When Can Shareholders Seek an Injunction to Stop a Merger in Japan?

Mergers are among the most transformative events a corporation can undertake, often involving significant changes to shareholder rights, corporate structure, and business direction. While mergers can unlock value and strategic advantages, they also carry the risk of unfairness to certain shareholders, particularly regarding the valuation of their shares or the process by which the merger is approved. In Japan, shareholders who believe a proposed merger is fundamentally flawed or detrimental to their interests have a statutory right, under specific circumstances, to seek a court injunction (差止請求 - sashitome seikyū) to halt the transaction before it becomes effective. This pre-emptive remedy is crucial, as unwinding a consummated merger is an exceedingly difficult and disruptive process.

The Statutory Framework for Shareholder Injunctions Against Mergers

The Japanese Companies Act (会社法 - Kaishahō) provides specific provisions enabling shareholders of companies involved in a merger to demand that their company cease the merger process. These rights are primarily found in:

• Article 784-2 (for shareholders of the target/absorbed company in an absorption merger): "In cases where a Stock Company carries out an Absorption-type Merger, if any of the following grounds exist, shareholders of the Stock Company-Type Absorbed Company... may demand that such Stock Company-Type Absorbed Company cease such Absorption-type Merger."
• Article 796-2 (for shareholders of the surviving company in an absorption merger): This provides a similar right to shareholders of the absorbing (surviving) company if certain conditions are met, particularly in the context of a "simplified merger" (簡易合併 - kan'i gappei) where their approval might be bypassed.
• Article 805-2 (for shareholders of consolidating companies in a consolidation merger): Analogous provisions apply to companies involved in a consolidation merger (新設合併 - shinsetsu gappei).

A common prerequisite for seeking an injunction under these articles is that the shareholder "is likely to suffer a disadvantage" (不利益を受けるおそれ - furieki o ukeru osore) as a result of the merger. This generally requires the shareholder to demonstrate a reasonable apprehension of tangible harm, often economic (such as receiving inadequate consideration for their shares or seeing their rights unfairly diminished), if the merger proceeds as planned.

Grounds for Seeking an Injunction

The Companies Act outlines two primary categories of grounds upon which shareholders can base their demand for an injunction:

1. Violation of Laws or Articles of Incorporation (法令又は定款に違反する場合 - Hōrei mata wa Teikan ni Ihan Suru Baai)

This is a general ground applicable to most mergers that require shareholder approval (e.g., Article 784-2, Item 1). Shareholders can seek an injunction if the merger process or the merger itself contravenes:

• Applicable Laws: This clearly includes procedural violations of the Companies Act related to the merger, such as defective notice of a shareholders' meeting, an improper shareholder resolution (e.g., insufficient votes, tainted approval process), or failure to adhere to mandatory creditor protection procedures where required.
• The Company's Articles of Incorporation (定款 - Teikan): If the merger is being pursued in a manner that violates provisions within the company's own articles.

The Critical Debate: Does "Violation of Laws" Encompass Breaches of Directors' Fiduciary Duties?
A significant point of legal debate revolves around whether a breach of directors' fiduciary duties—specifically, the duty of care (善管注意義務 - zenkan chūi gimu) or the duty of loyalty (忠実義務 - chūjitsu gimu)—in approving or structuring a merger constitutes a "violation of laws" for the purpose of these injunction statutes. This is particularly relevant when shareholders allege that the merger terms, especially the merger ratio, are grossly unfair due to directors' negligence or bad faith.

• Narrow Interpretation (Potentially Reflecting Drafters' Intent): The PDF's commentary for Problem 54 notes that some legislative drafters involved in the 2014 Companies Act amendments (which broadened these injunction rights) tended to interpret "laws" in this context as referring to legal provisions that directly impose obligations on the company as an entity, rather than general duties imposed on its directors. Under this restrictive view, a director's breach of their fiduciary duty in, for example, agreeing to a manifestly unfair merger ratio would not, by itself, be considered a "violation of laws" by the company that could ground an injunction under this specific item. Shareholders would have to rely on other remedies like appraisal rights or director liability suits.
• Broader Interpretation (Supported by Academic Criticism and Alternative Arguments): Many legal scholars and practitioners argue for a broader interpretation. They contend that a company acts through its directors, and if directors cause the company to enter into a merger based on a fundamental breach of their duties (such as approving terms that are clearly detrimental and unfair to a class of shareholders due to negligence or self-interest), this should be actionable as the company itself proceeding in a manner contrary to law. Proponents of this view often draw parallels with other provisions, such as Article 360 of the Companies Act (shareholder's right to demand cessation of a director's illegal act), where "illegal act" by a director is understood to include breaches of fiduciary duty. They argue that a narrow interpretation would unduly limit shareholder protection against substantively unfair mergers that are not short-form or simplified. This debate remains crucial for understanding the potential scope of injunctions based on substantive unfairness in regular, shareholder-approved mergers.

