Recent Amendments to the Commercial Code of Japan: Impact on Mergers & Acquisitions

Article excerpt


Effective October 1, 1999, the Commercial Code of Japan ("the Code") was amended to permit Japanese companies to effect corporate acquisitions and reorganizations by means of a "stock swap." (1) The new stock swap system was widely touted by the Government of Japan and commentators as a positive step towards promoting and facilitating merger and acquisition ("M&A") activity in Japan. In a nutshell, the stock swap amendment to the Code ("the Amendment") permits, among other things, an acquiror to compel minority shareholders of a target company to exchange their shares of target company stock for newly issued shares of the acquiror's stock in a tax-free manner, following approval of the transaction by holders of two-thirds of the shares represented at a meeting of the target's shareholders, and provides dissenting shareholders with appraisal rights (i.e. the right to receive the cash equivalent of the value of their shares rather than stock of the acquiror). (2) This new share exchange system can be used by Japanese companies to consummate both so-called "squeeze-out" (3) acquisitions and "going private" (4) transactions provided that stock, rather than cash consideration, is used. (5) On its face, the Amendment is a significant step towards creating a more flexible M&A environment similar to that of the State of Delaware, where a substantial majority of the corporations that have been involved in the M&A boom in the United States are incorporated. However, additional amendments to the Code are necessary if the goal is to create an economically efficient market for M&A activity in Japan while providing sufficient protection to minority shareholders. (6)

The Amendment is most notable for taking the first small step towards making it easier to acquire 100% of a Japanese company despite minority shareholder opposition. Until recently, squeeze-out transactions and contested or hostile acquisitions have been not only difficult, but also entirely unthinkable in Japan. In addition to oft-cited cultural taboos in Japan concerning the negative implications of acquisitions (i.e., that the target company was having financial problems or was being mismanaged), the traditional Japanese pattern of cross-shareholdings and stable shareholders and the obstacles inherent in the Japanese legal system have been largely responsible for the rarity of such transactions. The widely-publicized contested acquisition of International Digital Communications Inc. (IDC) last year before the Amendment was adopted was significant because it was one of the first high profile contested acquisitions of a Japanese company by a foreign company. Notably, however, the IDC acquisition and the more recent attempted contested acquisitions have involved cash, rather than stock consideration, making the Amendment inapplicable. Even if stock was the chosen form of consideration, foreign companies, such as IDC, are not permitted to use the stock swap mechanism and, thus, currently have no squeeze-out tool available to them. (7)

The going private transaction is also a fairly new concept in the Japanese M&A market. Unlike U.S. companies, Japanese public companies have not yet gone through the cycle of being bought by controlling shareholders in partnership with private equity funds, taken private, restructured, and then taken public again within a few years. (8) Whether or not this is an investment technique that should be encouraged in Japan is debatable, but it is clear that the current state of Japanese law makes it more difficult to replicate this model for both foreign and Japanese acquirors. Due to the nature of going private transactions, stock is rarely the desired form of consideration unless the transaction is part of an internal corporate reorganization. By preventing cash from being used in squeeze-out transactions, current Japanese law restricts the ability of Japanese, not just foreign, venture capitalists and controlling shareholders to successfully take a company private. …


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