Supreme Court affirms shareholders’ power to appoint representative director without board decisions

On February 21, 2017, the Third Petty Bench of the Supreme Court rendered a decision that a closed company with a board of directors may appoint a representative director by a resolution of the shareholders’ meeting, as well as the board of directors, if the articles of incorporation expressly permit the shareholders to do so. This puts an end to the controversy under Japan’s corporate law whetherthe appointment of a representative director is inherently vested in boards, or whether shareholders can alternatively exercise that power bypassing the board.

Background

A former representative director of a Japanese company sought injunctive relief to suspend a new representative director appointed at the shareholders’ meeting of the company. The company is a closed company (i.e., the transfer of its shares is restricted under the articles of incorporation) with a board of directors. The articles of incorporation provide that the representative director shall be appointed by the board of directors, but if necessary, it may also be appointed by the shareholders’ meeting. Normally, under Japan’s Companies Act, shareholders of a company elect directors who constitute the board, which then nominates and appoints the representative director that represents and acts on behalf of the company.

Discussion

While the board of directors was traditionally required for corporations (i.e., Kabushiki Kaisha) as part of their governance structure, it is no longer mandatory for closed corporations ever since Japan’s corporate law was amended in 2005. In a model without boards, shareholders may decide matters in connection with the company, and directors chosen by the shareholders execute the business affairs of the company. For companies with a board, the shareholders’ power is limited to matters only specifically provided under the Act or the articles of incorporation, and the board is primarily responsible for running the company. The representative director acts on the company’s behalf to execute the board’s decisions.

As the board’s fundamental role is to oversee corporate management by the representative director, it is natural to conclude that the board should have a say in the appointment and removal of the representative. However, because in closed companies, boards are optional, the question is whether to limit shareholders’ power as is done in public companies, considering the balance of power that shareholders have in closedcompanies without boards. Some are of the view that granting shareholders the right to appoint the representative director may undermine the board’s function to effectively oversee the management by the representative director.

Rulings

The Court sided with the view that the shareholders can appoint the representative director, without prejudice to such powers of the board, provided that the articles of incorporation expressly permit this. The Court reasoned that the Companies Act does not limit what can be provided in the articles, and granting shareholders the right to appoint the representative director does not exclude the board from doing so, thereby not impairing the board’s authority for oversight.

Comments

This decision clears the air on the longstanding controversy whether shareholders’resolutions are sufficient to replace the representative director. Many companies had to enact two-tier resolutions at the shareholders’ level (to elect directors) and at the board level (to appoint a representative director among directors). This is no longer necessary (without doubt) for closed companies provided their articles of incorporation contain the appropriate language. 

This may be useful for joint ventures that face challenges in convening boards, or wholly owned subsidiaries of global companies in thatthey can move forward with management changes more quickly.

We note that this decision only discusses the additional power of shareholders to appoint the representative director, and does not mention whether shareholders can take away that power from the board. In our view, that would be beyond the fundamental structure of Japan’s corporate law. If shareholders want such arrangements, they should eliminate the board of directors fromthe company by amending the articles of incorporation.

In addition, this ruling only applies to closed companies. As a background, shareholders in these companies may decide anything, as discussed above. In public companies, this may not be the case, as the board of directors cannot be eliminated. In such a structure, it makes sense that boards should be responsible for, and therefore given exclusive rights in, the appointment and removal of representative directors.