Injunction Against the Issuance of Shares for Subscription under Japanese Corporate Law

In the management of a company, fundraising is an essential activity for the growth and maintenance of a business. One of the representative means for this is the issuance of new shares to solicit subscribers, known as a public offering of shares. Through this process, a company can secure substantial funds relatively quickly, which can be allocated to capital investment, research and development, or improving financial constitution. However, the issuance of new shares can significantly impact the interests of existing shareholders. For instance, the so-called ‘dilution’ effect may occur when a large number of new shares are issued, reducing the value of the shares held by existing shareholders and their voting rights proportion at the shareholders’ meeting. This impact is particularly pronounced if shares are issued at a significantly favorable price to specific third parties or if the current management issues shares solely to maintain their control, unfairly harming the interests of existing shareholders.

To protect shareholders from such situations, Japanese Corporate Law grants them the right to seek an injunction against the issuance of new shares. This right to request an injunction is an extremely powerful legal tool to prevent illegal or unfair fundraising procedures in advance. The main cases where an injunction is granted are when the procedures violate laws or the company’s articles of incorporation, or when they are carried out by ‘significantly unfair methods.’ In particular, the determination of whether the ‘significantly unfair methods’ apply depends on the ‘main purpose’ of the issuance, which questions the intentions of the company’s management. This article focuses on the right to seek an injunction against the issuance of new shares under Japanese Corporate Law, explaining in detail what constitutes a violation of laws or articles of incorporation, and what specifically is meant by ‘significantly unfair methods,’ with reference to Japanese case law.

Overview of the Issuance of New Shares and the Right to Demand Injunction Under Japanese Corporate Law

In Japanese corporate law, the process by which a joint-stock company recruits new shareholders and issues shares in exchange for monetary payment is referred to as the “issuance of new shares,” which is a vital means for a company to raise the funds necessary for its business activities.

However, if this process is conducted improperly, existing shareholders may suffer disadvantages. For instance, the existing shareholders’ percentage of share ownership and voting rights might be unfairly diluted. Therefore, Japanese corporate law grants shareholders the right to demand an injunction against the issuance of new shares under certain conditions to protect their interests.

Article 210 of the Japanese Companies Act stipulates two main instances when a shareholder can demand an injunction against the issuance of new shares. The first is when the issuance violates laws or the company’s articles of incorporation. The second is when the issuance is carried out by significantly unfair methods.

If any of these situations apply and there is a risk that the shareholder will suffer a disadvantage, the shareholder can demand that the company cease the issuance. This demand for an injunction is a preemptive remedy that must be exercised before the issuance takes effect.

Ground for Injunction 1: Violation of Laws or Articles of Incorporation

The first ground on which a shareholder can request an injunction against the issuance of new shares is if the issuance procedure violates laws or the articles of incorporation. This concerns the objective flaws in the procedure.

A typical example of a legal violation is when the issuance procedure lacks the procedural requirements set forth by the Japanese Companies Act. For instance, in public companies, the issuance of new shares is generally determined by a resolution of the board of directors (Japanese Companies Act, Article 201, Paragraph 1; Article 199, Paragraph 1). However, when issuing shares at a particularly favorable price (favorable issuance) to shareholders, a special resolution at the shareholders’ meeting is required from the perspective of protecting shareholders’ interests (Japanese Companies Act, Article 199, Paragraph 2; Article 309, Paragraph 2, Item 5). Therefore, proceeding with the issuance by a board of directors’ resolution alone, despite it being a favorable issuance, constitutes a violation of the law.

Furthermore, the law also requires that shareholders be appropriately informed about the matters concerning the solicitation of shares. If the notice of the shareholders’ meeting that requires a resolution does not include a summary of the agenda concerning the solicited shares, or if the issuance is to be decided by a board of directors’ resolution without proper notification to shareholders or public notice (Japanese Companies Act, Article 201, Paragraphs 3 and 4), these too would be legal violations and could be grounds for an injunction.

An example of a violation of the articles of incorporation is when a company attempts to issue new shares exceeding the total number of shares it is allowed to issue as stipulated in its articles of incorporation. The total number of shares that can be issued must be stated in the company’s articles of incorporation (Japanese Companies Act, Article 27) and defines the upper limit of shares the company can issue. Issuing shares beyond this limit is a clear violation of the articles of incorporation and can be recognized as grounds for an injunction.

Since the facts of these legal and articles of incorporation violations are often objectively clear, they can be considered relatively easy grounds for shareholders to prove when seeking an injunction.

Ground for Injunction 2: Grossly Unfair Methods

The second ground on which shareholders can request an injunction is when the issuance of solicited shares is carried out by “grossly unfair methods.” Even if there is no formal violation of laws or articles of incorporation, an injunction may be granted if the substantive purpose or method of the issuance significantly harms the interests of the shareholders in an unfair manner. Whether or not it constitutes a “grossly unfair method” depends on whether the purpose of the issuance is legitimate. In Japanese case law, a concept known as the “primary purpose rule” has been established for this judgment.

