Japan: Private M&A Comparative Guide

1 Deal structure

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

Private M&A transactions are typically structured as either share deals or asset deals.

Share deals: Share deals are a structure through which the buyer acquires the target's shares. The most common structure for share deals is a share purchase based on a share purchase agreement.

Share exchanges and share deliveries are also used for share deals. Share exchanges are a structure that makes the target a wholly owned subsidiary of the buyer by acquiring all outstanding shares in it in exchange for the buyer's shares. Share deliveries are a structure that makes the target a subsidiary (including a wholly owned subsidiary) of the buyer by acquiring more than 50% of its shares in exchange for the buyer's shares.

Other structures used for share deals include third-party allotments and share transfers.

Asset deals: Asset deals are a structure through which the buyer acquires a whole or part of the target's business comprised of assets, debts, contracts and employees. Asset deals are carried out in the form of:

• mergers;
• business transfers; or
• company splits.

M&A transactions are sometimes carried out through a combination of a share deal and an asset deal. For example, the seller may carve out part of its business to a new company through a company split and sell the new company's shares to the buyer through a share purchase.

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

A share deal changes only the shareholding structure of the target, while an asset deal more or less causes changes to the target's business. Because of this difference, share deals have less impact on the target's business than asset deals, which often cause a disturbance in the target. On the other hand, in a share deal, the buyer may end up acquiring what it does not want such as the target's contingent liabilities; while in an asset deal, the parties can choose which parts of the target to transfer to the buyer (except for mergers, where the target's whole business is merged to the buyer).

Mergers, company splits, share exchanges, share transfers and share deliveries (collectively, ‘reorganisations') are stipulated in the Companies Act as methods of organisational restructuring. The parties thus must follow the rules and procedures stipulated in the act. On the other hand, share purchases and business transfers are carried out based on the agreement between the parties. Reflecting this difference, reorganisations are more complicated and time consuming than share purchases and business transfers. However, reorganisations allow the parties to do what cannot be done in share purchases and business transfers without stakeholders' consent or statutory procedures (see question 1.3).

Business transfers require the parties to obtain consent from the counterparty of the contracts and employees to be transferred, while company splits do not require such consent.

1.3 What factors commonly influence the choice of transaction structure?

• Target: Whether to choose a share deal or an asset deal will depend on whether the parties want to transfer all or part of the target's business. If, for example, the target operates A business and B business and wants to sell only A business, an asset deal is suitable.
• Timeline: Reorganisations require the parties to follow certain procedures under the Companies Act, which will affect the transaction timeline. In a transaction where time is of importance, a structure that does not require such procedures may be preferable.
• Stakeholders: If the target has many shareholders, the buyer may choose a share exchange instead of a share purchase, as this allows the buyer to acquire all shares of the target only through a special resolution of its shareholders' meeting. Also, if the target has many suppliers, customers and employees, the buyer may prefer a company split to a business transfer that will require the consent of all stakeholders.
• Consideration: Reorganisations are flexible in terms of the consideration the buyer pays: not only cash but also other assets such as the buyer's shares can be used. Therefore, if the buyer does not have sufficient cash to pay, it may choose a reorganisation to use its shares or other assets as consideration.
• Foreign company: Reorganisations are permitted only between Japanese companies. Therefore, a foreign company must have a Japanese company to carry out a reorganisation. Otherwise, a share purchase or business transfer may be chosen.

1.4 What specific considerations should be borne in mind where the sale is structured as an auction process?

The considerations from the seller's perspective are as follows:

• Burden: Auction processes usually impose a heavy burden on the seller's deal team as they need to respond to multiple bidders' due diligence questions in parallel. Proficient advisers should be retained to ensure the smooth progress of the process.
• Confidentiality: The greater the number of the bidders, the greater the risk of leaking confidential information. It is thus important to manage the confidential information by, for example, entering into a non-disclosure agreement and limiting access to the information.
• Price: Auction processes may help to maximise the sale price. However, if the target or business is unattractive, bidders may not be interested. Also, if the value of the target or business is too small, it will not be worth the cost of the auction process.

The considerations from the buyer's perspective are as follows:

• Time: The due diligence period and the number of questions are usually limited. Bidders often need to analyse synergies and risks within a very short timeframe.
• Offer: An attractive offer is necessary to win the attention of other bidders. In particular, Japanese companies tend to give importance not only to price but also to the post-closing treatment of the target's employees.
• Negotiation: Negotiation on a share purchase agreement (the first draft of which is usually prepared by the seller) should focus on material issues. Comments on immaterial or technical issues may make the bidder less attractive.

2 Initial steps

2.1 What agreements are typically entered into during the initial preparatory stage of a private M&A transaction?

Non-disclosure agreement (NDA): NDAs are usually executed between the seller and the potential buyer before the information memorandum of the target is disclosed to the potential buyer. Unilateral NDAs are often used in auctions. NDAs define as confidential information:

• the existence and details of the potential transaction; and
• the information disclosed to the potential buyer.

NDAs prohibit:

• the use of such information for any purpose other than the potential transaction; and
• the disclosure of such information to any third party.

Memorandum of understanding (MOU)/letter of intent (LOI): While not always the case, agreements called MOUs or LOIs are executed before beginning a substantive negotiation and due diligence process.

MOUs/LOIs set out the basic understanding about the potential transaction between the parties at the time of signing, including:

• the basic terms and conditions;
• a preliminary timeline; and
• how to implement due diligence.

Also, MOUs/LOIs sometimes have a clause granting the potential buyer an exclusive right to negotiate with the seller about the transaction for a certain period. In many cases, MOUs/LOIs provide that the clauses therein are not legally binding on the parties, except for the confidentiality clause and the exclusive negotiation right clause.

2.2 Which advisers and stakeholders are typically involved in the initial preparatory stage of a private M&A transaction?

In the initial preparatory stage, only a limited number of advisers and stakeholders are involved.

Financial advisers: The seller and buyer each appoint their own financial advisers. The role of the financial advisers includes:

• conducting a valuation of the target;
• managing the due diligence process; and
• communicating with the counterparty.

In addition, the seller's financial advisers usually:

• prepare the information memorandum;
• search for potential buyers; and
• in the case of auctions, handle the bid process.

The buyer's financial advisers usually conduct financial due diligence. Financial adviser services are provided by:

• accounting firms;
• investment banks;
• securities firms; and
• independent advisers.

In small transactions, the seller and the buyer sometimes appoint intermediary firms which act for both the seller and the buyer in the same transaction.

Legal advisers: The seller and buyer also each appoint their own legal advisers who:

• advise on the transaction structure and legal issues; and
• negotiate with the counterparty on agreements.

The buyer's legal advisers also conduct legal due diligence.

