1 Deal structure

1.1 How are private and public M&A transactions typically structured in your jurisdiction?

In general, for both private and public M&A transactions in Japan, the structures that are commonly used to acquire a company include:

  • acquisition of the target's shares;
  • business transfers; and
  • various types of corporate reorganisations as stipulated in the Companies Act. Mergers, share exchanges, share transfers, company splits and share deliveries are methods of corporate reorganisation.

With respect to the acquisition of more than one-third of the shares in a public company, a mandatory tender offer or takeover bid regulations will be triggered.

1.2 What are the key differences and potential advantages and disadvantages of the various structures?

Acquisition of shares: The easiest way to gain control over a target is to acquire its shares. Although a share acquisition changes the composition of shareholders, the organisation of the target remains unaffected.

Business transfer: A business transfer involves the transfer of all or a part of a business from one entity to another. During this process, specific assets, liabilities, agreements and employees of a target are identified and transferred individually. Using this procedure, it is possible to transfer all or part of a target's business. One advantage of a business transfer over a share acquisition is that there is no risk of taking on unexpected liabilities, since each item to be transferred must be specifically identified and listed. To the extent that an asset or liability is not listed, it will remain with the original owner.

Merger: A merger is usually completed in accordance with an agreement between two or more companies, followed by some or all of the involved companies dissolving, and a surviving company or a newly established company respectively succeeding all rights and obligations of the dissolving company, without a liquidation procedure. A merger generally requires special resolutions at the shareholders' meetings of all of the involved companies.

Share exchange: In a share exchange transaction, an existing stock company makes another existing stock company its wholly owned subsidiary. This transaction generally requires special resolutions at the shareholders' meetings of both stock companies. Through a share exchange, a stock company can acquire 100% ownership of a target.

Share transfer: A share transfer is a reorganisation procedure in which a newly established stock company makes another existing stock company its wholly owned subsidiary. It generally requires a special resolution at the shareholders' meeting of the existing stock company.

Company split: A company split is a reorganisation procedure in which a company transfers all or part of its rights and obligations to another entity. It generally requires a special resolution at the shareholders' meeting of each company involved. All of the assets, liabilities, employment agreements, as well as other rights and obligations of the splitting company are comprehensively and automatically succeeded by the succeeding company. In this respect, a company split differs from a business transfer.

Share delivery: Share delivery is a reorganisation procedure in which a company acquires, with its own shares as consideration, the majority of shares from the shareholders of a target. Unlike a share exchange, this can be used even where a company does not intend to acquire 100% of the shares in the target.

1.3 What factors commonly influence the choice of sale process/transaction structure?

Major factors that may influence the choice of transaction structure include whether the company wishes to:

  • simply acquire the shares in the target;
  • carve out part of the target;
  • change the capital structure; or
  • merge two or more entities into one entity.

Other key factors to consider are:

  • whether the consideration should be cash or otherwise; and
  • the relevant tax benefits of each transaction structure.

Consideration is usually cash for acquisition of shares and business transfers. However, in order to facilitate domestic and cross-border M&A transactions, the relevant laws and regulations have recently been reformed in order to make it easier for buyers to use their shares as consideration in transactions.

As legal structures for M&A transactions become more flexible, the creation of tax-efficient transaction schemes may become the most critical issue for companies in Japan.

2 Initial steps

2.1 What documents are typically entered into during the initial preparatory stage of an M&A transaction?

Non-disclosure agreement/confidentiality agreement: A non-disclosure agreement or confidentiality agreement is usually entered into between the seller/target and the buyer at the beginning of an M&A transaction. Upon conclusion of such non-disclosure agreement or confidentiality agreement, the basic information regarding the business and financial condition of the target is disclosed by the seller/target to the potential buyer. After considering the results of the preliminary due diligence, the buyer will indicate whether it intends to acquire the target and sets out its proposed terms for the acquisition.

Letter of intent/memorandum of understanding: Thereafter, the seller and the buyer will negotiate the basic terms for the acquisition and enter into a letter of intent or memorandum of understanding. Usually, a letter of intent:

  • includes the basic terms of the acquisition;
  • states that further negotiations between the parties will be held in good faith in accordance with the terms contained in it; and
  • provides an outline of the schedule for the remaining acquisition processes.

