The Japanese legal system has its origins in the civil law tradition and is mainly based on written law. Under the Constitution of Japan (1946), state power has been separated into three branches (ie, legislative, executive and judicial branches) which are independent of each other.
The legislative body is the Diet. The Diet possesses the authority to appoint the Prime Minister, enact laws, approve budgets and ratify treaties.
The executive power is vested in the Cabinet. The Cabinet consists of the Prime Minister and other Ministers of State, and it has the power to control and supervise all administrative branches. There are more than ten Ministries under the Cabinet. The organisation and affairs of each Ministry are based on the establishment law applicable to that specific Ministry.
Judicial power is vested entirely in the courts. The courts consist of the Supreme Court, high courts, district courts and summary courts. The courts handle civil, criminal and administrative cases. The Japanese judicial system has a three-tier structure and appeals may, in principle, be made two times. The Supreme Court is the court of last resort for all cases.
Under the local autonomy principle, administration in local areas is dealt with by local public entities (eg, prefectures and cities). The local public entities have both legislative and executive powers but not judicial powers.
Therefore, business entities operating businesses in Japan may be in touch with both national level bodies and with local level legislative and executive bodies.
Certain foreign direct investment (FDI) in Japan requires the review of the Ministry of Finance and relevant ministries under the Foreign Exchange and Trade Act (FEFTA). Under the FEFTA, foreign investments in Japan may, in general, be freely conducted. However, investments from countries that have no treaties on inward direct investment (including some countries in Africa and Central Asia), and investments in “designated businesses” and “core businesses” may require FDI notification to the Japanese government. These businesses are:
(i) weapons, aircraft, nuclear facilities, space, and dual-use technologies;
(ii) cybersecurity, electricity, gas, telecommunications, water supply, railways, oil, and businesses related to rare-earth metals; and
(iii) heat supply, broadcasting, public transportation, biological chemicals, security services, agriculture, forestry and fisheries, leather manufacturing, and air or maritime transportation.
Designated businesses consist of those in points (i), (ii) and (iii) and core businesses consist of those in point (i) and part of point (ii). The category of businesses related to rare-earth metals was added to the list in November 2021.
Notification of foreign investment in these industries to the Japanese government is given, via Bank of Japan (the Japanese central bank), prior to the acquisition of the Japanese company’s shares (pre-closing FDI notification) at least 30 days prior to the making of such investment. Upon receipt of the pre-closing FDI notification, the government will review, and may recommend changes to, or the cancellation of, the investment. If the foreign investor does not accept the recommendation, then the government may order a change or cancellation of the investment, which is legally binding. Please also note that many FDIs that are not subject to pre-closing FDI notification are still subject to a post-closing report, depending on the type of transaction.
Outlook and FDI Developments
The Japanese market continued to experience the effects of COVID-19 in the first half of 2022. However, as opposed to 2020 and 2021, most domestic business activities were conducted normally, and restrictions on the entry into Japanese territories from overseas were gradually lifted in the second half of 2022. While some businesses – including in the food and beverage, tourism, entertainment and aviation industries – have continued to be affected by the effects of COVID-19, domestic business activities are expected to become more active with strong consumer appetite for consumption in 2023.
Separate from the effects of COVID-19, Japanese business activities were largely affected by the historically weak Japanese yen, as well as the global economic recession caused by the war in Ukraine in the second half of 2022. Due to the weakness of the yen, Japanese companies have struggled to purchase overseas assets with their own cash, while, on the other hand, a number of international players have become very actively involved in in-bound investments in Japan, as they have found the Japanese market to be increasingly attractive due to the significantly lower prices of Japanese yen-based assets.
It will also be of interest to observe the possible effects on investments in Japan brought by the enactment of the Economic Security Promotion Act in May 2022, which established a new framework for economic security.
Stock Exchange Reform
One of the most drastic changes in the Japanese market in 2022 was the recategorisation of the Tokyo Stock Exchange (TSE).
Before the recategorisation, the TSE was divided into four different market divisions: First Section, Second Section, Mothers, and JASDAQ (Standard and Growth). The TSE then announced its intention to recategorise the four market divisions into three new divisions: the “Prime Market”, “Standard Market”, and “Growth Market”, effective from 4 April 2022. Since the re-categorisation also accompanies the changes to, or tightening of, the listing standards for each division, it necessitated many TSE listed companies to engage in M&A or other restructuring activities to reconsider their current business portfolio and profitability. Such trend lasted until the first quarter of 2022.
Recent Trends in Japan
Overall, Japan’s economy and business climate is stable and seems to be moving towards a “post-COVID” era. No specific revision to the FDI rules has been made, and there has not been any high-profile enforcement action or litigation recently. The number of domestic M&A transactions was still significantly high in 2022, partially due to the number of privatisations and restructuring activities driven by the TSE reform and active in-bound investments, as mentioned above.
Other notable recent movements include:
It is very difficult to predict whether these trends will continue in 2023 and onwards, especially because it is very uncertain whether the Japanese economy will be further affected by the depreciation of the Japanese yen and the global recession trend.
Share deals, asset deals, and corporate reorganisation transactions such as mergers and share exchanges are often used in Japan.
In general, with respect to the acquisition of more than one third of the shares in a public company, mandatory tender offer or takeover bid (called a TOB in Japan) regulations will kick in.
One of the main legislative purposes of the TOB regulations is to provide general shareholders with an opportunity to consider whether to accept the purchaser’s offer on an informed basis. The Financial Instruments and Exchange Act (FIEA) provides for strict disclosure rules for a TOB, including:
Other than corporate reorganisation transactions, the consideration for acquisitions is generally cash.