2.3 Can the seller pay adviser costs or is this limited by rules against financial assistance or similar?

Basically, the seller pays the financial advisers it retained. While there are no general financial assistance rules in Japan, payment of the seller's adviser costs by the target is usually prohibited by the definitive agreement, as it would decrease the value of the target.

3 Due diligence

3.1 What due diligence is typically conducted in private M&A transactions in your jurisdiction and how is it typically conducted?

Usually:

• legal due diligence by legal advisers;
• financial and tax due diligence by accountants; and
• business due diligence by consultants or the buyer.

Depending on the case, environmental, real estate, IT, employment and IP due diligence may also be conducted.

The typical due diligence process is as follows: after a non-disclosure agreement (NDA) has been signed, the buyer and its advisers submit an information request list and a list of questions to the seller through its financial advisers or intermediary. Then the requested materials and response to the questions are disclosed, usually in a virtual data room. The buyer and its advisers examine the disclosed materials and responses and provide additional information requests and questions. After several cycles of this process, the buyer's advisers prepare due diligence reports. Interviews with management and other key personnel may also be conducted during the due diligence process.

Vendor due diligence is not commonly conducted.

3.2 What key concerns and considerations should participants in private M&A transactions bear in mind in relation to due diligence?

In due diligence, the buyer must carefully specify and analyse:

• dealbreakers that make the buyer decide to stop the transaction, such as:
• • material compliance risks;
  • contingent liabilities; and
  • off-the-books debts;
• debt-like items that should be deducted from the enterprise value of the target, such as:
• • unpaid wages;
  • unpaid social insurance premiums;
  • lease obligations; and
  • pending claims; and
• any other issues that should be corrected by the seller before closing or addressed by the buyer post-closing.

From the seller's perspective, it is important to prevent the disclosed confidential information of the target from being misused or leaked to third parties by entering into an adequately drafted NDA with the buyer. Also, the seller should bear in mind the following:

• Personal data: Under the Act on Protection of Personal Information, except as allowed under the act, personal data cannot be provided to a third party without the data subject's consent. The seller must take care not to disclose personal information in breach of the act.
• Gun jumping: The disclosure of competitively sensitive information to competitors could be deemed as substantive gun jumping. To minimise this risk, the seller may enter into a clean team agreement with the buyer and disclose competitively sensitive information only to the buyer's clean team.

3.3 What kind of scope in relation to environmental, social and governance matters is typical in private M&A transactions?

In Japan, environmental, social and governance (ESG) risks are becoming increasingly recognised in M&A transactions. ESG risks include:

• environmental risks such as:
• • air, soil and water pollution;
  • polychlorinated biphenyl waste; and
  • asbestos;
• social risks such as:
• • diversity;
  • harassment;
  • data privacy; and
  • human rights violations in the supply chain (eg, slavery, human trafficking or child labour); and
• governance risks such as:
• • corporate governance;
  • accounting fraud;
  • cartels; and
  • bribery.

However, ESG due diligence is not commonly conducted, especially in small transactions.

4 Corporate and regulatory approvals

4.1 What kinds of corporate and regulatory approvals must be obtained for a private M&A transaction in your jurisdiction?

Corporate approvals: Under the Companies Act, a private company's shares cannot be transferred without the approval of:

• the company's board of directors (if it has a board of directors);
• the shareholders' meeting (if it does not have a board of directors); or
• any other bodies set forth in the articles of incorporation.

Also, to carry out reorganisations or business transfers, each party may be required to obtain the prior approval of its shareholders' meeting unless exempt under the Companies Act.

Regulatory approvals: If a party to the transaction is in a regulated industry (eg, financial institutions), the relevant authorities' approval may be required under the relevant laws.

Merger control: See question 9.2.

4.2 Do any foreign ownership restrictions apply in your jurisdiction?

Under the Foreign Exchange and Foreign Trade Act (FEFTA), a foreign investor that intends to make an inward investment to a Japanese company that operates in certain designated industries must submit prior notification to the minister of finance and the relevant ministers. The relevant terms are defined as follows:

• ‘Foreign investors' include non-resident individuals and foreign companies, and Japanese companies of which 50% or more of the voting rights are directly or indirectly held by them.
• ‘Inward investments' include acquisitions of 1% or more shares of a Japanese listed company or any number of shares of a Japanese non-listed company.
• ‘Designated industries' are industries relevant to national security, such as:
• • military;
  • aviation;
  • space development;
  • nuclear power;
  • cybersecurity; and
  • pharmaceuticals for infectious diseases.

After the notification has been accepted, the investment is prohibited for 30 calendar days. The minister of finance and the relevant ministers may advise or order that the investment be stopped or modified. The notification is exempt in certain cases.

Even if the company does not fall under any of the designated industries, with some exceptions, foreign investors must file a post-facto report within 45 days of the inward investment.

In addition, acquisitions by foreign persons of shares of Japanese companies in certain industries (eg, telecoms, media, aviation) are regulated by relevant laws.

4.3 What other key concerns and considerations should participants in private M&A transactions bear in mind in relation to consents and approvals?

Consent from suppliers, customers and employees: The target's contracts with suppliers and customers may include so-called ‘change of control' (CoC) clauses that prohibit:

• a change of ownership of a party to the contract; or
• a transfer of rights, obligations or status under the contract to a third party.

If the transaction triggers a CoC clause, the target must obtain consent from the counterparty prior to closing.

In the case of business transfers, the seller must obtain the consent of each employee who will be transferred to the buyer. Such consent is unnecessary in the case of company splits but the target must follow employee protection procedures under the Act on the Succession to Labor Contracts upon Company Split and the Supplementary Provisions of the Act for Partial Revision of the Commercial Code, etc (see question 10.1).

In structuring a transaction and making out a timeline, the parties must take into account:

• whether necessary consents can be obtained and how long this will take; and
• the time needed to carry out the necessary employee protection procedures in the case of company splits.

Corporate and regulatory approvals: In the case of reorganisations and business transfers, the parties must consider the time needed to obtain the approval of the shareholders' meeting (if required). Also, if a prior notification under the Anti-monopoly Act, FEFTA or other laws is required, the waiting period under the relevant law must be considered.

5 Transaction documents

5.1 What documents are typically prepared for a private M&A transaction and who generally drafts them?

Definitive agreement: In the case of share purchases and business transfers, share purchase agreements (SPAs) and business transfer agreements (BTAs) are executed, respectively.

In the case of reorganisations, reorganisation agreements (eg, merger agreement, company split agreement) or plans (eg, company split plan) are required under the Companies Act. In addition, the parties often execute more detailed additional agreements called business succession agreements or integration agreements.

Which party will prepare the first draft of these agreements differs depending on the transaction; but in the case of auctions, the seller usually prepares an initial draft.

