Taking control of a Japanese publicly listed company

Key words

Against the background of such development, the following keywords play a vital role for decision makers and advisers targeting Japanese listed companies: flexibility, transparency, certainty and fairness. In the next sections, I want to discuss some of the most recent regulations and practices with reference to each of these keywords.

Flexibility

Methods and key factors

In short, the acquisition of voting rights of any company can be effected by each of the following methods, or by combination of two or more of them:

a) Accumulation of shares in the stock market;

b) Purchase of a controlling stake from a major shareholder;

c) Purchase of shares by way of public offer outside the market;

d) Purchase of shares from target; or

e) Acquisition of shares by way of merger.

The choice of acquisition structure is of course heavily dependent on business, tax and accounting issues. Set out below are a few key legal considerations that may determine the choice of acquisition method:

a) whether to keep the target publicly listed, or to take it private;

b) whether to acquire the target shares gradually, or all at once;

c) whether a friendly or unsolicited approach with management will be taken; and

d) whether to use cash or shares as consideration.

Keep it public/ Take it private

Keep public

An acquirer may wish to maintain the listed status of the target in the interests of continued direct access to capital markets, or to take advantage of the favourable perception from suppliers, customers, future management or labour forces of companies with 'public' status. So, what type of acquisition method above does this eliminate? The short answer is none, but this does not mean that every method can be used in all circumstances – each has its limitations.

Market transaction

The first option is to acquire shares in the market. This is perhaps the most straightforward method, but because of the pricing mechanism of the market, it may be the most costly. Having said that, there are examples of unsolicited acquirers having accumulated more than 40% of voting rights by way of market transactions.

Private sale

Let's assume the target has a major shareholder who owns a controlling stake in the company. The simplest way to acquire control in such case would be to privately negotiate with the shareholder and execute a purchase contract. However, to avoid triggering the mandatory tender offer regulation under FIEA, private deals should be limited to the following circumstances:

a) When an acquirer will own 5% or less of voting rights after such deal (though such block may not be considered as 'controlling stake');

b) When an acquirer will own one-third or less of voting rights after such deal, if the shares are purchased from a small number of shareholders (i.e. less than 11 shareholders within the 60-day period, hereinafter the same);

c) When an acquirer will own two-thirds or less of voting rights after such deal, if it already owns a majority and shares are purchased from a small number of shareholders;

d) If the deal results from the exercise of certain rights, but only if expressly permitted by regulations (e.g. exercise of pledge, stock option, and non-voting stock or bond convertible to voting stock); or

e) If the deal falls into one of the limited categories explicitly exempted by regulations (e.g. when seller is the acquirer's subsidiary or parent company for at least one year).

This regulation is so complex that explaining the detail would take up the remaining space of this article and even this journal, but the following rules are worth highlighting:

a) In calculating the ratio of voting rights (5%, one-third, majority or two-thirds), the number of potential (or dilutive) shares (e.g. stock options, non-voting stock or bond convertible to voting stock) is taken into account. However, only the potential shares that the acquirer will be holding after the deal are counted (not only in the numerator, but also in the denominator), and therefore can be higher than the ratio on a fully diluted basis (where all potential shares in the denominator are counted);

b) The number of voting rights not yet held but to be held if the contract is performed must be counted (e.g. if a share purchase contract has already been signed pending completion);

c) Voting rights (including potential ones) held by persons 'acting in concert' must be counted. If the acquirer has an agreement with another person (which need not be in writing and could be found to exist by the court based on certain facts) to act in concert with respect to the exercise of voting rights, or acquisition of shares, they will be found to be acting in concert. Furthermore, certain persons are deemed to act in concert merely on the basis of having a particular relationship with an acquirer (for example, a spouse, parent or child, or director of an acquirer, or if you own 20% or more of existing voting rights of an acquirer, or if 20% or more of your existing voting rights is owned by an acquirer);

d) These regulations generally target transactions outside the market, but they also apply to certain market transactions (TosTNeT and other off hour tradings).

