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Trends and climate
What is the current state of the M&A market in your jurisdiction?
The Japanese M&A market has grown increasingly active in recent years. The number of M&A transactions in 2017 almost equaled that of 2016 with respect to volume and value, with 1,873 deals reported between January 2017 and October 2017. Private equity funds have played particularly active roles ‒ for example:
- Bain Capital and its co-investors acquired Toshiba Memory Corporation for approximately Y2 trillion and Asatsu-DK Inc for approximately Y160 billion; and
- Kohlberg Kravis Roberts acquired Hitachi Kokusai Electric Inc for approximately Y215 billion and Hitachi Koki Co Ltd for approximately Y147 billion.
Have any significant economic or political developments affected the M&A market in your jurisdiction over the past 12 months?
Since December 2012, when the Liberal Democratic Party under the leadership of Shinzo Abe won the general election and implemented its new economic policy (popularly dubbed ‘Abenomics’), M&A transactions have been continuously active in Japan. However, over the past 12 months, no significant economic or political developments have affected the M&A market in Japan.
Are any sectors experiencing significant M&A activity?
Large Japanese manufacturers remain focused on their core businesses and divesting their non-core businesses. Carve-out or spin-off transactions are expected to remain a trend across manufacturing sectors in Japan.
Are there any proposals for legal reform in your jurisdiction?
No significant proposals for legal reform in Japan in relation to M&A transactions have been announced.
What legislation governs M&A in your jurisdiction?
The following laws govern M&A transactions in Japan:
- the Companies Act;
- the Financial Instruments and Exchange Act; and
- the Anti-monopoly Act.
If a target engages in a heavily regulated industry such as banking, insurance or media and telecoms, the parties should pay careful attention to the laws regulating that industry.
How is the M&A market regulated?
Various regulations may apply to M&A transactions, including the following:
- The Companies Act governs certain types of transaction, including mergers, demergers, share swaps and issuances of shares.
- The Financial Instruments and Exchange Act and the rules of stock exchanges regulate M&A transactions involving listed companies (eg, tender offer regulations, mandatory disclosure requirements and insider trading regulations).
- The Foreign Exchange and Foreign Control Trade Act regulates foreign investment in Japan, which requires pre-closing approval from the Japanese government or post-closing filing depending on the industry subject to investment.
- The Anti-monopoly Act may apply to M&A transactions depending on the parties’ competitive position; a pre-closing filing is required if certain thresholds are met.
- Laws regulating specific industries (eg, the Banking Act and the Insurance Business Act) may apply to M&A transactions depending on the subject industry.
Are there specific rules for particular sectors?
The Foreign Exchange and Foreign Control Trade Act regulates investments by foreign investors. An investment into certain specified businesses is subject to prior approval from the Japanese government. In most cases, such prior approval is granted within 30 days (often substantially shortened) as long as the necessary filing is appropriately made. Typically, the government will be more sensitive and conservative if the subject business relates to Japan’s national security, such as the military or nuclear industries. Further, if the target operates in a highly regulated industry such as banking, insurance or media, relevant regulations provide for specific rules in M&A transactions.
Types of acquisition
What are the different ways to acquire a company in your jurisdiction?
Stock deals and asset deals are available. With regard to share purchase transactions, if a target is privately held, the transaction is structured as a simple sale and purchase of shares of the target. If a target is listed, a tender offer is likely to be required to take control the listed company, which must be made in accordance with the Financial Instruments and Exchange Act. With regard to asset deals, in addition to asset transfers and business transfers, demergers pursuant to the Companies Act are available.
Due diligence requirements
What due diligence is necessary for buyers?
Under Japanese law, a director of a company has a fiduciary duty, which is subject to a business judgment rule, where the court generally respects business judgments made by directors. As a prerequisite to applying the business judgment rule, the court requires directors to undertake reasonable investigations or research (including obtaining advice from outside experts) before making business judgements ‒ conducting due diligence is an important factor in this process. Legal due diligence in Japan typically covers areas such as:
- company organisation;
- shares and shareholders;
- material assets and intellectual property;
- material contracts;
- labour matters;
- litigation and disputes;
- governmental licences and permits; and
- other compliance issues.
What information is available to buyers?
If a target is privately held, publicly available information is limited to the information described in a commercial registry, including:
- the company name and address;
- its incorporation date; and
- the names of directors and auditors.
Shareholder information is not included. If a target is listed, thereby subjecting it to mandatory disclosure rules under the Financial Instruments and Exchange Act and rules of the stock exchange on which it is listed, some material information is available, including:
- financial quarter information;
- material information for investors; and
- large shareholder information.
What information can and cannot be disclosed when dealing with a public company?
