The M&A market in Japan continued to grow in 2019. The number of transactions increased by 6.2% from 2018, continuing the trend of year-on-year increases for the eighth consecutive year since 2012. Transaction value decreased 38.5% from 2018, which had been a record year due, in large part, to the value of outbound transactions, including Takeda Pharmaceutical’s acquisition of Shire with a transaction value exceeding JPY6.9 trillion.
However, among the top five transactions in value in 2019, two were domestic transactions: the integration of two online service companies (Yahoo Japan (Z Holdings) and LINE), and the sale of Hitachi Chemical by Hitachi.
The key trend over the last few years can be seen in the high level of outbound transactions, both in terms of number and value. While the number of outbound transactions continued to increase (by 6.3% from 2018), the number and value of domestic transactions were also notable in 2019. This is being driven by large Japanese companies focusing on their core business, both through dispositions of non-core businesses and increasing stakes in core subsidiaries.
For example, Hitachi sold Hitachi Chemical, and Toshiba launched tender offers to take private some of its listed group companies. Also, succession is a key issue for all types and sizes of companies, and we have recently seen many sell-offs by founders, often to buy-out funds.
Another notable trend in 2019 has been the appearance – albeit still rather modest - of unsolicited and hostile takeovers. Given the historical dearth of these transactions in Japan, it was quite notable that Itochu, one of the largest Japanese trading houses, succeeded in obtaining a near majority of Descant, a sporting apparel company, through a hostile bid.
There has also been a lot of attention on the strong competition for Unizo, a real estate company, after a sudden unsolicited tender offer by HIS. Given the rise in shareholder activism in Japan, and a decline in reputational concerns about strategic takeovers, it is likely that this trend will continue.
M&A activity in Japan is being seen in a wide range of industries, including the pharmaceutical, healthcare, consumer, financial, chemical and electronics sectors.
A company is acquired in Japan by a share acquisition or a business (asset) acquisition. This can be accomplished through a contractual purchase of shares or business (assets), or a statutory business combination (or corporate restructuring) conducted pursuant to the provisions of the Companies Act (ie, a merger, share exchange, share transfer or company split).
A forward triangular business combination – such as a merger whereby a merger subsidiary of an acquirer merges with a target company whose shareholders receive the parent’s (acquirer’s) stock – is permitted under the Companies Act.
A share acquisition from one or more third parties (other than a company) may be made through an "on-market" or "off-market" transaction. Whilst the tender offer rules under the Financial Instruments and Exchange Act (FIEA) do not generally apply to market transactions, an off-market acquisition of shares of a listed company is subject to the tender offer rules if an acquirer seeks to acquire shares in excess of certain thresholds provided in the FIEA (see 6.2 Mandatory Offer Threshold).
A share acquisition may also be made by a "'share exchange", one of the statutory business combinations, whereby an acquiring company can acquire 100% of the shares of a target company upon a two-thirds shareholder vote. A share acquisition may also be made through a subscription of shares issued by a target company.
Generally, a listed company can issue shares by a board resolution unless the issue price is a deep discount from the market price or after the issuance, the total outstanding shares exceed the authorised number of shares provided for in its articles of incorporation (see 3 Recent Legal Developments).
Even if the board approves an issuance that results in an acquirer holding a majority of the shares of a target company, the acquirer is not required to offer to purchase shares from minority shareholders.
A business (asset) acquisition is generally conducted through a contractual buy-sell agreement or a statutory company split, which is a statutory spin-off procedure. Third-party consents are required to effect a contractual business acquisition; for example, consents from counterparties to transferred contracts and transferred employees are required.
However, these consents are not statutorily required in the case of a company split. Instead, the Companies Act requires the parties to a company split to comply with various procedures, including the ones for creditor protection.
The Financial Services Agency (FSA) administers securities regulations under the FIEA, including regulations involving tender offers, public offerings and proxy solicitations. The Ministry of Finance (MOF), the Ministry of Economy, Trade and Industry (METI), and other relevant ministries regulate cross-border transactions under the Foreign Exchange and Foreign Trade Act (FEFTA), including inward/outward investments.
The Japan Fair Trade Commission (JFTC) regulates transactions that substantially restrain competition under the Act on Prohibition of Private Monopolisation and Maintenance of Fair Trade (the Anti-monopoly Act).
Tokyo Stock Exchange, Inc (TSE) and other stock exchanges oversee transactions involving a listed company.
Foreign Exchange and Foreign Trade Act
Under the FEFTA, a foreign investor is required to file prior notification with the MOF and the competent ministers and wait a certain period (in principle 30 days, which may be extended up to five months, or shortened if the ministers determine there is no need of further examination), if the foreign investor intends to acquire: shares of a private company (except an acquisition of shares of a private company from another foreign investor, unless the acquisition may have potential risk of harming national security) or 10% or more of shares or voting rights of a listed company; and such target company engages in the restricted businesses regarding national security, public order, public safety or smooth management of the Japanese economy identified in the FEFTA. The FEFTA also provides a post-acquisition notification requirement for foreign investors.
The restricted businesses were expanded in May 2019 by adding manufacturing of information processing equipment and parts, software related to information processing, and information and communications services. Due to this expansion, the applicability of the prior notification requirement under the FEFTA has become much wider.
In addition, an amendment to the FEFTA passed in November 2019 will lower the threshold for the prior notification requirement from 10% to 1% with respect to acquisitions of shares or voting rights in listed companies, which may expand foreign investments subject to the prior notification requirement. However, the amendment will also establish exemptions from the prior notification requirement. Under the new rules, the blanket exemption may be available for foreign financial institutions, and the regular exemption may be available for general investors (excluding state-owned enterprises) and certain SWFs accredited by the authorities. Both exemptions are conditioned on compliance with the conditions with respect to passive investments. Under the blanket exemption, foreign investors are exempted from the prior notification requirementUnder the regular exemption, foreign investors are exempted from the prior notification requirement for investments in a company engaging in the restricted businesses other than the core sectors that relate to national security listed in the public notice, and if foreign investors being eligible for the general exemption comply with the heightened conditions with respect to passive investments, the threshold is increased from 1% to 10% even for investments in a company engaging in the core sectors. The amendment will become effective on May 8, 2020 and start to apply entirely on June 7, 2020.
There are also some restrictions on the holding of shares by a foreign investor in a company engaging in certain types of businesses, such as airline and broadcasting businesses.
The Anti-monopoly Act prohibits any acquisition that substantially restrains competition in a particular field of trade, or that would be conducted by using unfair trade practices.
Potential acquisitions that would exceed certain thresholds require prior notification to the JFTC. In particular, if a company with domestic sales (aggregated with domestic sales of its group companies) of more than JPY20 billion intends to acquire shares in a target company with domestic sales (aggregated with domestic sales of its subsidiaries) of more than JPY5 billion and that acquisition results in holding more than 20% or 50% of the voting rights in the target company, the acquiring company must file prior notification of the plan of acquisition with the JFTC at least 30 days prior to the closing of acquisition (the waiting period may be shortened if the permission of the JFTC is obtained).
If the JFTC determines, during this 30-day period (the first phase review), that a more extensive review is necessary, it proceeds to a second phase review. The period of the second phase review is up to 120 days from the prior notification or 90 days from the acceptance by the JFTC of all information that it requests the acquiring company to provide, whichever is the later.
If the JFTC determines that an acquisition violates the Anti-monopoly Act, the JFTC may order the party to take measures to eliminate the antitrust concerns, including a disposition of shares and assets. Similar filing requirements and subsequent procedures pursuant to the Anti-monopoly Act apply to other means for the acquisition of a target company or its business, such as a merger, company split, share transfer and business/asset transfer.
The Japanese labour law regulations of primary concern to an acquirer are restrictions on the ability of an employer to terminate employment agreements. An "at-will" employment agreement is not legally permitted in Japan. Rather, a dismissal can be found to be invalid if it lacks objectively reasonable grounds and is not considered to be appropriate in general societal terms (Article 16 of the Labour Contracts Act). Therefore, an acquirer should be aware that it may be difficult to undertake typical lay-offs after the consummation of an acquisition.
As discussed in 2.3 Restrictions on Foreign Investments, certain foreign investments shall be subject to the national security review by the Japanese government.
Conflicts of Interest
The most significant legal M&A development in Japan in the last three years regards jurisprudence concerning transactions that involve the conflicts of interest of a director or controlling shareholder, particularly in the context of going private transactions. In Japan, dissenting shareholders unsatisfied with such transactions have initiated a number of appraisal proceedings to demand the courts to determine the fair value of their shares.
Despite many of these proceedings, uncertainty persisted regarding the standard of review by the courts in such proceedings.
