Understanding Family Governance: What Business Owners Should Build to Prevent Asset and Business Succession Troubles

In the corporate world, asset succession and business continuity are unavoidable challenges. The selection of successors, division of property, and transfer of management rights are complex issues that can lead to family disputes and corporate turmoil.

This article provides insights into resolving these issues through the implementation of family governance, ensuring the sustainable growth of the company. It also offers detailed guidance on what business owners should consider when drafting a will.

The Significance of Building Family Governance Rules for Asset and Business Succession by Executives

In constructing family governance, we will explain the significance of executives planning for asset succession and business succession, as well as the importance of wills.

The Importance of Asset Succession and Business Succession for Executives

If executives wish to ensure that their business continues to operate smoothly even in the event of unforeseen circumstances, it is essential to prepare for potential troubles in asset succession and business succession in advance.

Executives often face the following situations in asset and business succession:

To avoid the loss of assets and confusion among stakeholders, it is necessary to prepare for a smooth transition of company management and to continue stable operations.

Related article: What Should Executives Design in Family Governance? Detailed Explanation of Construction and Operation Management Methods[ja]

The Necessity of Creating a Will

To solve issues related to asset succession and business succession, creating a will is indispensable. Without a will, the estate is inherited by the statutory heirs in accordance with their legal inheritance shares. Inheritances without a will require estate division negotiations, which often become a source of conflict.

Executives possess various assets, such as real estate and stocks. If even one person opposes the valuation or division method of each asset, it can lead to legal disputes.

Deepening conflicts through disputes can have a significant negative impact on smooth business operations and asset protection, making it crucial to determine the contents of the inheritance in advance through a will.

Necessary Measures When Creating a Will

As mentioned above, creating a will is essential for executives. However, appropriate estate management cannot be expected by merely creating a will; additional measures are also required.

This is because there is a possibility of disputes arising from opposition to the contents of the will.

If there are grievances about the business successor or factional disputes, situations may arise where the dispute is fueled by claims of infringement of the reserved portion or by challenging the validity of the will. Considering measures against claims for the reserved portion infringement and will invalidity disputes, as explained later, is indispensable.

Furthermore, if tax arrangements are denied during a tax audit, you may have to contend with tax authorities, and the succession of assets or business may not be realized as planned.

It is also important to share knowledge so that heirs are prepared to deal with disputes if they arise.

The Importance of Addressing Inheritance Share Infringement in Asset and Business Succession

When business owners, whose assets include company shares, draft a will, the issue of “inheritance share infringement” often arises. Here, we will explain the concept of inheritance share infringement and the importance of taking measures against it during asset and business succession for business owners.

What is Inheritance Share Infringement?

The “inheritance share” refers to a portion of the decedent’s estate that is legally reserved for certain heirs and cannot be freely disposed of by the testator. Conversely, the portion that the testator can dispose of without restriction is called the “disposable share.”

Inheritance share infringement occurs when the testator disposes of more than the disposable share, resulting in the heirs receiving less than their reserved inheritance share.

A will that infringes on the inheritance share is not invalid. However, if an heir’s inheritance share is infringed upon, they can claim the equivalent amount of the infringement from the recipient of any gifts or bequests made by the decedent (in this article, the business owner). This claim is known as an “inheritance share infringement claim.”

Why Business Owners Should Take Measures Against Inheritance Share Infringement Issues

When an inheritance share infringement claim arises, it can disrupt the smooth transition of business succession, necessitating the consideration of countermeasures.

Business owners often have a significant portion of their assets in company shares, and to facilitate smooth business succession, they may concentrate the management of these shares in the hands of a specific successor. This can create an imbalance between the successor and other heirs, potentially leading to disputes over the inheritance share infringement amount.

Furthermore, there are cases where the successor, who has been claimed against for the inheritance share infringement amount, may have to sell the inherited shares to a third party to pay the equivalent amount. This could result in an unexpected third party becoming involved in the business, potentially leading to the collapse of the designed family governance.

To avoid disputes arising from inheritance share infringement, it is crucial to forecast potential issues and consider dispute avoidance before drafting a will.

Points to Consider When Planning Countermeasures

When considering measures against inheritance share infringement claims, it is important to be mindful of the purpose of the inheritance share system. The significance of the inheritance share system is to protect a certain expectation of the heirs regarding the estate, such as ensuring their livelihood. It serves to maintain fairness among heirs and protect the rights of statutory heirs in case of an unjust will.

