2. Reverse share split
(for acquirers owning two-thirds or more of the voting rights of the target company)
As a first step, the acquirer (either directly or through a Japanese special acquisition vehicle) launches a tender offer to acquire the target company’s shares. If the acquirer purchases at least two-thirds of the voting rights of the target company, then a special meeting of the target company’s shareholders is held to approve the reverse share split. Upon approval by shareholders owning at least two-thirds of the voting rights of the target company (which threshold includes the shares owned by the acquirer, so passage of the resolution is assured), then the target company can effect a reverse share split pursuant to which the consolidation ratio is set to a level that is sufficiently high to render after the split all (or a targeted number) of minority shareholders with fractional share ownership. Since fractional shares cannot be issued under Japanese corporate law, the sum of the fractional shares are either sold to a third party designated by the target company (typically the acquirer) or are repurchased by the target company itself upon receipt of court approval (which approval is a standardized procedural step as opposed to a potential substantive challenge, and it normally takes approximately two to four weeks to obtain such court approval), and then cash consideration is distributed to the minority shareholder in an amount equal to the quantity of shares owned by the minority shareholder multiplied by the offer price in the first-step tender offer.
While easy to implement, a drawback of a reverse share split is that it may not apply automatically to holders of share options or warrants of the target company (unlike the demand for sale of shares method, as discussed above), so an examination of these instruments will be necessary to determine if a reverse share split is beneficial. On the other hand, a reverse share split can be particularly helpful if the acquirer plans to own the target company with co-investors since the consolidation ratio can be set to a level that will not eliminate the ownership of consortium members.
Considering the time to obtain court approval and to follow the record date, notice period and meeting formalities under Japanese corporate law, the approximate time to complete a reverse share split is normally three to four months.
Less Common Methods to Squeeze-Out Minority Shareholders
If an acquirer purchases at least two-thirds of the voting rights of the target company, squeezing out minority shareholders by way of a cash-out merger (
genkin kōfu gappei) or a cash-delivery-share-exchange (
genkin kōfu kabushiki kōkan) are other effective methods to squeeze-out minority shareholders considering the Japanese taxation reforms effective from October 1, 2017. However, these procedures are rarely used in Japan because (i) each can be relatively more burdensome if the acquirer directly acquires the target company’s shares (as opposed to acquiring shares through a special acquisition vehicle), (ii) each can cause some tax disadvantages or unintended tax incentives for shareholders to oppose the first-step tender offer in order to be bought-out in the second-step squeeze-out transaction, and (iii) normally neither has any material advantages over the reverse share split method (which method has been widely tested by Japanese courts and considered an acceptable way to squeeze-out minority shareholders, so the reverse share split method adds to deal certainty).
Remedies Available to Dissenting Shareholders
Shareholders who object to a squeeze-out transaction can (i) petition a court to appraise the fair value of their shares, (ii) pursue a legal action against the directors of the target company claiming that they acted in bad faith or with gross negligence when performing their duties (e.g., the directors did not pay sufficient attention to the interests of the minority shareholders), (iii) request an injunction to prevent the closing of the squeeze-out transaction, or (iv) seek to nullify the squeeze-out transaction in its entirety.
An appraisal is the most common remedy selected by dissenting shareholders when challenging a squeeze- out transaction because a dissenting shareholder may realize a direct financial gain if it is awarded an increase in the purchase price for its shares (which economic incentive may motivate a dissenting shareholder to undertake the time and expense to challenge a going private transaction). While pursuing a legal action against the directors of the target company also can lead to financial gain for a dissenting shareholder, such suits are uncommon in Japan due to the high burden of proof that must be satisfied and comprehensive discovery is not available in Japan (so a dissenting shareholder will face an uphill battle to meet its burden of proof to succeed). Seeking an injunction or nullification of a squeeze-out transaction is uncommon in Japan too because neither approach will likely confer a monetary benefit to the dissenting shareholder. In light of the foregoing, this newsletter focuses on the appraisal remedy.
Appraisal Process
A dissenting shareholder must follow certain procedures to exercise its appraisal rights, and the target company can reduce the likelihood of an appraisal award if it follows safe harbor procedures, each as discussed below.
Standing to invoke. To initiate an appraisal proceeding, a dissenting shareholder must not tender its target company shares in the first-step tender offer, and it must comply with additional procedures depending on the squeeze-out method utilized by the acquirer:
- In a demand for sale of shares, the dissenting shareholder must be a shareholder of the target company prior to the date the target company’s board of directors issues its notification or public notice concerning its approval of the call option exercise by the Special Controlling Shareholder. In addition, the dissenting shareholder must petition a court to appraise the value of its shares between 20 days prior to the effective date of the squeeze-out and the day immediately preceding the effective date of the squeeze-out.
- In a reverse share split, the dissenting shareholder must vote against the reverse share split at the relevant shareholders’ meeting, deliver a repurchase demand to the target company between 20 days prior to the effective date of the reverse share split and the day immediately preceding the effective date of the reverse share split, and if the target company and the dissenting shareholder are unable to agree on a fair price for the target company shares owned by the dissenting shareholder within 30 days from the date discussions are requested to commence, then the dissenting shareholder or the target company can petition a court to appraise the value of the target company shares owned by the dissenting shareholder.
The purchase price discussions between the target company and a dissenting shareholder in the reverse share split context are held in confidence, so a dissenting shareholder ordinarily will not become aware of the price paid to another dissenting shareholder unless a dispute is brought to trial and a final court decision is published.
Safe harbor procedures. Appraisal cases in Japan were historically treated as non-contentious cases in which courts had reasonable discretion to determine fair value. Some Japanese lower courts made their fair value determinations by analyzing the value of the target company prior to the M&A transaction versus the increase in value to the target company after the M&A transaction. The bifurcation of value analysis exposed transactions to unpredictable outcomes because courts were inconsistent in their valuation methodologies, and some courts even considered the tender offer price as the baseline to determine the increase in value to the target company after the M&A transaction. This baseline approach to valuation exposed going private tender offer transactions to an inherent risk of challenge since courts ordinarily would award a dissenting shareholder an amount equal to at least the tender offer price, so a dissenting shareholder theoretically had little to lose when challenging a transaction (other than time, advisor expenses, and reputation risk). In one fell swoop, Japan’s Supreme Court changed the appraisal valuation rubric in a controlling shareholder going private transaction.
