Utilization of Class Shares and Fundraising under Japanese Corporate Law

The corporate environment in Japan is often perceived as traditional, yet it provides a sophisticated and flexible framework for corporate governance and fundraising through the strategic use of class shares. Defined under the Japanese Companies Act, these specialized shares enable corporations to align shareholder rights and obligations to achieve diverse business objectives. This includes attracting certain types of investors, protecting management control, and facilitating smooth business succession. For foreign companies and investors seeking to navigate the complexities of the Japanese market, understanding these versatile tools is not merely a matter of legal compliance but a critical strategic imperative. This article will explain the basics of class shares under Japanese corporate law, their various forms, practical applications, and the significant role that Japanese case law has played in shaping their implementation.

The Basics of Class Shares and Their Position Under Japanese Corporate Law

In Japan, there is a fundamental principle that all shares issued by a company are equal in terms of rights and obligations. However, Japanese Corporate Law provides an important exception to this principle by allowing companies to issue “class shares,” which differ from ordinary shares in specific aspects of their content. This flexibility enables companies to design their capital structure to meet various strategic needs, such as attracting certain types of investors, managing control, or facilitating business succession.

Article 108, Paragraph 1 of the Japanese Corporate Law explicitly states that a stock company can issue “two or more types of shares with different provisions concerning the following matters” . This provision allows companies to grant diverse rights and conditions to the shares they issue, enabling the existence of multiple types of shares. This article serves as the basis for Article 2, Paragraph 13 of the Japanese Corporate Law, which defines a class share-issuing company . This flexible system allows companies to intentionally differentiate shareholder rights for specific purposes that cannot be achieved with ordinary shares alone.

The matters listed in Article 108, Paragraph 1 of the Japanese Corporate Law, which can have different provisions, are as follows. These items provide a comprehensive legal framework for companies to adjust the control and economic rights of shareholders:

• Dividends of surplus: Companies can set the method and conditions for determining the value of the dividend property to be distributed to shareholders.
• Distribution of residual assets: Companies can set the method and type of distribution of residual assets in the event of dissolution.
• Matters in which shareholders can exercise voting rights at the general meeting: Companies can restrict the matters in which voting rights can be exercised or set specific conditions.
• Requirement of the company’s approval for the transfer of such class shares: Companies can stipulate that the transfer of shares requires the company’s approval.
• The right for shareholders to request the company to acquire such class shares: Shareholders can be granted the right to request the company to buy back shares.
• The company’s right to acquire such class shares upon the occurrence of certain events: Companies can be granted the right to forcibly acquire shares upon the occurrence of specific events.
• The company’s right to acquire all of such class shares by resolution of the general meeting: Companies can be granted the right to acquire all of a certain type of shares by resolution of the general meeting.
• For matters that require a resolution at the general meeting (or the board of directors in companies with a board of directors, or the liquidator in companies with a liquidator), the need for a resolution of the class shareholders’ meeting consisting of the class shareholders: Companies can require a resolution of the class shareholders’ meeting in addition to the usual general meeting resolution for certain important matters.
• The right for class shareholders to elect directors or auditors at the class shareholders’ meeting: Specific types of shareholders can have the right to elect directors or auditors.

These items serve as powerful tools for companies to finely tune their capital structure. For example, by combining provisions on “Dividends of surplus” with “Restrictions on voting rights,” it is possible to design preferred shares for investors who do not seek involvement in management but expect high economic returns. Thus, class shares enable companies to flexibly set the balance between control and economic benefits according to their specific needs.

Utilizing Shares with Restricted Voting Rights

Shares with Restricted Voting Rights and Shareholder Equality

Shares with restricted voting rights are a type of stock that have limitations on the voting rights that can be exercised at shareholders’ meetings. The main purpose of these shares is to facilitate fundraising while allowing existing management or certain shareholders to maintain control over the company. For example, a startup company in need of significant capital can raise funds from external investors without diluting voting rights by issuing this type of stock. In exchange for restricted voting rights, investors can enjoy economic benefits such as the right to receive preferential dividends. This serves as a direct solution to reconcile the conflicting goals of capital injection and maintaining control.

