There has been a remarkable increase in squeeze-out transactions such as management buyouts (MBOs) or delisting of listed subsidiaries in Japan in recent years. However, rules that govern such transactions have been unclear. To address this, regulations governing disclosure requirements on MBOs were amended and certain guidelines for MBOs (the MBO Guidelines) were published in 2007 by a study group hosted by the Ministry of Economy, Trade and Industry. The courts have also become more active in this area by resolving cases concerning the acquisition price of shares in squeeze-out transactions. These cases include the Rex Holdings case (Tokyo High Court decision of September 12 2008 and Supreme Court decision of May 29 2009), the Sunstar case (Osaka High Court decision of September 1 2009) and the Cybird case (Tokyo District Court decision of September 18 2009).
In recent squeeze-out transactions in Japan, "class shares subject to wholly call" (CSWC) have often been used to squeeze out minority shareholders. CSWC are a new type of class shares introduced by the Companies Act of Japan implemented in 2006. Shares issued and outstanding can be converted into CSWC through an amendment to the articles of incorporation. A company may acquire CSWC based on the resolution of its shareholders meeting. In the course of squeeze-out transactions, another class of shares is usually delivered to the shareholders as consideration.
In recent squeeze-out transactions, two steps are usually involved. First, the purchaser (in MBO transactions, this typically refers to a company set up by management) makes a takeover bid against a target company. Under Japanese law, the purchaser is not entitled to purchase the shares in the target company held by minority shareholders remaining after the takeover bid (which, under the Companies Act of the UK, is available for shareholders who hold more than 90% of both share capital and voting rights of a company). Therefore, some outstanding shares held by minority shareholders could remain outstanding after such bid. To squeeze out minority shareholders who do not sell their shares, the target company amends its articles of incorporation to introduce CSWC.
Provisions regarding CSWC in the articles of incorporation allow such shares to be exchanged with another class of shares at an exchange ratio entitling minority shareholders to obtain rights only with respect to fractions of such other classes of shares. Because a fraction of a share cannot be issued under the Companies Act, the minority shareholders will, as a consequence, only receive cash equivalent to the price of the fractions of shares. Such price is generally based on the offer price of the takeover bid (the offer price in a takeover bid is practically also used as the acquisition price in the squeeze-out).
If minority shareholders are dissatisfied with the acquisition price of CSWC, they can ask courts to determine such price pursuant to the Companies Act. These requests have been the subject of the recent cases, which all agreed on the following points:
- Although the Companies Act does not contain any provision on how to determine the price for the acquisition of CSWC, such price should be "fair" as at the acquisition date.
- The fair price should consist of (i) the objective value of the relevant shares as at the acquisition date and (ii) a premium. A premium is necessary because the shareholders are deprived of the right to be benefited by any possible increase in the stock price.
However, these cases are divided on how the objective value of the shares should be determined, how much the amount of the premium should be, and other issues.
The Rex Holdings case
In the Rex Holdings case, the court decided that the acquisition price should be higher than the offer price used in the takeover bid based on the following analysis:
(i) Objective value of shares
In the Rex Holdings case, as well as the other two recent cases, the Tokyo High Court determined the objective value of the shares as at the acquisition date based on the market price. The court said that the market price in the stock market generally reflects the objective value of a listed company. Strictly speaking, the target company in squeeze-out cases would already be delisted by the time of the squeeze-out and there would be no market price of the target company's shares as at the acquisition date. But in this case, the court stated that because the acquisition date was close to the delisting date, it was reasonable for the objective value of the shares of the company (which had just been delisted) to be based on the market price during a certain period close to the acquisition date unless there was an exceptional circumstance which made the market price not reflect the objective value of the company.
One of the main issues of the recent cases is which market price should be used. The conclusions in the cases all agree that the market price after the announcement of the takeover bid should be disregarded as it is influenced by the offer price in the bid and does not reflect the objective value of the shares. However the courts took different approaches in determining which price should be used as the market price. In the Rex Holdings case, the average market price during the six-month period before the announcement of the takeover bid was used.
Let us look at the facts of this case. The target announced the posting of extraordinary losses and the downgrading of earnings forecast about three months before the announcement of the takeover bid. The court stated that because there was no clear reason to post extraordinary loss at that time and no actual positive aspect of the background of the posting was mentioned in the announcement, it could not be denied that it was made to worsen the financial results of the target company in view of the implementation of the MBO transaction and the announcement had a potential negative impact on the target company's value in the share market. However, the court also said that the posting was lawful and based on facts, and should therefore be reflected in the objective value of the shares. Based on this, the court concluded that although the market price of the shares after the announcement of such posting and downgrading were heavily influenced by such announcement, the average market price of the period after such announcement as well as that of the period before such announcement should be considered in determining the objective value of the shares. So the court used the average market price during the six-month period before the announcement of the takeover bid. This included the period both before and after the announcement of the posting and downgrading.
