General overview

What legislation governs M&A activity in your jurisdiction?

The Companies Act, the Securities and Exchange Law (the SEL) and the Anti-Monopoly Law (the AML) primarily govern takeovers and mergers in Japan. The Foreign Exchange and Foreign Trade Law (the FEFTL) has an important bearing on transactions involving foreign companies, and the rules of stock exchanges are also relevant to transactions involving listed companies.

Business-specific laws, such as the Banking Law or the Insurance Business Law, are relevant in M&A transactions depending on the businesses of relevant parties.

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

The Companies Act, which replaced the portions of the Commercial Code related to companies, became effective in May 2006. The Companies Act contains some amendments relating to M&A activity. First, there are broader exceptions to the requirement to hold a shareholders meeting for M&A transactions. When a larger company acquires a smaller company, a resolution at a shareholders meeting is not necessarily required for the acquiring larger company. According to an old rule under the Commercial Code, the number of the shares issued by the acquiring company in a merger had to be 5% or less of the number of the company's outstanding shares, but this threshold has now been increased to 20%. In addition, if a company holds more than 90% of voting rights of another company, a short-form merger is now available, in which an approval at a shareholders meeting of the controlled company is not necessary. These amendments, together with certain procedural de-regulation, have expedited the process of M&A transactions.

Second, the existing restrictions on the type of consideration that can be used for mergers or share swaps will be eliminated in May 2007. The consideration is currently limited to shares of the acquiring company unless the transaction is qualified under the Industry Revitalization Act. The change will enable cash-out mergers and triangular mergers, the latter of which can be also used for cross-border M&A. Under the Companies Act, a subsidiary can receive shares issued by its parent company for statutory restructuring purposes and use the parent company's shares as consideration to be paid to the shareholders of a target company in a triangular merger.

The Companies Act introduced more flexibility for the terms and conditions, and issuance process of classified stock and warrants, and made it possible to set a higher minimum resolution requirement for amending the articles of incorporation or for discharging directors.

As described in detail below, the tender offer regulations (the TOB Regulations) under the SEL were also substantially changed in December 2006.

The volume of M&A deals involving Japanese companies reportedly increased to its highest levels three years in a row – 2,211 in 2004, 2,725 in 2005 and 2,775 in 2006. The total deal value of announced transactions in 2006 jumped by more than 27% to about ¥15,028 billion ($125 billion), up from ¥11,808 billion in the previous year.

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

According to Mergers & Acquisitions Research Report, the two largest M&A transactions relating to Japanese companies in 2006 (by announced value) were:

• Japan Tobacco's acquisition of British tobacco maker Gallaher Group for ¥2.25 trillion, the largest acquisition ever by a Japanese company.
• Softbank's acquisition of the Vodafone Group's ailing Japan unit, Vodafone KK, for ¥1.75 trillion.

Tender offers constituted a large portion of M&A activity in Japan in 2006. There were three hostile acquisition attempts involving listed companies, including the high-profile hostile acquisition attempt by Oji Paper, the nation's largest paper manufacturer, of Hokuetsu Paper Mills in July. This was the first hostile tender offer by a blue-chip company against a large domestic competitor. The other two attempts were by Don Quijote against Origin Toshu in January and by Steel Partners Japan Strategic Fund against Myojo Foods in October. None of those attempts was completed because of the appearance of white knights.

2006 can also be characterized by the substantial increase of management buyouts (MBOs). The number of MBOs increased to 80 from 67 in 2005 and the total announced value to ¥687 billion from ¥297 billion. Companies that decided to go private through MBO were, among others, Skylark, Q'sai, Toshiba Ceramics and Rex Holdings.

How, and to what extent, is foreign involvement in M&A transactions in your jurisdiction regulated/restricted?

Under the Companies Act, M&A in the form of corporate structural reorganization, such as statutory mergers and share swaps can only be executed among domestic companies, and the consideration for these transactions, in principle, must be shares in the acquiring company. However, from May 2007 the restrictions on consideration will be lifted and triangular mergers will become available, so a foreign company will be able to take over a Japanese company by forming a new Japanese subsidiary into which the target company is merged. This is in line with the Japanese government's goal to promote economic growth through increased foreign direct investment (FDI), which includes a target of doubling Japan's stock of inward FDI as a percentage of GDP by 2010. According to the Tax Reform Proposal released by the ruling Liberal Democratic Party in December 2006, despite the decision to confer tax deferral treatment to triangular mergers, the specific requirements are still under deliberation.