However, in order to facilitate domestic and cross-border M&A transactions, relevant laws and regulations have been reformed and it is now easier to use the purchaser’s shares as consideration in the transaction.
As legal structures for M&A transactions become more flexible, the creation of tax-efficient transaction schemes may become the most critical issue for companies/businesses in Japan.
Other than the regulatory regime under the FEFTA which, basically, applied to FDI, major relevant regulations in connection with domestic M&A transactions are antitrust/competition regulations and TOB regulations.
For antitrust/competition regulations, please see 6. Antitrust/Competition.
The TOB regulations, as stated in 3.1 Transaction Structures, generally apply to acquisitions of more than one third (or 5%, if the number of counterparties within 60 days is more than ten) of the voting rights of the shares in a public company. Other than the information disclosure requirements mentioned in 3.1 Transaction Structures, certain rules for conduct are also stipulated under the FIEA, which include that:
Under the Japanese Companies Act, there are four types of business vehicle:
The main business vehicle used in Japan is a stock company. All public companies are stock companies. Furthermore, most private companies are also stock companies. For tax reasons, a limited liability company (Godo Kaisha) may be more advantageous to overseas investors on some occasions (for example, limited liability companies can be deemed as pass-through entities under US tax laws), but, as it is a relatively new form of legal entity, it is sometimes deemed as lacking legal stability compared to a stock company. For overseas investors who seek to have a flexible governance structure, however, a limited liability company still seems an attractive choice.
The most common corporate governance structure with respect to a private stock company is a board of directors and corporate auditor(s). While it is possible for a private stock company to not have a board of directors that makes decisions concerning the organisation, operations and management via director(s) or the shareholder meetings, many private stock companies do. The corporate auditor(s) is a unique governance body, the role of which is to supervise, monitor the management decisions and the business operations conducted by the directors.
As regards public stock companies, it is common to have a board of directors and a board of at least three corporate auditors. Currently, in order to strengthen the corporate governance structure, a certain number of public stock companies have shifted to companies with three committees (namely, audit and supervisory committee, nominating committee and remuneration committee); all of which consist of at least three directors, with the majority as outside directors.
In 2013, a corporate governance reform was positioned as a key policy to promote foreign investment in Japan. This led to the establishment of the Stewardship Code as a code of conduct for institutional investors in 2014, and the Corporate Governance Code as a code of conduct for public companies in 2015.
The general principle under the Companies Act is to treat all shareholders equally.
Cumulative voting for appointing directors is allowed in Japan unless the articles of incorporation state otherwise. Therefore, even minority shareholders have the opportunity of appointing director(s). The Companies Act also stipulates that certain types of companies can issue shares of different classes and can let shareholders of those different classes elect their own directors. Accordingly, if minority shareholders can obtain a majority of votes within their share class, they have the opportunity to appoint a director to the board.
Further, under the Companies Act, minority shareholders are granted certain rights against the company and directors including, without limitation, the rights to:
A stock company must provide its annual financial statements at its head office and branch offices at least two weeks before its annual shareholders’ meeting. Furthermore, a stock company shall publicly disclose a summary of its balance sheet (in the case of a large company, the balance sheet and profit and loss statement) for each fiscal year. In addition, changes to certain matters such as an increase of paid-in capital and amendments to the articles of incorporation shall be registered with the relevant authorities.
A public stock company must undertake more stringent disclosure obligations, such as:
The main equity market in Japan is the Tokyo Stock Exchange (TSE), established in 1878. Up until 4 April 2022, the TSE mainly offered three market divisions:
In addition to these market divisions, the TSE also managed JASDAQ (for emerging companies). JASDAQ in turn offered two sub-markets:
The TSE has since re-categorised these market divisions into three new market divisions (Prime Market, Standard Market and Growth Market), with effect from 4 April 2022 (see 2.1 Recent Developments and Market Trends).
Aside from capital markets, bank financing is another way to access funds. Companies will typically choose whether to raise funds through capital markers or debt financing, based on various factors such as interest rates, relationships between banks, funding costs, shareholders’ intentions, or overall trends in capital markets.
The key statutes and regulations affecting the securities markets in Japan are set out below.
The FIEA regulates the issuance, placement and trading of securities, such as corporate shares, corporate bonds, and interests or shares in investment trusts and investment corporations. It also regulates the primary and secondary markets of such securities in Japan.
The FIEA regulates financial transactions in a cross-sectoral manner including various derivatives, commodity funds, partnerships, investment advisory/management services, investment trusts, etc.
The FIEA also regulates the dealing, brokering, underwriting and distribution (acting as a selling group member in a public offering), and arranging of private placement of FIEA Securities by foreign securities firms.
The Act on Investment Trusts and Investment Corporations
The Act on Investment Trusts and Investment Corporations (ITICA) regulates investment trusts and investment corporations, both domestic and foreign, including the establishment and operation of investment corporations registered as such under the ITICA, while the operation of domestic investment trust management companies registered as such under the FIEA are primarily regulated by the FIEA.
The rules of the Japan Securities Dealers Association apply to all securities dealing. In addition to these, each securities exchange also has its own rules to regulate public companies.
FDI through investment funds is also subject to regulations under the FEFTA. See 7. Foreign Investment/National Security for details of the regulations under the FEFTA. When filing a pre-closing FDI notification under the FEFTA, information regarding general partners (and parent companies) of the funds may also need to be disclosed.
The rules and regulations applicable to the marketing and sale of interests/shares in foreign investment funds are categorised into two major parts. The rules and regulations applicable to foreign investment trusts/foreign investment corporations are entirely different from those applicable to interests in foreign collective investment schemes. Therefore, the specific requirements to be met for private placement of the funds vary depending on the legal characteristics of each fund.
