Legal Considerations on the Responsibilities and Obligations of Executing Members in Japanese Limited Liability Companies

In the Japanese corporate legal system, the Godo Kaisha (GK) is widely utilized by domestic and international businesses due to the simplicity of its establishment procedures and the extensive allowance for statutory autonomy. Unlike a Kabushiki Kaisha (KK), which is based on the separation of ownership (shareholders) and management (directors), a Godo Kaisha fundamentally operates with the ‘members’ who are investors also managing the company. The core of this management is the ‘executive member.’ Executive members have broad authority to execute the company’s business, but with that authority comes significant legal duties and responsibilities. Understanding these obligations is essential for the sound operation and risk management of a Godo Kaisha. This article provides a detailed legal perspective on the central duties borne by executive members of a Godo Kaisha under Japanese corporate law, namely the duty of care, duty of loyalty, prohibition of competition, restrictions on conflict of interest transactions, and the liability for negligence in the event of a breach of these duties. These provisions form the basic framework for regulating the actions of executive members and protecting the company and its stakeholders.

The Fundamental Duties of Executive Officers in Japan: The Duty of Due Care and the Duty of Loyalty

The foundation of all actions taken by executive officers is based on two fundamental duties: the “Duty of Due Care” and the “Duty of Loyalty.” These duties form the core of the trust relationship between the executive officers and the company and are clearly defined under Japanese Corporate Law.

Firstly, executive officers owe the company the “Duty of Due Care of a Good Manager,” which is based on Article 593, Paragraph 1 of the Japanese Companies Act. The Duty of Due Care means that executive officers must perform their duties with the level of care that would be expected objectively, according to their position and the nature of their duties. For example, if a company makes a large investment based on personal judgment without sufficient market research or profit forecasting, resulting in significant losses for the company, or if due diligence on a trading partner is neglected, leading to irrecoverable accounts receivable, there may be a breach of the Duty of Due Care.

Secondly, executive officers owe the company the “Duty of Loyalty.” This duty is imposed by applying the provisions related to the directors of a stock company (Article 355 of the same law) as per Article 593, Paragraph 2 of the Japanese Companies Act. The Duty of Loyalty requires executive officers to comply with laws and the company’s articles of incorporation and to faithfully execute their duties for the benefit of the company as a whole. This means that executive officers must not prioritize their own interests or those of third parties over the interests of the company.

These duties of Due Care and Loyalty are the most fundamental among the obligations of executive officers and cannot be exempted or mitigated by the provisions of the articles of incorporation. Specific duties such as the prohibition of competition and restrictions on conflict of interest transactions can be understood as concretizations of the Duty of Due Care and Loyalty in specific situations. Therefore, actions that violate these specific provisions inevitably constitute a breach of either the Duty of Due Care or the Duty of Loyalty, providing a legal basis for pursuing the responsibility of executive officers.

Non-Competition: Protecting Business Opportunities of Companies Under Japanese Corporate Law

To prevent executive employees from exploiting their position to seize business opportunities of the company, Japanese Corporate Law has established strict provisions regarding non-competition. This represents one of the key regulations that concretize the duty of loyalty expected from executive employees.

According to Article 594, Paragraph 1 of the Japanese Companies Act, executive employees, as a general rule, cannot engage in specific competitive activities without the approval of all other employees . There are two types of ‘competitive transactions’ targeted by this regulation. The first type is “engaging in transactions that belong to the same category of business as the joint-stock company, for oneself or a third party” . This prohibits executive employees from conducting transactions that are in substantial competition with the company’s business, either on their own account or on account of others. The second type is “becoming a director, executive officer, or an employee who executes business for a company with a business purpose similar to that of the joint-stock company” . This restricts involvement in the management of competing companies.

The most significant feature of this provision is that the approval requirement is, in principle, the “unanimous consent of all other employees” . Compared to the majority vote of the board of directors or the shareholders’ meeting of a joint-stock company, this requirement is extremely strict. This strictness reflects the cooperative nature of a limited liability company and is based on a strong trust relationship among its members. If even one member opposes, the competitive activity is not permitted.