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 after an inward investment that includes any acquisition of shares in a closely held company or an acquisition of more than 10% of a publicly listed company's outstanding shares.

Prior notification requirements for inward FDI, however, apply to specific cases such as investments from certain countries (for example, Iraq or North Korea), or investments in certain regulated industries, including broadcasting, aircraft manufacturing, nuclear power, explosives manufacturing, leather products manufacturing, agriculture, public transportation and vaccine production. For these types of investments, foreign investors must not complete the transaction until 30 days after competent ministers receive notification. The regulations under the FEFTL are now under deliberation for potential amendments, which could have more impact on cross-border M&A transactions.

As well as 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?

When announcing corporate structural reorganizations such as mergers, share swaps, and corporate de-mergers to shareholders under the Companies Act, the adequacy of the consideration, among other things, must be disclosed. According to the recently proposed regulations under the Companies Act, extensive disclosure would be required in a triangular merger.

There are substantial disclosure requirements under the SEL in the case of a tender offer.

When M&A transactions involve issuance of new shares, a target may be required to file a securities registration statement or submit a securities notice under the SEL.

Also, if a listed company contemplates an M&A transaction that could influence investment decisions, continuous disclosure requirements may apply and the company may have to make public disclosure under the SEL or the relevant stock exchange rules.

To what extent do disclosure requirements achieve market transparency?

In the case of a tender offer, detailed and further amended disclosure requirements have achieved a high degree of market transparency in Japan.

M&A transactions involving the issuance or sale of shares constituting a public offering under the SEL are subject to additional disclosure requirements. The issuing company is required to file a securities registration statement and to deliver a prospectus to offerees. If companies issue shares in the process of a merger, de-merger or other corporate structural reorganization, this share issuance is not deemed a public offering. However, the definition of public offering that triggers the requirement of a securities registration statement will be broadened to cover share issuances in certain categories of corporate structural reorganizations by the Financial Instruments and Exchange Law, which will replace the SEL some time this year.

How significant an issue is prospectus liability in a typical M&A transaction?

Prospectus liability issues exist only if a share issuance or sale is deemed a public offering or where a tender offer procedure is undertaken. Material misstatements or omissions made in a prospectus carry criminal and civil penalties. Sanctions in the context of a tender offer are discussed below.

In the case of a public offering, while there is no class action type of lawsuit under Japanese law (even for securities litigation), a special rule for civil liability provides that a person who makes material misstatements or omissions in a prospectus could be subject to a strict liability standard, which does not require proof of negligence on the part of the offerer.

The price paid for the securities minus the market price of the securities (or the sale price, if the securities are already sold in the secondary market) is deemed the amount of the damages for a civil liability, unless a cause for the damages other than material misstatements or omissions can be proven. Civil liability extends to officers of the offerer, including directors and statutory auditors, unless they can prove that they did not know, and were not able to know after exercising due care, the material misstatements or omissions.

How have recent M&A transactions and/or legislation dealt with the issue of material adverse change clauses?

The TOB Regulations provide that, if certain enumerated types of material adverse changes (MAC) occur with respect to a target company, an offerer can withdraw an offer or decrease the offer price even though the offerer is, in principle, prohibited from revoking its offer once it is made.

Apart from the above, as there is no legislation dealing specifically with the issue of MAC clauses in Japan, case law on MAC clauses is fact-specific, making it difficult to predict court decisions on this issue. It is not common to have specific MAC clauses in M&A contracts among Japanese companies.

What are the main unresolved issues in your jurisdiction?

In tandem with the increase of MBOs, squeeze-outs of minority shareholders after acquisitions of large stakes in targets have increased in recent M&A transactions. Under the current laws, to squeeze out minority shareholders, the parties would generally: (i) use classified stock, that is, callable shares, which has recently become available under the Companies Act; (ii) use fractional shares in connection with share swaps or mergers; or (iii) execute cash-out share swaps or mergers upon being qualified to do so under the Industry Revitalization Act. However, the rules for such squeeze-outs are not clear with regard to which method, under which circumstances and after what procedures are taken, it is permissible to execute squeeze-outs. This will become an even bigger issue when cash-out mergers or share swaps will become generally available under the Companies Act from the second enforcement in May 2007.

