JAPANESE UPDATE – A Step Towards Easing Restrictions on Use of Exchange Offers by Japanese Companies Making Foreign Acquisitions

Executive Summary/Highlights: 

  • Japanese legal hurdles to cross-border exchange offers or triangular mergers have deterred Japanese acquirers from using their stock in cross-border acquisitions.
  • A recent amendment to the Law on Special Measures for Industrial Revitalization and Innovation, which took effect on July 1, 2011, introduces a new path to facilitate exchange offers by Japanese firms by eliminating some legal hurdles.
  • While the amendment is an important step forward to make exchange offers more feasible for Japanese buyers, its applicability is limited and there remain issues that must be addressed before exchange offers become a common practice inJapan.


Introduction of New Rules regarding Exchange Offers by Japanese Firms

1.         Exchange offers generally not feasible under existing rules

A shrinking domestic market and strong yen are driving more and more Japanese firms to seek out opportunities for overseas mergers and acquisitions.  However, to date there have been only a few cases in which Japanese companies have used their stock as acquisition consideration in acquiring a foreign company.  Among a variety of factors contributing to the scarcity of stock consideration in cross-border acquisitions by Japanese firms are legal hurdles in conducting cross-border exchange offers or triangular mergers under Japanese law.

In particular, exchange offers in which an acquirer’s stock is offered as consideration has not been a viable option for Japanese buyers.  Because such exchange offers involve the issuance of new shares or the reissuance of treasury shares by the Japanese acquirer in exchange for contributions-in-kind of the target company’s shares tendered, the prevailing Japanese corporate law regime regarding the issuance or reissuance of shares and contribution-in-kind applies to exchange offers by Japanese firms.  However, the current regime is not tailored to the unique considerations relevant to such exchange offers and as a result creates significant impediments to the use of such exchange offers.  For instance:

(i)           If the value of the target company’s shares significantly deteriorates following a Japanese acquirer’s decision to offer its shares in exchange for the target company’s shares tendered, the target company’s shareholders tendering their shares and certain directors of the acquirer may be personally liable for the difference between the value of the target company’s shares at the time the acquirer decides to offer its shares and the value at the time the acquirer’s shares are issued or reissued;
(ii)          A review by a court-appointed inspector of the value of the target company’s shares as determined by the acquirer’s board or shareholders may be required, making it difficult to set the schedule for an exchange offer; and
(iii)         If the acquirer’s stock is offered at an exchange rate that reflects a premium over the market price of the target company’s shares, a super-majority (two-thirds) approval of the acquirer’s shareholders may be required.

2.         New rules under the amended Industrial Revitalization Law

An amendment to the Law on Special Measures for Industrial Revitalization and Innovation (the “Law”), which became effective as of July 1, 2011, introduces special measures that aim to eliminate several of the legal hurdles imposed by the Companies Act of Japan, subject to certain conditions.  The Ministry of Economy, Trade and Industry of Japan (“METI”) promulgated this amendment in connection with its efforts to promote both domestic and cross-border mergers, acquisitions and restructuring transactions by Japanese companies as part of Japan’s growth strategy.  Set forth below are some of the key points to be noted with regard to such special measures:

(1)        Eligibility requirements and other noteworthy points

–             First, in order to be eligible for the special measures, a Japanese acquirer must submit a plan that falls under one of the four categories of approved transactions involving exchange offers set forth in the Law, and obtain the approval of METI.  The four categories are, namely, “reconstruction plan,” “plan for reuse of business resources,” “business resources integration plan, and “resource productivity innovation plan.”  The plan should include the terms of a proposed transaction and elaborate the gains in productivity to be achieved by the contemplated transaction.  METI publishes detailed criteria and numerical thresholds that a submitted plan must meet in order to obtain its approval.
–             The availability of special measures is limited to exchange offers in which a Japanese acquirer aims to acquire “effective control” of the management of another company.  In this regard, METI requires an acquirer to establish the minimum number of shares to be tendered in an exchange offer such that the acquirer will own 40% or more of the voting control of the target company following the transaction.
–             The target company of an exchange offer eligible for the special measures can be either domestic or foreign.
–             A Japanese acquirer can itself, or through its wholly-owned subsidiary, conduct an exchange offer.  Particularly in the case of a cross-border exchange offer, a Japanese acquirer may elect to establish a wholly-owned subsidiary in the jurisdiction in which the target company is located and have it conduct an exchange offer in which the Japanese parent’s stock is offered pursuant to the tender offer regulations of the jurisdiction.
–             Consideration for the exchange offer can be the acquirer’s stock or a combination of the acquirer’s stock and cash.

(2)          Legal consequences of the special measures

–             In the case of an exchange offer to which the special measures apply, no review by a court-appointed inspector is required (see 1(ii) above), and neither the target company’s shareholders nor the Japanese acquirer’s directors are under any obligation to compensate the Japanese acquirer for a significant decline in the value of the target company’s shares (see 1(i) above).
–             Under the special measures, no approval by the acquirer’s shareholders is generally required for the issuance or reissuance of the acquirer’s shares in connection with an exchange offer (see 1(iii) above), as long as the product of the net asset amount per share multiplied by the number of shares to be delivered to the tendering shareholders of the target company does not exceed one-fifth of the net asset amount of the acquirer.  Note that, in the case that a combination of stock and cash is offered as consideration, the cash portion is not counted toward the one-fifth threshold.  As an exception to the foregoing, if a designated number of the acquirer’s shareholders (generally one-sixth or more of all voting shareholders) notifies the acquirer of their opposition to the proposed exchange offer within the requisite period, a super-majority (two-thirds) approval of shareholders is required to approve the issuance or reissuance of the acquirer’s shares in connection with an exchange offer.
–             In addition, to afford protection to a Japanese acquirer’s shareholders opposed to a proposed exchange offer, such shareholders have the right to require the acquirer to purchase their shares at a “fair price” subject to certain conditions.

3.         Issues that remain to be addressed

Although the amendment to the Law discussed above is an important step forward toward increasing the use of exchange offers by Japanese firms in which their stock is offered as consideration, there remain Japanese tax, securities law and other issues arising from such exchange offers.  For example, the Japanese tax code does not allow for the deferral of capital gains tax on the part of the target company’s Japanese shareholders who tender their shares in exchange for the offered shares of the acquirer, which may act as a disincentive for the use of exchange offers.  These remaining issues must be further discussed and addressed in order to provide Japanese companies with the assurances they need to make use of their stock as acquisition consideration in acquiring a domestic or foreign entity.

The views expressed herein are solely those of the author and have not been endorsed, confirmed or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.