In July 2016, the Supreme Court clarified the standard of review in a case regarding the fair value of the shares of Jupiter Telecommunication (JCOM). Sumitomo Corporation, a major Japanese trading house, and KDDI, a major Japanese telecoms operator, were major shareholders of JCOM (which was publicly listed on the JASDAQ stock exchange), collectively holding approximately 70% of all of JCOM’s shares.
Sumitomo Corporation and KDDI jointly took JCOM private through a tender offer and a subsequent statutory squeeze-out procedure. Several foreign institutional shareholders filed an appraisal claim, but the Supreme Court decided that in a transaction in which a major shareholder conducts a tender offer and privatises a listed company in a subsequent squeeze-out procedure, unless special circumstances exist that evidence unexpected changes of the circumstances that formed the basis of the transaction, the courts should determine that the fair value of the shares is equal to the tender offer price if an independent committee is established and expert opinions are considered (to eliminate arbitrary decisions and conflicts of interest), and if the tender offer is conducted through procedures generally accepted as fair (such as disclosure of the plan to acquire remaining shares in a subsequent squeeze-out procedure at the same price as the tender offer price, to eliminate coerciveness).
Response to the Supreme Court Decision
The Supreme Court’s decision was generally welcomed by M&A practitioners; the decision highlights the importance of, and incentivises relevant parties to implement, procedural fairness in transactions. The decision gives greater clarity to the results of appraisal proceedings and should reduce arbitrary claims of shareholders regarding the valuation of shares. The premise underlying such a decision is that the courts are not experts in the valuation of shares and if the transaction is considered as an arm's length transaction (ie, sufficient measures are taken to eliminate any potential conflicts of interest in the transaction), the tender offer price that was determined among the parties to the transaction should be respected.
Based on this Supreme Court ruling, M&A practitioners expect that the courts will more carefully scrutinise the procedures taken by the parties to a transaction to protect the interests of minority shareholders, although questions remain as to the full scope of measures that should be taken in various scenarios to enable a transaction to be considered as an arm's length transaction.
Fair M&A Guidelines
Spurred in part by the Supreme Court’s decision, in June 2019 the Ministry of Economy, Trade and Industry (METI) issued the “Fair M&A Guidelines” which replaced the prior MBO guidelines issued in September 2007. The new guidelines set out basic principles that should be observed to ensure fairness in M&A transactions involving conflicts of interests (both management buyouts and transactions by a controlling shareholder), as well as guidelines regarding practical measures, including the establishment of an independent special committee.
In connection with the foregoing developments, the parties to transactions involving conflicts of interests have started taking more cautious approach to ensure procedural fairness in such transactions.
The FIEA, the primary regulation that governs takeovers of public companies, has not been changed in any significant way in recent years. However, amendments to the Companies Act of Japan that came into full effect in May 2015 have had some impact on takeovers of public companies. The amendments to the Companies Act include the introduction of an express squeeze-out right as described in 6.10 Squeeze-Out Mechanisms.
As described in 6.3 Consideration, the most recent changes in the law that may have a certain impact on M&A transactions are those that would facilitate exchange offers.
Exchange offers in Japan are generally subject to certain restrictions on contributions in kind under the Companies Act, which require the inspection of the assets to be contributed by a court-appointed inspector unless certain exemptions apply. Special legislation that was enacted in 2011 relaxed such restrictions and permitted exchange tender offers under certain circumstances where the transaction is pre-approved by the relevant government ministries, but no exchange tender offer has been used in practice, as no deferral of taxation on capital gain has been permitted for the selling shareholders. To facilitate exchange offers, the tax law and the special legislation were amended in 2018.
A bidder who is not willing to wage a hostile takeover usually avoids building a stake as a "toehold" before launching an offer in Japan. In Japan, the building of a toehold without notice to target management is viewed as having the potential to affect negatively management’s willingness to accept an acquisition offer, and the resistance of management to a takeover may significantly lower the chance of a successful takeover, since a limited number of hostile takeover attempts have succeeded in Japanese M&A history.
Furthermore, there is an experimental study indicating that a bidder’s ownership ratio in a target company prior to launching an offer did not lower the subsequent tender offer premiums paid by the bidder in Japan. Should a bidder decide to build a toehold, it would purchase the shares on the market or through a private transaction with one or a limited number of principal shareholders.
A shareholder is required under the FIEA to file a large-scale shareholding report with the relevant local finance bureau within five business days after its shareholding ratio in a listed company exceeds 5%. When calculating the shareholding ratio, the shares held by a joint holder are aggregated. A joint holder includes certain affiliates and another shareholder with whom a shareholder has agreed on jointly acquiring or transferring shares in a target company, or on jointly exercising the voting rights or other rights as a shareholder of the target company.
After filing the report, if the shareholding ratio increases or decreases by 1% or more, an amendment to the report must be filed within five business days from that increase or decrease. Financial institutions that trade securities regularly as part of their business and satisfy certain requirements under the FIEA are required to file the report only twice a month (the special report).
As described in 9.3 Common Defensive Measures, some Japanese listed companies have adopted, in most cases by a resolution of a shareholders meeting, takeover defence measures that prevent an acquirer from acquiring shares in a company in excess of a certain threshold. The threshold is generally set between 15% and 30% (20% in most cases).
Further, as described in 6.2 Mandatory Offer Threshold, an acquisition of shares of a listed company may be subject to the tender offer rules under the FIEA, which prohibit a bidder from acquiring more than one third of the voting rights of the target company through off-market trading or off-floor trading.
Dealings in derivatives are allowed in Japan. A bidder may purchase derivatives regarding shares in a target company to build an economic stake in that target company or hedge risks regarding its shares in the target company.
Equity derivatives may be subject to large-scale shareholding reporting obligations. Options pertaining to shares may trigger disclosure if, upon exercise, they would result in excess of a 5% shareholding. However, holding equity derivatives that are cash-settled and do not transfer the right to acquire shares would not be likely to trigger disclosure.
According to the relevant guidelines of the FSA, derivatives that transfer only economic profit/loss in relation to target shares, such as total return swaps, are generally not subject to disclosure. This being said, even holding such cash-settled equity derivatives may trigger disclosure, if a holder purchases long positions on the assumption that a dealer will acquire and hold matched shares to hedge its exposure.
Shareholders which intend to implement a tender offer must disclose in a tender offer registration statement the method of acquisition of control or participation in the management of the target company, and its management policy and plans after the acquisition.
Shareholders, which are certain financial institutions, must disclose in a large-scale shareholding report their intention to make a proposal that would materially affect the issuer’s business (including a proposal of an acquisition or disposition of material assets, a large amount of borrowings, an appointment or dismissal of a representative director, a material change of board composition, or a merger, company split or any other business combination).
If a target company is a listed company, it must disclose the deal when the board approves the contemplated transaction. Typically, this approval is given on the day that a definitive agreement is to be signed by the target company and the disclosure is made on the same day.
In general, there is no legal requirement to disclose the deal when the target company is first approached or when negotiations commence. If a non-binding letter of intent is signed by the target company, the deal is sometimes (but not very commonly) disclosed. In those cases where disclosure is made at an early stage, the purpose is often to allow the parties to discuss the deal openly with a wider group of relevant organisations or personnel.
For example, if the transaction might require the competition authorities to conduct third-party hearings, the parties may prefer to disclose the transaction sooner rather than later and to discuss the possibility of the transaction with the authorities in order to expedite the authorities’ review.
Where there is a leak of information concerning a listed company that would have a material impact on investors’ decisions, the TSE will make enquiries of the listed company and, if necessary, may require it to make timely and appropriate disclosure of the matter. In May 2014, the TSE introduced a new rule whereby the TSE may provide an alert to investors if it considers it necessary to do so when leaked information is unclear or otherwise requires the attention of investors to gain information of the relevant listed company or its shares.
In a negotiated transaction, due diligence generally includes a comprehensive review of a target company’s business, legal, financial/accounting and tax matters. The scope of due diligence may vary, depending on the size and nature of the deal or any time constraints in the parties’ negotiations, and may be focused on material issues by setting a reasonable materiality threshold.
Depending on the level of antitrust issues involved, the parties may be restricted from exchanging certain competitively sensitive information during due diligence so as to avoid so-called gun-jumping issues under the Anti-monopoly Act. In short, the parties must operate as separate and independent entities until the applicable waiting period under the Anti-monopoly Act has expired and therefore the parties must not engage in conduct that could facilitate unlawful co-ordination during that period.
In a friendly transaction, a standstill provision (which generally prohibits a potential acquirer from acquiring a target company’s shares outside a negotiated transaction) is not very common in Japan.