For triangular mergers, the tax treatment is also a big issue to be resolved.

A few legal issues remain when launching an exchange offer under the Companies Act, despite exchange offers already being available under the SEL. How to price target shares with proper premium in a process of tender offer, for example, remains unclear, avoiding the questions of discounted issue (shareholders approval is required if the acquirer's share issuance is at a price considerably lower than market price) and contribution in kind (problematic if the target shares are evaluated higher than the market price) at the same time.

In December 2006, the Trust Law was fundamentally amended for the first time since 1922. Although this amendment has made the business trust available for the first time and its flexible character might be suitable for some M&A transactions, the future of business trusts in the M&A context depends on the regulations, tax treatment and accounting rules related to the business trust, the details of which are still under consideration.

Takeovers

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

The SEL sets out the TOB Regulations while the Financial Services Agency administers these regulations.

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

A takeover can be achieved through a merger, share swap, or de-merger under the Companies Act or a business asset transfer, share acquisition, or any combination of the above. To obtain a control over a company, a share issuance allotted to third parties can also be used.

When a listed company is a target, the norm is to complete a tender offer for shares of the target and to obtain as large a stake in the target company as possible before undergoing a statutory merger or a share swap.

How differently are hostile and voluntary takeover bids treated?

Hostile takeover attempts have been extremely rare in the past, but the risk of becoming subject to a hostile takeover attempt has become a common concern among the management of Japanese listed companies. Under the TOB Regulations, hostile and voluntary takeover bids are treated equally. However, certain parts of the amendments to the TOB Regulations that became effective in December 2006 are particularly relevant to hostile takeover bids (although applicable to friendly bids).

Target's opinion report

The opinion report of the target company regarding a tender offer is informative for its shareholders in making their decisions on the offer, especially in the event of hostile offers. Under the new TOB Regulations, the target company is obliged to issue its opinion report with respect to the offer within 10 business days after the offer is made. In the opinion report, the target company is required to state whether it intends to effect any takeover defensive measures and, if so, the specific details of those measures.

Target's inquiry process

The new TOB Regulations permit the target company to make inquiries of the offerer in its opinion report. The offerer is obliged to provide its response to any queries within five business days after receipt.

Offering period

The new TOB Regulations provide that the offer period must be between 20 and 60 business days (calendar days were used previously). If the offerer sets an offer period for less than 30 business days, the target has the right to extend the offer period up to a total of 30 business days by so requesting in its opinion report.

Withdrawal of offers and change of offer terms

Under the new TOB Regulations, the circumstances in which an offerer is permitted to withdraw its offer have been broadened to include, for example, a stock split and disposal of valuable assets of the target company and its subsidiaries, and enforcement of certain takeover defensive measures taken by the target. Further, an offerer can decrease its offer price under certain circumstances, including a stock split, if the offerer has included this possibility in its offer registration statement.

Contested acquisitions

The new TOB Regulations, in their attempt to make contested acquisitions transparent and fair, provide that if, during a tender offer period set by an offerer, a large shareholder, holding more than one-third of the voting rights of the target company acquires more than 5% of the target, the acquisition must be made under a tender offer. Both a white-knight offerer and a hostile offerer can be subject to this requirement.

Obligation to acquire all tendered shares

An offerer is not required to acquire shares exceeding the upper limit it sets in its offer registration statement. However, if the offerer were to acquire such a large percentage of shares that the target company would probably be de-listed, minority shareholders would be in an extremely unstable position. So, under the new TOB Regulations, the upper limit set by an offerer cannot exceed two-thirds of the voting rights of a target company.

The new TOB Regulations also provide that, if an offerer seeks to purchase two-thirds or more of voting rights in the target company, it is required to make an offer to acquire all classes of equities, including those not listed.

What penalties are imposed for parties who violate takeover regulations (or equivalent)?

A party violating the TOB regulations will be subject to both civil and criminal sanctions under the SEL.

The specific criminal sanctions depend on the regulations violated. For example, in the case of failure to submit an offer registration statement or to publish a public notice on a tender offer, the sanction is up to five years' imprisonment and/or a ¥5 million fine. If a public notice is published or an offer registration statement is filed with material misstatement, the sanction is up to 10 years' imprisonment and/or a ¥10 million fine. Violators may be subject to additional fines of up to ¥500 million in the first case above and up to ¥700 million in the second case above if the violations are committed on their behalf by representatives or employees.

