On June 7, the amended ordinances prepared by the Japanese government to implement amendments to the Foreign Exchange and Foreign Trade Act (Fefta) were fully implemented, which, among other things, impose certain restrictions on foreign direct investments made by foreign investors and subjects the transaction to substantive review by Japanese authorities.
Takeaways for Japan-based startups and non-Japanese investors
Think ahead
Both Japan-based startups and non-Japanese investors should address at the very beginning of term sheet discussions whether the investment by such investor would be subject to the prior filing requirement under the Fefta and, if so, whether to seek an available exemption. In this regard, while the Japanese government publishes the list of all listed companies in Japan to categorise whether they are conducting Restricted Businesses or core Restricted Businesses, such a database is not available for unlisted companies. As such, a careful examination by startups themselves and consultation with their counsel, as well as the Bank of Japan, should be conducted.
This exercise is critical, because it could potentially materially delay the timing of closing due to the 30-day waiting period after the filing (subject to shortening or extension of such period) as discussed above.
Drafting of investment agreements
From the foreign investor’s side, not only should the clearance of the prior filing process pursuant to the Fefta be a condition to closing (if it is necessary to make such a prior filing), but they should also request that companies provide in a purchase agreement or similar document proper representations and warranties as to the categories of business that the company is engaged in, in order to enable the foreign investor to analyse and decide whether or not to make a prior filing.
Further, if an investor is relying on the “General Exemption”, because acquisitions of equity interests for the purpose of violating the non-managerial involvement conditions are not eligible for prior filing exemptions, caution should be exercised if the right to appoint directors or the right to receive certain information is provided for in the investment agreements.
Observer vs director
Since any affirmative vote by a foreign investor with respect to a proposal to elect such foreign investor, or a closely related person of such foreign investor, as a director is one of the Restricted Actions, it is likely that exercise by a foreign investor of board nomination rights with respect to a Japanese company engaged in a Restricted Business pursuant to the articles of incorporation or a shareholders agreement now requires prior filing. According to an answer from the Ministry of Finance given through the public comment procedure, whether or not such foreign investor in fact has a right to appoint specific nominee directors can be broadly interpreted, so startups may prefer giving an observer right instead, to avoid such prior filing requirement.
Watch out for exit path issues
Both Japan-based startups and non-Japanese investors should also note that prior filing requirements for the Restricted Actions could potentially affect their exit path, because any affirmative vote by the foreign investor with respect to a proposal for an M&A exit, including business transfer (jigyou jouto), merger, company split (kaisha bunkatsu) or similar transaction, could be considered a Restricted Action.
According to an answer from the Ministry of Finance given through the public comment procedure, it is generally understood that any affirmative vote referred to here is limited to votes at the shareholders meeting in which the proposal was made by the relevant foreign investor itself or through other shareholders. As such, generally speaking, the exercise of consent rights under protective provisions of the shareholders agreement should not be considered a Restricted Action. However, this is more of a facts-and-circumstances test, so careful review should be conducted for each transaction.
First published in JDSupra