Trends and climate
What is the current state of the M&A market in your jurisdiction?
In 2014 Japanese companies were reportedly involved in 2,285 M&A transactions. This number grew by approximately 11.6% on the previous year, marking the third consecutive year of growth. Significant recently announced or completed deals include:
- the acquisition of Beam Inc by Suntory Holdings Limited for approximately $16 billion in the liquor industry;
- the acquisition of Toll Holdings Ltd by Japan Post Co, Ltd for approximately $6.4 billion in the logistics industry; and
- the acquisition of Protective Life Corporation by Dai-ichi Life Insurance Company, Limited for approximately $5.7 billion in the life insurance industry.
Have any significant economic or political developments affected the M&A market in your jurisdiction over the past 12 months?
The Japanese economic environment has significantly improved under a series of economic policies adopted by the Abe administration, popularly referred to as ‘Abenomics’. For example, the Nikkei stock average recovered to a level that it had not achieved since the Lehman Brothers collapse in 2008. Many commentators consider the recovery to be one of the key reasons for the recent increase in M&A transactions in Japan.
Are any sectors experiencing significant M&A activity?
Almost all sectors have experienced significant M&A activity. Recently, several large Japanese insurance companies have announced intentions to acquire US insurance companies.
Are there any proposals for legal reform in your jurisdiction?
A bill to amend the Companies Act was adopted on June 20 2014 and the amended act came into force on May 1 2015. The following changes are expected to have a major impact on Japanese M&A practices.
Rules on third-party allotment of new shares
Under the former Companies Act, third-party allotments of new shares by a public company had to be approved by a resolution of the board of directors only, even if control of the company changed, unless the amount to be paid for the subscribed shares was particularly favourable to the subscribers.
Under the amended Companies Act, a certain type of third-party allotment of new shares requires a resolution of the shareholders’ meeting. In concrete terms, a public company that is willing to conduct a third-party allotment of new shares resulting in one party holding a majority of the shares must issue a notice to shareholders or a public notice containing certain details required by law. If shareholders holding 10% or more of the voting rights of the company notify the company that they are opposed to the third-party allotment of new shares within two weeks of the notice, the third-party allotment of new shares must be approved by a resolution of the shareholders’ meeting.
Rules on transfer of shares of a subsidiary
Under the former Companies Act, the transfer of shares of a subsidiary did not have to be approved by a resolution of the shareholders’ meeting.
Under the amended Companies Act, the transfer of the shares of a subsidiary must be approved by a special resolution of the shareholders’ meeting (passed by a two-thirds vote of the members present) if the book value of such shares is 20% or more of the total asset value of the transferring company and if, following the transfer, the transferring company will not be the parent of the company whose shares are transferred.
Rules on company splits
Recently there has been an increase in the abuse of company splits by unprofitable companies in order to avoid making payments. However, the former Companies Act offered insufficient protection from this abuse to the remaining creditors of the splitting company. As a result, the courts have issued many rulings on this issue in recent years.
The amended Companies Act offers better protection for the rights and benefits of the creditors of the splitting company. When a company splits in the knowledge that the split will be detrimental to its remaining creditors, they can demand payment from the new company up to the value of the assets obtained from the former company.
New cash-out method
Under the former Companies Act, a company could conduct a squeeze-out of minority shareholders by taking certain measures. In reality, companies commonly used shares subject to a class-wide call. However, the procedures for using this method were time consuming and inefficient. For example, a special resolution of the shareholders’ meeting had to be adopted to amend the articles of incorporation.
Under the amended Companies Act, special controlling shareholders that hold 90% or more of the voting rights of the target will have the right to purchase the remaining shares from the other shareholders without invoking the procedures for a shareholders’ meeting of the target, These procedures are expected to be used frequently for cash squeeze-outs. However, the squeeze-out measures under the former Companies Act are not prohibited under the amended Companies Act.
What legislation governs M&A in your jurisdiction?
The key laws governing general M&A transactions are the Companies Act, the Civil Act, the Financial Instruments and Exchange Law and the Anti-monopoly Law. If a party to an M&A transaction operates in a particular industry (eg, a financial institution), various special laws and regulations also apply.
How is the M&A market regulated?
The Companies Act regulates various corporate actions such as stock purchases, mergers, share exchanges, business transfers, company splits and issues of shares for subscription.
Financial Instruments and Exchange Law
The Financial Instruments and Exchange Law regulates listed companies. In terms of the M&A market, its key provisions govern tender offers, disclosures and insider trading.
Securities listing regulations
The securities listing regulations of each stock exchange also regulate listed companies with regard to issues of shares for subscription, transactions involving controlling shareholders and certain disclosure requirements.
