Capital Raising by Japanese K.K.s: Procedures and Points to Note for "Issuance of Shares for Subscription"

Japanese Attorney at Law - Bengoshi L.L.

• 8 min read

For any Kabushiki Kaisha (K.K., or joint-stock company) in Japan, securing adequate capital is fundamental to its establishment, ongoing operations, and future growth. While debt financing is one avenue, equity financing through the issuance of shares is a primary method for K.K.s to raise capital. The Japanese Companies Act (Kaisha-hō) meticulously regulates this process under the framework of "Issuance of Shares for Subscription" (boshū kabushiki no hakkō tō). This framework encompasses both the issuance of new shares and the disposal of treasury shares (shares previously repurchased by the company). Understanding the procedures, legal requirements, and key considerations, particularly concerning the protection of existing shareholders, is crucial for companies undertaking capital raising and for investors participating in such offerings. This article delves into the intricacies of issuing shares for subscription in a Japanese K.K.

Understanding "Issuance of Shares for Subscription" (Boshū Kabushiki no Hakkō tō)

The term "Issuance of Shares for Subscription," as defined and regulated under Articles 199 to 213A of the Companies Act, refers to the process by which a K.K., after its incorporation, offers shares to persons who subscribe for them and pay the subscription price. This is distinct from the initial issuance of shares at the time of the company's formation.

Purpose and Scope

Companies utilize this mechanism for various strategic reasons:

  • Funding Growth and Expansion: Securing capital for new projects, market entry, or capacity building.
  • Strengthening Financial Base: Improving the company's balance sheet and financial stability.
  • Strategic Alliances: Issuing shares to strategic partners to solidify business relationships.
  • Employee Incentives: As a form of equity compensation, though share options (shinkabu yoyakuken) are also commonly used.
  • Mergers and Acquisitions: As consideration in M&A transactions.

The regulations cover both the issuance of newly authorized shares (which increases the company's stated capital) and the sale of existing treasury shares held by the company (which does not directly increase stated capital but brings in funds).

Key Methods of Issuing Shares for Subscription

There are three primary methods through which a K.K. can offer shares for subscription, each with different procedural implications and impacts on existing shareholders:

  1. Shareholder Allotment (Kabunushi Wariate):
    In this method, the company offers existing shareholders the right to subscribe for new shares in proportion to their current shareholdings. This approach is designed to protect existing shareholders from dilution of their proportionate ownership and control. If shareholders exercise their pre-emptive rights, their percentage stake in the company remains unchanged. Procedures typically involve a resolution by the shareholders' meeting (or the board of directors/directors, depending on the company type and articles of incorporation) determining the subscription requirements, notification to shareholders, an application period, allotment, and payment.
  2. Public Offering (Kōbo):
    A public offering involves soliciting subscriptions from the general public or a wide range of unspecified investors. This method is commonly used by listed companies to raise significant capital from the market. Public offerings are subject to extensive disclosure requirements under the Financial Instruments and Exchange Act, including the preparation and filing of a securities registration statement and prospectus.
  3. Third-Party Allotment (Daisansha Wariate):
    This involves offering shares to specific third parties, who may or may not be existing shareholders. Third-party allotments are often used for strategic investments, to bring in new major shareholders, as part of M&A deals, or sometimes as a way to issue shares to executives or employees (though less common than share options for broad-based incentives due to tax implications for recipients). Because third-party allotments can significantly dilute the interests of existing shareholders (both in terms of control and economic value) if not managed carefully, they are subject to stringent procedural requirements and scrutiny, particularly concerning the issue price.

Procedures for Issuance of Shares for Subscription

The Companies Act outlines a detailed procedural framework for the issuance of shares for subscription:

1. Determination of Subscription Requirements (Boshū Jikō no Kettei) (Article 199)

The first step is to determine the key terms of the offering, known as "subscription requirements." These typically include:

  • The number of shares to be offered for subscription.
  • The issue price (amount to be paid in) per share, or the method for calculating it.
  • If shares are to be issued in exchange for non-cash assets (contribution in kind - genbutsu shusshi), a description of such assets and their appraised value.
  • The payment date or payment period.
  • Matters concerning the amount of stated capital and capital reserves to be increased.
  • If shares are allotted to existing shareholders proportionally, that fact and related details.

