Employee Rights in a Japanese LLC: From Profit Distribution to Management Participation

Since the enactment of the Japanese Companies Act in 2006 (Heisei 18), the Godo Kaisha (LLC) has become a popular corporate structure among entrepreneurs due to its ease of establishment and operational flexibility. Particularly, this form, introduced based on the American LLC (Limited Liability Company), is an attractive option for companies considering international business expansion. One of the most important concepts to understand about a Godo Kaisha is the status of its ‘members.’ Unlike ‘employees’ in a stock company, ‘members’ of a Godo Kaisha are the contributors to the company’s capital, that is, the owners. This status is similar to shareholders in a stock company, but with a crucial difference: a Godo Kaisha fundamentally assumes ‘unity of ownership and management.’ In other words, the members who are investors, as a general rule, manage the company themselves. This basic structure significantly defines the rights granted to the members. This article delves into the ‘interests’ held by members of a Godo Kaisha, which is a collective of rights and obligations towards the company, and deeply explores the nature of these rights. Specifically, it will clarify how the Japanese Companies Act defines and protects these rights, from two perspectives: the right to receive economic benefits from the company (self-interest rights) and the right to participate in and supervise the company’s management (common-interest rights), using specific articles and case law as references.

The Complete Picture of Member Rights in a Japanese LLC: Individual and Collective Rights

In a Japanese Limited Liability Company (LLC), the rights held by members are broadly categorized into two types based on their nature. This is a traditional method of organization under Japanese Corporate Law, and it is also used to explain the rights of shareholders in a stock company. The two categories are ‘individual rights’ and ‘collective rights’.

Individual rights (自益権, jieikiken) refer to the rights that members exercise against the company for their own economic benefit. These include the right to claim dividends from the profits generated by the company’s business activities and the right to receive a distribution of the remaining assets when the company is dissolved. These rights are personalityized as a direct return on the member’s investment in the company.

On the other hand, collective rights (共益権, kyōeikiken) refer to the rights that members have to participate in and oversee the management of the company for the benefit of the company as a whole. Specifically, this includes the right to execute the company’s business and the right to investigate the status of business execution. Collective rights aim not only at the interests of individual members but also at the healthy operation of the company as a joint enterprise.

In a stock company, where ownership (shareholders) and management (directors) are separated, individual rights (such as the right to receive dividends) and collective rights (such as voting rights at the shareholders’ meeting) are relatively clearly distinguished. However, in an LLC, where ownership and management are fundamentally aligned, the boundaries between these two types of rights are more fluid. For example, the right to execute business (a collective right) directly stems from the status of the members as owners, and the profits resulting from exercising this right are ultimately returned to the members through individual rights. Understanding this interrelationship is key to grasping the rights structure of a Japanese LLC.

The Specifics of the Right to Economic Benefits (Jikoeki-ken) Under Japanese Corporate Law

The core of an employee’s right to economic benefits, or self-interest rights (jikoeki-ken), is the right to partake in the profits of the company. Japanese Corporate Law defines this right in terms of two aspects: ‘distribution of profits and losses’ and ‘dividend of profits.’ While closely related, these aspects have significant differences in their legal implications and procedures.

Distribution of Profits and Losses Under Japanese Corporate Law

The distribution of profits and losses refers to the process of determining how the confirmed profits or losses of a company at the end of an accounting period are attributed to each shareholder and in what proportion. This distribution ratio is one of the most crucial elements in defining the economic relationships among shareholders.

Article 622, Paragraph 1 of the Japanese Companies Act stipulates the basic principle regarding this distribution ratio. According to this principle, if the articles of incorporation do not specify the distribution of profits and losses, the ratio is determined in accordance with the value of each shareholder’s contribution . This means that shareholders who have made larger contributions bear a greater share of the profits (or losses).

However, one of the unique features of a Japanese LLC (Limited Liability Company) is the flexibility to modify this principle through the “articles of incorporation autonomy” . Shareholders can freely determine the distribution ratio of profits and losses based on criteria completely different from the amount of their contributions by agreeing in the articles of incorporation . For example, if there is shareholder A who provides capital and shareholder B who provides superior technology or know-how, it is possible to set a higher profit distribution rate for shareholder B than for shareholder A, even if B’s contribution is smaller, in recognition of B’s contributions. This flexibility is one reason why LLCs are preferred for joint ventures that bring together talent with diverse forms of contribution.

Furthermore, Article 622, Paragraph 2 of the Japanese Companies Act stipulates that if the articles of incorporation determine the distribution ratio for only profits or losses, it is presumed that the ratio applies to both profits and losses . This provision interprets the reasonable intentions of the parties involved.

It should be noted that the distribution of losses does not necessarily mean an immediate demand for additional contributions. Typically, unless there is a special provision in the articles of incorporation, the amount of the loss is processed by reducing the book value of each shareholder’s interest. This outcome affects the amount of the interest to be refunded when a shareholder leaves the company and the distribution amount of the remaining assets in the event of the company’s liquidation .

