Japanese takeover rules for listed companies to be fully revised

July 2023  |  SPECIAL REPORT: MERGERS & ACQUISITIONS

Financier Worldwide Magazine

July 2023 Issue

In Japan, activists have been taking more actions against listed companies in recent years, and there are increasing indications that securities laws and regulations are inadequate to deal with them. As such, Japan’s tender offer regulations are expected to be fully revised for the first time in about 17 years. The large-shareholding reporting system is also expected to be revised, along with the tender offer regulations, some 10 years after its enactment.

In the past few years, hostile takeovers have become more prevalent in Japan. Particularly in 2021, several important court cases were issued regarding the validity of poison pills. Under the takeover defence measures commonly used in Japan, an acquirer that undertakes a large-scale purchase of a listed company is required to provide certain information within a period determined by the target company. If the acquirer fails to comply with this rule, the target company will allot stock option rights to all shareholders without consideration.

The acquirer, as one of the shareholders, will receive an allotment of stock option rights but will be subject to certain restrictions on exercising those rights, on the grounds that it has violated the above rules. Then, as a result of other shareholders exercising their stock options rights, the acquirer’s shares will be significantly diluted, and the hostile takeover will be thwarted.

In light of 2021 case law on the effectiveness of takeover defence measures, it was considered that, in principle, if the shareholders’ meeting is given the opportunity to approve or reject the introduction of a takeover defence measure and its invocation (i.e., the allotment of stock option rights), either in advance or after the fact, it was believed that the courts would tend not to grant an injunction.

However, last year, when a poison pill (which seemed to be permissible based on court decisions), was invoked against a takeover technique known as a ‘wolfpack’, it was held to be unlawful. In this case, a public company called Mitsuboshi introduced the takeover defence measures described above and allocated stock option rights to all shareholders in order to respond to in-market bids by an activist called Adage Capital (AC) and several shareholders whom Mitsuboshi determined were effectively working with AC to acquire Mitsuboshi’s shares. AC then filed an injunction for a court to enjoin Mitsuboshi from doing so.

The court granted an injunction against Mitsuboshi’s stock option rights on the grounds that there was a lack of “reasonableness” in invoking the takeover defence measures, despite the approval of Mitsuboshi’s shareholders to introduce and invoke these measures. The Mitsuboshi poison pills were considered problematic in that the method of withdrawing the acquirer’s rights was unclear.

The court focused on this issue because it is important for an acquirer to have clarity as to what measures would result in cancellation of stock option rights, so it can avoid damage and plan ahead. The court found that Mitsuboshi’s determination of “non-qualified persons” restricted from exercising their stock option rights was “arbitrary”.

AC had requested that an extraordinary meeting of shareholders be called to replace the directors of Mitsuboshi. Mitsuboshi had categorised several shareholders as “non-qualified persons” mainly because they acquired Mitsuboshi shares at almost the same time as AC and because they had agreed to AC’s proxy solicitation at the relevant extraordinary shareholders’ meeting.

The court made the above decision on the grounds that: (i) Mitsuboshi’s determination of “non-qualified persons” was not in line with the criteria for recognising an ‘act-in-consort’ set forth in the poison pills; and (ii) the possibility cannot be ruled out that current management’s recognition of non-qualified persons was arbitrary for the purpose of maintaining management control.

Even if, as the court found, Mitsuboshi’s determination of non-qualified persons was not appropriate, whether all ‘wolfpacks’ deserve legal protection requires a different consideration. Inadequacies in the content and operation of Japan’s tender offer regulations and large-shareholding reporting system, were the root cause of ‘wolfpacks’.

Under the Japanese Companies Act, for a shareholder to exercise the right to veto a special resolution at a shareholders’ meeting, an affirmative vote of one-third or more of the voting rights present at the meeting is required. Since not all shareholders will exercise their voting rights at a shareholders’ meeting, a shareholder that acquires around 30 percent of all voting rights will be practically able to exercise a veto right.

Furthermore, under the Japanese tender offer regulations, in principle an acquirer is not compelled to commence a tender offer unless it intends to acquire more than one-third of all voting rights of a listed company. Accordingly, it is possible for an investor to acquire around 30 percent of all voting rights of a listed company, practicably representing a veto right, solely through in-market purchases, without a mandatory tender offer process.

On the other hand, under Japan’s large-shareholding reporting system, once an acquirer of listed shares holds more than 5 percent of the voting rights in a listed company, it is required to file a large-shareholding report to the authorities within five days of the acquisition. This report needs to state the purpose for which the shares are held. However, enforcement of this regulation is said to be very weak. There are many cases of violations, including cases where an investor acquires more than 10 or even 20 percent of the voting rights of a listed company, but fails to file a large-shareholding report for a long period. With respect to the purpose of holding, there are many instances where ‘pure investment’ is stated, even when ‘acquisition of control’ would be more accurate.

Although criminal penalties and administrative fines can be imposed for violations, since the introduction of the large-shareholding reporting system only about 10 cases appear to have resulted in such sanctions. The definition of ‘act-in-consort’ in the large-shareholding reporting system is also problematic. In Japan, one of the requirements for ‘act-in-consort’ is an ‘agreement’ to acquire or transfer shares of the target company or to exercise voting rights jointly with other shareholders. But it is considered difficult to prove the existence of an ‘agreement’.

As a result of these institutional problems, it is possible for several investors to secretly acquire, through in-market purchases and in a short period of time, a volume of listed company shares large enough to effectively veto a special resolution at a shareholders’ meeting. A shareholder with a leading role among these investors could delay the filing of a large-shareholding report or falsify the purpose of its holdings. This makes it difficult for listed companies to respond effectively by the time they become aware that investors are engaged in a ‘wolfpack’ and purchasing more shares.

In light of the above issues, in March 2023 the Japanese government decided to fundamentally revise the tender offer regulations and the large-shareholding reporting system. Although the specific timing has not yet been determined, the process is expected to begin in 2023.

 

Norihiro Sekiguchi is a partner at Oh-Ebashi LPC & Partners. He can be contacted on +81 (3) 5224 5597 or by email: norihiro.sekiguchi@ohebashi.com.

© Financier Worldwide

BY

Norihiro Sekiguchi

Oh-Ebashi LPC & Partners

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