Liability

Liability of undertakings

What are the risk and compliance management obligations of members of governing bodies and senior management of undertakings?

Duties under the Companies Act

Directors and officers have a duty of care that includes a duty to supervise other directors and officers, and employees of the company. Under court precedents, directors are required to supervise the general operation of the company’s business by the representative director and, if necessary, to convene or request to convene the board of directors to ensure that the operation of the business would be done appropriately through the board. However, the courts also ruled that, since it was not practical to supervise all the actions of a representative director, the directors were deemed to be in violation of their duty of supervision only if they knew or should have known of the representative director’s actions but failed to act.

In addition, directors have a duty to establish the company’s internal control system. The courts ruled that, since an appropriate internal control system varies depending on the size, type of business and other aspects of the company, directors, who are considered specialists in the management of the company, have broad discretion in establishing the internal control system. The courts also ruled that, in principle, it is sufficient for directors to establish a control system to prevent foreseeable wrongdoings, and that the directors are not liable for negligence for failing to establish a risk management system to prevent all wrongdoings unless there are special circumstances in which the directors should have foreseen the occurrence of a wrongdoing that would usually be difficult to foresee.

A statutory auditor has a duty to supervise directors, not only over their actions but also over the establishment of the company’s internal control system.

 

Duties under the Financial Instruments and Exchange Act

In general, directors and officers have a duty to file securities reports and to ensure accurate and adequate disclosures in the internal control reports. A securities report must contain statements on the status of corporate governance, which must include an overview of the company’s internal control system, risk management system and a system that ensures compliance by the subsidiaries with internal control and risk management policies.

Do undertakings face civil liability for risk and compliance management deficiencies?

If there are any false statements, omissions or misleading statements of material fact in the description of corporate governance in the securities report, undertakings are subject to civil liability for investors who incur damages owing to these statements under the Financial Instruments and Exchange Act (FIEA). In relation to this, in a recent case, the court found that while the internal control system of a listed corporation (defendant) did not function appropriately, the defendant was not liable because the description of the internal control system was not found to be untrue.

Undertakings are also subject to civil liability if there are any false statements, omissions or misleading statements of material fact in the internal control report under the FIEA. However, there have been no cases that found such a civil liability.

In general, a violation of Japan’s Corporate Governance Code (the Code) introduced by the Tokyo Stock Exchange, Inc (TSE) itself does not result in civil liability of undertakings.

Do undertakings face administrative or regulatory consequences for risk and compliance management deficiencies?

If there are any false statements or omissions of material fact in the description of the status of corporate governance in the securities report, undertakings are subject to administrative monetary penalty under the FIEA. Recently, the Financial Services Agency (FSA), at the recommendation of the Securities and Exchange Surveillance Commission (SESC), imposed an administrative monetary penalty on a listed company owing to a false statement on the status of its corporate governance in its securities report. The listed company stated that they appointed a director in charge of compliance and formed an audit office. However, the SESC and FSA found that they had never appointed this director and that the audit office did not exist in substance.

The FIEA does not impose any administrative monetary penalty for a false statement or omission of material fact in the internal control report.

A false statement in the securities report is also a violation of listing rules. Thus, if the Japan Exchange Regulation (JPX-R) finds it necessary for the listed company to improve its internal control system, then the JPX-R will designate it as securities on alert. As securities on alert, the listed company will be delisted unless it rebuilds its internal control system within one-and-a-half years.

Do undertakings face criminal liability for risk and compliance management deficiencies?

If there is any false statement of material fact in the description of the status of its corporate governance in the securities report or the internal control report, undertakings are subject to criminal liability under the FIEA. However, there have been no cases that found such a criminal liability.

A violation of the Code introduced by the TSE itself is not subject to criminal liability.

Liability of governing bodies and senior management

Do members of governing bodies and senior management face civil liability for breach of risk and compliance management obligations?

Directors and officers have a duty of supervision, as a part of their duty of care, and a violation of that duty may result in the civil liability of the directors or officers to the company. The representative director is more likely to be found liable than other directors given that he or she is operating the business.

Directors have a duty to establish an internal control system, as a part of their duty of care, and a violation of that duty may result in civil liability of the directors to the company. However, in practice, directors are found to be liable only if there are special circumstances in which the directors should have foreseen the occurrence of a wrongdoing that would usually be difficult to foresee.

Directors and officers are subject to civil liability if there are any false statements, omissions or misleading statements of material fact in the description of the status of the company’s corporate governance in the securities report or the internal control report under the FIEA. However, there have been no cases that found such a civil liability.

Do members of governing bodies and senior management face administrative or regulatory consequences for breach of risk and compliance management obligations?

The Companies Act does not impose administrative sanctions on directors or officers if they violate their duty of supervision or duty to establish an internal control system.

The FIEA also does not impose administrative monetary penalties on directors or officers for false statements, omissions or misleading statements of material fact in the description of the status of corporate governance in the securities report or the internal control report.

Do members of governing bodies and senior management face criminal liability for breach of risk and compliance management obligations?

The Companies Act does not impose criminal liability on directors or officers for a violation of their duty of supervision or duty to establish an internal control system.

Making a false statement in the description of the status of corporate governance in the securities report or internal control report may result in criminal liability of directors or officers who are involved in making that false statement. However, there has been no case that found such a criminal liability.

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12 February 2021.