General Overview

What legislation governs M&A activity in Japan?

The main legislation to consider includes the Company Law, the Financial Instruments and Exchange Law (the FIEL) and the Anti-Monopoly Law (the AML) as well as the tax laws for the purpose of structuring a deal. The Foreign Exchange and Foreign Trade Law (the FEFTL) is also important for cross-border M&A activity.

Other legislation such as the Banking Law or Insurance Business Law might be relevant if the transaction involves banks or insurance companies.

What impact have recent legislative changes had on the nature and amount of M&A activity?

After a long controversy, a triangular merger became possible under new rules in the Company Law that came into effect as of May 1 2007. The Company Law now makes possible both the inbound and outbound triangular mergers involving a Japanese company. In both cases, this previously gave rise to almost insurmountable legal issues.

The FIEL became fully effective as of September 30 2007, changing its name from the Securities and Exchange Law. As described in detail below, the new disclosure rules under the FIEL require a private company that acquires a public company by way of statutory merger, stock swap and certain other methods specified in the rules to file a securities registration statement with the relevant authority.

Following the legislative changes, Citigroup acquired through its wholly-owned Japanese subsidiary all issued shares of Nikko Cordial in exchange for shares of Citigroup, which is reportedly the first triangular merger ever carried out under the Company Law of Japan. The deal value including the preceding tender offer was reported to be $12.514 billion.

What have been the most significant M&A transactions in Japan over the past year?

According to the Mergers & Acquisitions Research Report, the largest M&A transaction involving Japanese companies in 2007 (by announced value) was Citigroup's acquisition of Nikko Cordial.

A cash tender offer continued to be a major method to acquire a public company in 2007. There were seven unsolicited takeover attempts involving listed companies, including hostile tender offer attempts by Steel Partners Japan Strategic Fund (Steel) against Bull-Dog Source and Tenryu Saw Mfg. Both were launched in May and were ultimately unsuccessful. It is noteworthy that while previous unsolicited tender offers were unsuccessful due to the appearance of white knights, in the above examples the companies defended themselves against the corporate raider by introducing defensive measures. Bull-Dog actually implemented measures to forcefully dilute Steel's shareholding in Bull-Dog by issuing stock acquisition rights. Steel challenged this by filing a preliminary injunction, which was dismissed by the Tokyo District Court, with the decision upheld both by the Tokyo High Court and the Supreme Court.

On the friendly deal side, management buyouts continued to be popular. The number of management buyouts involving listed companies increased to 89 from 80 in 2006. The increase in the number of management buyouts resulted in the criticism that some of those transactions attempted to freeze out minority shareholders at an unfair price. In response to the criticism, the Ministry of Economy, Trade and Industry (METI) published the Guidelines on Management Buyouts for the Purpose of Enhancing Corporate Value and Securing Due Process on September 4 2007.

How, and to what extent, is foreign involvement in M&A transactions in Japan regulated or restricted?

Even after a series of deregulation measures in the Company Law, some corporate reorganisation structures, including statutory merger, stock swap and corporate spin-off, are available only for a transaction between domestic companies. Due to the new rules that came into effect in May 2007, however, a non-Japanese company may acquire a Japanese company in exchange for shares of the non-Japanese company, by utilising a triangular merger method, in which the non-Japanese acquirer causes its wholly-owned Japanese subsidiary to merge with a Japanese target company. As discussed above, Citigroup/Nikko deal was the first deal publicly announced that utilised this method.

Coinciding with this development in the Company Law, Japan's 2007 tax reforms include provisions that grant shareholders of corporations involved in a triangular merger a tax deferral on the resulting capital gains and losses. One of the key issues arising from the reforms relates to the concept of business relatedness, which the deal needs to meet to qualify as a tax deferral transaction. The 2007 reform requires that such business relatedness exists between the Japanese target company and the non-Japanese acquirer's wholly owned merger-subsidiary vehicle and not between the Japanese target and the non-Japanese acquirer itself. In April 2007, the tax authority issued a safe harbour for the business relatedness test. However, from a practical point of view, it still remains unclear under what circumstances the business relatedness test is satisfied.

