CORPORATE GOVERNANCE IN JAPAN:

THE LIABILITY of DIRECTORS to THIRD PARTIES1

By: Vicki L. Beyer

INTRODUCTION

A corporation is a legal person created under statutory provisions. As such, it exists independent of its owners. The company can conduct business as any "person" does, entering into contracts and incurring liability. Those assets, contracts and liabilities are considered to belong to the company. In a sense, the company becomes a shield which both obscures and protects the natural persons behind it.

Needless to say, however, a company can only operate through the efforts of natural persons. Accordingly, companies usually have employees to carry out the operations of the company and managers to oversee the employees. At the top of the entire organization are the company directors, whose duty it is to manage the company for the benefit of its owners, the shareholders. These directors are required by the law that allowed the creation of the corporation. Their duties are also fixed by that law.

After surveying the types of corporate structures available in Japan, this paper will examine the role of directors in Japanese stock corporations, most particularly the statutorily-created duty owned by these directors to third parties. It will then compare this duty with a similar statutorily-created duty in Australia.

COMMON CORPORATE STRUCTURES

In Japan, the statutory provisions regarding incorporation are found in Book II of the Commercial Code. This company law provisions of the Commercial Code provide for three types of business enterprises:2 the general partnership corporation (gomei gaisha), the limited partnership corporation (goshi gaisha), and the stock corporation (kabushiki kaisha). In addition, a fourth form, the limited liability corporation (yugen gaisha) is authorized under the Limited Liability Corporation Law.3 These forms are distinguishable primarily by the differences in the limitations on liability they provide.

The general partnership corporation (gomei gaisha) is an enterprise designed for small groups of people with strong personal relationships. All members of the corporation have equal rights to participate in the management of the corporation4 and all members are personally liable for corporate debts.5 Because of the personal liability incurred by members, memberships in the corporation are not freely transferable.6 Furthermore, they cannot be passed to the heirs of a member on his or her death.7

Unlike the general partnership corporation, the limited partnership corporation (goshi gaisha) vests management rights in one or more general partners.8 The general partner has personable liability for all corporate debts, while the limited partners are liable only up to the amount of their contribution to the corporation.9

While both the general partnership corporation and the limited partnership corporation seem, on the surface to be the equivalent of partnerships and limited partnerships under common law, their position under the law is that of corporations.10 Partnerships and limited partnerships also exist as contractual arrangements under the Japanese Civil Code.11 Because of the similarities between the corporate partnerships and the civil partnership, many of the Civil Code provisions apply mutatis mutandis to the corporate partnerships.12

The corporate form most familiar to common lawyers is the stock corporation (kabushiki kaisha). The shareholders of a stock corporation have no personal liability for the debts of the corporation. Rather, they risk only the exact amount of their investment.13 Both the issue price of shares and the minimum part value of shares is Y50,000.14 Prior to 1991, a stock corporation could be formed with as little as Y350,000. in capital: one Y50,000. share held by each of the seven promoters. In 1991, a provision was added fixing the minimum amount of capital at Y10,000,000.15

A stock corporation is managed by a minimum of three directors elected by the shareholders.16 These directors, in turn, elect a representative director whose name is shown on the corporate registry as the representative of the corporation.17

The limited liability corporation (yugen gaisha) offers limited liability as enjoyed by corporate shareholders while maintaining the simple and flexible structure of partnership corporations. Although the limited liability corporation is also based on the comparable German structure, known as the Gesellschaft mit beschrankter Haftung (GmbH), it was not adopted until 1938, several years after the other corporate forms. The Limited Liability Corporations Act that was enacted in 1938 greatly simplified many of the procedures for incorporating and operating business. The particular flexibility of a limited liability corporation is the fact that only one director is required.18 The intention of the new law was to encourage small, closely held enterprises to choose to incorporate under this form.

In spite of this, however, the limited liability corporation is not necessarily the corporate form chosen by closely held enterprises. While it is a popular form for wholly-owned subsidiaries of large corporations, the stock corporation is the form preferred by one man companies. Among the theories offered to explain this phenomenon have been that stock corporations can obtain credit more easily than limited liability corporations and that formation as a stock corporation is more prestigious.19

It is also interesting to note that prior to 1981 the limited liability corporation minimum capitalization requirement of Y100,000. far exceeded the stock corporation minimum capitalization requirement of Y3,500., creating an incentive for organizations to incorporate at stock corporations even though their size and structure indicated that the limited liability corporation form might be more appropriate.20

Among the problems to arise because organizations choose to incorporate as stock corporations even though that form may be inappropriate for them, corporate governance problems are possibly the most notable. Accordingly, the history of corporate governance in Japan and its present structure will now be examined.