(ii) Premium
In the Rex Holdings case, the Tokyo High Court explained that two kinds of values were realised in MBOs: (i) the value which cannot be realised without the MBO and (ii) the value which can be realised even without the MBO. The court stated that (ii) should be basically distributed to the shareholders while (i) should be shared between the management and the shareholders considering the risk taken and the effort made by the management after the buyout.
The court ruled that the premium should be determined after considering these values based on the profitability and performance shown in a business plan. In the Rex Holdings case, however, the company didn't submit a business plan or any valuation report of the shares based on a business plan.
Because of this, the court used its discretion in determining that the amount of the premium should be 20% of the objective value of the shares in reference to the premiums added to the market price of the shares in MBOs made at, or about, the time the MBO in the Rex Holdings case was carried out.
(iii) Other issues
While the Supreme Court affirmed the Tokyo High Court decision in the Rex Holdings case, a concurring opinion by a Supreme Court judge mentioned that there were statements in the takeover bid notice to the shareholders stating that (i) it was not clear whether the courts will accept applications by shareholders who will not sell the shares at the takeover bid for the determination of the acquisition price, and (ii) such shareholders should proceed to conduct the necessary procedures on their own after the takeover bid. According to the opinion, these statements were deemed to have possible coercive effects, which should be avoided to give the shareholders an appropriate opportunity to evaluate the MBO.
These statements, or ones similar to them, have often been used in disclosure documents of takeover bids in squeeze-out transactions. This concurring opinion would therefore affect future squeeze-out transactions.
The Sunstar case
In the Sunstar case, the court decided that the acquisition price should be higher than the offer price used in the takeover bid based on the following analysis:
(i) Objective value of shares
Like the Rex Holdings case, the court stated that (i) the objective value of the shares should be based on the market price for a certain period close to the acquisition date, and (ii) the market price after the announcement of the takeover bid should be disregarded.
Unlike the Rex Holdings case, the court stated that the market price after the management started to prepare for the buyout should also be disregarded: it is easy to see that directors of the target company would make manipulations cause a decrease in the share price. In the Sunstar case, an announcement regarding a downgrading of earnings forecast was made approximately three months before the takeover bid was announced. The court suspected that such downgrading announcement was one of the manipulations made because there was no clear reason for it. The court also analysed (i) the market price movement of the shares and (ii) the fact that the profits of the business year when the takeover bid was made were unusually low compared with the profits of previous years and the profit forecasts for subsequent years.
Based on the above, although the court did not clearly show when the management started to prepare for the MBO, the court determined that the objective value of the shares should be ¥700, the approximate value of the market price one year before the announcement of the takeover bid.
(ii) Premium
The court concluded that the premium should be 20% of the objective value of the shares based on the premiums in other MBOs, made at or about the time the buyout of the Sunstar case was carried out, the same conclusion in the Rex Holdings case.
In this case, the court stated that the premium should be calculated based on the valuation report of the shares prepared for the MBO. Unlike the Rex Holdings case, the valuation report was actually submitted to the court. But the court ruled that the report was unreliable and could not be used for calculating the premium because there were disclaimers at its beginning and the report was not disclosed to the public. The court therefore used its discretion in determining the amount of the premium, based on the premiums in other MBOs. It must be noted that the disclaimers in the report have been used in similar reports. As a consequence, this decision may trigger practical and controversial issues.
Please note that, under the current laws, valuation reports obtained by a bidder in a takeover bid of MBOs and delistings of listed subsidiaries are now required to be disclosed in the disclosure documents in respect of the takeover bid (at the time of the squeeze-outs in the Rex Holdings and Sunstar cases, such disclosure was not required and the valuation report submitted to the court in the Sunstar case was prepared by the target company, which is still not required to be disclosed under the current laws).
(iii) Other issues
The court concluded that the statements in the bidder's notice to shareholders, similar to those found possibly coercive in the Rex Holdings case, could have possible coercive effects. The court also pointed out that the company changed the way it implemented the squeeze-out after the takeover bid and it put the shareholders, who made no offer in relation to the takeover bid, at an unexpected disadvantage (such shareholders were imposed with tax on the deemed dividends, which would not have occurred had the original manner of implementation been followed). Those facts seemingly gave an unpleasant impression to the court and may have influenced the court to make a conclusion unfavourable to the company.
The Cybird case
In the Cybird case, the court decided that the acquisition price should be the same as the offer price used in the takeover bid, based on the following analysis:
(i) Objective value of shares
Like the Rex Holdings and Sunstar cases, the court stated that (i) the objective value of the shares should be based on the market price for a certain period close to the acquisition date unless there was an exceptional circumstance which made the market price not reflect the objective value of the company, and (ii) the market price after the announcement of the takeover bid should be disregarded.
