Japan's Commercial Code Reform and the Treatment of "Pseudo-Foreign Companies"

June 23 (Thursday) 2005

The new commercial code draft revision, hailed as the "Great Reform," is now being discussed in the Diet. Though the bill has received various criticisms, one item in particular that has been the object of international focus during the past few weeks is article 821, which contains the regulations concerning "pseudo-foreign companies" (giji gaikoku kaisha), a.k.a quasi-foreign companies.

First is it important to briefly explain what a pseudo-foreign company is. Under article 482 of the former commercial code, all companies doing business in Japan have to be established according to Japanese law. Pseudo-foreign companies are foreign companies that mainly do business in Japan but, because they are foreign, are not established according to Japanese law. A typical example is a company whose main office is located abroad but who has branch offices in Japan. When setting up a branch office, it is not necessary that the company be in compliance with Japanese laws.

This is the first reform in five years of a law that extends back to the beginning of the century. Because the reform changes the broader regulations relating to companies, many are saying that it will establish, for the first time, a system for corporation law. As a part of these changes, article 482 of the former commercial code has been rewritten and "modernized." Specifically, item 1 of article 821 in the new commercial code states that "pseudo-foreign companies cannot do business in Japan," while item 2 states that "if a pseudo-foreign company should damage a client as a result of a transaction, the individuals of the pseudo-foreign company must compensate the damages."

Concerned people were not aware that these articles and items were included in the new commercial code until after May. In other words, once the draft revision was submitted to the House of Representatives, it was then passed to the House of Councilors who began deliberations on it at the end of May. The revised law is expected to be passed in the next few days.

Thus, only recently has it been widely recognized just what the law implies: from the day it is passed, no pseudo-foreign company can do business in Japan. Three years ago, Prime Minister Koizumi invited global attention when he announced to the world his policy to double incoming FDI. Formal legislation, such as this, that closes out pseudo-foreign companies from Japan will give a contradictory message. Thus, a serious debate is taking place amongst the interested parties.

Legally speaking, there is no problem with the revisions themselves. Japan is a lawful nation and a sovereign nation, and this goes without saying. The problem, however, has to do with whether or not enough explanation has been given beforehand to those (particularly foreign companies) that will be affected by such a strict law. Foreign companies say no. The Justice Ministry holds to the policy that an explanation on their website is sufficient. They had to watch over it until it became a bill. A second problem has to do with the fact that doing business through the branch office is a practice that has been established since the early 1900s, especially by financial institutions. The practice, moreover, was developed under the guidance of the Japanese government, who advised foreign companies to setup branch offices instead of establishing subsidiary companies. How can we now tell companies who have conformed to the will of the government and have done decades of business in Japan that, because of this one simple law, "your business must go as of today?"

Foreign interest groups such as the ACCJ (American Chamber of Commerce in Japan) and the EBC (European Business Council in Japan) are expressing their alarm to the Japanese government, the people involved, and to me as member of the Committee on Japan Directed Foreign Investment. In the few days remaining, they are making requests to see whether or not the House of Councilors can amend the bill.

From the government's perspective, because the commercial code is an issue that is tied up with the privatization of the postal system, it will be extremely difficult, politically speaking, to amend the law in the Diet once it has been approved by the Cabinet.

In this way, the issue of article 821 of the commercial code has become a difficult tangle. Though the bill itself is lawful, it must be said that there are problems in its delivery, and problems in the way of explanations.

With the current state of Japanese politics as it is, in the case that an immediate bail out plan cannot be put together, it may be necessary for the Diet and the policy makers to sit and wait. However, if this becomes the case, it will be necessary for them afterwards to do everything within their power to secure the trust of Japan's international community.