Measures that ignore this premise are not in line with current law and are meaningless. To implement effective measures, it is essential to fully respect the content and significance of the current legal inheritance share system.

Key Points to Know When Considering Measures Against Infringement of the Reserved Portion of an Inheritance

When considering measures against the infringement of the reserved portion of an inheritance, it is crucial to foresee whether the succession plan may infringe upon the reserved portion and to what extent the infringement might occur.

Here, we will explain the key points you should know when considering measures against infringement of the reserved portion.

Method for Calculating the Amount of Infringement of the Reserved Portion

The amount of infringement of the reserved portion is calculated using the following formula:

In this calculation process, the “Amount of property serving as the basis for calculating the reserved portion” is a particularly contentious item. This refers to the total value of the property owned by the decedent at the time of inheritance commencement and the value of gifted property, minus the total amount of debt.

The reasons why the “Amount of property serving as the basis for calculating the reserved portion” is often disputed include the following:

• It is difficult to accurately assess the fair market value of the property
• Interpretations often differ regarding the scope and value of gifts with reservation of ownership

Reservation of ownership refers to the rule that gifts made close to the time of inheritance commencement are considered part of the decedent’s estate for inheritance purposes.

We will explain in detail the disputes regarding reservation of ownership below.

Disputes Over Whether a Gift Qualifies as a Special Benefit

In the case of gifts to heirs, only those considered “special benefits” are included in the amount of property serving as the basis for calculating the reserved portion. Therefore, determining whether the nature of the gift qualifies as a special benefit is extremely important.

The following are examples of gifts that can be considered special benefit property:

• Gifts made for marriage
• Gifts made for adoption
• Gifts made as capital for living expenses

Gifts made as capital for living expenses refer to property transfers that broadly serve as the foundation for living, such as start-up funds or a residence.

However, it is important to understand that what is recognized as a special benefit is judged based on individual circumstances.

Disputes Over Whether the Gift Was Made Within the Specified Period

The inclusion of gifts in the amount of property serving as the basis for calculating the reserved portion depends on when the gift was made.

This is because, according to the provisions of the Japanese Civil Code, gifts to non-heirs made within one year of the commencement of inheritance and special benefits to heirs made within ten years prior to the commencement of inheritance are subject to reservation of ownership.

The criterion for judging the timing of the gift is the date of the gift contract. The timing of the fulfillment of the gift is irrelevant, so be careful.

Additionally, as an exception, when both parties to the gift knew that it would harm the reserved portion beneficiary, there is no time limit. When determining the scope of reservation of ownership, it is necessary to judge both the timing of the gift and whether the parties knew it would lead to infringement of the reserved portion.

Disputes Over the Valuation of the Gift Amount

The value of the gift subject to reservation of ownership is assessed at the value at the time of inheritance commencement. This means that even if the property received by the beneficiary is destroyed or its value has increased or decreased, it is evaluated as if it were still in its original state at the time of inheritance commencement.

However, when the destroyed property is non-listed shares or similar assets, valuation at the time of inheritance can be difficult, and the views of both parties often clash. Since the valuation at the time of inheritance is only known at that moment, understand that it is also difficult to have a detailed forecast at the time of writing the will.

Handling Claims for Infringement of the Reserved Portion of an Inheritance

To address claims for infringement of the reserved portion of an inheritance, consider the following steps:

1. Inheritance and gifts of property other than shares
2. Renunciation of the reserved portion
3. Utilizing fixed agreements and exclusion agreements under the Japanese Act on Facilitation of Succession of Family Business (平成23年(2011年))

In addition, the following measures are also effective:

• Considering lifetime gifts
• Considering compensated transfers
• Utilizing life insurance
• Utilizing death severance payments
• Utilizing codicils to wills

We will explain each of these in detail.

Inheritance and Gifts of Assets Other Than Stocks

The fundamental approach to addressing claims for infringement of the reserved portion is to create a will that prevents the infringement of the reserved portion from occurring in the first place.

For example, one could consider inheriting or gifting assets other than stocks to other beneficiaries entitled to the reserved portion.

However, it is essential to consider the possibility of fluctuating valuations of the estate. If the value of stocks increases after the will is created, an unexpected reserved portion may arise at the start of the inheritance.

