[ Nippon Keidanren ] [ Policy ]

Revision of the Corporations Law

Securing International Competitiveness for Corporations,
Respecting the Choices of Corporations, Shareholders, and Other Stakeholders

[ Tentative Translation ]

October 16, 2003
Nippon Keidanren
(Japan Business Federation)

I. Introduction -- History of Revisions to the Corporations Law and Events to Date

The Corporations Law constitutes the essential infrastructure for the support of corporate activities. In its Recommendations Concerning Commercial Law Reform of October 2000, Nippon Keidanren made an urgent proposal for change regarding the following five key issues: (1) easing of legal requirements and establishment of a market-oriented legal framework in order to secure corporations' international competitiveness; (2) formulation of legislation conducive to restructuring of operations and organizations; (3) diversification and increased efficiency of financing methods; (4) fostering of venture business; and (5) advancement of IT usage.

A series of five revisions to the Corporations Law ensued from this initiative, namely: (1) lifting of the prohibition on treasury-stock holdings, with concomitant lawmaker-initiated legislation in June 2001; (2) adoption of electronic formats for corporate documentation, introduction of stock subscription warrants, and diversification of share classes in November 2001; (3) strengthening the functions of the corporate statutory auditor system and review of derivative shareholders lawsuits, with concomitant lawmaker-initiated legislation in December 2001; (4) a wide-ranging revision of the Corporations Law in May 2002; (5) removal of the ban on acquisition of own stock subject to resolution of the Board of Directors by authorization provided in the articles of incorporation, with concomitant lawmaker-initiated legislation in July 2003. Moreover, a draft proposal for revision of the Corporations Law regarding non-issuance of share certificates and provision of publications in electronic form will be submitted soon to the Diet. We would like to thank everyone involved for devoting their energies to accomplishing these goals.

Additionally, at the suggestion of the Minister of Justice, in September 2002, an initiative was launched to modernize the Corporations Law, which will finalize this reform effort. Issues include resolution of imbalances between the various rules and regulations in the Corporations Law, and deliberations to review and make practical changes appropriate to contemporary business.

The Legislative Council of the Ministry of Justice is currently considering the purport of requests advanced by the business community regarding greater flexibility in the range of options available for group reorganization, streamlining corporate governance requirements, and a wider range of methods for financing and returning profits to shareholders. The Council is expected to release a general draft proposal soon. In light of this occasion, Nippon Keidanren presents here once more its key propositions concerning revision of the Corporations Law to secure corporations' international competitiveness and respect the choices of corporations, shareholders, and other stakeholders.

II. Perspectives on Revision of the Corporations Law

1. Enhanced flexibility in the execution of corporate operations and in management, and increased freedom to select governance under articles of incorporation

Amid severe international competition, companies seek to select structures for their group organization and corporate organs that will maximize competitive strength. Beginning April this year, the Corporations Law permitted the "Company with Committees (Iinkai-to-setchi-kaisha)" system and the "Company with Committee for Important Assets (Juyozaisan-iinkai-setchi-kaisha)" system, and meanwhile, many companies are implementing executive officer systems. We believe that the amended Corporations Law must respect structures adopted by companies based on shareholder decisions, allow for diversity in the way corporate operations are executed, and provide flexibility in the formation of corporate organs under governance by the articles of incorporation.

(1) Adequate Reflection of Shareholder Concerns in Company Management
(i) Protection of genuine shareholders and derivative lawsuits brought by contemporaneous shareholders or Voting Unit shareholders

Protecting genuine shareholders is prerequisite to implementation of effective governance by articles of incorporation. It is therefore appropriate for a Board of Directors to exercise flexibility in making decisions on the exercise of voting rights by shareholders whose shareholder status was acquired, for instance, as a result of corporate restructuring or capital increase or a similar event after the record date.

Further, as to derivative shareholder lawsuits, it needs to be considered whether the person bringing the lawsuit has the standing required to act as a representative of genuine shareholders. In cases where lawsuits are brought by persons having acquired shares of a company only after the alleged wrongdoing that causes the litigation or by persons holding only odd-lot shares, examination of such shareholders' standing as plaintiffs is appropriate.

