Minority Squeeze-Outs Under the Amended Japanese Companies Act by Shuhei Uchida, Mori Hamada & Matsumoto
Minority squeeze-outs under the amended Japanese Companies Act by Shuhei Uchida, Mori Hamada & Matsumoto
An amendment of the Companies Act of Japan finally passed the Diet on June 20, 2014, after a period of consideration that had continued for more than four years (the “Amendment”). It is currently expected that the Amendment will become effective on April or May, 2015.
I. Amendment of the Japanese tax treatment at the level of the target company. This Companies Act tax treatment has been controversial and has been The Amendment is the first substantial revision of strongly criticised by M&A practitioners, but the tax the Companies Act since it was first enacted in authority in Japan has been reluctant to change the 2006. While the Amendment is most often relevant rules on the grounds that a share exchange associated with the reforms it makes to the rules is organisational in nature, despite its economic regarding corporate governance of listed companies effect being quite similar to a sale and purchase of (such as disclosure related to the nomination of the shares in the target company. outside directors and a stricter definition of outside Therefore, to avoid the negative tax consequences directors), it is also important for M&A practitioners of a share exchange, squeeze-outs have been most due to the substantial changes it makes to rules commonly effected through a more complicated relevant to M&A transactions. In particular, the “fractional share” procedure. In this type of squeeze- Amendment should change the landscape of out, the target company, upon adoption of a squeeze-out transactions involving Japanese target shareholder resolution, reclassifies all outstanding companies. I discuss below the statutory changes shares as shares that are subject to a call option, relevant to squeeze-out transactions based on my which are referred to in Japanese as “wholly callable experience as one of the drafters of the stock” ( zenbu shutoku joukou tsuki shurui kabushiki ). Amendment. I will try to describe the full picture of Upon exercise of the call option, the wholly the new squeeze-out regime rather than focusing on callable stock is then exchanged for a new class of the details of the various squeeze-out procedures. stock. However, the exchange ratio for the new shares is set at a level that results in minority II. Reform of squeeze-out rules shareholders being entitled to receive only fractional 1. Current practice shares. That is because there is a procedure under Under existing Japanese law prior to the the Companies Act whereby fractional shares are Amendment, buy-outs of listed companies involving not required to be issued, but rather may be sold to a squeeze-out of minority shareholders are typically the acquirer upon court approval, with the cash conducted through a two-step acquisition: (i) a first- proceeds distributed proportionately to the step tender offer and (ii) a back-end squeeze-out of minority fractional shareholders. the remaining minority shareholders. While the Minority shareholders who are not satisfied with Financial Instruments and Exchange Act applies to the amount of cash consideration are entitled to the first-step tender offer, the Companies Act exercise appraisal rights; i.e., the right to file a applies to the back-end squeeze-out. petition to the court to determine the fair value of Under the Companies Act, the back-end squeeze- their shares. See Figure 1 for the basic structure of out could be conducted through a share exchange the fractional share squeeze-out by means of wholly (kabushiki-koukan ) with cash consideration, whereby callable stock. the acquiring company obtains all shares of the 2. Drawbacks of current practice target company and pays cash consideration to the Despite its common use, the fractional share existing shareholders. However, a share exchange squeeze-out procedure has three major drawbacks. with cash consideration is not commonly used in (a) Shareholder resolution practice because it would lead to a realisation of First, a fractional share squeeze-out is time capital gains on the target company’s assets consuming due to the necessity of holding a (including goodwill), usually resulting in unfavourable shareholders meeting at the target company.