However, Japanese Corporate Law allows for high flexibility in limited liability companies, and this strict principle can be modified by special provisions in the articles of incorporation . For example, the articles of incorporation can relax the approval requirement to something like “approval by a majority of the other members” . Therefore, to understand the specific rules regarding executive employees’ competition, it is essential to review not only the provisions of the Companies Act but also the company’s articles of incorporation.

If an executive employee violates this provision and engages in a competitive transaction, the transaction itself is considered valid to protect the safety of the transaction . However, the executive employee who violated the provision will be liable for damages to the company. In this regard, Article 594, Paragraph 2 of the Japanese Companies Act places an important provision to reduce the burden of proof on the company. Namely, the amount of profit gained by the executive employee or a third party from the competitive transaction is presumed to be the amount of damage incurred by the company . This allows the company to claim compensation based on the profits gained by the violator without having to specifically prove the amount of damage.

Restrictions on Conflict of Interest Transactions: Balancing the Interests of Companies and Employees in Japan

To regulate transactions that may prioritize the personal interests of executive employees over the interests of the company, Japanese Corporate Law has established “Restrictions on Conflict of Interest Transactions.” This is another crucial system to ensure the duty of loyalty that executive employees owe to the company.

Article 595, Paragraph 1 of the Japanese Companies Act stipulates that, in principle, when an executive employee engages in a conflict of interest transaction, they must obtain the approval of a majority of the other employees not involved in the transaction. This requirement is more lenient than the unanimous consent required for competitive transactions, as it only requires a “majority” approval. This suggests that the law views competitive transactions as a serious and constant threat to the company’s business itself, whereas conflict of interest transactions primarily concern the fairness of prices and conditions in individual transactions, indicating a different nature of risk.

The transactions subject to these regulations are mainly classified into two types. One is “direct transactions.” This refers to cases where an executive employee enters into a contract directly with the company, either for themselves or a third party. For example, this includes cases where an executive employee sells real estate they personally own to the company or borrows money from the company.

The other type is “indirect transactions.” These are transactions between the company and a third party other than the executive employee, which substantially conflict with the interests of the company and the executive employee. Typical examples include cases where the company provides a debt guarantee for the personal debts of an executive employee or establishes a security interest on the company’s assets to secure the executive employee’s debts.

Similar to the regulation of competitive transactions, the approval requirements for conflict of interest transactions can also be modified by provisions in the articles of incorporation. For instance, more stringent approval requirements can be set for more significant transactions, or approval can be waived for minor transactions, allowing for flexible design tailored to the company’s actual situation.

If a conflict of interest transaction is conducted without obtaining approval, the validity of the transaction may vary depending on whether the counterparty is a third party. However, in consideration of transaction safety, it is generally interpreted as valid. Nevertheless, if an executive employee neglects to obtain approval and the company incurs damages, they may be held liable for negligence in the performance of their duties. Additionally, Article 595, Paragraph 2 of the Japanese Companies Act clarifies that the prohibition on self-contracting and dual agency set forth in Article 108 of the Japanese Civil Code does not apply to conflict of interest transactions that have obtained proper approval. This allows executive employees to represent the company in concluding contracts, even if they are parties to the transaction, provided that the approval procedures are followed.

Comparing Obligations in Japanese LLCs and Corporations

To gain a deeper understanding of the obligations borne by executive members of a Japanese Limited Liability Company (LLC), it is effective to compare them with those of directors in a corporation, the most common company structure in Japan. While the obligations of both are similar, the differences in their underlying organizational structures lead to significant variations in approval procedures, among other aspects.

The fundamental difference lies in the relationship between the company and its managers. In a corporation, the owners (shareholders) and the managers (directors) are generally separate, and the relationship between the directors and the company is legally defined as an “agency” relationship. In contrast, in an LLC, the investors who are members typically manage the company, integrating ownership and management. The relationship between the executive members and the company is governed not by an agency contract but by the articles of incorporation, which is a contract among the members.

