A New Era for Japanese M&A? Fresh Guidelines from Key Japanese Government Agency Seek to Stimulate Corporate Value Creation through Development of Fair M&A Market

Executive Summary

• Draft of New Guidelines Published. On June 8, 2023, the Ministry of Economy, Trade, and Industry (“METI”), a Japanese government agency tasked with promoting economic vitality in the private sector,[1] published (in draft form) the first revision in nearly two decades to key corporate governance and public takeover guidelines (such draft, the “2023 Guidelines”). The 2023 Guidelines address corporate takeovers with a focus on best practices for responding to unsolicited offers.
• A New Direction? METI published the 2023 Guidelines with a stated goal of promoting and encouraging desirable M&A transactions, which is a change in posture compared to the 2005 Guidelines (as defined below).
• Response Policies and Countermeasures. A key area of the 2023 Guidelines concerns takeover response policies adopted as defenses to hostile takeovers. Response policies are often used by Japanese companies as means to authorize (and to indicate to potential bidders that the company is prepared to take) specified defensive actions to a takeover bid (“countermeasures”).
• Emphasis on Shareholder Intent and Transparency. The 2023 Guidelines emphasize that companies should adopt policies and implement countermeasures in response to takeover bids in accordance with the “rational intent of shareholders.” Shareholders should have the opportunity, time, and information necessary to assess takeover proposals. In the case of an unsolicited bid, a company may adopt without shareholder approval a takeover policy that contemplates specific countermeasures, for example, as a way of encouraging the bidder to negotiate with management and provide additional information to shareholders. Generally, shareholder consent should be sought before any countermeasures are actually implemented. However, in cases of expediency, boards may implement countermeasures first and subsequently seek confirmatory shareholder consent. Forgoing a shareholder vote altogether on countermeasures (either prior or post-facto) is permissible in very limited circumstances only (e.g., where there is a high probability of buyer having an unfair advantage at the expense of other shareholders).
• Necessary and Proportionate. The 2023 Guidelines reiterate and clarify the idea from the prior guidelines (the Guidelines Regarding Takeover Defense for the Purposes of Protection and Enhancement of Corporate Value and Shareholders’ Common Interests, or the “2005 Guidelines”) that any countermeasure implemented in response to a takeover bid must be “necessary and proportionate” to survive judicial review. Shareholder intent plays a role here, too. For example, shareholder resolutions approving countermeasures are considered presumptively “necessary” in principle. Proportionality is inferred based on the ability for an unsuccessful bidder to mitigate their damages. Examples given in the 2023 Guidelines include policies and countermeasures that give a bidder the opportunity to avoid dilution by withdrawing or terminating its bid prior to the implementation of countermeasures that result in actual dilution and harm to the bidder. Additionally, policies and countermeasures, which are designed to secure sufficient time and information for shareholder assessment or that allow the board time and leverage to negotiate more favorable acquisition terms, are more likely to be viewed as necessary and proportionate.
• Comment Period Open Now. METI is inviting public comments on the 2023 Guidelines until August 6, 2023. Interested parties may submit comments by completing the form appended to the cover note to the 2023 Guidelines.  

Background

The 2023 Guidelines come at a moment when the Japanese economy is at a crossroads. On the one hand, decades of low GDP growth have contributed to an environment with considerable inertia directed toward preserving the status quo. On the other, the global macroeconomic and socio-political environment has shifted such that Japan now is in a more favorable position than it has been in many years. Recognizing this opportunity, the 2023 Guidelines seek to convince the business community here that M&A can be a desirable solution to pressing problems. To accomplish this, however, companies must overcome established hostility toward unsolicited takeover proposals.

The 2005 Guidelines were a product of the reform era from which they emerged. At the time, the dismantling of the traditional practice of cross-shareholding by the country’s biggest conglomerates had just begun, and it was feared that this would leave Japanese corporates vulnerable to activist attack.[2] Furthermore, because of the insulation provided by the cross-shareholding system, Japanese companies had little experience with unsolicited bids. The result was that companies rushed to adopt takeover defense policies like the kind advocated by the 2005 Guidelines—i.e., standing policies adopted even when there was no active threat of a hostile takeover.

