[ Nippon Keidanren ] [ Policy ]

Further Revision of M&A Legislation is Needed

December 12, 2006
Nippon Keidanren

Further Revision of M&A Legislation is Needed (Outline)

I. Need for Revision of M&A Legislation

Nippon Keidanren (Japan Business Federation) issued a written proposal, "Reasonable Defense Measures against Takeovers Detrimental to Corporate Value Are Needed" in November 2004, which called for the prompt implementation of a mechanism to apply some brakes on company purchasing activities that may undermine corporate value of acquired firms. Company Law was subsequently enacted in May 2006 as a result of the considerable efforts of The Liberal Democratic Party of Japan, (chiefly its Judicial Affairs Division and the Corporate Governance Committee), as well as the government ministries and agencies concerned. Moreover, the Securities and Exchange Law was amended in June. Following gradual implementations, this law will go into effect as the Financial Instruments and Exchange Law in summer 2007.

These new laws notwithstanding, Japan's overall legal provisional framework is inadequate for the blocking of corporate merger and acquisition attempts that are detrimental to corporate value or that harm the national interest through the outflow of technology, especially when compared to that of Europe and the US. There are also inadequacies in Japanese laws that apply to shareholder protections. Moreover, compared with Europe and the US, people's general understanding and experience with M&As cannot be termed "developed" in Japan. As a result, there are insufficient relevant judicial precedents.

Concern is most acute when it comes to Japan's manufacturing sector. This is because Japan's overall international competitive edge could be lost through an overseas outflow of technological and research and development capabilities which have been cultivated over many years. Such a flow could in turn damage the national interest.

While such concern accumulate, increased flexibility in merger compensation under the Company Law (allowing shareholders of the merged companies to be paid with money, their parent companies' shares, or various other means, instead of with shares of the acquiring company), which had been postponed for one year, will take effective in May 2007. It is true that greater flexibility in merger compensation will facilitate corporate restructuring. This will present, however, serious problems. Particularly in a "triangular merger (in which an acquiring company provides shareholders of the merged companies with their parent companies' shares in exchange for the shares of the merged companies)," shareholders could suffer losses because there are no restrictions on the shares of the parent company to be granted to the shareholders of the company absorbed. Shareholders who oppose the merger are granted only the right to demand the purchase of their shares, which is actually insufficient. There are concerns that difficult circumstances for Japanese shareholders could arise because of differences in such areas as language, corporate accounting systems, and the extent of financial information disclosure. If the new law is enforced without necessary amendments, there remains a distinct possibility that a foreign company could absorb a Japanese firm as a 100% subsidiary without directly spending its own money. This might encourage hostile acquisitions with more active M&A attempts than hitherto, giving rise to unexpected problems.

Article 9 of the Supplementary Provisions of the Enforcement Regulations of the Company Law provides for "taking measures including necessary reconsideration" relating to the greater flexibility of compensation for mergers by the actual enactment in May 2007. This should be the opportunity to comprehensively and promptly carry out wide-ranging revisions, not only of the Enforcement Regulations of the Company Law, but also of M&A legislation overall for the enhancement of the related legal framework.

II. Status of M&A Legal Provision in Europe and the US

The legal system relating to M&A varies with each country in Europe, and the US, based on domestic law. There are no international standards.

In the US, powerful defensive measures against takeovers that include the so-called "poison pill" can be adopted and put into motion only by the decision of boards of directors, and these measures have come into wide use. In addition, measures have been taken in the laws and regulations of many states to regulate improper M&As, such as legislation or regulations for business combinations that restrict mergers by hostile acquirers, so that minority shareholders or stakeholders of the target of a hostile acquisition do not suffer unreasonable disadvantages. From the perspective of shareholder protection, when a foreign company merges with and acquires a US-listed company with shares as compensation, the same detailed provisions concerning filing and disclosure are applied as for companies listed in the US, in accordance with the US accounting standards. These provisions include requirements of the Sarbanes Oxley Act. As a result, SEC-registered shares are used as compensation for mergers and acquisitions in almost all cases. There are also the Exon-Florio provisions to comprehensively regulate acquisition of a domestic company by foreign company from the perspective of national defense and economic security. In addition, stock market listing regulations are flexible in allowing the use of various classes of shares and the adoption of defensive strategies. For example, the NYSE and NASDAQ allow companies that issue shares with multiple voting rights to be listed, like Google and Goldman Sachs.

