by Stephen Givens
In a significant precedent that adds a missing piece or two to Japan’s wobbly and shifting poison pill doctrine, in late July the Supreme Court upheld decisions by the Osaka District Court and Osaka High Court that invalidated a poison pill hastily set up by target Mitsuboshi Corporation (TYO 5820) to fight off an investor group with shadowy China ties that had amassed a more than 20% stake quietly in the open market.
A Gloss on Last Year’s Tokyo Kikai Seisakusho Case
The facts in the Mitsuboshi decision are in many ways similar to those of the Tokyo Kikai Seisakusho (TKS) (TYO 6335) poison pill case decided in November 2021. In both cases investors with China ties quietly acquired a sizable stake in a small, obscure target that lacked a pre-existing poison pill.
In TKS, these facts proved an embarrassment to recent judicial iterations on the poison pill, which seemed to make shareholder ratification of a poison pill both a necessary and sufficient condition for validation. [See footnote #1.] Applying the still-fresh shareholder ratification principle would have allowed Asia Development Corporation (ADC), the Chinese-controlled company that had already acquired 40% of TKS, effectively to block an after-the-fact poison pill.
Japan’s courts came to TKS’s rescue by recognizing a novel “majority of the minority” principle that permitted TKS management to exclude ADC as an “interested party” from the shareholder vote to ratify a poison pill. The TKS decision focused on the specific facts of the case without elaborating more broadly on the case’s limits or its implications. The legal basis and scope of the new doctrine announced in TKS were left unclear.
Issues Left Dangling by TKS
One large question left open by TKS was the scope of management’s discretion to hand-pick which shareholders are allowed to vote. Clearly, this is a constitutional issue within corporate law. Shareholder democracy is gutted if management, supposedly the shareholders’ servant, is allowed to select its own masters. Some of the language in the TKS decision suggested that management’s authority to disqualify shareholders would be narrowly limited to ratification of poison pills, and not extend to other matters, such as charter amendments and elections of directors, specifically reserved for voting by shareholders under the Company Act. Were the courts to recognize management discretion to disqualify selected shareholders from voting on basic matters specifically reserved to shareholders under Company Law, the implications would be earth-shaking.
Another question left dangling by TKS relates to the property rights implications of a retroactive poison pill that would destroy the economic value of shares already lawfully held by a shareholder. The TKS poison pill, if triggered, would have destroyed the economic value of TKS shares held by ADC in excess of 20%. This contrasts with a forward-looking poison pill that applies only to shares that have not yet been acquired beyond the defined percentage threshold. ADC quickly divested the excess shares to avoid the retroactive bite.
Board Authority to Disqualify “Interested” Shareholders from Voting on Poison Pills Has Limits
The Mitsuboshi decision adds light to these issues without resolving them. Irritatingly but not surprisingly, the Mitsuboshi decision never directly refers to the TKS case or tries to reconcile the two.
The main lesson to be taken from the Mitsuboshi case is that management does not have unlimited discretion to pick and choose which shareholders may vote. The key fact in the Mitsuboshi case, and its critical difference from the TKS case, is that management overreached in trying to disqualify shareholders who were sympathetic to, but not direct participants in, the Chinese investor group. At the same time, the Mitsuboshi case, troublingly, implies that management’s legal authority to disqualify shareholders from voting does indeed extend to basic matters reserved to shareholders under the Company Act.
Summary of Facts in Mitsuboshi
Group with China Connections Quietly Acquires 21.63%
Starting in July 2021 a group of entities and individuals clustered around someone known as Toshiyuki Honda began acquiring shares in Mitsuboshi Corp., a small manufacturer of electrical wire with annual revenues of ¥9 billion and a market capitalization of a mere ¥1.3 billion trading at the time at around ¥1,000 per share. Honda and his businesses appear to have overlapping China connections and background. Honda is the representative of a private company called Waen Trading, engaged in plastic recycling in Japan and China. The objectives of Honda and his group in seeking to acquire a large stake in Mitsuboshi are unclear; my own speculations are briefly offered below.