Stockholdings, mergers, company splits and business transfers that will substantially restrain competition in a particular market are prohibited under the Anti-monopoly Law. The law also sets certain thresholds that require parties to submit prior notification to the Japanese Fair Trade Commission.
Are there specific rules for particular sectors?
Various laws and regulations apply to particular sectors. For example, financial institutions such as banks, insurers and securities companies are regulated under specific regulations. If a company plans to conduct an M&A transaction involving a financial institution, in many cases it must obtain prior approval from or submit prior notification to a governmental authority.
Many other types of company operating businesses that require approvals or licences may be required to obtain new approvals or licences or to notify a relevant authority when setting up new companies.
Types of acquisition
What are the different ways to acquire a company in your jurisdiction?
If shares of the target are listed on a stock exchange, in certain cases the purchase of such stock must carried out by a public tender offer.
A merger integrates two or more companies into a single corporate entity. Shareholders of the absorbed company are usually allotted shares in the surviving company, but cash and other assets of any kind (including shares of the surviving company’s parent) may be allotted to shareholders of the absorbed company in a cash-out merger or the equivalent of a triangular merger under the Companies Act.
Under a share exchange, an acquirer becomes the absolute parent of a target by allotting a specific consideration in exchange for all shares of the target. Shareholders of the target are usually allotted shares in the acquirer, but cash and other assets may be allotted to shareholders of the target in the same way as a merger.
Business transfer and company split
An acquiring company may take over part of a business comprising the target’s integrated assets, employees, intellectual property and/or commercial rights. A business transfer and company split is used when a company intends to choose which assets and debts to acquire.
Issuance of shares for subscription
An acquiring company can execute a subscription agreement with a target and receive new shares issued by the target. However, since outstanding shareholders remain, the acquirer cannot obtain all of the shares in the target only through the subscription of new shares issued by the target.
Due diligence requirements
What due diligence is necessary for buyers?
The scope of legal due diligence changes depending on factors including the transaction type, deal size and the industry in which the target operates. Due diligence for a general M&A transaction should cover at least:
- the organisation;
- material assets and contracts;
- labour issues;
- regulatory compliance; and
- contingent liabilities, including litigation and disputes.
What information is available to buyers?
If the target is not listed on a stock exchange, the scope of public information available to the acquirer is limited (ie, only the information set out in the commercial register is available). On the other hand, if the target is a listed company, various public information is available about the company, including the following:
Annual, semi-annual and quarterly securities reports – listed companies must file these reports, which must contain:
- an outline of the company;
- the status of the business;
- the status of facilities; and
- accounting statements and other information.
These reports can be accessed free of charge online through the Financial Services Agency’s Electronic Disclosure for Investors Network (EDINET).
Timely disclosure and extraordinary reports – the securities listing regulations of each stock exchange require that listed companies timely disclose information to investors that may affect their investment decisions. Timely disclosures for the past five years are available online through the Timely Disclosure Network (a paid subscription to the Tokyo Stock Exchange is required). Extraordinary reports disclose information regarding corporate actions or other important matters that have occurred in relation to the company that are prescribed in the Financial Instruments and Exchange Law. The reports contain information that is in some respects similar to information that must be timely disclosed and can be accessed free of charge through EDINET.
What information can and cannot be disclosed when dealing with a public company?
Where the target is a public company, it must make timely disclosure of material facts concerning the operations, business, assets or securities that may have a significant impact on investors’ decisions.
In addition, if the acquirer obtains inside information about a public target, it may not acquire the target’s shares until such information is disclosed to the public, except for certain cases provided under the Financial Instruments and Exchange Law. Therefore, handling insider information is a key issue when dealing with a public company.
How is stakebuilding regulated?
Where the target is listed on a stock exchange, stakebuilding is regulated as follows.
A holder of securities whose shareholding is larger than 5% (including a holder of options to obtain a shareholding larger than 5%) (known as a ‘large shareholder’) must file:
- a large shareholding report within five business days of becoming a large shareholder; and
- an amendment report within five business days of the date on which its shareholding increases or decreases by 1% or more after becoming a large shareholder.
