Legal Affairs of Silent Partnerships in Japanese Commercial Law: An In-Depth Explanation of Structure, Liability Scope, and Loss Management

One of the business structures defined under Japanese Commercial Law is the “silent partnership” (tokumei kumiai). This system is based on a contractual relationship between investors who provide capital for a specific business and operators who carry out the business using that capital. The most notable feature of a silent partnership is that the investors, known as silent partners, remain anonymous to external third parties, and their liability is limited to the amount of their investment. Due to its flexibility and confidentiality, silent partnerships are utilized in various project financing fields, such as real estate investment, funding for film and content production, and venture capital funds. However, the legal nature of a silent partnership fundamentally differs from that of corporations with legal personality, like stock companies. A silent partnership is a pure contractual relationship without legal personality. This fact has significant implications for the rights and obligations between parties, the attribution of property, and the sharing of risks in the event of business failure. In this article, we will provide a detailed explanation from a professional perspective on the legal framework of silent partnership contracts under Japanese Commercial Law, the legal relations between parties, the scope of liability for silent partners, and specifically, the handling of losses arising from the business, based on the provisions of Japanese Commercial Law and case law.

The Legal Framework and Parties of a Tokumei Kumiai Agreement Under Japanese Law

The basic structure of a Tokumei Kumiai (TK) agreement is defined under Article 535 of the Japanese Commercial Code. According to this article, a TK agreement is established when “one party contributes to the business of the other party and agrees to share the profits arising from that business.” This contract consists of two parties with distinct roles.

One party is the “operator.” The operator manages all aspects of the business under their own name. This includes entering into contracts related to the business, managing assets, and assuming liabilities—all external activities are conducted solely by the operator. The operator can be either an individual or a corporation.

The other party is the “silent partner.” The silent partner acts as an investor in the business. While they contribute money or other assets to the operator, they do not directly participate in the management of the business nor do they have the authority to transact with third parties on behalf of the operator. As the name suggests, the existence of the silent partner is, in principle, not disclosed to third parties.

An extremely important point here is the legal attribution of the contributions made by the silent partner. Article 536, Paragraph 1 of the Japanese Commercial Code clearly stipulates that “the contributions of the silent partner belong to the property of the operator.” This means that the ownership of the contributed money or assets is completely transferred to the operator. This provision has a direct impact on the status of the silent partner in the event of the operator’s bankruptcy, which will be discussed later.

Unlike a civil law partnership, where multiple parties jointly conduct a business, or a joint-stock company formed by shareholders, a TK agreement is strictly a bilateral contract between the operator and the silent partner. This structure does not require collective decision-making bodies like a partnership meeting or a shareholders’ meeting, thus enhancing operational flexibility while concentrating authority and responsibility for the conduct of the business on the operator. Therefore, for the silent partner, the success of their investment depends entirely on the operator’s management skills and integrity, making due diligence on the operator essential before entering into the contract.

Legal Relationships in Business Operations and Among Parties Under Japanese Law

In a Japanese silent partnership (tokumei kumiai), legal relationships are clearly distinguished between the operator and third parties, known as “external relations,” and between the operator and silent partners, known as “internal relations.”

In external relations, only the operator is the subject of rights and obligations. All assets and liabilities arising from business activities are legally treated as those of the individual operator or the corporate entity that is the operator. Therefore, third parties such as business transaction counterparts can only assert contractual rights or demand the fulfillment of obligations against the operator. Silent partners bear no direct rights or obligations towards third parties.

On the other hand, the internal relations between the operator and silent partners are governed by the content of the silent partnership agreement and the provisions of the Japanese Commercial Code. The main rights of silent partners exist as contractual rights, with the core being the “right to demand profit distribution” according to the ratio stipulated in the contract.

Additionally, silent partners are granted significant rights to oversee the business’s financial status. According to Article 539, Paragraph 1 of the Japanese Commercial Code, silent partners have the right to inspect the operator’s balance sheet at the end of each business year and examine the status of the business and its assets. Furthermore, Paragraph 2 of the same article stipulates that, “in the event of significant cause,” they may inspect the status of the business and its assets at any time with the court’s permission, ensuring a means of supervision in cases where the operator’s misconduct is suspected.

