M&A activity in Japan has remained stable in 2021. Inbound investments into Japan, in particular, has seen steady growth despite the ongoing restrictions on cross-border trade as a result of the COVID-19 pandemic. As the Japanese market continues to offer foreign business operators and investors with opportunities for investments and collaboration, the level of investments in the Japanese market is expected to continue on an uptrend.
There are various ways in which foreign business operators and investors may enter the Japanese market. These include establishment of a business presence in Japan (through subsidiaries or branches, for example) to develop new businesses, acquiring existing Japanese companies to gain a foothold, forming joint ventures with local businesses, or entering into the alliances or collaboration arrangements with local businesses. In addition, Japanese legislation also provides for several methods by which foreign business operators and investors may raise funds in Japan.
There are, however, various factors that foreign investors should be aware of before entering the Japanese market. Based on our experience, certain issues, particularly those concerning Japanese laws and regulations, as well as market and business practices, should be carefully considered. This article aims to provide practical insights and pointers on some of these issues.
Entry into the Japanese Market
Establishing a Business Presence in Japan
Foreign companies wishing to explore the possibility or feasibility of entering the Japanese market may begin the process by establishing a representative office in Japan. This is an option that some foreign companies have found useful as an initial step because representative offices are allowed to perform certain preparatory business functions, such as conducting market surveys, collecting market information, and engaging in certain promotional and advertising activities. An added advantage of representative offices is that they are not required to be registered with local authorities, which removes the need to jump through resource-consuming administrative and regulatory hoops.
For foreign companies nearing the stage of launching or developing broader- or full-scale business activities in Japan, however, setting up a registered business office in Japan would be a more appropriate approach. Registered business offices in Japan take different forms, such as branch offices or foreign company subsidiaries registered under the Companies Act of Japan (the "Companies Act"). It should also be noted that the establishment of registered business offices in certain regulated industries, such as banking, insurance, cybersecurity, broadcasting and aviation, amongst others, may involve additional regulatory compliance, such as prior notification, prior consultation and post factum reporting requirements. It is therefore vital for foreign business operators and investors to conduct due diligence on the relevant legal requirements with the assistance of local counsel before moving to set up a registered business office in Japan.
Differences between Branches and Subsidiaries
There is a fundamental difference between a branch office and a subsidiary. A branch office has no separate legal identity and is considered part of the foreign company that established it. A subsidiary, on the other hand, has its own identity and is considered a separate juridical person from its parent company under the Companies Act. As a result, a subsidiary is subject to the company registration system in Japan. What this means, in practice, is that branch offices are subject to less regulations and restrictions as compared to subsidiaries, although it should be noted that the foreign parent company that has established a branch office would be regarded as directly responsible for the actions and activities of the branch office.
Types of Companies in Japan
The Companies Act provides for two forms of company: (i) a stock company (Kabushiki Kaisha) and (ii) a membership company (Mochibun Kaisha). The latter in turn can be grouped into the three sub-categories of (i) the limited liability company (Godo Kaisha), the general partnership company (Gomei Kaisha) and the limited partnership company (Goshi Kaisha)). One of the primary differences between a stock company and a membership company is that the former separates its ownership from its management; by contrast, the equity owners of a membership company generally participate in management level decision-making in respect of the company.
The stock company structure is the most prevalent company structure in Japan. All public companies and most private companies in Japan are established in the form of stock companies. The Companies Act allows for a variety of corporate governance structures. The most common corporate governance structure among private stock companies comprise a board of directors and corporate auditor(s), in charge of supervising and monitoring the decisions of management and the manner in which directors perform their functions. However, it is possible for a small company that has been set up for purposes of establishing a presence in Japan not to have a board of directors as a governing organ, particularly in the initial stages of the company when the scope of its operations in Japan is still limited. In such cases, the shareholders and director(s) of the company will make decisions regarding the company's operations and management. In other words, it may be a practical approach in the initial stages of entry into the Japanese market to simply appoint an individual as the sole director to manage the company's affairs, instead of establishing a board of directors at the outset.
