A Complete Guide to the Share Issuance System in Japanese Corporate Law

The Japanese Corporate Law continues to evolve to support corporate growth strategies and organizational restructuring, adapting to the times. The ‘share issuance’ system, introduced by the amended Corporate Law enacted on March 1, 2021 (2021), is one of the newest and most strategic tools available. This system allows companies to use their own shares as consideration instead of cash when making another corporation a subsidiary, bringing significant changes to the practice of M&A (mergers and acquisitions). Unlike the traditional method of using shares as consideration, such as ‘share exchange,’ which presupposes the complete acquisition of a subsidiary (100% share acquisition), share issuance aims for subsidiary status through the acquisition of over 50% of voting rights, enabling more flexible capital alliances and M&As. Furthermore, it eliminates the need for complex procedures such as value assessments by court-appointed inspectors associated with ‘in-kind contributions,’ allowing for more rapid and efficient transactions. The establishment of this system is not merely a technical legal amendment; it reflects a clear policy intention to encourage companies, especially those with high growth potential but not abundant in cash reserves (such as venture and technology companies), to strategically utilize their share value to execute M&As. This article provides a comprehensive explanation of the share issuance system under Japanese Corporate Law, from its legal definition and specific procedures to important aspects such as the protection of shareholder and creditor rights.

Overview of the Share Issuance System for Strategic Utilization Under Japanese Corporate Law

To accurately understand the share issuance system, it is essential to first grasp its legal definition under Japanese Corporate Law. Article 2, Paragraph 32-2 of the Japanese Companies Act defines share issuance as “a stock company issuing its shares to the transferor of shares of another stock company, in order to make that other stock company its subsidiary (limited to those prescribed by the Ministry of Justice ordinance), as consideration for the transferred shares” . This definition includes several important elements that delineate the scope of the system’s application.

Firstly, the parties involved in this procedure must both be “stock companies” based on the Japanese Companies Act; the company issuing shares to become the parent company (the share-issuing parent company), and the target company (the share-issuing subsidiary) . Therefore, transactions involving foreign corporations or partnerships as parties cannot utilize this system .

Secondly, the purpose of share issuance is limited to making another stock company a “subsidiary” . This means that as a result of the share issuance, a new relationship must be created where the share-issuing parent company holds more than 50% of the voting rights of the share-issuing subsidiary . The determination of this “subsidiary” status is based on an objective and clear “shareholding standard,” and the “substantial control criterion,” which considers a company to be substantially controlling even if it holds less than 50% of the voting rights, is not applied . This clear standard is an intentional design to prevent disputes over the applicability of legal procedures and to ensure the stability of transactions. Therefore, the share issuance system cannot be used for the purpose of acquiring additional shares of a company that is already a subsidiary by holding more than 50% of the voting rights .

Comparing Share Issuance, Share Exchange, and In-kind Contribution in Japan

The strategic value of the share issuance system becomes clearer when compared with other similar M&A methods. Understanding the differences between share issuance and the representative methods of share exchange and in-kind contribution is crucial for formulating the most effective M&A strategy.

The most significant difference from share exchange lies in the level of acquisition required. Share exchange aims to reorganize the target company into a wholly-owned subsidiary (holding 100% of voting rights). In contrast, share issuance does not necessarily require the acquisition of 100% of the shares; it can be used for a more flexible purpose of acquiring a majority of voting rights to make the company a subsidiary. This allows the acquiring company to secure management control while avoiding negotiations and conflicts with minority shareholders who oppose the acquisition.

On the other hand, when compared with in-kind contribution, the simplicity of the procedure stands out. In-kind contribution involves issuing new shares in exchange for non-monetary assets (in this case, shares of the target company), and under Article 207 of the Japanese Companies Act, it generally requires a valuation of the contributed assets by an inspector appointed by the court. This procedure can be time-consuming and costly, but share issuance, being positioned as a reorganization act, is not subject to such in-kind contribution regulations. As a result, companies can execute M&A more quickly and at a lower cost.

