Explanation of Bonds with Stock Acquisition Rights under Japanese Corporate Law

Bonds with Warrants in Japanese Corporate Law are a crucial financial instrument for companies to raise capital. They are a hybrid security combining two distinct elements: a bond and a warrant. The bond is a debt security issued by the company, while the warrant represents the right to acquire the company’s stock at a future date under specific conditions. Bonds with Warrants enable flexible capital raising for the company and offer investors both the stable income of a bond and the growth potential of equity. This financial product is clearly defined under Japanese Corporate Law, with specific legal requirements set for its issuance, transfer, and the exercise of rights.

One of the most distinctive features of Bonds with Warrants is that their components, the bond and the warrant, can be separated and transferred independently. This separability means that investors can sell the bond portion to recover funds while retaining the warrant to benefit from potential stock price increases in the future. Even if the warrant is exercised, the bond itself does not cease to exist; it continues as a debt obligation. Such personalityistics allow the issuing company to immediately raise funds through the bond while simultaneously encouraging future equity participation through the warrant, enabling a more complex capital-raising strategy. For investors, it provides the flexibility to sell the bond to ensure liquidity while retaining the potential upside of the warrant, and vice versa, broadening their investment strategy options. This article will provide a detailed explanation of the legal nature of Bonds with Warrants, their differences from convertible bonds with warrants, issuance procedures, transferability, and the exercise of warrants, based on Japanese regulations. By doing so, it offers a foundation for those interested in Japanese corporate finance to deeply understand this complex financial instrument.

The Nature of Bonds with Warrants in Japan

Bonds with warrants are securities that combine both corporate bonds and warrants, and their legal nature is clearly defined under Japanese Corporate Law. Specifically, they are defined in Article 2, Paragraph 22 of the Japanese Companies Act. This definition indicates that bonds with warrants are not merely debt securities but complex financial instruments that include the right to acquire future shares.

One of the most important personalityistics of bonds with warrants is that the bond component and the warrant component can be separated and transferred independently. This separability means that investors can trade the bond and warrant parts individually according to market conditions. For example, an investor could transfer the bond portion to a third party, obtaining funds in return, while retaining the warrant portion to pursue profits from potential future increases in stock prices. Even if the warrants are exercised, the bond itself does not extinguish but continues to exist as a debt obligation. Article 260 of the Japanese Companies Act stipulates that the warrants do not expire even if the bonds are redeemed. This provision clearly demonstrates that the warrants and the bonds each have their own independent legal existence.

This separability provides significant strategic flexibility for both the issuing companies (from the perspective of capital structure management and attracting a diverse investor base) and investors (from the perspective of risk management, liquidity, and individualized investment strategies). As a result, more complex and nuanced financial engineering is possible compared to simple convertible bonds with warrants. Companies can design and optimize the terms of the bond and warrant components separately according to their funding needs and market demands. Investors can selectively pursue either the stable returns of the bonds or the growth opportunities through conversion of the warrants into shares, aligning with their investment goals and risk tolerance, thus enabling the execution of more diverse investment strategies.

Differences Between Bonds with Share Options and Convertible Bonds with Share Options Under Japanese Corporate Law

Bonds with share options are often confused with convertible bonds with share options, a similar financial instrument. While both combine bonds and share options, they have crucial differences in their legal nature and functions.

Convertible bonds with share options are defined under Article 2, Paragraph 23 of the Japanese Companies Act, and are personalityized by the feature that the bond itself is converted into shares when the share options are exercised, resulting in the extinction of the bond. In other words, investors allocate the face value of the bond to the payment for shares, and the bond transforms into equity. Therefore, the bond and the share options are inseparable, and cannot be transferred separately.

In contrast, with bonds with share options, the bond remains in existence even after the share options are exercised. Investors need to pay an additional amount when exercising the share options. Since the bond and the share options are separable, investors can continue to hold the bond while exercising the share options to acquire new shares. This fundamental difference significantly affects the risk and return profiles of both instruments, as well as the purposes for which issuing companies utilize them. With bonds with share options, investors can enjoy a ‘hybrid’ return, retaining the income source from the debt security while also benefiting from the potential capital gains of the shares. On the other hand, convertible bonds with share options serve as a temporary alternative, paving a more direct path to equity, and after conversion, they depend entirely on the performance of the shares. This distinction is crucial for investors evaluating corporate financial products and for companies designing their capital structures.

