Issuing Bonds by Japanese Companies: Types, Procedures, and Management Points

Alongside equity financing through the issuance of shares, debt financing via the issuance of corporate bonds, or shasai (社債), stands as a critical avenue for Japanese companies (Kabushiki Kaisha, K.K., and other corporate forms) to raise capital for various purposes, including business expansion, refinancing existing debt, and funding specific projects. The Japanese Companies Act (Kaisha-hō) provides a comprehensive framework governing the definition, types, issuance procedures, and ongoing management of these debt instruments. Understanding this framework is essential for companies contemplating bond issuances, for investors considering bond purchases, and for legal and financial professionals advising on such transactions.

What are Bonds (Shasai) under the Japanese Companies Act?

Under the Japanese Companies Act, a "bond" (shasai) is defined as a monetary claim against the issuing company that meets certain requirements stipulated in the Act, primarily that it is issued in accordance with the provisions concerning the solicitation of subscribers for bonds (Article 2, item 23; referring to Article 676). Essentially, corporate bonds represent a form of borrowing by the company from a multitude of investors (bondholders) under uniform terms and conditions for each series of bonds.

Distinction from General Loans

While both bonds and general bank loans represent debt obligations for the company, there are key distinctions:

• Multiple Creditors: Bonds are typically issued to a large number of investors, whereas loans are often from a single lender or a small syndicate of lenders.
• Standardized Terms: Each series of bonds has uniform terms (interest rate, maturity date, etc.) applicable to all bondholders of that series.
• Transferability/Tradability: Bonds, especially those of publicly listed companies or those issued under the book-entry system, are often designed to be transferable, allowing investors to buy and sell them in secondary markets. This contrasts with many commercial loans, which are less liquid.
• Direct Recourse to Capital Markets: Bond issuances allow companies to tap directly into capital markets for funding, diversifying their financing sources beyond traditional bank lending.

Legally, a bond represents a claim for the payment of money based on what is essentially a loan agreement for consumption (kinnsen shōhi taishaku keiyaku) between the company and the bondholders. For the company, the outstanding bonds constitute liabilities.

Types of Bonds Issued by Japanese Companies

Japanese companies can issue various types of bonds, categorized based on different features:

1. Based on Registration/Bearer Status (Historically More Relevant)

• Registered Bonds (Kimei Shasai): The names and addresses of the bondholders are recorded in the company's bond registry (shasai genbo).
• Bearer Bonds (Mukimei Shasai): The holder of the physical bond certificate is deemed the rightful owner.
  However, with the prevalence of the book-entry transfer system, the practical significance of this distinction for newly issued bonds, especially publicly traded ones, has greatly diminished.

2. Based on Attached Features

• Bonds with Share Options (Shinkabu Yoyakuken-tsuki Shasai) (Article 2, item 22): These are bonds to which share options (shinkabu yoyakuken – the right to acquire shares of the issuing company) are attached. Upon exercising the option, the bondholder can acquire shares. There are two main sub-types:
  • Conversion-Type (Convertible Bonds): Upon exercise, the bond principal is effectively "converted" into shares, and the bond itself is extinguished.
  • Warrant-Type (Bonds with Detachable Warrants): Upon exercise, the bondholder pays a separate exercise price to acquire shares, and the bond itself remains outstanding as a debt instrument.
• Straight Bonds (Futsū Shasai - Ordinary Bonds): These are bonds that do not have any share options attached. They represent a pure debt obligation with fixed interest payments and principal repayment.

3. Based on Transfer System

• Book-Entry Transfer Bonds (Furikae Shasai): These bonds are handled under the electronic book-entry transfer system established by the "Act on Book-Entry Transfer of Company Bonds, Shares, etc." (the "Book-Entry Act"). Physical bond certificates are not issued for these bonds; ownership and transfers are recorded and managed electronically in databases maintained by the Japan Securities Depository Center (JASDEC) and account management institutions (e.g., securities firms, banks). Most publicly offered and traded bonds in Japan are now book-entry bonds.
• Bonds with Certificates (Shasaiken Hakkō Shasai): These are bonds for which physical bond certificates are issued. While less common for new public issues, this form might still be used in certain private placements or for older outstanding bonds.