Compliance with these regulations is highly advisable, not least because failure to comply constitutes a criminal offence (up to five years in jail and/or a JPY5 million (US$61,000) penalty for individuals and a JPY500 million (US$6.1 million) penalty for corporations) and may result in a surcharge (25% of total price). Careful consideration is advised because of the complexity of rules and the tendency of the regulator to interpret FIEA broadly so as to capture any circumvention of the purpose of the law.

Partial tender offer

Mandatory tender offer rules may compel a potential acquirer to announce a tender offer even where this is not desired. On the other hand, in cases where the shareholders of a target are widely dispersed, it may be appropriate to announce a tender offer in order to collect sufficient voting rights. In either case, the tender offer procedure set out in FIEA must be followed. The following illustrates a few aspects of this procedure:

a) The offer period must last for at least 20 business days, and at most 60 business days (but may be extended if required by law);

b) A detailed tender offer statement must be filed, and if a misstatement or change of facts is found therein, an amendment too. The offer period will be extended so that a period of 10 days or more following any amendment remains. Any material misstatement or omission may constitute a criminal offence (up to 10 years in jail and/or JPY10 million penalty for individuals and JPY700 million penalty for corporations), and may result in a surcharge (25% of total market value);

c) An equivalent price must be offered to all shareholders;

d) The acquirer (together with persons acting in concert) cannot acquire shares of the target during a tender offer period outside tender offer procedure;

e) The acquirer cannot withdraw from a tender offer unless one of the limited categories of exceptions applies.

Where it is preferable to maintain the target's listed status, the acquirer needs to take care not to acquire so many shares as may expose the target to delisting. For example, the Tokyo Stock Exchange will delist a listed company if its tradable share ratio is less than 5%, or if the number of shareholders is less than 400 (for the latter, subject to a grace period). It is possible to manage the risk of delisting by setting a cap to the tender offer. In other words, a maximum number of shares to be acquired in the procedure may be set, and in such case, an acquiror is not obliged to purchase any shares exceeding the maximum. If tendered shares are more than the maximum, shareholders will be treated pro rata in accordance with the number of shares tendered by each shareholder. The cap can be up to two-thirds of voting rights, so it is not permissible to set a cap of 90%, or even of 67%.

Third party allocation

In the previous scenarios, voting rights are acquired from existing shareholders. It is possible though to acquire voting rights from the target itself. Third party allocation (TPA) has been a relatively common method to acquire control in a listed company and involves a simple issuance of shares to be allocated to the acquirer. In principle, the Company Act permits the target to issue shares by board approval without shareholders' approval. Shareholders' approval is required if the:

a) price of shares is a 'specially favourable price' (generally interpreted as a 10% or more discount against the most recent market price);

b) issuance results in a dilution of 25% or more, unless the opinion of an independent third party is obtained (note that stock exchanges tend to require shareholders' approval even if an opinion is obtained); or

c) issuance exceeds the authorised number set out in the articles of incorporation (authorised capital).

In other words, control can be acquired with a substantial discount if approval is successfully obtained. The issuance of shares is subject to an injunction if it is found to be an 'unfair issuance', particularly if there is no legitimate need for finance.

Merger

Voting rights of the target can also be acquired by way of merger. In this case, shareholders' approval is generally required, and moreover, a Japanese entity needs to be qualified as a party to the merger. In addition, careful planning is needed in respect of regulations against a backdoor listing.