Ancillary agreements: Various types of agreements may be executed ancillary to a definitive agreement. They include the following:

• Shareholders' agreement: Shareholders' agreements are typically executed in the case of a partial acquisition (between the buyer and the seller) or joint acquisition (among buyers). The target may also be a party.
• Management delegation agreement: This is usually executed between the buyer and the owner-manager(s) of the target when the owner-manager(s) will remain involved in the company's management post-closing.
• Transition service agreement: This is usually executed between the seller and the target, especially in carveout deals, for the target to receive certain services (eg, IT, accounting, logistics) or IP licences from the seller, to facilitate the smooth transition of the target to the buyer group post-closing.

Which party will prepare the first draft of the ancillary agreements will differ depending on the transaction.

5.2 What key matters are covered in these documents?

Definitive agreements:

• SPA: The SPA usually contains:
• • an agreement on share transfer;
  • the price and price adjustments;
  • closing procedures;
  • representations and warranties;
  • covenants;
  • conditions precedent;
  • indemnity;
  • termination; and
  • general provisions (eg, confidentiality, governing law, jurisdiction)
• BTA: In addition to the items covered in SPAs, BTAs provide for the details of the assets, debts, contracts and employees to be transferred and the process of transfer.
• Reorganisation agreement/plan: The Companies Act specifies what must be provided for in reorganisation agreements/plans – for example, company split agreements must contain details such as:
• • the parties' name and address;
  • the rights and obligations to be transferred;
  • the consideration for the company split; and
  • the effective date.
• Business succession agreement. The contents are similar to those of BTAs.

Ancillary agreements:

• Shareholders agreement: This provides for, among other things:
• • the management and governance of the target;
  • the handling of the target's shares; and
  • how deadlocks are resolved.
• Management delegation agreement: This stipulates:
• • the term;
  • managers' duties;
  • compensation; and
  • other conditions of delegation.
• Transition service agreement: This stipulates matters such as:
• • the services to be provided;
  • the term; and
  • service fees.

5.3 On what basis is it decided which law will govern the relevant transaction documents?

Under the Act on General Rules for Application of Laws, the parties can freely agree on the governing law in the agreement. If the governing law is not specified in the agreement, it is governed by the law of the place with which it is most closely connected at the time of the agreement under this act.

In transactions between Japanese companies regarding a Japanese target, the parties usually choose Japanese law as the governing law.

In transactions between a Japanese company and a foreign company, the parties tend to choose as the governing law the law based on which the target was established, as the procedures and effect of the transfer of the target's shares are subject to the law governing the establishment of the target.

6 Representations and warranties

6.1 What representations and warranties are typically included in the transaction documents and what do they typically cover?

Typical representations and warranties (R&Ws) are as follows:

• Seller/buyer:
• • Incorporation and existence.: It is legally formed and existing (there is no concept of ‘good standing' in Japan) and has all powers needed to conduct its business.
  • Authorisation and enforceability: It has the authority to execute and perform the agreement. Internal procedures have been all done. The agreement is enforceable.
  • No conflict: The execution and performance of the agreement do not conflict with laws, internal rules and contracts.
  • Approvals: Governmental approvals necessary to consummate the transaction are not required or have been obtained.
  • Insolvency proceedings: It is not insolvent or bankrupt. No such proceedings are pending.
  • Anti-social force: It has no relationship with anti-social force such as gangs and other organised crime groups.
  • Title (seller only): The shares are owned by it and are free of any liens.
• Target:
• • Incorporation and existence: As above.
  • Shares and potential shares: Total number of authorised and outstanding shares and potential shares.
  • Group companies: The target's subsidiary and affiliates.
  • Financial statements: Financial statements were made in accordance with the applicable account standards and accurate. There are no contingent liabilities or off-books debts.
  • Disclosure: Disclosed information is true and accurate, and does not omit facts that make it misleading.
  • Other items: These include permits, compliance, assets (including real estate and intellectual properties), contracts, employment and benefits, taxes, insurance, litigations, environment, related-party transactions and broker fees.

6.2 What are the typical circumstances in which the buyer may seek a specific indemnity in the transaction documentation?

Typical circumstances where the buyer may seek a specific indemnity include when it finds in the due diligence:

• pending litigation and claims;
• pending investigations;
• taxation risks;
• environmental issues;
• potential unpaid wage; or
• other compliance issues.

6.3 What remedies are available in case of breach and what is the statutory timeframe for bringing a claim? How do these timeframes differ from the market standard position in your jurisdiction?

Under the Civil Code, if the counterparty breaches the SPA, the other party can claim:

• performance of the obligation;
• compensation for damage; and
• termination of the agreement.

In addition, when the delivered shares have non-conformity in their kind, quality or quantity, the buyer can demand:

• cure of the non-conformity; and
• a reduction in price.

If the counterparty's act constitutes a tort or fraud, the other party can claim respectively:

• compensation for damage; or
• rescission of the agreement.

The statute of limitations differs according to the types of remedy. For example, in the case of performance of the obligation, compensation for damage, cure of the non-conformity or a reduction in price, it is the earlier of:

• 10 years from when the right became exercisable; or
• five years from when the entitled party came to know that it was exercisable.

However, SPAs customarily have an exclusive remedy clause, which excludes any remedies under the Civil Code and limits the party's remedies to the indemnity and termination set forth in the SPA. It is customarily provided in SPAs that:

• termination is possible only before closing; and
• indemnity is allowed within, depending on the case, six months to two years from closing, which is shorter than the statute of limitations.

Exclusive remedy clauses are construed not to exclude the claim for delivery of the shares and payment of the purchase price. It is uncertain, however, whether exclusive remedy clauses can exclude claims based on fraud or tort.

6.4 What limitations to liability under the transaction documents (including for representations, warranties and specific indemnities) typically apply?

SPAs usually have the following limitations on indemnity:

• Cap, floor (basket) and de minimis: Indemnity can be made only up to the cap amount and only when the aggregated amount of individual damages exceeding the de minimis amount exceeds the floor amount. When the floor is exceeded, according to the SPA, all amounts of damages or only the amount exceeding the floor can be indemnified. The former arrangement (tipping basket) is more common than the latter (deductible basket).
• Claim period: See question 6.3.

In many cases, SPAs provide that these limitations apply to indemnity based on breach of both covenants and R&Ws.

Also, SPAs in many cases provide that these limitations do not apply to:

• violation with wilful act or gross negligence; or
• violation of fundamental R&Ws such as the seller's ownership of the shares.

In addition, SPAs sometimes have an anti-sandbagging clause – a clause prohibiting a party from making claims based on a breach of R&Ws known to the party. Even without such clause, there is a court decision suggesting that a party that knows, or does not know due to gross negligence, the other party's breach of R&Ws cannot make a claim based on such breach where the agreement has neither an anti- nor pro-sandbagging clause (Tokyo District Court, 17 January 2006).

