Japan: Recent Developments In Takeover Defense Discussions In Japan

The corporate value study group, comprising leading scholars and practitioners and orchestrated by the Ministry of Trade, Economy and Industry of Japan ("METI"), has recently issued a report on takeover defense measures (the "2008 Report"). The 2008 Report, issued on June 30, 2008, is neither a document with any legally binding effect nor a formal report of a government agency. However, it is expected to have a great impact on M&A activities in Japan because the 2008 Report reflects the views of both leading practitioners and academia and, above all, is intended to lay a foundation for a level playing field in M&A activities in Japan. This Commentary summarizes the discussions on takeover defense measures and the 2008 Report, with our comments on the expected impact on market practices.

Spread of Shareholders Rights Plans

Back in 2005, formal guidelines relating to takeover defenses, entitled the "Defense Measures Guidelines" ("2005 Guidelines"), were first distributed in Japan. The 2005 Guidelines were the joint product of METI and the Ministry of Justice. Since the publication of the 2005 Guidelines, the number of companies adopting takeover defense measures has rapidly increased from 13 (as of June 2005) to more than 560 (as of the end of June 2008), accounting for approximately 11 percent of all listed companies in Japan.

The takeover defense measures adopted by these companies are very similar, following the general principles proposed by the 2005 Guidelines. The 2005 Guidelines propose in principle as follows: (i) a takeover defense measure (the "Defense Measure") should contribute to the preservation or increase of a company's corporate value; (ii) the Defense Measure should be adopted by a resolution of the general meeting of the shareholders or, if adopted by the board of directors, should be subject to the shareholders' decision of whether to retain or abolish the same; and (iii) the Defense Measure should be designed so as not to be used for the disguised purpose of the entrenchment of the management of the target company. Such a typical Defense Measure is referred to in Japan as a "prior warning type takeover defense measure," which generally calls for an offeror to provide information on a proposed acquisition plan (or a takeover offer) and to wait for a certain specified review period by the board of directors of the target company before it commences an acquisition of shares in excess of a certain level, which is usually 20 percent of the issued and outstanding shares of the target company.

The 2005 Guidelines were well received by the business community as they laid down the foundation for a common basis of reasonable Defense Measures for Japanese companies at a time when there was a serious legal question as to whether it was lawful to adopt such Defense Measures. The 2005 Guidelines, however, were neither perfect nor comprehensive; they only prescribed general principles to be followed when adopting Defense Measures but did not address the issue of the requirements for the legitimate implementation by a target company of a Defense Measure to fend off an unwanted suitor. A takeover battle in the summer of 2007 between Bull-Dog Sauce, a TSE-listed local manufacturer of Worcester sauce, and Steel Partners Japan, a U.S.-based hedge fund, was a showcase for legal issues concerning the actual implementation of a Defense Measure, and it stirred up public debate and controversy in Japan.

Bull-Dog Sauce v. Steel Partners

Bull-Dog Sauce Co., Ltd. ("Bull-Dog Sauce") is one of the well-known Tonkatsu sauce manufacturers in Japan, established in 1926. Steel Partners Japan Strategic Fund ("Steel Partners"), then holding approximately 10.25 percent of the shares of Bull-Dog Sauce, launched a hostile tender offer in May 2007, without advance notice to or negotiation with Bull-Dog Sauce. At this time, Bull-Dog Sauce had no Defense Measure in place.

In the face of Steel Partners' hostile tender offer, Bull-Dog Sauce proposed to its shareholders at the June 2007 annual general meeting of shareholders to introduce and invoke a Defense Measure, which proposal was approved by an overwhelmingly high ratio of affirmative votes—more than 80 percent of all the voting rights and 88 percent of the votes represented at the meeting. This Defense Measure (or poison pill) adopted by Bull-Dog Sauce took the form of the free allocation of share purchase warrants to all the shareholders of record of a given day at a rate of three warrants per one share, with a special feature disallowing Steel Partners to exercise such warrants. Instead, it provided for cash consideration payable to Steel Partners, with the net effect of diluting Steel Partners' shareholding from its prior shareholding ratio of approximately 10.25 percent to less than 2.82 percent.