Since the buyer has only conducted a preliminary due diligence and has not received sufficient information on the target to determine the final terms of the acquisition, a letter of intent typically states that the basic terms for the acquisition contained therein are not legally binding until a definitive agreement has been executed by and between the parties.

For the buyer, one of the most important points to be included in a letter of intent is its exclusive right to negotiation as a binding term. The length of this period is negotiated between the parties and differs from case to case, but the average exclusivity period is around three months.

2.2 Are break fees permitted in your jurisdiction (by a buyer and/or the target)? If so, under what conditions will they generally be payable? What restrictions and other considerations should be addressed in formulating break fees?

Yes, break fees by a buyer and/or the target are permitted in Japan. If the seller breaches the exclusive right clause in the letter of intent, the buyer will be entitled to compensation for damages. However, the amount of damages is difficult to determine in practice. Therefore, it may be in the buyer's best interests to include a liquidated damages clause in the letter of intent. However, from the seller's perspective, it is very difficult to accept such a liquidated damages clause and thus such clauses are rarely seen in practice. It is also rare to see a (reverse) break fee clause that enables the seller or the target to be entitled to compensation for damages.

2.3 What are the most commonly used methods of financing transactions in your jurisdiction (debt/equity)?

Strategic buyers use various methods for financing transactions, such as leveraged buy-out loans, corporate loans, corporate bonds, rights offering and combination thereof. Buyers who are listed on stock exchanges in Japan are subject to financial and stock exchange regulations in connection with issuance of securities (ie, bonds and/or shares) on a case-by-case basis. In line with global practice, financial buyers, such as private equity funds, frequently use leveraged buy-out loan in addition to sourcing funds from their investors.

2.4 Which advisers and stakeholders should be involved in the initial preparatory stage of a transaction?

It is common for an investment bank or the financial advisory service department of an accounting firm to participate as a financial adviser for the purpose of managing the preliminary acquisition process and calculating the acquisition price. For the purpose of structuring the transaction and preliminary due diligence, legal, tax and accounting advisers are occasionally involved in the initial stage of the transaction.

2.5 Can the target in a private M&A transaction pay adviser costs or is this limited by rules against financial assistance or similar?

The target in a private M&A transaction may pay adviser costs to the extent that such payment would not trigger any breach of fiduciary duties of the target's director(s). In practice, the target may occasionally bear adviser costs in private M&A transactions involving private equity funds. However, in cases where there are minority shareholders that do not sell their shares in the target, the parties to the M&A transaction should seek consent from such minority shareholders for the payment of adviser costs by the target in order to avoid future claim from such shareholders.

3 Due diligence

3.1 Are there any jurisdiction-specific points relating to the following aspects of the target that a buyer should consider when conducting due diligence on the target? (a) Commercial/corporate, (b) Financial, (c) Litigation, (d) Tax, (e) Employment, (f) Intellectual property and IT, (g) Data protection, (h) Cybersecurity and (i) Real estate.

A buyer should consider the following points when conducting due diligence on a potential target in Japan:

  • Commercial/corporate:
    • Prior share transfers involving the target's shares;
    • The rights and liabilities associated with prior acquisitions completed by the target;
    • The anti-assignment clauses and the termination provisions in material contracts; and
    • The target's potential links to organised crime (or anti-social force).
  • Litigation:
    • Private resolution of disputes in the form of settlement agreements or otherwise (as litigations are rarely initiated in Japan).
  • Employment:
    • Employee-related contingent liabilities (in particular, outstanding payments of salary caused by the insufficient recording of overtime).
  • Real estate:
    • Confirmation of title on both land and buildings (as land and buildings are separate forms of property in Japan).

3.2 What public searches are commonly conducted as part of due diligence in your jurisdiction?

Online databases for corporate registry, real estate registry and intellectual property are commonly used as part of legal due diligence in Japan. Although courts provide certain online databases for cases, only significant cases are available and the databases are not comprehensive.

3.3 Is pre-sale vendor legal due diligence common in your jurisdiction? If so, do the relevant forms typically give reliance and with what liability cap?

Pre-sale vendor legal due diligence is not very common in Japan. Such due diligence is occasionally conducted in order for the seller to organise relevant information and to identify existing issues, especially if the vendor intends to sell the target through an auction process. Even if a vendor legal due diligence report is disclosed to potential buyers, it is just for information only. Buyers and their lenders do not rely on this report.