Specific indemnities are usually subject to no such limitations or more relaxed limitations (eg, higher cap, lower floor and/or longer claim period).

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

Warranty and indemnity (W&I) insurance is now widely used by Japanese companies in cross-border transactions, especially auction deals, where the purchase of W&I Insurance is often a condition for bidding. W&I insurance is also used where the seller is an investment fund, which will often require the buyer to purchase W&I insurance to avoid indemnity liabilities post-closing.

Traditionally, W&I insurance is not as common in domestic deals as in cross-border deals. However, this situation is changing as Japanese major insurance companies are now beginning to underwrite W&I insurance. In Japan, the premium is approximately 1% to 3% of the maximum amount of coverage.

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

Holdback: The most common approach is to make the payment in instalments. By paying only a portion of the total purchase price at the closing and holding back the remainder for a certain period, the buyer may offset the remaining purchase price and indemnity claims should an indemnity event happen.

Escrow: Escrow is a mechanism whereby the buyer deposits the remaining purchase price with an escrow agent until the payment becomes due. The agent pays the escrow amount to the seller when the payment becomes due unless an indemnity event happens during the escrow period, in which case the agent pays the indemnity amount to the buyer and the seller receives the balance. In Japan, trust banks offer escrow services. Escrow is used when the seller is unwilling to accept a holdback mechanism due to the low creditability of the buyer.

Guarantee: Where the buyer is concerned about the seller's ability to pay the indemnity, it may request the seller to have a third party guarantee the seller's indemnity liabilities. The buyer may also request a guarantee where the seller is:

• a small company with insufficient assets; or
• a fund that is scheduled to be dissolved shortly after the closing.

W&I insurance: W&I insurance is also used to insure indemnity claims. However, W&I insurance does not cover indemnity liabilities arising from certain events such as:

• risks known to the buyer;
• criminal fines; and
• environmental risks.

6.7 Do sellers in your jurisdiction often include restrictive covenants in the transaction documents? What timeframes are generally thought to be enforceable?

Where the seller is a Japanese company, it often requests to include in the SPA a covenant that requires the buyer to maintain for a certain period (usually two to three years) after closing the target's employees under the same employment conditions as before closing. However, the enforceability of this covenant is uncertain as even if the buyer breaches this covenant, it would not be likely to cause damages to the seller.

Other restrictive covenants that the seller may want to have in the SPA include those that prohibit the buyer from:

• suing the target's resigning directors in connection with their activities before their resigning; and
• letting the target use the seller's name, trademarks, logos and so on.

These covenants are generally thought to be enforceable regardless of the term.

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

It is common to include conditions to closing in the SPA where there is a gap between signing and closing. Non-occurrence of a MAC is often included as a condition to closing for the buyer, especially when its bargaining power is stronger than the seller's. When SPAs have a MAC clause, ‘MAC' is usually very widely defined by the buyer. However, in recent deals, it has been defined to include exceptions called ‘carveouts' – that is, changes that would not qualify as a MAC. Typical carveouts include changes in:

• general economic conditions;
• financial and capital markets; and
• the industries in which the target is active.

Also, since COVID-19, infectious diseases and pandemics have come to be specified as carveouts.

Where there is a gap between signing and closing, SPAs usually require the parties to make R&Ws not only on the signing date but also on the closing date. Also, the accuracy of the counterparty's R&Ws on the closing date is usually specified as a condition to closing for both parties.

6.9 What other conditions precedent are typically included in the transaction documents?

• Compliance with covenants: The parties have performed all obligations to be done by the closing and have not performed any prohibited acts. This includes the cure of any violations of laws by the target discovered in the due diligence process.
• Completion of reorganisation: Where the transaction is structured as a combination of the target's internal reorganisation and a share purchase (see question 1.1), the target has completed such internal reorganisation.
• Merger filings and other statutory procedures: The buyer has obtained all necessary merger clearances from the relevant competition authorities. The parties have taken all necessary procedures required by relevant laws.
• No injunction procedure: No injunction procedure or similar that seeks for suspension of the transaction is pending.
• Approval of share transfer: The target has obtained the necessary approval for the share transfer from the relevant body (see question 4.1).
• Ancillary agreements: The parties have executed, or have had relevant third parties execute, all ancillary agreements (see question 5.1).
• Resignation letters: The target's directors who are supposed to resign their office have signed and submitted resignation letters to the buyer.
• Consent from counterparties: The target has obtained the necessary consent from the counterparties of the contracts as required by such contracts (see question 4.3).
• Finance out (not very common): Where the buyer is using acquisition finance, the buyer has procured the necessary funds (see question 7.8).

7 Financing

7.1 What types of consideration are typically offered in private M&A transactions in your jurisdiction?

In share purchases and business transfers, cash is most commonly used as the consideration. The buyer's shares or other assets are seldom used as consideration because, if the buyer delivers its shares or other assets in exchange for the target's shares or business, this will be deemed as a contribution in kind by the seller. Under the Companies Act, to accept a contribution in kind, unless exempt by law, the seller must file a petition to the court for the appointment of an inspector, who will investigate the value of the assets to be contributed. This procedure is costly and time consuming, and the result of the investigation is unpredictable.

On the other hand, in reorganisations, the type of consideration is flexible – with some exceptions, the following can be used as consideration:

• cash;
• the shares of the buyer or the buyer's parent company;
• the buyer's corporate debt;
• share acquisition rights;
• share acquisition rights with debts; and
• anything of value.

Contribution-in-kind regulation does not apply, even where the buyer's shares are used as consideration. In practice, the buyer's shares are often used as consideration, especially when the buyer is a listed company. On the other hand, where the buyer is not listed, cash is preferred to the buyer's shares (see question 7.3).

7.2 What are the key differences and potential advantages and disadvantages of the various types of consideration?

The main advantage of cash consideration is that it is easy to use. Cash can be used as consideration in:

• share purchases;
• business transfers; and
• most types of reorganisations.

However, it cannot be used as consideration in:

• incorporation-type company splits;
• share transfers; or
• share deliveries (in share deliveries, cash consideration is permitted only with the buyer's shares).

On the other hand, an advantage of using shares as consideration is that it will not cause a cash outflow from the buyer. However, as discussed in question 7.1, to use the buyer's shares as consideration in share purchases or business transfers, the buyer must adhere to the contribution-in-kind regulations of the Companies Act. Also, by delivering the buyer's shares to the seller, the buyer's shareholding structure will change. For the seller, disposition of the buyer's shares may be difficult if the buyer's shares are not traded on the market.

Assets other than cash and the buyer's shares (eg, share acquisition rights of the buyer) can also be used as consideration. However, the buyer's assets are rarely used as consideration, as it is difficult to assess the value of such assets. For the seller, the disposition of such assets may be difficult.