The FEFTL regulates foreign investment in Japanese companies. In most cases, foreign investors are only required to file a report with the Bank of Japan within 15 days of the closing of a direct inward investment that involves any acquisition of shares in a closely held company or an acquisition of 10% or more of a listed company's outstanding shares.

A prior notification is required for investment from countries such as North Korea or Iraq, or investments in certain regulated industries, including broadcasting, aircraft manufacturing, nuclear power, explosives manufacturing, agriculture, public transportation and satellite/rocket production. For these types of investments, foreign investors must file a notification with the Bank of Japan three months before the anticipated closing date. Foreign investors of these types may not consummate the transaction during the 30 days after the competent ministers receive notification. The waiting period may be shortened to 15 days in most cases.

In addition to the regulations under the FEFTL, certain regulated industries, including Japan's national telephone company (NTT), television and radio broadcasting and airlines, have maximum foreign ownership thresholds.

Due Diligence

What are the principal disclosure requirements in a typical M&A transaction?

Just as in many other countries, in Japan the buyer usually performs a due diligence investigation of the target company to determine whether to proceed. In some cases where the seller wants to sell itself or its subsidiary to one of the bid participants, a due diligence investigation is performed by the seller first. In the case where the target is a public company, extra care must be taken in performing an investigation to comply with the insider trading regulations under the FIEL.

In most cases, shareholders' approval is required to consummate a corporate reorganisation such as statutory merger, stock swap, corporate spin-off, and transfer of business. Under the Company Law, certain types of material information such as the reasons for and the outline of the transaction must be disclosed in a convocation notice of the shareholders' meeting. More detailed information, including the reasonableness of consideration with supporting materials and the parties' financial information, needs to be prepared for shareholders' review. A public company involved in a corporate reorganisation is generally required to file an extraordinary report with the relevant authority pursuant to the FIEL, as well as to release a letter to public through the electronic disclosure system run by the Tokyo Stock Exchange (TDnet). Substantial disclosure requirements under the FIEL apply to a bidder that contemplates a tender offer.

To what extent do disclosure requirements achieve market transparency?

Under the Securities and Exchange Law, the predecessor of the FIEL, an acquirer was not required to file a securities registration statement as a result of corporate reorganisation that involves issuance of shares. After the reform of the securities law, a registration statement generally needs to be filed for an acquisition of a public company by a private company. A prospectus does not have to be delivered to each of shareholders of the target company. It should be noted that in the context of a triangular merger an overseas company not listed on one of Japan's stock exchanges is deemed a private company and thus is required to file a securities registration statement. Having filed a registration statement, the company is subject to continuous disclosure rules under the FIEL and required to file annual and quarterly reports as well as extraordinary reports.

Has the issue of material adverse change clauses become more important with the recent failure of some large M&A deals around the world?

In respect of large M&A deals, a material adverse change clause (MAC) is often found in a definitive agreement as a catch-all provision to allow an acquirer to refuse to close a deal under certain unexpected circumstances. Especially in a domestic deal, though, the MAC is usually provided without a definition, presumably relying on flexibility on the acquirer's side.

Following the worldwide subprime mortgage crisis, the MAC potentially seems to have become more important in the context of M&A. It was reported on November 14 2007 that the closing of the merger between Mizuho Securities and Shinko Securities was postponed partly due to the subprime mess. Although it is unlikely, given the tendency of Japanese companies to avoid litigation, that the subprime would trigger soaring litigations over MACs, it might work as a means of leveraging power on the acquirer's side.

Takeovers

Are there any specific regulations and/or regulatory bodies governing takeovers in Japan?

The FIEL sets out the tender offer regulations and the Financial Services Agency implements detailed rules on tender offers. Japan Fair Trade Commission (JFTC) takes care of merger control rules and implements guidelines.

What are the various methods by which a takeover can be achieved?

