What are the Points to Note in Stock Transfers? Detailed Explanation of Specific Clauses to Include in the Contract

One commonly used scheme in M&A for venture companies is the transfer of shares. The reason for its popularity is that the procedure for transferring shares is relatively simple compared to other M&A schemes.

Therefore, for businesses that are about to undertake a share transfer, we will explain the points to be careful about when creating a share transfer agreement.

What is a Share Transfer Agreement?

First, let’s explain the basic matters of what a share transfer agreement is and how it works.

What is a Stock Transfer?

In M&A, a stock transfer refers to a method of company sale where the shareholders of the selling company transfer their shares to the buying company. In the case of venture companies, the shareholders of the selling company are often the founders.

When a stock transfer is made, the shareholders of the selling company can receive the consideration for the stock transfer in exchange for losing control (management rights) of the company.

On the other hand, the buying company inherits the control (management rights) of the selling company through the stock transfer, and usually proceeds to make it a subsidiary.

Points to Note in Share Transfers

While share transfers offer many advantages, there are also points that need to be considered. Therefore, we will explain the points to note when conducting a share transfer.

Treatment of Executives in the Selling Company

Whether the founder or executives of the selling company will remain in the company after the share transfer depends on the contents of the share transfer agreement.

However, transferring shares means that the new shareholder, the buying company, can appoint and dismiss directors at its discretion.

Therefore, it is necessary to be aware that if the buying company deems it unnecessary, there is a possibility of dismissal.

Does the Selling Company Have Full Control of Its Shares?

In actual M&A situations, there may be cases where share transfers cannot be used and other methods such as business transfers are inevitably chosen.

A typical case where share transfers cannot be used is when not all the shares of the selling company are comprehended in detail.

This situation is unlikely to occur in venture companies that were originally considering an IPO. However, if a number of years have passed since the company’s founding, or if the founder gave shares to relatives and acquaintances as part of a relationship at the time of founding, it may be unclear who owns the shares.

If it is unclear who owns how many shares of the selling company, it becomes difficult to carry out a share transfer.

Even if all shareholders are known, if outsiders own shares, approval for the share transfer must be obtained from those shareholders. This also applies to cases where investment has been received from a VC (Venture Capital). If approval for the share transfer cannot be obtained from all shareholders, it will be difficult to carry out the share transfer.

Checkpoints for Share Transfer Agreements

Let’s explain the main clauses that need to be checked when concluding a share transfer agreement, following the template of the agreement. In the following clause examples, “Party A” is the shareholder who is the seller, “Party B” is the buying company, and the company subject to the stock company is “Company X Co., Ltd.”

Provisions Regarding Share Transfer Agreement

Article ○ (Share Transfer)
Party A shall transfer ○ shares of the issued common stock of Company X to Party B on ○ year, ○ month, ○ day, and Party B shall accept this transfer.

The core of the share transfer agreement is the agreement regarding the share transfer.

Clearly state the company that is going to be the subject of the share transfer, and stipulate the types and the numbers of shares. If there are multiple shareholders who will be the sellers, all shareholders will be parties to the share transfer agreement.

Clause on Transfer Consideration

Article ○ (Transfer Consideration)
The consideration for the shares in question, which Party B will pay to Party A, shall be set at ○○ million yen.

Alongside the share transfer agreement, the clause concerning the transfer consideration forms the core of the share transfer contract. Here, the amount of consideration that the selling shareholder will receive from the buying company due to the share transfer is clearly stated.

Furthermore, in some share transfer contracts, the amount per share may also be stated. Even in such cases, it is crucial to include in the clause a provision that unambiguously determines the total amount to be paid.

Provisions Regarding Closing

Article ○ (Payment Procedure)
1. Party A shall transfer the shares to Party B in exchange for receiving the payment of the transfer price stipulated in Article ○ on the transfer date, and shall request a change of name to Party B’s name for the shares.
2. Party B shall make the payment of the transfer price stipulated in the preceding paragraph by transferring the transfer price to the bank account designated separately by Party A.

After the conclusion of the share transfer agreement, it is common for the actual share transfer procedure to be executed after a certain period. This execution procedure based on the share transfer agreement is called “closing”.

At closing, the buying company pays the transfer price stipulated in the share transfer agreement to the shareholders of the selling company. At the same time as this payment, the buyer receives the transfer of shares.

In the transfer of shares, the necessary procedures differ depending on whether the selling company is a share certificate issuing company or not.

Share Certificate-Issuing Company

In a share certificate-issuing company that issues share certificates, the requirements for perfection against the third party is the delivery of share certificates, and the requirements for perfection against the selling company is the rewriting of the shareholder register.

The requirement for perfection is a requirement legally necessary to assert the fact that a share transfer has been received to the selling company and third parties, similar to registration in real estate transactions.

