Procedures for Issuing New Shares (Capital Increase) under Japanese Corporate Law and the Impact on Existing Shareholders

When Japanese companies seek to raise funds for business expansion, new project initiatives, or debt repayment, issuing new shares, or capital increase, is one of the most crucial methods. This approach allows for the procurement of funds without incurring new debt and offers the flexibility to utilize the raised capital, thereby enhancing the financial stability of the company. However, since issuing new shares can significantly impact the rights of existing shareholders, Japanese Corporate Law requires strict adherence to procedures.

The fundamental concept of the new share issuance system under Japanese Corporate Law is to ensure the agility of fundraising for companies while simultaneously protecting the rights of existing shareholders. This legal framework is designed not merely as a procedural guideline but to carefully balance the two critical elements of securing necessary capital for corporate growth and protecting the rights and interests of shareholders. This balance is achieved by varying procedural requirements depending on the type of shares issued and their potential impact.

Existing shareholders may face the dilution of their shareholding percentage and voting rights due to new share issuance, which can reduce their influence over company management. Additionally, an increase in the total number of issued shares could lead to a decrease in the value per share. Considering these potential impacts, adhering to the appropriate legal procedures set forth in Japanese Corporate Law is essential. Failure to comply can lead to legal disputes, such as claims for the invalidation of new share issuance (Article 828 of Japanese Corporate Law), posing a significant risk of invalidating the issuance itself. This could unexpectedly harm new shareholders, business partners, and other third parties, potentially undermining the very purpose of the capital increase.

This article provides a detailed explanation, based on Japanese legal provisions, of the main types of new share issuance, the specific legal procedures involved, and the impact on existing shareholders, which foreign investors and companies should understand when considering capital increases in Japan. Our aim is to offer a clear understanding of new share issuance under Japanese Corporate Law.

Key Types and Characteristics of New Share Issuance Under Japanese Corporate Law

Under Japanese Corporate Law, there are three main methods of issuing new shares, each distinguished by whom the shares are issued to. The chosen method of issuance significantly affects subsequent procedural requirements and the impact on existing shareholders.

Issuance of New Shares by Third-Party Allotment Under Japanese Corporate Law

Third-party allotment refers to the method of allocating new shares to specific third parties. While these “third parties” can include existing shareholders, it is classified as a third-party allotment unless the shares are allocated equally to all existing shareholders in proportion to their shareholding ratios. Particularly in private companies where share transfer restrictions are in place, third-party allotment has become the most common means of fundraising.

A significant personalityistic of this method is the high likelihood of changes in the existing shareholding ratios due to the addition of new shareholders or the unequal acquisition of shares by existing shareholders. As a result, the relative dilution of existing shareholders’ voting rights and rights to receive dividends may occur. However, there are advantages to targeting specific investors, such as high flexibility in fundraising and the ability to execute quickly. Since changes in shareholding ratios can affect the voting rights of existing shareholders, Japanese corporate law mandates compliance with certain procedures to protect shareholders.

Issuance of New Shares by Shareholder Allotment Under Japanese Corporate Law

Shareholder allotment is a method where new shares are allocated to all existing shareholders in proportion to the number of shares they currently hold. This approach’s most significant feature is that the existing shareholders’ ownership percentages remain unchanged after the issuance of new shares. Consequently, concerns about compromising fairness among shareholders are minimal, and the procedures for protecting existing shareholders are considered to be the least extensive compared to other methods. If the consent of all shareholders is obtained, rapid fundraising is possible; however, the amount of capital that can be raised depends on the financial capabilities of the existing shareholders, which may not be suitable for raising large sums of capital.

Public Offering and Issuance of New Shares in Japan

A public offering is a method where a company solicits investments broadly from general investors and allocates new shares to applicants. This method, like third-party allotments, has the potential to change the shareholding ratio of existing shareholders. Public offerings are primarily used by publicly listed companies as a means of raising funds, and are usually not available to private companies. When a public company conducts a public offering, it is subject to stringent disclosure requirements under the Japanese Financial Instruments and Exchange Act. Similar to third-party allotments, because there is a possibility of fluctuation in shareholding ratios, specific procedures are required to protect existing shareholders.