Decision-Making Body (Articles 199(2), 200, 201)

The corporate organ responsible for determining these subscription requirements depends on whether the company is public or non-public:

  • Non-Public Companies (Hikōkai Kaisha): As a general rule, a special resolution of the shareholders' meeting is required (Article 199, paragraph 2; Article 309, paragraph 2, item 5). This higher threshold is to protect the interests of existing shareholders in closely-held companies, as new share issuances can significantly alter control dynamics and dilute economic stakes.
  • Public Companies (Kōkai Kaisha): Generally, the board of directors can determine the subscription requirements by resolution (Article 201, paragraph 1), provided the issuance is within the total number of authorized shares stated in the articles of incorporation. This allows public companies greater agility in capital raising. The board can also delegate this authority to the shareholders' meeting (Article 200).
  • Shareholder Allotment Specifics: For shareholder allotments, even non-public companies can authorize the board of directors (or directors, if no board) to determine the subscription requirements if their articles of incorporation so provide (Article 202, paragraphs 3 and 4).

Notification or Public Notice of Subscription Requirements

Once the subscription requirements are determined, they must be notified to prospective subscribers or publicly announced (e.g., Article 201, paragraphs 3 and 4 for public companies; Article 203, paragraph 1, refers to notification for applications).

Application, Allotment, and Payment

  1. Application for Subscription (Mōshikomi) (Article 203): Persons wishing to subscribe for the shares submit an application to the company in accordance with the determined requirements.
  2. Allotment (Wariate) (Article 204): The company then decides to whom and how many shares it will allot from among the applicants. The company has discretion in allotment unless it's a shareholder allotment where shareholders have a pro-rata right.
  3. Payment (Haraikomi) (Article 208): Subscribers to whom shares have been allotted must pay the full subscription price in cash (or provide the non-cash assets for contributions in kind) by the specified payment date or within the payment period. Partial payment is generally not sufficient.

Timing of Becoming a Shareholder (Article 209)

Subscribers become shareholders of the shares for which they have paid on the payment date (or on the last day of the payment period, if a period is specified).

Registration of Change in Capital

Following the issuance, the company must register any increase in its stated capital with the Legal Affairs Bureau.

Special Considerations and Shareholder Protection

The Companies Act incorporates several mechanisms to protect the interests of existing shareholders when new shares are issued.

A. Regulation of Advantageous Issuance (Yūri Hakkō Kisei) (Articles 199(3), 201(1))

This is a critical protection against the dilution of existing shareholders' economic value.

  • Definition: An "advantageous issuance" occurs when shares are offered for subscription at a "particularly favorable price" (tokuni yūri na kingaku) – meaning a price significantly lower than the fair market value of the shares.
  • Rationale for Regulation: Issuing shares at a deep discount to specific parties unfairly dilutes the economic interest of existing shareholders who are not offered shares at the same price.
  • Requirements for Public Companies: If a public company intends to issue shares at a particularly favorable price, it is not sufficient for the board of directors alone to approve it. A special resolution of the shareholders' meeting is also required (Article 199, paragraph 3, applied mutatis mutandis by Article 201, paragraph 1). The directors have a duty to explain to the shareholders' meeting the reasons why such an advantageous issuance is necessary (Article 199, paragraph 3).
  • Determining a "Particularly Advantageous Amount": What constitutes a "particularly favorable price" is a factual determination. Courts have considered various factors, including the difference between the issue price and the prevailing market price (or a reasonably assessed fair value for unlisted shares), the necessity and reasonableness of the issuance at that price, and the impact on existing shareholders. A Supreme Court judgment on December 17, 1996 (Minshu Vol. 50, No. 10, p. 2766) provided guidance, suggesting that a price that is not justifiable based on market conditions or other rational grounds for the company could be deemed particularly advantageous. Significant discounts from market price without compelling corporate reasons often trigger this scrutiny.

B. Issuance Involving Change of Control or Significant Dilution (for Public Companies)

Beyond the advantageous issuance rules, specific concerns arise when a third-party allotment by a public company could lead to a change in control or significant dilution of existing shareholders' voting power (e.g., if the new shares represent 25% or more of the post-issuance outstanding shares, or if the issuance results in a more than 50% dilution).

