Share Options (Shinkabu Yoyakuken) in Japan: Issuance Procedures, Exercise, and Shareholder Remedies

Japanese Attorney at Law - Bengoshi L.L.

• 7 min read

Share options, known in Japanese corporate law as shinkabu yoyakuken (新株予約権 – literally, "new share reservation rights"), are versatile financial instruments that grant the holder the right, but not the obligation, to acquire shares of a company under predetermined conditions. While commonly associated with employee stock options, their application under the Japanese Companies Act (Kaisha-hō) is broader, encompassing tools for capital raising, mergers and acquisitions, and even as components of convertible bonds. Understanding the legal framework for issuing and exercising shinkabu yoyakuken, and the remedies available if issuance procedures are flawed, is crucial for companies considering their use and for potential holders.

Understanding Shinkabu Yoyakuken (Share Options)

A shinkabu yoyakuken is a right granted by a company to a person (the option holder) to demand that the company either issue new shares to them or transfer existing treasury shares held by the company to them, upon the exercise of this right (Article 2, item 21; Article 236, paragraph 1 of the Companies Act).

Key Characteristics and Purposes:

  1. Nature of the Right: It is an option, meaning the holder can choose whether or not to exercise it. If exercised, the holder typically pays a pre-determined "exercise price" (kōshi kakaku) to acquire the shares.
  2. Purposes of Issuance:
    • Employee and Director Incentives (Stock Options): This is a very common use, aligning the interests of key personnel with those of shareholders by allowing them to benefit from future increases in share price.
    • Capital Raising: Companies can issue shinkabu yoyakuken to investors for a subscription price, raising immediate funds, with the potential for further capital influx if the options are exercised.
    • Mergers and Acquisitions: They can be used as part of the consideration in M&A deals or issued to executives of an acquired company.
    • Convertible Bonds and Bonds with Warrants: Shinkabu yoyakuken are integral to "bonds with share options" (shinkabu yoyakuken-tsuki shasai). In a "conversion-type" bond, the bond itself is converted into shares upon exercise. In a "warrant-type" bond, the bond remains outstanding, and the holder pays an additional exercise price to acquire shares.

The Companies Act provides a comprehensive framework governing the issuance, content, transfer, and exercise of these rights.

Issuance of Shinkabu Yoyakuken

The issuance of shinkabu yoyakuken can occur through two primary methods: an allotment to specific subscribers (募集新株予約権 - boshū shinkabu yoyakuken, or "share options for subscription") or a gratuitous allotment to existing shareholders (shinkabu yoyakuken musho wariate).

A. Issuance of Share Options for Subscription (Boshū Shinkabu Yoyakuken) (Articles 238-241)

This is the more common method for targeted issuances, such as stock options to employees or allotments to specific investors. The procedure involves several steps:

  1. Determination of Subscription Requirements (Boshū Jikō no Kettei) (Article 238):
    The company must first determine the key terms ("subscription requirements") of the share options it intends to issue. These include:
    • The content and number of the share options to be issued.
    • The amount to be paid in for each share option (the issue price of the option itself, which can be zero if issued gratuitously, as is common for employee stock options), or the method for calculating such amount. If no payment is required, that fact must be stated.
    • The date for allotting the share options.
    • If the share options are attached to bonds, specific details about those bonds.
    • The "exercise price" per share to be paid upon exercising the option, or its calculation method.
    • The "exercise period" during which the option can be exercised.
    • Conditions under which the option can be exercised (e.g., vesting conditions for employee stock options).
    • The class and number of shares to be issued or transferred upon exercise.
    • Matters concerning the amount of stated capital and capital reserves to be increased upon exercise.
    • Whether the options can be transferred, and if so, whether company approval is required for transfer.
  2. Decision-Making Body for Subscription Requirements:
    • Non-Public Companies (Hikōkai Kaisha): As a general rule, a special resolution of the shareholders' meeting is required to determine the subscription requirements (Article 238, paragraph 2; Article 309, paragraph 2, item 7). This is because issuing options can lead to future share dilution and impact existing shareholders' interests.
    • Public Companies (Kōkai Kaisha): Generally, the board of directors can determine the subscription requirements by resolution (Article 240, paragraph 1), unless the issuance is at a "particularly favorable price" (tokuni yūri na払込金額 – a very low or zero issue price for the option itself) or under "particularly favorable conditions" for the subscribers. In such "advantageous issuance" cases, a special resolution of the shareholders' meeting is required (Article 238, paragraphs 2 and 3), and directors must explain the reasons for such favorable terms.
      • When issuing stock options to directors or employees, it is common for public companies to obtain shareholder approval (often as part of director remuneration approval) even if not strictly an "advantageous issuance" of the option itself, due to the potential impact on shareholder value and governance considerations.
  3. Notification or Public Notice, Application, and Allotment (Articles 203-205, applied mutatis mutandis by Article 242, 243):
    Similar to the issuance of shares for subscription, procedures for notifying potential subscribers, receiving applications, and allotting the share options must be followed.
    • If the issuance is open to unspecified persons (a public offering of options), public notice is required.
    • For targeted allotments (e.g., to employees), direct notification to the intended allottees is common.
    • The company then allots the share options to the subscribers.
  4. Payment for Share Options (if any): If the share options are issued for a price, the subscribers must pay this amount by the allotment date.

B. Gratuitous Allotment of Share Options to Shareholders (Shinkabu Yoyakuken Musho Wariate) (Articles 277-279)

A company can also allot shinkabu yoyakuken to its existing shareholders without requiring them to make any payment for the options themselves (a "gratuitous allotment"). This is often used as a form of rights offering or, in some contexts, as part of a takeover defense strategy (a "poison pill," though the effectiveness and legality of such pills are complex and subject to scrutiny).