No general rules apply regarding the restriction of information disclosed in the course of M&A transactions involving a public company. Disclosure of information restrictions (where applicable) depend on the target. Some technology companies are highly cautious with regard to disclosing technical information to buyers, as such buyers may be potential or actual competitors. Further, some companies are extremely cautious in disclosing highly confidential agreements with third parties.
Sometimes, in the course of due diligence, a buyer receives material information from a listed target, which is subject to the insider trading regulations under the Financial Instruments and Exchange Act. In such cases, unless the material information is disclosed to the public in the manner as described in the act, the relevant parties may be unable to sell or buy the shares of the target. Thus, the parties must pay close attention to whether the received information falls under the definition of ‘material information’ under the act and whether any disclosure of the fact is necessary before implementing the contemplated transaction.
How is stakebuilding regulated?
The Financial Instruments and Exchange Act regulates stakebuilding. Generally, anyone that holds 5% or more of the shares in a listed company (ie, a large shareholder) must file a report within five business days from the acquisition of the shares; any subsequent change of more than 1% is also subject to disclosure unless the shareholding becomes less than 5%.
Further, a tender offer is mandatory for certain off-maker acquisitions of shares of a listed company. While the Financial Instruments and Exchange Act provides for complex rules governing transactions subject to tender offers; the general rule is that a tender offer is required for off-market acquisitions of shares of a listed company exceeding one-third of the shares.
The Anti-monopoly Act requires a pre-closing notification to be sent to the Japan Fair Trade Commission if a buyer is going to acquire shares exceeding 20% or 50% of the voting rights of the target, as long as certain thresholds are met.
What preliminary agreements are commonly drafted?
Typically, M&A negotiations begin with a non-disclosure agreement. As the discussions progress, a memorandum of understanding or letter of intent setting out the basic terms and conditions of the transaction is executed, particularly for large and complex transactions. In most cases, a memorandum of understanding or letter of intent is non-binding, except for exclusivity and confidentiality provisions. Depending on the transaction, the parties may forgo a memorandum of understanding or letter of intent and directly enter into a definitive agreement.
What documents are required?
For share acquisitions or business transfers, the definitive agreement is a sale and purchase agreement. For mergers, share swaps or demergers, parties must enter into a merger, share swap or demerger agreement, which must provide for certain matters as required under the Companies Act (the Companies Act also provides for certain procedures, such as a procedure to protect creditors; such statutory procedure involves some additional documentation). As such statutorily required agreements must be disclosed, parties sometimes enter into separate agreements or memoranda which set out more detailed terms and conditions ‒ such as detailed representations and warranties, covenants and indemnifications ‒ which are believed to not be subject to the disclosure rules.
Which side normally prepares the first drafts?
If the sales process is an auction process, the seller normally prepares the first draft of the definitive agreement. Otherwise, whether a seller or buyer prepares the definitive agreement depends on the transaction and the parties.
What are the substantive clauses that comprise an acquisition agreement?
Substantive clauses include:
- closing conditions;
- pre-closing covenants;
- post-closing covenants;
- representations and warranties of the parties and the target; and
Price adjustment clauses are becoming more common. The most popular price adjustment mechanism is a working capital adjustment.
What provisions are made for deal protection?
No reliable statistical data is available for deal protection clauses in Japan, but some transactions involve provisions for deal protection. The most typical deal protection provision is a no-shop provision, which restricts a seller from negotiating with or providing information to a competing buyer. No-shop provisions in Japan often accompany a fiduciary out provision, which allows a seller to talk to a competing buyer where a superior offer is made by the competing buyer. While break-up and reverse break-up fee provisions are uncommon, these fees are sometimes discussed and negotiated, particularly for transactions involving private equity buyers.
What documents are normally executed at signing and closing?
Parties execute a definitive agreement, such as a share purchase agreement or business transfer agreement at signing. Normally, no other documentation is executed at signing. Typically, ancillary agreements such as transition service agreements and licence agreements are signed on or before closing. If a transaction involves a merger, demerger or share swap, the parties usually enter into a transaction agreement which sets out the detailed terms and conditions of the transaction (eg, detailed representations and warranties, covenants and indemnification) at signing, and the formal merger, demerger or share swap agreement is entered into between signing and closing. The Companies Act sets out matters that must be included in such agreements.
Are there formalities for the execution of documents by foreign companies?
No special formalities exist for the execution of documents by a foreign company.
Are digital signatures binding and enforceable?
Under the Act on Electronic Signatures and Certification Business, a digital signature has the same legal effect as a handwritten signature, and contracts executed by digital signatures are binding and enforceable. However, digital signatures are rarely used for the execution of contracts in Japan.
Foreign law and ownership
Can agreements provide for a foreign governing law?
Agreements may provide for a foreign governing law except for the provisions that govern certain types of transaction, such as a merger, demerger, share swap or issuance of shares, which must be governed by Japanese law – namely, the Companies Act.
What provisions and/or restrictions are there for foreign ownership?
