Japan
Shareholder derivative action: safeguards against abuse
by Koji Takahashi
he shareholders of a company entrust the daily
management of the company to a group of experts,
namely directors. But as the owners of a company,
shareholders maintain certain means of influence over themanagement of the company in order to protect the value of
their shares and their right to receive dividends. Normally theirinfluence is exercised through the expression of opinions andthe casting of votes at shareholders' general meetings. However,there are other means of influence and one of them is thederivative action. It is an action against directors brought by ashareholder on behalf of the company. Where a company hasT

incurred damage due to a breach of duty by a director, thecompany is entitled to take an action against the director, but is
usually reluctant to do so. The derivative action enables
shareholders to enforce directors' liability on behalf of thecompany. This article examines some aspects of its recentaction (see Amicus Curias, Issue 6, p. 7).

SAFEGUARDS AGAINST ABUSE
A shareholder wishing to bring a derivative action must firstdemand that the company initiates an action against thedirectors and must allow the company 30 days to decide
whether to accede to or reject the demand (art. 267(2) of theCommercial Code. art. 267(3) provides an exception where
there is a risk that the company may suffer irrecoverable loss by
the lapse of 30 days). Only a shareholder who owns a sharecontinuously for the past six months may make this demand(art. 267(1) of the Commercial Code).
These requirements may be effective in curbing frivolous
actions. However, thev will have a limited effect in deterring
those shareholders who are determined to abuse the derivativeaction. A shareholder can bring a derivative action even if theyJO

operation in Japan.

bought a share after discovering an assailable director's conduct.

REFORM OF THE DERIVATIVE ACTION

All they have to do is wait six months after buying a share, makea demand and wait a further 30 days. The decision of thecompany not to bring an action, however well-reasoned, cannot
stop the shareholder starting an action. (To avoid bias in favour

In Japan the derivative action was relatively unused until
recently.
The obvious disincentive for shareholders to bring a derivative
action is meagre personal reward for winning the action, since
any recovery awarded accrues to the company, not to theplaintiff-shareholder. The shareholder benefits only indirectly
through the increase in dividend or in the value of his shares,of the targeted directors, it is not directors but auditors who aregiven power to decide whether the company should accede to
the shareholder's demand: art. 275 4 of the CommercialCode.)which can be negligible.
One of the other disincentives, until recently, was expensive
filing fees that a plaintiff might have to pay to initiate a derivativeaction. Until recently the filing fees were a certain proportion of
the amount claimed from the directors. In derivative actions thisamount can be enormous.
However, in the aftermath of a series of corporate scandals
that came to light with the collapse of the bubble economy, steps
were taken in 1993 to strengthen the shareholders' grip on
management by making the derivative action more available. As
one of the main features of the reform, the filing fees were setat 8,200 yen (approximately £40), regardless of the contested
amount (art. 267(4) of the Commercial Code; art. 4(2) of the
Civil Procedure Expenses Act).

EFFECT OF THE REFORM
The 1993 reform resulted in a dramatic increase in thenumber of derivative actions. The size of actions has also grownsince the amount of filing fees no longer goes up with theamount claimed. Consequently, the derivative action has now
become a potent deterrent to managerial misconduct.
On the flip side, concern is growing over abusive derivativeactions. Corporate racketeers called sokaiya and otherunscrupulous shareholders may use the derivative action to put
pressure on directors with a view to extorting money or toresolving a personal dispute with the company in their favour.
Regardless of the strength of their claim, the directors may findit cheaper to yield to their demand than to fight through theFAME
In one case, a derivitave action was brought in order that the plaintiff
might become famous and thus able to claim higher tees as an
attorney

DISMISSAL OF THE CASE AS AN ABUSE OFRIGHTThe intended purpose of conferring on shareholders the rightto pursue a derivative action is to obtain recovery of damages forthe company. If a shareholder brings a derivative action for otherpurposes, e.g. to cause harm to the directors, it may bedismissed as an abuse of right (e.g. Nagasaki District Court, 19February 1991).
However, since a plaintiff-shareholder's personal gain fromwinning a derivative action can be minimal, it is not always
possible to expect shareholders to bring a derivative action
genuinely for the purpose of obtaining recovery for thecompany. If the claim is well founded, the action should not bedismissed too easily just because the plaintiff has an unintended
purpose. Thus in one case, the plaintiff brought the derivative
action in order to become famous, so that he would be able toclaim higher fees as an attorney. The court denied the motion todismiss the action on the ground of abuse of right. Instead, it
proceeded to try the merits of his claim and eventually held in
his favour (Tokyo High Court, 3 July 1989; affirmed by SupremeCourt, 9 September 1993. See also Tokyo District Court, 1831April 1991; Tokyo District Court, 26 October 1995).