In certain cases, civil liability could be applied on a strict liability standard, which does not require proof of negligence on the part of the offerer. Provisions in the SEL set out certain methods to calculate the damages depending on the violation. Similar to the civil liability for material misstatements or omissions in a prospectus discussed above, officers of the offerer, including directors and statutory auditors, could also be subject to civil liability in case of material misstatements or omissions in an offer registration statement or offer prospectus.

What are the thresholds for disclosing bids and offers?

Even before the recent statutory amendments, the following types of acquisitions of shares in listed companies were subject to the TOB Regulations:

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

In response to criticism triggered by Livedoor's use of an off-hour trading system to acquire shares in Nippon Broadcasting System in 2005, the TOB regulations were amended once in 2005. Now, if an acquirer acquires more than one-third of the outstanding voting rights through an off-hour trading systems (for example, Tokyo Stock Exchange Trading Network System – ToSTNet) that acquirer would be subject to the TOB Regulations.

The new TOB Regulations further expanded the scope of the transactions subject to the TOB Regulations. In addition to contested acquisitions discussed above, they apply to all rapid serial acquisitions (other than acquisitions of newly issued shares) after which an acquirer holds more than one-third of the outstanding voting rights and: (a) which are made within a period of three months; (b) the total purchases of which exceed 10% of outstanding voting rights, irrespective of the method of acquisition (including market-based acquisitions or acquisitions of newly issued shares); and (c) out of which, the off-exchange or off-hour trading system acquisition purchases (excluding an acquisition over a tender offer) exceed 5% of outstanding voting rights.

Competition/Antitrust

What have been the main recent developments in competition policy and legislation as they relate to M&A in your jurisdiction?

The AML governs the merger control framework from a viewpoint 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 Merger Guidelines were last revised in May 2004, and have since clarified certain aspects of the AML, including the categories of business combinations whose impact on competition should be reviewed, provided clearer definition of markets and explained the factors that are given consideration upon assessment on whether a particular transaction would substantially restrain competition.

The Merger Guidelines are being further revised to ease regulations on M&A transactions that would enhance Japan's international competitiveness. On January 31 2007, the Japan Fair Trade Commission (the JFTC) published and requested public comments on a draft of the revised Merger Guidelines. The revision is expected to take effect in April 2007.

The proposed standards of safe harbours under the Merger Guidelines would use the Herfindahl-Hirschman Index (HHI) as the primary yardstick to judge whether a proposed merger or acquisition would hinder fair competition, instead of the current benchmark of domestic market shares of companies involved.

While the current standards are based almost entirely on the domestic situation, the proposed standards take into account the international situation as corporate activities expand across borders.

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 provisions.

Parties to M&A transactions that face potential problems under competition laws tend to voluntarily apply to the JFTC for prior consultation to reduce the risk of transactions being blocked during the later formal notification 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 certain 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 requirements?

The AML regulates four main types of business concentrations: (i) statutory mergers; (ii) statutory de-mergers; (iii) business asset 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 and that of the other exceeds ¥1 billion) are exceeded.

Share acquisitions are, in contrast, only subject to a reporting requirement after the transaction is completed 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 if an acquiring company has assets (non-consolidated) of more than ¥2 billion, and, together with its subsidiaries and any Japanese parent, total assets of more than ¥10 billion and 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

Akiko Sueoka Mori Hamada & Matsumoto After four years as an officer at the Ministry of Health and Welfare, Akiko Sueoka joined Mori Hamada & Matsumoto in 2000 and has since focused her practice on M&A transactions. She graduated in 1994 with an LLB from Keio University, and in 2003 with an LLM from Harvard Law School. She was admitted to practise in Japan in 2000 and in New York in 2004. She worked at Simpson Thacher & Bartlett in New York from 2003 to 2004 and at Pavia e Ansaldo in Rome from 2004 to 2005. From 2005 to 2006, she was seconded to the Ministry of Economy, Trade and Industry, where she was an associate director in charge of issues on the Limited Partnership Act for Investment, the Trust Law and the Financial Instruments and Exchange Law. Her published work includes "Hostile Takeover Defenses in the EU Takeover Directive and the TOB Regulation" (2005).