The legal basis for this type of stock is found in Article 108, Paragraph 1, Item 3 of the Japanese Companies Act. This provision allows for different stipulations regarding matters on which voting rights can be exercised at shareholders’ meetings. Restrictions on voting rights can be limited to specific matters (e.g., the appointment of directors) or apply to all matters.

However, when a public company issues shares with restricted voting rights, significant constraints are imposed by Article 115 of the Japanese Companies Act. This article stipulates that “when the number of shares with restricted voting rights exceeds half of the total number of issued shares, the company must immediately take necessary measures to reduce the number of shares with restricted voting rights to half or less of the total number of issued shares.” This provision functions as a ‘check and balance’ mechanism to prevent excessive control by specific shareholders in public companies and to maintain a degree of shareholder equality to some extent. Although a violation of this obligation does not invalidate the issuance of the shares themselves, it does create an obligation for the company to take corrective measures. This means that while private companies have greater freedom, public companies face statutory restrictions that promote shareholder democracy and influence decisions on capital structure.

Relevant Japanese Case Law

An important case related to the issuance of shares with restricted voting rights is the decision by the Tokyo District Court on January 17, 2012 (Sogo Building Center Co., Ltd.). In this case, a company with all shares transfer restricted issued new shares (20,000 ordinary shares) without a resolution of the shareholders’ meeting, and a shareholder filed for a provisional injunction to prohibit the exercise of voting rights on the new shares. The court ruled that the absence of a shareholders’ meeting resolution to decide on the solicitation items constituted a cause for invalidity of the issuance of the solicited shares, recognized that the issuance of the new shares was invalid, and granted the provisional injunction to prohibit the exercise of voting rights. This case demonstrates the importance of shareholders’ meeting resolutions in the issuance of new shares and how defects in such resolutions can affect the exercise of voting rights of the issued shares. It suggests that strict adherence to procedures is essential to enjoy the flexibility offered by different types of shares, and that if there are procedural deficiencies, the courts will intervene to protect shareholders’ rights.

Utilizing Golden Shares with Veto Rights in Japan

Golden shares, also commonly referred to as shares with veto rights, are a potent type of stock that allows certain shareholders to exercise a de facto veto over resolutions concerning significant company matters. These shares manifest their power by requiring resolutions at the general shareholders’ meeting or the board of directors to also be approved by a class shareholders’ meeting composed of golden share holders, for specific resolutions (Article 108, Paragraph 1, Item 8 of the Japanese Companies Act). In other words, unless the golden share holders approve, the proposal will not be sanctioned. This mechanism enables even a minority of shares to exert decisive influence at critical junctures in company management.  

The strategic use of golden shares is diverse. The most common application is as a defense against hostile takeovers. For example, a founder who retains a minority of golden shares can maintain control over the company after stepping down, preventing unwanted acquisitions or business transfers. In the context of business succession, a predecessor in management can transfer ordinary shares to a successor while retaining golden shares, thus maintaining a check on the successor’s management and serving as a ‘safety valve’ for critical business decisions. Items that can be set for golden shares include the appointment and dismissal of directors and representative directors, determination of directors’ compensation, business transfers and mergers, asset transfers, high-value financing, issuance of new shares, and significant organizational changes. While this concentration of control can provide strategic advantages, it also entails governance risks.  

However, exercising golden shares comes with risks. Their powerful authority can sometimes permit ‘dictatorial’ decisions by managers, potentially hindering valuable M&A or business proposals for the company. Additionally, if golden shares fall into the hands of heirs other than the designated successor, there is a risk of causing turmoil in company management. Therefore, careful consideration and design are essential when utilizing them, such as limiting the scope of veto rights to significant company matters.  

Utilization of Redeemable Shares

Overview of Redeemable Shares

Redeemable shares are a type of stock that a corporation can acquire without the consent of shareholders, provided certain conditions (“redemption causes”) predetermined in the articles of incorporation occur. This means that the company has the right to forcibly buy back shares from shareholders. The consideration for the acquisition can be cash, the company’s bonds, new share subscription rights, other types of shares, etc., as stipulated in the articles of incorporation. This system contrasts with the shareholder’s right to request redemption, where the shareholder can unilaterally demand the company to acquire their shares.  