In the Cybird case, the court stated that the objective value of the shares should be the weighted average market price during the one-month period before the takeover bid's announcement (although the court did not explain why such period was appropriate). Like the Rex Holdings and Sunstar cases, announcements regarding realisations of impairments in respect of the shares owned by the company which were made eleven months and five months before the announcement of the takeover bid were discussed in the Cybird case to determine whether the announcements were exceptional circumstances which made the market price not reflect the objective value of the company. The court concluded that as the realisations of impairments were appropriate, and the announcements were made irrespective of the MBO and far from the timing of the announcement of the takeover bid, the announcements were not exceptional circumstances.
(ii) Premium
The court said that instead of determining the amount of the premium separately, in this case, it would be more appropriate to determine the entire acquisition price, including the premium at the court's reasonable discretion. This would be based on (i) the forecasts of profitability and performance according to the buyout's purpose and future business plan, (ii) whether, in light of the measures taken to prevent conflicts of interest, negotiations over the acquisition price and position of the management, the MBO was agreed after arm's length negotiations based on an independent organisation's valuation, and (iii) whether the MBO went through a fair process (including whether appropriate disclosure was made). In this regard, the court pointed out the following facts:
- No forecasts of profitability and performance were disclosed;
- the independent committee was established by the company and the committee consulted and negotiated with the bidder;
- the CEO of the company negotiated with the bidder very strictly to raise the offer price;
- appropriate disclosures were made;
- the period for the takeover bid was relatively longer;
- both the bidder and the target company obtained the valuation report from their respective independent financial advisors; and
- no major shareholders opposed the MBO.
Based on these facts, the court stated that the buyout was agreed after arm's length negotiations based on an independent organisation's valuation and went through a fair process. It concluded that, under such circumstances, the offer price in the takeover bid included the possible premium at a maximum. Therefore, the court affirmed the acquisition price determined by the company, which was the same as the offer price (if calculated, such acquisition price was the objective value of the share plus the premium of 17.34%).
However, this decision is only a district court decision, and the pronouncements could be reversed by the higher courts. Nonetheless, the pronouncements in the Cybird case would serve as useful references in implementing squeeze-out transactions.
Practical attitude to be taken
While the criteria laid out in each of these recent cases are not usual or clear, they will have a big influence on squeeze-out transactions in Japan. It seems safe to conclude that in cases where there are circumstances making the transactions seem unfair (such as the amendments to earnings forecasts in the Rex Holdings case and the Sunstar case), the court would likely use its discretion to determine the acquisition price. Conversely, if the implementation of the squeeze-out transactions is recognised to be fair as in the Cybird case, the court would likely affirm the acquisition price determined by the company. As a practical step, it would be prudent not to amend the financial results and forecasts of the company at a date close to the squeeze-out transaction without any justifiable reason and to take the steps taken in the Cybird case (such as establishing an independent committee and the use of a longer period for the takeover bid, which are also suggested by the MBO Guidelines).
As a final note, the increase in squeeze-out transactions in Japan will likely be accompanied by more court cases. Hopefully, the criteria of the courts would become clearer and their pronouncements would provide better guidance to stakeholders in MBO transactions.
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About the author
Shiho Koizumi is a partner at Anderson Mori & Tomotsune. She has been involved with a variety of international and domestic transactions including M&As, corporate reorganisations and financial transactions. She has also been engaged in a wide range of corporate matters in the areas of corporate law, business transaction law, labour law, IP law, and dispute resolution.
Shiho received her LLM from University of Southern California Law School in 2006 and her LLB from Keio University in 1998. She is admitted to practice law in Japan and New York. |
Contact information
Shiho Koizumi
Anderson Mori & Tomotsune
Izumi Garden Tower
6-1, Roppongi 1-chome
Minato-ku, Tokyo 106-6036
Japan
Tel: +81 3 6888 1093
Email : shiho.koizumi@amt-law.com |
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About the author
Yoshinori Aoyagi is an associate at Anderson Mori & Tomotsune. His practice focuses on M&A, corporation law-related issues such as shareholders meetings and corporate governance, Financial Instruments and Exchange Law issues such as TOB and public offerings, tax and antitrust. He also provides advice to a variety of clients on various general corporate matters.
Yoshinori received his LLMs from New York University in 2008, University of Tokyo in 2000 and his LLB from University of Tokyo in 1998. He is admitted to practice law in Japan and New York. |
Contact information
Yoshinori Aoyagi
Anderson Mori & Tomotsune
Izumi Garden Tower
6-1, Roppongi 1-chome
Minato-ku, Tokyo 106-6036
Japan
Tel: +81 3 6888 1109
Email : yoshinori.aoyagi@amt-law.com |