Amongst the different types of membership companies, the limited liability company (Godo Kaisha) structure is generally considered a suitable structure for the Japanese subsidiary of a foreign company if the size and scope of business operations of the subsidiary is expected to be limited. This structure may sometimes be preferred over the stock company structure from the viewpoint of foreign investors for the following reasons: (i) they may offer tax advantages, such as for investors seeking pass-through tax advantages under U.S. tax laws and (ii) a limited liability company offers more flexibility than a stock company in terms of its governance structure.
Acquisition of or Investment in a Japanese Company
The acquisition of an existing Japanese company may in some cases be a more straightforward route for a foreign investor to enter the Japanese market. With that said, investment in a Japanese company, which enables a foreign investor to build up its business contacts and relationships in Japan, is also a practical way by which to achieve business expansion in Japan. Foreign investments in Japanese startups, in particular, have been on the rise in recent years, and the uptrend of investments in and collaborations with Japanese startups by foreign investors is expected to continue. (More information on investments in a Japanese start-up is available here).
Amongst the possible ways in which a Japanese company may be acquired under the Companies Act, share purchase is generally the most common option. The primary contract involved in an acquisition is the sale and purchase agreement (the "SPA"). SPAs for acquisitions of Japanese companies are typically governed by Japanese law as a result of the preference of the Japanese party(ies) involved. In a partial acquisition or minority investment (as is typical for investments in start-ups), the shareholders agreement (the "SHA") also takes on critical importance. This is because SHAs stipulate the governance structure of a company as well as the exit options and procedures applicable to the company's investors. From this point of view, the governing law of the SHA would most likely be the laws of the company's incorporation (i.e., Japanese law).
Where the governing law of the SPA is not the laws of Japan, it should be noted that matters regarding lawful and valid transfer of title in the shares of a Japanese company incorporated under the Companies Act would nevertheless be governed by Japanese law. Accordingly, retention of Japanese counsel is highly advisable to ensure the proper handling of transaction closing. As far as the SHA is concerned, it is also essential for a foreign investor to appoint local counsel to protect its shareholder interests in matters such as veto rights, pre-emptive rights, tag-along and/or drag-along rights, and rights in dead-lock situations, amongst others. Due to the myriad differences between Japanese law concepts and the legal principles in other legal systems, particularly the common law system, foreign investors entering the Japanese market should also retain Japanese counsels who are familiar with cross-border transactions. This is critical in ensuring that foreign investors receive personalized service and advice, so that their commercial and other concerns are carefully considered and handled, whether in transaction structuring, due diligence, negotiations or drafting of commercial terms.
As a result of recent changes in the foreign direct investment (the "FDI") regulations of Japan, regulatory filings have become an area of particular concern for foreign investors.
By way of background, foreign investors who acquire or invest in Japanese companies that belong to "designated business sectors1" are required to provide pre-closing notifications2 to the relevant governmental authorities.3 In this regard, the scope of "designated business sectors" has been significantly broadened under recent amendments to the FDI regime in Japan. Hence, the chances of a foreign investor being subject to the pre-closing notification requirement has increased considerably. Although Japanese authorities have tried to mitigate the administrative burdens of investors by introducing a new exemption regime to the pre-closing notification requirement, the framework of such exemption regime is fairly technical and complex. As a result, consultation with local counsel is critical for purposes of determining the applicability of the pre-closing notification requirement (or any exemption thereto) to any proposed acquisition of or investment in a Japanese company. (More information on inward direct investment regulations in Japan for foreign investors is available here.)
Furthermore, certain types of FDIs involving "business combinations" (such as the acquisition of shares or businesses) that may have anti-competitive implications could trigger a mandatory pre-closing filing requirement with the Japan Fair Trade Commission (the "JFTC"). In this connection, the JFTC has recently issued merger filing guidelines that could affect foreign investments in Japan. (More information on these guidelines is available here.)
Matters concerning post-acquisition/investment strategies and integration, including the integration of a newly set up Japanese subsidiary, often pose an important and challenging task for foreign investors. The following is an outline of some of the practical issues that foreign investors commonly encounter following their acquisition or investment in Japan.
