As Pressure on Japanese Corporate Boards Rises, the Legal Uncertainty Around Corporate Defenses Stands Out

Corporate governance in the world’s third-largest economy is at an inflection point. Facing an influx of foreign and domestic activists in their shareholder registers, Japanese boards are pressured to explore what defenses are legal. Unfortunately for them (and their lawyers), the Japanese courts have done a poor job of clarifying what is OK and what is not.

On October 29, 2021, the Tokyo District Court upheld Tokyo Kikai Seisakusho’s exclusion of Asia Development Capital (ADC), a 40% shareholder, from voting at the shareholder meeting. This ruling, which was supported by the Tokyo High Court and Japan’s Supreme Court, is not yet publicly available. But one Tokyo-based corporate lawyer who received the opinion on a confidential basis lambasted the District Court’s reasoning. The opinion read that “it cannot be summarily said that in light of the relevant circumstances, it was unreasonable to leave the judgment whether corporate value or collective shareholder interests would be harmed to the decision of the shareholders affected.” The decision reportedly does not refer to precedent or statute, nor does it spell out what circumstances wouldn’t be enough to exclude a shareholder.

The circumstances in the Tokyo Kikai case were as follows. TSE-listed ADC is a Chinese-controlled entity with an admittedly shady reputation that includes past securities fraud, murky ownership, and unclear business operations. It had rapidly built up a 40% stake over warnings from Tokyo Kikai and failed to offer a management plan to the company’s board. Under Japanese law, with more than 33% ownership, ADC would have veto rights over important board decisions. Sensing danger, Tokyo Kikai convened a special shareholders meeting to vote on implementing a poison pill, and it decided to exclude ADC from that vote. After failing to obtain an injunction in court, ADC conceded to reduce its stake to 32.7%, just below the 33% threshold.

The Japanese courts have been loath come up with a clear rule on corporate defenses. The only Supreme Court case to ever consider poison pill-like defenses, Bull-Dog Sauce (2007), is disappointingly vague, and its value as precedent is questionable. In that case, sauce manufacturer Bull-Dog Sauce’s board attempted to ward off a takeover by U.S. private equity fund Steel Partners by proposing an option dividend that could be exercised by all shareholders except Steel Partners. Unlike a traditional poison pill, Steel Partners would receive cash compensation if the options were exercised, effectively forcing it to cash out as a shareholder. As many as 83.7% of the Bull-Dog Sauce shareholders (virtually every shareholder other than Steel Partners) voted for the proposal, and the U.S. investor went to court for an injunction.

Steel Partners lost. The highest court ruled that the discriminatory dividend did not violate the principle of shareholder equality (Article 109 of Japan’s Companies Act) because it was reasonable. The court reasoned that the interests of shareholders depend on the continuance and development of the company, and when these are threatened by a particular shareholder, discriminatory treatment of that shareholder to protect the other shareholders’ interests is not per se unreasonable. Shareholders must decide whether a particular shareholder is a threat to corporate value, and their decision, if informed and made through proper procedures, must be respected. Since 83.7% of the shareholders had voted in favor of the board’s proposal, they had evidently determined that Steel Partners was a threat, so the defensive measure was legal.

Bull-Dog Sauce involved unusual facts unlikely to recur. In its wake, the poison pills that Japanese companies adopted did not involve cash payments to compensate hostile acquirers. What little the case did suggest is that boards should obtain shareholder ratification of defensive measures, given how much value the Bull-Dog Sauce court assigned to the shareholder vote in that case. Thus, in contrast to Delaware, where boards can independently adopt pills, Japanese boards typically obtain shareholder approval before implementing defensive measures. To illustrate, a Tokyo court recently struck down a poison pill because it was implemented without shareholder ratification.

With Japan, Inc. more threatened than ever before, the need for clarity is at an all-time high. After a record amount of shareholder activism last year, 2021 is shaping up to be an even more eventful year for Japanese boards. Probably the biggest recent highlight was Toshiba’s decision to unwind its conglomerate structure after years of shareholder pressure, adding another chapter to the rollercoaster Toshiba saga of rigged shareholder votes, collusion with government officials, and the CEO being shown the door. Another highlight is SBI’s ongoing hostile takeover attempt for Shinsei Bank, one of the country’s largest banks. The trend of rising activism in Japan is unlikely to reverse course, and one hopes that the country’s courts will address the need to clarify what corporate defenses are legal.