Buying a Japanese Company: Share Transfer vs Business Transfer, and What Due Diligence Covers

There are two main ways to buy a Japanese company: a share transfer and a business transfer. In a share transfer only the shareholder changes; the company itself, with its contracts, employees, permits and liabilities, carries on as before. In a business transfer the buyer takes over selected assets, contracts and employees one by one, which requires the consent of each counterparty and each employee (Civil Code, Articles 539-2 and 625(1)). The choice affects the corporate approvals you need, the risks you inherit and where due diligence should focus.

• Your overseas headquarters wants to buy a Japanese customer or competitor by acquiring its shares
• The owner says "I'll sell you the shares, just change the name in the register", but the articles of incorporation restrict share transfers
• You want to buy only one division of a loss-making company, but you do not know whether the employees and customers will come with it
• You have signed heads of terms and your team has not yet agreed what due diligence should cover

In a share transfer, the buyer acquires the shares and becomes the shareholder. The company remains the same legal entity, so its contracts with customers, its employment contracts, its permits and its liabilities, including those not on the balance sheet, generally stay with the company. The process is relatively contained, but you take on the company's risks as a whole.

In a business transfer, the buyer purchases a business, meaning a set of assets, contracts, know-how and so on, from the selling company. The buyer can choose by contract what it takes over. In exchange, each contract, employee and permit has to be moved individually, which takes time and effort.

In practice, a share transfer is the usual starting point if you want the whole company, and a business transfer if you want a particular division or set of assets. The final choice depends on off-balance-sheet risk, whether permits must be re-obtained, how likely employees are to consent, tax and other factors.

Shareholders may transfer their shares (Companies Act, Article 127). But a company may provide in its articles of incorporation that acquiring its shares by transfer requires the company's approval (Article 107(1)(i) and (2)(i)). Such shares are called restricted shares (Article 2(xvii)). In unlisted small companies, it is common for all shares to be restricted.

A shareholder who wants to sell restricted shares can ask the company to decide whether it approves the buyer's acquisition (Article 136). The buyer can also make the request, but generally jointly with the shareholder shown in the shareholder register (Article 137).

If the company has a board of directors, the board decides; otherwise the shareholders' meeting does, unless the articles provide otherwise (Article 139(1)). The company must notify the requesting party of its decision (Article 139(2)). If it gives no notice within two weeks of the request, or any shorter period set in the articles, approval is deemed given (Article 145(i)).

If the company refuses but the request asked the company to buy the shares in that case, the company or a buyer it designates must purchase them (Articles 138 and 140). Without approval, a buyer generally cannot ask for the shareholder register to be updated in its name (Article 134). A share transfer cannot be asserted against the company or other third parties unless it is entered in the shareholder register (Article 130(1)).

In practice, the parties usually arrange for the approval resolution to be passed before closing, with a copy of the minutes delivered before the price is paid.

A company whose articles provide for share certificates is called a company issuing share certificates (Articles 117(7) and 214). For such a company, a transfer of shares takes effect only when the certificates are delivered (Article 128(1)). Older companies sometimes still have this provision in their articles even though no certificates have actually been issued. Check the articles and the certificate position early and agree with the seller how to deal with it.

A company transferring all of its business, or an important part of it, must have the transfer agreement approved by resolution of its shareholders' meeting by the day before the effective date (Companies Act, Article 467(1)(i) and (ii)). This is a special resolution: shareholders holding a majority of the voting rights (reducible to one third by the articles) must be present, and two thirds of the votes of those present must be in favour (Article 309(2)(xi)).

Where part of a business is transferred and the book value of the assets transferred does not exceed one fifth of the company's total assets (or a lower ratio set in the articles), the transfer is excluded from this approval requirement (Article 467(1)(ii)). Approval is also unnecessary where the buyer is a special controlling company holding nine tenths or more of the seller's voting rights (Article 468(1)).