CORPORATE GOVERNANCE IN THE STOCK CORPORATION

Under the original Commercial Code and prevailing business practices at the turn of the century, when it was enacted, shareholders held unlimited power but each director had individual authority to represent the corporation in carrying out the shareholders' resolution.21 This authority was similar to that of a partner, whose sole action can bind the partnership.

The 1950 revisions of the Commercial Code, which were patterned on the Illinois Business Corporation Act of 1933, changed corporate governance so that it more closely resembled the pyramidic structure of corporate governance that is familiar to common lawyers.22 This represented serious changes to both the authority and the duties of corporate directors.

Under the revisions, the directors, acting as a board, were given authority to "determine the operation of the business of the corporation."23 The directors, acting as a board, are also to select one or more of their number to "represent" the company.24

The broad authority given to directors under Art. 260 is limited only by the powers reserved for the shareholder as stated in the Articles of Incorporation.25 Directors own the corporation a duty of loyalty: to act in good faith in the interests of the corporation.26 This duty of loyalty includes the duty to avoid competing with the corporation27 and the duty to avoid conflicts of interests.28 Other duties that have been read into the statute include a duty of care29 and a duty to monitor the other director.30

Most boards of directors are very hierarchical, with the representative director at the top. Consequently, the reality of the situation is that with or without the power to do so, the representative director, frequently acting without the advice and consent of the board, makes the corporation's decisions and instigates its actions.

In the case of small "family"-type operations, the hierarchy is even more obvious. It is not unusual for the board of directors of a "family" corporation to include the spouse and off-spring of the main shareholder, who is the true dynamo of the organization. This may occur to create beneficial tax treatment or to allow more control to the main shareholder or simply because the Commercial Code requires that stock corporation have three directors.

It also happens in these situations that a public figure or otherwise well known person might be asked to serve on a board of directors because the use of that person's name will assist the corporation in gaining financing or credibility. Pertinent information about the corporation, including the names of directors and the names and address of representative directors, must be recorded in the commercial registry.31 This type of public registration serve to establish facts which define legal relationships and is, therefore, very important in the Japanese legal system.32 It is also, at least theocratically, the first place that creditors and others wishing to transact business with a particular corporation will go to investigate the condition of the corporation.

These "figurehead" directors usually have no part in the actual management of the company and, in most cases, do not even regularly attend director's meetings or examine company records. Indeed, they often refrain from active participation in managing the corporation or supervising the other director. Although these directors maybe doing what is expected of them, arguably they are not actively fulfilling their statutory duties.

STATUTORY BACKGROUND OF LIABILITY TO THIRD PARTIES

The director's duties mentioned above are owed to both the corporation and to third parties. In particular, Article 266-3 creates joint and several liability on the part of corporate directors to third parties where the directors, in the performance of their duties as directors, have acted in bad faith or have committed gross negligence resulting in injury to the third party.

Article 266-3 cases are most often brought against non-shareholding directors of small corporations who are on the board of directors for one of the noncommercial reasons discussed above. More lawsuits are brought based on this statute than on any other provision of the Japanese Commercial Code.33

The notion of director liability to third parties has existed in the Japanese Commercial Code since its inception at the turn of the century. The liability was originally found in the second paragraph of Article 17734, which provided:

Under this provision, the director's action must have been unlawful; ie, in violation of either a statute or the Article of Incorporation.35 Additionally, there must have been sufficient causation, which, according to the courts, could only be demonstrate by injury to the corporation resulting in injury to the third party.36

Other specific features of judicial interpretations of the second paragraph of Article 177 include the fact that liability under this provision did not required wrongful intent, negligence or violation of a specific right.37 Directors who acted as representative of the company, as well as those who only acted in internal administration, could be held liable.

Major amendments were made to the Commercial Code in 1938. No change was made to the text of Article 177, although it was renumbers and became Article 266.38 In the 1950 revisions of the Commercial Code, the second paragraph of Article 266 was separated out to become Article 266-3. At that time it was also amended to its present form:

The standard for liability has now clearly become action with wrongful intent or gross negligence, just the opposite of the pre-war code. Consequently, many decisions of cases brought under Article 266-3(1) are defining the scope of wrongful intent or gross negligence.39

Additionally, under judicial interpretation of the post-war Article 266-3(1), it is no longer required that the directors improper management injure the corporation.40 Rather, it is considered sufficient that the third party be able to show a casual relationship between the director's breach of duty and the third party's injury, regardless of the consequence to the corporation.