However, even if there is no standstill provision, see 4 Stakebuilding, in practice those bidders acquiring the shares of the target company without the target company’s prior consent have traditionally been viewed by Japanese listed companies as being unfriendly bidders. Therefore, any acquisition of shares in advance of a negotiated transaction might jeopardise the friendly nature of the transaction.
If a target company is a listed company, it is not always the case that the target company will grant exclusivity (ie, a commitment by the target company not to negotiate a similar deal with any other third party for a certain length of time) to a particular bidder. However, for example, a financially distressed target company may offer exclusivity to a potential sponsor with the aim of soliciting the sponsor to consider and negotiate the deal.
Exclusivity may also be agreed upon to bind the acquirer and the target company in the context of a business integration (such as a merger) of the two parties.
It is permissible but not very common for an acquirer and a target company to document a tender offer (commonly followed by a second-step cash squeeze-out of the remaining minority shareholders who did not participate in the tender offer if an acquirer intends to acquire 100% of the shares of the target) in a definitive transaction agreement.
Procedurally, the target company will be required to disclose its opinion with regard to the contemplated tender offer, including the grounds and reasons for the opinion, the second-step process in a two-step acquisition structure and any policy or plans after the tender offer. Therefore, typically, the target company does not take any actions that would be inconsistent with the process outlined in its own disclosure, even if there is no such documentation between the acquirer and the target company.
It is more common, however, immediately prior to the launch of a tender offer, for a buyer and principal shareholder of a target company to enter into an agreement where the shareholder agrees to tender its shares in the contemplated tender offer (see 6.9 Irrevocable Commitments).
The length of the process for acquiring or selling a business can vary, depending on a number of factors, including the size and type of assets being acquired or sold, the type of target company (whether public or private), the level of due diligence required and the length of time needed to obtain required regulatory approvals.
An auction will normally be structured as a two-phase process. In phase one, the seller will usually require the potential buyers to submit a non-binding indication of interest, which typically will address, among other things, the indicative offer price, proposed deal structure, possible conditions that the buyer may seek and necessary regulatory approvals.
In phase two, a few selected buyers will be given access to the data room for due diligence and will be required to submit their final bid, together with a mark-up of the draft transaction agreement circulated by the seller. After final bids are submitted, the seller will seek to negotiate and finalise the transaction agreement quickly so that the signing can occur as soon as practically possible. After the signing, the parties will seek any applicable regulatory approvals or clearances for the transaction, such as antitrust clearance and any required prior notification under the FEFTA (see 2 Overview of Regulatory Field).
In an acquisition involving a tender offer, the tender offer period must be set between 20 and 60 business days. If the acquisition is effected through a two-step process, where the tender offer is followed by a second-step squeeze-out of the remaining minority shareholders who did not participate in the tender offer, the process of the second step will depend on the level of shareholding that the acquirer owns after the first-step tender offer.
If an acquirer owns 90% of the voting rights of a target company, the acquirer can complete the second step rather quickly (typically around one month) by exercising the Squeeze-out Right (see 6.10 Squeeze-Out Mechanisms).
In cases where the acquirer is unable to achieve the 90% threshold in the first-step tender offer, the second step will usually take a few months, because in those cases the second step will require the target company to convene a shareholders' meeting and to complete the court permission procedures (see 6.10 Squeeze-Out Mechanisms).
With respect to a listed company (and some other types of companies), the FIEA provides specific requirements for a mandatory tender offer. Overall, the primary threshold for a mandatory tender offer is one third of the voting rights of a target company (One-Third Rule). Therefore, subject to certain limited exceptions, an acquirer must conduct a tender offer if the “total shareholding ratio” (kabukentou shoyu wariai) of the acquirer exceeds one third after the purchase and the purchase is made in off-market trading or off-floor trading (ie, trade-sale-type market trading). This means that an acquirer cannot obtain, for instance, a 40% stake of voting shares from the principal shareholder of a listed company through a private buy/sell transaction.
The total shareholding ratio is defined in detail in the FIEA and the calculation generally includes the aggregate voting rights of the target company held by the acquirer and certain special affiliated parties (tokubetsu kankeisha) of the acquirer (on an as exercised and as converted to common stock basis).
The one-third threshold for this purpose derives in part from the requirement under the Companies Act for a special resolution of the shareholders for certain important actions (ie, merger, amendment to the articles, dissolution), which requires approval by two thirds of the voting rights present at the relevant shareholders meeting. Therefore, ownership exceeding one third of the voting rights will effectively grant a shareholder a veto right over any special resolution of the shareholders at a shareholders meeting.
In addition to the One-Third Rule above, there are a few other situations where a mandatory tender offer is required.
If the total shareholding ratio of an acquirer exceeds 5% as a result of an off-market purchase. An exception applies to the 5% Rule if the acquirer has not purchased shares in off-market trading from more than ten sellers in aggregate during the 60 days before the day of the purchase on which the threshold is crossed (ie, during a 61-day period including the date of the threshold-crossing purchase).
Rapid Buy-Up Rule
If the total shareholding ratio of the acquirer exceeds one third as a result of the acquisition of shares within a three-month period, whereby the acquirer accumulates more than a 10% shareholding through on-market trading, off-market trading and subscription of newly issued shares from the company, and that accumulation includes an accumulation of more than 5% through off-market and off-floor trading (ie, trade-sale-type market trading).
The Rapid Buy-Up Rule was introduced in 2006 with the primary aim of capturing a combination of on-market and off-market trading or a combination of off-market trading and new share issuances, which in each case would result in an acquirer holding more than a one-third total shareholding ratio. This effectively means that, for example, if an acquirer obtains 30% of the voting shares through off-market trading, it cannot then purchase additional shares during the next three-month period at market, off-market (including a tender offer) or otherwise that would result in its shareholding ratio exceeding one third.
Counter Tender Offer Rule
If, during the period in which there is an ongoing tender offer by a third party, an acquirer with an existing shareholding ratio of more than one third purchases more than a 5% additional shareholding. The Counter Tender Offer Rule effectively captures on-market trading, because off-market trading resulting in a total shareholding ratio exceeding one third will be subject to the One-Third Rule in any event.
While cash is more commonly used as consideration in acquisitions, the type of consideration varies depending on the nature and structure of the acquisition.
Share Purchase for Business Transfer
In a share purchase or business transfer, the consideration has been predominantly cash-only. However, an exchange offer through which the acquirer offers its own securities as consideration in a tender offer is legally permitted and there is special legislation specifically relaxing the rules related to such exchange offers under certain circumstances where the transaction is pre-approved by the relevant government ministries.
The special legislation was amended in 2018, for example, to expand the scope of such pre-approved transactions from tender offers only to a “transfer” in general, which would include a sale of privately held shares. The amendment also resolved a taxation issue of the selling shareholders and now allows deferral of taxation on capital gain if the acquirer obtained the approval of a “special business combination plan” from the relevant governmental ministries.
There is a caveat, however, that such special business combination plan that allows the deferral of taxation for the selling shareholders can be obtained only where a corporation (kabushiki kaisha) incorporated under the laws of Japan offers its own shares as the consideration of the transaction (ie, such deferral of taxation is not available where the consideration offered is shares of a Japanese or foreign parent company).
Statutory Business Combinations
In a statutory business combination, such as a merger, share exchange or company split, stock is more commonly used as consideration, although cash or another consideration is legally permitted and it is often seen in the case of a company split.
Cash and Stock
A mix of cash and stock is not common in Japan. The aforesaid amendment to the special legislation allows a mix of cash and stock, although the special business combination plan that allows the deferral of taxation for the selling shareholders is available only where the full consideration is stock of the acquirer.
However, a cash tender offer followed by a second-step stock-for-stock merger or share exchange is often seen and this structure effectively provides the shareholders with the choice of cash or stock.
The FIEA strictly regulates tender offer conditions and permits the withdrawal of a tender offer only upon the occurrence of certain narrowly defined events. Those withdrawal events must also be specifically provided in the tender offer registration statement. The withdrawal events include:
A financing condition is not permitted and an acquirer must prepare, as part of the tender offer registration statement, a document evidencing pre-arranged financing on a firmly committed basis. If the pre-arranged financing is subject to conditions, the substance of these conditions is generally required to be described in the statement.
A minimum acceptance condition is permitted for a tender offer. Where a minimum acceptance condition is specified in the tender offer registration statement, an acquirer will not purchase any shares if the number of shares tendered is lower than that specified minimum number. If a minimum acceptance condition is set at the commencement of the tender offer, that minimum threshold may not be increased by the acquirer, but the acquirer may decrease or remove the condition.
