What Qualifies as an "Advantageous Issuance" of New Shares in Japan and What Are the Requirements?

When Japanese corporations (kabushiki kaisha) decide to issue new shares, they must navigate a framework of rules designed to balance the company's need for capital with the protection of its existing shareholders. One particularly important set of regulations governs what is known as an "advantageous issuance" (有利発行 - yūri hakkō) of new shares. This refers to situations where a company offers new shares to specific parties—typically third parties rather than existing shareholders on a pro-rata basis—at a price deemed "specially favorable." Such issuances can significantly impact existing shareholders by diluting their economic interest and voting power, and thus are subject to heightened scrutiny and stricter procedural requirements under the Japanese Companies Act (会社法 - Kaishahō).

The Legal Framework for Advantageous Issuance

The core provisions addressing advantageous issuances are found in several articles of the Companies Act:

• Article 199 (Subscription Requirements for Shares for Subscription):
  • Paragraph 2 states that if a company proposes to offer shares for subscription, the subscription requirements (including the issue price) must be determined by a shareholders' meeting resolution, unless delegated to the board by the articles of incorporation or a prior shareholders' meeting resolution.
  • However, a critical exception arises when the issuance is to persons other than existing shareholders (a third-party allotment - 第三者割当 daisansha wariate) at a "specially favorable price" (特に有利な金額 - toku ni yūri na kingaku). In such cases, Paragraph 2 mandates that the matter, including the favorable price, must be approved by a shareholders' meeting. This cannot be broadly delegated to the board for advantageous issuances to third parties.
• Article 200 (Explanation to Shareholders' Meeting for Third-Party Allotments):
  • Paragraph 1 specifically requires that when a company seeks shareholder approval for a third-party allotment at a specially favorable price (as per Article 199, Paragraph 2), the directors must explain to the shareholders' meeting "the reasons for the necessity of offering Shares for Subscription to such persons at such specially favorable issue price."
• Article 201 (Determination of Subscription Requirements by Public Companies):
  • Paragraph 1 generally allows the board of directors of a public company (公開会社 - kōkai kaisha) to determine subscription requirements. However, this general power is subject to the specific requirements for advantageous issuances. If a public company intends an advantageous issuance to third parties, it must still comply with the shareholder approval mechanism outlined in Article 199, Paragraph 2.
• Article 309, Paragraph 2, Item 5 (Special Resolutions of Shareholders Meetings):
  • This article specifies that a resolution under Article 199, Paragraph 2 (which includes approvals for advantageous issuances to third parties) requires a special resolution. A special resolution generally necessitates the attendance of shareholders holding a majority of the total voting rights and approval by at least a two-thirds supermajority of the votes cast.

The overarching purpose of these provisions is to prevent the expropriation of value from existing shareholders through dilutive share issuances to favored parties at unfairly low prices.

Defining a "Specially Favorable Price" (特に有利な金額)

The central question in an advantageous issuance analysis is what constitutes a "specially favorable price." The Companies Act does not provide a precise numerical definition or percentage discount. Instead, it is a qualitative assessment made on a case-by-case basis, considering all relevant circumstances. The core idea is that the price is significantly lower than the fair market value of the shares at the time the decision to issue is made.

Determining Fair Value

The assessment of whether an issue price is "specially favorable" requires a determination of the shares' fair value. This process differs for listed and unlisted companies:

• Listed Companies:
  • Market Price as a Primary Benchmark: For companies whose shares are publicly traded, the prevailing market price is the most important starting point. The Supreme Court of Japan, in a judgment on April 8, 1975 (Showa 50), provided foundational guidance, stating that the "fair issuance price" (公正発行価額 - kōsei hakkō kakaku) should be determined by considering factors such as the market price of existing shares, historical price trends, trading volume, the company's financial condition (assets, earnings, dividends), the number of shares already issued, the number of new shares to be issued, and general stock market conditions. The goal is to strike a balance between the company's need for capital and the protection of existing shareholders' interests.
  • Averaging Periods and Reference Dates: Courts often look at average market prices over a certain period (e.g., one, three, or six months) leading up to the board's resolution to issue the shares. The PDF's Problem 16 illustrates this, where Y社, a TSE 2nd Section listed company, resolved to issue shares at 393 yen. The market price on the day before the resolution was 1,010 yen, and the six-month average was 720.67 yen, both significantly higher than the issue price.
  • Exclusion of Abnormal Market Fluctuations: If the market price is demonstrably distorted due to temporary factors like takeover speculation, market manipulation, or extreme volatility unrelated to the company's intrinsic value, courts may adjust or place less weight on such prices. A Tokyo District Court provisional disposition on July 25, 1989 (Heisei Gan), acknowledged that artificially inflated market prices due to takeover activities might need to be disregarded or adjusted when assessing fairness.
  • Industry Self-Regulatory Rules (e.g., JSDA Guidelines): Guidelines issued by industry bodies like the Japan Securities Dealers Association (JSDA) often provide benchmarks for permissible discounts from market price in third-party allotments. These guidelines typically suggest that an issue price should not be lower than, for example, 90% of the market price on the day before the board resolution or 90% of an average market price over a recent period (e.g., one to six months). While not legally binding in themselves, courts frequently refer to these guidelines as an indicator of market practice and reasonableness. The case in Problem 16 specifically references these JSDA guidelines, calculating that even under the most favorable interpretation of these rules, the issue price should have been at least 650 yen, far above the proposed 393 yen. A Tokyo District Court provisional disposition on September 5, 1989 (Heisei Gan), recognized the rationality of such industry standards.
• Unlisted Companies:
  • Valuation is inherently more complex due to the absence of a readily ascertainable market price. Courts and parties will rely on various valuation methodologies, including:
    • Discounted Cash Flow (DCF) analysis.
    • Comparable company analysis (looking at valuation multiples of similar listed or recently transacted private companies).
    • Net asset value (NAV) method.
    • Earnings-based valuations (e.g., P/E multiples).
      The choice of method and the specific assumptions used can be heavily contested.

The "Particularly Favorable" Threshold

There is no fixed percentage discount (e.g., 10%, 20%) that automatically triggers the advantageous issuance rules. It is a qualitative judgment. A substantial discount from the assessed fair value, without a compelling and clearly articulated justification, is likely to be deemed "particularly favorable" and thus necessitate the special shareholder approval.

Rationale for Heightened Requirements

The stringent requirements for advantageous issuances are rooted in two primary concerns for existing shareholders:

1. Economic Dilution: When new shares are issued to third parties at a price below their fair value, the overall value of the company is not increased proportionally to the number of new shares. This means the per-share value of existing shareholders' holdings decreases, diluting their economic interest in the company's assets and future earnings.
2. Dilution of Voting Power: The issuance of new voting shares to a select group of third parties inevitably reduces the proportionate voting power of existing shareholders. If this is done at a favorable price, it can be perceived as an unfair shift in control or influence without adequate compensation to the company (and thus indirectly to existing shareholders).

The Special Shareholders' Meeting Resolution

If an issuance to third parties is determined to be at a "specially favorable price," the following shareholder meeting requirements apply:

• Information to Shareholders (Article 200, Paragraph 1): The directors have a legal obligation to explain to the shareholders at the meeting why it is necessary to issue shares to these specific persons at such a favorable price. This explanation should cover the benefits the company expects to receive in return for offering the discount (e.g., strategic alliance, securing critical technology or resources, financial rescue). This enables shareholders to make an informed decision.
• Special Resolution (Article 309, Paragraph 2, Item 5): The approval must be by a special resolution, which requires:
  • A quorum of shareholders representing a majority of all voting rights (this can be modified by the articles of incorporation).
  • Approval by at least two-thirds of the voting rights present at the meeting.
    This higher threshold reflects the potentially significant impact of advantageous issuances on the rights of existing shareholders.

Consequences of Non-Compliance with Advantageous Issuance Rules

Failure to comply with the legal requirements for an advantageous issuance can lead to serious consequences:

1. Director Liability to the Company (Article 212, Paragraph 1, Item 1)

If shares are issued at a "specially favorable price" without the requisite special shareholder resolution (or if the approval was based on inadequate or misleading explanations by directors), directors who were involved in the decision can be held personally liable to the company. This liability is for the amount of the shortfall, i.e., the difference between the fair value of the shares at the time of issuance and the actual (favorable) issue price.
This liability typically arises if the director acted in collusion (通じて - tsūjite) with the subscriber to whom the shares were advantageously issued. It aims to make the company whole for the value it failed to receive.