  • While the Companies Act does not have explicit statutory provisions directly mandating a shareholder vote for all such dilutive third-party allotments (unless it's an advantageous issuance), stock exchange rules and evolving corporate governance norms in Japan increasingly pressure companies to seek shareholder approval or provide thorough explanations and justification for such issuances.
  • Case law (e.g., Tokyo High Court decision, September 12, 2005) has also indicated that in circumstances where an issuance is primarily aimed at entrenching management or frustrating a takeover, and results in substantial dilution without a compelling corporate purpose, it may be challenged as an abuse of director's authority or a grossly unfair issuance, potentially leading to an injunction.

C. Pre-emptive Rights (Shinkabu Hikiuke-ken)

Unlike some U.S. state corporate laws that provide for statutory pre-emptive rights (the right of existing shareholders to subscribe to new share issuances proportionally to maintain their stake), the Japanese Companies Act does not grant automatic statutory pre-emptive rights to shareholders of a K.K.

  • However, a company can voluntarily provide for pre-emptive rights in its articles of incorporation (e.g., by creating a class of shares with such rights under Article 108, paragraph 1, item 8, or by specifying shareholder allotment as the method for particular share issuances).
  • The "shareholder allotment" method described earlier effectively functions as a form of pre-emptive offering, achieving a similar outcome of allowing existing shareholders to maintain their proportionate interest.

D. Remedies for Shareholders in Case of Improper Issuance

If an issuance of shares for subscription violates laws or the articles of incorporation, or is conducted in a grossly unfair manner, shareholders have legal remedies:

  1. Injunction Against Issuance (Hakkō Sashitome Seikyū) (Article 210):
    Shareholders who are likely to suffer a disadvantage due to an impending share issuance that violates laws or the articles of incorporation, or is conducted by a grossly unfair method, can petition the court for an injunction to stop the issuance. This is a pre-emptive remedy. Common grounds include an advantageous issuance by a public company without the required special shareholders' resolution, or an issuance exceeding the number of authorized shares.
  2. Action for Declaratory Judgment of Invalidity of Share Issuance (Shinkabu Hakkō Mukō no Uttae) (Article 828, paragraph 1, item 2):
    After the shares have been issued, certain parties (shareholders, directors, statutory auditors, etc., at the time of issuance) can file a lawsuit to declare the share issuance invalid. This action must generally be filed within six months from the effective date of the issuance (or one year for public companies whose shares are listed or otherwise publicly traded). The grounds for invalidity are typically significant violations of law or the articles of incorporation that fundamentally taint the issuance process (e.g., a complete lack of a necessary resolution, or issuance based on a fraudulent valuation for contribution in kind).
  3. Action for Declaratory Judgment of Non-Existence of Share Issuance (Shinkabu Hakkō Fusonzai Kakunin no Uttae):
    In extreme cases where there was effectively no issuance act at all (e.g., a purported issuance that was never actually carried out) or the defects are so severe that the issuance is considered legally non-existent from the outset, this action can be brought.
  4. Liability of Directors:
    Directors can face personal liability to the company in connection with improper share issuances:
    • If directors collude with a subscriber who acquires shares at a grossly unfair price, they may be liable for the shortfall (Article 212).
    • If directors are involved in a "disguised payment" where a subscriber does not actually pay for the shares, they can be held liable (Article 213-2).
    • In cases of contribution in kind, directors can be liable for any shortfall if the actual value of the contributed property is significantly less than its stated value in the subscription requirements, unless they can prove they exercised due care (Article 213).

Conclusion

The "Issuance of Shares for Subscription" is a vital mechanism for Japanese K.K.s to raise capital and achieve strategic objectives. However, the process is governed by a complex set of rules under the Companies Act, with significant variations depending on whether the company is public or non-public, and the method of issuance chosen. A central theme throughout these regulations is the protection of existing shareholders from unfair dilution of their economic and voting interests, exemplified by the stringent rules on advantageous issuances and the availability of remedies like injunctions and actions for invalidity. For companies planning to raise equity in Japan, and for investors considering participation, a thorough understanding of these procedures, decision-making requirements, and shareholder protection mechanisms is indispensable for ensuring compliance and making informed decisions.