Scheduling M&A transactions: practical considerations regarding FDI

Highlights

• It can be difficult and time consuming to confirm whether a target's business constitutes a 'specified type of business' which requires a foreign investor to submit a prior notification under the Foreign Exchange and Foreign Trade Act (FEFTA). This process may delay the M&A transaction schedule.
• The Japanese authorities sometimes ask foreign investors to submit additional information through prior notification procedures under the FEFTA (in addition to a prior notification form), which may take substantial time to prepare. This may delay the prior notification procedure and the M&A transaction schedule.
• The FEFTA and related public notice have been amended multiple times in recent years; therefore, non-Japanese companies and investors should check the latest foreign direct investment (FDI) regulation before proceeding with M&A transactions in Japan.

Introduction

When a non-Japanese company or investor proceeds with an M&A transaction in Japan, one of the key regulations to observe is the FEFTA, which regulates FDI in Japan. However, regulation under the FEFTA can delay the M&A transaction schedule. Therefore, this article sets out practical considerations relating to Japan's FDI regulations which non-Japanese companies and investors should bear in mind when scheduling an M&A transaction.

Overview of FDI regulation

When a foreign investor proceeds with inward direct investment under the FEFTA (eg, a business transfer, merger, company split or certain types of share transfer), it must generally submit a prior notification or a subsequent report to the authorities. A subsequent report will not affect the M&A transaction schedule because all relevant procedures are taken after the closing of the transaction. However, a prior notification may affect the M&A schedule because foreign investors are prohibited from proceeding with inward direct investment for 30 days after the authorities' receipt of the prior notification. The authorities may shorten or extend this 'waiting period'; the maximum waiting period is five months, but it is usually shortened to two weeks. In case of portfolio investments, the waiting period is usually shortened to five business days. In addition, the authorities may suggest that the foreign investor amend the scheme or stop the inward direct investment if, among other things, it would:

• negatively affect national security, the maintenance of public order or public safety; or
• have a material adverse effect on the smooth functioning of the Japanese economy.

If the foreign investor refuses to follow the authorities' suggestion, the authorities can order the foreign investor to change the scheme or stop the inward direct investment.(1)

Penalties apply if:

• a foreign investor does not submit a prior notification;
• the notification includes false information;
• a foreign investor proceeds with inward direct investment during the waiting period; or
• a foreign investor refuses to follow an order of the authorities to change a scheme or stop inward direct investment.

In such cases, the foreign investor will be subject to a penalty of up to three year's imprisonment, a fine of up to Y1 million or both. However, if the amount equivalent to three times the value of the subject matter of the violation exceeds Y1 million, the fine to which the foreign investor is subject will be no more than such equivalent amount.

Specified types of business

Prior notification under the FEFTA is generally required if:

• the foreign investor is not a national of a designated country under the FEFTA;
• the target's business is a specified type of business under the FEFTA; or
• the prospective transaction concerns Iran.

In many cases, the main issue is whether a target's business constitutes a specified type of business, the determination of which can be difficult and time consuming. For example, the following types of software business constitute a specified type of business:

• entrusted development software business;
• embedded development software business; and
• package software business.

These terms are defined in the Japanese Standard Industrial Classification as follows:

• 'Entrusted development software business' means business regarding the development of a program of electronic calculation equipment, as well as research, analysis and advice relating to such development.
• 'Embedded development software business' means business regarding the development of software which is embedded in information and communication equipment, transport machinery and household electrical appliances, among other things, which implements the function of such equipment, machinery or appliances.
• 'Package software business' means business regarding the development of a package program of electronic calculation equipment, as well as research, analysis and advice relating to such development.

IT business, including software business, develops rapidly and information as to a target's business can be insufficient to determine whether the target's business constitutes any of the above types of business. In such cases, the foreign investor may need to ask the target for details on the target's business. This process may delay the M&A transaction schedule.

Prior notification process

If a foreign investor is required to submit a prior notification under the FEFTA, it must complete a template prior notification form (available on the Bank of Japan's website) and provide basic information regarding:

• the investor;
• the target; and
• the transaction.

For example, in case of a share transfer, the required basic information includes:

• the representative's name, an overview of the business, the foreign investor's address and nationality and a URL to the foreign investor's website;
• the target's name, address, purpose of business, capital amount and foreign capital ratio before and after the share transfer;
• the reason for submitting the prior notification; and
• details of the share transfer, such as:
  • the number of transferred shares;
  • the share transfer price; and
  • the shareholding ratios of investors before and after the share transfer.

The authorities sometimes ask foreign investors to submit additional information through the prior notification procedure. Such additional information may include:

• additional information on the foreign investor, such as:
  • sales amounts;
  • number of employees;
  • main customers;
  • a list of its directors and auditors (among others);
  • a profile of its representative; and
  • details of its shareholders and group companies;
• additional information on the target; and
• additional information on the purpose of the M&A transaction.

Foreign investors sometimes have many shareholders and group companies, in which case it can take substantial time to prepare the above information. In addition, the information must be submitted in Japanese, so translation time may be required.

If the list of additional information required is short, the authorities will usually check it with the foreign investor by phone. If the list of additional information is long, the authorities will send a questionnaire to the foreign investor within approximately one week of their receipt of the prior notification. As mentioned above, the waiting period is usually shortened to two weeks, but the preparation of the above information can take longer than one week from the investor's receipt of the questionnaire.

The authorities disclose factors to be considered for FDI screening.(2) According to the disclosed factors, the authorities are largely concerned with maintaining:

• national security;
• public order;
• public safety; and
• the smooth functioning of the Japanese economy.

The scope of these factors is broad and the authorities sometimes request additional information which the foreign investor cannot supply within a short period. In such cases, the foreign investor may need to discuss with the authorities how to respond to the additional information request.

A prior notification can be submitted from six months before the transaction. If there is a risk that the authorities will request excessive additional information regarding the transaction, the foreign investor should consider submitting a prior notification early. Even if the details of the transaction have yet to be finalised, prior notification will be effective if the actual transaction falls within the description of the notification. For example, in case of a share transfer, a foreign investor can include on the prior notification form the maximum number of shares to be transferred in the prospective M&A transaction.

Since the prior notification process may delay an M&A transaction schedule, foreign investors should carefully consider the timing of submitting such a notification.

Recent amendments to FEFTA and related public notice

In recent years, the government has made multiple amendments to the FEFTA and related public notice. A timeline of the major recent amendments is as follows.

The above amendments expanded the scope of the subject matter of a prior notification under the FEFTA.

A non-Japanese company or investor which proceeds with an M&A transaction in Japan should keep an eye out for future amendments to the FEFTA and related public notice.

Comment

When a foreign investor proceeds with an M&A transaction in Japan, the person in charge of the transaction should take note of Japan's FDI regulations, as explained above, and pay careful consideration to the transaction schedule.

Endnotes

(1) There is one published case in which the authorities issued an order to stop inward direct investment (2008).

(2) The English translation of the factors is available on the Ministry of Finance's website.