Exemption of Directors from Liability

Directors’ duty of care

The relationship between a stock company and its directors and accounting auditors is one of delegation (Article 330 of the Companies Act), and the provisions of the Civil Code regarding delegation apply. Therefore, the directors of a stock company owe a duty of care to the company in accordance with the provisions of the Civil Code (Article 644 of the Civil Code). If he/she causes damage to the company due to negligence in the course of his/her duties, he/she is liable for damages to the company as a breach of the duty of care of a good manager. For example, if a company’s money is loaned to a third party without sufficient security and the company is unable to collect, the director who agreed to the loan is liable for damages to the company.

Director’s duty of loyalty

Directors are required to comply with laws, regulations, the articles of incorporation, and resolutions of the general meeting of shareholders, and to faithfully perform their duties for the benefit of the company (Article 355 of the Companies Act). This is the so-called duty of loyalty. It is the duty not to sacrifice the interests of the company to benefit oneself or a third party when there is a conflict between the interests of the company and the interests of an individual.

Liability of Directors for Damages

A director, accounting counselor, corporate auditor, executive officer, or accounting auditor is liable for damages to the company if he/she neglects his/her duties (Article 423, Paragraph 1 of the Companies Act). Although directors are liable for damages to the company under the provisions of the Civil Code if they breach their duty of care or duty of loyalty, the provisions of the Companies Act clarify that officers are liable to the company for negligence in the performance of their duties.

Principles of business judgment

The principle of business judgment is applied to determine the liability of the officers of a stock company. Whether or not the management judgment was appropriate is judged based on the following criteria.

1. The director must not have any interest in the management decision.
2. The director is sufficiently informed about the management decision to the extent that he or she reasonably believes it is appropriate under the circumstances.
3. The director reasonably believes that the management decision is in the best interests of the company.
4. The management decision is not in violation of any laws or regulations.

Exemption from liability for damages to the company

The liability of directors of a stock company for damages to the company can be exempted by the consent of all shareholders (Article 424 of the Companies Act). In a small company of a certain size, the number of shareholders is limited, so it is likely that the liability may be exempted with the consent of all shareholders.

Partial Exemption from Liability

When an officer performs his/her duties in good faith and without gross negligence, he/she may be exempted from liability for an amount exceeding the minimum liability limit by a resolution of a general meeting of shareholders (Article 425, Paragraph 1 of the Companies Act). In this case, the director must explain “the fact that caused the liability and the amount of liability,” “the limit of the amount that can be exempted and the basis for calculation,” “the reason why the liability should be exempted and the amount of exemption,” at the shareholders’ meeting at which the resolution for exemption from liability is adopted. The minimum liability limits are as follows.

1. Representative directors and representative executive officers: 6 times the amount of annual remuneration.
2. Directors other than representative directors and executive officers other than representative executive officers: 4 times the amount of annual remuneration.
3. Other directors, accounting advisors, corporate auditors, and accounting auditors: 2 times the annual remuneration.

Provisions in the Articles of Incorporation regarding exemption by directors, etc.

In the case of a company with corporate auditors, etc., the articles of incorporation stipulate that, if the officer has performed his/her duties in good faith and without gross negligence, the portion of liability in excess of the minimum liability amount may be exempted with the consent of a majority of the directors, if deemed particularly necessary, taking into consideration the nature of the facts that caused the liability, the circumstances surrounding the performance of duties by the officer, etc., and other circumstances. The articles of incorporation of a company may provide that the portion exceeding the minimum liability amount may be exempted with the consent of a majority of the directors (Article 426, Paragraph 1 of the Companies Act).

Liability limitation agreement

With respect to the liability of directors, accounting counselors, corporate auditors, and accounting auditors other than executive directors for the company, the articles of incorporation may provide that if such officers perform their duties in good faith and without gross negligence, their liability shall be limited to the higher of an amount previously determined by the company or the minimum liability limit within the amount specified in the articles of incorporation. The Company Law of Japan stipulates that the Company may enter into an agreement with a director or an executive officer of the Company to limit his/her liability to the higher of the amount previously determined by the Company or the minimum liability amount within the amount specified in the Articles of Incorporation (Article 427, paragraph 1 of the Company Law). This is a so-called limited liability contract.

Directors and Officers Liability Insurance (D&O Insurance)

D&O insurance is an insurance policy that provides for payment by the company on behalf of the directors and officers of the company in the event that they are held liable for damages to the company. If a director or officer is personally liable for a large amount of damages, the liability of the director or officer will become too great and there will be no one left to become a director or officer. Therefore, D&O insurance is designed to cover the director’s liability, and the company can also pay the premiums for D&R insurance.