A takeover can be achieved through a merger, stock swap or corporate spin-off under the Company Law or a transfer of business, share acquisition, or any combination of the above.

In the inbound merger context, aside form a triangular merger by Citigroup and Nikko Cordial, 2007 saw a remarkable trans-border business combination that utilised a Japanese version of the double dummy acquisition structure. This technique was used in a deal by GCA Holdings, Japan's major independent M&A advisory firm listed on the Tokyo Stock Exchange, and Savvian LLC, a California-based independent M&A advisory firm. According to the press release, here's how the double dummy works in the GCA/Savvian deal: holders of Savvian LLC shares transfer all of those shares to Savvian, Inc, a Delaware corporation, in exchange for shares of Savvian, Inc. The holders of Savvian, Inc shares then transfer all of those shares to Savvian KK, a Japanese corporation, in exchange for shares of Savvian KK. Savvian KK and GCA Holdings then consummate a corporate reorganisation form called kyodo kabushiki-iten, or joint stock transfer, where Savvian KK and GCA Holdings jointly form a new holding company (New Holdco) and all shareholders of Savvian KK and GCA Holdings become holders of the New Holdco shares by operation of law. The New Holdco is listed on the Tokyo Stock Exchange. The distinctive aspect of this GCA/Savvian deal is that the transaction is reportedly qualified as a tax-free reorganisation both under the Japanese and US federal tax laws. Under the current circumstances of triangular merger tax treatment described above, a transaction of the double dummy feature could be an option under certain conditions.

How differently are hostile and voluntary takeover bids treated?

Although hostile and voluntary takeover bids are treated as equal under the original tender offer regulations, the revised regulations that took effect at the end of 2006 affect hostile takeover bids.

Opinion report of management

Under the current tender offer regulations, the target company must issue an opinion report within 10 business days after the offer is made. The target company is required to state in the report the management's position on whether it will implement any takeover defensive measures and the details of those measures.

Inquiry process

The management of the target company may question the offeror in the opinion report and the offeror must respond to the queries within five business days of receiving such questions.

Offering period

If the offeror sets an offer period of less than 30 business days, the target may extend the period up to a total of 30 business days by requesting this in its opinion report.

Withdrawal of offers

The offeror may withdraw its offer upon implementation of takeover defensive measures by the target.

Contested acquisitions

If a large shareholder holding more than one-third of the voting rights of the target acquires more than 5% of additional shares in the target, then that acquisition must be subject to the tender offer regulations.

What penalties are imposed for parties who violate takeover regulations?

A party violating takeover regulations will be subject to civil and criminal sanctions under the FIEL.

A strict liability standard could apply in certain cases in terms of civil penalty, where the plaintiff is not required to prove negligence on the part of offeror. The FIEL provides certain methods to calculate the damages, depending on the violation. Like the civil liability for material misstatements or omissions in a prospectus, officers of the offeror, including directors and statutory auditors, could also be subject to civil liability in the case of material misstatements or omissions in a tender offer registration statement or offeror prospectus.

In addition, the Financial Services Agency (FSA) proposed on March 4 2008 a new regulation that enables the FSA to impose a surcharge duty if a bidder fails to notify the public of a tender offer or there are material misstatements or omissions in a tender offer notice.

What are the thresholds for disclosing bids and offers?

The following types of acquisitions of shares in listed companies are subject to the tender offer regulations:

Off-market purchases of more than 5% (including shares held before the purchase) of the outstanding voting rights of a company from more than 10 sellers during a 60-day period.

Off-market purchases of more than one-third (including shares held before the purchase) of the outstanding voting rights of a company from any number of sellers.

Certain types of market purchase, including an off-hour trade through the Tokyo Stock Exchange Trading Network System, or ToSTNeT, of more than one-third (including shares held before the purchase) of the outstanding voting rights of a company.

