Due diligence in M&A deals involving Japanese companies

Due diligence investigation of target Japanese companies must be conducted during the process of their acquisition. Due diligence is necessary to identify any legal issues affecting a target company if an acquirer wishes to establish a new relationship with that target. It also helps facilitate the post-acquisition integration of the target company into the company it has been acquired by.

When to conduct due diligence?

Due diligence is usually carried out after a memorandum of understanding or a letter of intent has been entered into. In case of tender submissions, due diligence is usually carried out after the first tender is submitted.

For a large M&A project in Japan, a vendor will usually appoint a securities firm or an investment bank as a financial adviser, and due diligence will generally be conducted in accordance with the schedule set by that financial adviser. If a vendor enjoys a dominant bargaining position due to the presence of a number of potential acquirers, it is likely that the due diligence will run for too long, which may not be beneficial to the sale process. However, the bidders may have difficulty convincing the vendor to shorten the schedule significantly.

During a due diligence investigation, a target company will need to prepare information to be provided to the acquirer. Either the vendor or the acquirer may be able to take the leading role in the preparation of such information, depending on their respective bargaining strength. If the acquiring party wishes to obtain information effectively, it should be proactive by submitting a list of the information requested, and read all the publicly available information in advance.

DD in Japan: things to note

Given the numerous differences between Chinese and Japanese laws, a Chinese enterprise must first identify the legal issues affecting a target company as well as the risks associated with compensation obligations, administrative penalties and criminal liability under Japanese law. The impact of these risks on the future operations of the target company should then be analyzed.

The following points are worthy of note:

Status of shares

If an acquisition is to be carried out through the issue of new shares or the transfer of existing shares, the status of all the shares of the target company can be confirmed by consulting the articles of association, company registration and register of shareholders. This is particularly important as many Japanese companies issue convertible corporate bonds and corporate bonds carrying new share subscription rights. If such bonds have been issued, an acquirer will need to confirm the extent of the ownership it can acquire if the shares are diluted to the maximum upon completion of the acquisition.

Minutes

In addition to the minutes of shareholders’ meetings, minutes of board meetings and key senior management meetings should be inspected. They are essential because they may contain information about disputes and outstanding issues relating to important projects.

Non-compete and change of control

The inspection of major contracts involving joint ventures, business cooperation agreements, purchasing and licensing is the core of a due diligence investigation. It is vitally important to confirm whether there are any non-compete or change of control clauses in these contracts. If there is a non-compete clause, an acquiring party is likely to find itself in breach of the clause even before the target company has commenced any new business. An acquiring party may also find itself having to assume liability for damages after the acquisition is completed.

Clauses that may obstruct integration

If a Japanese company with business in China is to be acquired, care should be taken to confirm whether there are any exclusive rights in the contracts covering the Chinese market. In other words, if a target company grants to a business operator other than the acquiring party an exclusive sales right or a sales licence covering products that the target company makes, this will create an obstacle to post-acquisition integration.

Personnel issues

It is necessary to confirm whether there are any inappropriate agreements between the target company and its previous and existing senior management staff and directors covering remuneration and pensions. This must be noted even if a contract between the original founders does not contain any title of director, president or consultant. It is also necessary to confirm in the labour provisions, labour contracts and other written information whether there is any outstanding overtime pay, past disciplinary cases, or past or existing labour disputes or potential disputes.

Sector-specific approvals

An acquiring party needs to engage lawyers with relevant professional knowledge to confirm whether a target company has violated any particular legislation governing its industry (such as banking，securities or insurance).

Environmental issues

Japan’s environmental laws contain stringent standards. For instance，the law on soil contamination may increase the burden on land owners and other business operators. An acquirer may need to engage a special environmental consultancy to conduct land surveys.

Confidentiality issues

Before due diligence is conducted, a target company will require an acquiring party to enter into a confidentiality agreement or (in case of a tender) to make an undertaking at the time of submitting a tender. Such an agreement or undertaking will prevent the acquiring party from leaking to a third party any secrets accessed during a due diligence investigation for purposes other than those connected with the acquisition.

In particular, when a company which is competing with the acquirer is being acquired, the acquirer may want to use the target’s confidential information for its business purposes even if the acquisition is not ultimately concluded. This information must be destroyed and restrictions placed upon its use should an acquisition ultimately turn out to be unsuccessful.

Hiroshige Nakagawa is a partner at Anderson Mori and Tomotsune and chief representative of its Beijing Office