Distribution of Profits

While profit and loss distribution determines the attribution of accounting profits, the distribution of profits refers to the actual act of distributing a company’s assets to its members. Under Article 621, Paragraph 1 of the Japanese Companies Act, members have the right to demand profit distribution from the company.

While the “dividend of surplus” in a stock company can be sourced from both retained earnings and capital surplus, the “distribution of profits” in a limited liability company, as the name suggests, is sourced solely from profits. This distinction is also crucial for the protection of the company’s assets.

The procedures for profit distribution in a limited liability company are highly flexible. Legally, members can demand profit distribution at any time, which could potentially destabilize the company’s cash flow. Therefore, in practice, it is extremely important to specify in the articles of incorporation the timing, frequency, and procedures for profit distribution. For example, by stipulating that “distribution will be made after the final settlement of accounts at the end of the fiscal year, based on the decision of the majority of the managing members,” planned asset distribution becomes possible.

However, this freedom of distribution is subject to strict legal constraints, known as “capital maintenance regulations.” Article 628 of the Japanese Companies Act stipulates that a company cannot make profit distributions if the amount exceeds the company’s profits on the day of distribution. This is an absolute rule to prevent the undue outflow of company assets and to protect the company’s creditors. The company has both the right and the obligation to refuse any distribution requests that violate this regulation.

If a company makes a distribution (illegal distribution) in violation of these capital maintenance regulations, the responsibility is significant. According to Article 629, Paragraph 1 of the Japanese Companies Act, the members who executed the business related to that distribution are jointly and severally liable to pay the company an amount equivalent to the distribution. Managing members cannot escape this liability unless they prove that they did not neglect their duties in the performance of their tasks. As a general rule, the consent of all members is required to be exempt from this obligation, but this is limited to the amount of profits that existed at the time of distribution. Furthermore, the company’s creditors can directly demand payment from the members who received the illegal distribution. Thus, behind the flexibility of profit distribution lies the stringent responsibility for asset preservation imposed on both members and managers.

Specific Content of Rights to Participate in and Supervise Management (Common Benefit Rights) Under Japanese Law

Common benefit rights define the rights of members as owners of a company to engage in and supervise its management. In a joint-stock company, where ownership and management coincide, the design of these common benefit rights is fundamental to governance.

Rights to Execute Business and Representation

Japanese Corporate Law structures the execution of business and representation in a joint-stock company by first establishing principles and then allowing for customization through the articles of incorporation.

As a principle, under Article 590, Paragraph 1 of the Japanese Corporate Law, all members have the right to execute the company’s business (business execution rights). If there are multiple members, the company’s business is decided by a majority of the members unless otherwise provided in the articles of incorporation (Article 590, Paragraph 2). Furthermore, members who execute business also have the authority to represent the company, in principle (Japanese Corporate Law Articles 599, Paragraphs 1 and 2). This means that, unless otherwise specified, all members are business-executing members and also representative members.

However, having all members involved in management decision-making and external contractual actions can be inefficient or lead to unclear responsibilities. Therefore, Japanese Corporate Law allows for the concentration of authority through the articles of incorporation. Specific members can be designated as ‘business-executing members’ in the articles of incorporation. In this case, the business execution rights are limited to those designated members, and other members are excluded from management decision-making. Decisions regarding business are made by a majority of the business-executing members (Japanese Corporate Law Article 591, Paragraph 1).

Moreover, it is also possible to designate certain individuals among the business-executing members as ‘representative members’. When representative members are designated, the authority to legally represent the company is concentrated in those representative members, and other business-executing members are responsible only for internal business execution. Additionally, if a corporation is a member, it must appoint and register a ‘business executor’ as a natural person to conduct business.

Supervisory and Investigative Rights

Even members who do not have business execution rights, that is, investors who have stepped back from the front lines of management, retain important rights to protect their investment. This includes the right to investigate the company’s business and the state of its assets.

Article 592, Paragraph 1 of the Japanese Corporate Law clearly states that even members without the right to execute business can investigate the company’s business and assets. This is a very powerful authority to supervise the business execution of business-executing members and to check for misconduct or management errors.

In light of the importance of this investigative right, the law makes it difficult to easily deprive members of this right. Article 592, Paragraph 2 of the Japanese Corporate Law, while allowing the articles of incorporation to provide otherwise for this investigative right, stipulates with a proviso that “it is not possible to stipulate in the articles of incorporation that members are restricted from conducting an investigation pursuant to the provisions of the same paragraph at the end of the business year or when there is an important reason.” This means that even the articles of incorporation cannot deprive members of their minimum supervisory rights. This provision is a crucial safeguard that serves as the last bastion for minority members or investors who do not participate in management to protect their investment. In the case law discussed later, the infringement of this investigative right became a significant point of contention.

Comparing Rights Between a Japanese Joint Stock Corporation (KK) and a Limited Liability Company (LLC)

The distinctive rights of members in a Limited Liability Company (LLC) can be better understood by comparing them with the rights of shareholders in a Joint Stock Corporation (KK), the most common corporate form in Japan. The differences between the two stem from the fundamental relationship of ‘ownership and management’ .