In the process of issuing new shares, the strictness of the regulations set by the Japanese Companies Act is directly related to the potential dilution of existing shareholders’ rights. Methods like shareholder allotments, which essentially maintain the existing ownership structure, tend to have relatively lower regulatory hurdles. In contrast, third-party allotments and public offerings, which have the potential to significantly alter shareholding ratios, trigger more stringent protective measures. This suggests that companies need to carefully evaluate the balance between flexibility in fundraising and the complexity of legal procedures when choosing a method of capital raising. This point is particularly important when considering third-party allotments that have the potential to create new controlling relationships. Foreign investors should understand that the selected issuance method reflects the company’s stance on shareholder relations and regulatory compliance.

Comparison of Types of New Share Issuance Under Japanese Corporate Law

Comparing the various methods of issuing new shares highlights their personalityistics and the impact on existing shareholders.

The Specific Process of Issuing New Shares Under Japanese Corporate Law

The procedure for issuing new shares is carried out through several important stages based on the Japanese Companies Act. Whether the company is a public company (one that has not established restrictions on the transfer of shares in its articles of incorporation) or a private company (one that has established such restrictions), the specific requirements vary depending on the chosen method of issuance.

Determining the Terms of Offering and the Decision-Making Body

In Japan, when a company issues new shares, it must first determine the “terms of offering” in detail. These include the number of shares to be offered, the payment amount per share, the content and value of any non-monetary property to be contributed, the due date or period for payment or delivery of property, and matters related to the increase in capital stock and capital reserve when issuing shares (Japanese Companies Act, Article 199, Paragraph 1).  

The body responsible for deciding these terms varies depending on the nature of the company. For private companies, a special resolution at the shareholders’ meeting is generally required (Japanese Companies Act, Article 199, Paragraph 2). A special resolution requires a higher affirmative vote than an ordinary resolution (Japanese Companies Act, Article 309, Paragraph 2, Item 5). On the other hand, for public companies, a resolution by the board of directors is usually sufficient (Japanese Companies Act, Article 201, Paragraph 1). This allows public companies to proceed with fundraising more dynamically.  

However, even for public companies, a special resolution at the shareholders’ meeting is mandatory when the issuance qualifies as a “favorable issuance” (issuing shares at a particularly favorable price for certain subscribers) (Japanese Companies Act, Article 201, Paragraph 1, and Article 199, Paragraph 3). In this case, directors have the duty to explain to the shareholders’ meeting why it is necessary to solicit subscriptions for the offered shares under such favorable conditions. This provision is designed to prevent directors from abusing their authority and unfairly diluting the interests of existing shareholders. Furthermore, the shareholders’ meeting may delegate the authority to decide on the terms of offering to the board of directors (Japanese Companies Act, Article 200, Paragraph 1).  

The distinction made by Japanese corporate law between public and private companies in terms of the decision-making body for the terms of offering reflects the governance style of each corporate form. Public companies are assumed to have high market liquidity and a broad shareholder base, thus allowing for more flexible management through board decisions. In contrast, private companies often have a limited shareholder composition and a close tie between ownership and management, thus seeking direct shareholder approval through a special resolution at the shareholders’ meeting to protect the concentrated interests of a limited number of shareholders. This structural difference indicates that the Japanese legal system recognizes the dynamics of diverse stakeholders in different corporate structures. For foreign entities, understanding whether the target company is public or private is crucial for grasping the complexity and duration of capital increase procedures and the level of shareholder involvement.

Specifically, the concept of “favorable issuance” functions as an important trigger to ensure fairness in capital transactions under Japanese corporate law. When new shares or stock options are issued at a “particularly favorable” price or terms for the subscribers, the law overrides the usual decision-making authority of the board of directors in public companies, mandating a higher level of shareholder scrutiny (special resolution and directors’ duty to explain). This serves as a direct mechanism to prevent self-dealing by management or controlling shareholders and undue dilution. This particular legal provision emphasizes that the Japanese legal system places a strong emphasis on fairness and transparency in capital transactions. Foreign investors must be acutely aware of this rule, as transactions that could be considered favorable issuances, even in public companies, must be handled with the utmost care and transparency to avoid significant legal challenges and reputational damage.