The Foreign Exchange and Foreign Trade Control Act regulates investments by foreign investors. Investments into certain companies that engage in businesses specified by the act and its relevant regulations and ordinances are subject to the government’s prior approval, and the government has broad discretion as to whether approval of a given investment is granted. Foreign investors may not implement a transaction until the 30-day period from the filing has expired; but usually such period is substantially shortened. However, the government may extend this waiting period or even deny the transaction if (for example) the subject company is highly regulated due to national security concerns (eg, relating to the military, nuclear, aviation, media or telecoms industries).
Investments from foreign investors in businesses not subject to prior approval by the government are nevertheless subject to post-closing notification to the minister of finance by the 15th day of the following month of investment, excluding any acquisition of less than 10% of the shares of a listed company, which is not subject to post-closing notification.
Valuation and consideration
How are companies valued?
Companies may be valued in a number of ways, including:
- discounted cash-flow analysis;
- comparable company analysis; and
- net asset analysis.
Among other factors, the valuation method depends on the structure of the transaction and the subject company. While there is no rule under Japanese law concerning valuation methods, certain types of M&A transaction involving listed companies must disclose the valuation method used to calculate the purchase price.
What types of consideration can be offered?
Any asset may be used as consideration. However, buyers usually offer cash and occasionally shares.
What issues must be considered when preparing a company for sale?
Usually, it is necessary to consider, among other issues, whether:
- any material obstacles to selling the company exist (eg, a substantial amount of contingent liability or a possibility of termination of material contracts);
- any time-consuming or otherwise burdensome processes exist (eg, obtaining permission from relevant authorities); and
- the company should be sold by auction.
While buyers usually prefer exclusive negotiations, sellers may consider an auction in order to elicit a higher amount of consideration.
What tips would you give when negotiating a deal?
The nature of the target, as well as the requirements of the counterparty and the client, must be fully understood in order to provide the best possible deal for both parties.
Are hostile takeovers permitted and what are the possible strategies for the target?
While hostile takeovers are permitted in Japan, they are uncommon – only a few have been successful. Targets can deal with hostile takeovers in various ways. A popular anti-takeover plan adopted by listed companies in Japan is to announce possible dilutive issuances of stock acquisition rights, similar to the ‘poison pill’ method in the United States. However, since the corporate governance code was introduced in Japan, anti-takeover plans have become increasingly unpopular among investors, and the number of companies adopting such plans has gradually decreased.
Warranties and indemnities
Scope of warranties
What do warranties and indemnities typically cover and how should they be negotiated?
Typical items covered by representations and warranties include:
- organisational matters;
- financial matters;
- property (eg, real estate and intellectual property);
- labour matters;
- litigation; and
Representations and warranties are heavily negotiated between the parties, based on factors such as the results of due diligence and the view on risk allocation.
Limitations and remedies
Are there limitations on warranties?
Definitive agreements usually set out limitations such as time limits, caps and baskets on indemnification. Further, they often provide for knowledge qualifiers concerning certain warranties, under which such warranties are limited by the seller’s knowledge. A lower court precedent exists which essentially holds that, unless otherwise stipulated in the definitive agreement, anti-sandbagging (ie, where a party may not pursue indemnification based on a misrepresentation or breach of warranty if the party was aware of such misrepresentation or breach at the timing of signing) is the default rule.
What are the remedies for a breach of warranty?
Monetary remedies are usually provided under definitive agreements as remedies for breach of warranties. Further, before closing, a party may walk away from the transaction (due to the non-satisfaction of a condition precedent), or terminate the definitive agreement, in case of a material breach of warranty by the other party.
Are there time limits or restrictions for bringing claims under warranties?
Definitive agreements usually set out certain time limits in which to bring claims under warranty. Further, where there is no such provision, it is understood that a five-year statute of limitations is applicable to such claim (this will be changed to 10 years (at the longest) after the amendment of the Civil Code comes into effect in April 2020).
Tax and fees
Considerations and rates
What are the tax considerations (including any applicable rates)?
With regard to stock deals, capital gains are subject to tax, which varies from around 20% to 34% depending on the particulars of sale.
With regard to asset deals, sale proceeds are subject to tax of around 30% to 34% depending on the particulars of sale. Further, if an asset deal is conducted as a straightforward sale and purchase of assets, consumption tax will be imposed at the rate of 8% (10% from October 2019) on the transfer of taxable assets.
A certain amount of stamp duty (for asset deals) and a registration tax (if the transaction involves an amendment to the commercial registry, such as a demerger or share swap) may also be imposed. Tax amounts depend on the relevant consideration or asset or the structure.
Exemptions and mitigation
Are any tax exemptions or reliefs available?
Where the transaction is made by merger, demerger or share swap and meets certain requirements, such transaction is tax qualified and the taxation of the sales proceeds is deferred.