The post-war changes to Article 266-3 and the subsequent interpretation of that article by the Japanese judiciary indicate that when owners of small business choose the stock corporation form of incorporation rather than the limited liability form and, because of their choice, obtain credit which the corporation ultimately defaults on, the rights of the creditor will be paramount to the rights of the corporation its owners or its directors (including those persons who merely lend their name to the corporation without actively participating in its management). Arguably, this is an attempt by policy makers to bring law and reality closer together, either by forcing small businesses into the limited liability corporate form, where they were to be, out by forcing them to conduct themselves more like stock corporations, whose form they have chosen.41 Amendment to the Commercial Code in 1981 and 1991 increasing the amount of capital necessary for the creation of a stock corporation support this notion.

The readiness of the court to automatically favor the creditor has probably taken Article 266-3 further than its drafters intended. However, when compared with the alternative of judicially developing a body of law without clear legislative mandate, as will be discussed below, the court's willingness to go so far becomes understandable. Additionally, because of the Japanese registration requirement described above, a suit against corporate directors provides a defined group of defendants, where when attempting to gain restitution b y piercing the corporate veil one cannot be certain that all possible defendants are named.

JUDICIAL ATTITUDE TOWARD DIRECTOR LIABILITY

Most Article 266-3 cases involve one-man corporation or closely-held corporation. These cases most often arise because the small corporation, possibly under-capitalized to begin with, has become insolvent and its creditors are looking for someone against whom they can recover.

The doctrine of disregard of the corporate entity, also know as piercing or lifting the corporate veil, has only recently begun to be employed by Japanese courts.42 The courts are reluctant to use the doctrine of disregard, however, because it has no statutory basis and therefore constitutes court-made law.

When it is used, the doctrine of disregard provides a means to protect unsuspecting parties from injury. It reaches the individual[s] who "owns" the corporation when the corporation is nothing more than the owner's alter ego, brought into existence to shield the owner from liability.43 Scholars have identified two occasions on which the doctrine of disregard should be employed: when the privilege of incorporation is abused and when the corporation is a mere facade.44

Both of these notions are usually present in cases brought under Article 266-3, where the corporation is often owned by a single individual or family and the various procedure requires for operating a corporation are not complied with. Bringing a case under Article 266-3 instead of under the doctrine of disregard provides a statutory-approved cause of action, far more palatable to courts in civil law jurisdiction. More importantly, however, Article 266-3 case are most often brought not against the owner[s] of the corporation but against a nonshareholding director.45

Izuo Kozai K.K. v. Muto46 is considered the progenitor of the Supreme Court's current status on director liability to third parties. In that case, Muto, a public figure, was asked by Koketsu, representative director of Kikusai Kogyo K.K., to serve as an additional representative director of the corporation. Since the corporation was having financial difficulties, the purpose of putting Muto in the position of representative director was to give the corporation credibility. Muto was told that he had no responsibilities as representative director and that Koketsu would manage the business. With this understanding, Muto gave Koketsu his seal, to be used in the execution of business.47 Koketsu, without Muto's knowledge or approval, issued a note in Muto's name for the purchase of steel materials. The corporation subsequently defaulted on the note, giving rise to this lawsuit.

The court found Muto liable despite a vigorously asserted defense. Muto insisted that he had performed his duties to the best of his ability; he clearly instructed Koketsu not to take any action without his approval and continually asked Koketsu about the nature of potential transactions.48 The court seem to ignore this defense as it held that:

In holding that Muto was grossly negligent in failing to supervise Koketsu, and, therefore, was in violation of Article 266-3(1), the court interpreted the statute as extending to third parties the duties a director owes to the corporation where the third party can show that the director's breach caused the injury complained of.50 The court added that it was not necessary for the corporation to have been damaged by the director's negligence. The court cited the economic importance of the corporate form and the reliance placed by corporations on directors fulfilling their duties as two reasons that third parties were entitled to such protection. According to one commentator, this interpretation is consistent with the general trend of post-war decisions.51

A more difficult example of a representative director being held liable to a third party is the case of K.K. Nippon Sutadeo v. Nakamura.52 Nakamura's son-in-law, Itoh, requested that she allow her name to be used as the registered representative director of K.K. Tempodo, a corporation he would manage.53 Itoh assured his mother-in-law that her registration as representative director would cause her trouble. Itoh then caused Tempodo to loan money to another corporation owed to him. As a result of the loan, Tempodo because insolent and Nakamura found herself the defendant in a suit brought by a creditor. Nalamura's status as representative director had never actually been confirmed by the board of directors. Despite that, the court held that since she had allowed her name to be placed in the commercial registry, she was estopped from claiming that she was not a representative director. The court made specific mention of the fact that the plaintiff could not know from the commercial registry entry that Nakamura was not actually the representative director.