2. Grossly Unfair Terms/Ratio in Specific Types of Mergers (著しく不当な場合 - Ichijirushiku Futō na Baai)

This ground (e.g., Article 784-2, Item 2) is specifically applicable in situations where the usual shareholder approval process at the target company (in a "short-form merger" - 略式合併 ryakushiki gappei) or the surviving company (in a "simplified merger" - 簡易合併 kan'i gappei) is statutorily bypassed.

• Short-Form Mergers (略式合併): These occur when the acquiring/surviving company already holds 90% or more of the voting rights of the target/absorbed company. In such cases, the target company's shareholder meeting to approve the merger can be omitted (Article 784, Paragraph 1).
• Simplified Mergers (簡易合併): These apply to the surviving/acquiring company when the value of the assets or shares being delivered as merger consideration is small relative to the net assets of the surviving company (typically not exceeding 20% of net assets, as per Article 796, Paragraph 3 and related cabinet orders). In these cases, the surviving company's shareholder meeting to approve the merger can be omitted.

Because shareholders in these bypassed companies do not get a direct vote on the merger, the Companies Act provides them with a specific right to seek an injunction if the terms of the merger (including the merger ratio, cash consideration, or other allotment details) are "grossly unfair" (著しく不当 - ichijirushiku futō) and they are likely to suffer a disadvantage. This allows for a direct judicial review of the substantive fairness of the deal terms in these special circumstances.

Application to Problem 54 (Merger with A社):
The PDF's Problem 54 involves Y₁ (parent company) planning to absorb A社, its 95%-owned subsidiary, through a short-form merger. Shareholder X of A社 believes the merger ratio is grossly unfair, favoring Y₁. In this scenario, because it's a short-form merger where A社's shareholder approval is bypassed, X (as a minority shareholder of A社) can directly seek an injunction against A社 under Article 784-2, Item 2, arguing that the merger terms (the ratio) are "grossly unfair" and that X is likely to suffer a disadvantage. X's success would depend on presenting compelling valuation evidence to the court demonstrating the manifest unfairness of the ratio proposed by the parent, Y₁.

The Challenge of Proving "Gross Unfairness" or "Likely Disadvantage"

Regardless of the specific ground invoked, shareholders seeking an injunction face significant evidentiary burdens:

• Proving "Gross Unfairness" of Terms: This involves complex valuation arguments. Shareholders must typically demonstrate that the merger ratio or consideration offered is not just suboptimal, but falls substantially outside a range of reasonableness, often requiring expert financial testimony. Courts are generally cautious about substituting their own business judgment for that of the directors who negotiated the deal, especially in arm's-length transactions, unless the unfairness is clear and significant.
• Demonstrating "Likely to Suffer a Disadvantage": The shareholder must show a probability of actual harm, usually economic loss. This could involve demonstrating that the consideration they will receive is worth materially less than the fair value of their shares, or that their rights as shareholders will be otherwise unfairly diminished.

Procedural Aspects of Injunction Proceedings

Given the time-sensitive nature of mergers, shareholders almost invariably seek injunctive relief through expedited provisional disposition proceedings (仮処分 - karishobun) under the Civil Provisional Remedies Act (民事保全法 - Minji Hozen Hō), rather than through a full, ordinary lawsuit which would take too long.

Key requirements for obtaining a provisional disposition include:

1. Prima Facie Showing of the Right to be Protected: The shareholder must make a credible preliminary showing of the grounds for injunction under the Companies Act (e.g., violation of law, grossly unfair terms).
2. Necessity of the Provisional Remedy: The shareholder must demonstrate that an urgent court order is necessary to prevent significant harm or imminent danger that cannot be adequately addressed through post-merger remedies (which, as noted, are often difficult to obtain or insufficient). This involves showing that allowing the merger to proceed would cause irreparable or hard-to-compensate harm.
3. Balancing of Harms: In deciding whether to grant a provisional disposition, courts will conduct a balancing of interests. They weigh the potential harm to the applicant shareholder if the injunction is denied and the merger proceeds, against the potential harm and disruption to the company (and its other shareholders and stakeholders) if the merger is wrongly enjoined. A Supreme Court provisional disposition judgment on August 30, 2004 (Heisei 16), highlighted the importance of this balancing exercise. Security (a bond) may also be required from the applicant.