A Joint Stock Corporation (KK) is based on the principle of ‘separation of ownership and management,’ where the shareholders, as investors, delegate management to directors who are experts in running the business. Shareholders’ rights are primarily consolidated in influencing management indirectly through exercising voting rights at the shareholders’ meeting and receiving dividends.

On the other hand, a Limited Liability Company (LLC) is based on the principle of ‘unity of ownership and management,’ where the investors, who are members, manage the company themselves. As a result, their rights are more direct and flexible. For example, profit distribution is not bound by investment ratios and can be freely determined in the articles of incorporation. Decision-making can also be done swiftly through mutual agreement among members, without the formal procedures of a shareholders’ meeting. The transfer of interest requires the consent of all other members, reflecting a closed structure that emphasizes personal trust relationships within the company .

Below is a table summarizing these key differences.

From this comparison, it is clear that a Limited Liability Company (LLC) is suitable for small-scale joint ventures aiming for flexible and swift management based on personal trust relationships, whereas a Joint Stock Corporation (KK) is suited for large-scale business operations that gather broad capital and separate ownership from management.

Employee Disputes and Court Precedents: Expulsion of Members in Japan

The flexibility and closed nature of a Japanese Limited Liability Company (LLC) can be a significant advantage while the trust among members is maintained. However, once that trust collapses, it can lead to serious stagnation and conflict in management. In such situations, the ultimate legal recourse is the expulsion of the problematic member from the company.

Article 859 of the Japanese Companies Act stipulates that a company can request the expulsion of a member through a lawsuit based on a majority resolution of the other members, in cases where the member has committed misconduct or a serious breach of duty, or other unavoidable circumstances. Two contrasting court cases provide important insights into how these “unavoidable circumstances” are interpreted.

Firstly, there is a case where a request for expulsion was not granted, as seen in the Tokyo District Court’s decision on July 3, 2019 (2019). In this case, within an LLC composed of a married couple, member A, the wife, sought the expulsion of Y, her husband and the representative member. A claimed that Y had forged her signature to create financial statements and had failed to comply with requests to inspect the accounting books. However, the court rejected the claim. The primary reason was that the company’s business was substantially dependent on Y’s activities alone, and expelling Y would significantly hinder the company’s continuity. The court acknowledged Y’s actions as problematic but ruled that the conflict between the spouses brought into the company did not make Y’s expulsion “unavoidable” for the company’s survival.

Secondly, there is a case where a request for expulsion was granted, as seen in the Tokyo District Court’s decision on November 29, 2021 (2021). This case also involved an LLC with two members, where one member (a corporate entity) had an executive who committed serious misconduct by misappropriating company funds for personal use. The other member requested the expulsion of the corporate member associated with the offending executive. The court granted this request. The decision stated that the misappropriation of funds clearly fell under “committing an act of dishonesty in executing business” as per Article 859, item 3 of the Companies Act, and fundamentally destroyed the trust between members. In this case, the severity of the misconduct outweighed the impact of expulsion on the business, and it was deemed unavoidable to expel the member who committed the wrongdoing for the healthy continuation of the company.

These two cases demonstrate that in deciding on expulsion, courts consider not only the formal illegality of the act but also the substantive elements, such as the impact on the company’s business continuity and the extent to which the act has destroyed the trust between members. There is a clear distinction between serious misconduct that threatens the company’s existence, such as embezzlement, and issues like management disagreements or failure to exercise supervisory authority. This highlights the limited circumstances under which expulsion can be used as a last resort for members and suggests the importance of resolving disputes through established procedures and negotiations set out in the articles of incorporation before conflicts escalate.

Summary

In this article, we have comprehensively explained the rights of members in a Japanese LLC (Godo Kaisha) from the perspectives of individual and collective interests. The greatest appeal of a Japanese LLC lies in the operational flexibility supported by the principle of statutory autonomy. From the method of profit distribution to the design of the management structure, members can freely design the company’s form based on their own agreement. However, this freedom is not unlimited. The law sets important frameworks to maintain the company’s integrity, such as strict capital regulations for creditor protection and the guarantee of supervisory rights over executive managers. As court cases indicate, legal resolution can be challenging when the trust relationship among members collapses, thus the most crucial risk management is to create a clear and detailed articles of incorporation that all members agree upon at the start of the business. It should concretely include each member’s rights and obligations, the decision-making process, and methods for resolving potential future disputes.

Monolith Law Office has a proven track record of providing a wealth of legal services to a wide range of clients, both domestic and international, from the establishment and operation of LLCs to dispute resolution. Our firm boasts a team of professionals, including English-speaking experts with both Japanese attorney qualifications and foreign legal qualifications, who support the construction of the most suitable governance structures for our clients’ businesses from an international perspective. If you require specialized advice on complex issues related to the rights of members as discussed in this article, please do not hesitate to consult with our firm.