4 Regulatory framework

4.1 What kinds of (sector-specific and non-sector specific) regulatory approvals must be obtained before a transaction can close in your jurisdiction?

Foreign direct investment: Certain foreign direct investment (FDI) in Japan requires the review and clearance of the Ministry of Finance and relevant ministries under the Foreign Exchange and Trade Act (FEFTA). Under the FEFTA, foreign investments in Japan may, in general, be freely conducted. However, investments from countries that have no treaties on inward direct investments (including some countries in Africa and Central Asia), as well as investments in 'designated businesses' and 'core businesses', may require FDI notification to the Japanese government. These businesses are:

  • weapons, aircraft, nuclear facilities, space and dual-use technologies;
  • cybersecurity, electricity, gas, telecommunications, water supply, railways and oil; and
  • heat supply, broadcasting, public transportation, biological chemicals, security services, agriculture, forestry and fisheries, leather manufacturing and air transportation or maritime transportation.

All of the above constitute designated businesses; while those in the first and some in the second bullets above constitute core businesses.

Merger filing: Japan has a merger control regime. Certain types of FDI involving a 'business combination' – such as the acquisition of shares, mergers, share transfers and acquisitions of businesses – will trigger a requirement to file a prior notification to the Japanese Fair Trade Commission (JFTC) for review and clearance. For example, in the case of an acquisition of shares, a prior notification will be required if:

  • the total domestic sales of the acquiring company's side exceed JPY 20 billion;
  • the total amount of domestic sales of the acquired company and all of its subsidiaries exceeds JPY 5 billion; and
  • the ratio of voting rights of the acquiring company after the acquisition newly exceeds 20% or 50%.

The requirement to file a prior notification applies regardless of whether the company is a domestic company or a foreign company.

Sector-specific regulations: With regard to industries such as telecommunications, broadcasting and aircraft, which are related to public infrastructure, the buyer may be subject to further regulations when it acquires all or part of the business or the shares in such businesses. These should be checked on a case-by-case basis.

4.2 Which bodies are responsible for supervising M&A activity in your jurisdiction? What powers do they have?

Foreign direct investment: Notification of foreign investment in the regulated industries to the Japanese government (the Ministry of Finance and relevant ministries) is given, prior to the acquisition of the Japanese company's shares (pre-closing FDI notification), at least 30 days (which may be extended up to five months) prior to the investment. Upon receipt of the pre-closing FDI notification, the government will review, and may recommend changes to or the cancellation of, the investment. If the foreign investor does not accept the recommendation, the government may order a change or cancellation of the investment, which is legally binding.

Merger filing: If a business combination is subject to the prior notification requirement, it is prohibited, in principle, for companies to close the transaction for a period of 30 days after filing the prior notification, unless the JFTC reduces this period at its discretion. The JFTC may request reports, information and materials from the parties during the period; and if it is considered necessary, this waiting period may be extended up to 120 days from the filing of prior notification. In the review of business combinations, the JFTC may require remedies from the parties to a contemplated business combination. The JFTC also has the authority to block a potential transaction that would result in a substantial restraint of competition in any field of trade, either before or after the investment is made.

4.3 What transfer taxes apply and who typically bears them?

In general, a seller is subject to capital gain taxation in Japan when it sells shares and/or assets to a third party, and the seller typically bears such tax. In case of a business transfer, certain transferred assets are subject to consumption tax. The buyer usually pays the seller the amount for consumption tax in addition to consideration of business transfer and subsequently the seller pays the consumption tax to the tax authority.

5 Treatment of seller liability

5.1 What are customary representations and warranties? What are the consequences of breaching them?

M&A contracts for a transaction where the target is a Japanese company usually contain the seller's and/or the target's representations and warranties, and the items customarily included do not deviate from the transaction documents in other jurisdictions. Among others, there are usually representations and warranties as to:

  • the seller's legal capacity, authority, enforceability, absence of violation of law and solvency; and
  • the target's existence, organisation, legal compliance and business operation.

A representation and warranty as to the seller's and/or target's absence of any relationship with anti-social forces is a typical item to be included in a Japanese M&A contract where the relevant party is a Japanese company or individual. The concept of 'fairly disclosed' is not very common in Japanese M&A contracts, and the parties frequently negotiate whether to include sandbagging or anti-sandbagging clause.