This structural difference directly affects the requirements for approval of competing transactions and conflict of interest transactions. The table below summarizes the main differences in approval requirements between executive members of an LLC and directors of a corporation without and with a board of directors.

As the table clearly shows, the most significant feature of an LLC in Japan is the possibility of “Changes by Articles of Incorporation.” In a corporation, the approval authorities for competing and conflict of interest transactions are fixed by law, and cannot be altered by the articles of incorporation. However, in an LLC, these critically important governance matters can be freely designed to suit the company’s actual situation through the articles of incorporation. For example, in a small company with a very strong trust relationship among members, the strict rules as per legal principles can be maintained, while in a company with many members where more rapid decision-making is required, the approval requirements can be relaxed. This flexibility is the allure of an LLC and, at the same time, the reason why scrutinizing the articles of incorporation is essential in evaluating the company’s governance.

Duty of Care and Liability for Negligence: Legal Consequences of Breach of Duty Under Japanese Corporate Law

When executive officers fail to fulfill their duties of due care and loyalty, or violate non-compete obligations and restrictions on conflict-of-interest transactions, they can be held legally responsible. This responsibility is known as “liability for negligence,” and Japanese Corporate Law (Companies Act) stipulates two types of liabilities: those towards the company and those towards third parties.

Firstly, the liability towards the company is defined in Article 596 of the Japanese Companies Act. According to this article, executive officers are liable to compensate the company for damages incurred due to their negligence in fulfilling their duties. If multiple executive officers are jointly involved in negligence, they are jointly and severally liable. The term “negligence in fulfilling their duties” encompasses all acts that violate the duties of due care and loyalty, including causing damage to the company as a result of engaging in competitive or conflict-of-interest transactions without approval.

Next, the liability towards third parties is established in Article 597 of the Japanese Companies Act. This liability arises when executive officers cause damage to third parties (such as business partners or creditors) in the performance of their duties. However, the requirements for recognizing this liability are more stringent than those towards the company. The article stipulates that executive officers are liable for compensating third parties for damages only when there is “malice or gross negligence.” Mere negligence (minor negligence) does not result in the executive officers being directly liable to third parties.

The difference in these liability requirements reflects the intent of the law. Within the company, executive officers should bear a high duty of care, and even slight negligence can lead to liability, maintaining internal discipline. On the other hand, in relations with external third parties, it is necessary to protect executive officers so they can make quick and bold decisions without excessively fearing the risks associated with normal business judgments. If they were exposed to litigation risks from third parties even for minor negligence, it could lead to a chilling effect on management. Therefore, the law intentionally limits personal liability towards third parties to extremely malicious cases, such as intentionally causing damage (malice) or lacking the significant care that a normal person would not fail to exercise (gross negligence). This balanced system design is an essential legal foundation for promoting sound corporate management.

Conclusion

As detailed in this article, managing members of a Japanese LLC (Godo Kaisha) play a crucial role in the management of the company while also bearing comprehensive duties such as the duty of care and loyalty under Japanese Corporate Law. Moreover, to protect the company’s interests, specific restrictions are imposed on competitive activities and conflict of interest transactions, which generally require the approval of other members. Violations of these duties can result in personal liability for damages to the company or third parties due to negligence in their duties. Particularly for LLCs, where the articles of incorporation allow for broad autonomy, it is essential to review the company’s articles in addition to the legal provisions to understand the specific rules that apply to each company.

Monolith Law Office has a proven track record of providing legal services related to the governance and responsibilities of officers of LLCs to numerous clients within Japan. Our firm boasts a team of professionals, including English-speaking experts with both Japanese attorney qualifications and foreign legal credentials, capable of accurately explaining the complex provisions of Japanese Corporate Law in an international business context and providing practical advice. From the establishment of an LLC, designing its articles of incorporation, building a compliance system for business execution, to handling disputes should they arise, we are committed to robustly supporting your business from a legal standpoint.