It is necessary to stipulate the rewriting of the shareholder register and the delivery of share certificates in the closing clause. However, even if it is a share certificate issuing company, there is no need to actually issue share certificates unless requested by shareholders.

Therefore, there are the following two patterns for share certificate issuing companies.

• Share certificate issuing companies that have already issued share certificates
• Share certificate issuing companies that have not yet issued share certificates

In the case of a share certificate issuing company, the transfer of shares before the issuance of share certificates does not take effect against the selling company. And, a share certificate issuing company that has not yet actually issued share certificates needs to issue share certificates before the transfer of shares.

Non-share Certificate Issuing Company

As it stands, unless it is an old company, most recent companies are non-share certificate issuing companies. This is because, under the Companies Act enacted on May 1, 2006 (Heisei 18), it is a principle that a corporation does not issue share certificates.

In the case of a non-share certificate issuing company, the requirement for perfection to a third party and the selling company in the transfer of shares is the rewriting of the shareholder register. Therefore, it is sufficient to stipulate that a request for rewriting of the shareholder register is made at closing, as in the clause example above.

Clause on Representations and Warranties

Article ○ (Representations and Warranties)
1. Party A represents and warrants to Party B that, as of the date of this Agreement and the date of this transfer, each of the matters set forth below is true and accurate.
(1) (omitted below)
2. If Party A or Party B discovers a fact contrary to the matters represented and warranted in the preceding paragraph, and this causes damage to the other party, they shall compensate the other party for the damage.

The representation and warranty is a statement by a contracting party that the matters described in the clause are true and guaranteed.

In English, it is referred to as “Representation and Warranty,” a concept originally from Anglo-American law.

In Japan, it is used in important transactions between companies, such as financial transactions or M&A.

In a share transfer, a procedure called “due diligence” (DD) is conducted before the conclusion of the share transfer agreement, where the buyer company thoroughly examines the corporate value of the seller company from various angles, such as finance, legal, and human resources.

However, it is impossible to investigate all aspects of the selling company through due diligence due to time and cost constraints.

On the other hand, for the buyer, if the existence of off-balance-sheet liabilities becomes apparent after the share transfer, it would result in a significant loss.

Therefore, to supplement due diligence, the seller is made to represent and warrant certain matters (such as the absence of off-balance-sheet liabilities) in the representation and warranty clause.

Then, if a fact contrary to the represented and warranted matter is discovered after the share transfer, a clause is included to compensate (indemnify) for the damage caused to the other party.

Although not included in the clause example, please note that there are cases where the buyer represents and warrants certain matters to the seller.

The following are examples of matters that can be stipulated in the representation and warranty clause.

However, if the buyer company has particular concerns, it is basically possible to stipulate any matter as a representation and warranty clause.

• Procedures required by law, articles of incorporation, or other internal regulations for the share transfer have been carried out
• No approval or consent from the administration or a third party is required for the share transfer
• The total number of shares that the selling company can issue is ○ common shares, and the total number of issued shares is ○ shares
• All issued shares have been legally and validly issued and fully paid up
• As of the date of the share transfer agreement, the seller’s shareholders have disclosed all important information about the selling company and all information requested by the buyer that the seller is aware of and possesses

Provisions on Transfer Approval

Article ○ (Transfer Approval, etc.)
Party A shall, by the transfer date, obtain the approval of the board of directors of Company X and make any other institutional decisions necessary for the transfer of shares, and shall also have Company X do so.

Many shares of a company before its initial public offering (IPO) are restricted transfer shares.

Restricted transfer shares are shares that are stipulated in the articles of incorporation to require the company’s approval to transfer to a third party.

When transferring restricted transfer shares, it is necessary to make the necessary institutional decisions within the selling company. The necessary institutional decisions are as follows. However, if there are different provisions in the articles of incorporation, the articles of incorporation will take precedence.

• Companies with a board of directors – Approval at the board of directors
• Companies without a board of directors – Approval at the general meeting of shareholders

In the case of restricted transfer shares, you cannot claim to the company that you have received a share transfer without the necessary institutional decisions. Therefore, it is necessary to complete the institutional decisions by the closing.

Summary: Legal Knowledge Japanese Company Act is Required to Include Special Clauses in the Contract of Stock Transfer

When conducting M&A, including stock transfers, knowledge of the Japanese Companies Act is essential.

Furthermore, stock transfers are extremely important transactions that can determine the fate of a company or business, for both the seller and the buyer.

Therefore, to prevent any trouble, it is common to consult with external experts such as lawyers and tax accountants, and seek their assistance when concluding a stock transfer agreement.

Not only for stock transfers, but also when conducting M&A, it is necessary to consult with a tax accountant in advance about the taxes that will be incurred as a result.

As specialized legal knowledge, including the Japanese Companies Act, is required, it would be advisable to consult with a lawyer who specializes in corporate legal affairs regarding legal matters.