Rapid serial acquisitions of more than one-third (including shares held before the purchase) of the outstanding voting rights of a company (a) that are made within a three-month period, (b) the total purchase of which exceed 10% of outstanding voting rights, irrespective of the method of acquisition (including a market trade and subscription of newly issued shares), and (c) out of which, the off-market or off-hour trading system acquisition purchases (excluding an acquisition over a tender offer) exceed 5% of outstanding voting rights.

Contested acquisitions, as discussed above.

Competition/Antitrust

What have been the major recent developments in competition policy and legislation as they relate to M&A in Japan?

The AML governs the merger control framework in the light of competition in Japan. The interpretation of the AML in this regard is supplemented by the Guidelines to Application of the Antimonopoly Act Concerning Review of Business Combination (the Merger Guidelines). The revised Merger Guidelines were issued on March 28 2007 to ease regulation on M&A transactions and keep pace with fast-changing competition laws around the world.

The revised Merger Guidelines introduced the "small but significant and non-transitory increase in price" test (SSNIP test) in defining a relevant market. The relevant market combines the product market and the geographic market. The former Merger Guidelines stated that the geographic market would focus primarily on domestic business activities, even if the subject company's areas of business extended overseas, because the law is intended to protect domestic competition. As a result, the relevant geographic market was prone to being defined without considering worldwide competition. The new Merger Guidelines clearly state that the geographic market can be defined across the border.

The former Merger Guidelines used the post-merger concentration ratio and the market share of the parties as a threshold of safe harbour for the purpose of reviewing horizontal mergers. Instead of using the market share concept, the revised Merger Guidelines introduced the incremental change in market power concept. The Herfindahl-Hirschman Index measures market concentration.

How are the competition/antitrust regulations enforced in your jurisdiction?

The JFTC is an independent administrative commission that exclusively enforces the AML, including merger control regulations.

Parties to M&A transactions that face potential problems under competition laws voluntarily apply to the JFTC for pre-consultation to reduce the risk of transactions being blocked during the later formal notification process. Together with the revision of the Merger Guidelines, the JFTC announced changes to its policy on the pre-consultation process for business combinations, to improve transparency in its process.

How do legislation and regulation approach the issue of "abuse of dominant position" ?

Under the AML, the substantive test for clearance is "whether the transaction would substantially restrain competition in a particular field of trade." The Merger Guidelines provide detailed guidance on the test and explain how the test is to be applied in relation to horizontal, vertical and conglomerate business combinations. The Merger Guidelines also establish safe harbours that apply to each of these three categories of transactions.

To what extent are parties to an M&A transaction subject to prior notification requirement?

The AML regulates four main types of business concentrations: (i) statutory mergers; (ii) statutory corporate spin-offs; (iii) business transfers; and (iv) share acquisitions.

The first three types of transactions are subject to a prior notification requirement and a 30-day waiting period if the applicable thresholds (the total assets of one party exceeds ¥10 billion ($97 million) and that of the other exceeds ¥1 billion) are exceeded.

In contrast, share acquisitions are only subject to a reporting requirement after the transaction is consummated each time the ratio of voting rights held by the acquiring company in the target company crosses the 10%, 25% or 50% thresholds within 30 days of crossing each relevant level. The acquiring company must have assets (non-consolidated) of more than ¥2 billion, and together with its subsidiaries and any Japanese parent have total assets of more than ¥10 billion, if the target company is a Japanese company with assets (non-consolidated) of more than ¥1 billion, or is a foreign company that in combination with the sales of its Japanese subsidiaries has net sales in Japan of more than ¥1 billion.

Author biography

Masakazu Masujima Mori Hamada & Matsumoto Masakazu Masujima is a senior associate at Mori Hamada & Matsumoto. His practice includes international and domestic M&A transactions, acquisition finance and private equity. He worked at the Palo Alto office of Wilson Sonsini Goodrich & Rosati in 2006 and 2007, where he focused on venture financing and initial public offerings for technology and growth companies at variety of stages. Masujima received an LLB from the University of Tokyo in 2000 and an LLM from Columbia Law School in 2006. He is a member of the Daini-Tokyo Bar Association (2001) and the New York State Bar Association (2006).