A shareholder agreement refers to a contract between two or more parties who either jointly establish a corporation for a specific project or business or involve a new investor in an existing company. This agreement sets out the rights and obligations between shareholders concerning the operation of the company.
In a Japanese joint-stock company, corporate governance and management are generally carried out through shareholder meetings and the board of directors, applying the majority rule based on each shareholder’s equity ratio. Shareholder agreements create a privately negotiated framework for company management, distinct from the statutory governance structures. These agreements are especially crucial for protecting the interests of minority shareholders, who may otherwise be disadvantaged by majority rule.
Among the key elements often included in shareholder agreements are the right to nominate directors and the clause binding the exercise of voting rights. For instance, Shareholder A might have the right to nominate two out of four directors, and the other shareholders are contractually obligated to exercise their voting rights to ensure those nominees are appointed at the general shareholders’ meeting.
This post will focus on voting agreements in shareholder contracts, particularly in the context of recent discussions and court rulings in Japan that have addressed the validity and enforceability of such agreements.
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Validity of Voting Agreements in Japan
In Japan, earlier legal theories suggested that voting rights were considered to have a nature of public rights, meaning that private agreements restricting or prohibiting their exercise would be deemed invalid. However, the current prevailing view has shifted to recognize that voting agreements are valid under the principle of freedom of contract, allowing shareholders to predetermine how their voting rights will be exercised.
It should, however, be noted that the Japanese courts still have a tendency to limit the validity of these agreements in certain cases. Below, we’ll take a closer look at two significant court rulings that highlight these limitations.
Tokyo High Court Ruling, January 22, 2020: Limiting Binding Effect Based on Changing Circumstances
In this case, three shareholders had entered into an agreement to appoint each other as directors of the company. The complication arose because the agreement had been made over 50 years earlier, and all the original parties had since passed away, with their shares being inherited by others.
The Tokyo High Court acknowledged the validity of the voting agreement but concluded that it was only effective for the immediate shareholders’ meeting at the time of the agreement. Given the significant passage of time and the altered circumstances, the court ruled that the agreement was no longer legally binding.
The court emphasized the importance of evaluating the context of each shareholder agreement, noting that the parties’ intentions and the surrounding circumstances must be carefully considered to determine whether a binding legal effect was intended at the time the agreement was made.
“Shareholder agreements vary widely depending on the attributes of the parties involved, the terms of the contract, the motives and objectives behind the agreement, the types of shares or voting rights held by the parties, and the timing of the agreement. As such, the parties’ understanding of whether the agreement has legal force, and if so, to what extent that legal force applies, also differs significantly. When evaluating claims based on a shareholder agreement, it is essential to review each agreement on a case-by-case basis, taking into consideration the intent of the parties and the relevant provisions of corporate law and other applicable regulations. The court must explore whether the parties intended for the agreement to have legal enforceability, or if it was merely a gentleman’s agreement without legal effect. If the parties intended for the agreement to be legally binding, the court must then determine the scope of that enforceability—whether it is limited to claims for damages, allows for the enforcement of voting rights in line with the agreement, provides grounds for the cancellation of resolutions made in violation of the agreement at a shareholders’ meeting, or includes provisions regarding the expiration of the agreement. The court will then assess the facts to decide if the legal effects claimed by the parties can be upheld”
This 2020 Tokyo High Court ruling, which traces the development of legal theories and practices in Japan concerning voting agreements, provides insights into various key issues surrounding these agreements. It is widely regarded as one of the most authoritative sources for understanding the current judicial stance on the enforceability of voting agreements in Japanese courts.
Tokyo High Court Ruling, May 30, 2000: Limiting Binding Effect Based on Contract Duration
This case involved a shareholder agreement between two business partners who agreed to elect themselves as directors and receive compensation for 18 years. The court acknowledged the general validity of the voting agreement but ruled that the 18-year duration excessively restricted the freedom to exercise voting rights. The court thus limited the enforceability of the agreement to 10 years.
This ruling faced criticism, as some argued that long-term agreements can create a stable environment for minority shareholders and new investors under the shareholders agreement.