In a 100% acquisition deal, the minimum acceptance condition is typically set such that the voting rights held by an acquirer after the tender offer will reach two thirds of a target company’s voting rights on a fully diluted basis. The ownership of two thirds of the voting rights of the target company will ensure that the acquirer will be able to pass a special resolution of the shareholders at a shareholders' meeting (eg, merger, amendment to the articles, dissolution). The acquirer will then proceed to the second step of the acquisition to squeeze out any remaining shareholders who did not tender their shares in the tender offer (see 6.10 Squeeze-Out Mechanisms).
If an acquirer does not seek 100% ownership of a target company, the minimum acceptance condition is typically set such that the voting rights held by the acquirer after the tender offer will be a majority of the voting rights of the target company on a fully diluted basis. The majority ownership will allow the acquirer to pass an ordinary resolution of the shareholders at a shareholders' meeting (ie, election of directors, dividend). The primary purpose of a deal of this type is typically to allow the shares of the target company to continue to be listed on a stock exchange.
In addition, the acquirer may also set a maximum number of shares to be purchased by the acquirer, provided that the total shareholding ratio of the acquirer after the tender offer will remain less than two thirds (which means that the acquirer cannot set that maximum at a level of two thirds or higher). If the number of shares tendered exceeds that maximum number, the acquirer must purchase the tendered shares on a pro rata basis. If, for instance, a bidder sets both a minimum and maximum at the level of a simple majority, a majority acquisition can be achieved without purchasing all shares tendered.
In a statutory business combination, there are no specific limitations on conditions. However, in practice, the conditions in a business combination among listed companies are typically quite limited, such as necessary shareholder approval and regulatory approvals and clearances. A financing condition is not commonly used in a business combination because, as explained in 6.3 Consideration, stock is more commonly used as the consideration for a business combination.
In a tender offer, as explained in 5.5 Definitive Agreements, it is permissible but not very common for an acquirer and a target company to document a tender offer in a definitive transaction agreement. Hence, it is usually not practical for an acquirer to seek deal security measures, such as break-up fees or match rights, with the target company.
However, it is more common for a buyer and principal shareholder of a target company to enter into an agreement where the shareholder agrees to tender its shares in the contemplated tender offer (see 6.11 Irrevocable Commitments). The irrevocable commitments often include certain deal security measures such as non-solicitation provisions. Non-solicitation provisions and force-the-vote provisions (or a like) are also often seen in a statutory business combination.
If an acquirer does not seek 100% ownership of a target company, the acquirer may seek certain contractual protections, such as the right to designate members of a company’s board of directors, veto rights over certain material matters, and information rights to receive periodic financial information and business reports.
However, if the target company is a listed company, such protections may be quite limited because the target company will not be likely to accept such protections of the acquirer from a corporate governance standpoint.
In certain circumstances, shareholders can vote by proxy. See 6.10 Squeeze-Out Mechanisms.
In a tender offer for 100% of a listed company, the remaining shareholders who did not tender their shares in a successful tender offer will generally be squeezed out through a second-step squeeze-out mechanism.
Special Controlling Shareholders
In practice, if an acquirer owns 90% of the voting rights of a target company after the first-step tender offer (thereby becoming a special controlling shareholder), the acquirer will usually complete the second step by exercising a statutory right to force the other shareholders to sell their shares to the special controlling shareholder (the "Squeeze-Out Right"), a mechanism introduced under the 2015 amendment to the Companies Act.
To exercise the Squeeze-Out Right, a special controlling shareholder must first notify the board of a target company of certain particulars regarding the squeeze-out, including the amount of consideration, and obtain the target company’s approval to proceed. When the board approves the squeeze-out, the target company must then notify its shareholders of the particulars of the squeeze-out or make a public notice on or before the 20th day prior to the acquisition date.
Upon exercising the Squeeze-Out Right, dissenting shareholders will have the right to exercise appraisal rights. In addition, if the exercise of that right would violate law or the company’s articles of incorporation, or the consideration is grossly improper, the dissenting shareholders will have a right to seek an injunction.
Share Cancellation Scheme
In cases where the acquirer is unable to achieve the 90% threshold in the first-step tender offer, it may still implement the second-step squeeze-out through other means, typically the so-called share cancellation scheme, to the extent that the acquirer holds two thirds of the voting rights of the target company (ie, the threshold to pass a special resolution at the target company’s shareholders meeting).
The share cancellation scheme normally takes a few months, as the process requires the target company to convene a shareholders' meeting and to complete certain court permission procedures (as described below). In the shareholders' meeting, the acquirer can vote by proxy. A straightforward cash-out merger or statutory share exchange is legally permitted under the Companies Act, but traditionally not used because it was not treated as "tax qualified", meaning that the target company would be required to revalue its assets at the then-current market value basis and recognise taxable gains from the transaction.
However, under the 2017 tax reforms, "tax qualified" treatment has become available in the case of a merger or share exchange where a surviving or parent corporation has at least two thirds of the total outstanding shares of a disappearing or subsidiary corporation. It was expected that there may be an increase in the number of such cash-out mergers or share exchanges going forward, but they are still rarely used.
In the share cancellation scheme (by way of use of stock combination), a target company will implement a share cancellation in which the ratio of share cancellation is set so that the shares held by each minority shareholder will become less than one full share of the target company.
In completing the share cancellation scheme, there is a procedure under Japanese law whereby the fractional interests that would be allocated to the minority shareholders will instead be sold by the target with court permission, with the minority shareholders receiving cash, usually in an amount substantially equivalent to the offer price used in the first-step tender offer.
If there is a principal shareholder of a target company, it is relatively common for an acquirer to obtain an irrevocable commitment from the principal shareholder to tender its shares in the target company in the contemplated tender offer. The commitment will be made in a written agreement (oubo keiyaku), which is negotiated prior to the announcement of the transaction by the parties. Where such a commitment exists, material terms of the commitment are disclosed in the tender offer registration statement.
The commitment may be negotiated to include a certain level of representations and warranties by the principal shareholder in relation to the business of the target company. It is also possible for the parties to negotiate a clause where the principal shareholder will be required to revoke its tender upon the occurrence of certain events (ie, material breach of representations and warranties by the principal shareholder or failure of the target company’s board to recommend the contemplated transaction to the shareholders).
However, by a combination of this clause and the minimum acceptance condition (that would not be satisfied but for the tender by the principal shareholder), the acquirer could essentially withdraw the tender offer in circumstances that would not constitute permissible withdrawal events under the FIEA.
The regulator (FSA) has interpreted this type of clause as being subject to strict tender offer withdrawal restrictions under the FIEA (as explained above). For example, the agreement by a principal shareholder to revoke its tender on the failure of obtaining financing by a bidder would not be permitted because this falls outside the scope of the statutorily defined withdrawal events under the FIEA.
Whether this type of commitment agreement includes a clause that would permit the principal shareholder to refuse to tender in the event that a competing bid is made by a third party at an offer price higher than the tender offer price varies, depending on the type of principal shareholder (eg, a founder, senior management, a private company, a listed company) and other factors. This is a matter of negotiation and may be incorporated in the commitment, particularly if the deal did not involve an auction process and the principal shareholder is interested only in the financial aspects of the transaction.
If an acquisition is made by a tender offer to the shareholders of a listed company, a bidder must publicly announce the bid at the beginning of the tender offer by:
Bullet points two and three are required pursuant to the FIEA and are to be made or filed on the tender offer commencement date. As the press release in item is only required by the stock exchange regulations, if the bidder is not a listed company, the bidder is not required to issue a press release, although the target listed company is required to issue a press release immediately after it has formed an opinion (regarding its endorsement or not) of the tender offer.
If a bidder’s press release is required, it is usually made one business day before the tender offer commencement date (simultaneously with the target company’s press release unless the bid is unsolicited). However, in certain exceptional situations, a bid is publicly announced by the bidder and the target company in advance of the commencement of the tender offer, such as when earlier public disclosure would be required to obtain merger clearance in certain jurisdictions.
When an acquisition is made by a statutory business combination (ie, merger, corporate split, share exchange or share transfer) whereby an acquirer’s shares are issued as consideration, the filing of a security registration statement by the acquirer is required if there are at least 50 shareholders of a target company and the target company is a reporting company under the FIEA, and no security registration statement has already been filed in relation to the same class of shares as the shares to be issued upon such a statutory business combination.
For example, if a foreign purchaser acquires a Japanese listed company by way of a triangular merger and issues the shares of the foreign purchaser as consideration of the merger, the foreign purchaser will be required to file a security registration statement unless it has already become a reporting company in Japan under the FIEA.
