Ensuring Fairness in Management Buyouts in Japan

A management buyout (MBO) is an acquisition of a company (the “target”) by its management, in which the management acquires all shares in the target on the assumption that the target's business will continue, and the management thus contributes all or part of the funds for the acquisition.

As the management is the acquirer in an MBO, there is a structural “conflict of interest” between the management and the shareholders of the target, in that the management has an incentive to acquire the shares in the target at the lowest possible per-share acquisition price from the shareholders. In addition, there is an “asymmetry of information” between the management and the shareholders in that the management usually has accurate and abundant information concerning the target, while the shareholders usually do not have equivalent information.

Due to these “conflicts of interest” and “asymmetries of information”, there is a strong concern that the acquisition price being proposed by the management in an MBO might not be fair and would thus be detrimental to the interests of the shareholders. Therefore, in proceeding with an MBO of a listed company in Japan, certain measures to ensure the fairness of the acquisition price and protect the interests of minority shareholders are taken in practice, as further described herein.

The Ministry of Economy, Trade and Industry (METI) published the “Guidelines on Fair M&A Practices – To Enhance Corporate Value and Secure Shareholder Interests” (the “METI Guidelines”) on 28 June 2019, which include specific practical measures to ensure the fairness of certain types of M&A transactions, including MBOs (the “Fairness Measures”).

The Fairness Measures are proposed as “best practices” in the METI Guidelines, and non-compliance with the METI Guidelines does not have immediate specific legal consequences. However, compliance with the METI Guidelines increases the probability of a court considering the acquisition price to be fair when a shareholder disputes its fairness in court. In recent Japanese court cases, the acquisition price negotiated and agreed between the relevant parties in an MBO has been respected by the court where the court determines that certain Fairness Measures have been effectively taken throughout the whole process of the MBO.

The Fairness Measures proposed in the METI Guidelines include the following three principal measures, which should be undertaken carefully in each transaction where possible.

In Japan, an independent Special Committee is established by the target in almost all MBO transactions as a Fairness Measure. The Special Committee usually consists of three or more members who are considered to be independent of the acquirer and the target, and who do not have a strong incentive or personal interest to complete the transaction. The independent outside directors (or corporate auditors) of the target are usually deemed to be appropriate as members of the Special Committee.

The Special Committee reviews and advises the board of the target on:

As effective review of the Special Committee is considered key to ensuring the fairness of an MBO in Japan, the review process of the Special Committee is respected throughout the transaction process, with the Special Committee being substantially involved in the negotiation of the acquisition price. The Special Committee’s review usually takes at least several months.

A “Market Check” is another measure proposed in the METI Guidelines as a Fairness Measure to be undertaken in an MBO. The question raised in each transaction is the extent to which the Market Check should be conducted to ensure the fairness of the MBO. This requires a case-by-case analysis.

A Market Check may be categorised as one of the following three types:

It should be noted that, under Japanese law, the directors of the target are not legally obliged to maximise the sale value of the target for the benefit of its shareholders by conducting a “pre-market check” or “go-shop” in the event that the target is put up for sale. In some cases, the management solicits a “sponsor” for the MBO (ie, a co-investor who contributes part of the funds for the acquisition), in which case the management’s selection of the sponsor may serve as a “pre-market check”, depending on the process of such selection.

The METI Guidelines state that making the support of a majority of shares held by the “general shareholders” (ie, shareholders excluding the management and others who have specific interests – other than those as shareholders – in the successful completion of the transaction) a precondition for consummating an MBO, and announcing such precondition (the so-called “Majority of Minority (MoM) condition”) in advance, has a certain degree of effectiveness as a Fairness Measure.

In Japan, however, whether an MoM condition is established should be carefully considered in each transaction from the perspective of ensuring the successful implementation of the transaction. In cases where the MoM condition may make the MBO more difficult to complete, the MoM condition may not necessarily be required, as long as other Fairness Measures are effectively undertaken.