2. Shareholder's Right to Seek an Injunction (Article 210, Item 1)

If a company is about to issue shares in a manner that violates the Companies Act or its articles of incorporation—which includes issuing shares at a specially favorable price to third parties without the necessary special shareholder resolution—and shareholders are likely to suffer a disadvantage (不利益を受けるおそれ - furieki o ukeru osore), those shareholders can apply to a court for an injunction (差止請求 - sashitome seikyū) to prohibit the issuance.
The case study in Problem 16, where shareholders Xら are considering legal action to stop Y社's issuance, directly involves this remedy. The Tokyo District Court provisional disposition of June 1, 2004 (Heisei 16), referenced in the PDF's commentary for Problem 16, is an example where a court considered an injunction in the context of an alleged advantageous issuance. The success of such an injunction would depend on the court's assessment of whether the price is indeed "specially favorable" and whether the proper shareholder approval was obtained.

3. Potential Invalidation of the Share Issuance (新株発行無効の訴え)?

Once new shares have actually been issued and registered, challenging their validity becomes significantly more difficult due to the strong legal policy favoring the stability of transactions and the protection of those who may have subsequently acquired the shares. While a fundamental defect in the issuance process, such as a complete lack of issuing authority or a severe violation of mandatory shareholder rights, might theoretically form the basis for a lawsuit to invalidate the share issuance (新株発行無効の訴え - shinkabu hakkō mukō no uttae, under Article 828, Paragraph 1, Item 2), courts are generally very reluctant to grant this remedy for consummated issuances. Issues related to price fairness are more commonly addressed through director liability or pre-issuance injunctions.

Distinction from "Unfair Issuance" (不公正発行 - Fukōsei Hakkō)

It's important to distinguish "advantageous issuance" (which is price-focused) from the broader concept of "unfair issuance" (不公正発行 - fukōsei hakkō). An unfair issuance, which can also be grounds for a pre-issuance injunction under Article 210, Item 2, refers to an issuance of shares conducted by a "grossly unfair method" (著しく不公正な方法 - ichijirushiku fukōsei na hōhō). This often involves situations where the primary purpose of the issuance is improper, such as:

• Maintaining or entrenching current management control.
• Diluting the voting power of a specific, often dissident, shareholder.
• Facilitating a takeover by a friendly party on terms detrimental to other shareholders.
  An issuance might be "unfair" due to its purpose or effect on control, even if the issue price itself is at or near fair market value and thus not "advantageous" in the narrow sense of Article 199(2). Problem 16, while framed around the advantageous price, also has an undercurrent of a control dispute, as shareholders Xら had previously made shareholder proposals for director elections, suggesting the issuance to A might also be scrutinized for unfair purpose.

Brief Comparison with U.S. Corporate Law

While the goal of protecting shareholders from unfair dilution is shared, the mechanisms differ:

• Pre-emptive Rights: In the U.S., statutory default pre-emptive rights (allowing existing shareholders to subscribe to new shares pro-rata to maintain their ownership percentage) are now uncommon for public corporations, though they can be provided for in a company's charter. Protection against dilution in the U.S. relies more heavily on directors' general fiduciary duties.
• Director Fiduciary Duties: U.S. directors owe duties of loyalty and care. Issuing shares to insiders or favored third parties at a demonstrably unfair (low) price, or for an improper corporate purpose that harms existing shareholders, would likely be a breach of these duties. This could lead to shareholder derivative suits seeking damages or equitable relief. The analysis would focus less on a specific statutory rule for "advantageous price" and more on the overall fairness of the transaction, the process by which it was approved, and the directors' motivations.
• State Anti-Dilution Provisions: Some state corporate laws or judicial precedents may provide specific protections against oppressive or unfair dilution, but the approach is less uniformly codified than Japan's rules on advantageous issuance.

Conclusion

The Japanese Companies Act imposes specific and robust requirements when a company contemplates issuing new shares to third parties at a "specially favorable price." These rules, centered around mandatory disclosure to shareholders and approval by a special supermajority resolution, are designed to protect existing shareholders from the adverse effects of economic and voting power dilution. Directors who fail to adhere to these procedures face the risk of personal liability for any shortfall in the value received by the company, and shareholders have the right to seek a pre-issuance injunction to halt such offerings. The determination of what constitutes a "specially favorable price" is a critical, fact-specific inquiry, often guided by market data, valuation principles, and established industry practices, ensuring a balance between corporate financing needs and shareholder equity.