7.3 What factors commonly influence the choice of consideration?

Cash position: If the buyer has sufficient cash, cash consideration is the preferred option. Conversely, if the buyer does not have sufficient cash or wants to avoid cash outflow, it may consider using other assets such as the shares of the buyer or its parent company as consideration.

Listed company: If the buyer is a listed company, it may want to utilise its shares as consideration; and the seller may accept this as it can sell the buyer's shares on the market at any time. However, if the buyer is not a listed company, it and its existing shareholders may not want the seller to be its shareholder; and the seller may not want to own the buyer's shares as they cannot be sold on market.

Contribution-in-kind regulations: The parties can escape the contribution-in-kind regulations in certain cases, including where:

• the total number of the buyer's shares to be delivered to the seller does not exceed one-tenth of the total number of the buyer's issued shares; and
• the total value of the assets to be contributed does not exceed JPY 5 million.

If these exceptions are available, the buyer may consider using its shares as consideration.

Purpose: If the purpose of the transaction is not an acquisition but an internal group restructuring or business integration, share consideration may be selected.

Tax: See question 13.1.

7.4 How is the price mechanism typically agreed between the seller and the buyer? Is a locked-box structure or completion accounts structure more common?

The purchase price is determined subject to the discussion and negotiation between the seller and the buyer based on their valuation of the enterprise value of the target or business. The valuation method varies depending on the case; but in private M&A transactions, a discounted cash-flow method and a net asset method are commonly used.

As for the price mechanism, a completion accounts structure is widely used. This is especially preferred where:

• there is a gap between signing and closing;
• the adjustment amount may become large as the target's net debts and working capital are likely to fluctuate between signing and closing; and
• the date of the target's financial statements based on which the buyer carried out a valuation is far in the past from the signing date.

A locked-box structure has recently become common, especially in private M&A transactions. It is preferred where:

• the period between signing and closing is short;
• the adjustment cost is large considering the deal size;
• the seller wants to fix the price at the closing; and
• the seller is supposed to be dissolved soon after the closing.

7.5 Is the price typically paid in full on closing or are deferred payment arrangements common?

Payment in full on closing (while subject to adjustment soon after closing where a completion accounts structure is adopted) is more common than deferred payment arrangements. That said, deferred payment arrangements are also used if the parties have the special means to adopt them. The typical structures for deferred payments include holdback, escrow and earnouts.

As for holdback and escrow, see question 6.6.

Earnouts are an arrangement whereby the buyer pays a certain amount of the purchase price and commits to paying an additional amount post-closing according to the target's achievements of pre-agreed goals. Earnouts are used where there is disagreement between the seller and the buyer as to the target's performance in the future. Earnouts are not common but are sometimes used – especially in the acquisition of startups whose success is uncertain.

7.6 Where a deferred payment/earn-out payment is used, what typical protections are sought by sellers (eg, post-completion veto rights)?

Earnout: As the amount paid as an earnout will be determined in accordance with the achievements of the pre-agreed goals, the seller may want to monitor and control the buyer's management of the target. To this end, the seller may request the buyer to:

• operate the target's business as the same way as the target has operated before closing;
• make efforts to achieve the goals;
• provide the seller with access to the target's books and other information so that the seller may confirm the target's progress; and
• refrain from taking any actions that may make it difficult to achieve the goals.

The seller may also request the buyer to pay the full amount of earnouts when the buyer breaches any of its obligations.

Holdback: If a holdback structure is used, the seller may request the buyer to deposit the holdback amount to an escrow agent to cover the buyer's credit risks. The seller may also request the buyer to have a third party guarantee the buyer's payment of the holdback amounts.

7.7 Do any rules on financial assistance apply in your jurisdiction, and what are their implications for private M&A transactions?

There are no general rules on financial assistance in Japan. The target can provide financial assistance to the buyer for the acquisition of the target's shares. It can also provide the target's assets as collateral where the buyer borrows money from financial institutions for the acquisition.

However, if a company's shares are acquired by a third party on the account of the company, this acquisition will be deemed as a share buyback, in which case the company must follow the rules on share buybacks under the Companies Act. Therefore, if the buyer is nominal and it acquires the target's shares on the target's account, this will be deemed as a share buyback and the target must follow such rules and procedures.

Under the Companies Act, where a company acquires its own shares from a shareholder, the company must obtain a special resolution of the shareholders' meeting, in which:

• the shareholder that is to sell the company's shares to the company cannot vote; and
• the other shareholders can request the company to acquire the company's shares held by them.

Also, the total amount that the company pays to acquire its own shares cannot exceed the ‘distributable amount' at the time of the acquisition. The ‘distributable amount' is, very roughly speaking, the amount of the surplus as of the end of the previous financial year while certain adjustments are needed.

7.8 What other key concerns and considerations should participants in private M&A transactions bear in mind from a financing perspective?

Where the buyer intends to use an acquisition finance, it must bear in mind the following factors, among others:

• Collateral: The lender usually requires the target to provide its assets as collateral. Therefore, the buyer must investigate whether the target owns any assets that can be used as collateral and whether there are any restrictions on their use as collateral in the due diligence process. For example, provision of the target's assets as collateral may be prohibited or restricted by applicable laws or contracts with third parties.
• Target's debts: The lender usually requests that the target have repaid all outstanding loans before closing. Therefore, the buyer must specify all of the target's outstanding loans, as well as the costs (including break fees) and procedures for pre-payment.
• Finance-out: To avoid a situation where the buyer is obliged to pay the purchase price under the share purchase agreement (SPA) but cannot borrow money from the lender, the buyer may want to have a finance-out clause (see question 6.9) as a condition to closing in the SPA. However, the seller is usually unwilling to accept this clause and may request its deletion or that a reverse break fee clause be included in exchange for accepting it.

8 Deal process

8.1 How does the deal process typically unfold? What are the key milestones?

The process differs depending on whether the deal is an auction transaction or a negotiated transaction.

In auction transactions, the typical process is as follows:

• The seller provides an anonymous teaser to potential buyers through its financial adviser.
• Potential buyers interested in the acquisition submit a confidentiality letter to the seller.
• The seller provides the potential buyers with a process letter and information memorandum.
• The potential buyers that intend to participate in the bid submit a non-binding letter of intent.
• The seller selects the bidders that pass the first bid and provides them with a process letter for the second bid.
• The bidders conduct due diligence and submit a final binding offer with a markup to the draft definitive agreement prepared by the seller.
• The seller selects the prospective buyer that passes the second bid.
• The seller and the prospective buyer negotiate and enter into a definitive agreement.
• The seller and the buyer close the transaction.

In a negotiated transaction, the process is as follows:

• The seller and the buyer enter into a confidentiality agreement.
• The seller and the buyer enter into a memorandum of understanding.
• The buyer implements due diligence.
• The seller and the buyer negotiate and enter into a definitive agreement.
• The seller and the buyer close the transaction.