In general, representative directors are held to a somewhat higher standard of performance because of their role in the management of the organization and because of their name is associated with the company ion the public registry. In particular, courts seem to feel that innocent outsiders should be entitled to rely on he information contained in the public registry. Therefore, as regards director liability to third parties, even in the most extreme situations, representative directors have not been able to escape liability.

In the above cases, clearly the court found that nonfeasance constituted a breach of the representative director's duties. It is not unreasonable to reach the conclusion that complete abandon of one's statutory duties is gross negligence. Additionally, in cases involving representative directors, who, by virtue of being listed as such on the commercial registry, have lent their names and reputations to the corporation, it is not difficult to find that such negligence caused the injury complained of.

In the case of regular directors, however, it is somewhat more difficult to infer causation. The existence of the representative director regulates regular directors to a figurehead or bureaucratic position. By and large they merely approve the decisions of the representative director, who is closer to the actual management of the corporation. Thus, it is possible for regular directors to be completely inactive in the affairs of the corporation as well as completely ignorant of its condition. Despite this, however, the Supreme Court has been able to find regular directors liable by broadening their duties to include adequate supervision of the representative director.

In Kobayashi v. Hashimoto,54 defendants Hashimoto and Matsuzaki were directors of an electrical appliance sales and repair operation which was managed by Asano, the representative director. During the existence of the corporation, no shareholder's meetings or directors' meetings were ever convened. The demise of the corporation coincided with the maturity of a note issued by Asano, who had unilaterally decided to expand the business to include automotive repair. Plaintiffs, holders of the note, alleged that their inability to recover on the note from the insolvent corporation was caused by the negligence of the representative director, both regular directors--Hashimoto and Matsuzaki--, and the statutory auditor.55

When plaintiffs prevailed at the trial court, Hashimoto and Matsuzaki appealed, asserting that they could not have prevented Asano from issuing the note, nor could they have foreseen the corporation's inability to repay the notes. For these reasons, they argued that they had not been negligent in performing their duties as directors. The Supreme Court summarily rejected this appeal stating:

Obviously the court is calling on directors to activity keep themselves informed of the affairs of the corporation, even though its management has been entrusted to the representative director. At the time, this holding represented a broad expansion of the directors' duty of supervision.

A still further expansion came with the holding of Daido Sanso K.K. v. Suga,57 a case involving an outside director, Kishitake, who had accepted the directorship with the condition that he not participate in the management of business. Since board meetings were never convened, Kishitake was completely inactive. In finding Kishitake liable, the court specifically stated that directors have a duty to convene a board meeting where it appears necessary and that such duty extends even to outside directors.

Dziubla argues this expansion of the regular director's duty to supervise has been ignored by lower courts, citing cases where lower courts have refused to hold regular directors liable despite the very specific language of the Kobayashi.58 Given the practical allocation of powers between representative directors and regular directors, or the relative lack of power by regular directors, this attitude in the lower courts is easy to understand. Nonetheless, since the 1981 amendments to the Commercial Code include apparent codifications of Supreme Court holdings regarding director liability, the lower courts are, to a large degree, prevented from avoiding liability as they have in the past.

THE AUSTRALIAN POSITION

In Australia, as in Japan, there are practical differences between the roles played by inside and outside directors and between the management of large corporations and small family-type corporations In Australia, as in Japan, third parties are sometimes injured by a corporation but, for a variety of reasons, cannot seek restitution from the corporation.

Accordingly, Australia, too, has a statute governing director liability to third parties.59 Original companies legislation in Australia was patterned after the British legislation. In 1961, a "Model Law," prepared by a commonwealth parliamentary committee, was enacted in each state. Section 374C was added to this Uniform Companies Act in 1971, creating liability where creditors has been intentionally defrauded, This section was the forerunner of s.556, which was in effect from 1 July 1982 to 31 December 1990 and has now been replaced by s.592 of the Corporations Law. The liability of directors created by s.556(1) is for fraudulent action - namely the incurring debt - taken by directors where there were reasonable grounds to expect that the company would be unable to meet its debts. Section 556(2) sets out defenses include lack of expressed or implied authority be the director charged and lack of reasonable expectation that the company could not pay its debts.