Comparison Table: Bonds with Share Options vs. Convertible Bonds with Share Options in Japan

Issuance of Bonds with Warrant Options in Japan

When issuing bonds with warrant options in Japan, strict procedures and requirements based on the Japanese Companies Act must be followed. Companies must first determine the terms of the offering for the bonds with warrant options. Article 249 of the Japanese Companies Act mandates the specification of detailed matters such as the number of bonds with warrant options to be offered, the amount of each bond, the content of the warrant options, the conditions for their exercise, and the payment amount upon exercising the warrant options. Notably, the payment amount upon exercising the warrant options is a critical element, as stipulated in Article 242, Paragraph 1 of the Japanese Companies Act.

In addition to determining the offering terms, Article 250 of the Japanese Companies Act prescribes the decision-making process for the offering to specific parties and the determination of matters related to the underwriting rights of the offered bonds with warrant options. While the decision-making process for issuance generally suffices with a resolution by the board of directors, in certain situations, such as when the issuance is on ‘favorable terms’ for existing shareholders, a special resolution at the shareholders’ meeting is required under Article 251 of the Japanese Companies Act. This is an important provision to protect the interests of existing shareholders.

While many issuance matters can be decided by a board of directors’ resolution, the requirement for a special resolution at the shareholders’ meeting under Article 251 of the Japanese Companies Act in the case of ‘favorable issuance’ suggests that the Japanese Companies Act places a strong emphasis on protecting existing shareholders from dilution and unfair benefit transfers. This is not merely a procedural requirement but serves as a vital safeguard for shareholder protection. It indicates that Japanese corporate governance highly values transparency and shareholder consent when financial instruments like bonds with warrant options are issued in ways that could disadvantage existing shareholders. Companies must carefully consider the terms of issuance to avoid this higher approval standard, which could complicate and delay the fundraising process.

As for the offering procedures, under Articles 253 and 254 of the Japanese Companies Act, applications for, allotment of, and payment for the offered bonds with warrant options are carried out. Companies set a payment date or payment period, and investors must make payments in accordance with these terms.

Transfer of Bonds with Warrants in Japan

Bonds with warrants in Japan offer high flexibility due to the separability and transferability of their components: the bond and the warrant. Japanese Corporate Law sets forth provisions regarding these transfers.

Companies are obligated to maintain a register for bonds with warrants, recording specific details. Article 255 of the Japanese Corporate Law stipulates the creation of this register and the items that must be recorded. Furthermore, Article 256 of the Japanese Corporate Law prescribes the specific details that must be entered into the bond register, such as the number of bonds with warrants, the amount, the names or titles and addresses of the holders, and matters related to the transfer.

In addition, corporations may issue bond certificates with warrants. According to Article 257 of the Japanese Corporate Law, when such bond certificates are issued, their transfer becomes effective upon the delivery of the certificates. This provision governs the method of transfer when the securities physically exist; if no certificates are issued, the entry in the register becomes the requirement for opposing the transfer.

The ability to separately transfer bonds and warrants enhances market liquidity and flexibility for investors. However, the obligation to create a register for bonds with warrants under Article 255 of the Japanese Corporate Law, and the prescribed details for the bond register under Article 256, mean that corporations must continue to record owner information. Moreover, the allowance for the optional issuance of bond certificates with warrants under Article 257 suggests that when certificates are issued, transfers become effective through delivery, which may complicate real-time tracking of ownership compared to a book-entry system. This dual system reflects a balance between the free transferability of these financial instruments (benefiting investors and market efficiency) and the ability of issuing corporations to manage records of bondholders and warrant holders (for purposes such as managing interest payments, warrant exercise notices, and notifications of shareholder meetings post-conversion).