  • Decision-Making Body: The decision for a gratuitous allotment can generally be made by the shareholders' meeting (ordinary resolution for non-public companies; special resolution for public companies if it involves particularly favorable exercise conditions or certain types of shares), or by the board of directors if authorized by the articles of incorporation (Article 277).
  • Pro-Rata Allotment: The options are typically allotted to shareholders in proportion to their existing shareholdings.
  • Shareholders Automatically Become Option Holders: Unlike options for subscription where an application is needed, in a gratuitous allotment, shareholders automatically become holders of the allotted share options on the allotment date, unless they opt out or the options are non-transferable and subject to conditions they do not meet.

Content and Transferability of Shinkabu Yoyakuken

Content of Share Options (Article 236)

The "content" of a share option, which must be determined at the time of issuance and usually stated in the option certificate (if issued) or related agreements, includes:

  • The class and number of shares to be acquired upon exercise.
  • The exercise price per share.
  • The exercise period.
  • Conditions for exercise (e.g., vesting schedules, continued employment).
  • Reasons for which the company can acquire the share option (call provisions).
  • Restrictions on transfer, if any.
  • Provisions for adjustments to the number of shares or exercise price in case of stock splits, mergers, etc.

Transferability (Article 254 et seq.)

  • Shinkabu yoyakuken are generally transferable unless their content explicitly restricts transfer or requires company approval for transfer (Article 254, paragraph 1).
  • If share option certificates (shinkabu yoyakuken shōken) are issued, transfer is effected by delivery of the certificate.
  • If no certificates are issued, transfer requires an agreement between the transferor and transferee and is perfected against the company and third parties by recording the transfer in the "Share Option Ledger" (shinkabu yoyakuken genbo) maintained by the company (similar to the shareholder registry).

Exercise of Shinkabu Yoyakuken (Article 280 et seq.)

When an option holder decides to exercise their shinkabu yoyakuken, they must follow specific procedures:

  1. Notification of Exercise: The holder must notify the company of their intention to exercise, specifying the options being exercised and the date of exercise.
  2. Payment of Exercise Price: Simultaneously with or prior to the exercise date, the holder must pay the full exercise price for the shares to be acquired. If the share option is part of a "conversion-type" bond with share options, the "payment" is typically effected by the deemed repayment of the bond principal.
  3. Becoming a Shareholder: The option holder becomes a shareholder of the shares on the date they exercise the option and complete the payment (Article 282).
  4. Registration of Changes: The company must then update its shareholder registry and register any increase in stated capital.

The company cannot refuse a valid exercise of a share option if all conditions for exercise are met and payment is duly made.

Remedies for Shareholders in Case of Improper Issuance or Exercise

If the issuance of shinkabu yoyakuken is flawed, or if their exercise might improperly harm existing shareholders, the Companies Act provides certain remedies, analogous to those for improper issuance of shares:

  1. Injunction Against Issuance (Hakkō Sashitome Seikyū) (Article 247):
    Shareholders who are likely to suffer a disadvantage due to an impending issuance of share options that violates laws or the articles of incorporation, or is conducted by a grossly unfair method (e.g., an advantageous issuance to specific parties without proper shareholder approval), can petition the court for an injunction to stop the issuance.
  2. Action for Declaratory Judgment of Invalidity of Share Option Issuance (Shinkabu Yoyakuken Hakkō Mukō no Uttae) (Article 828, paragraph 1, item 3):
    After the share options have been issued, certain parties (shareholders, directors, statutory auditors, etc.) can file a lawsuit to declare the issuance invalid. This action must generally be filed within six months from the date of issuance (or one year for certain publicly offered options). Grounds are typically significant violations of law or the articles of incorporation.
  3. Injunction Against Share Issuance Upon Exercise (Shinkabu Hakkō Sashitome Seikyū) (Article 286-2):
    If the issuance of shares upon the exercise of a share option would violate laws or the articles of incorporation, or be grossly unfair (e.g., if the option itself was defectively issued and should not be exercisable, or if the exercise price is now grossly unfair due to a failure to adjust it as per the option terms), shareholders can seek an injunction to stop the company from issuing shares pursuant to such exercise.
  4. Action for Declaratory Judgment of Invalidity of Share Issuance Upon Exercise (Shinkabu Hakkō Mukō no Uttae) (Article 828, paragraph 1, item 4):
    If shares have already been issued pursuant to a defective exercise (or exercise of a defectively issued option), shareholders can sue to declare that share issuance invalid, subject to time limits.
  5. Liability of Directors:
    Directors can face personal liability to the company if they are involved in an improper issuance of share options, particularly if it's an advantageous issuance that harms the company or existing shareholders without proper justification and approval. The rules are similar to those for liability related to the issuance of shares.

Self Share Options (Jiko Shinkabu Yoyakuken)

A company can acquire and hold its own shinkabu yoyakuken ("self share options" or treasury share options) under certain circumstances (Article 273 et seq.). These self share options generally do not carry exercise rights while held by the company. The company can either cancel them or re-allot them.

Conclusion

Shinkabu yoyakuken are a flexible and widely utilized tool in Japanese corporate finance and governance. Whether employed as stock options to incentivize management and employees, as a means to raise capital, or as a component in sophisticated financial instruments, their issuance and exercise are subject to a detailed regulatory framework under the Companies Act. This framework aims to balance the company's need for flexibility with the protection of existing shareholders from undue dilution or unfair treatment. For companies considering issuing share options, and for potential recipients or investors, a thorough understanding of the applicable procedures, the rights and conditions embedded in the options, and the available legal remedies is essential for navigating this area of Japanese corporate law effectively.