If it becomes apparent that any one of the seller's or the target's representations or warranties is untrue before the completion of a transaction, the conditions precedent to the buyer's obligations will not be satisfied and the transaction will not be completed. If, on the other hand, a breach of any representation or warranty is discovered only after the completion of the transaction, the seller and/or the target will be required to compensate the buyer for the relevant damages, assuming that such a mechanism has been correctly included in the relevant Japanese M&A contact.

5.2 Limitations to liabilities under transaction documents (including for representations, warranties and specific indemnities) which typically apply to M&A transactions in your jurisdiction?

In a Japanese M&A transaction, there is generally no statutory limitation applicable to the seller's liabilities, except for the statute of limitations that could be applicable to each of the buyer's rights to claim compensation from the seller in relation to its breach of relevant representations and warranties and specific indemnities. However, it is typical for parties to negotiate a provision limiting the seller's liabilities in a Japanese M&A contract. Usually, such contractual limitations include:

  • an indemnity cap and a floor (both basket and de minimis thresholds); and
  • a time limit for the period during which the buyer may claim compensation against the seller.

In addition to fundamental representations and warranties, it is also common to have specific indemnity items agreed upon between the parties, which relate to specific legal issues discovered through the buyer's due diligence of the target that are not subject to any such liabilities or subject only to smaller limitations.

There is no universal market standard of contractual limitations, as the contracts are negotiated under varied circumstances. Typically, the indemnity cap is set as a certain percentage of the deal value; and if the deal value is larger, the indemnity cap is agreed at a lower range.

In addition, in the absence of any sandbagging or anti-sandbagging clause that clearly allows or disallows the buyer to claim damages, the Japanese courts are inclined to limit the buyer's right to claim damages if it was aware of the any breach of representation and warranty by the seller, from a perspective of fairness between the parties.

5.3 What are the trends observed in respect of buyers seeking to obtain warranty and indemnity insurance in your jurisdiction?

In a Japanese M&A transaction, the buyer sometimes considers purchasing warranty and indemnity (W&I) insurance on its own or at the seller's cost, especially if it is suspicious about the seller's financial situation after the transaction. In other cases, the seller may request the buyer to purchase W&I insurance, especially in an auction deal, where the seller tends to seek stronger protection and W&I insurance is considered an effective tool to achieve such purpose.

Until recently, all providers of W&I insurance were foreign-based insurers, which made Japanese parties hesitant to introduce W&I insurance into their transactions due to practical burdens, including the necessity to provide the outcome of the due diligence in English. However, as there are currently a few market players that can provide W&I insurance solely in Japanese, W&I insurance is becoming more widely recognised by Japanese parties and more commonly used in Japanese M&A transactions.

5.4 What is the usual approach taken in your jurisdiction to ensure that a seller has sufficient substance to meet any claims by a buyer?

If there are any concerns regarding the seller's capability to meet any subsequent claims possibly made in relation to a Japanese M&A transaction, the most straightforward solution for the buyer will be to make part of its payment only after completion of the transaction (ie, hold-back) or to make instalment payments. The time gap between completion and the second payment and how the instalment amounts are allocated will depend on the specific concerns that the buyer has in the transaction and other relevant factors. It is also not uncommon – especially in a cross-border transaction – to structure an escrow payment mechanism between the parties using a third-party escrow agent, or to require the seller to put part of the consideration paid by the buyer into a separate bank account with the buyer's pledge so that the funds in such account will be frozen for a certain period of time.

The buyer may also require a reliable third party (eg, a parent company) to guarantee the seller's future payment in relation to the buyer's potential claims. Such guarantee is usually required in cases where the seller is an individual or an investment fund that is expected to be dissolved within a short timeframe.

5.5 Do sellers in your jurisdiction often give restrictive covenants in sale and purchase agreements? What timeframes are generally thought to be enforceable?

Although it always depends on the specific circumstances behind the transaction as to whether restrictive covenants are required, the seller commonly gives restrictive covenants when it sells its sole business or shares in the target to a third-party buyer. As is the case in many other jurisdictions, the restrictive covenants usually take the form of a duty to non-compete and/or duty to non-solicit.