Section 556 required misfeasance on the part of the director. Although it has been suggested that the liability of directors should be "widened" to extend to nonfeasance when the injured party is a third party such as a creditor,60 the notion is currently subject to rather hot debate.61

To make out a case under s.556(1) the plaintiff must show that the director had, objectively, reasonable grounds to expect that the company would be unable to pay its debts. When this has been done, the burden of proof shifts to the defendant to establish a s.556(2) defense. Where the director charged in a s.556 case is an inactive director, the question becomes whether the director had implicitly or expressly authorized the debt.

An early s.556 case raising the issue of authorization of the debt was Tasmanian case of Coates v. Hardwick.62 In that case, defendant was a chartered accountant who was a shareholder/director in a hotel operation. When the hotel began to experience difficulties in mid-1982, the manager was instructed to conducts its business on a cash basis, high, it appears, he did not do. Following his dismissal in September 1982, another manager was appointed and given thee same cash-only mandatee. Computer lists of creditors prepared in November and December showed that no debts had been incurred. A computer list prepared in February after the sale of the hotel shows several current debts that had been incurred by the manager between December and February. The defendant argued that these debts were not chargeable to him a director because he had not authorized them and had, indeed, forbidden their incurrance. Further, he was not aware of the debts until well after they had been incurred. While it appears to have been argued that the defendant was shirking his s.229 duty to monitor the manager he had appointed,63 the court accepted the defense, finding that the defendant had sufficiently monitored the manager but had not been aware of the debts and that there was no evidence of implied or expressed authority for them.64

The New South Wales case of Metal Manufacturers Ltd. v. Lewis,65 also raised questions of the availability of the defense of lack of authorization where a manager--specifically in this case, a managing director--had been appointed. The case was an action by a creditor of the company against Mr. and Mrs. Lewis as the directors of the company. Because Mr. Lewis had acted as the managing director, he did not contest judgement against him.66 Mrs. Lewis, on the other hand, sought to establish the applicability of s.556(2) on the basis that she was a director for "signing purposes only" and had never taken part in the management of the company, leaving that to her husband as the managing director.67 Two of the three judges were persuaded by this argument.

Mahoney and McHugh JJ.A. felt that Mrs. Lewis has carried her burden of proof that she had not authorized or consented to the incurring of the debt. Specifically, McHugh J.A. stated "I think that the authority or consent of which para.(a) speaks must be an authority or consent to the incurring of the very debt and not an authority or consent to the incurring of debts generally."68 After stating that "mere inactivity" cannot be authorization unless the person knew or suspected that a debt would be incurred, McHugh J.A. also pointed out that the authorization should before the incurring of a particular debt and that lack of authority to prevent a debt implies lack of authority to prevent a debt implies lack of authority to incur a debt.69 He went on to note that "in the ordinary course of business, a director does not authorize or consent to the incurring of each debt of the company. [Rather] each debt is authorized by the general authority which the general manager has, not by the vote of each director who appointed him to his position."70 The judgement of Mahoney J.A., which was not as forceful, echoed this notion of the autonomy of a managing director's authority.

Kirby P. issued a strong dissenting opinion which began by discussing the policy reasons for the inclusion of s.556 in the Code, pointing out that Parliament wanted to encourage greater responsibility by directors when the company is in a borderline insolvency situation and to provide recourse to creditors.71 He then pointed out that by using the words "expressed or implied authority or consent," the statute meant to catch those persons who did not take part in the management of the company but had to be aware of the facts that debts were being incurred on an on-going basis simply because the company was an on-going concern.72 "The time has passed when directors and other officers can simply surrender their duties to...those with whom the corporation deals by washing their hands, with impunity, leaving it to one director...or to a general manager to discharge their responsibilities for them."73

Since the decision in Lewis, three Victorian cases74 have held inactive directors liable, thereby creating a schism in the Australian legal community.