Summarizing these differences, the following table is presented:

Standard Procedures for Stock Issuance: A Step-by-Step Explanation

The procedures for executing stock issuance are primarily carried out by the issuing parent company and must go through a series of stages as stipulated by the Japanese Companies Act.

First, the issuing parent company formulates a “stock issuance plan” based on Article 774-2 of the Japanese Companies Act. This plan must include the matters prescribed by Article 774-3 of the same act. Specifically, it should detail the trade name and address of the subsidiary company receiving the stock, the minimum number of shares to be transferred (which must be sufficient to achieve subsidiary status), the number and valuation method of the parent company’s shares to be issued as consideration, the content of any cash or other consideration included, the deadline for subsidiary shareholders to apply for the transfer of shares, and the effective date when the stock issuance takes effect.

Next, the issuing parent company is required to prepare and keep the formulated stock issuance plan and related documents at its head office from a prescribed date, such as two weeks before the shareholders’ meeting, until six months after the effective date (pre-disclosure procedure), as per Article 816-2 of the Japanese Companies Act.

In principle, the stock issuance plan must be approved by a special resolution at the shareholders’ meeting of the issuing parent company before the effective date. A special resolution, as defined by Article 309, Paragraph 2, Item 12 of the Japanese Companies Act, requires the attendance of shareholders holding a majority of the voting rights and the approval of at least two-thirds of the voting rights of the attending shareholders—a very stringent requirement.

After approval by the shareholders’ meeting, the issuing parent company notifies the shareholders of the subsidiary company who wish to transfer their shares about the approved plan (Article 774-4 of the Japanese Companies Act). Shareholders wishing to transfer must submit a written document to the parent company by the application deadline, indicating the number of shares they wish to transfer. Here, one of the most distinctive features of the stock issuance system, the “principle of free allocation,” comes into play. Based on Article 774-5 of the Japanese Companies Act, the issuing parent company is free to decide from whom and how many shares to accept and how to allocate the consideration. This allows the parent company to strategically control the shareholder composition after M&A, for example, by prioritizing applications from friendly long-term shareholders.

Finally, when the effective date specified in the stock issuance plan arrives, legal effects occur. Shareholders of the subsidiary who have transferred their shares receive the parent company’s shares as consideration and become new shareholders of the parent company (Articles 774-7 and 774-11 of the Japanese Companies Act). After the effective date, the parent company is obligated to promptly create post-disclosure documents detailing the number of shares acquired, among other things, and keep them at its head office for six months (Article 816-10 of the Japanese Companies Act).

Procedures for Protecting the Rights of Shareholders and Creditors Under Japanese Corporate Law

Issuing shares can have a significant impact on a company’s organization, which is why Japanese Corporate Law has established strict procedures to protect shareholders and creditors who may be adversely affected.

Share Repurchase Rights of Dissenting Shareholders

Shareholders of a parent company issuing shares who have exercised their voting rights against the share issuance plan at the shareholders’ meeting can demand that the company repurchase their shares at a ‘fair price’ based on Article 816-6 of Japanese Corporate Law. This right is crucial for ensuring that shareholders who oppose significant corporate decisions have the opportunity to recover their invested capital.

Determining a ‘Fair Price’: Insights from Japanese Case Law

If shareholders and the company cannot agree on a ‘fair price,’ the courts will ultimately determine the price. In calculating this ‘fair price,’ Japanese courts do not use a uniform method but instead adopt a multifaceted approach that considers the company’s financial status and all other circumstances. Recently, valuation methods that focus on the future profitability of the company, such as the Discounted Cash Flow (DCF) method, have been gaining importance.

Particularly significant is the judicial decision regarding the application of the so-called ‘illiquidity discount,’ which reduces the stock price due to the difficulty of selling the shares on the market. The Supreme Court of Japan, in its decision on March 26, 2015, indicated that when using valuation methods that focus on the business value of the company (such as the DCF method), it is generally not permissible to apply a discount for illiquidity when calculating the repurchase price for shareholders exiting the company. This precedent is likely to extend to the scenario where dissenting shareholders demand the repurchase of their shares. This judicial decision is crucial from the perspective of shareholder protection, as it prevents minority shareholders from being forced out of the company at an unfairly low price due to their shares being non-public or held in a minority, thereby safeguarding their interests.