A company acquiring the whole of another company's business also generally needs approval by its shareholders' meeting (Article 467(1)(iii)). This is not required where the book value of the consideration does not exceed one fifth of the buyer's net assets (or a lower ratio set in the articles) (Article 468(2)). Even then, if shareholders holding a certain number of shares notify their opposition, a shareholder resolution is required (Article 468(3)).

A company carrying out a business transfer must notify its shareholders at least 20 days before the effective date (Article 469(3)). Dissenting shareholders may demand that the company buy their shares at a fair price (Article 469(1)). There are exceptions, such as where the shareholders' meeting that approves the transfer of the whole business also resolves at the same time to dissolve the company (Article 469(1)(i)). If the seller has minority shareholders besides the owner, plan for this possibility.

In a business transfer, employment contracts do not move automatically. An employer cannot assign its rights to a third party without the worker's consent (Civil Code, Article 625(1)). The MHLW guidelines on business transfers likewise state that individual consent is needed from each employee expected to transfer. They say the transferor should explain the overall situation fully and consult with employees with a view to obtaining their consent, and that if working conditions are to be changed on transfer, consent to that change is also needed. A dismissal solely because an employee refused to consent is treated as an abuse of rights and not permitted (Labor Contract Act, Article 16).

Contracts with customers and suppliers work the same way. Transferring a party's position under a contract requires the other party's consent (Civil Code, Article 539-2). Whether key customers, landlords and licensors will consent can become a condition of the deal. Whether a permit or licence passes automatically in a business transfer depends on the law that governs it, and in some cases it must be obtained again.

For what to watch if you do not take over some employees, or need to reduce headcount at the Japanese company, see "Dismissing an Employee in Japan".

Unless the parties agree otherwise, a company that has transferred its business must not carry on the same business in the same municipality or adjacent municipalities for 20 years from the date of the transfer (Companies Act, Article 21(1)). If the parties agree that the seller will not compete, the agreement is effective only for up to 30 years from the transfer (Article 21(2)). In either case, the seller must not carry on the same business for the purpose of unfair competition (Article 21(3)).

For overseas buyers, the statutory scope of 20 years and the same and adjacent municipalities often does not fit the actual business. It is common to set the territory, duration and scope of the restriction expressly in the contract.

If the buyer continues to use the seller's trade name, it is also liable to pay the debts arising from the seller's business (Companies Act, Article 22(1)). This liability does not arise if, without delay after the transfer, the buyer registers at its head office location that it is not liable for the seller's debts. The same applies to any third party to whom the buyer and seller have given notice to that effect (Article 22(2)).

Even without continuing the trade name, if the buyer advertises that it assumes the seller's debts, the seller's creditors can claim against the buyer (Article 23(1)). And if the seller transferred the business knowing that this would harm creditors whose claims were not taken over, those creditors can claim performance from the buyer up to the value of the property it acquired, unless the buyer did not know of the harm when the transfer took effect (Article 23-2(1)).

Share acquisitions above certain sizes must be notified to the Japan Fair Trade Commission in advance (Antimonopoly Act, Article 10(2)). Under the current thresholds, notification is required where the buyer's group has total domestic sales exceeding JPY 20 billion, the target and its subsidiaries have total domestic sales exceeding JPY 5 billion, and the buyer's voting rights will exceed 20% or 50% (Antimonopoly Act Enforcement Order, Article 16). A company that has filed generally may not acquire the shares until 30 days have passed from the date the filing is accepted (Article 10(8)).

There is also prior notification for business acquisitions, for example where the buyer's total domestic sales exceed JPY 20 billion and the domestic sales of the business acquired exceed JPY 3 billion (Article 16(2); Enforcement Order, Article 21).

When an overseas company or investor acquires shares in a Japanese company, prior notification or a post-transaction report under the Foreign Exchange and Foreign Trade Act may be required. The answer depends on the business sector and the shareholding, so see "Acquiring or Investing in a Japanese Company under the Foreign Exchange Act".

