Cash-Outs in Japanese Corporate Law: Legal Strategies for Achieving Complete Control

In the context of Japanese Corporate Law, “cash-out” refers to a strategic act that carries a specific legal meaning, distinct from the general financial concept of cash outflows. Within the framework of corporate law, cash-out, also known as “squeeze-out,” is a procedure where the controlling shareholders forcibly acquire the shares held by minority shareholders in exchange for cash. The aim of this action is to bring the target company under 100% control and establish complete managerial authority. By implementing this method, a company can enjoy numerous strategic benefits, such as swift decision-making, reduced management costs, and the execution of long-term business strategies without being influenced by minority shareholders’ intentions. However, as these methods directly affect the property rights of minority shareholders, Japanese Corporate Law has established detailed regulations to maintain a strict balance between the interests of controlling shareholders and the protection of minority shareholders’ rights. This article will explain the four main cash-out methods recognized under Japanese Corporate Law, namely, “demand for sale of shares by a special controlling shareholder,” “share consolidation,” “utilization of class shares with an entire acquisition clause,” and “application of share exchange,” detailing their legal requirements, procedures, and practical issues.

The Strategic Objectives of Cash-Outs Under Japanese Corporate Law

The motivation behind executing a cash-out goes beyond the superficial goal of simply increasing the percentage of stock ownership. It fundamentally transforms the governance structure of a company and maximizes management efficiency. Eliminating minority shareholders is a means to achieve larger strategic objectives.

Firstly, it allows for the acceleration of decision-making. When shareholders are consolidated into a single person or group, there is no need to convene a general shareholders’ meeting for important management decisions. Articles 319 and 320 of the Japanese Companies Act stipulate that resolutions can be made in writing with the consent of all shareholders, but this procedure becomes a practical option only when there is 100% control. This enables dynamic responses to market changes and business opportunities.

Secondly, it significantly reduces management costs and administrative burdens. When minority shareholders exist, the company must continue to bear various management costs, such as sending notices of general shareholders’ meetings, distributing business reports, paying dividends, and managing shareholder registries. A cash-out completely eliminates these costs and the associated human resources.

Thirdly, it enables management from a long-term perspective. In publicly traded companies or those with many shareholders, it can be difficult to implement strategies that do not immediately lead to profits, such as long-term research and development investments or large-scale capital expenditures, due to expectations for short-term stock prices and dividends. Cash-outs free management from short-term market pressures, allowing them to focus on decisions for sustainable growth.

Fourthly, it facilitates M&A and organizational restructuring. A wholly-owned subsidiary can flexibly carry out mergers, company splits, and business transfers with the decision-making of the parent company alone. The risk of organizational restructuring stalling due to opposition from minority shareholders is eliminated.

Fifthly, it completely eliminates the risk of shareholder derivative lawsuits. Shareholder derivative lawsuits are the right of shareholders to pursue the management responsibility of company officers, but this right can only be exercised by shareholders. The absence of minority shareholders frees directors from the risk of this type of litigation, enabling them to make bolder management decisions.

Finally, it also has the effect of preventing the dispersion of shares. Especially in private companies, when a shareholder’s death leads to inheritance, shares can become dispersed among numerous heirs, making company decision-making difficult. Cash-outs are an effective means to prevent such dispersion of shares and maintain a stable management foundation.

Method 1: Share Transfer Request by Special Controlling Shareholders

Introduced by the 2014 amendment to the Japanese Companies Act, the “Share Transfer Request by Special Controlling Shareholders” is one of the most efficient methods for achieving a cash-out. This system provides a pathway for shareholders who already overwhelmingly control a company to quickly achieve complete subsidiary status.

The legal basis for this method is stipulated in Article 179 and subsequent articles of the Japanese Companies Act. It is available only to “Special Controlling Shareholders,” that is, shareholders who hold more than 90% of the voting rights of the target company. Meeting this high voting rights requirement significantly simplifies the procedure.

The procedure is as follows: First, the Special Controlling Shareholder notifies the target company of the conditions such as the acquisition price and date (Japanese Companies Act Articles 179-2 and 179-3). Next, the board of directors of the target company approves this request. A key feature of this system is that it does not require a resolution at the shareholders’ meeting (Japanese Companies Act Article 179-3). After the board’s approval, the target company notifies the remaining minority shareholders (the transfer shareholders) of the approval at least 20 days before the acquisition date (Japanese Companies Act Article 179-4). This notification is legally considered to have made the transfer request. Then, on the designated acquisition date, the Special Controlling Shareholder automatically acquires all the transfer shares, regardless of whether payment of the consideration has been completed (Japanese Companies Act Article 179-9). This procedure can include not only shares but also stock acquisition rights, allowing for a more certain cash-out.