Under the Financial Instruments and Exchange Law, if a party intends to purchase shares of listed companies, purchases must be made by tender offer in the following cases:
- the aggregate voting rights held by the acquirer and ‘any affiliated persons’ (as defined in the Financial Instruments and Exchange Law ) divided by the total voting rights in the target (the ‘total voting ratio’) after the purchase to be made outside the stock exchange market exceeds 5% (unless the aggregate number of sellers under the contemplated share purchase and other sellers of shares to the acquirer that traded outside the stock exchange market within 60 days before the day of the purchase is less than 10);
- the aggregate number of sellers under the contemplated share purchase to be made outside the stock exchange market and other sellers of shares to the acquirer that traded outside the stock exchange market within 60 days before the date of the contemplated share purchase is less than 10 and the total voting ratio exceeds one-third after the purchase;
- the purchase is made according to certain methods of purchase prescribed by the prime minister (including purchasing through the Tokyo Stock Exchange Trading Network System) and the total voting ratio exceeds one-third after the purchase;
- within any three-month period:
- more than 5% of the voting shares are purchased outside the stock exchange market or by certain methods of purchase prescribed by cabinet order;
- in total more than 10% of the voting shares are obtained through purchases inside and outside the stock exchange market or issuance of shares for subscription; and
- the total voting ratio exceeds one-third after the purchases or the issuance;
- a party whose total voting ratio exceeds one-third intends to purchase over 5% of the shares of the listed company; or
- certain other cases as prescribed by cabinet order.
What preliminary agreements are commonly drafted?
This depends on each transaction’s type, size and schedule. In a large-scale, long-term transaction, commonly the parties first execute a memorandum of understanding in which they outline the transaction’s purpose, structure, schedule and general terms and conditions.
What documents are required?
- An agreement setting down the terms and conditions for the transaction.
- Certain documents regarding matters subject to disclosure regarding execution or closure of the transaction.
- Public notice of commencement of a tender offer and registration statement for a tender offer.
- A tender offer explanatory statement.
- Notice of the purchase.
- Public notice of the number of tendered share and tender offer report.
Merger/share exchange/company split
- An agreement setting out the terms and conditions for the transaction.
- A security registration statement (in certain cases, as set out in the Financial Instruments and Exchange Law).
- Certain documents subject to advanced disclosure, including the relevant agreement.
- A public notice in relation to the procedures for creditors’ objections.
- Certain other documents regarding matters subject to disclosure after execution of the transaction.
- Notice in relation to the appraisal rights of opposing shareholders.
Issuance of shares for subscription
- A share subscription agreement or share application certificate.
- A security registration statement (in certain cases set out in the Financial Instruments and Exchange Law).
Which side normally prepares the first drafts?
The seller generally prepares the first draft, but this depends on the specific circumstances of a transaction.
What are the substantive clauses that comprise an acquisition agreement?
The substantive clauses in an acquisition agreement cover the price (including any price adjustments), timing and place of closing, representations and warranties, covenants, conditions precedent, indemnification and termination.
What provisions are made for deal protection?
In recent years, the number of transactions including deal protection clauses (eg, break-fee clauses and exclusive negotiation clauses) has increased. However, because there are few court precedents on this matter, it is unclear whether a court would confirm the validity of such clauses, especially when they might conflict with the fiduciary duties of a target’s directors.
What documents are normally executed at signing and closing?
At signing, a definitive agreement setting out the general terms and conditions of the transaction is executed. At closing, in some cases the parties execute ancillary transaction agreements relating to the post-transaction business (eg, distribution agreements, service agreements and licence agreements).
Are there formalities for the execution of documents by foreign companies?
Are digital signatures binding and enforceable?
Although Japan has a law on digital signatures, generally parties do not execute M&A transaction agreements through digital signatures.
Foreign law and ownership
Can agreements provide for a foreign governing law?
What provisions and/or restrictions are there for foreign ownership?
The minister of finance must be notified pursuant to the Foreign Exchange and Foreign Trade Act by the 15th day of the month following that in which an acquisition of shares in a Japanese company takes place:
- where the acquisition of listed shares results in the shareholding ratio of the foreign investor (after aggregation with the shareholdings of certain affiliated companies and other entities or individuals prescribed by law, such as family members or parent companies, that jointly agree to exercise their voting rights with the foreign investor) reaching 10% or more; or
- for the acquisition of unlisted shares.
In addition, with regard to certain regulated industries deemed critical to national security (eg, weapons, aircraft, nuclear power, space development or related electrical device or software industries), the foreign investor must provide prior notification to the minister of finance and the minister in charge of the relevant industry, and cannot obtain the shares until 30 days after notification. In certain situations prescribed in the Foreign Exchange and Foreign Trade Act, the minister of finance and the minister in charge of the relevant industry may block or modify the investment.
Other restrictions on capital injections by foreign entities are set out in specific laws regulating specific industries, such as telecommunication, broadcast and aviation.
Valuation and consideration
How are companies valued?