What are the common methods used to mitigate tax liability?
With regard to intra-group company transactions, parties usually seek a way to satisfy the requirements to be considered a tax-qualified transaction (ie, as applies to mergers, demergers or share swaps).
What fees are likely to be involved?
In principle, other than the stamp duty and registration tax mentioned above, there are no fees (except for advisers’ fees) involved in M&A transactions.
Management and directors
What are the rules on management buy-outs?
Directors participating in a buy-out are deemed to be directors with a special interest. The Companies Act requires such directors to avoid participating in the board resolutions concerning such buy-out transactions. Further, in some cases, the target will introduce an independent committee in order to further avoid any conflicts of interest with respect to the above directors.
In addition, the rules of stock exchanges require that a detailed disclosure be made in the case of management buy-outs in order to provide sufficient information to shareholders.
What duties do directors have in relation to M&A?
The directors of a company have fiduciary duties to the company and are liable, pursuant to the Companies Act, to third parties which suffer damage due to the wilful misconduct or gross negligence of such directors in the course of performance of their duties as directors. The fiduciary duties of directors are subject to the business judgment rule established by the court, and the court will generally respect business judgements made by directors unless the decision-making process, or the decision itself, is found to be unreasonable.
Consultation and transfer
How are employees involved in the process?
If a labour union is present, the collective bargaining agreement sometimes requires that the union be consulted before certain M&A transactions. Further, even if a collective bargaining agreement does not require approval from the union with regard to M&A transactions, parties usually try to avoid objections from the union in order to facilitate a smooth transfer.
With regard to asset deals, employees have certain rights to object to being transferred to the buyer (see below).
In principle, other than the above, employees are not involved in the M&A process.
What rules govern the transfer of employees to a buyer?
With regard to an asset deal through a straightforward sale and purchase of assets, the individual consent of each employee is required in order to transfer such employee to the buyer.
With regard to an asset deal by demerger, the Law Concerning Succession of Employment Agreements upon Demerger governs the transfer of employees. Under this law, employees who are expected to be transferred to the buyer, but who are not primarily engaged in the transferred business, or who are not to be transferred to the buyer, but who are primarily engaged in the transferred business, are entitled to opt out of (or opt into) their own transfer to the buyer.
In the case of stock deals, it is considered that there is no transfer of employees; therefore, there is no rule in that regard.
What are the rules in relation to company pension rights in the event of an acquisition?
With regard to stock deals, pensions and other benefits remain with the target, and thus employees remain entitled to the same rights thereunder. However, if the target’s pension plan is managed by a seller group, on closing (ie, when the target is no longer a member of the seller group and the taget’s employees become unable to participate in the seller group’s pension plan), the buyer may have to establish a new pension plan or transfer the target’s employees to the existing pension plan of the buyer.
With regard to asset deals, the necessary procedures differ depending on the system adopted by the buyer and the seller. If both seller and buyer adopt a defined contribution plan, the assets already contributed to the plan on behalf of the employees can be transferred without undertaking any special procedures. However, most of the other cases require relevant government authority approval (or notification to such authority) and the consent of employees.
Other relevant considerations
What legislation governs competition issues relating to M&A?
The Anti-monopoly Law governs competition issues relating to M&A in Japan, under which it is generally prohibited from acquiring shares, businesses or assets by demerger, or all or a substantial part of the seller’s business by business transfer, as a result of which competition in certain fields or trades is substantially restrained.
Further, subject to certain threshold requirements and exceptions, the Anti-monopoly Law requires filing of a prior notification with the Japan Fair Trade Commission if the buyer:
- increases its shareholding in a target with a certain amount of sales in Japan and the resulting shareholding ratio exceeds 20% or 50%; or
- purchases a seller’s business by sale and purchases the business or assets by demerger.
Notification is typically accompanied by a 30-day waiting period.
Are any anti-bribery provisions in force?
Yes. Such provisions prohibit bribery of officials generally and are not specific to bribery made in connection with business combinations. Bribery of foreign public officials with regard to an international commercial transaction for the purpose of gaining illicit profits is prohibited under the Unfair Competition Prevention Act, and those who commit such bribery are subject to imprisonment of up to 10 years or criminal fines of up to Y10 million (or both). Further, bribery of domestic public officials with regard to such officials’ duty is prohibited under the Criminal Code, and those who commit such bribery are subject to imprisonment of up to three years or criminal fines of up to Y2.5 million (or both).
What happens if the company being bought is in receivership or bankrupt?
Once a target is subject to bankruptcy or other similar proceedings, the court and a trustee become involved and usually lead the transaction. Typically, the court or trustee prefers the auction process to sell the business to sponsors. Further, in many such cases where insolvency proceedings commence, the transaction must be implemented on an as-is basis without any meaningful representation or warranties regarding the quality of the business.