(i) Integration of Japanese Company into Investor's Corporate Organization
In the case of an acquisition of a Japanese target or the establishment of a Japanese subsidiary, it is possible for a foreign investor to exercise control of the Japanese company from outside Japan and to integrate the Japanese entity into the investor's corporate group. This is an issue of importance because some who have ventured into the Japanese market ultimately do not succeed due to failure to recognize and address differences in corporate vision, culture, labor concerns or otherwise.
In the context of M&A, a reasonable approach may be to place key persons from the foreign investor in the Japanese target company to enable the foreign investor to win over the target's employees through the establishment of rapport. In particular, given the cultural differences, foreign investors should consider involving management personnel with a deep understanding of the foreign investor's corporate vision to enable them to familiarize themselves with the corporate culture of the Japanese target company and identify potential hurdles to seamless integration. A successful integration process is also often dependent on key persons at the target company. Accordingly, it is vital for a foreign investor to identify personnel at the target company who are reliable and capable of contributing to a smooth and synergistic integration. This would also involve appropriate retention plans for such key personnel.
(ii) Management of Corporate Seal
Arrangements regarding the "corporate seal" of a Japanese investee company is also a practical issue that foreign investors frequently face.
In Japan, the affixation of a corporate seal to contracts and other corporate documents is essential to evidence the legality and validity of those documents. As a matter of practice, Japanese companies occasionally affix an unregistered corporate seal to day-to-day and relatively non-material business contracts and documents, while reserving their affixation of the "registered corporate seal" (Jitsu-in) to material contracts and documents. In principle, so long as the person affixing the registered or unregistered seal is duly authorized to do so, no questions of legality and validity would arise. With that said, a registered corporate seal contains more evidential "weight" than unregistered corporate seals in situations where the validity of a contract is disputed in court. Moreover, under certain circumstances, the Japanese legal principle of "apparent authority" protects contract parties who are not aware (without negligence on their part) of the lack of authority on the part of their counterparties to affix such counterparties' registered corporate seals onto a document.
The practical implications of the above is that a foreign investor should give serious thought to the usage of the corporate seals (including, in particular, the registered corporate seal) of its company in Japan and how the secure storage of such seal should be managed, especially where a foreign investor has no local representative to carry out such functions. The measures taken by foreign investor to address this issue include (i) limiting the number of directors, officers and employees who have access to the registered company seal, and/or (ii) establishing internal rules for the use of the registered seal, including the maintenance of a log book to record information on usage of the seal.
The steady growth of inbound investments into Japan suggest ample opportunities for foreign business operators and investors in the Japanese market for acquisitions, business collaborations and partnerships with Japanese companies. To make full use of such opportunities, foreign investors should bear the aforementioned insights and pointers in mind. Additionally, they should also understand the characteristics and mindsets of Japanese companies and the manner in which local businesses are conducted. For example, those familiar with Japanese business culture would understand that Japanese companies sometimes face difficulty in making prompt business decisions due to the hierarchical nature of Japanese companies and the multi-layered process they have to undergo in corporate decision-making. However, the assistance of experienced local counsel, particularly from the initial stages of a proposed transaction, would often help to make the process as efficient and straightforward as practicable.
1. "Designated business sectors" are, broadly, industries that are deemed critical to the national security, public safety and economy of Japan.
2. This typically involves a waiting period of 30 days during which the authorities will review a proposed transaction for possible issues before providing clearance for the transaction. In practice, clearance will be issued before the expiration of the 30-day waiting period (e.g., two weeks or less) in a straightforward case of FDI. In complex cases, however, the entire review period could take up to a few months or more to complete, thereby giving rise to significant deal uncertainty. In some instances, the relevant authorities may also make their clearance conditional upon certain post-investment undertakings by the relevant foreign investors. A prudent foreign investor should consider initiating prior consultations with the relevant authorities before filing a prior notification (the "pre-filing consultation") to resolve potential issues that the authorities may find problematic. From our experience, pre-filing consultations would be advisable for potentially complex cases.
3. By contrast, foreign investors who acquire or invest in Japanese companies that do not fall within "designated business sectors" are simply required to submit a simple post-completion report.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.