On the other hand, systems are in place to protect the rights of minority shareholders. The most important protective measure is the right to petition the court for a determination of a “fair price” (price determination petition, Japanese Companies Act Article 179-8). In addition, if the procedure violates laws or the price is significantly unfair, claims to stop the acquisition (Japanese Companies Act Article 179-7) or to argue for the invalidity of the acquisition after the fact (Japanese Companies Act Article 846-2) are also recognized.

An important guideline for the operation of this system was set by the Supreme Court decision on August 30, 2017 (Matsuya Share Transfer Request Related Purchase Price Determination Petition Case). This decision limited the range of shareholders who can file a price determination petition to those who held shares at the time when an official notice or announcement regarding the share transfer request was made. This prevents speculative acquisition of shares after the announcement of a cash-out and the initiation of litigation, thereby enhancing the stability and predictability of the procedure.

Method 2: Share Consolidation

Share consolidation is a corporate procedure under Japanese law that has long been utilized as a method for cashing out by integrating multiple shares into one. The advantage of this method lies in its lower voting rights requirements compared to the demand for the sale of shares by special controlling shareholders, meaning it can be executed with a special resolution at the shareholders’ meeting.

The legal basis for this method is Article 180 of the Japanese Companies Act. Execution requires a special resolution at the shareholders’ meeting, with the approval of two-thirds or more of the voting rights of the attending shareholders (Article 309, Paragraph 2, Item 4 of the Japanese Companies Act). The crux of the procedure is to set an extremely high consolidation ratio (for example, consolidating 10,000 shares into 1 share) so that the number of shares held by minority shareholders becomes a fraction of less than one share (fractional shares).

As a specific procedure, first, the board of directors determines the reasons for the share consolidation, the consolidation ratio, and the effective date, and proposes these to the shareholders’ meeting (Article 180, Paragraph 4 of the Japanese Companies Act). Once the special resolution is passed at the shareholders’ meeting, the share consolidation is executed on the effective date. As a result, minority shareholders end up holding only fractional shares, which do not confer any rights as a shareholder. Subsequently, the company follows the procedures set forth in the Japanese Companies Act to sell these aggregated fractional shares (often purchased by the controlling shareholders or the company itself) and completes the actual cash-out by distributing the proceeds to the original fractional shareholders.

Protection for minority shareholders is also well defined. Shareholders who oppose the share consolidation have the right to demand that the company buy back their shares at a ‘fair price’ after casting a dissenting vote at the shareholders’ meeting (share buyback request right under Article 182-4 of the Japanese Companies Act). This is a separate right exercised in advance of the fractional share processing. Furthermore, shareholders dissatisfied with the sale price of the fractional shares can petition the court to determine the price (Article 182-5 of the Japanese Companies Act). Additionally, if there are defects in the resolution procedure or if the content of the resolution is significantly unfair, it is also possible to file a lawsuit to cancel the resolution.

A significant judgment regarding the legitimacy of this method was the Sapporo District Court decision on June 11, 2021 (2021). In this case, the issue was whether a share consolidation for the purpose of cashing out violated the principle of shareholder equality. The court ruled that as long as the consolidation ratio is uniformly applied to all shareholders, it is a procedure contemplated by the Companies Act and does not violate the principle of shareholder equality. This judgment holds significant importance as it supports the legality of this widely used practice in the field.

Method 3: Utilizing Class Shares with All Acquisition Provisions

Employing class shares with all acquisition provisions is the most procedurally complex among the four methods, yet it leverages the flexibility of the Japanese corporate law’s class share system to offer a potent cash-out strategy. This method can achieve complete subsidiary integration even in contested situations, provided the controlling shareholder can secure two special resolutions at shareholders’ meetings.

This approach is based on the provisions related to class shares in Article 108, Paragraph 1, Item 7, and Article 171 of the Japanese Companies Act. Its most distinctive feature is the requirement of two stages of special resolutions, each needing the approval of at least two-thirds of the votes.

The procedure unfolds in two stages. In the first stage, the company amends its articles of incorporation through a special resolution at the shareholders’ meeting to convert all issued common shares into a new type of share (class shares with all acquisition provisions), stipulating that “the company can acquire all of them by a resolution at the shareholders’ meeting.” In the second stage, the company holds another special resolution at the shareholders’ meeting to decide on the acquisition of all these class shares with all acquisition provisions (under Japanese Companies Act Article 171). This resolution determines the consideration for the acquisition, which is designed to issue new common shares to the controlling shareholder and cash or fractional shares that amount to less than one share to the minority shareholders. As a result, minority shareholders ultimately receive cash and exit the company.

Protection for minority shareholders is also provided in two stages. Shareholders who oppose the amendment of the articles of incorporation in the first stage can exercise their share purchase request rights. After the share acquisition resolution in the second stage, shareholders dissatisfied with the acquisition price can petition the court to determine a fair acquisition price (under Japanese Companies Act Article 172).

The approach to price determination in this method was illustrated by the Tokyo High Court ruling on October 6, 2020 (the MAG net Holdings case). This case law demonstrated a judicial approach to meticulous valuation, considering the enterprise value as if the cash-out had not occurred (the so-called “hypothetical absence price”) when determining a “fair price,” highlighting the judiciary’s role in protecting the economic interests of minority shareholders.