Notification or Public Notice to Shareholders

Following the decision on the terms of the offering, a company must notify its shareholders of the offering terms or make a public notice at least two weeks before the payment due date as stipulated by Article 201 of the Japanese Companies Act (2005). This notification or public notice is established to ensure that shareholders have the opportunity to object to the issuance of new shares if there are any issues. In the case of public companies, if a notification has been made in accordance with Articles 4(1) to 4(3) of the Japanese Financial Instruments and Exchange Act, there may be instances where this notification requirement does not apply as determined by Ministry of Justice Ordinance when there is no risk of inadequate shareholder protection (Japanese Companies Act, Article 201(4)).

Subscription Applications and Allotment Under Japanese Corporate Law

Individuals wishing to subscribe to new shares must apply for the issuance after receiving a notification from the company. At this time, it is necessary to inform the company of one’s name, address, and the number of shares they wish to subscribe to. Following the application, the company will, as a general rule, decide through a resolution of the Board of Directors who will be allotted how many shares. Once the number of shares to be allotted is determined, the company will notify the applicants of the number of shares allocated to them.  

Performance of Capital Contributions

Subscribers to new shares must pay the full amount of the subscription price for the allocated shares by the designated payment due date at the payment handling location specified by the company, as stipulated under Article 208, Paragraph 1 of the Japanese Companies Act. In cases where non-monetary assets (in-kind contribution assets) are used for the purpose of capital contributions, these assets must be provided within the designated date or period, according to Article 208, Paragraph 2 of the Japanese Companies Act. Should a subscriber fail to make the payment, their right to become a shareholder of those shares will be forfeited. Furthermore, subscribers to new shares are not permitted to offset their obligations related to the performance of capital contributions against any claims they may have against the company, as per Article 208, Paragraph 3 of the Japanese Companies Act.  

Registration Procedures Under Japanese Corporate Law

Following a capital increase, a company in Japan must complete the associated change registration at the Legal Affairs Bureau within two weeks from the effective date of the capital increase. This registration process incurs a registration and license tax, requiring payment of either 0.7% of the increased capital amount or 30,000 yen, whichever is higher. After completing the registration procedures, the company must also prepare a statement of changes in shareholders’ equity to clearly reflect the changes in its net assets.  

Impact on Existing Shareholders and Legal Protection Under Japanese Corporate Law

The issuance of new shares can significantly alter the rights and interests of existing shareholders, which is why Japanese Corporate Law provides robust legal protections.

The Dilution of Voting Power Ratios and Its Impact on Stock Prices

When new shares are issued, the total number of outstanding shares increases. If existing shareholders do not acquire the new shares in proportion to their current holdings, their ownership percentage, and consequently, their voting power at the shareholders’ meeting, becomes ‘diluted’. This dilution can potentially weaken the influence of existing shareholders on company decisions, including the appointment of directors.

The increase in the total number of outstanding shares can potentially decrease the value per share, which may result in a decline in stock prices. Existing shareholders, feeling a reduction in their influence over the company and the value of their holdings, may decide to sell their shares, which could lead to further declines in stock prices. Additionally, the issuance of new shares means that the same profits are distributed across more shares, resulting in a decrease in earnings per share (EPS), which is another economic impact.

The Impact on Management Rights and the Importance of Shareholder Protection Under Japanese Corporate Law

When a third-party allotment of new shares occurs, new shareholders may acquire significant voting rights and demand the appointment of new directors, potentially impacting the company’s management rights. On the other hand, this dilutive effect can also be used as a defense mechanism against hostile takeovers by reducing the shareholding ratio of the acquiring company.

Considering these substantial impacts on management rights and economic interests, Japanese Corporate Law places a high emphasis on the protection of existing shareholders. Companies must ensure that the procedures for issuing new shares are conducted fairly and do not unjustly harm the interests of existing shareholders.

The dilution of shares and changes in management control are not merely theoretical impacts. They are the primary reasons why Japanese Corporate Law imposes strict procedural requirements and form the foundation of shareholder protection. The possibility of legal remedies for shareholders, such as lawsuits for the invalidation of new share issues (Article 828 of the Japanese Companies Act), acts as a strong deterrent against procedural abuse and reinforces the legal system’s commitment to corporate fairness. This signifies to foreign investors that, while the risk of dilution inherent in capital increases exists, the Japanese legal system provides significant remedies when procedural transparency and fairness are compromised. This understanding can influence investment decisions and approaches to negotiating capital increase terms.