In both cases, the signing of a definitive agreement is a key milestone. In auctions, selection of the prospective buyer is also a key milestone.

8.2 What documents are typically signed on closing? How does this typically take place?

Ancillary agreement: Ancillary agreements are signed prior to closing (see question 5.1).

Bring-down certificate: Each of the seller and buyer provides the counterparty with a bring-down certificate – a document certifying that the conditions precedent in the definitive agreement have been satisfied as of the closing date.

Request for registration of share transfer: If the target is not a share certificate-issuing company (see question 8.3), upon closing, the seller delivers to the buyer a written request for registration of the share transfer signed by the seller. The buyer then signs the document and submits it to the target to register the change of ownership of the shares in the target's shareholder register.

Receipt of purchase amount: In addition, when the seller receives the purchase price from the buyer, it delivers a signed receipt to the buyer on the closing date.

8.3 In case of a share deal, what is the process for transferring title to shares to the buyer?

This depends on whether the target is a share certificate-issuing company – that is, a company whose articles of incorporation states that it issues share certificates representing its shares.

If a company is a share certificate-issuing company, delivery of the share certificates is a requirement for the share transfer to take effect and to be perfected against third parties. In addition, registration of the share transfer in the company's shareholder register is necessary for the share transfer to be perfected against the company.

Therefore, upon closing, the seller delivers share certificates to the buyer and the buyer submits to the target a request for registration of share transfer signed by the buyer while showing the share certificates to register the share transfer in the target's shareholder register.

If a company is not a share certificate-issuing company, the share transfer takes effect only through the agreement between the seller and the buyer. However, registration of the share transfer in the company's shareholder register is necessary for the share transfer to be perfected against the target and third parties.

Therefore, upon closing, the seller delivers to the buyer a written request for registration of the transfer of shares signed by the seller. The buyer then signs the document and submits it to the target to register the share transfer in the target's shareholder register.

8.4 Post-closing, can the seller and/or its advisers be held liable for misleading statements, misrepresentation, omissions or similar?

The buyer may pursue the seller's liability in accordance with the provisions of definitive agreements in case of misleading statements, misrepresentations, omissions or similar by the seller.

On the other hand, the buyer usually cannot pursue the liability of the seller's advisers unless their conduct amounts to a fraud or a tort.

8.5 What are the typical post-closing steps that need to be taken into consideration?

• Shareholder register: Immediately following closing, the buyer has the target register the share transfer in the target's shareholder register (see question 8.3).
• Directors: The target holds a general shareholders' meeting to elect new directors and statutory auditors. The election is registered in the corporate register of the target.
• Amendment of the articles of incorporation: As necessary, the target amends its articles of incorporation to, for example, change its corporate name, business purposes or management structure.
• Foreign Exchange and Foreign Trade Act (FEFTA) filing: If the buyer is a foreign company, it may have to submit an ex post facto report under the FEFTA (see question 4.2).
• Notice to counterparties: The target may be required to notify the change of ownership to the counterparties of contracts under the provisions therein.

9 Competition

9.1 What competition rules apply to private M&A transactions in your jurisdiction?

Under the Act on Prohibition of Private Monopolisation and Maintenance of Fair Trade, certain types of M&A transactions that substantially restrain competition are prohibited. Also, prior notification to the Japan Fair Trade Commission (JFTC) is required if the transaction meets certain thresholds. The applicable thresholds vary depending on the transaction structure, as illustrated by the following examples:

• Share acquisition: Notification is required where:
• • the total domestic turnover of the acquiring company group exceeds JPY 20 billion;
  • the total domestic turnover of the target and its subsidiaries to be acquired exceeds JPY 5 billion; and
  • the acquiring company group will hold more than 20% or 50% of the voting rights in the target post-closing.
• Business and asset transfer: Notification is required where the acquiring company group with a total domestic turnover of more than JPY 20 billion acquires:
• • the whole business of another company whose total domestic turnover exceeds JPY 3 billion;
  • a substantial part of another company's business whose total domestic turnover of exceeds JPY 3 billion: or
  • the whole or substantial part of another company's fixed assets used for its business and the total domestic turnover of such assets exceeds JPY 3 billion.

In addition, separate thresholds are set for:

• mergers;
• joint incorporation-type company splits;
• absorption-type company splits; and
• joint share transfers.

The standard waiting period is 30 calendar days after acceptance of the notification, although this can be shortened by the JFTC.

9.2 What key concerns and considerations should participants in private M&A transactions bear in mind from a competition perspective?

In transactions between competitors, the parties must bear in mind gun jumping. ‘Gun jumping' generally refers to:

• failure to notify;
• breach of a standstill obligation; or
• substantial gun-jumping (cartel).

Failure to notify and breach of standstill obligation: Where the transaction requires prior notification to the JFTC (see question 9.1), the parties must not close the transaction or take any actions that would be deemed to constitute closing of the transaction before the 30-calendar-day waiting period has elapsed.

Substantial gun jumping: Where the parties are competitors, they must take care regarding the exchange of competitively sensitive information. While the information exchange itself will not be deemed as a cartel, if the parties are competitors, they usually implement a ‘clean team' arrangement so that competitively sensitive information is disclosed only to the clean team members of the counterparty.

However, to our knowledge, no gun-jumping case has been sanctioned under the Anti-monopoly Law so far; while in Canon and Toshiba Medical in 2016, the JFTC issued a warning that the structure taken by the parties could be a violation of the notification obligation.

In addition, if a definitive agreement imposes a non-compete obligation on any of the parties, it must be carefully drafted so as not to be deemed as an illegal market split.

10 Employment

10.1 What employee consultation rules apply to private M&A transactions in your jurisdiction?

Special consultation is required in the case of company splits. Under the Act on the Succession to Labour Contracts upon a Company Split, the splitting company must make efforts to obtain the understanding and cooperation of the workers at all workplaces:

• through consultations with:
• • the labour union organised by the majority of the workers; or
  • if no such union exists, a person representing the majority of the workers; or
• by any other method equivalent thereto.

In addition, the splitting company must give written notice to:

• workers who are primarily engaged in the business to be transferred (‘primarily engaging workers'); and
• workers who are to be transferred by the company split (‘transferring workers').

Among those who receive the notice, objections may be filed by:

• primarily engaging workers who are not transferring workers; and
• transferring workers who are not primarily engaging workers.

Objecting workers will be transferred or not transferred, as the case may be, regardless of the provisions in the company split agreement or company split plan.

Also, the Supplementary Provisions of the Act for Partial Revision of the Commercial Code, etc (90/2000) requires the splitting company to consult with each primarily engaging worker and transferring worker before the notice above is given.

Even in a case other than a company split, prior consultation with the labour union may be required by the collective agreement between the company and the union.