There is no clear threshold as to the length of the restrictions legally enforceable in Japan, and again, this largely depends on the circumstances. In practice, the terms agreed upon by the parties range from one year to five years; but if the seller is an individual, the buyer should consider agreeing on a shorter term because such individual has the right to choose his or her profession under the Constitution of Japan.

5.6 Where there is a gap between signing and closing, is it common to have conditions to closing, such as no material adverse change (MAC) and bring-down of warranties?

Yes, it is very common to include conditions precedent in Japanese M&A contracts where there is a gap between signing and closing. While the parties usually discuss specific conditions reflecting the outcome of the buyer's due diligence of the target, most contracts include the following conditions:

  • the representations and warranties being true at signing (and closing);
  • the parties' compliance with laws and non-breach of their covenants; and
  • the absence of any governmental authorities' decision or judgment to restrict the implementation of the transaction (or more specifically, acquisition of the necessary permission or approval from the relevant authorities).

Recently, it has become more common for MAC/material adverse event (MAE) clauses to be included as a condition precedent in a Japanese M&A contract. Since the outbreak of COVID-19, the MAC/MAE clause is sometimes heavily negotiated between parties, especially as to whether a pandemic and/or epidemic is clearly indicated as a MAC event.

6 Deal process in a public M&A transaction

6.1 What is the typical timetable for an offer? What are the key milestones in this timetable?

As mentioned in question 1.1, if the target is a Japanese public company (ie, listed on any securities exchange in Japan), an acquisition of the shares in such public company will be made through a takeover bid. The takeover bid regulations generally apply to acquisitions of more than one-third (or 5%, if the number of counterparties within 60 days is more than 10) of the voting rights of the shares in a public company. If a potential buyer is to acquire a large stake from the target's principal shareholder and such acquisition triggers the takeover bid requirement, then the acquisition of the stake from such principal shareholder itself must be made through a takeover bid.

The period of the takeover bid must be 20 to 60 business days. If the takeover bid involves any conflict of interest between the buyer and the target (eg, where the buyer is the management of the target), the period is usually 30 business days or longer. Accordingly, it is safe to assume that it would take at least a few months to complete a takeover of a public company in Japan, as the buyer would expect some discussion period before it launches a takeover bid against the target.

6.2 Can a buyer build up a stake in the target before and/or during the transaction process? What disclosure obligations apply in this regard?

Once a buyer launches a takeover bid against the target, the buyer and its related persons are prohibited from purchasing any shares of the target outside of the takeover bid. This is a strict restriction under the Financial Instruments and Exchange Act, and only limited exceptions apply (eg, where the purchase is made only as the exercise of an option agreement concluded before the takeover bid).

On the other hand, a purchase of any shares of the target by the buyer or its related persons before the launch of a takeover bid is not prohibited under the relevant laws or regulations, insofar as such purchase itself does not trigger the takeover bid requirement. However, in certain circumstances, the purchase and the subsequent purchase through the takeover bid might be deemed as a single transaction and in such case, the purchase before the takeover bid may not be permissible. In addition, if the buyer or its related person has already obtained any material sensitive information of the target before the purchase, pursuant to the relevant insider trading regulations, the buyer or its related person may only be able to purchase the shares from any other insider of the target if the relevant information is disclosed by the target.

6.3 Are there provisions for the squeeze-out of any remaining minority shareholders (and the ability for minority shareholders to 'sell out')? What kind of minority shareholders rights are typical in your jurisdiction?

Yes, squeeze-outs are possible in Japan and the methods differ depending on the buyer's shareholding after a takeover bid.

Shareholding of 90% or above: If the buyer acquires 90% or more of the shares in the target through a takeover bid, it can follow the relevant 'demand for share cash-out' process under the Companies Act to squeeze out the minority shareholders. It is essentially a call option given to the buyer with the approval of the target's board of directors, where the buyer can require the remaining minority shareholders to compulsorily sell their shares to the buyer for cash consideration. While the minority shareholders do not have the right to dissent, they can dispute the amount of the cash consideration through court proceedings if they file the relevant petitions before the date of acquisition of the shares.