Almost 20 years later, Japan is in a different place. 2022 was a record year for Japanese M&A volume and Japanese companies continue to be appealing acquisition targets. As of spring 2023, nearly half of the TOPIX 500 Index—more than 1,800 listed companies—traded below 1x price-to-book, compared to about 25% of the European STOXX 600 Index and only 5% of the American S&P 500.[3] Japanese companies are similarly discounted from a price-to-forward-earnings perspective, with the TOPIX currently trading at a nearly 30% haircut to its U.S. counterpart.[4] Furthermore, since 2020, the number of unsolicited tender offers in Japan has started to increase, prompting several companies to invoke countermeasures and new court decisions on takeover response policies. Acknowledging a need for clearer guidance, the 2023 Guidelines seek to establish modern rules of the road to guide and encourage fair, value-creating M&A.

Overview of the 2023 Guidelines

The 2023 Guidelines are divided into four main parts: (1) an outline of the principles driving the revision, (2) a handbook for how company management and boards of directors should respond to takeover proposals, (3) best practices regarding information disclosure in public M&A, and (4) updates to the prior guidance regarding takeover response policies and countermeasures. This alert focuses on sections (1) and (4), but we note that the inclusion of sections (2) and (3) is potentially significant in that it may signal a desire by METI to give companies a more comprehensive toolkit for thinking about M&A.

New Principles: Centering Quantitative Analysis

Both the 2023 Guidelines and the 2005 Guidelines begin from the proposition that takeover defense policies should be used to guard against acquisitions that would damage “corporate value.” However, the 2023 Guidelines acknowledge that the definition of “corporate value” used by the previous version created disincentives for management to overuse takeover defense policies to block or discourage potentially accretive acquisition proposals.[5] Specifically, the 2005 Guidelines defined “corporate value” to encompass not only the textbook notion of “enterprise value,” but also qualitative intangibles, such as consumer, supplier, and employee relationships.[6] As a result, it was easy for management—especially those of companies who stood to benefit most from new management that M&A would provide—to block legitimate takeover proposals in the name of protecting “corporate value.”[7]

The 2023 Guidelines improve on this, envisioning a second definition of “corporate value” that is close to how it is traditionally conceptualized: equity value plus net debt.[8] The 2023 Guidelines advise that the board of directors and management should initially evaluate bids on the basis of this quantitative definition only,[9] although they concede that the qualitative definition may be considered in practice at later stages in the process, such as when shareholders are asked to consider the appropriateness of countermeasures.[10]

Response Policies and Countermeasures: Focus on Shareholder Intent

The 2023 Guidelines also improve on the mechanics of takeover response policies. In Japan, takeover defense is often a two-step process: first, a response plan is “adopted” by a company before any countermeasures that it authorizes are “invoked,” thereby effecting the defense. The 2005 Guidelines emphasized “prior disclosure” as a necessary condition for legally valid and reasonable plans, which, in practice, meant adopting a response policy in the absence of an active bidder.[11] The 2023 Guidelines do away with this recommendation,[12] acknowledging that it had the effect of sending a closed-for-business signal to the market and reduced external discipline on incumbent management.[13] Instead, the 2023 Guidelines present takeover response policies adopted in the “emergent phase”—i.e., once a bidder has already emerged—as an alternative, if one is to be adopted at all, noting that the pre-emptive style response plans have fallen out of favor in practice recently.[14]

Relatedly, against the backdrop of criticism that Japanese companies have historically been “indifferent” to shareholders,[15] the 2023 Guidelines center “shareholders’ intent” as a principle to steer management and directors in evaluating whether a takeover defense plan is appropriate.[16] As a general matter, the 2023 Guidelines advocate for obtaining shareholder consent prior to invoking countermeasures.[17] Such consent should be forgone by a board of directors only in “exceptional and limited circumstances,” and, in such cases, the company should seek confirmatory consent after the fact.[18] For example, utilizing a “majority‑of‑minority” resolution (or majority of non-interested parties’ resolution)[19] or sole board authority to invoke a takeover defense may be appropriate when the method of a bidder’s acquisition is coercive to the target’s shareholders, or when the acquiring party did not follow procedural rules.[20] The 2023 Guidelines caution against abuse of such tactics, however and underline that they should be used only in exceptional cases.[21]

Ensuring Enforceability of Countermeasures: Necessity and Proportionality

The 2023 Guidelines advise that the countermeasures should only be invoked when they are both necessary and proportionate and that they should consider, among other principles, shareholder equality, property rights, and the prevention of abuse by self-interested management. Companies risk injunction if a court finds that a countermeasure was not necessary or proportionate.[22]

