Shareholder Protection in Close Corporations and the Curious Case of Japan: The Enigmatic Past and Present of Withdrawal in a Leading Economy.

• Author: Koh, Alan K.

TABLE OF CONTENTS I. INTRODUCTION 1210 II. WITHDRAWAL REMEDIES AND CLOSE CORPORATIONS: AN OVERVIEW 1213 A. Close Corporations: Features and Problems 1213 B. Exit by Withdrawal as the Necessary Ultimate Solution 1216 C. Withdrawal as a Common Feature in Leading Economies 1217 III. THE PAST: THE CONTEXT AND PUZZLE OF JAPAN'S CLOSE CORPORATION LAW 1220 A. Japan's Two Close Corporation Forms: Kabushiki Kaisha ("KK") and Yugen Kaisha ("YK") 1220 B. Exit Without Withdrawal: The Exceptionalism of Japanese Close Corporation Law 1223 C. The Puzzle: Does Withdrawal's Historical Absence from Japan's Close Corporations Undermine the Case for Withdrawal? 1227 1. Partial, Functional Substitutes for a Formal Withdrawal Regime 1228 2. Reform Attempt of the 1980s 1231 3. Japanese Businesses Chose Close Corporation Forms Without Withdrawal for a Variety of Strategic Reasons 1233 IV. THE PRESENT: JAPAN'S GODO KAISHA (GK) CORPORATE FORM 1235 A. The GK as a "Membership Company" 1236 1. The Impetus for the GK 1236 2. "Membership Companies": Concept and Design Features 1237 B. Withdrawal: A Semi-Accidental but Defining Feature 1239 V. THE PRESENT: THE LAW OF WITHDRAWAL (TAISHA) AS APPLIED TO THE GK 1242 A. Withdrawal at Will 1242 1. General 1242 2. Deviation by Contract 1243 B. Withdrawal on "Unavoidable Grounds" (yamu wo enai jiyu) 1243 C. Effect of Withdrawal 1247 D. Valuation 1248 1. Default Provision 1248 2. Provision in Corporate Constitution 1250 VI. THE FUTURE: THE TRAJECTORY OF WITHDRAWAL JURISPRUDENCE AND SCHOLARSHIP IN JAPAN 1251 A. The GK's Growing Popularity and Legal Significance 1251 B. Standing on the Shoulders of Giants: What the Law and Scholarship of the United States, United Kingdom, and Germany Can Contribute to the Development of Withdrawal in Japan 1255 1. United States: Greater Complexity without Corresponding Guidance 1256 2. United Kingdom: Proven Track Record of Shareholder Protection against Economically Harmful Conduct through Unfair Prejudice 1258 3. Germany: Versatile, Judicially Developed Relief for a Wide Range of Situations. 1261 VII. CONCLUSION 1263 I. INTRODUCTION

Oppressed, outvoted, and outgunned minority shareholders have an obvious solution for their woes: vote with their feet, sell their shares, and leave the company. But this "Wall Street Rule" is only applicable to shareholders in publicly listed corporations. What if selling your shares on the stock market is simply not an option--because there is no market for them? Although the importance of shareholder exit is taken for granted by corporate governance scholars devoted to the study of public corporations, exit's equally essential role in close corporations--privately owned business entities for which a market for shares does not exist (1)--is often overlooked. Legal solutions enabling the shareholder to voluntarily exit a company with their capital such as the oppression or unfair prejudice remedies in the United States (2) and Anglo-Commonwealth (3) corporate law--which are defined as "withdrawal remedies" in this Article (4)--are therefore vital in close corporations. This family of doctrinally distinct but functionally equivalent legal solutions is ubiquitous and well-established in the world's leading corporate law jurisdictions--the United States, the United Kingdom, and Germany (5)--save one: Japan.

Until relatively recently, shareholders in Japan's close corporations had no access to withdrawal under the law, as neither of Japan's then-dominant close corporation forms--the Kabushiki Kaisha (KK) ("Stock Corporation") and the Yugen Kaisha (YK) ("Limited Liability Corporation")--offered it. (6) This omission attracted little attention in international corporate law literature and was unremedied by both judicial development and statutory reform despite the efforts of Japanese scholars influenced by foreign law models. (7) By revealing how shareholders and other stakeholders in Japan responded to the absence of withdrawal, this Article shows how Japan's experience powerfully demonstrates the importance of withdrawal remedies in practice. (8)