Shareholding of below 90%: If the buyer fails to acquire 90% of the shares in the target through a takeover bid, it can alternatively request the target to conduct a share consolidation to squeeze out the minority shareholders. The process is highly complicated, but to simplify, the target may consolidate the remaining shares after the takeover bid to allocate one or more target shares to the buyer (and any other shareholders acting in concert with the buyer), while allocating to each of the minority shareholders less than one share or fractional shares, which allows the company to purchase or have any third-party purchase the aggregate of such fractional shares under the Companies Act. In this process, minority shareholders have the right to dissent to the share consolidation by the target; and just as in a 'demand for share cash-out' process, the shareholders may finally file a petition to the court to dispute the amount of cash consideration they have received in the share consolidation process.

6.4 How does a bidder demonstrate that it has committed financing for the transaction?

In a takeover bid transaction, the tender offeror (the bidder) must disclose the details of the transaction in a takeover bid notification document disclosed upon the launch of the takeover bid. Pursuant to the detailed requirements under the Financial Instruments and Exchange Act and the relevant regulations, the tender offeror must disclose the source of its funds that it intends to use to purchase the shares from the target shareholders. Usually, the tender offeror relies on:

  • its own cash, in which case the tender offeror will specify the amount of the remaining cash in its bank accounts and attach proof of such remaining cash amount as an exhibit to the takeover bid notification;
  • borrowing from a third-party lender, in which case the tender offeror must:
    • disclose the details of the loan, including the identity of the lender and its fundamental terms, in the takeover bid notification; and
    • submit proof of the loan as an exhibit to the takeover bid notification; and/or
  • funding from its shareholder(s), in which case the tender offeror must:
    • disclose the details of the funding in the takeover bid notification; and
    • submit proof of it as an exhibit to the takeover bid notification.

As all of the above information is highly material to the tendering shareholders who will receive the payment, upon the tender offeror's submission of the draft takeover bid notification, the authority (the Kanto Local Finance Bureau) usually reviews the information very carefully.

6.5 What threshold/level of acceptances is required to delist a company?

The thresholds to require the delisting of a company on a securities exchange in Japan are complicated and various factors are usually taken into account. Under the rules of the Tokyo Stock Exchange, which were modified in April 2022, if the aggregate shareholding of the public shareholders of a listed company falls to less than 35% in the care of the Prime market (or 25% in the case of other market segments), this may trigger the delisting requirement, depending on the specific circumstance and other factors that may lead to delisting.

In a takeover bid transaction where the tender offeror – whether alone or together with its affiliated parties – aims to acquire 100% of the shares in the target, once it becomes clear that the tender offeror will highly likely succeed in acquiring 100% shares in the takeover bid and the following squeeze-out process, the relevant securities exchange designates that the shares in the target will be delisted within a month or so. The timing of such designation by the securities exchange is usually at the time of the initiation of the squeeze-out process by the tender offeror or the target.

6.6 Is 'bumpitrage' a common feature in public takeovers in your jurisdiction?

Until recently, in most of the takeover bid transactions in Japan, there were no material interruptions caused by an activist shareholder, a competitive buyer or any other third party, and transactions were successfully completed by the tender offeror with little or no difficulty. However, it is becoming increasingly common in Japan for activist shareholders or competitive buyers to interrupt a takeover bid, especially when the offer price in the takeover bid is relatively low compared to the net asset value of the target and the market prices for the period preceding the takeover bid.

Such third parties may take various actions. They may acquire a significant stake in the target and try to negotiate the price in the takeover bid. Alternatively, they may at times initiate or threaten to initiate a competitive offer to the public shareholders. A traditional action taken by shareholders that are dissatisfied with the takeover bid price is to file a petition with the court to dispute the price; although such action can be taken only after the takeover bid and the subsequent squeeze-out process have been completed.

6.7 Is there any minimum level of consideration that a buyer must pay on a takeover bid (eg, by reference to shares acquired in the market or to a volume-weighted average over a period of time)?

The consideration paid in a takeover bid transaction usually takes the form of cash and there is no statutory minimum of consideration in a takeover bid. In fact, if the tender offeror is to acquire only a certain block of shares from certain larger shareholder(s) of the target, which itself triggers the takeover bid requirement, the tender offeror may make the offer with cash at a discount price compared to the recent market price of the target shares, in order to avoid any tender from the other minority shareholders. However, as a matter of course, if the tender offeror would like to acquire as many shares as possible from the minority shareholders in a takeover bid, then the takeover bid price is usually significantly higher than the average market price in certain fixed periods preceding the takeover bid.