If the fund is regarded as either a foreign investment trust or foreign investment corporation, under the current regulatory environment and practice applicable to fund-type securities, there are two private placement exemptions for newly issued interests in the fund (namely, the “small number offerees exemption” and the “qualified institutional investors exemption”).
If the fund is regarded as a foreign collective investment scheme, a private placement for newly issued interests in the fund would be available if the number of investors is 499 or fewer (note that the threshold number is counted based on the number of subscribers, not the number of offerees). In practice, however, the number and category of Japanese investors would need to be limited in order to enjoy exemptions from the registration requirements imposed on the general partner of the fund.
Japan has a merger control regime. Certain types of FDI involving a “business combination” – such as the acquisition of shares, amalgamations, joint share transfers, and acquisition of businesses – would trigger a requirement to file a prior notification to the Japanese Fair Trade Commission (JFTC). For example, in the case of an acquisition of shares, a prior notification would be required if:
The requirement to file a prior notification applies regardless of whether the company is a domestic company or a foreign company.
If a business combination is subject to the prior notification requirement, it is prohibited, in principle, for the companies to close the transaction for a period of 30 days after filing the prior notification unless the JFTC shortens this period at its discretion. The JFTC may request reports, information and materials from the parties during the period, and if it is considered necessary, this waiting period may extend up to 120 days from the filing of prior notification.
A business combination that would result in the substantial restraint of competition in any field of trade is forbidden under the Antimonopoly Act. This regulation is applied regardless of whether such a business combination triggers the prior notification requirements mentioned in 6.1 Applicable Regulator and Process Overview.
As to the criteria for review, the JFTC publishes “Guidelines to Application of the Antimonopoly Act Concerning Review of Business Combination” (the “Business Combination Guidelines”). The Business Combination Guidelines give safe harbour in deciding whether a horizontal business combination substantially restrains competition. If the parties involved fall under any of the following situations after the implementation of the proposed business combination, the horizontal business combination is not considered to be a restraint on competition:
The Business Combination Guidelines also provide that the JFTC is highly unlikely to conclude that any business combination falling within the following threshold would substantially restrain competition:
In the review of business combinations, the JFTC may require remedies from the parties to a contemplated business combination. The Business Combination Guidelines illustrate certain types of remedies that the JFTC may require.
Business Transfer From a Party Group to Its Competitor
According to the Business Combination Guidelines, creating a new independent competitor or strengthening its existing competitor should be the prime remedies. The Business Combination Guidelines provide the following as examples:
Other Remedies or Commitments
The Business Combination Guidelines also provide the following remedies or commitments:
The JFTC has the authority to block FDI that would result in the substantial restraint of competition in any field of trade, either before or after the investment is made. Decisions of the JFTC may be appealed in a competent court.
In the case where a FDI is made without the prior approval of the JFTC:
Relevant Authorities and Types of FDI Subject to Review
Certain FDI in Japan requires review from the Ministry of Finance and relevant ministries pursuant to the FEFTA. Among other actions, certain acquisitions of a Japanese company’s shares would require foreign investors to file a pre-closing FDI notification.
The key factors to be examined in determining whether a pre-closing FDI notification applies to a foreign investor’s contemplated acquisition of shares in a Japanese company are as follows:
For acquisition of a privately held company
If the designated business of the Japanese company is not a core business, an exemption may apply. This exemption requires the foreign investor to refrain from participating in the business of the target company with respect to the following specific actions (“general restrictions”):
For acquisition of a listed company
If the foreign investor is a financial institution and undertakes the general restrictions, the investor will be exempted from the pre-closing FDI notification requirement.
If the foreign investor is not a financial institution and undertakes the general restrictions, the foreign investor will be exempted from the pre-closing FDI Notification requirement subject to the following further requirements.
Even if the foreign investor (when not a financial institution) undertakes all the applicable restrictions, no exemption will be available if the foreign investor intends to acquire a stake or voting rights of 10% or more of the outstanding shares of a target company engaging in a core business.
Foreign governments or government-affiliated entities are, in principle, not eligible for the exemption described above.
Timeline of Pre-closing FDI Notification
If a pre-closing FDI notification will be submitted, its lead time will need to be factored into the transaction schedule in consideration of the mandatory waiting period as described below.
In the review process, the government considers whether the contemplated transaction warrants particular scrutiny for its potential impact on national security or the Japanese economy.
The government may ask the foreign investor, among other things, for the following information:
The government does not clearly explain whether its criteria, considerations and analyses of review are different for:
However, since the FEFTA treats foreign governmental entities and other entities differently, and certain forms of minority investment are not subject to the pre-closing FDI notification, it is reasonable to expect that the government may see the three types differently in its review process.
The government may recommend a change to the details, or the cancellation, of the investment upon its review of the pre-closing FDI notification. A foreign investor who receives such a recommendation may either accept or reject it. However, if the foreign investor does not accept the recommendation(s), the government may order a change to the details, or the cancellation, of the investment, which is legally binding.
During the history of the FEFTA, there has only been one publicly available case where the government issued an order to cancel the investment to a foreign investor. This does not mean, however, that the government accepted all other investments. Rather than issuing an order, the government tends to, officially or unofficially, recommend that an investor voluntarily withdraw its notification in cases where the government is of the view that the investment should not be implemented.
As a condition for clearance, the government occasionally requests that the investor make certain commitments in connection with the target company and/or the designated business (eg, not proposing the company to dispose of the designated business).
As described in 7.1 Applicable Regulator and Process Overview, if an exemption is applied to a foreign investor, the foreign investor shall comply with the general restrictions and additional restrictions where applicable.