Various valuation methods (eg, the cost approach, the income approach and the market approach) are used, depending on the types of M&A transaction and the companies involved. Although there is no legal restriction on the valuation of companies, the parties are required to disclose the valuation methods they used in the press release and other disclosure documents if the related companies are listed. Therefore, it is general practice for companies to procure a valuation report from their financial advisers and, in some cases, their fairness opinion.
If a shareholder objecting to the transaction exercises the right to demand the company to purchase the shares it holds at fair value in accordance with the Companies Act, in some cases the court will review the transaction procedure, including the valuation method and decide on the fair value of the shares. Therefore, in some cases, the valuation method, and process will be examined in the course of court proceedings.
What types of consideration can be offered?
Any type of consideration can be offered, but cash or shares in the acquirer are the most common.
What issues must be considered when preparing a company for sale?
One of the most important issues for a seller to think about is whether it should sell through an open bid process with several potential acquirers or engage in exclusive negotiations with a particular acquirer. An open bid presents a higher likelihood of selling the target at a higher price. In general, however, potential acquirers prefer an exclusive negotiation process because of the greater certainty of the transaction and the increased flexibility with respect to transaction price and schedule. Thus, the process chosen depends on several factors, including the negotiating powers of both parties.
Another important issue to check is whether the target has any deal breakers (eg, a large amount of contingent liability or change of control clauses in material contracts). If the target has any of these issues, the transaction is unlikely to be completed. Even if the transaction closes, the seller may be liable to compensate the acquirer for any post-closing damages based on indemnification clauses in the definitive agreement.
What tips would you give when negotiating a deal?
In order to negotiate efficiently, parties must consider the point of no return and clearly set out their priorities on the matters to be negotiated at the initial stage, in accordance with the results of the due diligence.
Are hostile takeovers permitted and what are the possible strategies for the target?
It is possible to engage in a hostile transaction with respect to a stock purchase or a tender offer. In other transactions, the acquirer must first gain control of a majority of the target’s board of directors, because the implementation of such transactions requires its approval. In order to control the majority of the target’s board, an acquirer may exercise its shareholder’s right to propose the election of a certain number of directors of the target, in order to launch a proxy fight.
Until 2000, hostile transactions were uncommon in Japan – partly due to deep-rooted cross-shareholdings among Japanese companies and resistance to hostile bids in Japanese society. However, after 2000 the number of hostile transactions and attempted hostile transactions started to increase gradually, mainly due to the dissolution of cross-shareholdings and a change in attitudes towards hostile bids and takeovers by foreign companies. However, hostile transactions are still uncommon and almost all have been unsuccessful.
Warranties and indemnities
Scope of warranties
What do warranties and indemnities typically cover and how should they be negotiated?
Many issues are covered by representation and warranty clauses and indemnification clauses, and they vary depending on deal size, business type of the target, and other related factors. In general, these clauses should cover the following key aspects in the definitive agreements:
- the organisation, standing and power of the parties;
- the authority and validity of the agreements;
- the accuracy and completeness of financial statements;
- legal compliance;
- the status of assets, intellectual property and material contracts;
- contingent liabilities, including litigation, tax and environmental issues; and
- full disclosure.
Limitations and remedies
Are there limitations on warranties?
What are the remedies for a breach of warranty?
These depend on the circumstances. In general, if a breach of warranty is discovered before closing, the non-breaching party can refuse to close on the grounds that the conditions precedent are not satisfied or demand compensation for damages. On the other hand, if a party discovers a breach of warranty after closing, it usually cannot terminate the agreement and can only demand compensation.
Are there time limits or restrictions for bringing claims under warranties?
Under the Commercial Code, a party can file a claim for compensation for damages within five years of discovering the breach of warranty. However, the parties commonly stipulate a shorter statute of limitations for bringing claims under stock purchase agreements.
Tax and fees
Considerations and rates
What are the tax considerations (including any applicable rates)?
Asset acquisitions and disposals made through a merger, company split or share exchange may be tax exempt if they satisfy certain requirements. It is particularly common to seek tax-qualified transactions where the seller or the target has large built-in gains on the transferred asset. Japanese tax laws and regulations set out detailed and complicated provisions regarding such requirements.
Exemptions and mitigation
Are any tax exemptions or reliefs available?
Yes. If a transaction meets certain requirements set out in the tax laws and regulations, it may be deemed to be a tax-qualified transaction and certain taxes can be deferred.
What are the common methods used to mitigate tax liability?
If there is a possibility that an important tax issue may arise in a transaction, the parties commonly consult with the relevant tax authority and solve any issues based on specific background information before the transaction in accordance with the tax laws and regulation.