In the case of Heide Pty. Ltd. v. Lester,75 the court felt compelled to follow the decision in Lewis, although it was able to distinguish the case on its facts. In Lester, as in Lewis, the management of the company was left to the husband/director, although he did not have the title of managing director.76Unlike Mrs. Lewis, however Mrs. Lester, the "inactive" wife/director in Lester actually performed clerical tasks for the company four days a week. It was on this basis that the court was able to impute to her knowledge of the incurring of the debts, and because she did nothing to stop the incurring of the debts, determined that she had impliedly consented to them.77In particular, the court observed: " a director has the duties of care, diligence and skill and responsibility towards the creditors of the company of which he/she is a director. It is no answer to a claim to say 'I didn't know' or 'I left it to my husband to attend.' "78

Statewide Tobacco Services v. Morley,79probably the most controversial of the three Victorian cases, ,was not as delicate in its reasoning as Lester was. It found an inactive company director liable to a creditor of the insolvent company under facts quite similar to those in the Lewis case.

Mrs. Morley, the defendant, had been a director and shareholder in a company run by her husband. Although she had never been active in the company operations--indeed, her testimony showed a total lack of understanding of the business--, her husband regularly supplied her with statements of the company's accounts. After the husband relinquished management of the company to their son in 1978, Mrs. Morley no longer received any accounting records. The elder Mrs. Morley died in 1979 and it was informally agreed between Mrs. Morley and her son and her daughter--the three remaining shareholders/directors--that the younger Mr. Morley would continue to run the business. It would appear that Mr. Morley ran the business into the ground, as it became insolvent sometime in late 1987/early 1988 and went into receivership in November 1988. This case was subsequently brought against Mrs. Morley in her capacity as a director by one of the company's suppliers, who had sold goods to the company on credit in May and July 1988, after the company had become insolvent.

Like Mrs. Lewis in New South Wales, Mrs. Morley attempted to defend by claiming to be an inactive director under s.556 (2). Alas, in her case, Orminston, J. did not accept this argument. Even though it can be said that Mrs. Morley situation is more like that of Mrs. Lewis than Mrs. Lester--insofar as Mrs. Morley did not participate in the operations of the company in any way and did not even understand the most basic concepts about the business--, the court seemed more persuaded by Kirby P's dissent in Lewis. Indeed, Orminston J's analysis of the purpose and function of S.556 mirrors that of Kirby P.80 However, Orminston J. does not completely ignore the majority in Lewis. He quotes extensively from McHugh J.A.'s opinion, including the statement that "appointing a person to an office does not mean that the appointer is authorizing each debt of the company for which the appointee is responsible."81He then continues, however, with his own opinion, that:

It is on this basis that Ormiston, J. was able to hold that Mrs. Morley had impliedly authorized or consented to the incurring of the debt. He accepted the testimony of Mrs. Morley's son that she had asked him to manage the company after her husband's death and took this to be her authorization of the son's actions.83 Lewis was distinguished by the observation that there was no evidence that Mrs. Lewis had participated in any way in the appointment of Mr. Lewis to the position of managing director.84

Initial reaction to the Morley decision was that it created a conflict between two state jurisdictions.85 The conflict has spread further by a 1991 South Australian decision, Group Four Industries Pty Ltd v. Brosnan & Anor.86 That case, like Lester and Lewis, involved husband and wife directors where the husband ran the business with a limited amount of assistance from the wife, who then sought to defend on the basis of not impliedly or expressly authorizing the debt. Duggan J. distinguished Lester and found Mrs. Brosnan not liable on the basis of her complete lack of knowledge of the financial affairs of the business:

While Duggan J. attempted to distinguish or otherwise deal with Morley and ultimately simply decided not to follow it, he engaged in only a cursory discussion of the first Lewis decision and did not deal with the full court decision in that case. Accordingly, Brosnan makes little or no contribution to the development of the interpretation of s.556.

The latest word in this mess is from the full Supreme Court of Victoria, which upheld Orminston J.'s decision in Morley on 24 July. Particularly compelling to the court was the fact that Mrs. Morley knew that her son was incurring debts as part of his management duties and that she could have removed him from management if she had wanted to. The court also specifically stated that Mrs. Morley's implied authority did not have to relate to any particular debt. To so construe s.556 flies in the face of its reference to "any person who was a director of the company."

DISCUSSION

The reasoning in Morley goes much further than that of the Lewis majority. It is not inconsistent, however, with the recommendations of the Senate Standing Committee on Legal and Constitutional Affairs in its Report on Company Directors' Duties, which indicated that directors should not be permitted to rely on others.88 When the results of these cases--taken with regard to the reasoning of the courts--are synthesized, they are not inconsistent with each other. The rule that can be derived from such a synthesis is that even an inactive director can incur liability under s.556 where the director either (1) knew that debts were being incurred when the company was in tenuous circumstances or (2) had a role in the appointment of the person who incurred thee debts. While this comes very close to creating liability for nonfeasance, it is consistent with the Senate Standing Committee report and the overall policy that most judges are associating with the provision.