Redeemable shares have their legal basis in Article 108, Paragraph 1, Item 6 of the Japanese Companies Act. Possible redemption causes include “the arrival of a separately determined date” or “a specific shareholder losing a specific status.” When the company exercises its right to acquire, it must acquire all the targeted shares on the acquisition date and, without delay after the effectuation, announce or notify the shareholders that the redemption cause has occurred (Japanese Companies Act, Article 170).  

Purposes of Utilizing Redeemable Shares

Redeemable shares are utilized for various strategic purposes.

• Succession Planning: In cases where there are multiple successor candidates, redeemable shares can be issued to all candidates in advance. Eventually, only the shares of the chosen successor are converted into ordinary shares, while the shares of other candidates are exchanged for non-voting shares or cash, facilitating a smooth transition of management. Additionally, upon the death of an owner-president, the company can buy back dispersed shares and consolidate them to the successor. This serves as a powerful tool for efficiently managing ownership and facilitating intergenerational transitions.  
• Fundraising: They can be issued as an alternative to corporate bonds and later acquired in exchange for cash upon repayment, or issued as non-voting shares with preferred dividends and later converted into ordinary shares. This allows the company to build a flexible capital structure tailored to specific fundraising needs.  
• Exclusion of Shareholders (Squeeze-out): Redeemable shares can be used to forcibly acquire shares from undesirable shareholders or investors who have achieved a specific objective. For example, they can be applied in shareholder restructuring during a Management Buyout (MBO) or company reorganization. This means that the company has the ability to actively manage ownership and exclude unnecessary shareholders.  
• M&A and Business Reorganization: As part of organizational restructuring, specific shares can be forcibly acquired to streamline the capital structure. This simplifies the capital structure in complex M&A transactions and accelerates the integration process.  

In the acquisition process of redeemable shares, the consideration cannot exceed the distributable amount on the acquisition date. However, there is no limit on the distributable amount when issuing the company’s own shares as consideration. This constraint demonstrates an important balance in protecting the financial health of the company while securing the economic interests of shareholders.  

Relevant Japanese Case Law

Regarding the determination of the acquisition price for redeemable shares, a fair price assessment by the courts is required. For instance, the Supreme Court decision on July 1, 2016 (Heisei 28), overturned the Tokyo High Court’s judgment on the determination of the acquisition price for all redeemable shares and decided on a new price per share.  

In the Tokyo High Court decision on October 6, 2020 (Reiwa 2), considering the principle of prohibition against detrimental changes, the court dismissed the appeal against the determination of the share acquisition price and maintained the original decision. These cases clarify the utmost importance of fair price calculation when the company exercises its acquisition right, ensuring the recovery of shareholders’ invested capital. This provides a guarantee to foreign investors that their investments will be fairly valued, even in the event of a compulsory acquisition.

Utilizing Shares with Demand Rights in Japan

Shares with demand rights allow shareholders to request the acquisition of their held shares by the corporation. This means that shareholders have the right to have the company buy back their shares at their own will, in contrast to shares with acquisition clauses where the company unilaterally acquires the shares. This right has a legal basis in Article 108, Paragraph 1, Item 5 of the Japanese Companies Act. As a mechanism that enables shareholders to request the company to buy back shares, it functions to ensure investor-driven liquidity and risk mitigation.

Shares with demand rights are primarily utilized as an “exit strategy” for investors and as a flexible means of financing for companies. While shares are generally freely transferable, finding a buyer can be particularly challenging for private companies. In such situations, the company’s promise to buy back shares allows investors to invest with confidence. This lowers the investment threshold for investors, making it easier for companies to raise more funds.

Specific examples of utilization include:

• Lowering Investment Hurdles: By ensuring that investors can reliably recover their funds, the incentive to invest is increased. For instance, by attaching demand rights to shares that offer preferential dividends in exchange for restricted voting rights, investors can secure both economic benefits and liquidity. This becomes a crucial element for investors to invest with confidence, especially in less liquid private markets.
• Flexible Financing: By guaranteeing future buybacks to investors, companies can more easily raise additional funds. This allows companies to execute financing strategies flexibly according to specific projects or growth stages.
• Employee Incentives: Attaching demand rights to shares granted to employees ensures that the company will buy them back in the future, leading to increased motivation and retention of talented personnel. This serves as an incentive for employees to confidently hold shares and contribute to the company’s growth.