By March 2022 the Honda group, according to the facts recited in the Mitsuboshi decision, had collectively accumulated 21.63% of Mitsuboshi’s outstanding shares. Let it sink in that this was an investment of a mere ¥200 million, less than the cost of a luxury condo in Tokyo. In February a subset of the Honda group under the umbrella of an unincorporated association styled “Adage Capital” submitted a demand for an extraordinary shareholders meeting to remove the three most senior executives of Mitsuboshi and replace them with a slate of Adage-nominated directors.
This set off a flurry of legal wrangling in Osaka District Court and Mitsuboshi’s decision to defend with a poison pill. The Honda group began to solicit proxies for the EGM and informed Mitsuboshi management it would be prepared to acquire the company at between ¥4,000 and ¥5,000 per share. The facts to this point parallel those of the TKS case, the main difference being that there was a single acquirer in TKS, while Mitsuboshi involved a more nebulous group.
Mitsuboshi Responds with TKS-style Poison Pill
Applying the defense used in TKS, in April Mitsuboshi’s board adopted a “Large Scale Acquisition Plan” and established an independent committee to review it. The Plan broadly defined “Large Scale Acquirer” to include a shareholder group that acquired 20% or more of Mitsuboshi shares. The Board concluded that the Honda group met this definition. The Plan required members of the Honda group to report 60 days in advance of any planned further acquisition. It also required group members to submit information about their backgrounds and intentions. Violations of these restrictions would in turn trigger an issuance of dilutive free options, i.e. the poison pill, to shareholders other than members of the Honda group.
As strongly recommended by recent poison pill decisions, Mitsuboshi submitted the poison pill for shareholder ratification at a meeting held in May. Unfortunately for Mitsuboshi management, a majority of shareholders, even after excluding the Honda group, declined to endorse the poison pill, by a vote of 46% – 54%.
The financial incentives to vote against the poison pill were strong. By early May, in anticipation of a takeover bid, the share price had risen to around ¥4,000 per share. Voting for the poison pill would have been tantamount to voting against a profitable exit. After the poison pill was defeated, the stock price jumped to ¥6,000 per share.
A Second Bite at the Apple
Mitsuboshi management’s response was to give itself a second bite at the apple by re-submitting the poison pill at the upcoming June AGM. This time, to increase the odds that the poison pill would pass, it expanded the population of shareholders who would be disqualified from voting and be targets of the poison pill to include not only the Honda group but also shareholders from whom the Honda group had obtained proxies for the vote in May. (Interestingly, this group of shareholders included an affiliate of ADC, the Chinese-controlled company that had quietly acquired a 40% stake in TKS a year earlier.) Trying to disqualify and target shareholders who were merely sympathetic to the Honda group proved a bridge too far.
The disqualification of an expanded subset of shareholders from the June AGM vote resulted in a 54% – 46% short-lived Pyrrhic victory in favor of the poison pill, which Mitsuboshi management then proceeded to try to deploy by issuing stock rights that would have wiped out the economic value of the shares held by the Honda group and those who had given the Honda group their proxies, roughly 30% of the total shareholder population.
The Injunction Lawsuit
This triggered the Honda group’s lawsuit for an injunction against the poison plan in Osaka District Court under Article 247 of the Company Act, the provision that prohibits “extremely unfair” issuances of stock rights, judicial interpretation of which, beginning with the Bulldog Sauce case in 2005, shapes the contours of Japan’s poison pill law. The case was handled on an expedited basis, with the Osaka District Court handing down its decision on July 1, the Osaka High Court on July 21, and the Supreme Court on July 28. The Supreme Court summarily affirmed the lower court decisions without comment.
In finding that the Mitsuboshi poison pill was indeed “extremely unfair” to an extent that it violated Article 247, the Osaka District Court pointed to a number of overlapping factors.
First, that the poison pill would apply retroactively to shares acquired before the poison pill was adopted. The impact of a retroactive pill, the court noted, would be especially harsh where the defined acquirer group consisted, as here, of multiple, loosely related parties.
