Expected Amendment to Procedural Rules on Allotment of Shares

The legislative council of the Ministry of Justice of Japan compiled an outline of the proposed amendments to the Companies Act of Japan in September 2012, and such proposed amendments include an amendment to the procedural rules on allotment of shares.
 
Background of Amendment
 
Under the existing Companies Act, a “public company” (i.e., a stock company whose articles of incorporation do not require company approval for transfer of at least one class of its shares, such as a listed company) may conduct a third-party share allotment based on a board resolution without a shareholders resolution, unless the shares are to be issued at a “particularly favorable” price compared to their fair value.  Under such rules, there have been some cases in which listed companies conducted a third-party allotment, based solely on a board resolution, that resulted in a significant dilution of stock ownership or a change of control of the company.  A strong argument arose for the existing rules on share allotments to be amended so that neither may the rights of shareholders be significantly diluted nor control of the company be changed arbitrarily by a decision of the directors even if the shares are issued at a fair price.  Accordingly, each stock exchange in Japan created new regulations to the effect that, when a listed company conducts a third-party allotment that would result in an increase of voting rights by 25% or more of all the existing voting rights of the company or a change of control of the company, such company must either (a) obtain an opinion of a third party independent from management (i.e., directors) regarding the necessity and suitability of the third-party allotment, or (b) obtain shareholders’ approval of the allotment (e.g., by means of a shareholders resolution).  However, the argument remains that, apart from such stock exchange regulations, the Companies Act should also provide for appropriate rules on a third-party allotment that are applicable to a public company (including both listed and non-listed companies).
 
Proposed Amendment
 
Under the proposed amendment, when a public company intends to allot shares to a subscriber (except the company’s existing parent company) that would result, after issuance, in an increase of the voting rights held by the subscriber (together with those held by its subsidiaries) to more than half of all the voting rights of the company, the company must notify each shareholder, or give public notice (or, if applicable, make required securities filings), of, among other things, the name and address of the subscriber and the number of the voting rights the subscriber will hold as a result of the issuance, not later than two weeks prior to the expected effective date of the issuance.
 
If any shareholder or combination of shareholders holding not less than one-tenth of all the voting rights of the company notifies the company of its dissent from the share allotment within two weeks from the date of notice or public notice, the company must obtain, by a shareholders resolution, approval of the allotment not later than the day immediately preceding the expected effective date of the issuance; except that this requirement will not apply where the financial status of the company is significantly worsening and the share allotment is urgently needed in order to maintain the company.
 
Further details are as follows.
 
(i) Threshold

The proposed rules will apply to cases where the voting rights held by the subscriber (together with those held by its subsidiaries) will exceed 50% of all the voting rights of the company after the issuance.  Thus, for example, the proposed rules will apply, even if the allotted shares total only 3% of all the voting rights of the company, as long as the voting rights held by the subscriber will increase from 49% to more than 50% as a result of the allotment.  On the other hand, the existing parent of the company, when it is the subscriber, is excluded from the scope of the proposed rules because the control of the company does not change when the company allots shares to its existing parent.
 
(ii) Information Provided to Shareholders

The proposed rules aim to provide all shareholders with information necessary for them to decide whether or not to dissent from the allotment.  Such information to be provided to the shareholders, in addition to that required under the existing Companies Act, must include the identity of the subscriber and the number of the voting rights the subscriber will hold as a result of the allotment, and possibly, pending the final amendments, the details of the decision of the board of directors and the opinion of the board of statutory auditors of the company with respect to the allotment.
 
(iii) Resolution of Shareholders

Under the proposed rules, when the company must obtain approval by a shareholders resolution, such resolution must be made by a majority of the voting rights held by all the shareholders entitled to vote at the meeting where the shareholders holding the majority of the voting rights held by all shareholders of the company entitled to vote (this quorum requirement may be relaxed by the articles of incorporation but may not be relaxed to less than one-third of the voting rights held by all shareholders of the company entitled to vote) are present in person or through a written ballot or represented by proxy.
 
As to the exception for an urgent situation mentioned above, the company’s existence must be at risk in the absence of such allotment.  Only an urgent necessity for funding will allow a company to forgo the approval by a shareholders resolution.  When a company implements a share allotment without approval by a shareholders resolution on the grounds of an “urgent necessity” for funding, even where a shareholder or combination of shareholders holding not less than one-tenth of all voting rights of the company dissent from such allotment, such shareholders may file for an injunction against such allotment to dispute the “urgent necessity”.
 
Expected Impact on Practice
 
Under the proposed rules on share allotments, a public company will be required to set a timetable for allotments in case the company is required to obtain approval by a shareholders resolution.  In principle, a company would be required to choose two options: (i) set a period long enough to enable the company to hold a shareholders meeting before the expected effective date of the issuance in cases where a shareholder or combination of shareholders holding not less than one-tenth of all voting rights of the company dissent from the allotment; or (ii) not set such a long period but simply refrain from the allotment where it turns out that the approval by a shareholders resolution is required (and initiate the issuing procedures anew with the expectation of obtaining the approval by a shareholders resolution).  With respect to option (i), it is possible for the company to obtain the approval by a shareholders resolution voluntarily without waiting for dissent.
 
The submission to the Diet of the amendment bill is currently pending as there are many other matters that have priority over the Companies Act amendments, and it is not clear when the bill will be submitted.  However, it is expected to take place in the near future.  More details of the proposed rules will become known when the bill is actually submitted to the Diet, and the impact of the amendment should be further assessed at that time.
 
Mayuko Tsujimoto is an associate at Nagashima Ohno & Tsunematsu.  Her practice focuses on corporate matters, including M&A and corporate governance.  She graduated with an LL.B. from Kyoto University in 2008 and was admitted to the Bar in Japan in 2008. Mayuko can be contacted by phone on +81-3-3288-7000
 
Tsuyoshi Shimizu is a partner at Nagashima Ohno & Tsunematsu, one of the largest law firms in Japan.  His practice focuses on corporate matters, including M&A, joint ventures and corporate governance.  He graduated with an LL.B. from the University of Tokyo in 1996 and with an LL.M. from New York University School of Law in 2003.  He was admitted to practice law in Japan in 1998.  He worked at Pillsbury Winthrop Shaw Pittman LLP in New York as a visiting foreign attorney from 2003 to 2004, and worked at Japan’s Ministry of Justice from 2006 to 2008. Tsuyoshi can be contacted by phone on +81-3-3288-7000