1 Figure 1: Fractional share squeeze-out by means of wholly callable stock
Step 1 Minority shareholders Minority shareholders
Acquirer A B Acquirer A B
900 shares 100 shares 50 shares 900 shares 100 shares 50 shares (wholly callable (wholly callable (wholly callable (common stock) (common stock) (common stock) stock) stock) stock)
Target company Target company
Amendment of Approval of articles of incorporation shareholders meeting for reclassification
Step 2 Distribution of Minority shareholders cash consideration
Acquirer A B Acquirer A B
900 shares 100 shares 50 shares 6 shares Fractional Fra ctional (wholly callable (wholly callable (wholly callable (Class A stock) shares shares stock) stock) stock)
1 share in total (Class A stock)
Target company Target company
cash Acquisition of Issuance of wholly callable stock Class A stock by exercise of (I share for 150 shares of Sale to acquirer call option wholly callable stock) (or target company) Approval of shareholders meeting
Source: Mori Hamada & Matsumoto
A shareholder resolution is always necessary even squeezed out through a fractional share squeeze-out when the acquirer holds a very large percentage of that uses wholly callable stock because the the existing shares after the first-step tender offer, Companies Act does not provide any means of thereby making the result of the shareholder reclassifying potential shares as wholly callable stock. meeting self-evident. Due to the time consuming Therefore, unless a call option exercisable by the procedure for holding a shareholders meeting of a issuer is specifically provided in the terms of the listed company, it typically takes a couple of months potential shares, neither the acquirer nor the target to complete the back-end squeeze-out after company can acquire the potential shares without conclusion of the first-step tender offer. This means the consent of each of the potential shareholders. that the minority shareholders not tendering in the Practically, a target company that has issued stock first-step tender offer would have to wait for that options or convertible bonds must persuade each of period before receiving the cash consideration for the potential shareholders to tender their potential the back-end squeeze-out, which is seen by some as shares in the first-step tender offer, or alternatively, having a coercive effect to motivate shareholders to waive them. Failing this, the potential shareholders tender in the first-step tender offer even if they are will remain in placed even after the squeeze-out of not satisfied with the tender offer price. the minority shareholders, which would substantially (b) Consent of “potential shareholders” impede the effect of the squeeze-out. Second, holders of “potential shares,” such as stock (c) Complexity options ( shinkabu yoyaku ken ) and convertible bonds Third, the fractional share squeeze-out procedure is (shinkabu yoyaku ken tsuki shasai ), cannot be unnecessarily complicated and hard to understand
2 for shareholders and the general public. The procedure, provided a sufficient percentage of statutory procedure that permits, in essence, the shares are held by the acquirer. redemption of fractional shares for cash is already In sum, the Squeeze-Out Right enables a complex, and the extra step of reclassifying existing shareholder holding (directly or through one or shares as wholly callable stock as a tool to take more wholly owned subsidiaries) at least 90% of the advantage of that procedure further increases the total voting rights (a “Special Controlling complexity. Shareholder”) to force a cash acquisition of the A consolidation of existing shares could also be remaining shares held by the minority shareholders. used to create fractional shares without the This alternative would only require a resolution of complexity of first reclassifying existing shares as the board of directors of the target, instead of a wholly callable stock. However, share consolidations shareholder resolution, and will therefore are not commonly used in current practice because significantly expedite the squeeze-out procedure – minority shareholders would not be entitled to making it possible to complete the back-end appraisal rights in that scenario under the existing squeeze-out as early as 20 days after conclusion of rules. In the absence of any comparable measure to the first-step tender offer. protect minority shareholders, the use of a share It is notable that the Squeeze-Out Right would consolidation to effect a fractional share squeeze- apply to potential shares such as stock options and out has been seen by practitioners as entailing a convertible bonds. The Special Controlling significant risk that the entire squeeze-out Shareholder seeking to exercise the Squeeze-Out transaction would be challenged as being unfair. Due Right with respect to the existing shares would also to this concern, the use of wholly callable stock has have the right, but not the obligation, to force a cash been the only realistic option to conduct a fractional acquisition of potential shares. share squeeze-out. Upon exercise of the Squeeze-Out Right, the 3. Impact of the Amendment relevant shares and potential shares are transferred To address the drawbacks described above, the directly to the Special Controlling Shareholder, Amendment (i) introduces an alternative squeeze- significantly reducing the complexity entailed under out right that can be easily implemented by a 90% the currently used fractional share method. See controlling shareholder (the “Squeeze-Out Right”) Figure 2 for the basic structure of the Squeeze-Out and (ii) reforms the rules related to fractional share Right. squeeze-outs. Upon exercise of the Squeeze-Out Right, the (a) Introduction of Squeeze-Out Right Special Controlling Shareholder notifies the target The Squeeze-Out Right introduced by the company of the amount of cash consideration for Amendment will eliminate each of the above the remaining shares (and potential shares, if described drawbacks of the fractional share applicable), which amount must be approved by the
