Last year might well be remembered as the year when hostile takeover defences took hold in Japan. It is true that there have been some hostile takeovers or attempted takeovers in the past in Japan, including the takeover bid for Shoei Co Ltd by MAC (the so-called Murakami Fund), a Japanese investment fund, in 2000, and the bids for Yushiro Chemical Industry Co Ltd and Sotoh Co Ltd by Steel Partners, a US investment fund, in 2003/2004. In addition, Sumitomo Mitsui Financial Group Inc made an unsolicited merger proposal to UFJ Holdings Inc (UFJHD) and UFJ Bank Limited in the summer of 2004 while UFJHD was in merger discussions with Mitsubishi Tokyo Financial Group Inc. But, the practice of stable and cross-shareholding has been slow to change.

The shareholding ratio of foreign investors has increased and it has been repeatedly pointed out that the market capitalization values of large Japanese companies are much lower than those of their foreign competitors. Nonetheless, while it is certain that the New Year's resolutions of executives at most Japanese listed companies at the beginning of 2005 included the adoption of hostile takeover defences, it is probably equally certain that this goal was not among the top items on their lists. At the beginning of the year, hostile takeovers were still viewed as something that might occur to someone less fortunate, but not as something that would occur to one's own company any time soon.

The situation suddenly changed on February 8 2005, when Livedoor Co Ltd (Livedoor), a Tokyo Stock Exchange (TSE) Mothers-listed internet company established in 1996, announced that it had purchased about 35% of the shares of common stock of Nippon Broadcasting System Inc (NBS), a TSE Section II-listed radio broadcasting company, and planned to purchase additional NBS shares. Fuji Television Network Inc (Fuji), a TSE Section I-listed national television network company, had started a takeover bid for NBS on January 18 2005, to make NBS a wholly owned subsidiary of Fuji as a part of its intra-group restructuring. Both Fuji and NBS are core companies of the Fujisankei Communications Group, one of the largest media conglomerates in Japan, and this bid was an amicable one with no surprises expected. However, Livedoor suddenly stepped into the picture. The fact that NBS owned 22.5% of Fuji added a special twist to this case. If Livedoor could have successfully acquired control of NBS, it could have become by far the largest single shareholder of Fuji and could have acquired control over the management of this media conglomerate. The Japanese media followed every move of the parties until Fuji and Livedoor reached a settlement agreement on April 18 2005. As a result of this media circus, people from all walks of life in Japan became familiar with technical M&A terms such as poison pills, crown jewels, white knights and Pac-Man defences.

Executives at Japanese listed companies suddenly became concerned that their companies might become the next target of a hostile takeover. As a result, hostile takeover defences jumped to the top of their to-do lists. The problem, however, was that at that time, there were no reliable rules for hostile takeover defences in Japan, including whether and when management could adopt and use defensive measures, and what kind of defensive measures (for example, poison pills, golden stock, super voting stock) were available under Japanese law.

Administrative authorities' actions

Fortunately, administrative authorities in Japan had started to look into this issue as early as 2004. Japanese companies considering the adoption of defensive measures have found the work of administrative authorities to be helpful. However, neither the Corporate Value Report nor the Takeover Defence Guidelines mentioned below are of a legally binding nature and the courts might take (and have taken) a different position.

Corporate Value Report

The Corporate Value Study Group sponsored by the Ministry of Economy, Trade and Industry (METI) started in September 2004 to study hostile takeover defensive measures and defence rules by referring to their use abroad. This study group issued its Corporate Value Report summarizing the results of their study on May 27 2005, which proposed that the determination of whether a defensive measure is reasonable should be based on a "corporate value standard," which took into consideration: (i) whether there was an existing threat to corporate value; (ii) whether the defensive measures were proportionate to the threat; and (iii) whether the board's actions were prudent and appropriate. The corporate value standard is similar to the Unocal test, which was created by the Delaware Supreme Court in the US in the case of Unocal Corp v Mesa Petroleum Co (493 A2d 946, 955 (Del 1985)). The Corporate Value Report further recommended that: (i) the defensive measures be adopted before a specific hostile takeover occurs and the board disclose its details in advance; (ii) the defensive measures be redeemable depending on the result of a proxy contest; and (iii) certain appropriate devices be implemented to ensure that the defensive measures will not be used to allow the incumbent board members to entrench themselves on the board. The Corporate Value Report proposed that three devices would be appropriate for fulfilling the recommendation mentioned in item (iii) above: (i) evaluation by independent parties such as independent directors; (ii) inclusion of a chewable pill clause or permitted offer exception clause, which would provide that defensive measures will be redeemed if an acquisition proposal meets certain objective requirements established by the board in advance; or (iii) approval by the shareholders.