6.8 In public takeovers, to what extent are bidders permitted to invoke MAC conditions (whether target or market-related)?

Generally, in a takeover bid transaction, a tender offeror is prohibited from withdrawing its offer. There are a limited number of exceptions to this principle stipulated under the Financial Instruments and Exchange Act and the relevant regulations, including the case where the tender offeror failed to obtain an approval from the government authority; however, typical MAC conditions such as decline in the target's financial figures will not be included as such exception (even where such decline occurs as a result of the pandemic). Rather, clearer events – such as a decision of the target to sell its material part of business or cessation of a deal with a material customer – will be included.

In addition to the specific exceptions provided, the Financial Instruments and Exchange Act and the relevant regulations allow a tender offeror to withdraw its offer if any event analogous to such specific exceptions occurs at the target. In practice, for a tender offeror to rely on this exception, it must discuss with the Kanto Local Finance Bureau and agree on the specific event to be included on a case-by-case basis. However, the Kanto Local Finance Bureau is generally very strict in introducing such additional exceptions to a tender offer and it will be very challenging for a tender offeror to successfully introduce a new exception.

6.9 Are shareholder irrevocable undertakings (to accept the takeover offer) customary in your jurisdiction?

Yes, this is customary in Japan. In a takeover bid where the tender offeror aims to acquire as many shares as possible from the shareholders, it frequently tries to execute tender offer agreements in which the relevant shareholders (usually large shareholders) agree to tender their shares in the takeover bid. It is also common that a large shareholder of a public company agrees to sell its shares to a third-party buyer and such agreement is recorded in a tender offer agreement.

In both cases, since execution of tender offer agreements might immediately trigger the takeover bid requirement, such agreements are executed on the date of announcement of a takeover bid or the immediately preceding date of the takeover bid launch date. Pursuant to the Financial Instruments and Exchange Act and the relevant regulations, the outline of the terms and conditions of such tender offer agreements must be disclosed to the public.

7 Hostile bids

7.1 Are hostile bids permitted in your jurisdiction in public M&A transactions? If so, how are they typically implemented?

Yes, hostile bids are permitted. There are no direct or additional regulatory restrictions against a hostile bid, as long as the bid is compliant with the various regulations applicable to public bids.

In the Japanese market, there was an upward trend of hostile bids in the mid-2000s, mainly driven by domestic and overseas activist shareholders. Around that time, a number of Japanese listed companies introduced various pre-warning defence measures, including the most typical measure, which allows the board to issue share option rights to the existing shareholders to dilute the bidder's shareholding when a hostile offer is made.

Until recently, these pre-warning defence measures worked well in enabling listed companies to prevent activists from initiating hostile bids. However, in recent years, the Japanese market has experienced a steep rise in the number of hostile bids initiated by both strategic and financial buyers. One factor contributing to this trend is that quite a few listed companies started to rethink their corporate governance and abolished their pre-warning defence measures, which had been criticised by shareholders in various contexts.

In a friendly bid, the buyer and the target will usually spend at least one month in discussions and preparations before a takeover bid is launched. On the other hand, in a hostile bid, the buyer might announce its launch of the takeover bid without any prior notice to the target (assuming that the target has not adopted any pre-warning defence measures), and there is usually little lead time before the bid takes place. Alternatively, in other circumstances (including where pre-warning defence measures are in place), a potential bidder may try to enter into discussions with the target; but if such discussions are unsuccessful, the bidder may then launch a takeover bid against the target.

7.2 Must hostile bids be publicised?

There is generally no requirement for the target to disclose the fact that it has received a hostile offer from a bidder. However, if the hostile bidder goes so far as to initiate a takeover bid, the bidder is obliged to disclose the details of the bid and the background facts of the discussion between the bidder and the target in various documents. In addition, if a takeover bid is launched, the target is also obliged to publicise its opinion as to the offer, which usually states its clear objection to the offer.

In a number of cases, a hostile bidder is a large shareholder of the target or a shareholder that acquires a significant number of shares before its offer, so that it has some leverage in the negotiations with the target. In such cases, the intent of the bidder to initiate a bid can sometimes be inferred from its disclosure of an increase in the number of shares in the target in its large shareholding reports.

