Conflict-of-Interest Transactions Between Group Companies: Approval Procedures and Minutes in Practice

Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.

In a corporate group where the same person serves as representative director of several companies, when you are preparing a service agreement between two of those companies, there comes a moment when your hand stops just before the signature block. That is because the name on the client side and the name on the contractor side will be the same person. Together with the contract terms, you confirm whether this transaction requires approval at each company and which corporate body should adopt the resolution. If approval is required, the record of the resolution is kept together with the contract.

Where a representative runs several companies, or where group companies with capital relationships enter into service agreements or loans with one another, such transactions may constitute conflict-of-interest transactions under the Companies Act. Confirming whether approval is required at the stage of drafting the contract keeps the burden of going back much smaller than scrambling to fix things after an external audit or an investor's due diligence has pointed out the issue.

Main Types of Conflict-of-Interest Transactions

Article 356, Paragraph 1 of the Companies Act provides that when a director intends to engage in any of the following transactions, the director must disclose the material facts of the transaction at a shareholders' meeting and obtain its approval:

• When a director intends, for themselves or for a third party, to carry out a transaction within the line of business of the company (Item 1: competing transactions)
• When a director intends, for themselves or for a third party, to carry out a transaction with the company (Item 2: direct transactions)
• When the company intends to guarantee a director's debts, or otherwise carry out a transaction with a person other than a director in which the interests of the company conflict with those of that director (Item 3: indirect transactions)

Competing transactions under Item 1 and conflict-of-interest transactions under Items 2 and 3 are all subject to the same approval procedure, but the purpose of the regulation and the criteria for determining whether a transaction falls within each must be understood separately. Where a representative holds positions at several companies, the ones particularly examined are the second, direct transactions, and the third, indirect transactions.

Where a representative serves simultaneously as representative director of Company A and Company B, a service agreement or loan agreement concluded between the two companies takes the form of the representative director carrying out the transaction on behalf of the counterparty company. Although the representative director does not personally become a direct party to the contract, the transaction falls within the statutory wording "when a director intends, for themselves or for a third party, to carry out a transaction with the company," so the basic understanding is that it is treated as a direct transaction.

Typical examples of indirect transactions include Company A acting as guarantor for Company B's borrowing, and Company A providing its assets as collateral to support Company B's borrowing. The parties to the contract are Company A and the financial institution, which are separate entities from the representative personally and from Company B. However, the result is that Company A bears the debts of Company B, which the representative controls, and the interests of Company A and those of the director are placed in conflict; where such a conflict of interest is recognized, the transaction is subject to approval as an indirect transaction.

That said, the mere existence of a common representative or a group relationship does not necessarily mean that every guarantee or provision of collateral automatically constitutes an indirect transaction. The determination is made by confirming whether there is a conflict of interest between the company and the individual director, the shareholding relationships, and the substantive burden borne by the company. It is also worth noting that the mere fact that the transaction terms are at a fair level does not automatically exempt the transaction from the approval procedure.

Transactions routinely entered into among group companies broadly include those requiring attention. Many transactions can be covered, such as service agreements between a parent and a subsidiary, loans between companies with a common representative, and agreements under which one company guarantees another company's debts. Confirm each time whether each transaction fits the categories of conduct prescribed by law.

The Approving Body Depending on Corporate Governance Structure

The approval procedure for conflict-of-interest transactions differs depending on whether the company has a board of directors.

A company without a board of directors obtains the approval of a shareholders' meeting under Article 356, Paragraph 1 of the Companies Act. The flow is to disclose the material facts, such as the purpose, consideration, and term of the transaction, at the shareholders' meeting and then obtain an approval resolution in advance.

On the other hand, in a company with a board of directors, Article 365, Paragraph 1 of the Companies Act replaces "shareholders' meeting" in Article 356, Paragraph 1 with "board of directors," so approval by the board of directors suffices instead of the shareholders' meeting. In a corporate group, there may be a combination in which the parent company has a board of directors but newly established subsidiaries or sister companies do not. In such a case, identify the approving body for each company that is a party to the transaction, according to its governance structure. If Company A has a board of directors and Company B does not, the approving bodies differ by company: on Company A's side, approval by the board of directors; on Company B's side, approval by the shareholders' meeting.

In board resolutions, the treatment of directors with a special interest under Article 369, Paragraph 2 of the Companies Act becomes an issue. Article 369, Paragraph 2 of the Companies Act provides that a director who has a special interest in a resolution of the board of directors may not participate in the vote. A person who serves as representative director of both companies represents the counterparty to the transaction and is also in a position to participate in the decision-making of the company they represent, so they are understood to be a director with a special interest in the approval resolution.

A director with a special interest not only cannot exercise voting rights but is also excluded from "the number of directors who can participate in the vote," which is the basis for the quorum. When writing the minutes, do not remove that director's attendance from the meeting as a whole when they attended for other agenda items; instead, record accurately that they did not participate in the vote because they had a special interest in the deliberation and resolution of that agenda item. Then make clear in the minutes that the remaining directors, excluding the interested director, satisfied the quorum and the requirements for passing the resolution.

Post-Transaction Reporting to the Board of Directors

In a company with a board of directors, legal procedures remain even after the transaction has been carried out with prior approval. Article 365, Paragraph 2 of the Companies Act provides that in a company with a board of directors, a director who has carried out a transaction under any item of Article 356, Paragraph 1 must, without delay after the transaction, report the material facts of the transaction to the board of directors.

This post-transaction report is provided as an opportunity for the board of directors to confirm that there is no discrepancy between what was disclosed at the time of approval and the actual transaction. Together with the record of prior approval, decide who will make the post-transaction report. With ongoing transactions, a situation can arise in which, after prior board approval has been obtained once for a service agreement, individual orders and payments under the agreement continue, yet the status of the transactions is never reported to subsequent board meetings. Therefore, separately from the minutes of the approval resolution, record in the minutes the fact that a report was made and its content.

