Limitation of liability of director and auditor

Limitation of liability of director and auditor

Director’s liability in Japan

If you incorporate a company with your partner, your partner may hesitate to become director.

Because when he assumes director of the company, he will be liable for damages caused by the company.

So I would like to explain director’s liability in Japan.

Assumed that you are a representative director of the company and 100% shareholder and your partner will assume director.

When your company determines important matters, directors will determine it at meeting of directors.

Assumed that your company will borrow money from a bank. You and he make fake financial statement and submit it to bank and borrow money.

Or you make fake financial statement and submit it to meeting of directors. Then all directors agreed the content (your partner did not know that it was incorrect financial statement with gross negligence) and submitted it to bank and borrowed money.

After that your company does not repay the money. 

In this case, it is possible that the bank will file civil suit against your partner.
(If he loses the law suit, there is not limitation in his liability)

Even if you and your partner made agreement to limit his legal liability, he can not assert it toward the bank.

Because if he can limit his legal liability with such agreement, it should be disadvantage for the bank.

So he will purchase some kind of insurance. There is not other feasible option to limit his legal liability. 

Explanation below is legislation to limit his liability against shareholders of the company.

Contract for limitation of liability of director and auditor ( sekinin gentei keiyaku )

If a person is going to assume non executive director ( Hi gyomu sikko torishimariyaku = 非業務執行取締役 ), she can enter into contract with the company for limitation of liability ( Sekinin gentei keiyaku )

To be begin with, what is liability of directors ?

The relationship between a Stock Company and directors and accounting auditors is based on mandate ( Inin = 委任 ). 

So, directors and auditors ( = mandatary = Juninsha = 受任者 ) need to take care of their business with  a good manager

And they ( directors and auditors ) need to perform their duties for the Stock Company in a loyal manner

And moreover they need to Supervise the execution of the duties by other directors

If they neglect their duties, they are liable to such Stock Company for damages arising as a result of such negligence

If they are with knowledge or grossly negligent ( Jukashitsu = 重過失 ) in performing their duties, they are liable to a third party for damages

So, when she assumes director of her friend’s company, she will hesitate to do it.

In that case, she can reduce her liability by measures below (Only toward the company)

(1) In the case there is more than 2 directors and at least one Auditor, the company can provide that if directors performed their duties without knowledge nor grossly negligent ( Jukashitsu = 重過失),   they are exempted from liability

If there is such stipulation in the articles of incorporation, resolution made by majority of directors can such determine such exemption

( article 426 of company act = 会社法426条)

(2)  And there is another measure to limit her liability.

The stock company can provide in the articles of incorporation that the Stock Company may make contract with non executive Directors ( Higyomu sikko torishimariyaku = 非業務執行取締役 ), accounting auditors ( KANSA YAKU )

In this contract it is provided that liability of Directors and accounting auditor ( who performed their duties without knowledge nor grossly negligence ) shall be limited to either an amount specified by the Stock Company in advance within the limit of the amount provided for in the articles of incorporation, or the Minimum Liability Amount that is provided by company act ( = SAITEI SEKININ GENDOGAKU =最低責任限度額), whichever is higher.

Well, I know it is not easy to understand this sentence.

So, I will explain again.

1   In the case she is non executive director or auditor and has liability of negligence.

2  At the time of her negligence, she was without knowledge nor grossly negligence aso for her negligence
   ( 善意・無重過失 )

For example

She ( One of director, but non executive director ) and other directors of the company decided that the company would lend 100 million yen to XX company without collateral

When they made the decision, she did not know financial situation of XX company.

And the XX company went bankruptcy and it could not repay 100 million yen to her company.

She did not know XX company would go bankruptcy and for her it was difficult to foresee such bankruptcy

In this case, we can say she was without knowledge and grossly negligence

3  There is an stipulation in articles of incorporation

In this article, it says ” non executive director and auditor can enter into contract with the stock company for limitation of liability of director and auditor “

4  Based on this article of incorporation, non executive director and / or auditor enter into contract with the stock company

So, if she is executive director, she can not enter into contract with the company pertaining to limitation of liability

Executive director is a person who is executive director of the company or executive director of subsidiary of the company or executive officer or manager or employee

Before year of 2014, only outside director ( Shagai torishimariyaku ), outside auditor etc can enter into this contract with the company

However company act was changed.

As far as she is not executive director, she can enter into this contract

In the case she is executive director, she can supervise daily operation of the company

So, limitation of her liability is not possible

And even if she can make contract with the company, liability that can be limited is liability based on Article 423 of company act

Article 423 :  If a director, accounting advisor, company auditor, executive officer or accounting auditor neglects their duties, they are liable to such Stock Company for damages arose by such negligence

So, if her negligence leads to damage to third party, limitation of her liability is not possible

And she knew her negligence at the time of her performance, or she has severe negligence and could not know her negligence, limitation of her liability is not possible

In order that she enters into contract with the company, the company needs to provide it in articles of incorporation

Sample of articles of incorporation

(  contract for limitation of liability )

Articles 99

This company may enter into,  according to article 427 of company act, contract with director ( excluding executive director ) for limitation of liability provide in paragraph 1,  article 423

However, limitation of her liability is 1 million yen or the amount provide in company act and which is higher

So, if the amount of limitation calculated based on company act is 2 million yen, she needs to pay at least 2 million yen to compensate damages arose in the company

In order to provide this sentence in this articles of incorporation, the company needs to change content of articles of incorporation

So, resolution of shareholders meeting is required

And in the case there is auditor in the company, when the company is going to change content of articles of incorporation, auditor’s consent is required

Entering into this contract for limitation of liability of director etc is important matters toward the company

So, the company makes this contract, resolution in board of directors is required

As for calculation of ” the Minimum Liability Amount provided in company act ( = SAITEI SEKININ GENDOGAKU =最低責任限度額)  “

the Minimum Liability Amount = Annual amount of remuneration  + ( retirement remuneration  / duration of office )× 2 + Profit emerged by stock option etc

Assumed that she received remuneration of 9 yen in 2015 and 11  yen in 2016

She retired her office in 2016 and received retirement remuneration of 9 yen

She has been in her office for 3 years

She has acquired profit of 50 yen by selling stock option

She has negligence in her duty and it caused damage of 100 yen for the company

In the articles of incorporation of the company, it is provided that ” limitation of non executive director is 99  yen or the amount provide in company act and which is higher “

In that case, the minimum liability amount is

11 yen + 3 yen × 2  + 50 yen = 67 yen

99 yen > 67 yen

In this case she needs to reimburse 99 yen to the company

As for registration process

When the company has provided this sentence in the articles of incorporation, the sentence should be registered with legal affairs bureau

So, when you look at commercial register of a specific company, you can find out that the company has such article.

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