Takeover Defence Guidelines

In addition, METI and the Ministry of Justice (MOJ) jointly issued the Guidelines Regarding Takeover Defences for the Purpose of Protection and Enhancement of Corporate Value and Shareholder's Common Interests on May 27 2005. The Takeover Defence Guidelines stated that the purpose of takeover defensive measures is to protect and enhance corporate value and the interests of all shareholders as a whole and provided that companies implementing defensive measures should observe the following three principles:

1. Protecting and enhancing corporate value and the common interests of all shareholders as a whole. Takeover defensive measures should be adopted, used or redeemed for the purposes of protecting or enhancing corporate value as well as the common interests of all shareholders as a whole.
2. Prior disclosure and shareholders' will. The specific details of takeover defensive measures should be disclosed at the time they are adopted to allow shareholders to make appropriate investment decisions. In addition, the takeover defensive measures should reflect the reasonable will of the shareholders. In other words, the takeover defensive measures should be adopted at a general meeting of shareholders or, if adopted by board resolution, a mechanism should be included that will allow the shareholders to redeem such measures.
3. Ensuring necessity and reasonableness. Takeover defensive measures should conform to the requirements of Japanese corporate law, including the principles of shareholder equality and the protection of property rights. In addition, appropriate devices should be put in place to prevent abuses by the board.

Generally speaking, the Takeover Defence Guidelines recommended that defensive measures be adopted at a general meeting of shareholders; if adopted by board resolution, various additional requirements, including those proposed or recommended in the Corporate Value Report, should be met to increase the probability that the measures will be found legal or to increase the reasonableness of the measures adopted.

Discussions on Fair Takeover Defensive Measures

Even after issuing the Corporate Value Report, the Corporate Value Study Group continues to discuss fair takeover defence rules. This study group published on November 10 2005, a Draft Summary of Discussions on Fair Takeover Defensive Measures, summarizing their discussions on the disclosure of takeover defensive measures and the treatment of takeover defensive measures at the stock exchanges. This study group plans to issue another report in early 2006 to summarize the discussions that occurred after May 2005.

Legislative actions

Some legislative action in 2005 might affect the M&A market and M&A practices, including hostile takeovers.

New Company Law

A bill that amended portions of the Commercial Code of Japan (Shouhou) and created the new Company Law (Kaisha-hou) was passed by the National Diet on June 29 2005. The Company Law, which is expected to become effective in or about May 2006, is the new corpus of corporate law in Japan and is the first major enactment of corporate law since the Commercial Code was enacted more than a century ago. The Company Law will make Japanese corporate law more flexible than ever before.

One of the amendments contained in the Company Law is the introduction of triangular mergers. However, some Japanese companies expressed concern during the final stages of the deliberations leading up to the enactment of the Company Law that triangular mergers could facilitate hostile takeovers of vulnerable Japanese companies by foreign companies, referring to the large difference in the market capitalization values between Japanese companies and foreign competitors. To address these concerns, the effective date of the triangular merger provisions has been postponed for one additional year after the main body of the Company Law becomes effective so that Japanese companies will have a chance to adopt appropriate defensive measures available under the Company Law before triangular mergers become available.

The Company Law also permits greater flexibility in designing warrants and multiple classes of shares, which might enable Japanese companies to adopt various defensive measures not available under the current Commercial Code.

Proposals regarding the fair M&A rules

In addition, the Corporate Governance Committee of the ruling Liberal Democratic Party (LDP) issued on July 7 2005 its Proposals Regarding Fair M&A Rules. The proposals were based on three main policies: (i) the transparency of the M&A process and measures; (ii) a fair balance between the acquirer and the target; and (iii) the protection of the interests of the general shareholders and various stakeholders. Based on these policies, the LDP advocated several tasks including takeover bid rule reform and disclosure system reform. The proposals discuss not only defensive rules but also offensive rules.

Reform of the takeover bid rules

Based on the proposals of the LDP's Corporate Governance Committee, the Takeover Bid Working Group of the Financial Council sponsored by the Financial Services Agency started discussions in July 2005 to reform the takeover rules in an effort to improve the fairness of hostile takeovers.

Judiciary actions

Although administrative authorities have been trying to establish hostile takeover defence rules that they consider to be fair and reasonable, the courts have taken a slightly different view on the fairness and reasonableness of certain takeover defences.