If you wish to create a will that does not result in the infringement of the reserved portion, it is necessary to predict the valuation of the assets that will serve as the basis for calculating the future reserved portion.

Negotiating the Renunciation of Statutory Reserve

In cases where infringement of the statutory reserve is unavoidable, negotiating the renunciation of the statutory reserve is one of the possible solutions. However, negotiations for renunciation are conducted after the death of the testator. Since the parties involved are often in a conflict of interest situation, the process can be challenging.

Furthermore, it is possible to renounce the statutory reserve before the commencement of inheritance. To obtain approval from the family court for a pre-renunciation, the following requirements must be met:

• The statutory reserve beneficiary must renounce freely and of their own will.
• There must be objective rationality based on the philosophy of the Japanese Inheritance Law.

Since there is no apparent benefit for the statutory reserve beneficiaries, it may be difficult to gain their active cooperation. However, pre-renunciation is often initiated by family governance or company executives, making it relatively accessible and a measure that should be actively considered.

Understanding ‘Fixed Agreement’ and ‘Exclusion Agreement’ under the Japanese Act on Facilitation of Transfer of Business of Small and Medium-sized Enterprises (SMEs) (2023)

If there is no consent to renounce a compulsory portion of inheritance, consider utilizing the ‘Fixed Agreement’ and ‘Exclusion Agreement’ under the Japanese Act on Facilitation of Transfer of Business of Small and Medium-sized Enterprises (SMEs) (2023).

By entering into an Exclusion Agreement, the agreed-upon shares will no longer be subject to claims for infringement of the compulsory portion.

Furthermore, a Fixed Agreement sets the valuation of the agreed-upon shares at the time of the agreement, meaning that any subsequent increase in value will not be considered in claims for infringement of the compulsory portion.

Even if the value of the shares increases by the time of the inheritance, the amount of the compulsory portion for non-successors will not increase, thus eliminating disputes over valuation methods, which is a significant advantage.

Note that both Exclusion Agreement and Fixed Agreement can be used in conjunction. They allow for flexible responses, but as they require the agreement of the successor and all presumptive heirs, they can also be a burdensome approach.

Lifetime Gift of Company Shares

Gifting company shares during one’s lifetime, within the scope that is not included in the calculation of the statutory reserve, is one approach to address potential infringement of the statutory reserve.

When considering lifetime gifts, it is essential to implement them systematically, taking into account the following:

• The scope of assets subject to clawback for the calculation of the statutory reserve infringement claim
• The order of gifts and bequests that may lead to statutory reserve infringement claims

While meticulous preparation is necessary, it is an effective method for those who wish to proceed with asset succession as planned.

Attention to Consideration in Paid Transfers

Implementing inheritance tax measures by transferring assets expected to appreciate in value during one’s lifetime for a consideration is a common strategy. Such paid transfers can also be effective as a measure against compulsory portion claims.

This is because only the value of assets gifted without consideration is included in the calculation of the compulsory portion infringement amount; therefore, assets transferred for a consideration do not affect the compulsory portion.

However, if the consideration at the time of transfer is not deemed fair market value, it may be subject to a claim for recovery. Hence, it is necessary to verify and organize the fairness of the consideration.

Use Life Insurance with Caution

Utilizing life insurance is one strategy for addressing issues related to compulsory heirship rights. Life insurance proceeds are not included as special benefits in the calculation of compulsory heirship portions. Furthermore, life insurance can be used to prepare funds sufficient to meet claims for infringement of compulsory heirship amounts.

However, life insurance proceeds may exceptionally become subject to compulsory heirship rights under certain circumstances, so it is not a foolproof measure.

After all, life insurance proceeds play a vital role in securing the financial stability of families, among other things. Therefore, when considering using life insurance for compulsory heirship strategies, it is essential to proceed with caution.

The Feasibility of Utilizing Death Severance Pay

Death severance pay can be utilized as a measure against compulsory heirship rights. If death severance pay is considered part of the inheritance, it naturally falls within the assets used to calculate the compulsory heirship portion. Therefore, whether death severance pay is part of the inheritance is a critical issue.

However, the treatment of death severance pay varies depending on individual circumstances, so it cannot be said to be a foolproof strategy against compulsory heirship rights. Additionally, just like life insurance payouts, the role of death severance pay as a vital means of family financial security should also be taken into account when considering its use.

