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"):

A. Directors shall not blur a question of what interests a Defense Measure is trying to protect by referring to interests of stakeholders other than shareholders or apply an expansive interpretation of the conditions for invoking a Defense Measure with the hidden purpose of entrenching their positions.

B. Directors shall not implement a Defense Measure simply because of the suitor's plan to utilize the assets of the target company for collateral in the acquisition debt or a plan to cause the target company to declare a large amount of dividends, following a disposal of unnecessary properties subsequent to the takeover, where any such plan is not expected to result in an injury to the common interests of shareholders.

C. Directors shall not effectively deprive shareholders of an opportunity for their review of an offer by delaying the board review period for evaluation of the offer beyond the reasonable extent necessary or by repeatedly extending such review period.

D. Directors shall give serious consideration to the merits of an offer such as the terms and conditions of the offer and the effect of the offer on the common interests of shareholders, as well as the attributes and financial resources of the suitor.

E. Directors shall diligently engage in a negotiation with the suitor toward the betterment of the offer where there is a possibility that a revision of the terms and conditions of the offer may promote the common interests of shareholders.

F. Directors shall refrain from implementing a Defense Measure if a takeover is expected to increase the common interests of shareholders.

G. Directors shall discharge their duties by explaining fully the result of their evaluation of an offer, with sufficient factual basis, so as to allow shareholders to make an investment decision as to the appropriateness of the offer.

H. Directors shall ensure the independence of a special committee (if established) from the management and shall be responsible for their decision on whether to follow an opinion expressed by such committee.

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.

Except where a review period of an offer is extended unreasonably, this type of Defense Measure may be introduced and implemented by the board of directors. Directors of a target company are required to perform their duties to explain the result of their evaluation of an offer based on underlying facts so that shareholders can make a judgment as to the appropriateness of the offer or the target company can undertake negotiations with the suitor. The 2008 Report states, on the other hand, that a suitor should not be required to disclose all the details of the business plan or projected business results, because it is too burdensome a requirement and would make an offer more difficult.

  • 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.

The defense measure in this category may be implemented by a decision of the board of directors in order to protect the common interests of the shareholders. This is in effect similar to self-defense in the face of an abusive takeover attempt. Directors, however, should be able to establish that the takeover attempt in question would pose obvious harm to the common interests of the shareholders.

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

The 2008 Report generally cautions against the implementation of Defense Measures in this category. At a minimum this type of Defense Measure, the 2008 Report states, should be applied sparingly and the Defense Measure must satisfy the requirements of necessity and properness. The 2008 Report specifically refers to the caveat as to shareholders' approval, by stating that the approval by a large number of shareholders by itself does not necessarily justify an implementation of a Defense Measure. A question of whether a Defense Measure is legitimate depends upon such factors as whether the directors have performed their duties of explanation to the shareholders, the attributes of the suitor, substance of the tender offer, and composition of the shareholders of the target company.

Summary of Major Court Rulings on Takeover Defense Issues

Past Court Cases

Date of Ruling

Target Company

Type of Defense Measure


March 23, 2005

Nippon Broadcasting

Grant of share purchase warrants by a resolution of the board of directors to a certain affiliated company for the purpose of diluting the shares acquired by the suitor

Tokyo High Court:

Not legitimate because a company may not issue shares for the purpose of changing the shareholding status except where such issuance is justified in light of protection of the common interests of shareholders

June 15, 2005

NIRECO Corporation

Grant of share purchase warrants by a resolution of the board of directors to the then existing shareholders (as of a given record date) that is expected to dilute the shares of a suitor upon a takeover attempt in the future

Tokyo High Court:

Not legitimate because it causes damage to existing shareholders (as of a given record date) who are expected to suffer from the probable decline of the share price due to investors' aversion to such shares being subject to a possible and unknown dilution in the future

July 29, 2005

Japan Engineering Consultants, Co., Ltd.

Share split by a resolution of the board of directors with an effective date being set well after the date of a scheduled AGM for the purpose of allowing shareholders to consider at the AGM a takeover offer

Tokyo District Court:

Legitimate because the board of directors is entitled to adopt a suitable measure for the purpose of providing information and time to shareholders to deliberate upon the proposal

August 7, 2007

Bull-Dog Sauce Co., Ltd.

Grant of share purchase warrants by a resolution of the shareholders meeting, with a discriminative feature of disallowing the unsolicited suitor to exercise such rights

Supreme Court of Japan

Legitimate (see above)


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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Ken Kiyohara

Jotaro Yokoyama

Scott Jones

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