10.2 What transfer rules apply to private M&A transactions in your jurisdiction?

• Share deals: The employees' consent is not required as employment is not transferred.
• Asset deals:
• • Mergers and company splits: No employee consent is required as the employment contracts are transferred by operation of law; while special rules apply in the case of company splits (see question 10.1).
  • Business transfers: The consent of each employee is required to transfer employees (see question 1.3).

Prior consultation with the labour union may be required by the collective agreement between the company and the union (see question 10.1).

10.3 What other protections do employees enjoy in the case of a private M&A transaction in your jurisdiction?

Under the Labour Standards Act and the Labour Contracts Act, changes in work conditions that are disadvantageous to the employees in principle require the employees' consent. Also, the dismissal of employees is restricted under the Labour Contracts Act. Where the buyer intends to change the work conditions of the target's employees or dismiss them, it must comply with these acts.

In addition, as discussed in question 6.7, share purchase agreements commonly have a covenant that requires the buyer to maintain the work conditions of the target's employees for a certain period after closing.

10.4 What is the impact of a private M&A transaction on any pension scheme of the seller?

The corporate pension schemes that are commonly used by Japanese companies are:

• defined-benefit corporate pensions; and
• defined-contribution pensions.

The conditions of the pensions defer depending on the company. Generally, the pension scheme adopted by the target will not be automatically integrated into the buyer's pension. Therefore, the buyer must consider how to transfer the pension scheme of the target to that of the buyer and how to integrate its conditions. The transfer of the pension scheme and the change in the pension conditions are subject to rules set forth in the Defined-Benefit Corporate Pension Act and the Defined-Contribution Pension Act.

In the case of defined-benefit corporate pensions, if the target's pension reserve is insufficient, the target may be required to pay premiums to cover the shortfall as a special contribution under the Defined-Benefit Corporate Pension Act. The buyer therefore must take such shortage into account in the negotiation of the purchase price and the special indemnity.

As the conditions of the pension constitute a work condition of the employees, if the buyer changes the conditions of the pension in a way which is disadvantageous to the employees, it must follow the rules under the Labour Contracts Act (see question 10.3).

10.5 What considerations should be made to ensure there are no concerns over the potential misclassification of employee status for any employee, worker, director, contractor or consultant of the target?

Disguised consignment: If workers whom a company accepts as contractors are working under the direction and order of the company, this may be deemed as the acceptance of dispatched workers under the Act for Securing the Proper Operation of Worker Dispatching Undertakings and Improved Working Conditions for Dispatched Workers, in which case the company may be scrutinised and penalised.

At the same time, the company may be deemed to be employing such workers under the Labour Contracts Act, in which case the company must treat them as employees in accordance with the Labour Standards Act and the Labour Contracts Act.

Therefore, if the target accepts contractors, the buyer must confirm in the due diligence how they are treated by the target – especially whether they are given directions or orders from the target.

Nominal manager: Under the Labour Standards Act, managers and supervisors (those in a position of supervision or management or handling confidential processes) are not subject to the restrictions on working hours, rest periods and days off under the act.

However, if those who have been given the position or title of managers or supervisors are in reality given no such power as managers or supervisors, they may be deemed employees.

Therefore, the buyer must confirm in the due diligence:

• the basis on which the target categorises its staff as managers and supervisors; and
• whether they are in reality working as managers and supervisors.

10.6 What other key concerns and considerations should participants in private M&A transactions bear in mind from an employment perspective?

It has been said that Japanese employees are not used to M&A transactions and tend to have negative impressions where their employer is acquired, especially by a foreign company. Therefore, when acquiring Japanese companies, buyers should take care when explaining the deal to employees.

It is also said that the employment protection under Japanese labour law is relatively strong when compared to that in other countries. In particular, dismissal for restructuring is strictly restricted under Japanese labour law.

11 Data protection

11.1 What key data protection rules apply to private M&A transactions in your jurisdiction?

General rule: Under the Personal Information Protection Act, a business operator that handles personal information must obtain the prior consent of data subjects before providing their personal data to a third party, unless exempted by the act.

This rule applies to the provision of personal data in the course of due diligence and negotiations in M&A transactions. Therefore, if it is difficult to obtain consent from each data subject, the seller and the target may provide the buyer only with information that does not constitute personal data in the due diligence and negotiations.

This rule also applies after the target has been acquired, because even a parent company is deemed to be a ‘third party' for the purpose of the act (see question 11.2).

Mergers, company splits and business transfers: On the other hand, the act provides that the provision of personal data in conjunction with mergers, company splits and business transfers is allowed without the data subjects' consent. This exemption is construed to allow the provision of personal data for due diligence and negotiations conducted before closing. However, the party that provides the personal data must enter into an agreement with the other party to ensure that the other party takes the necessary security control measures.

Post-closing, the personal data owned by the target is transferred to the buyer. However, the buyer can handle the transferred data only for the purpose specified by the target before the closing.

11.2 What other key concerns and considerations should participants in private M&A transactions bear in mind from a data protection perspective?

Compliance: Regulations on personal data have become increasingly tight in recent years as social demands for the protection of personal information have grown. The leak of personal information may elicit social criticism as well as civil and administrative liabilities.

Therefore, the buyer must confirm in the due diligence whether the target is handling the personal information of customers, suppliers and employees in compliance with the Personal Information Protection Act and other regulations.

In addition to the act, some industries (eg, financial, medical and telecommunications) have industry-specific guidelines on the handling of personal information established by the relevant authorities. Therefore, the buyer must ensure that the target is compliant with these guidelines if applicable.

Post-closing: Post-closing, the buyer must consider how to utilise the personal information owned by the target. As even a parent company is deemed to be a third party, personal data must be provided from the target to the buyer only through the methods allowed under the act. Many Japanese companies use the so-called ‘joint use' schemes set forth in the act to utilise the data owned by group companies.

12 Environment

12.1 Who bears liability for the clean-up of contaminated sites? How is liability apportioned as between the buyer and the seller in case of private M&A transactions?

Under the Soil Contamination Countermeasures Act, where it turns out that a site contains certain designated hazardous substances that exceed the standards set forth in the act and the site is deemed harmful to human health or to pose a threat of such harm due to those substances, the owner, manager or occupier of the land is responsible for the clean-up of the site. If the soil contamination was caused by an act of any person other than the owner, manager or occupier, the party that cleans up the site may claim from that person the cost of the clean-up.

In share purchase agreements (SPAs), the seller is usually required to represent and warrant that there are no violations of environmental laws and regulations applicable to real estate owned or used by the target, so that the buyer may seek indemnity from the seller if the target incurs any clean-up costs post-closing. Also, a special indemnity clause may be provided in the SPA if the buyer finds any violation of environmental laws and regulations during due diligence.

12.2 What other key concerns and considerations should participants in private M&A transactions bear in mind from an environmental perspective?