After decades without withdrawal, in 2005 things changed--but not quite as one might expect. It was not the country's venerable close corporation forms that finally received long-overdue withdrawal rights; rather, a new close corporation form, the Godo Kaisha (GK), as introduced by the watershed Kaisha-ho ("Companies Act"), (9) came with withdrawal rights. A legislative invention inspired by the American limited liability company (LLC) and with no relationship to the YK, the GK was conceptualized as a third member of a new legal category, the Mochibun Kaisha (membership companies), which is separate and distinct from both the KK and YK. (10) The availability of withdrawal in the GK flowed from this quirk of legal classification, rather than as any belated response to earlier serious (but ultimately defeated) reform efforts arising from the problems associated with the lack of withdrawal in the KK and YK, or as any result of inspiration from the United States. (11) The advent of the GK presents corporate law jurists with a historic opportunity: a near-blank slate on which conflicts in a new close corporation entity can be solved without the baggage of bad precedent or outdated doctrine. Although Japanese jurists working on the GK have often looked to the United States as a source of inspiration and ideas, this Article offers a different perspective; it argues that withdrawal remedies developed in the United Kingdom and Germany offer greater guidance from a comparative perspective. (12)

This Article proceeds as follows. Part II first introduces the central features of close corporations and the concept of "withdrawal remedies," and then briefly introduces their operation in the United States, United Kingdom, and Germany. Part III sets out the historical context to Japan's close corporation law, and proceeds to identity--and offer a nuanced answer to--an unnoticed (in Western literature) but critical puzzle: If withdrawal is essential for close corporations, how did Japanese corporations and shareholders survive without it for so long? Part IV follows with a concise introduction to Japan's new close corporation form, the GK, highlighting its features and legal significance; some clarifications as to terminology will also be made. Part V is a detailed examination of Japan's withdrawal regime--the first such analysis in the English language. Part VI takes stock of the GK's growing importance, and offers comparative insights from the United States, United Kingdom, and Germany for the development of the GK's withdrawal regime. Notwithstanding the lack of jurisprudence and awareness about the GK's withdrawal regime and the KK's continued popularity as a close corporation entity despite the absence of withdrawal, the GK's ascendance makes withdrawal a rare and valuable opportunity for comparative corporate law jurists to make an impact on close corporation law: the corporate law of the ordinary businessperson.

2. WITHDRAWAL REMEDIES AND CLOSE CORPORATIONS: AN OVERVIEW

   1. Close Corporations: Features and Problems

      Close corporations, like all business corporations, possess standard corporate characteristics, such as separate legal personality (entity shielding) and formal separation at law of share ownership and management power. (13) Although impossible to define with certainty, (14) "close corporations" are associated with specific characteristics, particularly restrictions on shareholder exit and informal management arrangements.

      Restrictions on shareholder exit. Although equity interests in corporations may be freely transferred, (15) shares of close corporations are typically subject to share transfer restrictions, whether mandatory (16) or as adopted by the company's constitution. (17) Lack of secondary markets for such shares (18) means that unhappy shareholders do not have the option of following the "Wall Street Rule" and selling their shares on the stock market. (19) Thus, share transfer restrictions often translate into stable shareholding structures in close corporations with permanent majorities and minorities. (20)

      Informal management arrangements. Shareholders often participate directly in close corporation management as directors, employees, or both. (21) The absence of clear separation between ownership and control creates organizational and managerial problems distinct from public, widely held corporations. Overlap between management and shareholders and the small number of shareholders in a close corporation aligns the interests of the two classes. (22) Conflicts between directors and shareholders--the dominant agency problem in widely held corporations--are thus rare in close corporations. (23) Instead, the primary problem is conflict between shareholders, particularly majority/controlling versus minority shareholders. Despite advantages associated with the strong personal relationships between co-shareholders, (24) there is a downside: conflicts between shareholders are the "Achilles heel" of the close corporation. (25) Rent-seeking behavior aside, personal conflicts may also spill over into the business realm (26) with potentially devastating consequences for the corporation's operational health or even its continued existence. (27)

      Shareholder conflicts may arise when the majority and minority disagree on issues such as business direction or fundamental changes such as the sale or restructuring of the business. (28) Other conflict situations include unmet minority expectations on returns or participation in the business; or the exercise of rights or powers by the majority in ways that are abusive or harmful to the minority. (29) Absent special legal rules for the protection of the minority, the result is most often a fait accompli in favor of the majority; this is because the principle of majority rule grants majority shareholders substantial control over the...