7.3 What defences are available to a target board against a hostile bid?

If the target adopts pre-warning defence measures, the target board will consider whether it should activate these measures by typically:

  • obtaining the approval of a majority of shareholders; and
  • issuing share option rights to the existing shareholders.

At this stage, however, the target board and the hostile bidder usually have thorough-going discussions to prevent such drastic action.

Assuming that the target has not adopted any pre-warning defence measures, the most common measure available for the target board will be to call for a so-called 'white knight', or a friendly bidder. If the target board succeeds in finding a friendly bidder, the target will typically ask the bidder to subscribe for a certain number of shares in the target or alternatively launch a competitive bid against the target to prevent the hostile bid from succeeding.

The target board might take other drastic methods to decrease the value of the target itself, by making decisions to divest material assets to its associated company or to make significant amount of retirement payment to its incumbent directors. In a recent hostile takeover bid case (Maeda Corporation v Maeda Road Construction), the target board decided to declare a special dividend of over JPY 50 billion to its existing shareholders, after it was unable to secure a white knight bidder.

8 Trends and predictions

8.1 How would you describe the current M&A landscape and prevailing trends in your jurisdiction? What significant deals took place in the last 12 months?

The number of M&A deals in the Japanese domestic market was record high in 2021, despite the continued COVID-19 pandemic and the government's repeated precautionary actions. This trend was driven by an increasing number of inbound transactions initiated by foreign investors.

We are still seeing continued influences of COVID-19 in recent M&A deals. Typical deals of Japanese companies that we have seen recently include the following:

  • sales of their non-core businesses or less important subsidiaries to make their operations more efficient;
  • takeover bids to acquire 100% shares in the target and delist it, including a parent buying out its listed subsidiary's shares and management buy-out deals;
  • foreign-based private equity funds purchasing various Japanese companies' shares whose prices are relatively low after the pandemic; and
  • family-owned private companies selling their entire business to a larger buyer.

8.2 Are any new developments anticipated in the next 12 months, including any proposed legislative reforms? In particular, are you anticipating greater levels of foreign direct investment scrutiny?

Following the latest amendments to the Companies Act in March 2021, there will be some additional amendments expected in September 2022, including the mandatory provision of the documents for general shareholders' meeting in an electronic way, which is applicable to all listed companies. Although such amendments might not directly affect an M&A deal, the potential buyers of listed targets may need to be well aware of such amendments.

From the perspective of foreign investment in Japan, there was a significant amendment to the inward foreign direct investment regulations in 2020. The amendments to the Foreign Exchange and Trade Act have strengthened the screening of proposed foreign inward investment, mainly from a national security viewpoint, by (among other things) requiring foreign investors to follow stringent pre-transaction scrutiny procedures enforced by Japanese authorities if 1% of more of the shares or voting rights of a Japanese listed company are to be acquired, which is far below the original threshold of 10%, with certain exemptions. Also, the need to protect domestic companies engaged in healthcare/medical activities relating to COVID-19 prompted the government to add relevant sensitive business areas that require pre-transaction scrutiny in 2020. While no specific changes are expected in the coming few months, it is still possible that the government may further strengthen the level of foreign direct investment scrutiny in the near future, depending on the market situation.

9 Tips and traps

9.1 What are your top tips for smooth closing of M&A transactions and what potential sticking points would you highlight?

In general, Japanese M&A transactions are sophisticated and there are no specific practical hurdles to bear in mind. Unlike in other jurisdictions, government intervention in private transactions is relatively rare in Japan, even after the outbreak of COVID-19.

That said, if your counterparty is a Japanese listed company, you should generally expect that its internal decision-making process will be relatively slow. This is because the internal decision process is highly hierarchical and complex; and if the transaction is to be approved by the board of directors, you may have to wait until the ordinary board meeting, which takes place only once a month. For the same reason, it may also be that the person who is actually negotiating with you in an M&A transaction is not the decision-maker of the counterparty and therefore cannot make a quick decision at the negotiation table.

Culturally, Japanese people prefer to have close communications with their counterparties, so that the M&A transaction closes smoothly. Therefore, it is also key to a Japanese transaction to try to have a close and friendly relationship with Japanese counterparties, even though this has not always been easy to achieve during the pandemic.

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.