The NBS case

Livedoor's sudden purchase of about 35% of NBS's shares during Fuji's takeover bid for NBS resulted in NBS's board decision to issue warrants to Fuji to block Livedoor from acquiring a majority of NBS's shares. Livedoor immediately sought a preliminary injunction from the Tokyo District Court to stop NBS from issuing the warrants to Fuji. The Tokyo District Court granted the preliminary injunction, which prohibited NBS from issuing the warrants to Fuji and the Tokyo High Court affirmed this decision on appeal by NBS.

The Tokyo High Court's ruling can be summarized as follows:

1. The board is not allowed, in principle, to issue shares or warrants for the primary purpose of changing the shareholding ratio of the shareholders (to maintain the company's current business framework policy, which the board believes to be appropriate), because the board members are appointed and dismissed at the sole discretion of the shareholders, the owners of the company.
2. If special circumstances exist to justify issuing warrants to protect the interests of all shareholders as a whole, the issuance of warrants for the primary purpose of maintaining or obtaining management control is permitted.
3. Such special circumstances will be found to exist if a company establishes that a hostile acquirer does not intend in good faith to participate in the reasonable management of the company and circumstances exist that indicate that the company will suffer irreparable harm as a result of the acquisition of management control by the hostile acquirer. Examples of such hostile acquirers would include: (i) green-mailers; (ii) acquirers that intend to misappropriate the company assets; (iii) acquirers by way of a leveraged buyout (LBO); and (iv) acquirers that are short-term speculators. (The text of the decision that describes these examples is not clear and there are a couple of interpretations as to what the court meant in this context.)
4. The Court is not in a position to compare the relative corporate values of NBS if it remains a part of the Fujisankei Communications Group on the one hand and if it becomes a subsidiary of Livedoor on the other hand. Therefore, NBS's assertion based on the comparison of NBS's corporate values did not constitute a valid justification for the issuance of the warrants.

The decision of the Tokyo High Court is controversial in a number of respects. First, practitioners point out that it is difficult to meet the burden of proof referred to in this decision as a practical matter because no hostile acquirer is going to confess that it does not intend in good faith to participate in the reasonable management of the company. Secondly, there is some concern among practitioners that the language used to describe the examples of hostile acquirers given by the court listed in (3) above is not clear enough to provide practical guidance. In particular, there seems to be confusion over the fact that the court would appear to consider an LBO acquirer to be as undesirable as a green-mailer.

Nireco case

In March 2005, Nireco Corporation (Nireco), a Jasdaq-listed company, announced the adoption of a hostile takeover defensive rights plan in which each shareholder of record at the end of March would be granted a non-transferable warrant exercisable only in the event of a hostile takeover of the company. As a result, shareholders, including hostile acquirers, who purchase Nireco shares after the end of March will have their shareholdings diluted if the warrants are exercised. An investment fund sought a preliminary injunction from the Tokyo District Court to stop Nireco from issuing the warrants. The Tokyo District Court granted the preliminary injunction, which prohibited Nireco from issuing the warrants and the Tokyo High Court affirmed this decision on appeal by Nireco.

The Tokyo High Court affirmed the decision of the Tokyo District Court and stated that the issuance of the warrants should be suspended, because such warrants would cause unjustifiable harm to the current shareholders. The Court explained that the issuance would have a detrimental effect on the value of shares owned by the current shareholders and that the loss of value cannot be recouped by disposing of the warrants because such dispositions are prohibited.

In contrast, the Tokyo District Court stated that the issuance of the warrants should be suspended because the rights plan adopted by board resolution is justifiable only if the company establishes that: (i) the issuance of the warrants is designed in a way that reflects the "intention of a general meeting of shareholders;" (ii) the warrants are designed to become exercisable only if a hostile acquirer does not intend in good faith to participate in the reasonable management of the company and circumstances exist that indicate that the company will suffer irreparable harm as a result of the acquisition of management control by a hostile acquirer, and proper devices are built into the determination process to ensure that the board's decision will not be arbitrary; and (iii) the issuance of the warrants is designed in an appropriate fashion as a defensive measure adopted in advance of a hostile takeover as judged by such factors as the issuance of the warrants giving no unexpected harm to shareholders that are not relevant to the takeover. It is not clear whether the Tokyo High Court, which affirmed the decision of the Tokyo District Court but articulated different reasoning, has rejected the Tokyo District Court's reasoning.

The decision of the Tokyo District Court is also controversial because it has given a narrow interpretation of the board's authority to adopt defensive measures in advance, which is probably narrower than the authority provided in the Corporate Value Report or the Takeover Defence Guidelines.