The consideration for the acquisition of shares with demand rights can be stipulated in the articles of incorporation to include not only money but also other types of shares, corporate bonds, and stock acquisition rights. However, when the company responds to a demand for acquisition, it cannot provide consideration exceeding the distributable amount on the date of the request (Article 166, Paragraph 1 of the Japanese Companies Act). This limitation on the distributable amount is an important provision to protect the financial health of the company, demonstrating the interplay between legal stipulations and financial realities, where the ability of shareholders to exercise their rights is directly dependent on the financial state of the company.

Utilizing Shares with All Acquisition Clauses in Japan

Overview of Shares with All Acquisition Clauses

Shares with all acquisition clauses are a type of stock that allows a joint-stock company, through a special resolution of the shareholders’ meeting, to compulsorily acquire all issued shares of a specific class. This powerful tool enables a company to ‘sweep’ away a particular class of shares and is legally grounded in Article 108, Paragraph 1, Item 7 of the Japanese Companies Act. The consideration for the acquisition can be set in the articles of incorporation and may include cash, other types of shares, corporate bonds, or new share subscription rights, and in some cases, the consideration can be set to ‘none.’ This system is positioned as a final measure for corporate reorganization or concentration of control purposes.

Strategically, this system is mainly utilized in scenarios such as:

• Exclusion of Minority Shareholders (Squeeze-Out): By converting all ordinary shares into shares with all acquisition clauses and then compulsorily acquiring these shares through a special resolution of the shareholders’ meeting, a company can forcibly exclude minority shareholders. This is used to expedite decision-making and prevent interference by specific shareholders. This mechanism is extremely effective in streamlining shareholder composition and enhancing management efficiency.
• Corporate Reconstruction through 100% Capital Reduction: When a company in debt excess aims for reconstruction, it can acquire all existing shareholders’ shares and temporarily reduce the capital to zero, making it easier to accept new sponsorship. This refreshes the company’s financial base and paves the way for recovery. It is an important means for radical reconstruction when a company is on the brink of bankruptcy.
• Defense Against Hostile Takeovers: In the event of a hostile takeover, the company can convert the acquirer’s shares into shares with all acquisition clauses and compulsorily acquire them, functioning as a defense strategy to prevent the acquirer from obtaining management rights. In this case, shares with restricted voting rights may be issued as consideration. This allows the company to protect its control from unwanted acquirers.

Issuance and Acquisition of Shares with All Acquisition Clauses

The issuance and acquisition of shares with all acquisition clauses require a special resolution of the shareholders’ meeting. A special resolution requires the attendance of more than half of the voting rights of eligible shareholders and the approval of at least two-thirds of the voting rights of the attending shareholders. This enables the majority shareholders to acquire shares against the wishes of the minority shareholders. On the acquisition date, the company acquires all the shares with all acquisition clauses and, without delay after the effectuation, announces or notifies the shareholders that the cause for acquisition has occurred (Japanese Companies Act, Article 170). While this system grants significant authority to the majority, its exercise is subject to strict procedures.

Relevant Japanese Case Law

An important case law related to the squeeze-out using shares with all acquisition clauses is the Tokyo High Court decision on March 12, 2015 (Heisei 27). This decision indicated that even if the share issuance associated with the squeeze-out occurs while a lawsuit seeking to cancel the shareholders’ meeting resolution concerning the all acquisition clause shares is pending, and it becomes impossible to contest the invalidity, the benefit of the lawsuit does not disappear. Furthermore, even if a subsequent shareholders’ meeting resolution is made to ratify the decision, the benefit of the lawsuit does not disappear if the subsequent resolution is not validly established or if there is a risk of harm to the procedural rights and interests of the parties involved. This case emphasizes the importance of strict adherence to procedures in the process of a squeeze-out using shares with all acquisition clauses and suggests that a flawed resolution is not easily cured. It demonstrates that even with the exercise of strong control rights, the accuracy of legal procedures is extremely important, and foreign companies considering similar measures in Japan must exercise meticulous care.