For a tender offer, the bidder must disclose in the tender offer registration statement its financial statements, prepared in accordance with Japanese Generally Accepted Accounting Principles (GAAP) for the latest fiscal year, together with any quarterly or half-year financial statement after the date of the most recent full-year financial statement.
If the bidder is a foreign entity, it may provide financial statements prepared in accordance with the generally accepted accounting principles of its home country, with explanatory notes as necessary, to explain certain differences with Japanese GAAP, in lieu of Japanese GAAP financial statements.
When a business combination requires the filing of a security registration statement, the offeror must disclose, in the security registration statement, its financial statements for the last two fiscal years, together with any quarterly updates, prepared in accordance with Japanese GAAP.
However, a foreign offeror may produce financial statements prepared in accordance with the accounting standards of its home country or any other country in each case with the specific approval from the Minister for Financial Services of Japan.
Disclosure of transaction documents in full is not required for a tender offer. If there are any agreements between the bidder and a target company or its officers in relation to the tender offer itself or a disposal of material assets after the tender offer, the material terms of such agreements must be described in the tender offer registration statement.
For a business combination, the Companies Act requires parties to the business combination to prepare an agreement providing for statutorily required matters. A statutorily required agreement such as a merger agreement, share exchange agreement or company split agreement must be disclosed in full. However, in practice, such an agreement only addresses the matters required by law and is thus very short.
In many cases, the parties to a business combination enter into another agreement to provide in detail the terms of the business combination, in which case, only the material terms of such an agreement need be disclosed in the security registration statement (if the filing of the security registration statement is required as previously discussed) and the press release pursuant to the stock exchange regulations (if the party is a listed company).
Under the Companies Act, as a general principle, directors owe a duty of care as a good manager, and a duty of loyalty to the company and, indirectly, to the shareholders of the company.
Except for violations of law or situations involving a conflict of interest, the business judgment rule generally applies in determining whether directors have breached their duties. Under the business judgment rule in Japan, directors are not held accountable for their decisions unless the directors were careless and failed to recognise relevant facts in making their decisions or the process of the decision-making or the substance of the decisions was particularly unreasonable or inappropriate.
There have not been many judicial precedents addressing directors’ duties in M&A transactions, although, however, as far as M&A transactions without any conflict of interests are concerned, it is understood by M&A practitioners that the business judgment rule generally applies to directors in M&A transactions and there are a few judicial precedents confirming such understanding.
Use of an ad hoc special committee in M&A transactions involving conflicts of interest has become common in Japan. In almost all cases of management buyouts, and in many recent going private transactions by a controlling shareholder for cash consideration, boards of directors have established an ad hoc special committee to review the transaction.
In recognition of the importance of ensuring fair procedures in M&A transactions, the Fair M&A Guidelines emphasise the role of special committees and provide detailed guidelines including the composition of the special committees. The Fair M&A Guidelines explicitly state that outside directors who owe fiduciary duties to the company are the most suitable persons to serve as members of the special committees. In practice, we have also more frequently seen outside directors as members of special committees.
While the involvement of special committees in negotiations of transaction terms was limited in the past, the Fair M&A Guidelines state that it would be desirable that the special committees should be actively involved in negotiations on transaction terms, either directly or indirectly, through expressing their views to the project team members who are in charge of the negotiations rather than simply reviewing the transaction terms when they are agreed. As such, special committees are expected to play a more active role in negotiations.
As noted, in M&A transactions without any conflicts of interests, the business judgment rule generally applies to directors' decisions. Therefore, as long as directors make reasonable, informed business decisions based on sufficient information, including obtaining experts advice and information obtained through due diligence, the courts would normally defer to the judgment of the board of directors.
It is common for directors of a company in an M&A transaction to obtain financial, tax and legal advice from outside experts. Obtaining a valuation report from an independent outside financial adviser is recognised as a prerequisite to ensure fairness and transparency.
In practice, a valuation report is obtained by a target company in almost all tender offers and by both parties in many statutory business combinations such as mergers. In some cases, in addition to the valuation report, directors obtain a fairness opinion from an outside financial adviser, but this is not a prerequisite.
In appraisal proceedings to determine the fair value of shares of the target company, the courts generally respect the transaction terms including the valuation agreed upon by the parties if the transaction is an arms’ length transaction between unaffiliated parties, and if procedures that generally considered fair have been taken, such that the shareholders have approved the transaction after full disclosure of all material relevant information. However, if the transaction involves conflicts of interest of directors or controlling shareholders, such as in the JCOM case, the courts will also consider whether adequate measures have been taken to eliminate arbitrary decisions and the effect of conflicts of interest.
In 2013, the Tokyo High Court held in a breach of fiduciary duty claim with respect to a management buyout of Rex Holdings that while the decision to conduct the management buyout itself should be the business judgment, after stating the directors’ duty of care must be exercised for the common interests of the shareholders, the directors must perform their fiduciary duties to ensure that fair value is transferred among the shareholders, and to disclose adequate information necessary to ensure informed decision-making by the shareholders to determine whether to tender their shares in a tender offer.
Views are divided as to whether this court holding imposes a stricter standard of review or merely clarifies duties of directors in management buyouts. It is also not clear if this court holding applies only to management buyouts, or if it extends to transactions involving conflicts of interests or to any transactions in which disputes can arise regarding transfer of value among shareholders. In any event, as is the case for appraisal proceedings, the courts normally closely look into whether adequate measures to eliminate arbitrary decisions and the effect of conflicts of interest have been taken in transactions that involve conflicts of interest of directors or controlling shareholders.
Hostile tender offers have been permitted but historically not common in Japan. However, there were several hostile tender offers conducted by strategic buyers and an activist hedge fund in 2019-2020.
The background to this shift may be a decrease of stable shareholders who have, historically, tended to be reluctant to tender their shares in a target company in a hostile tender offer, which, in turn, is a result of the Japanese government’s policy toward decreasing cross-shareholdings that has been implemented through the adoption of Japan’s Corporate Governance Code (see 11.1 Shareholder Activism) and enhancement of disclosure regarding the cross-shareholdings in annual security reports.
There is no case law in Japan clearly setting out the parameters of legally permissible defensive measures or the directors’ duties in adopting such measures. However, there have been several cases that indicate the factors to be considered in determining the legality of defensive measures.
Defensive Measures to Ensure Necessary Time and Information for Shareholders to Consider an Offer
The Tokyo District Court held in 2005 that directors may take reasonable defensive measures to ensure necessary information and a reasonable period for shareholders to consider whether the shareholders should entrust the management of a company to incumbent directors or an acquirer.
Defensive Measures to Hold off a Takeover Attempt Because it is Substantively Inappropriate
The Tokyo High Court held in 2005 in the Livedoor v Nippon Broadcasting case that, where there is a contest for obtaining control of a company, defensive measures are generally not allowed for the primary purpose of lowering an acquirer’s shareholding ratio and maintaining or ensuring incumbent management’s control of a company.
However, if there are exceptional circumstances where the defensive measures are justified in the context of protecting the interests of shareholders as a whole, defensive measures may be allowed as long as they are necessary and reasonable.
In Japan, directors often propose the implementation of defensive measures at a shareholders meeting, rather than making their own final decision on these matters.
With regard to defensive measures approved by shareholders, the Supreme Court in 2007 held in the Steel Partners Japan Strategic Fund v Bull-Dog Sauce case that it was permissible under the equitable doctrine for a company to allot stock options to all shareholders that are only exercisable by shareholders other than the hostile acquirer, and callable for new shares by the company with respect to shareholders other than the hostile acquirer, as long as such allotment is necessary and reasonable to protect the common interests of shareholders from the probable damages to be caused by the bidder.
The most common hostile takeover defensive measures adopted by Japanese listed companies before a hostile acquirer emerges are the pre-warning type of defensive measures. A company sets and publicly discloses (warns) a procedure with which a would-be acquirer has to comply before starting an acquisition. Under the procedure, the acquirer has to provide the board of directors with information regarding the acquirer and its acquisition plan, and ensure the directors have time to consider the plan and prepare alternatives, and for shareholders to consider which plan is in shareholders’ interests.
A committee composed of members who are independent from the management of the company is usually established, which makes a recommendation as to the company’s response to the proposed acquisition. If the company determines that the bidder has not complied with the procedures set by the company, or that the proposed acquisition would cause clear harm to the corporate value and common interests of shareholders, it would allot stock options to all shareholders without contribution that are only exercisable by, or callable for new shares by the company with respect to, those shareholders other than the acquirer, resulting in a dilution of the shareholding ratio of the acquirer.
In most cases, it is provided that the board of directors may also confirm shareholders’ intentions concerning an allotment of such options by convening a shareholders' meeting.