Broadly, there are two categories of bids against which countermeasures might be necessary: bids with a flawed “method” and bids with flawed “details.”[23] The former concerns procedural issues: for example, whether a bidder has inappropriately rushed the bidding process without providing sufficient time, information, or negotiation opportunities or structured the acquisition in a way that acts to coerce the target’s shareholders to sell their shares, such as a two-step acquisition with a lower price paid to the target’s shareholders. The second concerns a bid’s substance, such as purchase consideration or potential deleterious effects on the “corporate value” of the target company post-acquisition. In considering whether to adopt countermeasures in response to a bid with flawed details, shareholders and the board should take a holistic perspective, and the guidelines provide that (unlike at the initial consideration stage, shortly after a bid is received) shareholders should be allowed to consider broader, qualitative measures of “corporate value,” such as how employee and supplier relationships would be affected by an acquisition.[24]

Having taken this broad view, countermeasures that are approved by shareholders (whether before- or after-the-fact) are considered presumptively necessary, in principle.[25] The 2023 Guidelines caution, however, that this presumption does not abdicate the board of directors of their separate obligation to carefully consider the necessity of countermeasures, ensuring fairness (e.g., through the involvement of a highly independent board of directors or special committee), and sufficiently fulfilling their duty to communicate with shareholders.[26]

Proportionality, on the other hand, is judged based on the amount and avoidability of damage suffered by a would-be buyer. Generally speaking, the 2023 Guidelines envision that a target company has some obligation to mitigate the damage suffered as a result of invoking countermeasures. For example, a plan that allows a buyer to unwind its position prior to the implementation of countermeasures, thereby avoiding actual dilution and damage, is considered more proportionate than one that does not.

Insights and Next Steps

• The 2023 Guidelines mark a shift in attitude, aimed at stimulating the M&A market in Japan.
• New guidance hopefully will encourage Japanese management to be more open to acquisition proposals, re-centering quantitative corporate value as the key decision-making factor in evaluating bids and emphasizing the primacy of shareholder intent in the decision-making process.
• Though the guidelines are not legally binding, similar prior pronouncements from the agency have had significant impact on the development of M&A law and practice.
• Interested parties have until August 6, 2023, to provide feedback on the draft guidelines.
• Final guidelines are expected to be published in 2H 2023.

[1] Ministry of Economy, Trade and Industry Mission Statement.

[2] 2005 Guidelines at 2. Note: References to the 2005 Guidelines are to the English reference translation.

[3] Dalton Investments at 2 (citing Japan Exchange Group).

[4] Hennessy Funds (citing Bloomberg).

[5] See, 2023 Guidelines at 40 (“there is an inherent risk that takeover [defense] policies may be used by companies which have considerable room for management improvement where the economic significance of an acquisition can be easily demonstrated, or a risk that it may be designed and operated in a manner preventing an acquisition to materialize.”). Note: References to the 2023 Guidelines are to the English reference translation.

[6] 2005 Guidelines at 4.

[7] 2023 Guidelines at 12, 40.

[8] Id. at 12.

[9] Id. at 11-15.

[10] Id. at 62 n. 84.

[11] 2005 Guidelines at 5.

[12] 2023 Guidelines at 43 n. 56 (“While the 2005 Guidelines establishes the “principle of prior disclosure,” the [2023] Guidelines cover cases where a takeover defense policy is adopted in an emergent phase [(i.e., after an active bidder has appeared)], so we have not classified prior disclosure as a general rule.”).

[13] Id. at 43.

[14] Id. at 4.

[15] Japan’s Powerful METI ‘Eager’ for Guidelines that Spur M&A, Official Says (Apr. 18, 2023).

[16] The 2023 Guidelines reference “shareholders’ intent” 12 times and “intent of shareholders” 9 times; the similar phrase “reasonable will of the shareholders” appears only 6 times in the 2005 Guidelines.

[17] 2023 Guidelines at 53-58.

[18] Id. at 16, 45.

[19] The 2023 Guidelines chose to use the term “majority of non-interested parties,” referring to a majority of shareholders with voting rights other than the would-be acquiror, rather than the term “majority-of-minority.” The drafters of the 2023 Guidelines prefer this term, due to the fact that would-be acquirors typically do not hold a majority stake in the target at the time when defensive measures are being considered by the target’s board.

[20] Id. at 56-57.

[21] Id.

[22] Id. at 42.

[23] Id. at 62.

[24] Id. at 62 n. 84.

[25] Id. at 53.

[26] Id. at 63