The “primary purpose rule” is a framework for judging unfairness based on whether the issuance of solicited shares has a legitimate primary purpose, such as raising capital for the company or strengthening business alliances, or whether it has an illegitimate primary purpose, such as diluting the shareholding ratio of certain shareholders to maintain and strengthen the control of the current management team.

If the primary purpose of the issuance is determined to be the unjust goal of maintaining the control of the current management, it is considered an issuance by “grossly unfair methods,” and the likelihood of an injunction being granted increases. There are several notable legal precedents where this rule has been applied.

For example, the Chujitsuya-Inageya case (Tokyo District Court, July 25, 1989) involved the department store Chujitsuya launching a hostile takeover bid against its competitor Inageya, during which the Inageya management planned a third-party allotment capital increase with the purpose of diluting Chujitsuya’s shareholding ratio. The court acknowledged the necessity of Inageya’s capital increase but determined that the primary purpose of the issuance was to reduce Chujitsuya’s shareholding ratio and maintain management control. Consequently, the court granted Chujitsuya’s request for an injunction against the issuance, deeming it “grossly unfair.”

In a more recent example, the Nippon Broadcasting System case is well-known. During this case, while Livedoor Co. was attempting to acquire control of Nippon Broadcasting System through a public tender offer for shares, the Nippon Broadcasting management decided to issue a large number of new share warrants to Fuji Television Network. Livedoor Co. sought an injunction to stop the issuance. The court (Tokyo High Court, March 16, 2005) pointed out that if the issuance were realized, Livedoor Co.’s shareholding ratio would be significantly diluted and determined that the primary purpose of the issuance was not to secure the interests of all shareholders but to prevent Livedoor Co. from establishing control and to maintain the current management’s control. As a result, the issuance was deemed to constitute a “grossly unfair method,” and the injunction was granted.

As these cases illustrate, the determination of whether a method is “grossly unfair” involves a highly individual and concrete judgment that not only considers the necessity of raising funds but also takes into account various circumstances such as the timing of the issuance, its scale, the selection of the underwriter, the degree of dilution, and fundamentally explores what the “primary purpose” behind it was.

Comparison of Grounds for Injunctions Under Japanese Corporate Law

The two grounds for injunctions we have discussed so far, “violation of laws or articles of incorporation” and “grossly unfair methods,” differ in nature. It is important for shareholders to understand the differences between them when considering a request for an injunction.

First, “violation of laws or articles of incorporation” is judged from an objective standpoint: whether the company’s actions violate the clear rules of laws or articles of incorporation. For example, the fact that a resolution at a shareholders’ meeting was required but not obtained can be relatively clearly proven with evidence such as minutes of the meeting. Therefore, if there is evidence of a violation, an injunction is more likely to be granted.

On the other hand, “grossly unfair methods” evaluate the subjective intent of the company’s management, focusing on what the “main purpose” of the issuance was. Even if the procedures followed are formally legal, the issue arises if the substantive purpose is unjust. Proving this “purpose” can be more challenging than proving objective facts. Shareholders must accumulate indirect facts such as the background of the issuance, the company’s financial situation, and the existence of disputes over control of management to persuade the court of the management’s unfair intent.

The table below summarizes the main differences between these two grounds for injunctions.

Thus, while these are different approaches to grounds for injunctions, in actual disputes, it is not uncommon for shareholders to make claims based on both grounds concurrently.

Summary

In this article, we have explained the injunction against the issuance of new shares under Japanese Corporate Law, focusing on the two main grounds: “violation of laws and articles of incorporation” and “grossly unfair methods.” The issuance of new shares is an important means of financing for a company, but it must always be conducted under fair procedures and purposes. In particular, when the issuance is carried out for improper purposes, such as maintaining management control, and unjustly harms the interests of existing shareholders, Japanese Corporate Law grants shareholders a powerful countermeasure in the form of the right to request an injunction. Courts tend to scrutinize the substantive purpose behind the issuance strictly, using frameworks such as the “primary purpose rule.” In complex situations, such as disputes over corporate control, it is crucial to accurately analyze from a legal perspective whether the planned issuance of new shares could be subject to an injunction.

Monolith Law Office specializes in legal services related to corporate governance and M&A, and has provided extensive advice and representation to numerous domestic and international clients regarding the injunction against the issuance of new shares discussed in this article. Our firm employs several experts who are not only qualified as Japanese attorneys but also hold foreign legal qualifications and are English speakers, enabling us to provide smooth communication and deep legal insights in international transactions and disputes. If you are facing legal issues related to the issuance of new shares, please do not hesitate to consult with us.