4. Based on Security

• Secured Bonds (Tanpo-tsuki Shasai): These bonds are secured by a pledge of or mortgage over specific company assets (e.g., real estate, machinery). If the company defaults, the bondholders have a priority claim on those pledged assets.
• Unsecured Bonds (Mutanpo Shasai): These bonds are not backed by specific collateral and rely on the general creditworthiness of the issuing company. Most corporate bonds issued by large, reputable companies are unsecured.

5. Other Classifications

Depending on the terms, bonds can also be classified as subordinated bonds (where claims rank below other senior debt in case of bankruptcy), perpetual bonds (with no fixed maturity date, though often with call options for the issuer), and others tailored to specific investor demands or issuer needs.

Procedures for Issuing Bonds (Boshū Shasai no Hakkō Tetsuzuki)

The issuance of bonds for subscription (boshū shasai) involves several key procedural steps under the Companies Act:

1. Determination of Subscription Requirements (Boshū Jikō no Kettei) (Article 676)

The company must first determine the principal terms of the bonds to be offered. These "subscription requirements" include:

• The total aggregate amount of the bonds to be issued.
• The amount of each individual bond (denomination).
• The interest rate (coupon rate).
• The method and due date(s) for redemption of principal.
• The method and due date(s) for payment of interest.
• Whether physical bond certificates will be issued.
• If the bonds have share options attached, the details of those options.
• Any provisions for a bond manager or representative bondholders.
• The issue price (if different from the face value, e.g., discount or premium bonds).

Decision-Making Body

• General Rule: For companies with a board of directors, the board of directors generally has the authority to decide on these matters (Article 362, paragraph 4, item 2). For companies without a board, the directors make these decisions (Article 348, paragraph 2).
• Delegation:
  • The articles of incorporation can stipulate that such decisions require a resolution of the shareholders' meeting.
  • In a "Company with Nominating Committee, etc.," this authority can be delegated to executive officers (Article 416, paragraph 4).
  • In a "Company with Audit and Supervisory Committee" meeting certain requirements (e.g., majority of directors being outside directors), this authority can be delegated to directors (Article 399-13, paragraphs 5 and 6).
  • The board of directors can also determine certain overarching matters (like the maximum aggregate amount of bonds to be issued) and then delegate the determination of more specific details to individual directors (Article 362, paragraph 4, item 5).

2. Application and Allotment (Mōshikomi to Wariate) (Articles 677, 678)

• Solicitation: Based on the determined subscription requirements, the company solicits subscriptions from potential bondholders.
• Application: Interested investors submit applications to subscribe for the bonds.
• Allotment: The company then decides to whom and in what amounts it will allot the bonds from among the applicants. A crucial point is that, unlike loan agreements which are typically consensual contracts, the issuance of bonds becomes effective upon allotment by the company, and the subscribers become bondholders at that point, irrespective of whether payment has been made (Article 678, paragraph 1). This is a specific exception to the general contract law principle requiring consideration for a contract to be formed (e.g., the "real contract" nature of loan agreements under Civil Code Article 587).

3. Payment (Haraikomi) (Article 679)

Subscribers to whom bonds have been allotted must pay the full subscription price by the specified payment due date.

4. Registration

The issuance of bonds must be registered in the company's commercial register at the Legal Affairs Bureau (Article 911, paragraph 3, item 21).

Management and Administration of Bonds

Once issued, the ongoing management of bonds involves several key elements:

A. Bond Registry (Shasai Genbo) (Article 681 et seq.)

• Purpose and Content: The issuing company must prepare and maintain a bond registry. This registry contains essential information about the bondholders, such as their names and addresses, and the class and amount of bonds held by each. For registered bonds or bonds for which no certificates are issued (and which are not book-entry bonds), the bond registry is crucial for determining ownership and for perfecting transfers against the company and third parties.
• Maintenance: The company is responsible for keeping the bond registry accurate.
• Inspection Rights: Bondholders and creditors of the company generally have the right to inspect and copy the bond registry.