(ii) Introduction of a litigation-committee system

In derivative shareholders lawsuits that promise less than the best for a company, all shareholders but those who bring the suit wish the Board of Directors to be relieved from the burden of having to respond. A litigation committee system needs to be established, introducing the concept of "legitimate representative"#1 in a derivative lawsuit. In such a system, in the event that a lawsuit is launched by shareholders claiming responsibility by directors, executive officers or auditors, the company would set up a litigation committee and, if that committee decided that the company would not pursue the question of responsibility by the directors or others, the courts would respect that decision.

#1 See "PRINCIPLES OF CORPORATE GOVERNANCE:ANALYSIS AND RECOMENDATIONS" §7.02(a)(4)(The plaintiff must be) able to represent fairly and adequately the interests of shareholders.
(iii) Review of the system of reduced liability of directors

Although the system of reduced liability of directors went into effect in May 2002, the resulting burden is still excessive and must be further reduced. Under the system, personal liability (after which companies are allowed to waive payment) stands at a minimum of 6 years' remuneration for representative directors, 4 years' remuneration for directors, and 2 years' remuneration for outside directors. Furthermore, under the principle of fault liability on the part of directors, the distinction between outside and inside director cannot serve as grounds for reduced liability. Directors' extent of liability should be a uniform measure comprising up to 2 years' worth of remuneration.

(2) Consideration for Operational Self-Governance
(i) Distribution of profits to be subject to Board of Directors' resolution in companies with Board of Corporate Statutory Auditors system

Shareholders of public companies express approval or disapproval on an ongoing basis through their behavior as investors by buying or selling shares. On the other hand, as corporate constituents, shareholders' principal means of expressing approval or otherwise is through exercise of voting rights at the general meeting of shareholders, and amid increasingly complex management environments, electing directors who will make management decisions reflecting shareholders' objectives fulfills this purpose. Those directors and other officers entrusted with management authority bear the same responsibility to shareholders whether they be external or internal appointees.

Under the current Corporations Law, authority to determine distribution of profits rests with the Board of Directors only in companies operating under the Company with Committees system. In the case of a company with a board of corporate statutory auditors, a distribution of profits proposal must be submitted to the general meeting of shareholders for deliberation. This treatment introduces disparities in the options available for structuring company operations and hinders self-governance in company management. Distribution of profits should be subject to resolution by the Board of Directors even in companies with a board of corporate statutory auditors, provided this has been stipulated in the articles of incorporation.

(ii) Fault liability principle to be applied to directors

Under the current Corporations Law, directors are subject to strict ("no fault") liability as well as joint and several liability in cases such as unlawful dividend payment, a structure that places directors under excessive liability. For companies with committees, this deficiency has been corrected by adopting the fault liability principle, except for instances of illegitimate prohibition to offer benefits in connection of exercise of shareholder rights. This difference undermines the neutrality of choice of corporate organs relative to companies with a board of corporate statutory auditors and limits companies' ability to decide their own styles of management.

It is disproportionate that even in cases when there is no negligence on the part of directors or other corporate officers, directors' property can be allocated as compensation for sustained losses and damages. The fault liability principle should therefore be used as the standard in relation to directors' liability to provide compensation for losses under application of property valuations rendered on an investment in kind basis. This is true also of directors' liability for unlawful dividend payments, transactions under conflict of interest, and illegitimate prohibition to offer benefits in connection of exercise of shareholder rights, all of which should be subject to the fault liability principle.

Providing accurate advance estimates of asset values is becoming difficult due to factors such as the introduction of the fair-value ("mark to market") evaluation system for financial products. As a result, companies are potentially exposed to capital deficits at the fiscal year-end which cannot be easily foreseen at the time of distribution of retained earnings. A fixed ceiling should therefore be set for directors' liability to compensate for losses resulting from authorizing such distributions.