The number of companies adopting these types of measures has been decreasing due to opposition by institutional investors. While 567 listed companies had adopted the measures as of 2009, 329 listed companies have adopted the measures as of 2019.
As discussed in 8 Duties of Directors, directors have a duty of care as a good manager and a duty of loyalty to a company, and the business judgment rule is generally available for directors’ decisions in Japan. Laws and court precedents do not clearly provide that an intermediate or heightened level of review (like the Unocal standards – enhanced scrutiny) apply to directors’ decisions where they implement defensive measures. The Tokyo High Court held in the Livedoor v Nippon Broadcasting case, however, that defensive measures implemented by incumbent directors are not allowed unless they are justified in light of the protection of the interests of shareholders as a whole.
Directors cannot "just say no" to a hostile takeover attempt.
In general, it is not very common in Japan for shareholders or other stakeholders in a company to bring litigation against the company or its directors in connection with M&A transactions. Under Japanese law, it is not easy for stakeholders to enjoin in advance the consummation of any type of M&A transaction because the grounds for an injunction are generally limited to a violation of law or the company’s articles of incorporation. The general view is that a violation by directors of their duties of care and loyalty is not deemed a violation of law.
The exception is that shareholders may seek injunctive relief against: the issuance of stock or stock options by the company pursuant to the Companies Act based on certain grounds, including that the issuance is unjust; and a short-form merger or exercise of the Squeeze-out Right (under the amended Companies Act), based on the grounds that the consideration is grossly improper.
Shareholders are more likely to bring legal action in connection with M&A transactions involving conflicts of interest, such as MBOs or squeeze-out transactions conducted by a controlling shareholder, after the transactions are completed. The most common litigation in Japan is litigation with respect to appraisal rights of shareholders. Moreover, shareholders sometimes file a suit against directors or corporate auditors of a target company for recovery of monetary damages suffered as a result of the violation of their duties of care and loyalty.
The environment surrounding shareholder activism in Japan has been changing over the last five years. Japan’s Corporate Governance Code (issued on 1 June 2015 and amended on 1 June 2018) and Japan’s Stewardship Code (issued on 26 February 2014 and amended on 29 May 2017) have worked as "the two wheels of a cart" to promote and achieve effective corporate governance in Japan.
The amended Corporate Governance Code expressly provides that companies should disclose their policies regarding the reduction of cross-shareholdings, which may have resulted in a reduction in the number of shares held by listed companies in cross-shareholding structures. Also, the amended Stewardship Code provides that institutional investors should disclose their voting records for each of their investee companies on an individual agenda item basis and the reasons for their voting, which may affect the voting behaviour of institutional investors and, consequently, supportive votes for listed companies may decrease.
With such changes in the environment as a backdrop, in the last few years, the number of public campaigns waged by activist shareholders has increased, and there were cases where shareholder proposals made by activist shareholders obtained affirmative votes from many other shareholders, including institutional investors. In 2019, several companies accepted employees of activists as directors, and proposed their election at a shareholders meeting as a company proposal (eg, Olympus accepted a director from ValueAct, and Kawasaki Kisen accepted a director from Effissimo Capital Management).
Activists usually focus on, among other things, demands to:
In addition, activists are engaging in so-called bumpitrage with respect to M&A transactions, including mergers, share exchanges or tender offers. Activists express their opinion that transaction consideration is lower than fair value and demand that a company increase the consideration. Activists also exercise their appraisal rights as dissenting shareholders with respect to M&A transactions and file a petition to the court for a determination of the fair price for the relevant shares after the completion of the transaction.
With respect to tender offers conducted as the first step of a squeeze-out transaction, or transactions requiring a shareholder resolution (such as a merger, share exchange, company split or share transfer), activists occasionally advocate, through a press release or other media, that the purchase price is lower than fair value. However, it is not easy for activists to obtain injunctive relief from a court prior to the completion of a transaction.
However, the amount of M&A activism has recently increased in Japan. For example, Oasis Management, a Hong-Kong based activist fund, waged a public campaign in 2016-17 against the acquisition by Panasonic of its listed subsidiary, PanaHome. Panasonic changed the structure of such acquisition from a share consideration transaction through a share exchange to a cash consideration transaction through a tender offer after Oasis Management commenced the public campaign. Oasis Management also waged a public campaign against the share exchange in which Alps Electric acquired all the shares in its listed subsidiary, Alpine Electronics, in 2018.
Elliott Management, the US-based activist fund, purchased a large amount of shares in Hitachi Kokusai Electric after the public announcement by KKR of a tender offer for the shares in Hitachi Kokusai Electric in 2017. KKR eventually increased the tender offer price by approximately 25%. As these cases show, if the market price of target company shares hovers at a level higher than the offer price as a result of the involvement of shareholder activists, uncertainty as to the completion of a transaction may increase and an acquirer may be required to pay more than it had planned to consummate the transaction.
Overview of Recent Trends
The M&A market in Japan continued to be robust in 2019, although we have started to face increasing uncertainty concerning the potential impact of COVID-19 in 2020. According to Recof, in 2019 the aggregate number of M&A transactions in which Japanese companies were involved was 4,088 (a 6.2% increase from the previous year), which represents an increase for eight consecutive years and a record high since 2006. Investment into start-up companies (both domestic and overseas) was one of the factors which led this trend. 1,375 transactions were investments into start-ups, consisting of 33.6% the total number of M&A transactions.
The number of domestic M&A deals in 2019 was 3,000, another record high. The Central Bank of Japan continues its unprecedented quantitative and qualitative easing policy. Consequently, stock prices have been high in the past few years, which in turn has substantially decreased the number of going-private transactions from 96 in 2008 to 39 in 2019. Yet there has been a steady increase in the number of M&A deals involving divestitures by traditional Japanese conglomerates; these companies are actively divesting non-core businesses aiming to focus more on their core businesses and/or to increase their return on equity. Supported by low funding costs and investors looking for a better return in an extreme low interest rate environment, private equity (PE) funds are acting as the key acquirers of these divested businesses. In fact, the number of domestic M&A deals involving PE funds (both domestic funds and global) in 2019 was 877, the largest ever. This constitutes 21.5% of the total number of M&A transactions in which Japanese companies were involved. Investment into start-ups and business successions due to founders’ retirement were other key drivers of the growth of domestic transactions.
In 2019, the number of outbound M&A deals also reached a new high for the sixth consecutive year, reaching 826. More and more Japanese companies are placing a greater emphasis on expanding their business overseas, due to Japan’s ageing society and declining population, which has put a strain on domestic organic growth.
It would be natural to expect that outbound M&A deals will keep increasing in the mid to long-term. In fact, several Japanese listed companies have announced in their mid-term business plans that they intend to make significant investments in M&A transactions overseas. At the same time, outbound M&A deals have been challenging for many Japanese companies due to the differences in legal and regulatory frameworks, language and cultural aspects. In this regard, a study group established by the Ministry of Economy, Trade and Industry (METI) (Study Group for Japanese Companies’ M&A Overseas) released a report in March 2018 setting out, among others things, material issues that Japanese companies should note in conducting outbound M&A deals, along with case studies. This report is expected to provide guidelines for best practices with regard to outbound M&A deals by Japanese companies as well as supporting their growth through investment.
The number of inbound transactions remained steady from 2015-2017 but showed a significant increase in 2018. In 2019, inbound transactions continued to be active, and the number of transactions has reached 262, a slight increase from 259 in 2018. This is the second largest number since the record high in 2007 (309 transactions). International PE funds continued to be quite active in the Japanese M&A market in 2019. Blackstone has closed its first M&A transaction in Japan, acquiring AYUMI Pharmaceutical Corporation. Lone Star has commenced a takeover of UNIZO Holdings Company, together with a company established by the target company's employees, which will be the first EBO (employee buyout) transaction in Japan if closed successfully. The increase of investment into start-ups was one other driver for the growth of inbound transactions. For example, in 2019, KKR made its first investment into a start-up company, from scratch Co, Ltd. In fact, the number of inbound investments into start-ups in 2019 was 111, a 42.3% increase from 2018, comprising 42.4% of all inbound investment transactions in 2019.
Development of the Japanese Investment Environment for Listed Companies in the Past Decade
Lack of rule of conduct for directors under hard law
In Japan, directors are not considered to be agents of shareholders; rather, the Companies Act sets out a requirement that directors owe the “duty of care of a prudent manager” to the company which they serve. Within this legal framework, with respect to the relationship between directors and shareholders, directors do not owe any fiduciary or other duties directly to each shareholder, but only an indirect duty to shareholders bypassing any such direct duty in its “duty of care of a prudent manager” to the company.
