Amendment of the Companies Act
On December 4, 2019, a bill to amend the Companies Act passed the Diet and was enacted. The amendment will be effective in 18 months from December 11, 2019, the date of promulgation. This amendment includes a wide variety of adjustments to the current legislation, primarily aiming to introduce more transparency in the corporate governance of large Japanese corporations. Nevertheless, some of the amendments have impacts on managing wholly-owned subsidiaries of multinational corporations or other closed companies. Of a variety of amendments introduced in the new legislation, we focus on the topics relevant to private Japanese corporations.
Equity compensation to directors
Under the current legislation, a company needs to determine the details of non-cash compensation to directors at the shareholders’ meeting or provide the same in the articles of incorporation. There was ambiguity on to what extent shareholders need to decide the details in giving directors equity compensation.
The amendment provides that shareholders need to vote on the maximum number of stocks or options to be issued for directors and other matters as provided in a relevant regulation. If a company is providing cash compensation to directors so they can purchase shares or options, this is equally subject to the voting requirement. The Ministry of Justice (“MOJ”) explains that this amendment is to protect the interests of shareholders by clarifying that they can vote against dilutive equity compensation.
By the time this amendment becomes effective, the MOJ will set out the regulation referred to in this amendment, which will likely be reflected in the Regulation for Enforcement of the Companies Act. We will not know what will be provided in the regulation until shortly before the amendment becomes effective. To date, the MOJ has revealed, as a preliminary proposal, that the voting requirement may possibly extend to conditions for equity compensation, such as a non-assignment or buy back clause in certain events, and terms on exercising granted options.
Officers’ indemnity
Currently, the Companies Act does not provide any rules on indemnification for directors, statutory auditors, and other statutory officers (“Officers”). While some assert that it is permitted under the current legislation, the majority holds that indemnification for Officers may create a conflict of interest between a company and its Officers, especially where an Officer receives indemnification for its negligent actions for which a company may pursue a claim against the Officer.
This amendment finally ends a controversy discussed for years by codifying explicit rules as to what is permissible in an indemnification agreement. According to the new rules, a company needs a resolution by the board of directors (or the shareholders’ meeting if the company does not have a board) to adopt an indemnification agreement that indemnifies an Officer for the following:
reasonable expenses to deal with a suspicion of a violation of law or a claim on the Officer's liability in performing its duties
losses incurred by the Officer to compensate or settle with a third party for its liability in performing its duties
The following may not be indemnified, even if so provided in the indemnification agreement:
expenses that are beyond reasonable
losses that are of a nature that the company may legally recover from the Officer
losses arising from willful misconduct or gross negligence of the Officer in performing its duties
Further, the company may recover indemnified expenses paid to an Officer if they were in bad faith in performing their duties.
As these rules are only for Japanese corporations, they do not apply to indemnification that foreign companies offer to Officers of their Japanese subsidiaries or affiliates. If you are a foreign parent company having Japanese subsidiaries, you now have a choice about whether to indemnify Officers of Japanese subsidiaries through their parent or through their Japanese subs. If you choose the latter, you should abide by these rules.
If you have already provided an indemnity to Officers in Japanese corporations, you might want to revisit your indemnity agreement before the amendment is effective, as the Act now declares that certain losses are not indemnifiable.
D&O insurance
Similar to the discussion of indemnification, there was an argument as to whether a company may pay the entire premium of D&O insurance for its Officers, as it may possibly create a conflict of interest between the company and Officers. For that reason, Officers in Japanese companies traditionally incur part of the premiums by themselves for D&O policies arranged by companies.
The new legislation requires Japanese companies to approve certain D&O insurance that names Officers as insured and covers their liabilities in connection with their duties or losses arising from claims for such liabilities at the board of directors (or the shareholders’ meeting if the company does not have a board).
This amendment seems to be trying to remove concerns surrounding D&O insurance so outside directors can play more active roles in Japanese companies. As a summary of indemnification and D&O insurance is likely to be required to be disclosed in annual reports for public companies, making them subject to disclosure requirements is perhaps another intent behind this amendment.