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M&A in Japan for Foreign Investors
Part 4: Squeeze-Out
By Hidetoshi Matsumura and Taisuke Ueno| Nishimura & Asahi
29/Jan/2018

1. Introduction

In our previous column, we explained some important regulations regarding the sales or purchase of shares of listed companies. This column provides a basic overview of transactions which are aimed to squeeze out minority shareholders in exchange for cash (“Squeeze-Out”).

On May 1, 2015, the amendment of the Companies Act of Japan to facilitate Squeeze-Outs (“Squeeze-Out Amendments”) became effective. The Squeeze-Out Amendments did not replace or invalidate the previous major method to effectuate Squeeze-Outs, the “shares subject to call” method (zenbu shutoku jokotsuki syurui kabushiki). Instead, the Squeeze-Out Amendments increased the variety of the methods that can be used to gain complete control over a Japanese target company.

Squeeze-Outs are typically used when an investment fund intends to acquire all the shares of the company (buyout), or a parent company intends to make a listed company a wholly-owned subsidiary. In particular, a buyout initiated by the company’s management (“MBO”) is a popular instance of a Squeeze-Out.

While a Squeeze-Out is a valid tool for a foreign acquirer to obtain complete control over an existing Japanese company with diverse minority shareholders, one should use sufficient care in order to comply with various procedural requirements and to prepare to defend against possible challenges by dissenting shareholders.

2. Process of a Squeeze-Out

(1) Outline

A Squeeze-Out is typically composed of two-steps. If the target company is a listed company, the first-step is a tender offer for the shares of the company (“TOB”) and the second-step is to squeeze-out the remaining minority shareholders. If the target company is a non-listed company, please see (4) below.

(2) TOB (First-Step)

As we have explained TOBs in our previous column, this column will build upon that with additional information about regulations regarding two-step acquisitions and MBOs. Please refer to our previous column for information about TOBs.

  (a) Requirement of Disclosure regarding Two-Step Acquisition

Two-step acquisition may cause coercively the shareholders to offer. In this regard, the terms and conditions of the second-step must be disclosed in the first-step under the Financial Instruments and Exchange Act of Japan (“FIEA”) and the Tokyo Stock Exchange’s Regulations. For example, the Tokyo Stock Exchange’s Regulations provide that the following items must be disclosed as a general rule:

(i) the anticipated date for the second-step of the Squeeze-Out;
(ii) the method and the consideration to be given for shares sold in the second-step; and
(iii) if the consideration of the second-step is different from the price offered in the course of the precursory tender offer process (“TOB Price”), the specifics of the difference and the reason.

  (b) Points to Note for MBO

MBOs may cause conflicts of interest between the management of the target company and minority shareholders thereof. In this regard, there are specific regulations for the TOB as a means of the MBO as below.

(i) Disclosure

Under the FIEA, the duties for disclosure are expanded. For example, FIEA requires the disclosure of the following items:

For the tender offeror,

i. if there are any measures to ensure the fairness of the TOB Price, the concrete details of those measures;
ii. the specific process for the decision to make the tender offer; and
iii. if there are any measures to avoid conflicts of interest, the concrete details of those measures.


For the target company,

iv. if there are any measures to avoid conflicts of interest, the concrete details of those measures.


Under the Tokyo Stock Exchange’s Regulations, timely disclosure, in cases where a listed target company conducts the announcement of an opinion or representation to shareholders, shall be made in a necessary and sufficient manner. For example, the following items are provided to disclose regarding the announcement of an opinion:

i. if the target company acquires advice from independent advisor, the name of the advisor and whether the advisor is materially interested with the tender offeror or the target company;
ii. if the tender offer period is short and the target company does not request for the period extension, the reason not to request;
iii. with respect to the directors and auditors who are interested with the announcement of an opinion, the specifics of the interest and whether they participate in the process of making decision; and
iv. if the target company has independent committee, the fundamental information on the committee, including the name and the occupation of the committee members.


(ii) MBO Guidelines

Some court decisions refer to the Guidelines on Increasing Corporate Value and Ensuring Regulatory Compliance in the Context of Management Buyouts (MBOs) (the “MBO Guidelines”) issued by the Ministry of Economy, Trade and Industry as a benchmark on the fairness of the transaction categorized as MBOs, if the management of the target company is to hold stakes in the target after the Squeeze-Out.

The MBO Guidelines state two principles. The first is “increase of corporate value” and the second is “consideration for shareholders’ interest through a fair process”. To realize the above principles, the MBO Guidelines propose practical measures which fall under the following three categories:

i. ensuring the opportunity for shareholders to properly judge about MBO by measures such as providing sufficient disclosure of the process, providing sufficient explanation about the personal interest of the directors, carrying out a Squeeze-Out in case where a large majority of the shares is acquired in the TOB, and setting the price for the Squeeze-Out in accordance with the TOB Price;
ii. avoiding arbitrariness in the decision making process by measures such as consulting with the outside officers or the independent committee on the propriety and conditions of the MBO, acquiring advice from an independent advisor on decision making method, and having the target company acquire the valuation report on the price from the independent valuation organization; and
iii. ensuring a situation which assures the appropriateness of the price by measures such as setting a relatively long tender offer period, etc.