Violation of the FEFTA and/or an order made by the government may be subject to criminal sanctions such as imprisonment and/or fines. Such criminal sanctions may be disputed through criminal litigation before the relevant courts.
There had, until recently, been no enforceable legal restrictions for a foreign investor in real estate transactions in Japan. However, in June 2021, the Act on Review and Regulation of Real Estate Usage was enacted and purchases of land near defence force bases or other areas with national security implications have been restricted since the autumn of 2022.
Under the FEFTA, cross-border transfer of a certain amount of funds is subject to post-facto reporting; however, such filing is generally handled by financial institutions in Japan involved in these transactions.
With regard to industries such as telecommunications, broadcasting and aircraft, which are related to public infrastructure, there are cases where foreign investment regulations are included in the laws regulating the relevant industry.
For example, the Civil Aeronautics Act provides that if one third or more of the voting rights of a corporation are held by foreign entities, the aircraft owned by the corporation may not be registered (Article 4 of the Civil Aeronautics Act). This means that if one third or more of the shares of a Japanese airline company are acquired by foreign entities, the airline company will be unable to continue its business operations. In order to avoid this, the Civil Aeronautics Act permits airline companies to reject any request for a registration of foreign entities in its shareholder registry if the change will result in one third or more of the shares being held by foreign entities.
Similarly, the Radio Act and the Broadcast Act limit foreign investment in corporations with radio station licences to not more than one third or one fifth (depending on the type of licence) of their voting rights, and the Act on Nippon Telegraph and Telephone Corporation, etc limits foreign investments in Nippon Telegraph and Telephone Corporation (NTT) to not more than one third of its voting rights.
Corporate tax and consumption tax are the main taxes generally imposed on companies doing business in Japan.
Corporate tax is a tax on the income of companies. Corporate tax is imposed on all incomes of domestic corporations regardless of whether their sources are in Japan or abroad. For foreign corporations, only domestic source incomes are subject to taxation. Partnerships are not subject to taxation, but their partners are taxed.
Consumption tax is a kind of value added tax. It is imposed on nearly all domestic transactions (sale and lease of goods and provision of service for consideration) and import transactions, excluding certain transactions, such as transfers and lending of land and transfers of securities.
The consumption tax rate is 10% of the sales amount, while the reduced tax rate of 8% applies to certain sales transactions, such as the transfer of foodstuffs.
Consumption tax is imposed on companies whose revenue for the reference period (which is the fiscal year preceding the last fiscal year in principle) is more than JPY10 million.
From 1 October 2023, new invoicing rules which require a “qualified invoice” (the “Qualified Invoice System”) will be introduced and come into effect in respect of consumption tax. Under the Qualified Invoice System, a purchaser of goods or services may take an input tax credit only if it receives a qualified invoice from a seller and retains it. A seller will need to be registered as a qualified invoice issuer in order to issue such an invoice to purchasers. If a company is registered as a qualified invoice issuer, consumption tax will be levied on its supply of goods or services even if its revenue for the reference period is JPY10 million or less.
In addition to the above, the following notable taxes may be imposed on companies:
Withholding at Source
For foreign corporations, Japanese taxation is relevant only in respect of their domestic source income. Certain domestic source income such as:
is subject to withholding at source.
The tax rate of withholding at source is, in principle, 20% (20.42%, including special income tax for reconstruction; hereinafter the same) with certain exceptions such as 15% (15.315%) for dividends from listed companies, 15% (15.315%) for interest on bonds and debentures.
Taxation Under Tax Treaties
For the purpose of avoiding international double taxation, tax treaties are in place between Japan and other countries. In the case where there is a conflict between a provision of tax treaty and that of local tax law, the former will prevail in principle. Tax treaties may provide rules regarding domestic source income or tax rates which are different from those provided by domestic tax laws. For example, under the Convention between the Government of Japan and the Government of the United States of America for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (the Japan-US Tax Treaty), lower tax rates apply to dividends and interest (10% and 0%, respectively). In the case of dividends, if dividends paid between a parent–subsidiary relationship (where the parent (i) has no less than 10%, or (ii) has had no less than 50% of the subsidiary’s shares for six months or more), the rate is (i) 5% or (ii) 0% under the Japan-US Tax Treaty.
There are no general limitations for “treaty shopping” under domestic tax law, but some treaties have the following to counter treaty shopping:
Tax Benefits of Consolidation by Companies and Their Controlled Subsidiaries
Tax benefits of consolidation by companies and their controlled subsidiaries are available. A company may, with approval by the National Tax Agency, adopt the consolidated return framework for itself and its subsidiaries that are, directly or indirectly, wholly owned by it. Under this consolidated return framework:
This consolidated return framework is being replaced by a new group relief framework, which applies in respect of any business year starting on or after 1 April 2022. Under the new group relief framework, each company within the group pays corporate tax calculated by offsetting profits and losses among the group companies, while under the old consolidated return framework, the ultimate parent company paid corporate tax on the group’s consolidated income.
A foreign investor may avoid tax on its Japanese subsidiaries through the excessive payment of interest from them to persons in foreign countries. To prevent this, the earning stripping rule applies in Japan. This rule provides that a corporation is not allowed to include “net interest” payments (excluding interest payment which is included in taxable income of the recipient in Japan) in excess of 20% of the “adjusted income” of such a corporation into deductible expenses.
In principle, there are no general exemptions for capital gains from sale or other disposition.
However, capital gains from the sale or other disposition of stocks in Japanese companies by a non-resident without permanent establishment are generally exempted from Japanese tax other than in certain situations such as those discussed below.
Capital gains from the sale or other disposition of certain large portions of stocks in Japanese companies by an FDI may be taxed. Specifically, when an FDI, that holds 25% or more of the outstanding shares of a Japanese company, sells 5% or more of the outstanding shares of such a company, the capital gains from such a transaction are subject to Japanese taxation.
