Hundreds of Japanese companies have erected takeover defenses to protect themselves from hostile takeovers in recent months, but the courts may tear some of them down, breaching the walls of fortress Japan for outsiders to acquire underperforming firms.
Japanese managers, weaned on consensus decision making behind closed doors, have been unnerved by a recent rise of shareholder activism such as New-York based hedge fund Steel Partners' unsolicited bid for Worcester sauce maker Bull-Dog Sauce (2804.T: Quote, Profile, Research).
A couple of years ago poison pills were virtually unheard of in the world's second-biggest economy, but now more than 300 Japanese companies have announced takeover defenses, also known as poison pills, to block change. Shareholders are increasingly considering countering them in court.
Legal precedents set in the coming months may shape the course of future hostile bids in Japan as well as the country's ability to entice foreign investment from increasingly acquisitive overseas companies and private equity funds.
Foreign buyout firms have made slow headway in Japan so far as risk-averse companies cling to national pride.
But hostile takeovers may become more common in tandem with the rise of foreign institutional investors willing to tender their stocks to the highest bidder -- and as capital ties with management-friendly shareholders such as banks unwind.
We don't believe that the Japanese corporate law allows poison pills, said Warren Lichtenstein, chairman and chief executive of activist hedge fund Steel Partners, Ltd., which has criticized takeover defenses adopted by several Japanese firms it has targeted including the country's third-largest brewer, Sapporo Holdings Ltd. (2501.T: Quote, Profile, Research).
Steel Partners has asked the Tokyo District Court to bar Bull-Dog Sauce from activating a pill, claiming it violates the principle of shareholder equality and is financially damaging.
Poison pills will be hotly debated at shareholders meetings in coming weeks when many will be put to a vote. Bull-Dog's AGM is set for June 24 and the court's decision is due June 27-28, though appeals may prolong the final outcome until mid-July.
We still don't know how the courts will decide on very important issues, we still need to build a body of findings, said Anthony Miller of activist fund Ramius Capital.
Based on past cases, the courts are likely to throw out pills adopted to protect managers' jobs without the approval of shareholders, enacted after a hostile bidder appeared or those that damage shareholders financially, lawyers said.
A typical Japanese defense is known as an advanced warning system, which enables the target to ask the bidder questions. If it is not satisfied with the answers, the board can trigger the issue of stock purchase warrants that would dilute the bidders' stake, making it more expensive for the takeover to succeed.
Courts that are asked to judge the merit of poison pills have very little case law to work with. But they will probably follow non-binding guidelines by the Ministries of Justice and of Economy, Trade and Industry in 2005 that poison pills are justified if they protect a firm from abusive and value-destroying hostile takeover bids.
In a rare case, the courts in 2005 blocked a warrant issue by Nippon Broadcasting System (4660.T: Quote, Profile, Research), ruling defensive measures adopted after the emergence of a bidder were in principle illegal.
Bull-Dog proposed its pill after Steel launched its bid.
In another landmark case the same year, the Tokyo High Court stopped Nireco (6863.Q: Quote, Profile, Research), a maker of measuring equipment, issuing warrants as it said the defense was protecting directors' jobs.
Courts have also ruled that the warrants issued by the target company have to be at a fair value.
Last year the Tokyo District Court upheld activist investor Dalton's argument that Suntelephone's (8083.T: Quote, Profile, Research) planned issue of warrants to a third party was unfair to all existing shareholders - as the warrants were not priced at fair value.
STAMP OF APPROVAL
A hotly debated issue among lawyers in Tokyo is how much support a poison pill needs among shareholders to be valid.
According to Institutional Investor Services, more than 60 companies adopted pills without a vote in 2006. This year however all companies have chosen to ask for approval.
However, many of the pills have been adopted with a simple majority, whereas many lawyers are convinced that a special resolution is needed, meaning more than two-thirds of the vote.
An issue of warrants requires a special resolution if it will lead to unfair dilution or the price is too low, said a lawyer at a leading Japanese law firm.
Bull-Dog's pill is the first court case where the poison pill is being challenged even though it may win shareholder approval, two thirds at that -- making it tough for Steel Partners to win.
A few more court rulings against poison pills may make more managers think twice about adopting them.
A poison pill is a double-edged sword. They have to be brave enough to fight against the invader by convincing shareholders of their business plan. I don't think they are prepared enough, said Takamitsu Araki, head of the corporate advisory division at Shinsei Bank.