On August 30 2006 Dowa Metals & Mining's board of directors adopted a resolution, under which gratis allotment of share purchase warrants (shinkabu yoyakuken) will be provided to shareholders who have held their shares for three years (the Dowa Model). This favourable treatment of long-term shareholders could be regarded as being against the principle of shareholder equality.

Dowa Model issues

Equality of shareholders

Katsuyuki Yamaguchi, a Japan-admitted attorney (bengoshi) of Nishimura & Partners, was involved in preparing the Dowa Model. He states that: "The scheme is not that gratis allotment of share purchase warrants will be provided because shareholders have held their shares for a long period (the last three years), but that gratis allotment of the corresponding numbers of share purchase warrants will be granted to shareholders as of September 30 according to the number of shares held by each shareholder and only shareholders who have held their shares for a long period will be able to exercise their share purchase rights. Every investor has the same right to purchase shares before September 30 and all shareholders have the same right to decide whether they will hold their shares for a long period after the purchase."

Regarding the Dowa Model, prosecutor Masami Hadama maintains that: "The scheme that (i) gratis allotment of share purchase warrants will be granted to shareholders as of a certain point of time according to the number of shares held by each shareholder and (ii) only shareholders who have held their shares for a long period thereafter will be able to exercise their share purchase rights, is not necessarily against the principle of equality of shareholders because all shareholders as of such point of time are equally provided with a right to choose whether they will hold their shares for a long period."

The model raises two questions regarding the principle of equality of shareholders under Law 86 of 2005 (the Company Law), Article 109.

First, Article 109(1) provides that "a joint stock company shall treat its shareholders equally depending on the substance and number of shares held by them," so it could be interpreted that rights of shareholders cannot be differentiated depending on whether they hold shares long term or short term.

A closed company may stipulate in its articles of incorporation (teikan) that the right to claim dividends, the right to claim distribution of residual assets and/or the right to vote differ for each shareholder (Article 109(2)). (There are no bylaws under the Company Law.) However, as Dowa Metals & Mining is a publicly held company, this provision does not apply.

Also, a joint stock company may issue different kinds of shares under the Company Law, Article 108. However, no item of this provision allows shares to be issued that give the shareholder the right to obtain shares after holding their shares long term. Kenjiro Egashira states: "Matters that may differ depending on the type of shares are limited to matters as listed in each item of Paragraph 1 of Article 108, and no other matters can differ. For example, in respect of voting rights, only changing certain voting rights so that such rights may not be exercised in respect of specified matters is allowed and any other arrangements, including those to cause any certain share to have multiple voting rights, are not allowed. ... If it is intended to substantially realize the latter case, there is no method other than to, where none of the shares of the relevant company is allowed to be transferred in accordance with its articles of incorporation, include in its articles of incorporation certain provisions to be applied only to specified shareholders" (Kabushiki Kaisha Ho, 2006). According to this interpretation, the type of shares for which a right to purchase shares is provided by reason of long-term holding will not be allowed because the right includes allowing the provision of multiple voting rights by reason of long-term holding. It would be difficult to hold prosecutor Hadama's assertion that this is not against the principle of equality of shareholders because "all shareholders as of such point of time are equally provided with a right to choose whether they will hold their shares for a long period" because shareholders should be equally treated after the long-term holding period as well. It is not enough that the principle of equality of shareholders is maintained only at the initial point (at the time that gratis allotment of share purchase warrants is provided).

Second, if the Dowa Model is implemented, it will impose unforeseen damage to shareholders. This is because, at the time of the gratis allotment of share purchase warrants, the share price will fall (at least theoretically). That is, if a shareholder that receives share purchase warrants free of charge transfers their shares at the time of the gratis allotment, the shares will be treated at a discounted price because the right to obtain shares based on long-term holding will not be provided to the assignee and the assignee will not be able to enjoy the value of the shares owned by the assignor. Also, because the price of a share differs depending on how long the shareholder holds the share, double pricing exists with respect to a share, which is clearly against the principle of shareholder equality.

It might be possible to argue that the Dowa Model can be implemented by changing its articles of incorporation to the effect that gratis allotment of share purchase warrants as intended in the Dowa Model may be provided by the resolution of the board of directors' meeting. This argument effectively rebuts the first discussion above, but not the second. However, shareholders who are against the Dowa Model are entitled to demand that their shares be purchased at the time the articles of incorporation are amended (a right that should be provided for in the company's articles of incorporation), so new investors purchasing shares in Dowa would be regarded as having made their investment while knowing of the Dowa Model's existence. (If an investor purchases shares without examining the articles of incorporation of the company they are investing in, they would be considered negligent, and must bear the responsibility of any damages.) However, whether the adoption of the Dowa Model by changing a company's articles of incorporation will be allowed is not discussed here.