ORDER FOR THE PROVISION OF SECURITY

totally sure that the defendant-directors are liable, especiallywhere the determination of their liability is subject to thebusiness judgment rule. In such cases the plaintiff does not

When a derivative action is initiated, on the fulfilment ofcertain requirements the court may order the plaintiff toknow that the claim lacks legal grounds. But the defendant may
still be able to show by prima facie evidence that the plaintiff isprovide security (art. 267(5) of the Commercial Code).

negligent in not knowing that the claim lacks legal grounds.

Dual purpose of the order
The primary purpose of orders for the provision of security isto secure the recovery of damages for a wrongful action. If aplaintiff loses a derivative action, he or she may have to pay
damages to the defendant if the court determines that he or shethat the claim lacked legal
knew or did not know in negligenceoo oor factual grounds or the institution of the action was otherwise
considerably improper. (For the requirements of a wrongfulaction in general, see Supreme Court, 26 January 1988; in thecontext of the derivative action, see Tokyo District Court, 25May 1990.)

that even if theTurningo to the second test,' this test suggests
ooplaintiff's claim is legallv and factually well founded, an order forthe provision of security may be made if the action is brought fora wrongful purpose. If the plaintiff's claim is well founded, theplaintiff will win the action and the question of damages for
O1

JJ'

wrongful action will not arise. Justification for making an orderin such cases would have to be sought from the secondary
purpose of the order, i.e. curbing abusive actions. However,instances where an order was made solely on the basis of thesecond test are in fact rare. Typically, the second test has been
employed to confirm the plaintiff's bad faith ascertained by the
first test. Thus where a plaintiff brings a derivative action solelyfor the purpose of avenging on directors, often the claim isgroundless and the plaintiff is aware of that (e.g. Nagoya High
Court, 8 March 1995; Nagoya District Court, 22 September1995).
So far a clear definition of wrongful purpose has not emerged.
It must be remembered that shareholders cannot always be
expected to bring a derivative action genuinely for the purposeof obtaining recovery for the company. The courts in some cases
suggested that ill-feeling towards directors alone did notOOO

constitute a wrongful purpose (e.g. Tokyo District Court, 22 July
1994; Tokyo District Court, 21 February 1995).
A particular question arises where a shareholder brings aderivative action in pursuit of what they see as social or politicaljustice. A claim may be framed in terms of accusing directors of
causing loss to the company by allowing excessive expenditure
The secondary purpose of orders for the provision of security
is to deter abusive actions. Orders are often made to attain bothpurposes. The primary purpose alone cannot explain why theto pursue their plan to build a nuclear power plant, a golf courseor the like. The courts have not yet reached a consensus as towhether such motives constitute a wrongful purpose. Whilecourts have often ordered a prohibitive amount of security,
leaving the plaintiff with no choice but to give up the action.
Since the courts have been displaying a strong tendency to grantmotion for security, some commentators are warning that thesome courts held that pursuit of perceived social or politicaljustice indicated a wrongful purpose (Nagoya District Court, 28February 1995; Gifu District Court, 16 January 1997; OsakaDistrict Court, 28 August 1996 the case turned on different

availability of the derivative action may be unduly restricted by
the increase in the costs of litigation, a result contrary to theissues), one appeal court reversed such ruling but added that, if
the plaintiff prosecuted their action in a manner driven solely byintention of the 1993 reform to lower the filing fees.

their social or political goal, the provision of security might beordered in the course of proceedings (Nagoya High Court, 15
November 1995; appeal from Nagoya District Court, 28

Requirements for issuing the order
The court may order the provision of security upon prima
facie showing by the defendant that the derivative action has
been brought in 'bad faith' (art. 267(6) and 106(2) of theCommercial Code). The Japanese word for 'bad faith', akui,February 1995). The answer to this question would depend on
the extent to which companies are to be expected to assume
social responsibilities. @appears in various contexts of different statutes and assumes
to malicious intent
from mere knowledge
different meaningsoodepending on the context. In the context of ordering theprovision of security in derivative actions, the previous cases,
although not invariably, have found 'bad faith':
thatknows or does not know in negligence
where the plaintiffo o1
the claim lacks legal or factual grounds;
where the plaintiff brings an action for a wrongful purpose.
(The leading case is Tokyo District Court, 22 July 1994.)
It is to be noted that the first of these two tests mirrors therequirements for obtaining damages for a wrongful action. A
shareholder, in initiating a derivative action, is sometimes notKoji Takahashi
Associate Research Fellow of the Institute of Advanced Legal Studies, PhD(London)