In Europe, there is no international legal system on corporate restructuring such as triangular mergers. Basically, merger compensation has to be shares of a merging company, so the takeover bid (TOB) is employed in cross-border M&As. For this, a strict obligation for a full buyout has been established, and therefore there is in principle no danger of a coercive case in which merger is forced based on unreasonable compensation after a takeover bid. Based on the TOB principles, the shareholdings of opposing minority shareholders will not be exchanged, as a general rule, for the shares of a non-EU company against their will. Notably, in order to fully own a company against the will of minority shareholders, the acquirer must obtain between 90% and 95% of the target's shares. Furthermore, some countries have an organizational system in which employees and the management together take managerial decisions, while others have legalized the poison pill. It is apparent that a number of countries have adopted various mechanisms to effectively make hostile acquisitions difficult.

III. Prompt Establishment of M&A Legal System in Japan

To protect shareholders and the national interest by preventing the outflow of technology related to national security, it is essential that Japan promptly enact legislation to prevent M&As that undermine corporate value and achieve equal footing with the US and Europe.

While calling for necessary provisions in the M&A legal system, Nippon Keidanren believes that the comprehensive establishment of an attractive business environment through radical reforms to corporate taxation, including the lowering of the effective tax rate, is most important to attract foreign direct investment.


Legislative Provision from the Perspectives of Shareholder Protection and Preventing M&As that Undermine Corporate Value

1. Strengthening of Rules for Greater Flexibility in Compensation for Mergers

When the company being absorbed is a listed company, the requirements for the resolution of a merger with compensation other than cash or negotiable securities of a Japan-listed firm (or equivalent negotiable securities that meet Japanese listing standards) should be tightened. For example, this should be subject to a special resolution, requiring the support of two-thirds of voting rights and that of more than half shareholders.

For all mergers with compensation other than cash or negotiable securities of a Japan-listed firm (or equivalent negotiable securities that meet Japanese listing standards), disclosure requirements should be tightened and made comprehensive. Strict accountability should be imposed on the executive officers of the absorbed company regarding their compensation.

2. Establishing Legislation on Regulations for Business Combinations

Under current law in the US state of Delaware, when a hostile acquirer has obtained at least 15% of shares, a merger cannot proceed within the next three years without the approval of two-thirds of the voting rights other than those of the hostile acquirer. This type of legal provision should be established in Japan in order to regulate improper M&As.

3. Revision of Takeover Bid System

When compensation in a takeover bid is other than cash or negotiable securities of a Japan-listed firm, there should be an obligation to offer shareholders the option between shares and cash, as is the case in Europe.

4. Revision of Listing Regulations

Listing regulations should be reviewed. Some possibilities would be to allow the issuance of various classes of shares, to permit the use of various defensive measures and to establish strict rules on conduct for a non-listed company attempting to buy a listed company.

Legislative Provision from the Perspective of Preventing the Outflow of Technology Related to National Security

5. Strengthening of Foreign Exchange and Foreign Trade Control Law, etc.

Under the Foreign Exchange and Foreign Trade Control Law, prior notification is required only for certain investments that could affect national security. Depending on the form of investment, however, there are concerns of other risks such as the possibility of a serious impact on the domestic economic structure or some harm to national security as a result of the outflow of technology or other causes. Recently, giant corporations -- not only in Europe and the US, but also in emerging economies backed by state funding capabilities -- are embarking on international M&A attempts.

From this perspective, a prompt review of the scope of the production and technological areas that should be subject to the regulation from a national security viewpoint, just like the Exon-Florio provisions in the US. Any necessary legal amendments should be carried out in the next ordinary session of the Diet.

Legislative Provision in the Taxation System Relating to Corporate Reorganization from the Perspective of Fairness

6. Maintenance of Tax Qualification Requirements

It is essential that tax qualification requirements for corporate restructuring be strictly applied to triangular mergers and to maintain, in particular, the business relevance requirement only to the relationship between the acquiring and acquired companies. Tax deferments should not be permitted for cases of a triangular merger through a subsidiary that is a "paper company," i.e., not engaged in actual business operation.

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