Second, the fact that the identified group consisted of multiple parties with indirect and in some cases tenuous relationships with each other. The court criticized the overly broad and nebulous definition of the group and the prohibited acts that would trigger the poison pill. ,
Ultimately, the Osaka District Court invalidated the Mitsuboshi poison pill based on an “overall judgment” (総合判断) that the poison pill’s primary purpose and effect were self-servingly to protect management. In reaching this conclusion the court relied heavily on the fact that the shareholder vote at the June AGM “approving” the poison pill was rigged to exclude shareholders who had indicated dissatisfaction with incumbent management by giving the Honda group their proxies.
The Osaka High Court, affirming the District Court’s decision, characterized the disqualification of shareholders who had given their proxies to the Honda group as tantamount to excluding a shareholder simply on the basis that he disagreed with management.
Next Steps Are Murky; Where is the FSA?
The Supreme Court’s affirmation of the injunction against the Mitsuboshi poison pill now opens the way for a decisive EGM demanded by the Honda group to replace Mitsuboshi management with a slate nominated by the Honda group.
The legal and tactical implications going forward are murky at best. Mitsuboshi’s stock price jumped from ¥7,000 at the beginning of July, when the Osaka District Court’s initial decision was released, to ¥13,000 in mid-July and back to ¥7,000 at the end of July. These valuations bear no relation to underlying fundamentals and imply rampant speculation and possible manipulation.
One possibility is that the Honda group will use temporary inflation of the stock price to exit and make a quick buck. Parallels to the ADC bid for TKS suggest that this may be a variation on a pump-and-dump scheme. The courts in the Mitsuboshi poison pill injunction case confirmed that the Honda group had been repeatedly remiss in filing required large shareholder reports to alert the investing public that a large position was being accumulated. One fervently hopes that this is being followed closely by the Financial Services Agency (FSA).
If the Honda group resists the temptation to dump its shares and succeeds in installing its nominees on the board, it will be in a position to leverage its control to the prejudice of general shareholders. One variation would be to cause Mitsuboshi to enter into disadvantageous transactional arrangements with members of the Honda group. Another would be to try to squeeze out general shareholders at a disadvantageous price. The weakness of Japanese law and courts in protecting general shareholders from abuse by controlling shareholders makes an onlooker nervous.
The final chapter of the Mitsuboshi story has yet to be written.
Dangling Issues
The Mitsuboshi poison pill decision, while preserving the main planks of the TKS decision, leaves a number of legal issues unresolved.
The decision confirms recent poison pill doctrine that shareholder ratification of poison pills is “highly desirable” but not absolutely legally required.
The decision implicitly upholds the authority of a board to disqualify “large acquirers” from voting on poison pills based on the “majority of the minority” principle announced in TKS. The authority to disqualify, however, is not unlimited. Excluding shareholders simply because they are sympathetic to a “large acquirer” goes too far.
The decision as it relates to shareholder disqualification is limited to the vote on Mitsuboshi’s poison pill, but implies that under the right facts and circumstances it could extend to matters, such as voting on charter amendments and election of directors, specifically reserved to shareholders under the Company Act. This is an issue that urgently needs to be clarified, as it goes to the constitutional heart of corporate law.
Retroactive poison pills, i.e. those that compel disgorgement of shares acquired before adoption of a poison pill, are valid but disfavored, especially if applied to a nebulous shareholder group and not a single “large acquirer”.
Stephen Givens
August 2022
Footnote
[1] The shareholder ratification principle for poison pills goes back to the 2005 Bulldog Sauce case, the original judicial precedent validating poison pills. In Bulldog Sauce, the Supreme Court suggested that courts would not second guess a poison pill that had been approved by 83% of shareholders. More recent cases, notably the 2021 Japan Asia Group decision suggests that an after-the-fact poison pill will not be valid if not ratified by a majority of shareholders. Other cases, however, suggest that a poison pill is legally valid upon adoption by the board of directors. Shareholder ratification is therefore commonly referred to as “confirmation of shareholder intent” (意思確認), to distinguish it from matters, such as charter amendments and election of directors, specifically reserved for determination by shareholder action under the Company Act.