Stocks in a Real Estate Related Corporation
Capital gains from certain sales or other disposition of stocks in a Japanese company whose real property accounts for 50% or more of the total assets of that company (a real estate related corporation) may be taxed. For example, in the case of stocks in a non-listed Japanese company, when an FDI (that holds more than 2% of the total outstanding stocks of a real estate related corporation on the last date of the preceding business year) sells stocks in that corporation, the capital gains from the transaction are subject to Japanese taxation.
Below are the special anti-avoidance rules that may be imposed on FDI in Japan.
Transfer Pricing Rules
If the price of a transaction between a Japanese company and its foreign affiliated company deviates from the price that would be used in the same transaction if carried out between unrelated parties, that transaction is deemed to have been conducted using the transaction price between unrelated parties. In such a case, the relevant tax liability will be recalculated accordingly.
Thin Capitalisation Rules
Thin capitalisation rules apply if a Japanese subsidiary receives a loan from its foreign parent entity in the amount of more than three times the amount of capital contributed by such foreign parent into the subsidiary. In that case, that Japanese subsidiary may not include the interest for the excessive amount into deductible expenses.
If both the thin capitalisation and the earnings stripping rules apply to a corporation, the larger amount between them will be used as the amount against which the revenues of the corporation in the relevant fiscal year cannot be offset.
Controlled Foreign Corporation (CFC) Rules
A corporation may try to avoid Japanese taxation by establishing a subsidiary in a foreign country with low tax rates and accumulating profits in that subsidiary. To counter this, the CFC rules were introduced. The CFC rules focus on each activity of a subsidiary in a foreign country. For example, if a subsidiary in a foreign country falls within the category of a paper company, a company deemed to be an actual cash box or a company located in a blacklist country, the profit of the subsidiary will be included in the parent company’s gross revenue amounts for Japanese tax purposes unless the tax rate applying to the subsidiary is 30% or more. If a subsidiary in a foreign country (other than a paper company, etc) does not satisfy certain economic activity requirements, the profit of the subsidiary will be included in the parent company’s gross revenue amounts for Japanese tax purposes unless the tax rate applying to the subsidiary is 20% or more.
Under general tax rules, 95% of the amount of dividends from a foreign subsidiary are exempted from counting as profits of the Japanese parent company. However, if a Japanese company receives dividends from its foreign subsidiaries and all or a part of the amount of dividends is included in deductible expenses in the country where such a subsidiary’s headquarters are located, the amount included into the deductible expenses at the subsidiary’s end will be excluded from such exemption.
Employment and labour matters in Japan are governed by a combination of various laws, including the Labour Standards Act (LSA), the Labour Contracts Act (LCA) and the Labour Union Act (LUA). While the LSA and LCA stipulate the fundamental principles of labour relationships between employers and employees, the LUA mainly governs matters related to collective labour management relationships. In addition to the LSA, LCA and LUA, the Act on Improvement, etc of Employment Management for Part-Time and Fixed-Term Workers, which was revised recently, requires employers to treat regular workers and non-regular workers in a well-balanced manner (or equally) and prohibits employers from treating them unreasonably differently.
It is particularly important when engaging in a Japanese business to understand that:
Labour unions are commonly organised in Japan. Traditionally, labour unions were predominantly organised by workers from a certain enterprise or business establishment but, recently, labour unions comprised of workers across different enterprises and industries have also become common. The right of collective bargaining is guaranteed by the Constitution and is not uncommon in Japan. Once a labour union initiates collective bargaining, the employer must negotiate with the labour union in good faith and failure to fulfil this obligation could lead to an accusation of unfair labour practices.
Among various protections for employees, it is particularly important to note that unilateral dismissal of an employee by an employer is very difficult in Japan. Specifically, a dismissal is invalid if the dismissal is not based on any objectively and socially justifiable cause, as clarified by the judicial precedents.
Under the LSA, employers are required to pay wages directly to employees in cash (ie, Japanese yen). The wages must also be paid in full, at least once a month on a certain date.
While the basic wage must be paid in cash, it is becoming common in Japan that employees receive additional benefits from employers in other forms, such as stock options or restricted stocks, in most cases as an incentive payment. Also, under certain conditions, employees working at an enterprise must be covered by an employees’ pension system, on top of the basic pension provided by the National Pension System.
Since employee compensation is a critical part of the labour conditions between an employer and employee, in principle, any reduction or material change in the payment of employee compensation requires the clear informed consent of the relevant employee. In the event that a Japanese enterprise becomes involved in an acquisition, or any transaction involving a change of control (eg, business transfer, share transfer or corporate split), the basic principle is that the compensation of the employees belonging to the relevant enterprise should be maintained even after such a transaction, in the absence of a clear agreement between the employer and the relevant employees.
Share Sale Transaction
In a share sale transaction, the work conditions for the employees are expected to be maintained after the transaction unless the company and the employees specifically agree to change them. There is no requirement for the company to consult with the employees prior to the transaction unless any collective agreement between the company and a labour union obliges it to do so.
Acquisition/Asset Sale Transaction
Apart from merger, where employment is automatically succeeded to by the merging entity, there are two types of acquisition/asset transfer transaction in Japan: business transfer and corporate split.
In a business transfer transaction, where the rights and obligations of the transferred business must be individually transferred, only targeted employees who agree to be employed by the buyer’s entity and give their individual consent thereto will be transferred to the buyer’s entity. In other words, while the employees do not have a mandatory right to transfer their employment in the transaction, they can also reject the transfer of their employment. It should be also noted that employers are advised to consult with the transferred employees prior to the transaction, based on the guidelines implemented by the Ministry of Health, Labour and Welfare.