The provisions related to silent partnerships set forth in the Japanese Commercial Code provide only a basic framework. For instance, the specific method of calculating profits, the timing and frequency of distributions, the financial standards the operator must adhere to, or the scope of significant business execution that cannot be conducted without the consent of silent partners are not defined by law. These matters are all determined by the silent partnership agreement between the parties. This point is both a source of flexibility for the silent partnership and a potential risk factor for investors. If the contract is inadequate, silent partners may only rely on the minimal protection provided by the Commercial Code, such as the annual right of inspection. Therefore, experienced investors seek to conclude comprehensive and robust silent partnership agreements that include detailed reporting obligations, clear profit calculation standards, and veto rights over certain significant matters.

The Scope of Liability for Silent Partners in Japan: Limited Liability and Its Exceptions

One of the attractive features of silent partnerships for investors in Japan is the limited liability they offer. As mentioned earlier, silent partners do not bear direct responsibility to third parties. Furthermore, within the internal relationship with the operator, their liability is, in principle, limited to the value of the assets they have contributed. This is referred to as “limited liability.” Article 536, Paragraph 1 of the Japanese Commercial Code stipulates that silent partners are not liable to third parties for the debts of the operator, providing the legal basis for limited liability. The greatest financial risk silent partners face is the loss of their contributed principal.

However, there are significant exceptions to this principle of limited liability. If a silent partner acts in a way that relinquishes their “anonymity,” they lose this protection. Article 537 of the Japanese Commercial Code specifically outlines this exception. If a silent partner allows their personal name or trade name to be used in the operator’s trade name, or consents to the use of their trade name as the operator’s trade name, they become jointly and severally liable for the debts incurred after such use.

This provision is not merely a matter of formal name usage. It is about determining liability based on the impression a silent partner’s actions give to third parties. By allowing their name to be used in the business, it creates the appearance to third parties that the individual is a joint operator. The law imposes liability in accordance with such misleading appearances created by the individual.

Therefore, the limited liability in a silent partnership is not an immutable right automatically guaranteed by legal formality, but rather a privilege granted on the condition that the silent partner maintains strict anonymity and passivity towards the outside world. This presents an important point of practical risk management for silent partners. For instance, if a silent partner or their agent directly participates in contract negotiations with third parties, if their name appears in marketing materials for the business, or if their own brand is advertised as being associated with the operator’s business, they may inadvertently incur unlimited liability. To enjoy the greatest advantage of a silent partnership—limited liability—silent partners must exercise meticulous care in their external actions.

Distribution of Profits and Losses and Handling of Excess Losses Under Japanese Law

In a silent partnership agreement in Japan, the method of distributing profits derived from the business can be freely determined by the contract between the parties. The law does not enforce specific distribution rates or formulas.

On the other hand, when it comes to bearing losses, Japanese Commercial Law sets clear principles. Article 536, Paragraph 2 of the Japanese Commercial Law states, “No distribution of profits can be claimed until the losses have been compensated for, even if the contribution has been reduced by the losses.” This means that silent partners are not obligated to bear losses beyond their initial contributions, even if the losses exceed the amount of their contributions. There is no legal obligation to provide additional funds to cover losses that exceed the initial contribution, and there is also no obligation to return previously received profit distributions.

This point is very important for understanding the fundamental risk structure of a silent partnership. The default legal rule is that the silent partner’s obligation to bear losses is limited to the amount of their contribution.

However, this rule can also be modified by a contract between the parties. Since the principle of private autonomy is widely applied to silent partnership agreements, the operator and the silent partners can agree to include provisions that allow silent partners to bear a certain range of excess losses (losses exceeding the contribution). Such clauses may be included to mitigate the risk on the operator’s side. Therefore, investors need to carefully examine the clauses related to the burden of losses when entering into a silent partnership agreement. It is essential to check whether the agreement includes any clauses imposing additional contribution obligations to accurately grasp the investment’s risk profile. Recognizing the difference between the legal default rules and the contractual agreements is of utmost importance.