Exercising Stock Acquisition Rights

The exercise of stock acquisition rights attached to bonds with stock acquisition rights is conducted according to specific conditions and procedures. When these rights are exercised, the company issues new shares. At this point, the holder of the stock acquisition rights must pay the company the amount stipulated separately, based on Article 242, Paragraph 1 of the Japanese Companies Act. This differs from convertible bonds with stock acquisition rights, where the face value of the bond is allocated to the payment.

The separability of stock acquisition rights and bonds becomes evident at the time of exercise. For example, even after the bonds have been redeemed, the stock acquisition rights do not expire and can continue to be exercised within their exercise period. Article 260 of the Japanese Companies Act clearly stipulates this point. Furthermore, Article 262 of the Japanese Companies Act establishes that the exercise of stock acquisition rights is independent of the redemption of bonds, further substantiating their independence.

The fact that stock acquisition rights persist even after the redemption of bonds and are exercised independently of bond redemption means that these two components have different ‘lifecycles’ and factors for evaluation. The value of the bond is influenced by interest rates and credit risk, while the value of the stock acquisition rights is affected by the stock price of the underlying asset, volatility, and the time remaining until maturity. This independence creates complexities for both the issuing companies (in managing debt and equity capital simultaneously) and investors (in evaluating the combined financial product and deciding when to exercise or sell each component). It enables sophisticated arbitrage trading strategies but also requires a deep understanding of both the debt and equity markets.

Stock acquisition rights typically have an exercise period set. Article 261 of the Japanese Companies Act provides for the statute of limitations on the extinction of stock acquisition rights, and once this exercise period has passed, the stock acquisition rights expire. Therefore, holders of stock acquisition rights need to carry out the appropriate procedures within the set period to avoid losing their rights.

Relevant Japanese Case Law

Bonds with warrants, due to their nature, are complex financial instruments, and their interpretation and valuation can be disputed in court. A relevant case from Japanese case law is the judgment by the Tokyo District Court on February 3, 1991 (1991).

This judgment focused on the issue of how to determine the fair value of bonds with warrants in a case concerning their valuation. Since bonds with warrants can be separated into the bond portion and the warrant portion, each potentially having its own market value, the overall valuation is not straightforward. The court faced the challenge of how to integrate the valuation based on the bond portion’s interest rate and credit risk with the valuation of the warrant portion, which considers factors such as stock price volatility and the exercise period (for example, the application of option pricing models). This decision suggests that not only the legal nature of bonds with warrants but also the calculation of their economic value requires specialized knowledge.

The existence of case law specifically focused on the ‘valuation’ of bonds with warrants indicates the inherent complexity of these financial instruments, particularly their separable nature, which may lead to disputes requiring judicial interpretation. The court is not merely applying definitions but is engaging with practical financial implications and valuation methodologies. This suggests that while Japanese law provides a framework for these financial instruments, their real-world application can give rise to ambiguities and differences of opinion, especially regarding fair value. Therefore, while the legal structure may be clear, the potential for disputes over financial implications and valuation necessitates careful consideration and specialized financial and legal advice. This underscores the need for robust valuation models and clear contractual terms to avoid future litigation.

Conclusion

In this article, we have provided a detailed explanation of bonds with stock acquisition rights under Japanese corporate law, covering their legal nature, differences from convertible bonds with stock acquisition rights, issuance, transfer, and the exercise of the stock acquisition rights. These bonds have the unique personalityistic of being separable and transferable from the stock acquisition rights, functioning as a flexible financing tool for companies and as a financial product that enables a variety of investment strategies for investors. Each stage, from issuance to exercise, is governed by strict procedures and requirements based on Japanese corporate law, making it extremely important to accurately understand these legal frameworks.

Monolith Law Office boasts a wealth of experience and deep expertise in Japanese corporate legal affairs, particularly in complex financial instruments such as bonds with stock acquisition rights, serving numerous clients within Japan. Our team of attorneys is well-versed in the latest legal interpretations and practical business practices in this field, providing precise and practical advice to address the various legal challenges that companies face. Additionally, our firm includes several attorneys who are native English speakers with foreign legal qualifications, enabling us to provide strong support for international clients to understand Japan’s complex legal system and conduct smooth business operations. If you require consultation regarding bonds with stock acquisition rights or other legal support related to Japanese corporate law, please do not hesitate to contact Monolith Law Office.