Incidentally, although there is a strong argument posited by eminent scholars and practitioners that directors owe a duty to maximise the interests of shareholders as a whole, to date there has been no precedent where the Supreme Court has identified such a duty, and the rules of conduct applicable to directors in M&A transactions remain ambiguous. Thus, it is usually the case that when a company receives a takeover offer without any prior agreement with the board of directors (whether unsolicited but friendly or hostile at the outset), the directors of the target company take into account the interests of all stakeholders surrounding the company, including those of business partners and employees. Even in a change in a corporate control situation, directors are not expected to act as auctioneers to maximise the acquisition price; rather, they are allowed to take actions to protect the value of the company itself. This attitude is consistent with the expectation or understanding of the general public in Japan, where companies are perceived as "public tools", which owe responsibilities to all stakeholders, and are not simply or exclusively the private possession of shareholders.
As a result, Japan has been a very difficult market for a long time for hostile takeovers and activists. There have been only very limited cases where shareholders have brought actions against the directors of companies, rejecting hostile takeovers, offering favourable acquisition prices; or activists have proposed seeking to increase the company’s return on equity or increase the efficiencies of businesses.
Development of Soft Law – Adoption of the Corporate Governance Code and Stewardship Code
Corporate governance code
With the increasing globalisation of the world economy, the need for rules of conduct for directors of Japanese companies has become apparent. In March 2015, the Tokyo stock exchange (TSE) adopted Japan’s Corporate Governance Code, which took effect in 2015 and was amended in 2018.
Based on five fundamental principles, the Corporate Governance Code sets out more detailed principles and supplementary principles. The Corporate Governance Code adopts a "comply or explain" approach, ie, listed companies are not required to comply strictly with each principle, but they are required to offer reasons for their not complying with a principle set out in the Code. While the Corporate Governance Code is "soft law" established by the TSE, and it is not legally required to be complied with (nor is it currently enforced by the courts), TSE-listed companies are required to comply with the Code to continue their listing on the TSE. As all TSE-listed companies continue to comply with the Code, and this has become an established custom, eventually principles under the Code should be recognised by the courts as rules of conduct applicable to directors of all companies.
While the Corporate Governance Code does not only focus on the responsibility of listed companies and of their directors to their shareholders – it addresses the importance of relationships with all other stakeholders as well – it has significantly increased the awareness of directors’ accountability to shareholders. Moreover, it has had significant influence on the corporate governance of listed companies. For example, the Corporate Governance Code expects all listed companies to elect two or more outside directors. Previously, most Japanese listed companies were sceptical about the role of outside directors. According to statistics published by the TSE, only 54.2% of companies listed on the TSE had one or more outside director(s) in 2013; this has increased to 96.9% (99.6% for First Section-listed companies) in 2017, two years after the Corporate Governance Code took effect.
Another example is the increased accessibility for international investors to shareholders’ meetings. The Corporate Governance Code states that listed companies should prepare a platform to enable shareholders to exercise their voting rights electronically (including the Electronic Voting Platform), and to translate their meeting notices into English. According to a survey for the year ending June 2018 by Shojihomu, 49.3% of companies (of those responding to the survey) used an electronic voting system (a 4% increase from the previous year), and the rate of companies which prepared English convocation notices and posted them on their website continued to increase (a 3.2% increase from the previous year).
As in many other jurisdictions, institutional investors are major players in the Japanese stock markets. In Japan, in particular, there are two streams of investment by government organisations in listed companies that have been increasing significantly in recent years:
As of March 2018, 9.6% of aggregate market capital in the TSE is held by these government organisations, an increase from 5.5% from March 2014.
Traditionally, domestic institutional investors, particularly banks, pension funds, insurance companies and other financial institutions were silent partners of listed companies, and rarely voted against the agendas proposed by the companies.
With the goal of promoting awareness of the fiduciary responsibilities institutional investors owe to their investor clients, and seeking to encourage institutional investors to engage in dialogue with investee companies to enhance their mid to long-term return on investments, Japan’s Stewardship Code was published in February 2014 by the Council of Experts on the Stewardship Code, a council set up by the Financial Services Agency of Japan and further updated in May 2017.
The Stewardship Code also takes a "comply or explain" approach. It expects institutional investors to voluntarily adopt principles and follow the suggested guidelines proposed in the code, and publicly disclose suggested matters under each principle, which, among other things, include adopting clear policies on how they fulfil their stewardship responsibilities, adopting policies on proxy voting and disclosing their voting activities, and how they monitor investee companies. If there is any principle an institutional investor does not adopt, the Stewardship Code expects the institutional investor to explain its rationale for non-adoption.
The Stewardship Code not only assumes that asset managers will contribute to the enhancement of corporate value of investee companies through day-to-day constructive dialogue, but it also expects the asset owners, eg, pension funds and insurance companies, to be more responsible for the enhancement of the mid to long-term investment return for their beneficiaries through setting and disclosing their policies on the fulfilment of their own stewardship responsibilities, and monitoring their investments.
Increasing pressures from the market and clients have caused traditional domestic institutional investors to become keenly aware of their responsibilities and their accountability to clients, and this enhanced awareness has changed the voting practices of investors. Many domestic institutional investors (including large life insurance companies who used to be friendly partners to their investee companies) now carefully consider each agenda item at shareholders’ meetings, and have started voting against company proposals if they think they, or the management’s behaviour, is not likely to be beneficial to the mid to long-term return on their investments. While the code of conduct under the Stewardship Code is addressed to institutional investors and does not bind listed companies directly, it has played a substantial role in enhancing the corporate governance of listed companies by improving the monitoring of corporate activities and results by institutional investor shareholders.
In March 2018, the FSA published a draft guideline for investor and company engagement, which became final and effective in June 2018. This guideline is intended to supplement the Corporate Governance Code and the Stewardship Code, and encourages institutional investors and listed companies to particularly focus on their dialogue with each other.
Unwinding of Cross-shareholdings
Another notable change during the past decade is the substantial decrease of cross-shareholdings among Japanese listed companies. Traditionally, shares in Japanese listed companies were cross-held by their business partners, including their "main banks", who acted as stable and management-friendly shareholders. This system of cross-shareholding weakened market discipline as it applied to listed companies and caused inefficiencies in the use of their financial resources.
In 2010, with the aim of indirectly inducing listed companies to reduce their cross-shareholdings, a regulation was amended to require listed companies to explicitly disclose, in their annual securities reports, the amount of shares held in other listed companies and the purpose of such share ownership if the purpose was for a reason other than pure investment.
The Corporate Governance Code has also played a substantial role in the unwinding of cross-shareholdings. The code requests listed companies to disclose their policy with respect to cross-shareholdings, and the boards of directors are expected to review the mid to long-term economic rationale and future outlook of major cross-shareholdings on an annual basis. The update of the Corporate Governance Code requires listed companies to review the purpose of cross-shareholdings and examine whether the risks and benefits of such holdings are in alignment with the cost of capital, and disclose the outcome of such examination.
With the improvement of transparency regarding cross-shareholdings and increasing pressure from the market, many listed companies have gradually decreased the amount of their cross-shareholdings. Listed companies now have less passive and management-friendly shareholders, and increasingly face the disciplining effect of stock market pressure to improve their financial performance.
Implications for Shareholder Activism
Due to the series of reforms implemented in connection with corporate governance, as described above, the Japanese stock market today imposes substantially more discipline on listed companies and institutional shareholders compared to a decade ago. As a result, the market environment today offers increased possibilities that a shareholder’s proposal contrary to the views of, or in response to, a management proposal may be accepted by a majority of the company’s shareholders.
In fact, there were several, albeit still not many, notable cases indicating the success of shareholder activism beginning from 2017. The first was a successful proxy fight conducted by Leno, an investment company in which other activist funds invest. Leno made a proposal against Kuroda Electric to elect one outside director designated by the funds, which eventually led to a proxy fight lasting two years. This proposal by Leno was finally approved at Kuroda’s shareholders’ meeting, the second time an activist fund has had its nominee elected as a director (the first being Steel Partners in 2009). Notably, Institutional Shareholder Services recommended voting in favour of Leno’s director nominee.
Another notable case in 2017 was the tender offer by Panasonic to purchase all of the outstanding shares of Panahome, a Japanese housing development company it did not own (at the time of the offer, Panahome was both a listed company and a subsidiary of Panasonic). Panasonic initially announced in December 2016 that it would be entering into a share exchange agreement with Panahome to acquire 100% ownership. After a strong opposition campaign lead by Oasis Management Company, a Hong Kong-based activist fund, Panasonic decided to terminate the share exchange agreement and instead commenced a tender offer at a 20% higher price than it would have paid in the exchange arrangement in April 2017.
