In June 2010, the Tokyo Stock Exchange (TSE) implemented a new regulation on transactions

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2 Corporate governance Protecting the minority Roy Umetsu and Makoto Sakai of Mori Hamada & Matsumoto look at new regulations on transactions involving the controlling shareholders of listed companies In June 2010, the Tokyo Stock Exchange (TSE) implemented a new regulation on transactions between a listed company and its controlling shareholder. The new regulation requires a listed company that is conducting a transaction with a controlling shareholder to obtain an opinion, from a person who has no interest in the controlling shareholder, that the transaction will not damage the interests of its minority shareholders. In Japan, a number of listed companies have a controlling shareholder. According to the Corporate Governance White Paper 2009 published by the TSE, 380 out of 2,378 companies listed on the TSE, or about 16%, have controlling shareholders. A transaction between a listed company and its controlling shareholder involves a potential risk for the minority shareholders in that a conflict of interest exists and a controlling shareholder tends to exert undue influence on the company or its board to approve the transaction, the terms of which may be unfair to the company but beneficial to that shareholder. If directors of the controlled company are truly independent from the controlling shareholder, such conflict of interest may not be a problem. However, the Companies Act of Japan and the stock exchange regulations do not always require listed companies to have outside directors, and even if a company decides to have them, directors coming from the controlling shareholder may qualify as outside directors of the company. In fact, the 2009 White Paper reports that 67.5% of the outside directors of companies listed on the TSE which have parent companies come from the parent. Although there have been numerous discussions on the protection of minority shareholders within the framework of the Companies Act, the potential liability of a controlling shareholder in relation to a transaction with the company has not been pursued in practice because of the absence of any express provision allowing a minority shareholder to bring a case against the controlling shareholder. Recently, things have started to change. The regulatory authorities have introduced a variety of rules in relation to this type of transaction, as part of the collective efforts by the Japanese government, stock exchanges and other regulatory authorities to improve Japan s market reliability. Among other things, the new regulation implemented by the TSE has had a practical impact on the corporate activities of listed companies. The new regulation requires the company to take action rather than just enhancing the contents of the disclosure Traditional remedies under the Companies Act The Companies Act does not expressly entitle a shareholder of a company to file a derivative IFLR JAPAN 011

3 action against the controlling shareholder in cases where the company has suffered a loss due to an unfair transaction between the company and the controlling shareholder. Instead, the Companies Act provides for certain protections, including the following two, to minority shareholders of a controlled company: (i) liability of directors for damages to the company (Article 423 of the Companies Act); and (ii) prohibition against the company from compensating any person regarding the exercise of shareholders rights (Article 412). The first protection makes the directors of a controlled company liable to the company if they breach their duties to it. The company s statutory auditor is tasked with filing a derivative action against the directors, and, failing that, the shareholders are entitled to file such action against the directors. If shareholders successfully establish the company s loss due to a transaction which has unfairly benefited the controlling shareholder to the detriment of the minority shareholders, then the directors who breached their duties must indemnify the company for the damages. However, in Japan, unlike other jurisdictions including the UK or USA, controlling shareholders do not owe any duty to the company or its minority shareholders. Therefore, the provision mentioned above does not mandate the controlling shareholder to indemnify the company, and thus does not always provide an adequate remedy to the minority shareholders, particularly where the directors involved do not have sufficient funds to meet their liabilities. The regulation impacted M&A and other corporate transactions immediately In this regard, one influential academic has theorised that if the controlling shareholder of a company was involved in the director s breach of his fiduciary duty, then the controlling shareholder can also be held liable to the company on the ground that the controlling shareholder has committed a tort against the company. Controlling shareholders liability based on this theory, however, has been rarely recognised by the courts, which leads practitioners to conclude that an action against the controlling shareholder has little chance of success. The second protection to minority shareholders involves prohibiting a company from giving benefits to any person regarding the exercise of shareholders rights. If this prohibition is violated, then the recipient of such benefits must return the same to the company (Article 120 of the Companies Act) and, under certain conditions, the directors and the recipient may be subject to criminal sanctions (Article 970). It is, however, not realistic to seek the liability of a controlling shareholder through this prohibition because it was originally intended to prevent corporate extortionists (sokaiya) from exploiting a company by imposing not only civil liabilities but also criminal sanctions, and has been rarely utilised to date with respect to business transactions between a company and its controlling shareholder. Although the Companies Act provides other remedies to protect minority shareholders in relation to specific types of transactions, such as appraisal rights in mergers or other corporate reorganisation transactions, the protections About the author Hideaki Roy Umetsu is an attorney at Mori Hamada & Matsumoto. His areas of practice cover international and domestic M&A transactions, tender offers, corporate restructuring and Asian practices. He was admitted to the Bar in 2004 in Japan and to the New York Bar in Umetsu was educated at the University of Tokyo (LLB., 2003) and the University of Chicago Law School (LLM, 2009). From 2006 to 2007, he worked as an associate director at Ministry of Economy, Trade and Industry of Japan, where he was in charge of M&A related laws and regulations. He also worked as a foreign temporary associate at Davis Polk & Wardwell from 2009 to Contact information Hideaki Roy Umetsu Mori Hamada & Matsumoto Marunouchi Park Building Marunouchi Chiyoda-ku, Tokyo Tel: hideaki.umetsu@mhmjapan.com Web: IFLR JAPAN