In a corporate split transaction, where the rights and obligations of the transferred business are automatically transferred, the transferring entity is obliged to give certain notices to the employees involved and the labour union, and also to consult with the employees and the labour union, prior to the transaction, pursuant to the Labour Contracts Succession Act. If an employee is primarily engaged in the transferred business but is excluded from the employees to be transferred, that employee has the right to require the company to mandatorily transfer their employment. On the other hand, if an employee is not primarily engaged in the transferred business but is included in the employees to be transferred, that employee has the right to require the company not to transfer their employment.
As described in 7.1 Applicable Regulator and Process Overview (Exemptions), as one of the general restrictions for a foreign investor to be qualified for an exemption of pre-closing FDI notification and review by the government, the foreign investor shall refrain from accessing non-public information concerning the target’s technology in the designated business. Intellectual property can be a key part of such non-public information. If the investor is eager to access such information, the investor is not qualified for an exemption and may be subject to filing a pre-closing FDI notification and review by the government as described in 7. Foreign Investment/National Security. Designated businesses subject to such review are as described in 7.1 Applicable Regulator and Process Overview.
A variety of intellectual property rights are recognised and well protected under Japanese law, including rights relating to patents (including a business utility patent), utility models, designs, trademarks, trade secrets and other interests protected under the Unfair Competition Prevention Act. It should be noted that registration is required under Japanese law to protect the relevant intellectual property right. Japan adheres to the first-to-file principle which holds that, in principle, first use does not establish one’s intellectual property right.
The Act on the Protection of Personal Information (APPI) is the basic legislation in Japan for the protection of personal information. Furthermore, the Personal Information Protection Committee (PPC) is the main authority that supervises the enforcement and application of the APPI.
Most of the provisions under the APPI apply to data handling operators, even though they are entities outside Japan, if they receive personal information when providing goods or services to individuals residing in Japan.
The civil/criminal/administrative sanctions for data-handling operators in violation of the APPI are relatively moderate compared to the GDPR.
An amendment to the APPI was undertaken in June 2020 and came into effect in 2022. Generally speaking, the 2020 amendment strengthens the regulatory framework under the APPI in various areas such as reporting obligations, penalties and extraterritorial enforcement.
There is no significant issue to be covered here, except for the issues addressed above.
Overall, the Japanese M&A market between the months of January to September in 2021 was quite stable. However, from October 2021 to September 2022, the aggregate M&A deal value experienced more than a 30% decrease, mainly due to the Russia–Ukraine conflict, the global economic recession, and the depreciation of the yen, even though the number of M&A deals has slightly increased. Having said that, small and medium-sized M&A deals, including those involving start-ups, remain active, and this trend is expected to continue in 2023. Set forth below is a summary of the most recent legislative amendments, stock exchange reforms and current practice relating to such amendments or reforms, and investment trends in the Japanese market.
Recent Developments in Law and Practice
Adoption of amendments to the Companies Act
The majority of the recently proposed amendments to the Companies Act took effect from March 2021.
Some of the enacted amendments, which were adopted to reflect the wishes of the business community, grant Japanese stock companies (kabushiki kaisha) greater flexibility in their management structures. For instance, under an amendment to the Companies Act which took effect in 2022, Japanese stock companies have been allowed to circulate material reference documents and convocation notices for shareholders’ meetings via online tools. Furthermore, in M&A deals, Japanese companies will have more flexibility to use their own shares as consideration in acquiring the shares of another Japanese stock company. On the other hand, certain other amendments to the Companies Act require Japanese stock companies to strengthen their internal corporate governance. For instance, stock companies are required to adopt board resolutions in certain circumstances, including where stock options are issued to directors as remuneration, or where a conflict of interest arises from any matter involving the company and a third party and the company’s board considers it appropriate to defer to the external directors to determine such matter.
As these amendments were published years ago, most Japanese companies, especially listed companies, have already prepared for their enactment. Accordingly, there has not been a serious degree of confusion regarding these amendments.
Current practice under the reformed foreign direct investment framework
From the perspective of foreign direct investment in Japan, there was a significant amendment to the inbound foreign direct investment regulations in 2020. The amendments to the Foreign Exchange and Foreign Trade Act (FEFTA), which took effect on 7 June 2020, strengthened the screening of proposed foreign inward investment, mainly from a national security viewpoint, by, among other things, requiring foreign investors to follow stringent, pre-transaction review procedures enforced by Japanese authorities if 1% or more of the shares or voting rights of a Japanese listed company are to be acquired, which is far below the original threshold of 10%, with certain exemptions. Also, the necessity of protecting domestic companies engaging in healthcare/medical activities related to COVID-19 prompted the government in July 2020 to add relevant sensitive business areas that require pre-transaction scrutiny.
While such amendments have been in effect for more than two years, even though the filing process for foreign direct investments have become more onerous in terms of paperwork, no serious inconvenience or delays in the process have been reported due to this reform.
Enactment of the Economic Security Promotion Act
Meanwhile, the Economic Security Promotion Act was enacted in May 2022 to serve as a new framework for economic security that goes beyond the regulation of foreign investment. An overview of the Act is as follows.
The Act consists of the following four “pillars”.