Technique 4: Application of Share Exchange

Share exchange is a system originally intended for organizational restructuring within corporate groups, but its flexibility in consideration can be applied to cash-outs. It is particularly used when a parent company aims to turn a listed subsidiary into a wholly-owned subsidiary.

This method is based on the provisions related to share exchange in Article 767 and subsequent articles of the Japanese Companies Act. In a typical share exchange, the shareholders of the subsidiary receive shares of the parent company as consideration. However, when the purpose is a cash-out, the consideration is given in cash (cash consideration share exchange) or other assets. This allows for the compulsory buyout of minority shareholders of the subsidiary. The procedure requires a special resolution at the shareholders’ meeting of both the parent and subsidiary companies, with at least two-thirds in favor, and the procedural burden is not insignificant.

The most important consideration in choosing this method is its tax treatment. In a qualified share exchange where parent company shares are given as consideration, taxation on the transfer gains and losses of the shareholders may be deferred. However, when cash is received as consideration, it is considered a sale of shares, and capital gains tax is immediately incurred on the transfer gains. This is critically important information for the cashed-out minority shareholders and becomes a significant factor in negotiating the terms of the transaction.

As a protective measure for minority shareholders, those who oppose the share exchange at both the parent and subsidiary companies can exercise their right to demand the purchase of their shares, seeking a fair price for the buyout of their shares.

Comparing Methods and Strategic Selection

The choice of cash-out methods should be a strategic management decision that comprehensively considers the controlling shareholder’s percentage of voting rights, the desired speed of the procedure, and the acceptable costs and complexity. There is no one method that is absolutely superior; the optimal choice depends on the situation.

For controlling shareholders with more than 90% of the voting rights, the “demand for sale of shares by a special controlling shareholder” is the most powerful option, as it does not require a shareholders’ meeting and allows for quick procedures with only a board of directors’ resolution. On the other hand, if the voting rights are between two-thirds and less than 90%, this method is not available, and one must consider either a “share consolidation” or the use of “class shares with full acquisition clauses.” Comparing these two, share consolidation, which requires only one special resolution, is generally more straightforward and faster than class shares with full acquisition clauses, which require two special resolutions. The “application of share exchange” is mainly used when aiming to make a subsidiary a wholly-owned subsidiary within a parent-subsidiary relationship, excluding minority shareholders by offering cash as consideration, but it requires special resolutions from both companies.

Practical Considerations and Litigation Risks Surrounding ‘Fair Price’ Under Japanese Corporate Law

Regardless of the chosen method for cashing out, the crux of success hinges on the determination of a ‘fair price’. Merely adhering to the formal procedures set by the Japanese Companies Act is insufficient. The substantive fairness of the consideration paid to minority shareholders is the most contentious issue and represents the greatest litigation risk for a company.

Case law indicates that courts do not unconditionally accept the prices proposed by companies. Courts utilize various corporate valuation methods, such as the Discounted Cash Flow (DCF) method, market stock price method, and net asset method, and consider sophisticated concepts like the hypothetical enterprise value without the transaction (the “but-for” price) and the fair distribution of synergies created by the transaction, to make independent judgments.

Therefore, for companies planning a cash-out, it is essential to prepare for this judicial scrutiny by objectively proving the fairness of the price. In practice, the most important risk management measure is to obtain a fairness opinion from an independent third-party evaluation institution. This opinion serves as strong evidence that the board of directors has fulfilled its duty of care in determining the price and forms the foundation for supporting the directors’ decision-making validity in litigation. Neglecting the determination of a fair price can lead to serious consequences, such as substantial litigation costs, waste of management’s time, court-ordered price increases, and damage to the company’s reputation.

Summary

As we have seen in this article, the cash-out is an essential strategic tool under Japanese Corporate Law that allows for the establishment of 100% control and thereby dramatically enhances the agility and efficiency of management. When executing a cash-out, it is necessary to choose the most suitable method from among the four main approaches, depending on the ratio of voting rights held by the controlling shareholder and the circumstances. However, regardless of the method used, the universal key to successfully and legally completing a cash-out without flaws is to earnestly calculate and offer a ‘fair price’ to minority shareholders. Ensuring this substantive fairness is the most critical aspect of risk management and the key to smooth transaction execution.

Monolith Law Office has a wealth of experience in providing legal services related to cash-outs, a theme central to this article, for numerous clients within Japan. Our firm offers comprehensive support, from the strategic planning of these complex transactions to compliance with the stringent procedures set forth by Japanese Corporate Law, and the management of litigation risks. Our firm also includes several English-speaking attorneys with foreign legal qualifications, enabling smooth communication and accurate legal advice even in the context of international M&A and organizational restructuring. In making the critical management decision to achieve complete control, we are your reliable partner. The sources used in this report can be found