Establishing a Japanese Business Presence

If you've been thinking its time to break into the Japanese computer software market with a domestic business presence, here are some tips on how to go about it, and what to watch out for.

by Karl Ruping

       Robert Orr, vice president of the American Chamber of Commerce in Japan, cautions that "information technology companies must ensure that their competitors do not enjoy a 'profit sanctuary' from which to support anti-competitive campaigns elsewhere." Foreign software developers must also keep track of technological advances emerging from Japanese R&D - and what better way to do this than through a Japanese office.

The forms of business
A domestic presence is not for all foreign software developers. High company establishment expenses are just the beginning of the financial cost-benefit analysis. Particularly in Tokyo, operating costs can make a formal presence prohibitively expensive. "There are also risks to establishing local operations that are difficult to calculate," warns Gerald McAlinn, professor of law at Aoyama Gakuin University.

       Japan's intellectual property laws appear robust but - with limited discovery rules and a slow court system - actual protection remains suspect. Small foreign companies are also at risk of losing staff to large Japanese companies willing to pay a premium for technical expertise. "While local sales and support operations may be necessary," McAlinn warns, "core research and development personnel are best left behind in the more secure home office."

       Setting up a Japanese business is neither easy nor inexpensive. The software developer must consider the level of investment needed to enter the Japanese market, and the appropriate form of corporate presence to ensure this investment will be successful. The following alternatives are available.

Freelancing
If you are an individual entrepreneur, you may be able to pursue business activities in Japan without establishing a formal commercial entity. Unless you are operating in the financial sector or other regulated industry, there are no registration requirements, establishment fees, or disclosure rules. Consider, however, that an individual faces unlimited liability and is subject to domestic personal income tax for all revenues generated in Japan.

       Also, a practical concern for the foreign entrepreneur is securing a long-term visa that permits operating independent of a domestic business entity, a native guarantor, or a Japanese spouse. And even if you have the proper visa, you'll find that Japanese clients and financiers are reluctant to do business with someone whose meishi (name card) lacks a corporate logo.

Partnerships
Two or more parties can establish a partnership under Japanese law. A nin-i kumiai is a Civil Code partnership wherein the parties equally share ownership (and profits or losses), unless otherwise detailed in a contractual agreement. A similar entity is the gomei kaisha, a partnership company that comes under the Japanese Commercial Code. Be aware, however, that the members of both a nin-i kumiai and gomei kaisha are jointly and severally liable for the debts of the partnership. This means that a creditor can pursue one or all general partners for the total amount of a valid claim against the partnership.

       A third option is a limited partnership company, the goshi kaisha. A limited partnership company consists of two types of members: general partners and limited liability partners. General partners represent the company and have unlimited liability for all partnership debts. Limited liability partners have no management rights and cannot represent the partnership, but their financial risk is limited to the amount of capital contribution.

       Both the gomei kaisha and goshi kaisha must register with the local Legal Affairs Bureau of the Ministry of Justice. Such partnerships are attractive for their ease of establishment and lack of capital contribution requirements, and may be a practical initial step for a cash-poor but idea-rich group of software entrepreneurs.Foreign corporations, however, are usually reluctant to assume the risks of unlimited liability under a nin-i kumai Civil Code partnership, and they are not permitted to act as a general partner of a gomei kaisha or goshi kaisha.

Representative/branch offices
Foreign corporations tend to first open either a representative office or a branch office in preparation for formal incorporation. A representative office can be established free of government registration requirements and domestic tax liability. While its foreign staff can qualify for investment/management visas, a representative office cannot engage in domestic business activities. Nevertheless, this restricted business presence is useful for performing preliminary market research, negotiating startup operations, and advertising in preparation for launching formal business activities.

       Unlike the representative office, a branch office can engage in domestic commercial activities. A branch office is a form of direct investment under Japanese law that requires notification to the Ministry of Finance and any other government agencies with regulatory authority over the particular industry. For the foreign software company, this is a single filing with the Bank of Japan. Within three weeks, the branch office must also register with the Legal Affairs Bureau, and designate a legal representative who is a resident of Japan. Despite the more demanding setup requirements, foreign entities generally favor the branch office as a preliminary step to incorporation.

Incorporation
Foreign companies who wish to establish a bona fide Japanese presence can choose from two forms of incorporation: a yugen kaisha (YK) or a kabushiki kaisha.

       The yugen kaisha, or limited liability company, is the easier to establish. It is designed for the small, closely held corporation that is directly managed by the equity owners. Up to 50 investors provide a capital contribution totaling at least ¥3 million. The investors must appoint at least one director, but they are otherwise free to determine the internal operation of the company. A yugen kaisha need not issue stock certificates, must hold only yearly shareholder meetings, and is not required to publicly disclose its financial documents.