Conveying Intentions through Codicils in Wills

A codicil in a will is a section that details the background and nuances of the will’s content, conveying the testator’s intentions to the beneficiaries. By ensuring that the heirs entitled to a reserved portion understand the will’s intent, it is expected that this will foster understanding and cooperation.

While codicils do not have legal binding force and only have de facto effectiveness, they can be quite impactful if family governance is functioning effectively.

By clearly organizing and explaining the details of lifetime gifts and the valuation of assets from the testator’s perspective, it may be possible to prevent the escalation of disputes.

Measures to Take When Drafting a Will to Address Disputes Over Its Validity

When business owners draft a will, they must consider measures to prevent disputes over the will’s validity, in addition to strategies for dealing with claims for infringement of the reserved portion.

The Importance of Addressing Will Invalidity Claims

A will invalidity claim is a legal challenge to the effectiveness of a will. There are numerous reasons why a will may be declared invalid, including but not limited to:

• Lack of testamentary capacity
• Non-compliance with statutory will requirements
• Mistake, fraud, or violation of public policy
• Revocation of the will
• Uncertainty of the will’s content
• Violation of the prohibition against joint wills

If a will is confirmed invalid, the estate will be divided as if no will had existed, which can lead to further disputes. Therefore, taking measures to prevent disputes over will validity is crucial.

We will now explain some of the most common and noteworthy causes of will invalidity and the corresponding measures to take.

Lack of Testamentary Capacity as a Cause of Invalidity and Countermeasures

A will made by a person lacking testamentary capacity is not effective. Under the Civil Code, testamentary capacity is granted to those over the age of 15, but the capacity of elderly individuals, especially those with dementia, is often contested.

There is no clear standard for determining testamentary capacity; it is judged from various perspectives, including psychiatric viewpoints, the content of the will, and other circumstances. To ensure testamentary capacity is recognized, it is advisable to draft a will early on.

Since a will can be rewritten any number of times, it is wise to prepare one early to be ready for sudden illness or accidents. If you are already of advanced age, it is necessary to undergo medical examinations to document that your memory and judgment are intact, thereby dispelling any doubts about your testamentary capacity.

Lack of Autograph in Holographic Wills as a Cause of Invalidity and Countermeasures

When creating a holographic will, the requirement of autograph, meaning the will must be handwritten by the testator, is essential. This is because a will in the testator’s handwriting is considered to reflect their true intentions.

If a person is unable to hold a writing instrument due to weak grip strength, their autograph ability is considered absent, and the will’s validity is not recognized. As a testator, it is preferable to use a notarized will whenever possible.

Lack of Oral Declaration in Notarized Wills as a Cause of Invalidity and Countermeasures

In the creation of a notarized will, except for individuals who are unable to speak or hear, it is necessary for the testator to make an oral declaration directly to the notary.

Some individuals may pretend to understand and respond while trying to conceal cognitive impairment, so the validation of oral declarations is strictly enforced. If the oral declaration is not deemed to have been effectively made, the will is invalid. Testators should create a notarized will while they are still able to articulate their wishes for the succession of their business and assets.

Summary: Business Owners Should Consult Lawyers for Asset and Business Succession

If business owners wish to protect their assets after their death and ensure the smooth operation of their companies, it is essential to proactively address potential troubles in asset and business succession. Proper estate management, which anticipates appropriate inheritance procedures, requires more than just drafting a will. It also necessitates measures that take into account disputes related to infringement of reserved portions of the estate or the confirmation of the invalidity of a will.

To implement effective dispute resolution strategies, one must accurately understand and organize their assets and the situation of stakeholders, based on the law and past court precedents. Therefore, when creating a will and arranging for asset and business succession, it is advisable to seek professional advice from a lawyer. By engaging a lawyer, you can correctly understand the inheritance system and establish regulations that are suitable for your specific needs.

Guidance on Measures by Our Firm

Monolith Law Office is a law firm with high expertise in both IT, particularly the internet, and legal matters. In advancing family governance, there are times when it becomes necessary to create contracts. Our firm provides contract creation and review services for a wide range of cases, from Japanese Tokyo Stock Exchange Prime-listed companies to venture businesses. If you are having trouble with contracts, please refer to the article below.

Areas of practice at Monolith Law Office: Contract Creation & Review, etc.[ja]