Analysis of the Case Study (Problem 54)

Problem 54 presents two merger scenarios involving shareholder X:

1. Y₁'s Merger with A社 (95% subsidiary, short-form):
   • As discussed, X, a minority shareholder of A社, can seek an injunction against A社 directly under Article 784-2, Item 2, by arguing that the merger ratio offered by the parent Y₁ is "grossly unfair" and will cause X disadvantage. X's success hinges on producing strong evidence of this gross unfairness in valuation.
2. Y₁'s Merger with B社 (70% subsidiary, requiring B社 shareholder approval):
   • This merger is not a short-form merger from B社's perspective, as Y₁ holds only 70%. Therefore, B社 shareholders, including X, will have an opportunity to vote on the merger.
   • Consequently, X (as a B社 shareholder) cannot use the "grossly unfair terms" ground of Article 784-2, Item 2 (or its equivalent for B社 as an absorbed company) to seek an injunction.
   • X's path to an injunction against B社 would be through Article 784-2, Item 1, alleging a "violation of laws or articles of incorporation."
   • To succeed based on an unfair ratio, X would need to argue that the directors of B社, by agreeing to a merger ratio grossly unfair to B社 shareholders (perhaps due to undue influence from the controlling parent Y₁), breached their fiduciary duties (duty of care or loyalty). Then, X must convince the court that this breach of directors' fiduciary duty constitutes a "violation of laws" for the purpose of the injunction statute – this is where the legal debate discussed earlier becomes paramount.
   • Alternatively, X might look for clear procedural violations in B社's shareholder approval process for the merger (e.g., inadequate or misleading disclosures about how the merger ratio was determined, or flaws in the meeting conduct).

Other Avenues for Shareholder X (as per PDF commentary for Problem 54)

The PDF commentary for Problem 54 also briefly mentions that, separate from direct merger injunctions against the company, a shareholder might consider seeking an injunction against the directors of A社 (Y₂) or B社 (Y₃) under Article 360 of the Companies Act (shareholder's right to demand cessation of a director's unlawful act). This would require showing that the directors' act of proceeding with the merger based on an allegedly unfair ratio is a breach of their duties and is likely to cause "irreparable harm to the company" (株式会社に回復することができない損害 - kabushiki kaisha ni kaifuku suru koto ga dekinai songai). The main challenge here, as with director liability suits for unfair ratios, is clearly defining and proving "harm to the company" when the primary issue is an allegedly unfair allocation of value between different sets of shareholders.

Brief Comparison with U.S. (Delaware) Law

In Delaware, the primary jurisdiction for U.S. corporate law:

• Preliminary Injunctions in Mergers: Shareholders can seek to enjoin mergers. Common grounds include material misdisclosures or omissions in proxy materials provided to shareholders, or breaches of fiduciary duty by the board, such as failing to satisfy heightened scrutiny standards like Revlon duties in a sale of control scenario, or failing to demonstrate "entire fairness" in a conflicted transaction (e.g., a merger with a controlling shareholder).
• Focus on Process and Disclosure: Challenges often center on ensuring that shareholders are fully informed before voting and that the board followed a fair process in negotiating and approving the deal, especially in controller-led transactions. An unfair price can be evidence of an unfair process or a breach of loyalty.
• Irreparable Harm Standard: To obtain a preliminary injunction, plaintiffs typically must demonstrate a likelihood of success on the merits of their underlying claim and that they will suffer irreparable harm if the injunction is not granted, and that the balance of hardships tips in their favor.

Conclusion

The right for shareholders in Japan to seek a pre-merger injunction provides an important, albeit challenging, avenue to prevent potentially harmful or unfair corporate reorganizations from proceeding. The statutory grounds vary depending on the nature of the merger: for short-form and simplified mergers where shareholder approval is bypassed, a "grossly unfair" merger ratio can be a direct basis for an injunction. For regular mergers requiring shareholder approval, the primary avenue is to demonstrate a "violation of laws or articles of incorporation." Whether the latter ground can be successfully invoked based on a substantively unfair merger ratio, by arguing it stems from a breach of directors' fiduciary duties, remains a complex and debated area of Japanese company law. In all cases, shareholders must also show they are likely to suffer a disadvantage, and courts will balance the competing interests before granting such a potent provisional remedy.