(iii) Flexibility in designing corporate organs

The revised Corporations Law effective since April this year introduced a Company with Committees system requiring en-bloc installation of three committees and an executive officer. In order to widen the range of management options, system choices should be introduced, such as that between a board of corporate statutory auditors and an audit committee, options should be made available for the various committees and executive officer systems, and improvements should be made to the Company with Committee for Important Assets system as well as to the institutions of substitute auditor and substitute director.

Moreover, the unification of legislations governing joint-stock companies and yugen-kaisha (traditional limited liability companies), respectively, must provide entities that have opted for limited liability under current law with the same options as heretofore regarding design of corporate organs.

Arrangements should also be made to allow for design of corporate organs to be determined freely, as suited to the circumstances of the company. For instance, in circumstances of corporate liquidation, extensive simplification of company organs should be permitted (by eliminating the institutions of full-time corporate statutory auditor, outside auditor, and board of corporate statutory auditors), with a minimum of court involvement, in order to secure as large a distribution of company assets for shareholders as possible.

(iv) Written resolutions by the Board of Directors

In matters subject to resolution by the Board of Directors, provided that individual directors have given their approval and corporate statutory auditors have expressed no particular opinion, the physical presence of directors is not necessary for a resolution. It is therefore desirable that such resolutions by the Board of Directors can be made in written form.

(3) Consideration for self-governance regarding group structure
(i) Adoption of the limited liability company system

In the United States, the limited liability company (LLC) is a recognized corporate form based on state law. Under this company form, owners have limited liability, while the entity itself offers the advantages of being able to own property and engage in business operations, also with its liability limited. At the same time an LLC can be operated flexibly like a partnership. Taxation of LLC income is not imposed at the entity but at the owner level, with the advantage that the LLC serves simultaneously as a conduit for taxation.

A similar scheme should be adopted also in Japan to facilitate new business ventures that carry high risk, or restructuring of business operations, or for starting joint operations among multiple companies.

(ii) Simplification of corporate organs of group internal affiliates

In a relationship between parent company and affiliate, notably in the case of holding companies and their holdings, the parent company efficiently allocates financial and personnel resources across the group while monitoring affiliates' business operations. Based on a perception of the entire group as a single entity, simplification of the design of corporate organs, especially in the case of fully owned subsidiaries, should be made possible (through amendments to the obligatory installation of external accounting auditors and full-time corporate statutory auditors/company outside auditors, and other measures).

(iii) Abolishment of minimum capital requirement

Effective group restructuring entails spin-offs as well as the founding of new companies, which are established based on a wide range of requirements that depend upon multiple factors such as required capital amount, company scale and character, and the credit standing requirements of interested parties such as customers and suppliers.

In order to be able to better meet these numerous conditions, regulations prescribing fixed minimum capital amounts for incorporation should be abolished.

2. Flexibility and Mobility in the Options for Reorganization

Realizing a group structure of competitive strength requires the ability to react flexibly to changes in the economic environment through reorganization. To this end, multiple options must be made available to respond to the demands of different organizational restructurings.

(1) Flexibility in determining merger value

Flexibility in value determination can facilitate smooth restructuring of organizations. In the cases of merger by absorption, division of a corporation, and share exchange (transfer of ownership through exchange of stock with an existing company), greater flexibility in the options available for merger compensation should be introduced by permitting payment in cash or in shares of a third corporation or other types of property in lieu of delivery of shares of the surviving entity to the shareholders of the merged entity.

(2) Relaxation of requisite conditions for simplified reorganization and sanctioning of summary restructuring methods

To facilitate swift implementation of reorganization, the requisite conditions for simplified reorganization#2 (currently restricted such that the number of new shares to be issued by the surviving entity on the occasion of a merger must not exceed 5% of the total number of its issued and outstanding shares) should be relaxed to allow assignees of the surviving company to receive 20% of its issued and outstanding shares. Regarding the book value of property to be spun off, conditions should be relaxed to 20% of total assets of the divesting company. However, new regulations have been under discussion regarding issuance of new shares for purposes unrelated to reorganization, which is understood to run parallel to simplified reorganization. Introduction of the new regulations would pose a major obstacle to flexible financing, and they should therefore not be adopted.

