Introduction to legal aspects of a Japanese merger

A leaf from a gingko tree, a Tokyo Minicipal symbol often depicted on railings or other street furniture.

A Japanese merger involves two or more companies becoming one company further to a defined process in the Japanese Corporate Law (below the ‘JCL’).  This article outlines legal aspects of the merger process as background for more detailed analysis of the Japanese tax treatment of mergers and other corporate reorganizations.

Definition of a Japanese merger

In a Japanese merger, two or more companies (below the ‘Ceasing Companies’) cease their activities and combine their operations within one single company (below the ‘Surviving Company’) under a process regulated by the Japanese Corporate Law.

Mergers can be divided into two categories:  In an ‘Absorptive Merger’ there is at least one Ceasing Company and a single Surviving Company that takes over the assets and liabilities of the Ceasing Companies. Japanese corporate law also allows a ‘New Company’ merger, in which a newly established entity takes over the activities of all the other existing Ceasing Companies in the merger transaction.

References below to a Surviving Company also apply to such a newly established company in a New Company merger unless otherwise indicated.

The continuation of the rights and obligations of the Ceasing Company

The rights and obligations of the Ceasing Companies are not extinguished by the merger, but instead are carried over to the Surviving Company (JCL article 750, 752, 754, 756). It is not possible to prevent some part of the rights and obligations of the Ceasing Companies transfer to the Surviving Company.  Rights and obligations not recognized by the Ceasing Companies at the time of the merger are also transferred to the Surviving Company.

Dissolution of the Ceasing Companies

The Ceasing Companies are treated as dissolved under the Japanese merger process without any separate shareholder resolution or other steps to dissolve the companies. Such dissolution occurs at the same point in time that the merger becomes legally valid.

The position of the shareholders of the Ceasing Companies

In consideration for the surrender of their shares as a result of the merger, the shareholders of the Ceasing Companies can receive in return shares, monetary assets or other assets.  In a New Company merger some part of the consideration given to these shareholders would include shares in the newly established company.

In an absorptive merger, in addition to shares of the Surviving Company, the shareholders of the Ceasing Company can receive share options, corporate bonds, and bonds with attached share option rights, money and other assets.  These can include, for example, the shares of a foreign parent company owning shares in a Japanese subsidiary that is a Surviving Company.  This would allow a foreign group to establish a Japanese bid vehicle that can participate in a typical cross-border triangular merger.

The timing of the effectiveness of the merger

In the case of an absorptive merger, the time that the merger is legally effective is determined explicitly in the merger contract (JCL articles 750, 752, 754, 756). Note that this is a change from the position under the old Japanese Commercial Law where the date when a merger was effective was at the time of its formal legal registration.

Mergers between different types of Japanese company

The Japanese Corporate Law directly defines and regulates four types of companies, with those types being illustrated on the diagram included in this article (see the ‘CORPORATE LAW’ section of the diagram).  Any of these four types of Japanese Company can be the Ceasing or Surviving Company in a Japanese merger, and given that some of these entities (for example, the Japanese ‘goudou gaisha’) can elect to be treated as fiscally transparent under the US tax code this may sometimes be of value to a US investor.

Note however that the special limited company form originally regulated under the former Japanese Commercial Law (in Japanese the ‘特例有限会社’ or ‘tokurei yuugen kaishi’) cannot become a Surviving or Newly Established company in a merger.

Mergers with a foreign company

Under the JCL a Japanese company and a foreign company cannot merge.

Mergers of companies with excess net liabilities

It is possible for a company with net liabilities (i.e. a company that is technically insolvent) to be the Ceasing Company in a Japanese merger. However, in order to help protect the interests of the shareholders of the Surviving Company such a merger requires the approval of a general shareholders meeting. The abbreviated procedures that exist in the JCL to hold such general shareholder meeting cannot be applied to a resolution for such a merger.

Third party objection to the merger

A significant defect in the merger process could give rise to the merger being treated as void for legal purposes.

An example of legal defect sufficiently serious to void a merger could be the lack of proper shareholder approval of the merger contract, or proper measures not being taken to settle amounts due to creditors who had opposed the merger under the procedures to protect creditor rights.

However, given the very great commercial uncertainty created by voiding a merger, there is a time limit and system of regulation that must be followed in order to set aside a merger.

Voiding a merger

A merger can only be set-aside as void by the Court (JCL article 828).  Persons who can sue to set aside a merger are limited to the shareholders of the companies involved in a merger (including those persons who cease to be shareholders as a result of the merger), directors, of the companies involved, their statutory auditors, liquidator, bankruptcy trustee, or creditors who did not approve the merger.

There is a six-month time period after the effective date of the merger to start proceedings to void the merger.

Effects of a voided merger

A decision to avoid a merger is effective against third parties and is not applied retroactively.  Assets acquired after the effective date of the merger are treated as held in common by the companies concerned.  Similarly, liabilities from such date are also treated as common obligations of the companies involved in the voided merger.

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