CONCLUSION

Neither Australia nor Japan is willing to tolerate corporations, or the persons who run them, defrauding third parties. Nonetheless, s.556 (now 592) in Australia is, in its language, far more limited than the Japanese Article 266-3. Section 556 may only be invoked by creditors and reacquired that the company b insolvent. Further, it includes specific defenses that may be asserted by the director charged. Essentially the defenses available result in a requirement of malfeasance on the part of the director in order for there to be liability. The director must have authorized in some way the debt that is the subject of the suit. Article 266-3, on the other hand, allows liability to be found in cases of nonfeasance, when the director fails to act to supervise even an authorized director.

In spite of these differences, however, some striking similarities exist in the judicial results of the two jurisdictions. Essentially, it is not acceptable in either jurisdiction that a director give blanket authorization to another and then fail to supervise the actions taken.

Interestingly, in both Japan and Australia, the fact that in reality small corporations are usually operated by one or a few individuals and that some directors are neither expected nor desired to play an active role has been an important consideration in some courts. While subsequent statutory amendments have resulted in the law rising above this practical effect in Japan, the controversy continues in Australia with the outcome not yet predictable.

1 This paper was prepared in 1992 as a working paper to complement a QUT Program on Nonprofit Corporations Seminar. It is a draft and should not be cited or quoted without written permission from the author. back

2 (Shoho) Law No. 48, 1899. Art.53. back

3 (Yugen Gaisha Ho) Law No. 74, 1938. back

4 Commercial Code, Art. 70. back

5 Commercial Code, Art. 80. back

6 Commercial Code, Art. 73. back

7 Commercial Code, Art. 85. back

8 Commercial Code, Art. 151. back

9 Commercial Code, Art. 157. back

10 Commercial Code, Art. 32 through Art. 36. back

11 Civil Code, Art. 667. back

12 Commercial Code, Art. 68. back

13 Commercial Code, Art. 200. back

14 Commercial Code, Art. 166(2) and Art. 168-3. back

15 Commercial Code, Art.168-4. back

16 Commercial Code, Art. 254. back

17 Commercial Code, Art. 261. back

18 Limited Liability Corporation Law, Art. 25. back

19 See generally, M. Tatsuta, Introduction: Types of Business Organizations," in M. Tatsuta & D. Henderson, Japanese Business Corporations Law (1982) (unpublished course materials used at the University of Washington School of Law). back

20 M. Tatsuta, "Risks of Being an Ostensible Director, " 8 J. Comp. Bus. and Cap. Mkt. L. 445, 453 at note 4. back

21 T. Blakemore & M. Yazawa, "Japanese Commercial Code Revisions--Concerning Corporations,"2 Am. J. Comp. L.12, 16-17 (1953). back

22 Id. at 15, 17. back

23 Commercial Code, Art. 260(1). back

24 Commercial Code, Art. 261. back

25 Commercial Code, Art. 230-10. back

26 Commercial Code, Art. 254-3. back

27 Commercial Code, Art. 264. back

28 Commercial Code, Art. 265. back

29 This duty derives from the statement in Art. 254(3) that the relationship between the corporation and the director is governed by provisions relating to agency. These provisions are found in Civil Code Art. 644. The duty is to perform with the care of a good manager. back

30 Commercial Code, Art. 260. back

31 Commercial Code, Art. 188. back

32 D. Henderson & J. Haley, Law and the Legal Process in Japan, 405 (1978). back

33 M. Tatsuta, comments on Article 266-3 at p. 475, T. Omori, ed., Chusshaku Kaishaho (Commentary on Corporation Law), Vol. 4 (1968); M.Tatsuta, "Risks of Being an Ostensible Director," Supra Note 20 at p. 447. back

34 The first paragraph created director liability to the company for "neglect" of any duty. See Codes Translation Committee of the League of Nations Association of Japan, The Commercial Code of Japan 308 (1931). back

35 J. De Becker, Commentary on the Commercial Code of Japan, Vol. 1, 287 (1913). back

36 The Commercial Code of Japan, supra Note 34, at 309, 312, 313. back

37 Id. at 309. back

38 M. Tatsuta, comments on Article 266-3 at p.475, T. Omori, ed., Chushaku Kaishaho, Supra Note 33. back

39 R. Dziubla, "Enforcing Corporate Responsibility: Japanese Corporate Director's Liability to Third Parties for Failure to Supervise," 18 Law in Japan 55 (1986). back