Challenging the Validity of New Share Issuance Under Japanese Corporate Law

If there are grounds for invalidity in the issuance of new shares, shareholders can file a “lawsuit to invalidate the issuance of new shares” as stipulated by Article 828 of the Japanese Companies Act. However, if the new share issuance has already taken effect and the company has commenced operations, declaring it invalid could potentially cause unforeseen damage not only to the new shareholders but also to third parties such as business partners. This situation highlights the serious implications of procedural deficiencies and how the law strives to balance stability and justice.

Issuance of Share Warrants and Their Impact on Existing Shareholders in Japan

“Share warrants” in Japan refer to the right to receive new shares from a company or the transfer of treasury shares under predetermined amounts and conditions. Share warrant holders can exercise their rights within a set period by paying a certain subscription price to acquire shares. This mechanism is often used to grant stock options to employees or to diversify fundraising methods.

The exercise of share warrants leads to an increase in the total number of issued shares, which can dilute the voting rights of existing shareholders and decrease the value of the shares. This disadvantage is similar to that of a direct issuance of new shares. In the issuance of share warrants, it is necessary to determine the “offering conditions” just like with the issuance of new shares (Article 238, Paragraph 1 of the Japanese Companies Act). For private companies, a special resolution of the shareholders’ meeting is generally required (Article 238, Paragraph 2 of the Japanese Companies Act). For public companies, a resolution of the board of directors is usually sufficient, but if the terms are particularly favorable to the underwriters, a special resolution of the shareholders’ meeting is necessary (Article 240, Paragraph 1 and Article 238, Paragraph 3 of the Japanese Companies Act).

Companies in Japan can also grant existing shareholders the right to be allotted share warrants (Article 241, Paragraph 1 of the Japanese Companies Act). The issuance of share warrants through shareholder allotment does not have the procedural restrictions associated with favorable issuances like third-party allotments.

The Japanese Companies Act treats the issuance of share warrants with the same caution as direct new share issuances, especially the provisions regarding “favorable issuance,” indicating that the law recognizes share warrants as a mechanism for “future” or “deferred” dilution. Therefore, even if the actual dilution occurs at the time of exercising the rights, the same shareholder protection mechanisms apply from the time of issuance. This emphasizes the importance of comprehensive due diligence. Foreign investors need to scrutinize not only direct new share issuance plans but also existing or planned share warrants, as they indicate future dilution risks and are regulated by the same shareholder protection principles. This represents the law’s foresight regarding changes in capital structure.

A potential issue for companies issuing share warrants in Japan is that whether the warrants are exercised is left to the discretion of the holders. If the stock price does not rise as expected and the rights are not exercised, the company faces the risk of not being able to raise funds as planned.

Summary

Deeply understanding the procedures for issuing new shares under Japanese Corporate Law is crucial for any company considering fundraising in Japan, especially foreign entities. The choice of method for issuing new shares (third-party allotment, shareholder allotment, or public offering) determines the complexity of the procedure and the extent of impact on existing shareholders. Strict adherence to legal requirements, such as the selection of decision-making bodies and the obligation to notify shareholders, is essential to avoid legal disputes, such as claims of invalid share issuance, which can have serious consequences for the company and its stakeholders.

The concept of ‘favorable issuance’ and regulations concerning ‘share subscription rights’ clearly demonstrate how the Japanese legal system prioritizes the protection of shareholder interests and fairness in capital transactions. These provisions emphasize the importance of considering shareholder rights and ensuring transparency when companies raise funds.

The attorney team at Monolith Law Office is capable of providing accurate advice and practical support to help foreign clients navigate the complex procedures of Japanese Corporate Law smoothly. This structure serves as a vital bridge for foreign companies, for whom language and legal system differences can often be barriers, in the Japanese legal environment. For consultations regarding new share issuance or fundraising, please contact Monolith Law Office. We are committed to strongly supporting the growth of your business from a legal perspective.