The Strategic Significance of Class Shares and Practical Considerations Under Japanese Corporate Law

Strategic Significance of Class Shares

In Japan’s corporate law, class shares offer extremely flexible and strategic solutions to various management challenges that companies face. Their main strategic significances are as follows:

• Enhancing Corporate Governance: Through the issuance of shares with restricted voting rights or veto rights, specific shareholders (e.g., founders or key investors) can maintain management control while raising new capital. This ensures stability and continuity in management and prevents unwanted external interference.
• Increasing Flexibility in Fundraising: By issuing preferred shares or shares with redemption rights, companies can offer attractive terms to investors, facilitating capital raising from diverse funding sources. This is particularly crucial for startups and growth companies to efficiently secure the capital necessary for growth.
• Smooth Business Succession: Utilizing shares with veto rights or redemption clauses can facilitate a smooth transition of management rights to successors, maintaining the influence of the previous management while preventing the dispersion of shares.
• M&A Strategy and Defense Against Hostile Takeovers: Shares with full acquisition clauses function as a powerful defense against minority shareholder exclusion (squeeze-outs), capital restructuring during company reorganization, and hostile takeovers. This allows companies to smoothly pursue strategic M&As and prevent unwanted transfers of control.

When considering the use of class shares, transfer-restricted shares (Article 107, Paragraph 1, Item 1 of the Japanese Companies Act) become a fundamental concept for many private companies. As the name suggests, these shares require company approval for transfer, effectively preventing undesirable individuals from becoming shareholders and protecting against company takeovers. Most small and medium-sized enterprises include this transfer restriction in their articles of incorporation. Introducing transfer-restricted shares can also simplify company operations and stabilize management by eliminating the need for a board of directors and extending the term of officers up to ten years. This type of share functions as a primary control protection mechanism for Japanese private companies and often forms the basis for other class share strategies.

Practical Considerations

In the introduction and operation of class shares, meticulous drafting of the articles of incorporation and strict adherence to related legal procedures are essential. In particular, attention is needed in the following areas:

• Clarity of Articles of Incorporation: The details of class shares must be clearly stated in the articles of incorporation, as ambiguous provisions can lead to future disputes. Clearly defining the scope of rights and obligations is crucial to avoid later troubles.
• Consensus Among Shareholders: Introducing or amending class shares requires thorough explanation and consensus building with existing shareholders. Especially, changes affecting existing rights cannot proceed smoothly without the understanding and cooperation of shareholders.
• Constraints on Distributable Amounts: When shares with redemption rights or acquisition clauses involve monetary compensation, it is necessary to understand that there are limitations on the company’s distributable amounts. This legal constraint is to maintain the company’s financial health, meaning that the exercise of shareholder rights is subject to the company’s financial condition.
• Registration Procedures: Proper registration procedures must be carried out for the issuance, amendment of terms, or acquisition of class shares. Inadequacies in these procedures can cast doubt on the legal validity of the shares.

Summary

The system of class shares provided under Japanese Corporate Law offers extremely practical and strategic solutions to the complex management challenges that companies face. Shares with restricted voting rights allow for the balance of fundraising and the maintenance of management control, while shares with veto rights enable certain shareholders to exert decisive influence on important company matters. Additionally, shares with acquisition clauses facilitate company-led adjustments to shareholder composition, and shares with demand rights ensure liquidity for investors. Furthermore, shares with full acquisition clauses are indispensable tools for the radical restructuring of capital composition, such as the exclusion of minority shareholders, company reorganization, or defense against hostile takeovers. These class shares can be utilized not only on their own but also in combination with foundational systems like restricted transfer shares to construct more layered corporate governance structures.

However, to maximize the use of these powerful legal tools, a deep understanding of Japanese Corporate Law, meticulous articles of incorporation tailored to the individual company’s situation, and strict adherence to legal procedures are essential. As demonstrated by Japanese case law, procedural defects can impair the legal effectiveness of even strategically valid measures. For foreign companies and investors to succeed in the Japanese market, it is crucial to accurately grasp these legal aspects and manage potential risks appropriately.

Monolith Law Office has a wealth of experience in assisting numerous clients with the utilization of class shares under Japanese Corporate Law. Our firm employs several English-speaking attorneys with foreign legal qualifications, enabling us to explain Japan’s complex legal system from an international perspective and provide optimal legal solutions tailored to specific business needs.