1. What are the trends impacting acquisition finance in your jurisdiction and what have been the effects of those trends? Please consider the impact of recent economic cycles, Covid-19, developments relating to sanctions, and any environmental, social, and governance ("ESG") issues.

In recent years, major global private equity funds have been actively investing in Japan. Along with their expanded presence, there has been the need for transactions in Japan to adopt features of global acquisition finance, such as the 'certain funds' concept that was rarely seen under traditional finance practice in Japan.

Other notable recent trends in the M&A market in Japan include the increasing number of growth investments using leveraged finance sponsored by private equity funds, including investments in pre-IPO target companies.

Since 2020, the global Covid-19 pandemic has led to a temporary downturn in M&A transactions, as well as a significant impact on existing completed acquisition financings where many portfolio companies required financial covenant waivers or emergency credit facilities. Among them, one of the largest scale leveraged financings in Japan has been forced into civil rehabilitation proceedings. While M&A transactions have been rebooted and remain active, financial terms (including the minimum equity requirement, interest margins, upfront fees and financial covenants) offered by lenders have become more stringent compared to pre-Covid years due to ongoing economic uncertainty and lenders' limited risk tolerance. As a forecast towards 2024, it is expected that the monetary policy of the Bank of Japan will shift to allow increase of interest rates, which may lead to higher interest rates in acquisition finance.

2. Please advise of any recent legal, tax, regulatory or other developments (including any reforms) that will impact foreign or domestic lenders (both bank and non-bank lenders) in the acquisition finance market in your jurisdiction.

The parallel debt structure has been a debated topic in Japan, and we do not see this structure used in the Japanese market except for parallel debt structures governed by non-Japanese law (such as English law or NY law) involving a Japanese-law governed security interest. One positive move towards utilizing the parallel debt structure in Japan is the amendment of the Civil Code (Act No. 89 of 1896, as amended) which came into effect in April 2020 and explicitly provides a concept of joint and several claims among multiple creditors created by a contract. It is anticipated that this amendment could facilitate the adoption of the parallel debt structure governed by Japanese law in the future.

3. Please highlight any specific high level issues or concerns in your jurisdiction that should be considered in respect of structuring or documenting a typical acquisition financing.

In the Japanese market, the three "mega banks" (MUFG Bank, Sumitomo Mitsui Banking Corporation and Mizuho Bank) play a dominant role in deals with larger exposures. This often leads to a situation where the capacity to retain the mega banks as arrangers is a key issue in order to successfully arrange acquisition finance of large-cap deals for amounts more than one billion US dollars.

In the Japanese market, a substantial part of acquisition finance transactions is documented based on a standard form unique to Japanese traditional banking practice, while documentation for acquisition finance transactions involving global private equity funds is usually made based on a model form of the Loan Market Association (LMA).

4. In your jurisdiction, due to current market conditions, are there any emerging documentary features or practices or existing documentary provisions/features which borrowers or lenders are adjusting or innovating their interpretation of, or documentary approach to?

ESG finance has been getting more attention from participants in the Japanese finance market.

For example, according to the Ministry of the Environment Government of Japan (MOE), the number of green loan deals has increased from one in 2017 to 180 in 2022. The Japanese government encourages expansion of ESG finance transactions by, for instance, issuing MOE guidelines for green loans, green bonds, sustainability-linked loans and sustainability-linked bonds. So far, the impact of ESG-related issues on the terms and conditions of acquisition finance documentation in Japan has been limited, but this is expected to change as ESG concerns grow in significance.

5. What are the legal and regulatory requirements for banks and non-banks to be authorised to provide financing to, and to benefit from security provided by, entities established in your jurisdiction?

A foreign investor (whether a bank or non-bank) who intends to engage in a money lending business in Japan must be either licensed as a foreign bank branch under the Banking Act of Japan or registered with the relevant authorities under the Money Lending Business Act of Japan (MLBA), unless the money lending in question satisfies an exemption from the MLBA (such as loans to certain affiliates). Both a licensed foreign bank branch under the Banking Act and a registered money lender under the MLBA are required to maintain a place of business in Japan.

6. Are there any laws or regulations which govern the advance of loan proceeds into, or the repayment of principal, interest or fees from, your jurisdiction in a foreign currency?

There is no specific law in Japan that prohibits or restricts the advance of loan proceeds into, or the repayment of principal, interest or other amount from, Japan in a foreign currency.

7. Are there any laws or regulations which limit the ability of foreign entities to acquire assets in your jurisdiction or for lenders to finance the acquisition of assets in your jurisdiction? Please include any restrictions on the use of proceeds.

Under the Foreign Exchange and Foreign Trading Act of Japan ("FEFTA"), when a foreign investor acquires shares in a Japanese company conducting business activities in certain types of designated business listed in the FEFTA (such as businesses related national defense and nuclear power), a notification is required to be filed with the Japanese government via the Bank of Japan.

8. What does the security package typically consist of in acquisition financing transactions in your jurisdiction and are there any additional security assets available to lenders?

A typical security package for Japanese acquisition financings include: (1) a pledge over shares in the borrower and the target (as well as its material subsidiaries); (2) a pledge over receivables of bank accounts of the borrower and the target (as well as its material subsidiaries) held with the lenders to the acquisition financings; and (3) security interests over other material assets of the target (as well as its material subsidiaries) that include, among others, intragroup loans, trade receivables, real estate, movable fixed assets and inventory, intellectual property rights, investment securities, insurance receivables and lease deposit receivables. The scope of the security package is in principle 'all assets', but the security package is usually negotiated between the parties based on a costbenefit analysis.

9. Does the law of your jurisdiction permit (i) floating charges or any other universal security interest and (ii) security over future assets or for future obligations?

Under the current Japanese law, there is no concept of a blanket security interest over all assets of a person or entity such as a floating charge. Accordingly, a security interest needs to be created individually over each type of asset.

In this connection, discussions on the establishment of a new regime of "business growth charge" (jigyou seichou tampo ken) to create a floating charge over all assets, including intangible assets (such as goodwill), have been ongoing within the Financial System Council (a working group within the Financial Services Agency of Japan) since 2022. The main purpose of the business growth charge is to facilitate smooth fundraising for small and medium-sized enterprises and start-ups that do not possess substantial tangible assets. However, it also presents the possibility of a new security regime for acquisition finance. According to the latest report by the Financial System Council, the chargee in a business growth charge is contemplated to be a security trustee whch has a special trust licence. Needless to say, industry players are closely monitoring these developments.

It is legally possible to create a security interest over (a) collective movable assets that are identifiable by location and types of asset or (b) collective receivables, including current and future claims that are identifiable by types of claim, timing (or a period of time) of occurrence and underlying contracts.

10. Do security documents have to (by law) include a cap on liabilities? If so, how is this usually calculated/agreed?

In order to validly create a revolving mortgage (ne-teitoken) over real estate (being a type of mortgage created to secure unspecified claims of a certain scope, typically a revolving facility), it is required by law to set a maximum claim amount (kyokudo-gaku) on the secured obligations. There is no explicit rule by law on how the maximum claim amount is calculated, and in practice it is up to commercial negotiations, while the total facility amount is usually referred to. For other types of security interests, there is no statutory requirement of including a cap on liabilities.

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Originally Published by The Legal 500

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