B. Bond Certificates (Shasaiken) (Article 687 et seq.)

• Issuance: As a general rule, a company that issues bonds must issue physical bond certificates for them, unless the bondholders request that certificates not be issued or unless they are book-entry bonds (Article 687). In practice, for widely distributed bonds, the book-entry system is now the norm, meaning physical certificates are often not issued.
• Content: Bond certificates must state specific information, including the company's trade name, the total amount of the bonds, the amount of each bond, interest rate, redemption terms, etc.
• Transfer:
  • Registered Bonds: Transfer requires endorsement and delivery of the certificate, plus a change of name in the bond registry for perfection against the company.
  • Bearer Bonds: Transfer is effected by simple delivery of the certificate.
• Bona Fide Acquisition: A person who acquires a bond certificate in good faith can generally acquire valid title, even if the transferor did not have good title.

C. Bond Managers (Shasai Kanrisha) (Article 702 et seq.)

• Role: A bond manager is an entity (typically a bank or trust company) appointed by the issuing company to act on behalf of all bondholders of a particular series. Their role is to receive payments of principal and interest, take necessary actions to protect the bondholders' claims (e.g., in case of default), and otherwise administer the bonds.
• Appointment: Appointment of a bond manager is common for publicly offered bonds to facilitate administration and protect dispersed bondholders.
• Duties and Powers: Bond managers have a fiduciary duty to act faithfully and impartially for the benefit of all bondholders. Certain significant actions, such as agreeing to a moratorium on payments or a modification of bond terms that materially affects bondholders' interests, require a resolution of a bondholders' meeting.

D. Bondholders' Meetings (Shasaikensha Shūkai) (Article 715 et seq.)

• Purpose: This is a collective body for bondholders of the same class to make decisions on matters affecting their common interests.
• Convening: Meetings can be convened by the issuing company or the bond manager. Bondholders holding a certain percentage (usually one-tenth or more) of the aggregate amount of that class of bonds can also demand that a meeting be convened.
• Resolutions: Resolutions are passed by specific voting majorities, typically requiring the affirmative vote of attendees representing a majority of the aggregate voting rights present at the meeting, which must also constitute at least one-fifth of the total aggregate amount of that class of bonds. The articles of incorporation or terms of the bonds can stipulate higher thresholds.
• Effect of Resolutions: Validly passed resolutions are binding on all bondholders of that class. Court approval may be required for certain types of resolutions (e.g., those consenting to actions detrimental to bondholders' rights).

E. Financial Covenants (Zaimu Jōkō)

It is common practice for bond indentures or offering circulars to include financial covenants. These are undertakings by the issuing company to maintain certain financial ratios (e.g., debt-to-equity ratio, interest coverage ratio) or to refrain from certain actions (e.g., incurring additional secured debt beyond a certain limit, making substantial dividend payments if certain financial conditions are not met).

• Purpose: Covenants are designed to protect bondholders by ensuring the company maintains a certain level of financial health and does not take actions that could unduly jeopardize its ability to service the bonds.
• Consequences of Breach: A breach of covenant can trigger various remedies for bondholders, often including the acceleration of principal repayment (making the entire bond amount immediately due and payable).

Conclusion

Corporate bonds are a versatile and vital instrument for Japanese companies to access debt capital markets, complementing equity financing. The Companies Act provides a detailed regulatory framework governing their issuance, the various types that can be offered (from straight bonds to complex bonds with share options), and the mechanisms for their ongoing administration and the protection of bondholder rights, including the bond registry, the potential role of bond managers, and the collective decision-making power of bondholders' meetings. With the increasing prevalence of the book-entry system, the practicalities of bond management and transfer continue to evolve. For both issuing companies and investors, a clear understanding of these legal and administrative aspects is crucial for successful participation in Japan's corporate bond market.