Where approval is given by a shareholders' meeting, that is, in a company without a board of directors, this post-transaction reporting obligation under Article 365, Paragraph 2 of the Companies Act is not imposed. The fact that whether a post-transaction report is required changes depending on the governance structure is easy to overlook when the structures of the group companies differ. Also, even in a company with a board of directors, if the matters to be reported are notified to all directors (and, in a company with company auditors, also to the company auditors) and the requirements of Article 372, Paragraph 1 of the Companies Act are satisfied, it is possible to omit the report. A company with company auditors here does not include a company that has only company auditors whose audit scope is limited to accounting. Since it is not uniformly required to hold an in-person board meeting for every individual order, set up the operation while taking the practical burden into account.

The Effect of Transactions Lacking Approval

The effect of a conflict-of-interest transaction carried out without approval is not determined uniformly. The effect is examined by distinguishing whether it is a direct transaction between the company and a director or a transaction involving a third party, and taking into account matters such as whether the counterparty knew of the lack of approval. The extent to which the company can assert invalidity also differs depending on these circumstances. It cannot be concluded that a transaction is always valid or always invalid simply because there was no approval.

In transactions between group companies, the representative is often thoroughly familiar with the internal circumstances of both sides of the transaction, so whether an explanation that the counterparty did not know of the lack of approval can hold up is checked against the history of the approval and the representative's knowledge. However, the specific contract terms, the extent to which the procedure was lacking, and the substantive impact on the company's profit and loss must be examined individually. In addition, even if a ratification resolution is adopted after the fact for an unapproved transaction, that alone is not understood to uniformly release the director from liability to the company for neglect of duties. If a procedural defect is found, it is safer not to decide on your own whether the transaction is valid, but to confirm at an early stage whether ratification is possible and how to correct the procedure.

Practical Handling of Intra-Group Transactions and Building the Framework

In a structure where a representative serves as representative director of several companies, transactions arising within the group may fall into the categories of conflict-of-interest transactions. In practice, the following checks and procedures are effective:

• Determining, before concluding a new intra-group contract, whether it is a conflict-of-interest transaction for each of the companies involved
• Listing each company's governance structure (whether it has a board of directors) and organizing the approving body for each counterparty
• Stating in the minutes of the approval resolution the name of the director with a special interest and that they did not participate in the vote
• Placing post-signing reports to the board of directors on the agenda for transactions involving a company with a board of directors
• Taking inventory of existing ongoing transactions (services, loans, guarantees, and so on) and confirming past approval procedures

In fundraising and audits, you may be asked to present, as related-party transactions, a list of contracts between group companies together with minutes evidencing the approval procedures. If unapproved transactions are discovered at this stage, negotiations to conclude the investment agreement or the audit schedule may be delayed. If the approval procedure is carried out together with the drafting of the contract, later explanations can also proceed smoothly.

As you take inventory of intra-group transactions, you may find that your due diligence preparation for fundraising as a whole needs to be revisited. This is covered in What Investors Look for in Legal Due Diligence Around Series A. Also, when reviewing the very structure in which multiple stakeholders are involved in the company's decision-making, organizing the decision-making rules discussed in Founder Agreements Can Only Be Drafted While the Founders Are Still Aligned may also be helpful.

For conflict-of-interest transactions between group companies, confirm both the contract terms and the approval procedures under the Companies Act. By establishing approval procedures appropriate to each company's governance structure as internal rules and standardizing the format of board minutes, you can reduce the burden of examining each individual transaction from scratch. LegalAgent's Corporate Governance support covers everything from taking inventory of group companies' governance structures to designing approval flows for conflict-of-interest transactions and reviewing minutes.

For companies with many ongoing transactions, a framework that allows day-to-day contract review and confirmation of approval procedures to be operated together is helpful. How to proceed with approval resolutions can be found in Operating the Board of Directors in Practice, and what to record in the minutes in How to Prepare Shareholders' Meeting and Board Meeting Minutes. If you would like to engage us on an ongoing basis for everything from contract review to checking board minutes, I hope you will also consider our Legal Outsourcing service.

Frequently asked questions

Do transactions between group companies constitute conflict-of-interest transactions?

They may constitute direct transactions or indirect transactions under the Companies Act. This is because a service agreement or a money loan between companies where the same person serves as representative director of both is, as a basic matter, treated as a direct transaction even though it is conducted on behalf of the company. Also, where one company guarantees the other's borrowing, for example, if the interests of the company and those of the director are in conflict, the transaction is understood to be subject to approval as an indirect transaction.

What is required in the approval procedure for conflict-of-interest transactions at a company with a board of directors?

A prior approval resolution of the board of directors is required. This is because, at a company with a board of directors, the board serves as the approving body in place of the shareholders' meeting. In that case, a person serving concurrently as representative director of both companies is understood to be a director with a special interest, cannot participate in the vote, and is also excluded from the quorum count. It is therefore likely necessary to record clearly in the minutes the fact that the director did not participate in the vote because of the special interest, and that the requirements were met by the remaining directors.

Is a conflict-of-interest transaction conducted without approval void?

It cannot be stated definitively that it is immediately void. This is because the effect of the transaction is not determined uniformly but is examined in light of circumstances such as whether it is a direct transaction or a transaction involving a third party, and whether the counterparty knew of the lack of approval. The extent to which the company can assert invalidity also differs depending on these factors. In addition, even if a ratification resolution is passed after the fact, that alone is not understood to uniformly release the director from liability to the company for neglect of duties.