Creditor Objection Procedures

When the consideration for share issuance includes property other than the parent company’s shares (such as cash) and the value of such property constitutes at least one-twentieth (5%) of the total consideration, procedures are necessary to protect the interests of creditors due to the outflow of the parent company’s assets. Article 816-8 of Japanese Corporate Law stipulates that creditors of the parent company issuing shares can raise objections in such cases.

When this procedure is required, the parent company issuing shares must publish a notice in the Official Gazette and individually notify known creditors. Creditors can raise objections within a period of at least one month. If an objection is raised by a creditor, the company has the obligation to either make payment to the creditor, provide adequate security, or entrust an appropriate amount of property to a trust company, unless there is no risk of harming the creditor (Article 816-8, Paragraph 5 of Japanese Corporate Law).

Simplified Share Delivery and Practical Considerations Under Japanese Corporate Law

The share delivery system in Japan includes exceptions that simplify procedures and important constraints that should be noted in practice.

Overview of Simplified Share Delivery

Article 816-4 of the Japanese Companies Act establishes a procedure known as “simplified share delivery.” This allows companies to omit the special resolution of the shareholders’ meeting, which is usually required, when the total value of the consideration for the shares delivered does not exceed one-fifth (20%) of the net assets of the parent company delivering the shares. This provision aims to reduce procedural burdens and enable swift decision-making for small-scale M&A transactions that have a minor impact on the company’s assets.

Limitations of the System and Strategic Points

While share delivery is a powerful tool, there are several important constraints on its use. As mentioned earlier, the parties are limited to Japanese stock companies, and it cannot be used for cross-border M&A involving foreign companies.

The tax perspective is also extremely important. In order for the shareholders of the subsidiary transferring shares to receive the tax benefit of deferring capital gains tax arising from the transfer, at least 80% of the total consideration received must be in the form of shares of the parent company delivering the shares. This effectively means that the cash ratio in a mixed consideration (a combination of shares and cash) must be kept below 20%. Furthermore, an important amendment was made for share deliveries conducted after October 1, 2023 (Gregorian calendar year), which excludes from this tax deferral measure any share delivery that results in the parent company becoming a “related party” under tax law. This measure is intended to prevent the abusive use of the system, and particular care is needed when companies with a major shareholder, such as a founding family, conduct share delivery.

Relation to Other Legal Regulations

Share delivery does not only involve the Japanese Companies Act. In particular, if the subsidiary company receiving the shares is a listed company, regulations under the Japanese Financial Instruments and Exchange Act, especially those concerning tender offer (TOB) regulations, may apply. Depending on the nature of the transaction, it may be necessary to proceed with TOB procedures in parallel with the Companies Act procedures. Therefore, to successfully execute M&A using share delivery, an integrated and specialized legal review across multiple areas of law, including corporate law, tax law, and financial instruments and exchange law, is essential.

Conclusion

The share issuance system is a flexible and powerful M&A tool for acquiring control of another corporation using one’s own shares as consideration. It offers the flexibility of not requiring complete subsidiary formation, the simplicity of procedures, and the strategic convenience of ‘allocation freedom,’ making it an important option in corporate growth strategies. However, its execution demands compliance with detailed legal procedures, appropriate responses to the rights of dissenting shareholders and creditors, and an accurate understanding of the complex relationships with related laws such as tax law and the Financial Instruments and Exchange Act. To manage these legal requirements properly and lead transactions to success, advanced expertise and extensive practical experience are essential.

Monolith Law Office has a proven track record of providing legal services related to M&A and corporate reorganization, including the share issuance system discussed in this article, to numerous clients within Japan. Our firm boasts professionals who are not only qualified as Japanese attorneys but also hold foreign legal qualifications and are English speakers, enabling us to provide the highest standard of legal support without language barriers, even in international cases. If you are considering utilizing the share issuance system, please do not hesitate to consult with our firm.