knowledge. Actions taken beyond the authority of the promoters can not only impose unexpected burdens on the company after its establishment but also carry the risk of unlimited liability for the promoters themselves. Overlooking actions that require strict procedures, such as the acceptance of assets, could even undermine the very foundation of the planned business. Identifying and properly managing these risks in advance is the first step towards a smooth company establishment and the realization of sound management in the future.

Monolith Law Office has a wealth of experience in supporting numerous clients with legal matters related to corporate law, especially during the stages before and after company establishment. Based on our deep understanding of Japanese corporate law, we analyze potential risks associated with the actions and responsibilities of a company in formation and propose the most suitable solutions for our clients. Furthermore, our firm includes several English-speaking experts with foreign legal qualifications, enabling us to provide meticulous and accurate legal support without language barriers, even to clients looking to expand their business internationally. If you have any legal concerns during the critical phase of company establishment, please do not hesitate to consult with us.