I. Strengthening of the supply chains of important items and raw materials
In order to mitigate the increasingly serious potential impact of disruptions in the supply of semiconductors and pharmaceuticals (brought about by the reliance of industrial infrastructures and medical services on digitalisation), and to counter a relative decline in Japan’s ability to secure critical supplies in times of supply disruptions (caused by the growth of emerging countries and the deepening of global value chains), the following measures will be implemented in accordance with a basic policy that will be formulated by the national government:
II. Securing the safety and reliability of key infrastructures
In order to mitigate the risk of cyber-attacks brought about by the large-scale digitalisation of critical facilities in key infrastructures, a prior assessment system will apply in respect of the introduction of critical facilities for key infrastructures, as well as the commissioning of maintenance and management services for critical facilities. Businesses/Business Operators that will be particularly affected include:
(i) companies that operate key infrastructure(s);
(ii) companies that supply specified critical facilities, or that supply parts to the key infrastructures classified under the preceding item (i); and
(iii) companies commissioned to manage and maintain the specified key infrastructures classified under the preceding item (i).
Foreign companies may find it difficult to pass the prior assessment for the supply of the specified critical facilities and the management and maintenance of the specified key infrastructures.
III. Implementing of systems to develop and support key technologies by both public and private sectors
For advanced technologies that are critical to the stability of daily life and economic activities, a framework of government support and co-operation between the public and private sectors will be implemented. According to written opinions issued by an expert advisory panel during the preparation of the bill, the key technologies that will be targeted for support include those that fall within the areas of space engineering, marine engineering, quantum technology, artificial intelligence and biotechnology.
IV. Prevention of leakage of sensitive data relating to inventions by non-disclosure of relevant patent information
In order to reinforce existing measures that seek to prevent the leakage of sensitive information in the course of patent applications, the Act introduces:
Businesses/Business Operators that will likely be affected by these measures are:
In principle, inventions that fall within specified technological areas and that originate in Japan are prohibited from being the subject of patent applications in other countries, and penalties may be imposed for the violation of this rule.
The impact of the new Act is unclear at present, as the ministerial ordinance setting out the relevant details of the Act has yet to be published. The Act is expected to gradually come into force by 2024. Businesses should take into account the potential impact of the new Act, particularly when acquiring or investing in Japanese companies that are engaged in sensitive national defence-related businesses.
Reform of the Tokyo Stock Exchange
Until April 2022, the Tokyo Stock Exchange (TSE) comprised of four market divisions: 1st Section, 2nd Section, Mothers and JASDAQ (consisting of two sub-markets, Standard and Growth).
The concept of each market division was ambiguous, which reduced convenience for many investors. Specifically, as well as there being overlap between the intended uses of the 2nd Section, Mothers and JASDAQ markets, the concept of the 1st Section was also unclear.
Additionally, the market divisions did not provide sufficient incentives for listed companies to sustainably increase their corporate value. For example, since the de-listing criteria were significantly less strict than the initial listing criteria, the de-listing criteria did not incentivise listed companies to continue to satisfy the level of quality required at the time of initial listing.
Furthermore, since the criteria for transfers to the 1st Section from other market divisions are lighter than the direct initial listing criteria for the 1st Section, the system did not encourage transferee companies to proactively increase their corporate value after listing.
Consequently, the TSE reformed these four market divisions into three new divisions: the “Prime Market”, “Standard Market” and “Growth Market”, with effect from 4 April 2022.
In accordance with the concept of each market segment, quantitative and qualitative listing criteria have been established for liquidity, corporate governance, and other elements. For example, in terms of liquidity, to be listed on the Prime Market, an entity must have at least 800 shareholders, a JPY10 billion tradable share market cap and a JPY20 million average daily trading value. Further, to ensure constructive dialogue with institutional investors, listed companies in the Prime Market must maintain “public market control” by maintaining a tradable share ratio, with so-called stable shareholders holding less than ⅔ of shares, and by appointing ⅓ or more outside directors. Since the reforms, approximately 1,800 companies (which is just under 50% of companies listed on the TSE as of April 2022) have opted for the Prime Market. Several hundred of these companies were allowed to remain on the Prime Market as a transitional measure, notwithstanding that they did not meet the Prime Market listing criteria. In due course it will be seen how the new market segments will impact M&A activity and investment in practice.
Sustainable Development Goals (SDGs)/Environmental, Social and Corporate Governance (ESG)
Over the past few years, the SDGs and ESG concepts have spread rapidly in Japan, affecting legislation and practice.
For example, on 13 September 2022, the Japanese government published the “Guidelines for Respect for Human Rights in Responsible Supply Chains” (the “Guidelines”) to more clearly explain and promote efforts to respect human rights, as required by the United Nations Human Rights Council in their “Guiding Principles on Business and Human Rights” (the “Guiding Principles”), published in 2011, and to promote other international standards among companies.
As with Section II of the Guiding Principles, the Guidelines mainly consist of three sections:
(i) the establishment of human rights policy;
(ii) the implementation of human rights due diligence (HRDD); and
With respect to the establishment of human rights policy (item (i)), companies are encouraged to express, both internally and externally, their commitment in fulfilling their responsibility to respect human rights by establishing a human rights policy. The Guidelines also recommend that companies engage and hold discussions among their internal departments as well as with external stakeholders and others concerned.
With respect to the implementation of HRDD (item (ii)), companies are encouraged to take four steps:
It is noteworthy that the Guidelines do not oblige companies to address all the adverse impacts identified but instead require companies to prioritise adverse human rights impacts depending on their severity, as it would be too impractical to tackle every adverse impact.
Finally, with regard to the remedies (item (iii)), in order to promptly deal with grievances over adverse human rights impacts and provide relief directly to the victim, companies are encouraged to either establish a regime to deal with grievances concerning the company and its stakeholders, or to participate in a grievance mechanism established by an industry organisation or equivalent.
When a foreign party decides to invest in a Japanese company, one of the critical factors to be considered is whether such Japanese company properly complies with the above and other related guidelines.