40 Izuo Kozai K.K. v. Muto, 23 Minshu 2150 (Sup. Ct., G.B., Nov. 26, 1969). Japanese cases are usually cited by the court and date of decision only. To avoid the confusion this sometimes causes to those unaccustomed to this practice, the names of the parties will be used herein. back

41 It is important to note that although the Limited Liability Corporations Act contains a provision identical to Article 266-3, the courts have demonstrated greater generosity in attaching liability under that provision. See generally, Maruyoshi Kozai K.K. v. Sato, 24 Minshu 1061 (Sup.Ct., 1st P.B., Jule 16, 1970), discussed in Dziubla, supra Note 39, at 64-66. back

42 See, e.g. Yamayoshi Shokai K.K. v. Hoshihara, 23 Minshu (No. 2) 511 (Sup. Ct., 1st P.B., Feb. 27, 1969); Egashira, Hojinkakuhinin no hori (The Doctrine of Disregard of the Corporate Entity), 4 Juristo Bekkan Horitsugaku no Soten Shirizu 32,35 (1983). back

43 Izuo Kozai KK v. Muto, 23 Minshu 511. back

44 Egashira, Supra Note 42. back

45 The court in Kobayashi v. Hashimoto, infra Note 57, pointed out that the defendant owner did not appear. It is likely that the unavailability of the owner of the corporation is another reason Article 266-3 cases outnumber doctrine of disregard cases. back

46 23 (12) Minshu 2150 (Sup. Ct., G.B., Nov. 26, 1969). back

47 Seals, rather than signatures, are used in the execution of most domestic documents and transactions in Japan. It is not unusual for one person to entrust his seal to another for the purpose of carrying out specific business. Neither is it unusual for the person to whom the seal has been entrusted to exceed their authority as agent. back

48 R. Dziubla, supra Note 39 at 61. back

49 23 Minshu at 2154-2155. back

50 23 Minshu at 2153. back

51 See M. Tatsuta, supra Note 20 at 447 and 454 note 7. back

52 26 Minshu 984 (Sup. Ct., 1st P.B., June 15, 1972). back

53 M. Tatsuta, supra Note 20, at 445. back

54 27 Minshu 655 (Sup. Ct., 3d P.B., May 22, 1973). back

55 Id. at 662. Asano did not appear in the case. See also, supra Note 45. back

56 Minshu at 656. back

57 Hanji (No. 971) 101 (Sup. Ct., 3d P.B., March 18, 1980). back

58 Dziubla, Supra Note 39, at 70-72. back

59 Section 556 of the Companies Code, now s.592 of the Corporations Law, contains the following language:

60 see e.g., Chapter 5, Senate Standing Committee on Legal and Constitutional Affairs Report on Company Directors' Duties, November 1989. back

61 See generally R.J. Burrell and S.S. Long, "Apathetic Directors Beware -- a recent Case Developments," Queensland Law Society (February, 1992) 5; L.D. Griggs, "Inactive Directors - Under Attack," 11 University of Tasmania Law Review 75 (1992). back

62 (1988) 6 ACLC 266. back

63 Id. at 269. back

64 Id. at 271. back

65 (1988) 6 ACLC 724. back

66 Id. at 731. back

67 Id. at 728. back

68 Id. at 735. back

69 Id. at 736. back

70 Id. back

71 Id. at 727-28. back

72 Id. at 729-30.back

73 Id. at 728. back

74 The third Victorian case, Commonwealth Bank of Australia v. Friedrich & Ors, (1991) 9 ACLC 946, was decided on the basis of "reasonable cause to expect" under s556(2)(b) rather than authority under s556(2)(a) and will not be discussed herein. back

75 (1990) 8 ACLC 958. back

76 Id. at 959. back

77 Id. at 963. back

78 Id. at 961. back

79 Statewide Tobacco Services Ltd. v. Morley, (1990) 8 ACLV 827. The decision was recently upheld on appeal. back

80 ACLC at 831-34. back

81 Id. at 839, quoting McHugh J.A. in 6 ACLC at 736. back

82 8 ACLC at 839. back

83 Id. at 829. back

84 Id. at 840. back

85 Uninvolved director liable for debts -- full details of new case, "Company Director, December 1990 at p.5. back

86 (1991) 9 ACLC 1181. back

87 Id. at 1190. back

88 Supra note 61. back

 

(translation by Vicki L. Beyer)

Temple University Japan