4 Corporate governance explained above are the traditional remedies which are possibly available in any type of transaction with the controlling shareholder. Recent developments Recently, in response to the growing demand for the adequate protection of minority shareholders, various regulating authorities have amended laws and regulations, including the FSA s Financial Instrument and Exchange Act (FIEA), the Companies Act and the TSE s listing regulations, to strengthen minority shareholder s protection. The FIEA, which applies to listed companies, requires a company to annotate its financial statements with details of any company transaction with related parties including its controlling shareholder (for example the name of the counterparty, content of the transaction and the company s policy to determine the conditions with related parties). In 2006, the Companies Act, which applies to all companies incorporated under that law, was amended to provide for a similar requirement. These legislative provisions are intended to indirectly regulate relatedparty transactions through the disclosure of that transaction. Aside from these protections, in 2008 the FSA amended the FIEA to oblige a company to disclose, in its periodic filings under the Act, the details of any measure adopted by the company to mitigate the impact of conflicts of interest in transactions with its controlling shareholder, such as the creation of a special committee to decide the conditions of the transactions independently of the board. The TSE, for its part, also implemented new regulations to address the same concerns as part of its Comprehensive Improvement Program for Listing System, which it launched to improve its listing system. In 2008, the TSE required listing companies which have controlling shareholders to disclose, in their Corporate Governance Reports which they regularly file with the TSE, company policies designed to protect minority shareholders in transactions with controlling shareholders. The 2009 White Paper describes two general trends observed in these policy disclosures. One type of disclosure generally describes company policies relating to transaction terms and conditions, while the other type describes company procedures in dealing with transactions with controlling shareholders. On top of this, listing companies were also required to disclose the implementation status of the measures taken under those company policies in their annual Disclosure of Matters Relating to Controlling Shareholders filed with the TSE within three months after the end of each business year. The regulations expounded above are typical examples of the progress in recent years in Japan to protect minority shareholder interests. It is worthwhile to note, however, that the FIEA, the Companies Act and the TSE s listing regulations only required additional disclosure of information. The TSE s new regulation Following the recent regulatory advances to protect minority shareholder interests, on June the TSE implemented a new regulation amending its securities listing regulations. Under the new regulation: if a listed company which has a controlling shareholder conducts certain material transactions relating to its controlling shareholder or certain other persons specified under the new regulation, the listed company will be required to obtain an opinion from an independent person and make timely disclosure, with sufficient information, of the transaction. Unlike previous regulations, the new regulation requires the company to take action (to obtain an independent opinion), rather than just enhancing the contents of the disclosure. A controlling shareholder mainly means a parent company which is defined as a company that (i) owns more than 50% of the voting rights of another company; or (ii) effectively controls another company based on 40% or more of its voting rights accompanied with other certain relationships with the controlled company. The controlling shareholder also includes a shareholder which owns, by himself and together with the voting rights owned by his close relatives, more than 50% of the listed company s voting rights. About the author Makoto Sakai is an attorney at Mori Hamada & Matsumoto. His areas of practice include international and domestic M&A, private equity, corporate restructuring and tax. He also provides advice to a variety of clients on various general corporate matters. He was admitted to the Bar in 2004 in Japan and to the New York Bar in He graduated from the University of Tokyo (LLB, 2003) and Cornell University Law School (LLM, 2009). He worked as a visiting attorney at Gibson Dunn & Crutcher in Los Angeles from 2009 to Contact information Makoto Sakai Mori Hamada & Matsumoto Marunouchi Park Building Marunouchi Chiyoda-ku, Tokyo Tel: makoto.sakai@mhmjapan.com Web: IFLR JAPAN 013