Furthermore, in instances of reorganization involving companies under the control of another, simplified procedures should be made available (summary restructuring measures) that do not require a general meeting of shareholders in light of the fact that resolutions by the general meeting of shareholders of controlled companies can have only formal significance.

#2 For instance, "short-form mergers", a small-scale merger no longer require shareholder approval.
(3) Review of inspector examinations

Examinations conducted by inspectors in the event of "post-establishment transfer" (jigo setsuritsu, whereby assets are transferred in such a way that they are deemed to be a transfer in kind) during restructuring proceedings can bring about suspension of operations. In order to realize smooth restructuring, examinations occasioned by subsequent incorporation should be abolished.

The range of securities exempt from examinations required in connection with investment in kind or assumption of property should be widened in accordance with the purport of regulations, and amended from "exchange-traded securities" to "securities with market values."

(4) Acquisition of parent company shares by affiliates

Although regulations governing acquisition and holding of treasury stock were relaxed in 2001, there has been no revision of prohibitions barring affiliates from holding parent-company shares.

As a result, complications arise in situations where affiliates plan to assume allotments of parent-company shares in the course of third-party companies' restructuring efforts or where affiliates in the course of their own restructuring activities plan to assume allotments of parent-company shares. Acquisition of parent company shares should therefore be permitted without restrictions on amounts.

Even with such relaxation, however, a company that becomes an affiliate following an increase in the ownership interest held in it, as part of a rescue effort or other such undertaking, will be compelled to sell at the proper time any shares it holds in its new parent company, thus giving rise to market confusion. Therefore, prohibition of acquisition of parent company stock by affiliates should, in principle, be abolished.

3. Diversification of Methods for Financing and Profit Distribution to Shareholders

In order to reinvigorate corporate activity, it is necessary to broaden the range of methods for financing and distribution of profits to shareholders, in step with capital market trends toward greater liberalization and diversification.

(1) Unification of regulations concerning method and timing of profit distributions to shareholders

When distributing profits to shareholders, corporations choose between dividend payment and acquisition of treasury stock, based on their perception of varied shareholder requirements and future company growth. Uniform treatment afforded acquisition of treasury stock and interim dividends as to the underlying financial resources has already been put into place under a revision of statutes during the Ordinary Session of the Diet this year. In order to attain greater flexibility in returning profits to shareholders, it is desirable for the same financial resources to be available for payments of profit distributions, interim dividends, paybacks concomitant with reductions in capital and capital reserves, paybacks of company property to shareholders through acquisition of treasury stock, etc., and other cash repayments based on profit distribution. We propose for such distributions to shareholders to be available at any time, also as investment in kind, subject to resolution of the Board of Directors.

(2) Consolidation of corporate bonds

In order to increase the liquidity of corporate bonds, provided that terms of issue with respect to coupon rate, payment dates, and redemption date, etc., are identical, the bundling of bonds into more easily marketable units should be permitted with regard to debt issues featuring different issue amounts, issue prices, and issue dates.

(3) Introduction of bonds with warrants with compulsory conversion

Issuance should be permitted of bonds with warrants exercisable automatically or by resolution of the Board of Directors upon occurrence of a conversion event to be determined in advance by the Board of Directors.

(4) Public sale of treasury stock without share issue procedures

Disposal of treasury stock requires procedures identical to those for new share issuance notwithstanding rigorous regulations applied to shares already in issue under the Securities and Exchange Law in order to prevent insider trading and market manipulation. Permission should be given for treasury shares with market values to be disposed through selling in the market.

III. Future Activities

Regarding the soon to be announced "General Draft Proposal for Modernization of the Corporations Law," a detailed separate comment will be submitted to the Minister of Justice and other persons involved.

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