Shareholder Returns in Japanese Corporate Law: Legal Regulations on Dividend Distribution of Surplus Funds and Treasury Stock Acquisition

Returning profits generated from business activities to shareholders, the owners of a corporation, is one of the fundamental activities in corporate management. This profit distribution to shareholders is commonly known as “dividends,” and under Japanese Corporate Law, there is a strict legal framework in place regarding the distribution of assets to shareholders. The purpose of this framework is to balance the protection of shareholder interests with another critical demand: safeguarding the rights of the company’s creditors.

The main methods of distribution to shareholders as defined by Japanese Corporate Law can be broadly classified into two categories. The first is the “distribution of surplus funds,” which corresponds to the payment of dividends as commonly understood. The second is the “acquisition of treasury shares for consideration,” where the company repurchases its own shares from shareholders, known as share buybacks. While these two methods differ in form, they share the economic reality of transferring company assets to shareholders. Therefore, Japanese Corporate Law places both under a unified regulatory framework.

At the heart of this regulation is the concept of “distributable amount,” which sets an upper limit on the total amount of assets that a company can distribute to its shareholders. This acts as a breakwater to prevent excessive outflow of company assets. Any distribution that violates this regulation is considered an “illegal dividend,” and the directors involved in the distribution, as well as the shareholders who received it, may incur significant legal liabilities.

In this article, we will first explain the specific procedures for “distribution of surplus funds” and “acquisition of treasury shares for consideration” as defined by Japanese Corporate Law. Next, we will clarify the objectives and fundamental principles behind the “distributable amount” regulation that governs these distribution acts. Finally, we will analyze in detail the legal liabilities that arise in the event of a violation of this regulation, incorporating recent court cases as well.

Key Methods of Distributing Profits to Shareholders Under Japanese Corporate Law

The Japanese Companies Act clearly defines the procedures for returning profits to shareholders. While it generally emphasizes the decision-making of the entire body of shareholders, it also provides exceptions that allow for more agile management decisions for companies that meet specific requirements.

Dividends from Surplus Funds Under Japanese Corporate Law

Distributing dividends from surplus funds is the most fundamental method for a company to allocate its accumulated profits to shareholders. Article 453 of the Japanese Companies Act stipulates that a stock company may distribute dividends from surplus funds to its shareholders, excluding the company itself when it holds its own shares.  

The principal procedure for implementing this distribution is a resolution at the shareholders’ meeting. According to Article 454, Paragraph 1 of the Japanese Companies Act, when a company intends to distribute dividends from surplus funds, it must determine the following matters by a resolution at the shareholders’ meeting each time:  

1. The type of dividend assets (cash or other assets) and the total book value thereof. However, the company cannot distribute its own shares as dividends.  
2. Details regarding the allocation of dividend assets to shareholders. This usually means distribution in proportion to the number of shares each shareholder holds.  
3. The date on which the dividend from the surplus funds becomes effective.  

This shareholders’ meeting resolution is typically passed by a “simple resolution,” which requires a majority of votes in favor.  

However, the law does not always require a shareholders’ meeting resolution. To enable more rapid distribution, under certain conditions, the decision-making authority can be delegated to the board of directors. For example, companies with a board of directors (companies with a board of directors system) can distribute dividends by a resolution of the board of directors once during the fiscal year, provided this is stipulated in the articles of incorporation. This is commonly referred to as an “interim dividend.”  

Furthermore, companies with more stringent governance structures, such as those with accounting auditors, can delegate the decision on dividends from surplus funds to the board of directors as a general rule, based on Article 459 of the Japanese Companies Act, by providing for it in the articles of incorporation. This provision is widely used, especially by listed companies, to execute dividend policies flexibly in response to changes in the business environment.  

Note that dividends can also be paid in assets other than cash (in-kind dividends). However, when distributing in-kind dividends without granting shareholders the right to demand payment in cash (cash distribution claim right), a “special resolution,” which has stricter approval requirements, is necessary at the shareholders’ meeting due to the significant impact on shareholders.  

