Japanese commercial banks, trust banks, and government-related banks play big roles as senior lenders. In particular, the Japanese acquisition finance market is dominated by Japan's three mega banks:

The early period of Japanese acquisition finance saw US and European-based banks playing big roles. However, few non-Japanese banks are currently active in the Japanese acquisition finance market.

Certain mezzanine funds, bank subsidiaries and lease companies play big roles as mezzanine financers. The mezzanine funds include:

Recently, the three mega banks have started participating in mezzanine financing for large-cap deals.

If the transaction is a carve-out transaction of a business from a large company, a de-merger (kaisha bunkatsu) in exchange for cash is frequently used as the form of acquisition. This method is a special form of asset acquisition using an organisational restructuring permitted under the Companies Act (Act No. 86 of 2005). In this method, the acquiring vehicle (Newco) enters into a de-merger agreement with a seller company and acquires the target business through the de-merger. In exchange for the asset transfer under the de-merger, the Newco pays a purchase price to the seller.

This de-merger method is used in preference to a pure asset transfer because the Newco does not need to obtain consents from the relevant counterparties for the transfer of the target business's necessary underlying agreements, unless this is specifically required by those agreements. In the case of the pure asset transfer, the Newco must obtain the counter-parties' consent to all of the agreements being transferred. Such agreements include employee agreements, for which obtaining such consent may be difficult.

The typical acquisition structure is a share acquisition. A new joint stock company (kabushiki kaisha) is usually formed as the acquiring vehicle (Newco), which becomes the borrower of the debts and receives equity investments. The Newco acquires the shares of the target company (Target) with the funds being financed by way of equity and debt.

While cash-out mergers are generally available under the Companies Act, they are rarely used for cash-out acquisitions because:

When the target company is a listed company, a tender offer followed by a squeeze-out process is typically used (see Question 12).

Usually, the buyer asks candidate lenders to submit letters of intent or highly confident letter, which do not include any binding commitment, and selects one or two lenders as mandated lead arrangers (MLAs). In an auction transaction, the buyer usually obtains a commitment letter from the candidate lenders before it provides the final bid letter, regardless of whether it requests the financing out closing condition to the seller.

After the selection of MLA, the buyer and MLA start negotiation of the:

In practice, in a leveraged transaction, the term sheet to be negotiated is very long (usually 50 to 80 pages) and is very detailed. However, if the transaction is an acquisition by a public company or a large private company, and the finance for the transaction is pure corporate finance, the term sheet is more simple (usually, around ten pages). This term sheet is usually drafted and handled by the MLA and its counsel. Although there is no official form for such a term sheet, in practice, many lenders in the market use a similar form. The commitment letter and the term sheet are usually written in Japanese and governed by the laws of Japan. However, if the buyer is a US or European private equity fund, sometimes the mandate letter and the term sheet based on Loan Market Association (LMA) forms are used (although the governing law is the law of Japan).

After the commitment letter phase, the buyer and MLA start negotiation of the definitive loan agreement and the security agreements. Such definitive agreements are usually drafted and handled by the MLA and its counsel.

Although there is no official form for such definitive agreements, in practice, many lenders in the market use a similar form. In addition, if the finance for the transaction is pure corporate finance, MLAs almost always use the model syndicated loan agreement form published by the Japan Syndication and Loan-trading Association (JSLA).

The governing law of such definitive agreements is always the law of Japan, although if the secured assets relate to a jurisdiction other than Japan, the governing law of the security agreements may be the law of that jurisdiction, depending on the applicable conflict of laws rules. The controlling language of such definitive agreements is usually Japanese. However, if the buyer is a US or European private equity fund, sometimes English is used as the controlling language (although the governing law is the law of Japan).

The buyer almost always incorporates a Newco for each transaction and the Newco acquires the target or the target business.

A joint stock company (kabushiki kaisha) is usually used as the Newco because it provides limited liability protection for its equity holder and is the most popular type of company used in Japan. The equity interest in the joint stock company is subdivided in the shares, and the equity interest is always held by the buyer.

In some cases, another type of company referred to as a limited liability company (godo kaisha) is used as the Newco because, in certain situations, it has certain tax benefits that the joint stock company does not have, including that:

The equity interest in the limited liability company is subdivided into units. Such equity interests are always held by the buyer.

The buyer almost always injects equity money into the Newco in the form of straight equity. Subordinated loans and preferred equity are rarely used as a form of equity injection.

Senior loans. Usually only senior loans are used for debt financing. However, if the size of the deal is large, or the leverage of the deal is high, mezzanine finance is used for the debt financing in addition to the senior loans.