In addition, the MBO Guidelines indicate that a higher floor number in the TOB is desirable. In practice, the floor number is often set to two-thirds of the voting rights, which is the minimum number required for a shareholder vote in the second-step.


Conflicts of interest may arise not only in MBO cases but also in the cases where the tender offer is made by a controlling shareholder, such as the parent company of the target. The scheme of the conflicts in MBOs is basically similar to the scheme in such TOB cases. Hence, the above expanded regulations are provided to be applicable to the company’s position statement regarding the TOB by the controlling shareholders. In addition, under the Tokyo Stock Exchange’s Regulations, a listed company shall obtain an opinion from a person or entity that is not interested with controlling shareholders, that any decision on the company’s position statement regarding the tender offer by the controlling shareholders will not undermine interests of minority shareholders of the company.


(3) Squeezing-Out the Remaining Shareholders (Second-Step)

After the first-step, the TOB described above, in order to complete a Squeeze-Out, the target company must undertake a second-step. Before the Squeeze-Out Amendments, the “shares subject to call” method was commonly used, although the “shares subject to call” method was not anticipated to be used for a Squeeze-Out. However, after the Squeeze-Out Amendments increased the variety of options available, “Demands for Squeeze-Outs” (as defined (a) below) and consolidation of shares are getting used commonly as a replacement for the “shares subject to call” method. Hence, we focus on these methods in this column.

(a) Demand for Squeeze-Out by Special Controlling Shareholder

A “Special Controlling Shareholder” (as defined below) may demand other shareholders and holders of share options to sell all of the outstanding shares and share options of the target company not owned by the Special Controlling Shareholder, other than any treasury shares held by the target company (“Demand for Squeeze-Out”).

A “Special Controlling Shareholder” means a person or entity that holds 90% or more (or a higher shareholding ratio if stipulated in the target company’s articles of incorporation) of the total voting rights in the target company, either alone or together with its wholly-owned subsidiaries (target company shares owned by a less than wholly-owned subsidiary of the person or entity do not count towards its shareholding ratio).

To make a Demand for Squeeze-Out, the Special Controlling Shareholder must follow the below procedure, which is set forth in the Companies Act of Japan:

(i) to notify the target company’s board of directors in writing of its intention to make a Demand for Squeeze-Out and provide the relevant details concerning the Demand for Squeeze-Out (in particular, the proposed closing date for the share purchase and the purchase price for the shares and share options held by the minority shareholders or holders of the options); and
(ii) to request that the board of directors of the target company accept the Demand for Squeeze-Out pursuant to such terms.


If the target company’s board of directors approves the Demand for Squeeze-Out, then the board must notify the minority shareholders in writing at least 20 calendar days prior to the proposed closing date for the share purchase.

Under the Tokyo Stock Exchange’s Regulations, the listed target company shall obtain from a person or entity that does not have an interest in the Special Controlling Shareholder, an opinion stating that any decision on approval or disapproval of a Demand for Squeeze-Out will not undermine the interests of minority shareholders of the company.

This method is becoming popular for cases in which a person or entity that intends to execute a Squeeze-Out holds 90% or more of the total voting rights in the target company, either alone or together with its wholly owned subsidiaries.

(b) Consolidation of Shares

The Squeeze-Out Amendments also provide shareholders with appraisal rights when a target company effects a consolidation of shares that results in the Squeeze-Out of minority shareholders’ shares.

For a consolidation of shares, the target company must adopt a special resolution at a shareholders meeting. The special resolution shall be made by a majority of two-thirds or more of the votes of the shareholders present at the meeting, where the shareholders holding a majority of the votes of the shareholders entitled to exercise their votes at such shareholders meeting are present, as a general rule. The ratio of the consolidation of shares is set so that each minority shareholder is entitled to less than one share (fractions). The target company shall sell the number of shares equivalent to the total sum of the fractions (in case where the total sum includes a fraction of less than one, such fraction shall be rounded off) to itself or third parties by auction or other methods at the market price or, if there is no market price, with the court permission and shall deliver the proceeds to the shareholders in proportion to the fractions attributed to them.

With respect to the share options of the target company, such options are not subject to a consolidation of shares, unlike a Demand for Squeeze-Outs. There are some ways to deal with such options, including to have option holders exercise their options to obtain shares and then offer such shares in the first-step TOB or to have option holders renounce such options.

(c) Squeeze-Out Price

The price paid to remaining shareholders (“Squeeze-Out Price”) is subject to review by the court in its final stage (please see 3.(2) below for the details of the review by the court). It is likely that the court would not issue the necessary approval if the Squeeze-Out Price is below the TOB Price. Therefore, it is customary to set the Squeeze-Out Price the same as the TOB Price.