Acquisition of Treasury Shares for Consideration Under Japanese Corporate Law

The acquisition of treasury shares for consideration, also known as share buybacks, is another important method of returning capital to shareholders. When a company acquires its own shares by paying compensation to shareholders, the transaction is economically similar to the distribution of surplus funds as dividends, as it involves the flow of funds from the company back to the shareholders.

This procedure generally involves a two-step approval process. First, under Article 156 of the Japanese Companies Act, a general resolution at the shareholders’ meeting sets the ‘framework’ for the acquisition of treasury shares. This resolution must specify the following:

1. The type and total number of shares that can be acquired.
2. The nature and total amount of consideration to be provided in exchange for the shares.
3. The period during which shares can be acquired (which cannot exceed one year).

This shareholders’ meeting resolution serves as a control mechanism by the shareholders to prevent unrestricted acquisition of treasury shares by the company’s management and to avoid unforeseen impacts on other shareholders. Within this approved framework, in companies with a board of directors, the board determines the specific conditions for each acquisition, such as timing and price. This ensures that all shareholders are provided with a fair opportunity to sell their shares.

Similar to the distribution of surplus funds as dividends, there are exceptions to the acquisition of treasury shares that allow for more efficient procedures. In particular, when listed companies acquire their own shares through the market, Article 165, Paragraph 2 of the Japanese Companies Act states that the acquisition of treasury shares can be decided solely by a board of directors’ resolution if the articles of incorporation provide for it. This provision enables the dynamic implementation of share buybacks without going through a shareholders’ meeting, responding to market conditions, and is widely adopted by many listed companies in Japan.

Regulations Governing the Distribution of Assets to Shareholders Under Japanese Corporate Law

After establishing the procedures for a company to distribute assets to shareholders, the next issue that arises is the quantitative limit of “how much can be distributed.” Japanese Corporate Law sets a strict financial regulation known as “distributable amount” to address this point.

The Purpose of Regulations on Distributable Amounts Under Japanese Corporate Law

The most crucial objective of the regulations on distributable amounts is to protect the creditors of a company. Under the Japanese corporate system, shareholders have ‘limited liability,’ which means they are only responsible up to the amount of their investment. Consequently, the only source of final repayment for the company’s debts is the property held by the company itself. If a company could distribute its property to shareholders without any restrictions, there would be a risk of depleting the company’s assets, leaving creditors unable to receive repayment.  

To prevent such situations, Article 461 of the Japanese Companies Act clearly stipulates that the total book value of acts that provide money or other assets to shareholders, such as the distribution of surplus funds or the paid acquisition of treasury shares, must not exceed the ‘distributable amount’ on the effective date of the act. This regulation is a fundamental rule that mandates the maintenance of company assets and protects the interests of creditors.  

The Principle of Distributable Amounts Under Japanese Corporate Law

The concept of the distributable amount refers to the portion of a company’s net assets that remains after excluding the legally required reserves, such as “capital stock” and “legal reserves,” which are essentially the “retained earnings.” Capital stock and legal reserves serve as the core assets of the company, functioning as security for creditors, and therefore, their distribution is generally not permitted.  

It is crucial to understand that the distributable amount is not a static figure determined once a year at the time of financial settlement. Japanese law bases the standard on the distributable amount on the “effective date” of the distribution act, which means it must be dynamically calculated each time a distribution is made. This calculation takes into account the most recent balance sheet at the end of the business year, as well as significant transactions that have occurred since then, such as the disposal of treasury shares or a decrease in capital stock. The complexity of this calculation can sometimes lead to regulatory violations in large corporations, as will be discussed later.  

Furthermore, Article 458 of the Japanese Companies Act sets an absolute minimum limit separate from the calculation of the distributable amount. No dividend from retained earnings can be made if it would result in the company’s net assets falling below 3 million yen. This requirement is in place to maintain the minimum financial foundation necessary for the company’s existence.  

Comparing Dividends from Surplus and Acquisition of Treasury Stock

As we have seen, both dividends from surplus and the paid acquisition of treasury stock are acts of returning capital to shareholders, and they are subject to the same financial resource regulation known as distributable amount. However, there are differences in the procedures and the impact on the company and shareholders. Dividends from surplus are uniformly distributed to all shareholders according to the number of shares held, whereas the acquisition of treasury stock involves individual transactions with shareholders who sell their shares, potentially affecting the stock price through a reduction in the number of shares in circulation and an increase in earnings per share (EPS).