Take private

Two-tier TOB

It may be appropriate to take the target private and control 100% of voting rights to avoid the burden of complying with significant regulations. In certain cases, not only the target but also its controlling shareholder is subject to disclosure. It may be desirable to avoid the pressure of being monitored by minorities, who might eventually resort to legal action. Conversion of a target to a private company is usually achieved by way of a two-tier tender offer, the second step of which deals with shares that have not been collected through the tender offer procedure by the following frameworks: (a) using a special class of shares, (b) consummating merger (or stock-for-stock exchange that creates wholly owned parent-sub relationship) using shares of the acquiror as consideration, or (c) consummating such merger using cash. Recently, (a) has been the most popular method: this involves the target first changing, by a special resolution at the shareholders meeting, common shares to the special class of shares that can in effect allow the company to redeem the whole class. It then exercises such call option by another shareholder's resolution and, in exchange, vesting them another class of shares with value large enough to give fractions thereof to remaining shareholders. These fractions will be collectively sold under court order. Fairness of prices in two-tier tender offers are often challenged at court by dissenting shareholders, especially in MBO transactions.

Triangular merger

A less popular alternative is a triangular merger using the stock of an acquirer. This is a challenging alternative but not unprecedented.

Transparency

Needless to say, transparency is the fundamental keyword in the context of an acquisition of a listed company. The identity of the acquirer is an area that should be afforded attention. An acquirer might need to file:

a) a large shareholders' report under FIEA, if it owns more than 5% of shares (calculated in a similar way as in the tender offer context in term of potential shares), where you need to disclose identity of holder, purpose of holding, financial source of acquisition etc.;

b) through the target, information about the controlling shareholder if you own 20% (or 15% if you nominate board member) or more of existing voting rights, where the target needs to disclose under stock exchange regulation, role of target in the corporate group, transactions between controlling shareholder and target, and policies to protect minority shareholders etc.;

c) a parent company report under FIEA, if the majority of existing voting rights is owned by a parent that is not publicly listed, where you need to disclose information regarding major shareholders, directors/ officers and financial status of parent;

d) a letter to confirm the absence of a relationship with anti-social forces.

In the case of a tender offer, a potential acquirer must disclose, among other things, background, purpose, and detailed method and process for calculating price for acquisition, and also any plans following the deal (any restructuring or replacement, if any).

Where a potential conflict is involved, regulations require further disclosure; practical challenges exist when meeting a requirement to disclose any measure taken to secure fairness and to avoid conflict, and to obtain the opinion of an independent third party.

Certainty

Regulators have recently been putting more emphasis on the certainty of transactions, focusing on the certainty of finance. The regulator will require an explanation of any source of financing, and a description of how secure it is. This applies either in cases of a tender offer, or in cases of a TPA. In the context of a tender offer, regulators are also sensitive to certainty of closing, and interpret the law in such a manner so as to limit the possibility of withdrawing from the deal.

Fairness

Regulators tend to interpret rules so as to capture any possible circumvention. In this regard, the underlying purpose of rules should be looked at carefully. One example that has caught the regulator's attention is whether the indirect acquisition of target shares through an intermediate holding company constitutes a violation of mandatory tender offer regulation. Regulators have recently been trying to clarify their interpretation of the rules by updating FAQs more frequently. We believe such efforts are making our market more transparent and attractive to potential investors.

Yuto Matsumura

Partner

Tel: +81 3 5223 7762 Email: [email protected]

Yuto Matsumura is a partner in the Corporate/M&A practice team at Mori Hamada & Matsumoto. His areas of practice include mergers and acquisitions in many different industries, corporate and securities laws, banking and international dispute resolution. In particular, he has extensive experience in cross border M&A. He was selected as one of the best lawyers in Japan for Corporate/M&A in IFLR1000 (2011 Edition), Chambers Global 2010, Chambers Asia 2010, PLC Which Lawyer? and Asialaw Profiles 2010; for Banking in International Who's Who of Banking Lawyers 2011 and Asialaw Leading Lawyers 2010; and for Dispute Resolution in Asialaw Leading Lawyers 2010. From 2002 to 2003, he worked with Sullivan & Cromwell in New York. He is a graduate of Columbia University School of Law (LL.M. 2002) and The University of Tokyo (LL.B.1996). He is fluent in Japanese, English and French.