Subsequently, the above-mentioned 2020 Tokyo High Court ruling adopted the view that “it is unnecessary to arbitrarily impose a validity period on shareholder agreements, such as those in some U.S. state laws that limit contracts to 10 years, in the absence of specific provisions,” departing from earlier interpretations.
Enforceability: Forced Performance of Voting Agreements
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Debate
In Japan, legal discussions regarding voting agreements have centered on the scope of enforceability. The key issue is whether, when a shareholder breaches a voting agreement, the other party can only claim damages, or whether they can also compel specific performance (e.g., through court orders or injunctions).
Traditionally, the majority view in Japan held that when a voting agreement was breached, only a claim for damages could be made. However, more recently, two prominent views have emerged:
The first view asserts that if all shareholders are parties to the voting agreement and the specifics of how the voting rights should be exercised are clearly defined, then specific performance (such as injunctions or presuming the vote has already been cast) can be enforced.
The second view argues that, even if not all shareholders are parties to the agreement, as long as the voting agreement is recognized as valid, the performance of contractual obligations should generally be enforceable under civil law, allowing for specific performance.
Case Law
In past rulings, several lower court decisions appeared to follow the traditional majority view, denying the enforceability of voting agreements through specific performance.
For example, in the Nagoya District Court decision on November 12, 2007, the court reviewed the validity of a voting agreement in light of the theory presented by the first view and ultimately dismissed the injunction request. The court reasoned that not all shareholders were parties to the agreement, and the voting obligations were not sufficiently clear as claimed by the creditor. However, this ruling merely used that reasoning as one of several grounds for dismissing the request. So it would be inaccurate to conclude that the Nagoya District Court was fully endorsing the first view of voting agreements in Japanese law.
The 2020 Tokyo High Court ruling, which followed the earlier Nagoya District Court decision, left open the possibility of enforcing voting agreements by opining that the enforceability of voting agreements may vary depending on the “specific circumstances” of each case.
Most recentlt, the Tokyo District Court ruling of June 24, 2022, went a step further by granting an injunction based on a shareholder agreement within a startup. This agreement included provisions for director nomination rights and binding voting obligations. The court upheld the enforceability of the voting agreement by compelling the exercise of voting rights in line with the agreement’s terms.
Effect of Shareholder Resolutions in Breach of Voting Agreements
In Japan, the dominant legal view is that when a shareholder bound by a voting agreement exercises their voting rights in violation of the agreement at a shareholders’ meeting, this does not constitute grounds for nullifying the resolution.
What is notable, however, is that when all shareholders are parties to the voting agreement, many legal scholars equate a breach of the agreement with a violation of the company’s articles of incorporation, which can serve as grounds for nullifying the resolution.
The 2020 Tokyo High Court ruling echoed this sentiment, stating that “if a shareholder resolution is made based on a vote that violates a voting agreement, it may be possible to annul the resolution in the same way as when there is a breach of the articles of incorporation.” The court limited this possibility to situations where all outstanding shares are held by parties to the voting agreement, to prevent any unintended impact on shareholders not bound by the agreement.
Conclusion
The debate in Japan over the validity and enforceability of voting agreements has evolved toward recognizing their legal effect. However, the scope of enforcement largely depends on the specific terms of the agreement and the circumstances at the time it was formed.
Foreign companies and startups entering into shareholder agreements with Japanese companies should thoroughly understand Japanese legal practices regarding such agreements and voting provisions. To minimize the risk of future disputes, it is essential to work with legal professionals to clearly define the voting terms and duration.
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Our law office has extensive experience in advising on shareholder agreements and voting restriction agreements in Japan, focusing on the nuances of corporate governance and the specific needs of our foreign clients. We understand that these agreements are crucial for maintaining harmonious relationships among shareholders and ensuring that decisions are made in the best interest of the company. If you need legal assistance or representation in these areas, whether you are a startup or an established enterprise, feel free to contact us by clicking here to discuss your unique situation and how we can support your business objectives.
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