Senior loans usually consist of Term Loan A, Term Loan B and revolver. Term Loan A is fully amortised while Term Loan B is paid at maturity in lump sum. Term Loan A and Term Loan B are used to finance the closing of the acquisition, refinancing and the transaction costs. The revolver is used to finance working capital. The term is typically five to seven years. Financial covenants typically include:

An unusual feature of the syndication market in Japan is that typically investors participate in all tranches on a pro rata basis, although this phenomenon may change in future. Credit rating for acquisition finance loans by rating agencies is not common yet in Japan.

Senior loans are secured by a security package after the Target or target business is acquired (see Question 7 and Question 8).

Mezzanine finance. Mezzanine financing is provided by way of non-voting preferred shares or subordinated loans. A high-yield debt market has not yet developed in Japan.

The preferred shares used for acquisition financing are usually non-voting, cumulative and non-participating shares, because the intention of mezzanine investors is to secure the agreed spread. In addition, to secure the mezzanine financer's position, conversion rights to the voting shares are usually attached to the preferred shares so that the financer can exercise the conversion right and seize control of the company in event of the company's financial distress. In addition, it is common for redemption rights to be granted to the mezzanine financer to secure its exit.

Since dividends to shareholders are paid out after the company repays to all creditors of the company, the mezzanine financer, as a preferred shareholder, is structurally subordinated to the senior lenders.

Subordinated loans are secured by a security package after the target or the target business is acquired, and the security package with respect to the subordinated loans is almost the same as the security package for senior lenders. The subordinate nature of the subordinated loans is created through an inter-creditor agreement among senior lenders, mezzanine financers and the borrower (see Question 7).

Equity kickers. Equity kickers are sometimes provided to the mezzanine financer. In Japan, equity kickers are granted to the mezzanine financer in the form of warrants called stock acquisition rights (shinkabu yoyaku ken). If the target is a non-listed company, as the shares of the target do not have liquidity, the mezzanine financer must demand tag-along rights against sponsors who own the common shares of the target to secure an exit for such warrants.

Although there is no official form for the definitive agreements, in practice many lenders in the market use a similar form. In addition, if the finance for the transaction is pure corporate finance, MLAs almost always use the model syndicated loan agreement form published by the Japan Syndication and Loan-trading Association (JSLA). If the buyer is a US or European private equity fund, sometimes the Loan Market Association form is used.

If mezzanine finance is provided in the form of a subordinated loan, an inter-creditor agreement is almost always executed among the borrower, the senior lenders, and the mezzanine financers.

It is very common to use contractual subordination arrangements. A contractual subordination arrangement is achieved by entering into an inter-creditor agreement between the borrower, the senior lenders, and the mezzanine financers. The contractual subordination arrangement is valid only between the senior lenders and the mezzanine financers and cannot be claimed against third parties such as general creditors.

Another way to create the contractual subordination of the subordinated loans is to make the subordinated loan a statutory subordinated claim by agreement between the borrower and the mezzanine financers. Such statutory subordinated claims may be created under:

However, since statutory subordinated claims are subordinate even to the general claims under the insolvency procedures, in practice, they are not used for mezzanine loans in acquisition finance.

Structural subordination occurs when the mezzanine financer provides loans to a holding company of the borrower. Such holdco loans sometimes become a method of mezzanine finance in Japan.

Usually, the agreement provides that:

Usually, the agreement provides that:

In practice, in Japan, an upfront fee is paid to the mezzanine financer only at the time of the disbursement of the subordinated loans under a fee letter. Therefore, there is no provision relating to payment of such fees in the inter-creditor agreement.

Under Japanese law, it is possible to grant ranks of security interest, and therefore it is common for only second-rank security interests to be given to the mezzanine financer. If the enforcement of the security interests is conducted through statutory enforcement procedures, no distribution is made to the second rank security interest holders until and unless the first rank security interest holders are fully repaid. However, if the enforcement of the security interests is conducted through private auction or private sale, this distribution rule does not apply. Therefore, it is common for the inter-creditor agreement to provide that the mezzanine financer must release its second rank security interests if the security interests are enforced through private auction or private sale, and the senior lenders request this. (This would be a worse position for the mezzanine financer than in a transaction that uses the LMA format inter-creditor agreement.)

In addition, if any distribution is made to the mezzanine financer before the full repayment of the senior loans, it is usually provided under the inter-creditor agreement that any such distributions received by the mezzanine financer must be turned over to the senior lenders.