Japan Engineering Consultants case

In May 2005, Yumeshin Holdings Co Ltd (Yumeshin), an Osaka Stock Exchange Hercules-listed company, made an unsolicited takeover proposal to Japan Engineering Consultants Co Ltd (JECC), a Jasdaq-listed company, and then acquired about 6.4% of JECC's shares. On July 8 2005, JECC issued a press release regarding the creation of its policy on material acquisitions of its shares and announced its Material Acquisition Rule, which requested that all acquirers of 20% or more of JECC's shares provide JECC's board with enough information for shareholders to make an informed judgment on the desirability of the investment offer and give the board time to consider the offer. The release further stated that, if an acquirer complied with the procedural requirements of the Material Acquisition Rule, the board would not use any defensive measures even if it was opposed to the acquisition; however, if an acquirer did not comply with the procedural requirements of the Material Acquisition Rule, the board would use any defensive measures against the acquirer that they deemed necessary to protect the shareholders' right to make an informed judgment on the investment offer. (In Japan, this type of defensive plan is now sometimes referred to as a pre-warning-type defensive plan.) Yumeshin announced on July 11 2005 that it had decided to start a takeover bid for JECC on July 20 2005, without complying with the Material Acquisition Rule. In response, JECC declared a stock split (kabushiki bunkatsu) to discourage Yumeshin from starting its takeover bid without complying with the Material Acquisition Rule, because the stock split would delay the settlement of stock transfers and the completion of Yumeshin's bid. Nevertheless, Yumeshin started its bid and sought a preliminary junction from the Tokyo District Court to stop JECC from declaring the stock split.

The Tokyo District Court dismissed Yumeshin's preliminary injunction petition, stating, among other things, that:

1. The implementation of the Material Acquisition Rule by JECC's board does not constitute the board's abuse of its own authority so long as the type of requested information and the length of the requested period for consideration are reasonable.
2. There are cases where JECC's board may use appropriate defensive measures against an acquirer that does not comply with the Material Acquisition Rule for the purpose of protecting the interest of the shareholders as a whole so long as such defensive measures do not conflict with the principles of the Securities Exchange Law and the principles of the allocation of authority between shareholders and the board under the Commercial Code.
3. The petition by Yumeshin is dismissed because Yumeshin has not established that JECC's stock split will make its takeover bid impossible or significantly increase the practical difficulties in consummating its bid.

It is not clear whether JECC could have taken more aggressive defensive measures than a pre-takeover bid stock split, such as the use of poison pills.

More hostile bids expected

Some Japanese listed companies have already taken steps to put hostile takeover defensive measures in place. In June 2005, several Japanese listed companies adopted Japanese-type rights plans designed to work in a manner similar to the rights plans generally used in the US. Several other Japanese listed companies have adopted pre-warning-type defensive plans. Some companies have also amended their articles of incorporation to make it easier for them to initiate defensive measures, including amendments to increase the number of their authorized shares to make it possible for them to issue more shares in defence of a hostile takeover.

Meanwhile, hostile takeovers continue to occur one after another against some Japanese famous companies – MAC Asset Management, a Murakami Fund company, acquired about 40% of the shares of common stock of Hanshin Electric Railway Co Ltd, and Rakuten Inc, an internet company established in 1997, acquired about 20% of the shares of common stock of Tokyo Broadcasting System Inc (another one of Japan's major national television network companies).

Considering that Japan is still recovering from its decade-long economic depression of the 1990s and early 2000s; that the stock prices of some of Japanese companies are still regarded as being undervalued; and that it is getting easier to procure substantial amounts of investment capital, hostile takeovers will probably continue to occur in Japan. So it is expected that hostile takeovers and takeover defences will remain hot topics for the business community and also for lawmakers and legal practitioners in Japan.

Author biography

Hiroshi Mitoma Nagashima Ohno & Tsunematsu Hiroshi Mitoma is a partner of Nagashima Ohno & Tsunematsu. His practice focuses on mergers and acquisitions, including hostile takeover defences, joint ventures, and structured finance transactions. He graduated in 1991 with an LLB from the University of Tokyo, Department of Law and in 1998 with an LLM from Harvard Law School. He was admitted to practise law in Japan (1993) and in New York (1999). He worked at Cleary Gottlieb Steen & Hamilton in New York City as a foreign associate from 1998 to 1999. He has been an associate professor at the Graduate Schools for Law & Politics of the University of Tokyo since 2004. Yuko Okamoto Nagashima Ohno & Tsunematsu Yuko Okamoto is an associate of Nagashima Ohno & Tsunematsu. She graduated in 2001 with an LLB from the University of Tokyo, Department of Law. She was admitted to practise law in Japan (2002) and has since practised mainly in the field of finance and M&A.