(4) Squeeze-Out in Non-Listed Companies

The Squeeze-Out process mentioned above is fundamentally applicable to a non-listed company. However, since except for in rare cases, the purchase of shares in a non-listed company is not subject to the TOB regulations in the FIEA, the purchaser may purchase the shares from minority shareholders in a more flexible manner. There are no procedural regulations, including disclosure requirements or the equal-price rule, which apply to non-listed companies, unlike the TOB procedures. In practice, however, because no market price or other objective index for fair value is available, negotiations with minority shareholders could be difficult.

3. Potential Challenges by Minority Shareholders

(1) Outline

Remedies available to minority shareholders who object to the Squeeze-Out Price are below:

With respect to a Demand for Squeeze-Out,

(a) a petition to the courts for a determination of the price;
(b) an enjoinment of the closing of the Demand for Squeeze-Out;
(c) an action seeking invalidation of the closing of the Demand for Squeeze-Out; and
(d) an action seeking liability of the target company’s board of directors arising from a breach of a duty to protect shareholders.

With respect to a consolidation of shares,

(a) an appraisal right and a petition to the courts for a determination of the price;
(b) an action seeking revocation of a resolution of a shareholders’ meeting; and
(c) an action seeking liability of the target company’s board of directors arising from a breach of a duty to protect shareholders.

In this column, we focus on the petition to the courts, which seems the most practical challenge.

(2) Petition to the Court

Shareholders remaining at the second-step are entitled to a petition to the courts for a determination of the price.

With respect to a Demand for Squeeze-Out, the petition may be filed within the period beginning 20 calendar days prior to the closing date of the Demand for Squeeze-Out to the day immediately preceding the closing date. With respect to a consolidation of shares, dissenting shareholders may file a petition to the court for determination of the price through an appraisal right (to demand that the target company purchase, at a fair price, the shares held by the shareholders). The appraisal right shall be exercised within the period beginning 20 calendar days prior to the effective date of a consolidation of shares to the day immediately preceding the effective date. If no agreement on the determination of the price is reached within 30 calendar days from the effective date of a consolidation of shares, a petition to the courts may be filed within 30 calendar days after the expiration of that period.

There is no explicit criteria in the laws to determine the price for a Squeeze-Out, thus it is up to the discretion of the court. Prior court decisions, including ones made by the Supreme Court of Japan, have also been published. Although these decisions pertain to the “shares subject to call” method, the decisions are fundamentally applicable to a Demand for Squeeze-Out or a consolidation of shares.

These decisions have established that the price to be determined by the courts means a fair price on the acquisition day, which is determined by adding (a) the estimated stock price rise (which shall be attributable to minority shareholders) to (b) the objective value. With respect to (b) the objective value, many decisions are based on the average of the market price during a certain term close to the acquisition date unless there are special circumstances where market price does not reflect the objective corporate value. With respect to (a) the estimated stock price rise, the Supreme Court of Japan have decided that the court should accept a Squeeze-Out Price (including the estimated stock price rise) if the first-step’s TOB process is fair, the Squeeze-Out Price is equivalent to the TOB Price, and there are no special circumstances in which there is an unexpected change of the situation where the two-step transaction is based. If the first-step’s TOB process is not found to be fair, the courts determine the estimated stock price rise themselves. For example, regarding MBO cases, some courts determined for themselves that the estimated stock price was equivalent to the premium (20% of the objective value), referring premiums in other MBOs close to the determination.

4. Conclusion

A Squeeze-Out seemed a relatively novel legal technique in Japan and a “shares subject to call” method was commonly used for a Squeeze-Out although a “shares subject to call” was not anticipated to be used for a Squeeze-Out. In the above situation, the Squeeze-Out Amendment increased the variety for a Squeeze-Out and sophisticated the scheme. As a result, it is becoming common to use Demands for Squeeze-Outs and consolidation of shares in place of the “shares subject to call” method. It should be also noted that cooperation and coordination with the target company is indispensable in order to complete a Squeeze-Out smoothly. Although a hostile Squeeze-Out is possible in theory, extremely careful planning is required in order to complete a Squeeze-Out process without the target company’s cooperation, for example, in neutralizing a defense measure taken by the target company.

About Author

  • Hidetoshi Matsumura
    Associate
    Nishimura & Asahi

Education:
University of Southern California Gould School of Law (LL.M., 2016/Graduate Certificates in Business Law and Entertainment Law) University of California, Davis, School of Law (LL.M., 2015) Keio University (LL.B., 2000)

Publications:
The International Comparative Legal Guide to: Mergers & Acquisitions 2010 (Japan Chapter), etc.

Areas of Practice:
M&A, Joint Ventures, Startups & Venture Capital, Corporate Governance, Robotics/Artificial Intelligence, Personal Data & Privacy/Big Data, etc.

About Author

  • Taisuke Ueno
    Associate
    Nishimura & Asahi

Education:
Kyoto University (LL.B., 2013)

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