Recent Investment Trends
The following provides an overview of some of the trends in the Japanese M&A market that we have witnessed in 2022, most of which are a continuation of trends observed in 2021.
Shareholder activism and an increase in hostile takeovers
Even prior to the year 2022, there was a trend of activist shareholders being increasingly proactive and aggressive in their proposals to Japanese listed companies. This trend only strengthened during the COVID-19 pandemic.
This trend has been driven mainly by the belief that Japanese listed companies still maintain capital reserves that they do not use effectively, and activist shareholders continue to request appropriate and sufficient returns be made to the shareholders. During the COVID-19 pandemic, the activists’ position remained the same. Despite this, proposals made by many activist shareholders during 2021 and 2022 were reported to be relatively modest and more sophisticated compared to those of prior years. For example, rather than simply seeking greater dividends or share buy-backs, a greater number of more constructive proposals have been witnessed, such as the implementation of measures to improve governance structures and capital productivity.
Another reason for this increased activism is that, following the introduction of the Corporate Governance Code in 2015, Japanese listed companies are required to maintain stronger corporate governance standards. Notwithstanding this, many listed companies have failed to establish appropriate internal corporate governance systems to date, which provides a strong opportunity of which activist funds may seek to take advantage.
The activation of the activist funds has also led to the increase in the number of hostile takeovers. The Japanese market has historically been very conservative, in which only a very few of the limited number of attempted hostile takeovers of listed companies have been successful. However, from the year 2020, there has been a marked increase in the number of hostile takeovers.
Aside from the role of activist funds, another underlying factor is an increase in the number of Japanese listed companies that abolished their anti-takeover plans. This is due to (i) the majority of Japanese listed companies adopting the Corporate Governance Code, which basically encourages dialogue between shareholders and companies and takes a negative view of anti-takeover plans and cross-shareholding, and (ii) an increase in the number of institutional investors signing on to the Stewardship Code, which led them to undertake greater accountability to their clients, and no longer allows them to simply support a company’s management without there being grounds justifying the support.
In 2020, among the various cases of hostile takeovers, the tender offer proposal made by City Index Eleventh, an activist fund led by Yoshiaki Murakami, against Toshiba Machine (currently renamed as Shibaura Machine) opened the door for discussions of the introduction of an event-driven type anti-takeover plan. A court ruling was not made as to the enforceability of the event-driven type anti-takeover plan introduced by Toshiba Machine. In 2021, some other listed companies faced similar situations and introduced their own event-driven type anti-takeover plans similar to the one introduced by Toshiba Machine. Currently, several cases regarding the requirements for and effectiveness of the introduction and implementation of such event-driven type anti-takeover plans have been the subject of legal proceedings and the courts have issued a series of orders this year, some of which have been quite controversial.
Impact of the TSE reform
As stated above, the TSE has re-categorised its market divisions. Since not all listed companies in the 1st Section were able to meet the requirements in order to continue to be listed in the Prime Market in their current state, one option for these companies to remain in the Prime Market would be to expand by way of M&A transactions. On the other hand, should they no longer wish to remain a public company, an MBO or other transition to private company status will be an option.
Further, in order to increase their tradable share ratio and tradable share market cap, and also to endure the stricter supervision from outside directors, more listed companies are turning more of their attention to their business portfolios. Namely, they are focusing more on profitable business units and disposing unprofitable business units to third parties.
The TSE reform was thought of as an inducement for the expansion of M&A transactions and, so far, it has indeed been a strong factor in the increase in the number of M&A transactions.
M&As and investments in start-ups
IPOs have accounted for a large proportion of start-ups’ exit means in Japan, due in part to the high number of small IPOs, and the fact that M&A activity has been relatively muted in comparison. However, from the perspective of stimulating the start-up market over the medium to long term, M&A deals targeting start-ups has been on the rise in recent years, partly due to government initiatives.
In March 2021, the Ministry of Economy, Trade and Industry (METI) published a research report recommending that M&A deals involving start-ups would contribute to the medium and long-term value enhancement of companies through open innovation. In addition, in July 2022, the Kishida Cabinet, declaring 2022 the “first year of start-up creation”, established a new minister in charge of start-ups and launched a start-up support policy to increase investment in start-ups tenfold over the next five years.
In fact, in 2021, there were 143 M&A deals targeting start-ups, the highest level in the last five years (80–95 cases annually in 2017–20.)
This trend continued throughout 2022 and is expected to continue in 2023.
Due to the economic recovery and cheap debt available in Japan, private equity firms have substantial funds that can be used for their acquisitions.
Recently, following the trend in the US, the Japanese arm of various global buy-out funds, such as Bain Capital and Carlyle, have started to make minority investments in start-ups or growth capitals.
Bain Capital subscribed for Series E shares in Hey, a leading payments and e-commerce platform in Japan that helps businesses to create bespoke online stores and process in-store cashless payments in 2020, and also invested in Linc’well which provides hospitals and patients with IT services. Carlyle became a minority investor in Japanese biotech unicorn, Spiber, in 2021, and invested in CureApp which develops healthcare applications in 2022.
While it may still be too early to forecast, it does appear that the boundaries between buy-out funds, venture capitals and growth capitals could become further unclear.
The Liberal Democratic Party of Japan, Japan’s current ruling political party, won the House of Representatives election held in October 2021 and the House of Councillors election held in July 2022, and the Kishida administration was expected to remain stable and in power for some time. However, support for the Kishida administration has continued to fall due to scandals involving cabinet-level politicians, stemming from the unfortunate assassination of former Prime Minister Abe, among others. Considering the above, it is difficult for the Kishida cabinet to take drastic policies, including those economic in nature, and no major changes are expected to be made to the recent M&A and investment trends explained above; these trends are expected to continue in 2023.