Legal Liability for Regulatory Violations Under Japanese Corporate Law

When distributions to shareholders exceed the amount available for distribution, it is considered an “illegal dividend,” and Japanese Corporate Law imposes strict legal liabilities on the involved parties. The liability mechanism has a two-tier structure: first, to swiftly recover the company’s assets, and second, to fairly distribute the ultimate loss among the stakeholders.

Article 462 of the Japanese Corporate Law stipulates that in the event of an illegal dividend, the following parties are jointly and severally liable to the company for the payment of an amount equivalent to the entire distributed property (not just the excess portion):

1. Shareholders who received the illegal distribution
2. Business executives (such as directors) who performed duties related to the distribution
3. Directors who proposed the distribution resolution at the shareholders’ meeting or board of directors’ meeting

This “joint and several liability” means that the company can demand payment of the full amount from any of the above parties. This robust provision enables the company to quickly recover the outflowed assets.

However, there are degrees of responsibility among the parties. Business executives, such as directors, can be exempted from this payment obligation if they can prove that they were not negligent in performing their duties, meaning they were not at fault. On the other hand, the shareholders’ obligation to pay the company does not initially consider whether they knew the distribution was illegal (whether they acted in good or bad faith).

The second stage of liability is the right of recourse among the parties involved. For example, if a director who was at fault paid the full amount in response to the company’s claim, that director could demand (seek recourse) from the “malicious” shareholder who knew the distribution was illegal and received it, to pay the portion they received. However, Article 463 of the Japanese Corporate Law stipulates that no recourse can be taken against “innocent” shareholders who received the distribution without knowing it was illegal, thus protecting innocent shareholders.

The directors’ liability cannot be waived, even if all shareholders agree, for the portion that exceeds the distributable amount. This clearly indicates that the capital regulation is a mandatory law aimed not only at protecting the interests of shareholders but also creditors. The Supreme Court of Japan has long held that the acquisition of treasury shares in violation of capital regulations is invalid (Supreme Court decision on September 5, 1968).

The importance of these regulations is evident from recent cases. In 2022, Nidec Corporation, a major manufacturer, was found to have miscalculated the distributable amount, resulting in illegal interim dividends and the acquisition of treasury shares. This case demonstrates that the calculation of the distributable amount is extremely complex and that even large corporations and their auditors are at risk of overlooking it. In the past, the Olympus scandal involved illegal dividends based on inflated profits from massive accounting fraud, leading to the former management being ordered to pay substantial damages in a shareholder representative lawsuit (Tokyo District Court decision on April 27, 2017, etc.). Furthermore, courts tend to judge not only by form but also by substance, as seen in a case where excessive executive compensation paid to a director who was the sole shareholder was deemed an illegal dividend that effectively circumvented the regulation of distributable amounts (Tokyo District Court decision on July 14, 2022).

Summary

In this article, we have explained the methods of profit distribution to shareholders under Japanese Corporate Law, focusing on the primary methods of “dividend distribution of surplus” and “paid acquisition of treasury shares,” as well as the core regulation that permeates both: the “distributable amount” regulation. These systems are intricately designed to balance the important corporate mission of returning profits to shareholders with the societal demand to maintain the financial foundation of the company and protect creditors. The procedures generally respect the will of the shareholders while allowing for dynamic decision-making by the board of directors under certain conditions, and if the financial resource regulations are violated, both directors and shareholders are subject to severe legal liabilities. As recent cases in well-known companies have shown, compliance with these regulations is an extremely important issue in corporate management.

Monolith Law Office has a wealth of experience in advising a wide range of domestic and international clients on matters related to Japanese Corporate Law. We provide expert insights into the formulation of shareholder distribution methods, compliance with distributable amount regulations, and the construction and risk management of various transactions related to corporate law. Our firm includes several legal professionals who are qualified foreign attorneys and native English speakers, ensuring that our international clients can accurately understand and appropriately respond to Japan’s complex legal regulations. If you have any inquiries regarding the themes discussed in this article, please do not hesitate to contact our office.