Even if the Dowa Model can lawfully be adopted, the articles of incorporation must be changed as a precondition. If the Dowa Model were adopted only by a resolution of the board of directors, without the necessary change to the articles of incorporation, it would obviously be considered unreasonable.

Favourable treatment of long-term shareholders

In the Dowa Model, it is provided that "the rate of shares to be provided to each shareholder shall be the number of shares entered or recorded in the register of shareholders on March 31 or September 30 each year during September 30 2006 to September 30 2009, whichever is least, divided by the number of share purchase warrants intended to be exercised or obtained." This means that an investor can enjoy the benefit based on the Dowa Model (obtaining 0.05 shares a share for almost no cost) by, instead of continuously holding shares for three years, purchasing shares in Dowa immediately before March 31 or September 30 each year so that their name will be entered or recorded in the register of shareholders as of these dates. (This means that the share price of Dowa rises before the record date and falls after the record date.) If favourable treatment based on the long-tem holding of shares is intended, only investors who have continuously held shares in Dowa for three years should be favourably treated.

The Third Amended and Restated Certificate of Incorporation of Google Inc, has Class A common stock and Class B common stock. One voting right is provided to one share of Class A common stock, while ten voting rights are provided to one share of Class B common stock. In principle: (i) the registered holders of shares of Class B common stock at the time of filing the Second Amended and Restated Certificate of Incorporation in Delaware (which was filed on June 28 2004); and (ii) the initial registered holders of any shares of Class B common stock that were originally issued by Google Inc after the effective time (June 28 2004), are regarded as holders of Class B common stock. However, if a holder of shares of Class B common stock transfers their shares to a third party, those shares of Class B common stock will be converted to shares of Class A common stock at the rate that one share of Class B common stock would be converted to one share of Class A common stock. That is, under the Certificate of Incorporation of Google Inc, investors are required to hold shares for a long time to enjoy the benefit (holding of shares with multiple voting rights). On the other hand, under the Dowa Model, an investor can enjoy the benefit (obtaining 0.05 shares a share for almost no cost), without holding shares for three years, by purchasing shares in Dowa in time to be entered in the register of shareholders as of the record dates, which will occur six times in the three years.

Defence against hostile takeovers

In the cases of Teijin Ltd (a Japanese chemistry company) and Shinki Bus Co (a Japanese bus operation company), although certain provisions regarding takeover defence measures have been included in their articles of incorporation, it is stipulated that the decision itself on takeover defence measures must be made by a general meeting of shareholders. In the case of Izumiya Co (a Japanese operator of a supermarket chain), it has been stipulated that takeover defence measures should be specified and decided by a general meeting of shareholders if it is during a peaceful period (before the appearance of a hostile buyer).

To reduce the risk of being judged null, takeover defences should be specified and included in the articles of incorporation. If this were done (and if this inclusion is allowed under the Company Law), it would be difficult to assert that the takeover defence measures are null because a new investor in a company would be regarded as having known of the company's articles of incorporation (including the takeover defences) before their investment. If an investor invested in a company without examining its articles of incorporation, it would be regarded as negligent and any damage arising from the lack of examination should be borne by the investor, based on the principle of self-responsibility. Any person who is a shareholder at the time the articles of incorporation are amended and who is against the takeover defence measures should be entitled to exercise the right to demand that their shares be purchased (which should be provided for in the company's articles of incorporation).

No Japanese statute contains restrictions relating to business combinations with interested shareholders constituting defensive measures against hostile takeovers, which are restrictions naturally enjoyed by any Delaware corporation in the US (see Akimitsu Kamori, "Defence Against Hostile Takeovers" (Daiichi Tokyo Bar Association, Sogo Horitsu Kenkyu-jo, Kaisha-ho Kenkyu Bukai (ed), "Q&A Shinkaisha-ho no Yoten," 309 (2005)).

Japanese companies should consider the possibility of including restrictions relating to business combinations with interested shareholders into their respective articles of incorporation as the first step. Then, they should examine what kinds of additional takeover defence measures could be adopted.

As one such additional takeover defence measure, Japanese companies should consider the possibility of amending their respective articles of incorporation to include a provision that a hostile takeover proposal must be primarily discussed at the board of directors' meeting and only when approved by the board of directors can the shareholders' judgment (exercise of voting rights) be sought (a board of directors initiative provision).

Author biography

Akimitsu Kamori Blakemore & Mitsuki Akimitsu Kamori is a partner of Blakemore & Mitsuki in Tokyo. His practice focuses on M&A and structured finance. Kamori worked at Dewey Ballantine in New York as an associate from 1988 to 1994. He received his LLM from Cornell Law School in 1987, and his diploma (in American law) from Yale University in 1986. He also received a diploma from the Legal Training and Research Institute of the Supreme Court of Japan in 1982, and LLBs (public law and private law) from The University of Tokyo in 1980 and 1978, respectively. Kamori was admitted to the Bar of Japan and New York in 1982 and 1988, respectively. His native language is Japanese and he is fluent in English.