Due diligence (DD) is the buyer's investigation of the target before the acquisition. It is not required by law; the parties decide how far to go depending on the size of the deal and the risks. Legal DD typically looks at:

• Corporate records: articles of incorporation, the commercial register, the shareholder register and minutes of shareholders' and board meetings, including the transfer-restriction and share-certificate provisions and whether past share issues and transfers were properly approved
• Key contracts: whether supply, lease, licence, loan and similar contracts let the counterparty terminate, or require its consent or notice, on a change of control or a transfer of the business
• Employment: employment contracts and work rules, unpaid overtime, employment disputes and, in a business transfer, which employees are to move
• Permits and licences: which permits the business depends on, and whether a change of shareholder or a business transfer requires a filing or a new permit
• Litigation: pending or threatened lawsuits and any administrative guidance or sanctions
• Intellectual property: whether trademarks, patents and software belong to the company and whether the business infringes third-party rights
• Personal data: how customer and employee personal information is managed, and the purposes stated when it was collected

Under the Act on the Protection of Personal Information, a person receiving personal data provided in connection with the succession of a business by merger or otherwise is not treated as a third party (Article 27(5)(ii)). The successor may not, without the individual's consent, handle that information beyond what is necessary for the purposes of use that applied before the succession (Article 18(2)).

Issues found in DD, and matters DD could not fully cover, are dealt with in the share purchase agreement or business transfer agreement. The main tool is representations and warranties, in which the seller confirms in the contract that certain facts about the company or business are true. They are not a statutory regime but contract terms set by the parties. The scope, cap and claim period of the indemnity for a breach are also set by contract. Issues found in DD are reflected in price adjustments, conditions to closing or specific indemnities.

For how we handle transactions overall, see "Mergers & Acquisitions".

1. Obtain the target's articles of incorporation and check the transfer-restriction and share-certificate provisions
2. Check the shareholder register and minutes for the current shareholders and past share movements
3. Decide whether you want the whole company or a particular business, and consider whether to proceed by share transfer or business transfer
4. List key contracts that need counterparty consent on a change of control or transfer
5. In a business transfer, agree with the seller which employees will move and how they will be informed and consulted
6. Check early whether JFTC notification and foreign exchange filings are needed

• Before signing a letter of intent or MOU, when you want to settle exclusivity and confidentiality
• When the articles provide for share certificates but the certificates cannot be found
• When a key customer contract lets the customer terminate on a change of control
• When some of the employees you want to take over in a business transfer are unlikely to consent
• When your overseas parent asks you to use its English-language share purchase agreement template

Our representative attorney is admitted in Japan and New York and handles transactions in Japanese and English, from drafting the agreements through due diligence to closing.

A share transfer is the starting point if you want the whole company, and a business transfer if you want only a particular business or assets. A share transfer is procedurally simpler, but you inherit the company's risks, including off-balance-sheet liabilities. A business transfer lets you choose what to take, but needs individual consent from employees and contract counterparties (Civil Code, Articles 625(1) and 539-2). Compare tax and permits as well before deciding.

The parties can sign a sale agreement, but without approval the buyer generally cannot ask for the shareholder register to be updated in its name (Companies Act, Article 134). If the company has a board of directors, the board generally decides on approval (Article 139(1)). In practice, the approval resolution is passed by closing.

No. Each employee's consent is needed (Civil Code, Article 625(1)). The MHLW guidelines on business transfers say the transferor should explain the transfer fully and consult employees with a view to their consent. A dismissal solely because an employee refused to consent is treated as an abuse of rights and not permitted (Labor Contract Act, Article 16).

In a share transfer only the shareholder changes; the employer, which is the company, stays the same. So no employee consent is needed to move employment contracts. If you plan to change working conditions after the acquisition, however, the usual employment law rules apply. When and how to tell employees is also an important practical question.

No. Representations and warranties are contract terms the parties agree in the share purchase or business transfer agreement. Which facts are warranted, how far the seller must indemnify a breach and for how long claims can be made are all negotiated. The terms are settled in light of the DD results.