       The kabushiki kaisha is a more sophisticated and expensive form of incorporation. Capital contribution is a minimum of ¥10 million, and there is no maximum number of shareholders. There must be three or more directors, of which at least one (a resident of Japan) is a representative director. The corporation must also (depending on its size) appoint one or three statutory auditors. The Japanese Commercial Code places limitations on the authority of the board of directors, ensures shareholder voting rights in regular shareholder meetings, and requires public disclosure of corporate financial statements.

       While the yugen kaisha is easier to establish and has fewer management regulations, most foreign corporations choose the kabushiki kaisha as the preferred form of domestic enterprise. One reason is that the kabushiki kaisha can raise funds by issuing shares. A further consideration is the perceived status of this highly capitalized corporation when dealing with banks, customers, and large suppliers.

Business protection under Japanese law
Before establishing a Japanese presence, a foreign company should be careful to ensure the protection of its proprietary information. Intellectual property rights are fundamentally territorial in nature; a foreign patent, for example, does not establish domestic rights unless the applicant also files in Japan within one year of application in any Paris Convention member state (such as the US or a European Union country).

       Copyright protection of computer software does not require registration or notification formalities, but the necessary level of creativity and the scope of legal protection in Japan may be different from other jurisdictions. [For more on this topic, see "Software Copyright Protection in Japan," April, page 35.-Ed.] Just in case a dispute does arise, the copyright owner is advised to register any proprietary software with the Cultural Affairs Agency in order to establish presumptive ownership and date of creation.

       Where other forms of intellectual property protection are not available or not effective, a company may rely on trade secret (or "know-how") provisions to protect its confidential business information. To qualify for this protection, the trade secret holder must undertake sufficient precautions to prevent the release of the proprietary information, such as requiring nondisclosure agreements from those with access to the information.

       Japanese trade secret law, however, suffers from a serious flaw. Legal procedures are constitutionally open to the public, and the Civil Code does not provide for protective orders or similar judicial measures to ensure privacy. Thus the irony is that, to enforce a trade secret in court, the plaintiff must reveal the proprietary information to the judge and to the rest of the world.

       Trade names and trademarks are a particular area of concern for the foreign company entering the domestic market for the first time. A newly formed company must register its name with the Legal Affairs Bureau located in the administrative district of the proposed corporate office. The corporate name must not conflict with a prior registration in the particular Bureau, but registration in one administrative district does not ensure that a similar corporate name is not or will not be registered elsewhere, or that there is no conflicting trademark. Foreign corporations who unwittingly rely on their registration may be surprised to find a similar name in use elsewhere or, worse, the same or a confusingly similar name registered as a Japanese trademark.

       A foreign corporation should perform a registered corporate name search and a trademark search prior to selecting and using a corporate name in Japan. To ensure exclusive use of a mark in your area of commercial trade, prompt trademark registration is essential.

       When it come to contracts and licensing agreements, some foreign right holders simply translate their standard documents into Japanese without further professional review. But Japanese legalese is just as archaic and complex as any other country's, and even the most cautious translator may not fully understand the implications of the legal terms involved. And beyond the issue of accurate translation is the concern for strategic drafting of those documents. Assuming effective judicial protection of proprietary information, for example,foreign legal staff normally might not consider incorporating an arbitration clause into a nondisclosure agreement to remove trade secret enforcement from a public court. To ensure effective protection for current and future intellectual property rights, the foreign corporation is highly advised to have an experienced Japanese lawyer revise its documents to be consistent with domestic law.

Other considerations
Some companies enter the Japanese market with the assistance of a domestic partner. In general, the incorporation procedures for a joint venture company are the same as for a wholly foreign-owned company. Depending on the size of the parties involved, the joint venture agreement may have to be filed with Japan's Fair Trade Commission to ensure the proposed entity does not hinder competition in a particular market.

       Joint ventures were once the preferred investment vehicle; the domestic party could secure the necessary business contacts, provide marketing expertise, and transfer experienced local employees. But a number of joint venture operations have failed due to conflicting management techniques and corporate philosophies, and increasingly foreign investors are choosing to go it alone. This is particularly true in the computer industry, a relatively new and dynamic market in which established Japanese companies do not enjoy a monopoly on domestic information or experienced staff.

       The post-bubble economy, meanwhile, has exposed some Japanese companies to outright purchases by foreign companies. In 1996, the number of domestic acquisitions by foreign parties numbered only 13 - but this was more than double the figure for the previous year. Intuit's $39 million acquisition of Nippon Micon and McAfee Associates' $21 million purchase of Jade KK shares suggests that this may increasingly be a way to establish a solid foothold in the Japanese software market.

       However, Japanese companies are reluctant to entertain a foreign suitor, and hostile takeovers remain largely a US phenomenon. The Foreign Exchange Law and the Security and Exchange Law both provide strict filing requirements on such stock purchases. The foreign company should seek experienced domestic advice on legal and practical strategies if pursuing an acquisition.

If you have questions about this month's topic, or about law and technology in general, you can contact Professor Ruping in care of the editors at editors@cjmag.co.jp.