Environmental issues that often arise in M&A transactions include polychlorinated biphenyl (PCB) waste and asbestos, as the handling and disposal of these substances are regulated by the Act on Special Measures concerning Promotion of Proper Treatment of PCB Waste and the Ordinance on Prevention of Health Impairment Due to Asbestos, respectively.

The buyer should confirm in the due diligence whether the target stores PCB waste and whether asbestos is used in the buildings that the target owns, uses or rents. If these substances are found in the due diligence, the costs of removal or appropriate treatment required under the relevant laws should be taken into account in the valuation.

As the costs of removal or appropriate treatment of contaminants can be significant, if the buyer discovers any specific environmental risks in the target, it should consider engaging specialists to carry out environmental due diligence.

In addition, the proper disposal of industrial waste by the target in accordance with the Waste Disposal and Public Cleansing Act often becomes an issue.

13 Tax

13.1 What taxes are payable on private M&A transactions in your jurisdiction? Do any exemptions apply?

• Share purchase: Capital gains tax is imposed on the seller.
• Business transfers: Capital gains tax and consumption tax are imposed on the seller.
• Reorganisations: In principle, capital gains tax is imposed on the party transferring assets (‘transferring company').

As for the shareholders of the transferring company, the consideration paid to them that exceeds the transferring company' s capital is deemed as dividends and a dividend tax is imposed on the shareholders. Also, if any assets other than the shares of the buyer or its wholly owning parent company are delivered to the transferring company's shareholders as consideration, capital gains tax is imposed.

However, if a reorganisation transaction meets certain requirements, it will constitute a ‘tax-qualified reorganisation' and no capital gain tax will be levied on the transferring company or deemed dividend tax on its shareholders. While the requirements for tax-qualified reorganisations are complex and will vary depending on the type of reorganisation, simply put, intra-group reorganisations and reorganisations for joint business can be tax qualified if other requirements are met.

In addition, stamp duty is imposed when making a hard copy of certain agreements, such as merger agreements.

13.2 What other strategies are available to participants in a private M&A transaction to minimise their tax exposure?

Tax-saving schemes that avail of the differences in applicable tax rates according to the type of income are often used. For example, when calculating an individual's retirement income, a certain deduction is permitted under the Income Tax Act. As a result, the tax rate applicable to retirement income can be lower than that applicable to share transfer income. Therefore, if the seller is an individual who is a director of the target, he or she can save tax by receiving a certain amount of retirement allowance from the target before closing and selling the shares of the target at the value without the paid retirement allowance, rather than selling the shares at the value including the unpaid retirement allowance.

Other tax-saving schemes include those availing of the target's net operating losses that can be carried forward in the future. For example, the buyer can succeed to the target's net operating loss by merging the target ; while certain restrictions exist in the Corporation Tax Act.

13.3 Is tax consolidation of corporate groups permitted in your jurisdiction? Can group companies transfer losses between each other for tax purposes?

Tax consolidation is allowed under the group relief system. This system is available to company groups comprised of a Japanese parent company and its wholly owned subsidiaries (excluding foreign companies). Group companies that wish to use the system must obtain advance approval from the commissioner of the National Tax Agency.

Under the group relief system, each company that belongs to the company group must file its own tax return; while, with certain limitations, profits and losses can be aggregated as a group. Corrections in a tax return of one group company will not affect the other group companies.

13.4 What other key concerns and considerations should participants in private M&A transactions bear in mind from a tax perspective?

Indemnity: The tax treatment of indemnity money is unclear. If it constitutes compensation, it will be taxable. However, if it is a refund of the purchase price, it will not. In this regard, in one case the National Tax Tribunal held (8 September 2006) that money paid by the seller to the buyer on the grounds of the seller's misrepresentation constituted a refund of the purchase price, and rejected the tax authority's claim that it should be treated as taxable profits. In this case, the share purchase agreement (SPA) provided that if the target incurs any losses due to the seller's misrepresentation, the seller must repay this amount to the buyer. Based on this decision, it is advisable to provide in the SPA that the indemnity will be treated as a refund of the purchase price.

Earnout: The treatment of earnouts is also unclear. If an earnout is classified as share transfer income, the applicable income tax rate is around 20%; whereas if it is classified as miscellaneous income, the rate can rise to up to 55%. In one case, the Osaka High Court (6 October 2016) held that the earnouts did not constitute share transfer income. The court held that the seller's right to claim earnouts did not definitely arise at the time of the share transfer. Based on this decision, earnout provisions should be carefully drafted so that the right to claim earnouts definitely arises upon the share transfer.

14 Trends and predictions

14.1 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 Nihon Keizai Shinbun reported earlier this year that in 2022, the number of M&A transactions involving Japanese companies reached a record high of 4,304; while the total value was around JPY 11.435 trillion, dropping by more than 30% from 2021. While the total value of transactions between Japanese companies increased by more than 26% to around JPY 4 trillion, the total value of inbound and outbound M&As decreased significantly by around 40% and 50%, respectively.

One recent trend is the increase in carveout deals, where companies sell non-core businesses to streamline their business lines. The demands for business succession of small and medium-sized enterprises remain high against a backdrop of ageing business owners and a shortage of successors.

Recent high-profile private M&A deals include:

• the acquisition of a science solution business of Olympus by Bain Capital;
• the acquisition Works Human Intelligence by GIC; and
• the acquisition of DHC by Orix.

14.2 Are any new developments anticipated in the next 12 months, including any proposed legislative reforms?

In 2023, the taxation of share deliveries will be revised. Currently, in order to promote the use of share deliveries, the taxation of the seller's capital gain earned through share deliveries is deferred under the Act on Special Measures Concerning Taxation. However, it has been pointed out that business owners are using this special treatment as a tax-saving scheme to transfer their holding shares to their private companies. Under the revision, such deferral is in principle not allowed where the buyer is a family-owned company after the share delivery. The revision will apply from 1 October 2023.

15 Tips and traps

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

• Language barrier: If the seller or the target is a Japanese company, the information on the target is often disclosed only in Japanese. The deal team often consists of non-English native speakers. Therefore, foreign companies should retain local advisers when conducting M&A transactions with Japanese companies to avoid misunderstandings and miscommunication.
• Trust: In Japan, personal relationships based on trust are valued in business. It is thus advisable to create opportunities for key personnel of the seller and the target to meet in person from the initial stages of the transaction in order to trust each other and build a good relationship.
• Employees: Employees of Japanese companies are usually not used to M&A transactions and may have a negative impression, especially when their employer is sold to a foreign company. The seller will be concerned to know how the employees of the target will be treated post-closing. Therefore, when negotiating with the seller, the buyer should explain to the seller how it plans to deal with the employees after the transaction.

Co-Authored by Mari Yamasaki.

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.