5 014 A material transaction refers to the wide range of transactions enumerated in the new regulation which are required to be disclosed under the disclosure rules of the TSE, including mergers (gappei), share exchanges (kabushiki kokan), share transfers (kabushiki iten), demergers (kaisha bunkatsu), tender offers, acquisitions of its own shares, grant of stock options, certain goprivate transactions, business transfers, business alliances, asset transfers and third-party allotments of company shares, and also covers certain transactions between a subsidiary of the listed company and its controlling shareholders. This definition covers transactions which could have a material impact on the company but excludes day-to-day transactions. In principle, any transaction specifically enumerated as a material transaction directly between a listed company and its controlling shareholders is covered, but broader actions of the listed company may also qualify. In case of a tender offer made by the controlling shareholder for the shares of a listed company, for instance, if the listed company expresses an opinion on that tender offer, that opinion will be deemed a transaction regulated by the new regulation although in that instance the listed company does not have any transaction with the controlling shareholder. Moreover, the phrase other persons specified under the new regulation (described in item (i)(b) above) includes broader categories of companies such as companies which have the same parent company as the listed company and the officers of the parent company and their close relatives. Therefore, even if a listed company conducts the above enumerated transactions only with the officers or the subsidiaries of the controlling shareholder, the new regulation will be triggered. When the new regulation is triggered, the listed company will be required to obtain an opinion from a person who has no interest in the controlling shareholder, such as an outside director, an outside statutory auditor or an independent special committee, saying that the transaction will not undermine the interests of minority shareholders of that listed company. A fairness opinion from an independent third party valuation institution may be submitted. The opinion should deal with various aspects of IFLR JAPAN Listed companies must carefully check well in advance of the completion of a transaction whether the new regulation will apply to them the transaction, such as the purpose of the transaction, the process of the negotiation, fairness of the consideration and whether or not the transaction would increase the corporate value of the listed company. In addition to the submission of an opinion, the listed company must also make a timely disclosure of the transaction. The disclosure, which will be in the form of a press release, must include an explanation of the opinion and the measures taken by the company to ensure the fairness of the transaction and to mitigate the conflict of interest, but the opinion itself is not required to be attached to the press release. If a listed company fails to comply with the new regulation, the TSE may (i) make a public announcement of such compliance failure; (ii) impose a listing agreement violation penalty; (iii) request the listed company to submit a report explaining the reasons for the compliance failure and proposed improvement measures; or (iv) designate the listed shares as a security on alert, in which case such listed company must promptly submit a document that contains the status of the company s internal control system and other related matters on each anniversary of such designation. The new regulation started to impact M&A and other corporate transactions in Japan immediately after its implementation. According to Mori Hamada & Matsumoto s research, as of October and based on disclosure documents, opinions required by the new regulation have been obtained in 28 transactions, of which opinions of special committees have been obtained in 16% of the cases, opinions of outside officers in 28%, fairness opinions in 23% and law firms or lawyers opinions in 23%, while the remaining 10% are unclear or unclassifiable based on the disclosure documents. As described above, the new regulation covers a relatively wide range of transactions including certain actions by the listed company which do not fall within the literal definition of transactions. Listed companies may not notice that the new regulation could be triggered in the contemplated transactions, whereas the sanctions for violating the new regulations could be severe. Therefore, listed companies must carefully check well in advance of the completion of a transacwww.iflr.com

6 Corporate governance tion whether or not the new regulation will apply to them. Possible amendment of the Companies Act Following the movement to afford wider respect and protection to minority shareholders as described above, the government, led by the Ministry of Justice s Legislative Council corporate law subcommittee, has begun discussing possible amendments to the Companies Act to address this issue. At the time of writing, members of this corporate law subcommittee are discussing the need for a new provision which will allow minority shareholders to bring a derivative action against the controlling shareholder if the company suffers a loss resulting from a transaction with the controlling shareholder that is potentially and structurally detrimental to the company. Not everyone is convinced of the need for further amendments to the Companies Act in this regard. The Japan Federation of Economic Organisations (keidanren), which exerts a powerful influence on legislative actions, has expressly opposed the proposed amendment in its position paper dated July This position paper claims that the Companies Act, as well as the regulations of the TSE and the Corporation Tax Act, adequately provide for various proactive measures and after-the-fact remedies to address this issue, and thus it is not necessary for minority shareholders to have legislative authorisation to sue the controlling shareholder in injurious related-party transactions. It is not possible to say at this stage whether the Companies Act will be amended to provide for a new provision or what the details will be. Yet, given the impact of this development in enhancing the rights of minority shareholders, it is worth following the discussion in this Subcommittee. Developments worth watching The developments mentioned above, including the new regulation, have prompted Japanese listed companies with controlling shareholders and their advisers to pay attention to specific factors, such as the purpose of the transaction, pursuit of the transaction, and fairness of consideration, when conducting any transaction with controlling shareholders. In the meantime, minority shareholder protections continue to evolve and develop further as practitioners in Japan eye possible amendments to the Companies Act to allow minority shareholders to file a derivative action against controlling shareholders. This last development is certainly worth watching in the coming months. IFLR JAPAN 015