Steel Partners sought to enjoin the issuance of such poison pill but lost three times consecutively before the Tokyo District Court, the Tokyo High Court, and the Supreme Court of Japan. The Supreme Court decision rendered in August 2007 upheld Bull-Dog's poison pill, holding that a discriminative treatment of shareholders is permissible (a) if the acquisition of control by a particular shareholder is expected to result in an injury to the corporate value of the target, thereby injuring the common interests of shareholders and (b) unless such discriminative treatment is found to be inequitable or lacks proportionality. In addition, the Court held that (a) the decision made by the shareholders' resolution at Bull-Dog's shareholders meeting that the common interests of shareholders are expected to be injured should basically be respected unless there is a defect that is so serious that the shareholders' own judgment is found to lack legitimacy, and (b) Bull-Dog's Defense Measure does not go against the principle of fairness and does not lack proportionality.

Consequences of the Bull-Dog Case

The Bull-Dog case appears to have had the effect of spreading the mistaken belief among Japanese companies that shareholder approval will be viewed favorably by the court and procuring a certain ratio of shareholders friendly to the management will make a bullet-proof takeover defense. This has had the effect of a revival of cross shareholdings among Japanese companies, which is reported to have increased from 11.1 percent (as of the end of March 2005) to 12.3 percent (as of the end of March 2008) of all listed shares. The Bull-Dog case also created an image among foreign investors that the Japanese market is closed and so protective that it is not attractive. The combination of these two unfortunate reactions seem to have had the effect of discouraging foreign investors from investing in Japan and thereby creating a diminished appetite for Japanese stocks. This background appears to have set the tone for the discussions at the corporate value study group, leading to the publication of the 2008 Report.

Framework of the 2008 Report and Directors' Code of Conduct

The 2008 Report starts by prescribing the basic perspectives (or principles in approach) to be noted by target companies in the face of unsolicited offers, and provides for a directors' code of conduct in adopting and implementing a Defense Measure. The Report further organizes the recent cases along the line of such basic perspectives to provide a basis for the directors' code of conduct proposed in the 2008 Report. The basic perspectives emphasized in the 2008 Report are that (a) compensation for the dilution of the shareholding in the target company should not be paid to an unsolicited suitor and (b) shareholder approval itself does not provide a definitive justification of a Defense Measure. Following these perspectives, the 2008 Report goes on to prescribe the following code of conduct for directors ("Code of Conduct"):

Three Classifications that Organize the Past Court Cases

With reference to the past court cases (see "Summary of Major Court Rulings on Takeover Defense Issues" below) the 2008 Report classifies the legal treatment of Defense Measures into three categories and provides for general requirements or commentaries for each of these three classifications, as follows:

• Defense Measures intended to ensure (a) the time and information for shareholders to consider the appropriateness of an offer or (b) the opportunity for negotiation between the suitor and the target company.
  
  

• Defense Measures intended to fend off an abusive takeover attempt where it is obvious it will be detrimental to the common interests of the shareholders.
  
  

• Defense Measures based on a judgment on the merits of an expected effect of the takeover.
  
  

Summary of Major Court Rulings on Takeover Defense Issues

Conclusion

As described above, the 2008 Report addresses the issue of the appropriateness of a takeover defense or other measures to frustrate hostile takeover attempts, and it sheds light on the directors' conduct in responding to such a takeover attempt. It is notable that the 2008 Report refers to the negotiation by the directors with an offeror with the view toward the betterment of the terms of an offer in order to promote the common interests of the shareholders (see Code of Conduct above). It further urges the directors of a target company to refrain from implementing a Defense Measure and to allow an offer to proceed promptly if a tender offer is expected to benefit the common interests of the shareholders (see Code of Conduct above).

However, coupled with the ambiguity of the concept of the "common interests of the shareholders," and given the fact that the boards of Japanese listed companies are still filled with "inside" directors, the true efficacy of the Code of Conduct in the 2008 Report remains unclear. As Japan is still a country where there are very few successful hostile takeovers, it may be that the "quality" of corporate governance of Japanese listed companies is the key to the realization of the 2008 Report's ultimate goal of contributing to the growth of the national economy. With the emergence in Japan of vigilant institutional investors as well as activist shareholders, the time is expected to come soon when Japan begins to follow worldwide trends in terms of M&A activities. To see that happen, however, the ingrained tendency in Japan of reviving cross shareholdings needs to be eliminated. At least it is encouraging to note that the 2008 Report (endorsed by METI) duly emphasizes the belief that hostile M&A activity will have the positive effect of disciplining the management of Japanese companies.

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