With the growing global trend of shareholder activism and changes in Japan’s market environment, including enhanced corporate governance measures, activist funds are expected to become more active in 2020. This may lead to increased market discipline obliging listed companies to improve their return on investment.
In 2019 and 2020, there were several unsolicited tender offers, which were initiated or proposed without prior agreement with the management of target companies. For example, in 2019, Itochu Corp has successfully closed a tender offer to increase its voting rights in Descente Ltd from 30.44 % to 40.00 %, despite opposition from Descente’s management. While it was unsuccessful, HOYA has made an unsolicited counter offer for the shares of NuFlare Technology Inc, following the commencement of a tender offer initiated by Toshiba. In 2020, Maeda Corporation successfully closed its tender offer for the shares of Maeda Road Construction despite its managements’ opposition, raising Maeda Corporation’s interest to 51% and turning Maeda Road Construction into a consolidated subsidiary. Although there are several unsuccessful transactions, these cases show a new trend, where not only financial buyers but also strategic buyers no longer hesitate, depending on the situation, to initiate hostile tender offers, and general shareholders are willing to tender their shares to the tender offerors.
Following an unsuccessful tender offer initiated by HIS Co, Ltd, Fortress Investment Group has launched a tender offer, which has also ended unsuccessfully, and Blackstone has made an unsolicited acquisition proposal for the shares of Unizo Holdings, while some of the employees of Unizo Holdings have launched a tender offer backed by Lone Star aiming to delist the company through an employee buyout. This is an unprecedented case where multiple buyers are competing against each other in the stock market, seeking support from general shareholders. This is also one of the consequences of the increased discipline imposed on listed companies and institutional shareholders compared to a decade ago.
Fair M&A Guidelines
In June 2019, the METI published the Fair M&A Guidelines, substantially, updating the MBO Guidelines published in 2007. Unlike in the USA, there is no common understanding of how the "duty of loyalty" concept should be interpreted, nor is it clear how conflict-of-interest transactions should be disciplined in general. Under such circumstances, the MBO Guidelines presented best practices on management buyout transactions and were also respected in many court precedents. The update by the Fair M&A Study Group aims to reflect the accumulation of legal and practical discussions and the progress of corporate governance reform over the past decade.
The Fair M&A Guidelines primarily focus on MBOs (management buyouts) and the acquisition by a controlling shareholder, where issues with respect to structural conflicts of interest and information asymmetries typically exist, aiming to provide a guideline to a fair process in those circumstances. Among other things, and although they are not required to be adopted, the Fair M&A Guidelines suggest the adoption of some or all of following methods to avoid conflict of interest issues between a buyer or between a controlling shareholder and other general shareholders of a target company: (i) establishment of an independent special committee at the target company; (ii) obtaining advice from independent, expert and external advisors; (iii) ensuring opportunities for other acquirers to make proposals (market check); (iv) establishing a "majority-of-minority condition" for the proposed transaction; (v) enhancing the provision of information to general shareholders so as to improve the process transparency; and (v) eliminating coerciveness. It is now common practice to adopt all these measures except for the "majority-of-minority condition" for MBOs (management buyouts) and acquisitions of a controlled company by a controlling shareholder.
In the context of a structural conflicts of interest issue in parent-subsidiary listings, multiple companies are now shifting to unwind these situations, either by delisting its listed subsidiary, or by selling the shares of its listed subsidiary to third parties. For example, in 2019, Toshiba launched several tender offers against its listed subsidiaries, NuFlare Technology Inc, Nishishiba Electric Co, Ltd and Toshiba Plant Systems & Services Corporation, all of which were successfully closed in 2020, whereby making each of them its wholly owned subsidiary. Hitachi used to have many listed subsidiaries, but as a result of their acquisitions and sales, including the announced sale of Hitachi Chemical to Showa Denko for about JPY964 billion (which has not yet been closed), it is expected to have only two by early 2020. The major listed companies are following this trend, and we expect to see less parent-subsidiary listing in the Tokyo Stock Exchange in the future.
Legal Developments in Recent Years
Faster and more cost-efficient process for cash-out transactions
Since 2006, although cash-outs of minority shareholders have been legally possible, these transactions have required approval at the shareholders’ meeting and in court by implementing class-shares and procedures similar to reverse stock splits. In May 2015, a new process for the cash-out of minority shareholders was introduced. This now enables a shareholder owning 90% or more of the voting rights of a target company – either alone or together with its wholly owned subsidiary, a special controlling shareholder – to compulsorily acquire the shares of the target company held by other shareholders, upon the approval of the board of directors of the target company (the call option by special controlling shareholder).
As a result of this amendment, the acquirer can avoid calling a shareholders’ meeting of the target company and seeking court approval for the payment to the minority shareholders. Also, appraisal rights were introduced and applied to reverse stock splits, which enable a reverse stock split to be used as a cash-out method. Although approval at a shareholders’ meeting and of the court are required when a shareholder does not own 90% or more of the target company, reverse stock splits have been increasingly used as a method for cash-outs.
In the vast majority of cash-out transactions of Japanese public companies seeking to acquire 100% of the outstanding shares of the target company, bidders have announced they will exercise the call option by special controlling shareholder if they are able to acquire 90% or more of the outstanding shares through a tender offer, and will conduct a reverse stock split if they do not reach that threshold.
Amendment of Companies Act
In December 2019, the Companies Act was amended to further facilitate the reform on corporate governance (the Amendment). The Amendment aims to further promote the reform of corporate governance of listed companies initiated by the Corporate Governance Code, as well as those of large private companies that are not subject to stock exchanges’ rules.
The Amendment mandates all listed companies to:
The Amendment also requires listed companies to make efforts to disclose reference materials to the convocation notice online, no later than three weeks before the date of shareholders’ meetings (where the Companies Act before the Amendment only required that those materials were released two weeks before the date of shareholders’ meeting), so that investors will have more time to consider the agenda of the meeting.
Amendment of Companies Act and tax reform to facilitate the use of share consideration
In Japan, although tender offer rules allow the use of shares as consideration, in practice the consideration offered for almost all tender offers is cash. This is because of a combination of the potential directors’ liabilities in such a transaction, the necessity of court approval for in-kind contributions under the Companies Act and the tax treatment applied (capital gains tax is imposed on the selling shareholders, and carrying over is not allowed). Although the Companies Act issues could be avoided, even under the current law, by obtaining certain approvals from the applicable Japanese ministries under the Act on Strengthening Industrial Competitiveness, shares were never used as consideration for tender offers, because of the tax treatment.
The Amendment includes an amendment to grant exemption to the in-kind contribution rule whenever a Japanese stock company uses its own shares as consideration to acquire more than 50% of another stock corporation’s (including non-Japanese companies equivalent to Japanese stock corporations) voting shares (stock distribution).
Additionally, a proposed amendment to the tax code is expected to permit any capital gain arising from the sale of shares (including but not limited to sales through tender offers) meeting certain conditions to be carried over, whenever approval of the applicable Japanese ministry to the underlying transaction is obtained pursuant to the Act on Strengthening Industrial Competitiveness. If this tax reform comes into effect and is extended to stock distribution transactions, share consideration may become a more practical method for acquisitions of public companies through tender offers, as well as of private companies, as in many other jurisdictions.
Amendments of Foreign Exchange and Foreign Trade Act
Japan used to have very lenient foreign investment control, but it is now following the global trend to control investment, which may mean restricting foreign investors' access to sensitive technologies or information.
In general, the Foreign Exchange and Foreign Trade Act requires pre-transaction filing for investments by non-Japanese investors into companies in certain business sectors, which filing triggers a 30-day waiting period and a government review. Any other investments only need post- transaction reporting.
Previously, business sectors relating to national security, public order and public safety were designated as restricted sectors.
Since August 2019, the range of restricted sectors has been expanded to cover industries related to information and communication technology, such as the manufacturing of semiconductors, cell phones or other communication devices, computer memory, PCs, and the development of software, and the telecommunication industry.
On November 22, 2019, the Foreign Exchange and Foreign Trade Act was amended, this now allows the government to lower the threshold for the filing down to 1% of the number of issued shares or the voting rights. As a result of this amendment, the following actions will also require a filing: (i) actions which may have material influence on governance (such as giving consent to agenda to appoint directors or corporate statutory auditors (kansayaku) or agenda proposing a sale of all of the business); and (ii) asset acquisitions by a non-Japanese resident from a Japanese resident entity through business transfer, merger and spin-off. Passive investors are expected to be exempted from the pre-filing requirements, and there will be a list specifying the companies in which investment requires pre-filing. The details will be set forth in the new Regulations, which are expected to be published soon and will come in effect by May 2020.