What fees are likely to be involved?
Financial, legal, accounting, tax and other professional adviser fees are likely to be involved. If a filing to governmental authorities is required, further fees will be applicable. However, government filing fees are generally reasonable.
Management and directors
What are the rules on management buy-outs?
In Japanese management buy-outs the management of the target commonly cooperates with a private equity fund to purchase all shares of a listed company. In such a transaction, the directors who participate in the transaction with the private equity fund will face a conflict of interest. In such case the directors of the target are at least subject to a duty to take appropriate measures to protect the interests of public shareholders. Under the Companies Act, directors with special interests in a transaction that is subject to a board resolution are prohibited from participating in the discussion and resolution at the board of directors’ meeting. Since the scope of the term ‘special interest’ in the statute is unclear, in practice directors without special interests but with personal economic interests in the acquirer often abstain from voting at the meeting.
In addition, to protect the interests of public shareholders and ensure the fairness of the process, a special independent committee is commonly formed to verify, among other things, whether the negotiations were properly conducted and whether the agreed price is fair and reasonable. However, in Japan, the members of these special independent committees are not necessarily independent directors of the company, because many listed companies do not have enough independent directors to compose a special committee. Therefore, it is common practice to create an independent special committee that also includes one or more independent statutory auditors or independent experts (eg, attorneys, accountants or academics). The role of the special committee in management buy-outs varies from transaction to transaction. Most committees serve only as examiners and check, among other things, whether the price and other terms and negotiations by the management are appropriate.
What duties do directors have in relation to M&A?
Under the Companies Act, directors have a duty to conduct the business of the company with the care of good managers. In addition, directors are required to perform their duties faithfully on behalf of the company. More than 40 years ago, the Supreme Court indicated that the directors’ duty of loyalty complements and clarifies the duty of care, and that these duties cannot be perceived as separate duties of corporate directors. In addition, it is generally understood that directors assume these obligations not to shareholders, but to the company.
Recently, the lower courts have applied a Japanese version of the business judgement rule to directors by limiting their inquiries to whether the directors exercised reasonable business judgement in light of the circumstances at the time of the decision. Essentially, the Japanese business judgement rule holds that directors should not be held liable for any damages resulting from their decision, provided that they can show that:
- there was no negligence in their assessment of the material facts; and
- there was no material unreasonableness in the content and process of the decision, judged against the standards of an ordinary manager.
Some court precedents exist with respect to the duties of directors in the context of M&A transactions, but the above rule also applies to these cases.
Consultation and transfer
How are employees involved in the process?
If a company is split up, the Employment Contract Assignment Law sets out the necessary procedures according to which the assignor shall consult with and give notice to employees and labour unions.
In other M&A structures the parties face no specific obligations to inform or consult employees about the transaction. However, in many companies a collective labour agreement between the company and the unions sets out the applicable procedures when the company intends to conduct a merger, split, share exchange or other transaction (eg, prior notification to, or sufficient consultation with, employees and labour unions).
What rules govern the transfer of employees to a buyer?
Apart from the Employment Contract Assignment Law, no specific laws govern the transfer of employees. The parties generally stipulate how to handle this matter in the transaction agreement.
What are the rules in relation to company pension rights in the event of an acquisition?
Complicated laws and regulations govern pension rights, so the parties should consult experts and consider carefully how best to deal with pension rights when negotiating a transaction.
Other relevant considerations
What legislation governs competition issues relating to M&A?
The Anti-monopoly Law governs competition issues relating to M&A. Under the law, stockholdings, mergers, company splits and business transfers that will substantially restrain competition in a particular market are prohibited. The law also sets certain thresholds that require related parties to submit prior notification to the Japan Fair Trade Commission.
Are any anti-bribery provisions in force?
Anti-bribery provisions are included in the Criminal Code and the Unfair Competition Prevention Act. However, these clauses are rarely applied in the course of an M&A transaction. On the other hand, foreign anti-bribery provisions (eg, the US Foreign Corrupt Practices Act and the UK Bribery Act 2010) apply to Japanese companies conducting global business. Thus, these regulations should be borne in mind.
What happens if the company being bought is in receivership or bankrupt?
In Japan, bankruptcy proceedings are commenced by court decision if the company is:
- unable to pay debts – where the company, due to its lack of ability to pay, is generally and regularly unable to pay its debts as they become due; or
- insolvent – where the company’s assets are insufficient to discharge its debts fully.
If a company is subject to bankruptcy, its business and assets are managed by a bankruptcy trustee appointed by the court.