Termination and Liquidation of a Silent Partnership Agreement Under Japanese Law

A silent partnership agreement in Japan can be terminated for various reasons. Article 540 of the Japanese Commercial Code refers to the provisions of the Japanese Civil Code regarding the termination of a partnership. The main reasons for termination are as follows:

• Expiration of the agreed duration of the partnership
• Achievement of the business purpose or impossibility of its achievement
• Mutual agreement to dissolve the partnership
• Death of a party or commencement of bankruptcy proceedings against a party
• Cessation or alteration of the operator’s business

Particularly important, Article 541 of the Japanese Commercial Code stipulates that “when the operator is subject to the commencement of bankruptcy proceedings, the silent partnership agreement shall be terminated.”

Upon termination of the agreement, liquidation procedures commence. According to Article 542 of the Japanese Commercial Code, the operator has an obligation to return the value of the contributions to the silent partners. However, if the contributions have already decreased due to losses, only the remaining amount needs to be returned. Even if the operator’s assets are insufficient to return the value of the contributions, silent partners cannot claim more than the shortfall unless there is fault on the part of the operator.

Regarding the nature of the right to claim the return of contributions, there is an important Japanese legal precedent. The Supreme Court decision on January 26, 1973 (1973), ruled that the right of a silent partner to claim the return of contributions upon termination of a silent partnership agreement is not a right to demand the return of the specific property contributed, but a “monetary claim” for the payment of an amount equivalent to the value of the contribution.

Considering this precedent and the legal provisions together, the greatest risk in a silent partnership becomes clear: the credit risk of the operator. As mentioned earlier, the contributions of silent partners become the property of the operator, and the right to claim their return at the end of the contract is a monetary claim. If the operator goes bankrupt, the silent partnership agreement is terminated, and the silent partners’ right to claim the return of their contributions is treated as an unsecured “general bankruptcy claim,” on par with other general creditors of the operator (for example, financial institutions or business partners). This means that silent partners must participate in the bankruptcy estate distribution procedures and can only recover their investment funds at the same rate as other general creditors. In many cases, the amount recoverable is significantly less than the initial investment. This is fundamentally different from shareholders of a corporation, whose personal assets are managed separately from the company’s assets, and represents a structural risk that must be understood when considering an investment in a silent partnership.

Comparing the Silent Partnership with Other Business Forms in Japan

To better understand the legal personalityistics of a silent partnership, let’s compare it with other major business forms in Japan, such as the “Civil Code Partnership” and the “Joint Stock Company (Kabushiki Kaisha).”

A Civil Code Partnership is established based on a contract, similar to a silent partnership, but the contributed assets become the “joint property” of all partners, and the business is generally operated by all members. The most significant difference is that the partners have unlimited liability.

A Joint Stock Company is a corporation established under the Japanese Companies Act, and it becomes the subject of rights and obligations. Shareholders have limited liability, which is capped at the value of the shares they hold. The company’s assets are clearly separated from the personal assets of the shareholders, and shareholders are not directly responsible for the company’s debts.

These differences significantly affect the way a business is operated, the location of risks, and the manner in which investors are protected. A silent partnership can be an effective option for those who want to avoid the strict legal regulations and operational costs associated with a Joint Stock Company, as well as the unlimited liability of a Civil Code Partnership. However, it also has the personalityistic that the assets belong to the operator, and the investor’s supervisory authority largely depends on the contract.

Conclusion

The silent partnership is an investment scheme provided by Japanese Commercial Law that offers high flexibility and is particularly effective for specific purposes. For investors, it presents two significant advantages: anonymity and limited liability. However, its legal structure is unique and encompasses inherent risks. Since the contributed assets become the property of the operator, the operator’s credit risk directly affects the safety of the investment. Additionally, the protection of silent partners largely depends on the content of the silent partnership agreement concluded between the parties, in addition to the minimum provisions of the law. Therefore, when utilizing a silent partnership, a deep understanding of its legal nature and meticulous contract design to manage risks appropriately are essential.

Monolith Law Office has a wealth of experience in providing legal services related to Japanese Commercial Law, including silent partnership agreements, to a multitude of clients both domestically and internationally. We are capable of comprehensive support, from the formation of silent partnership schemes in various industries to the due diligence of operators and resolution of disputes. Our firm also employs several English-speaking attorneys with foreign legal qualifications, ensuring that clients engaged in international business can smoothly utilize the Japanese legal system with our full support.