Figure 2: Squeeze-Out Right structure
Special controlling Minority Cash shareholder shareholders Exercise of squeeze-out right Acquirer A B
1350 shares 100 shares 50 shares (common stock) (common stock) (common stock)
Remaining shares
Notification of exercise Notification of Target company of squeeze-out right terms of squeeze-out
Approval of board of directors
Source: Mori Hamada & Matsumoto
3 board of directors of the target company. In making and cannot be used to force a cash acquisition of a decision on such approval, directors of the target potential shares. However, it would to some company would owe a duty of care to consider extent address the complexity issue described in shareholders’ interests; i.e., the fairness of the section 2(c) by simplifying the procedure for amount of cash consideration. Minority shareholders changing the shares held by minority shareholders (and the potential shareholders) would also have into fractional shares; the target company can appraisal rights to seek fair consideration in a court simply consolidate the shares by a ratio that would procedure. Further, if the price of the cash result in minority shareholders holding only consideration is deemed to be extremely fractional shares (see Figure 3 below). Although the inappropriate, the minority shareholders (and the currently common method for a fractional share potential shareholders) would be entitled to seek an squeeze-out – i.e. the use of wholly callable stock – injunction of the entire squeeze-out transaction. also continues to be available, consolidation of Unlike a share exchange with cash consideration, shares may come to be preferred by practitioners which has been categorised by the tax authority as due to this simplicity. an activity that is organisational in nature (as Unlike the Squeeze-Out Right, a fractional share described above), a transfer of shares upon exercise squeeze-out, including those conducted by means of of the Squeeze-Out Right takes the legal form of a consolidation of shares as described above, does not direct sale and purchase between the minority have a 90% voting rights requirement. Therefore, if shareholders and the Special Controlling the acquirer fails to obtain 90% of total voting rights Shareholder. Therefore, while there is not yet any upon completion of the first-step tender offer, a definitive tax ruling, it is expected that there would fractional share squeeze-out would be still available be no resulting tax gain at the target company upon as long as it is approved by a shareholder resolution exercise of the Squeeze-Out Right. with a supermajority vote (two-thirds of the votes (b) Reform of the rules related to fractional share cast). The 90% voting rights requirement for the squeeze-outs Squeeze-Out Right is only intended to set the bar The Amendment would grant appraisal rights to the for dispensing with a shareholder resolution; it is shareholders dissenting to a consolidation of shares not intended as setting the threshold for all types of used to effect a fractional share squeeze-out. This minority squeeze-out procedures. reform would give the minority shareholders an Until recently, there had been an argument that appropriate level of protection and thus enable a the fractional share squeeze-out should be share consolidation to be used as an alternative to prohibited because it goes beyond the original the current method of using wholly callable stock purpose of wholly callable stock. However, the for a fractional share squeeze-out. reform of the rules related to fractional share This would not address the issues described in squeeze-outs under the Amendment clarifies that sections 2(a) and (b) above, because a consolidation fractional share squeeze-outs are permissible under of shares will also require a shareholder resolution the Companies Act. Similarly, given that there was
Figure 3: Fractional share squeeze-out by means of share consolidation
Distribution of Minority shareholders cash consideration
Acquirer A B Acquirer A B
750 shares 100 shares 50 shares 5 shares Fractional Fra ctional (common stock) (common stock) (common stock) (common stock) shares shares
1 share in total (common stock) Consolidation of shares (150:1) Target company Target company
cash Approval of shareholders meeting Sale to acquirer (or target company)
Source: Mori Hamada & Matsumoto
4 no addition of a requirement of a “legitimate offer, the exercise of the Squeeze-Out Right would business purpose” for a squeeze-out, it is also now likely be the primary alternative for the reasons difficult to argue that any such purpose is necessary described above. On the other hand, if the acquirer in general. fails to satisfy the 90% threshold, the Squeeze-Out Right would not be available and the fractional share III. Summary squeeze-out by means of either a consolidation of As described above, the Amendment would add two shares or wholly callable stock would need to be practical alternatives for squeeze-outs: (i) a Squeeze- considered. Out Right that is available to a Special Controlling Shareholder and (ii) a fractional share squeeze-out by means of a consolidation of shares. Through Author: these reforms, the Amendment will expedite and Shuhei Uchida, Partner enhance the legal stability of squeeze-out Mori Hamada & Matsumoto transactions. Marunouchi Park Building A full analysis of the pros and cons of the 2-6-1 Marunouchi, Chiyoda-ku reforms implemented by the Amendment must wait Tokyo 100-8222, Japan until there is clarity as to the treatment under tax Tel: +81 3 5220 1859 or other laws. However, based on currently available Fax: +81 3 5220 1759 information, if the acquirer obtains at least 90% of Email: [email protected] the total voting rights through the first-step tender Website: www.mhmjapan.com
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