It is common for the senior lenders and the mezzanine financers to enter into an inter-creditor agreement even where the mezzanine finance is provided in the form of preferred shares. If so, the dividend claims or the monetary claims arising from the exercise of the redemption rights of the preferred shares are treated as the subordinated claims under the inter-creditor agreement. Usually, the agreement provides that:

Security interests are created to seize control of the target and its group companies (Target Group) and the financial value of the Target Group. In this sense, the shares of the Target Group are the most important security asset because by exercising the security interests over the shares, the lender can acquire and dispose of control over the Target Group. However, the lender needs to maintain the financial value of the Target Group at the same time. Accordingly, the basic principle is that, in addition to the share pledge, the lenders generally wish to enter into security arrangements over all, or substantially all, of the assets of the Target Group.

The lender and the borrower typically agree to exclude from the security package assets over which creation of a security interest or perfection is unlawful or too onerous or costly under the applicable law. The borrower further seeks to exclude assets or be exempted from the perfection requirements where it requires obtaining the consent of, or sending notice to, third parties, such as trade partners. This is because the borrower typically does not want those third parties to be aware of the existence of the security arrangements, which generally implies a weak financial position in Japan.

A grant of one security interest over all of a borrower's assets is called "corporate collateral" (kigyo- tanpo-ken) in Japan, but corporate collateral is not used in acquisition finance transactions. One reason is that the use of corporate collateral is limited by statute only to secure corporate bonds, which are not commonly used for acquisition finance in Japan. Another weakness of corporate collateral is that, as a general security interest, it is subordinated to other types of security interests that are created on more specific assets. Accordingly, a lender who holds corporate collateral cannot assert priority over a creditor who subsequently obtains a security interest over particular assets, which makes corporate collateral inappropriate for the purpose of acquisition finance.

Due to the weakness of corporate collateral, an acquisition finance lender in Japan usually creates security interests over each asset of the target and its wholly owned subsidiaries and perfects these security interests. In certain other jurisdictions, security interest on various assets can emerge from the same process. In contrast, because the method of creating security interest and its perfection varies asset by asset, this process incurs extra time and costs in creating security interests and their perfection.

There are various kinds of security interests under Japanese law, such as:

The kind of security interest used depends on the type of assets. As another classification if the secured loan is a revolving facility, revolving security interests (such as revolving pledges) are used, while, if the secured loan is a non-revolving facility such as a term facility, ordinary (non-revolving) security interests (such as ordinary pledges) are used.

Creating a security interest is subject to the directors' general fiduciary duty. In principle, creating a security interest for the benefit of directly or indirectly wholly owned or wholly owning companies does not raise a fiduciary duty issue because the security provider's and receiver's interests are deemed to be aligned. However, creating a security interest for the benefit of another group company without receiving corresponding benefits or obtaining consent from all the shareholders raises a fiduciary duty issue. Other than directors' general fiduciary duty, there are no specific restrictions such as restrictions on upstream security and financial assistance as seen in other jurisdictions.

Shares. The lenders typically create a pledge over shares. First, when the issuer of the shares is not a listed company and the articles of incorporation of the issuing company provide that share certificates are to be issued, execution of a pledge agreement and delivery of the share certificates to the pledgee is required to create the pledge. Continuous possession of the share certificates by the pledgee is then required to perfect the pledge against the issuing company and third parties. Usually, the security agent receives delivery of the share certificates and keeps them as proxy for all the pledgees.

Second, when the issuer of the shares is not a listed company and the articles of incorporation of the issuing company do not provide that share certificates are to be issued, execution of a pledge agreement is sufficient to create the pledge. Recording the pledge in the share ledger is required to perfect the pledge against the issuing company and third parties.

Third, if the issuer of the shares is a listed company, the pledge becomes effective when the pledgee has the increase in the number pertaining to the pledge described or recorded in the pledge column of the pledgee's account through application for the book-entry transfer (Act on Book-Entry of Company Bonds, Shares, etc. (Act No. 75 of 2001)).

A pledge of shares of partially-owned subsidiaries, such as joint ventures, may require the other shareholders' consent, as the shareholders' agreement typically requires this.

Inventory. See below, Movable assets.

Bank accounts. See below, Claims and receivables. One additional note on bank account receivables is that while a credit party can validly create a pledge over its receivable with respect to a fixed deposit account, it is unclear under Japanese law whether a credit party can validly create a pledge over its receivable with respect to an ordinary savings account, because the deposits vary over time by withdrawals, transfers and additional deposits.

Claims and receivables. Receivables (such as trade receivables and bank account receivables) are included in the security package by use of a pledge or by creating a security interest by way of assignment.

Execution of a security agreement is sufficient to create either a pledge or a security interest by way of assignment. However, if the underlying contract prohibits creating a security interest over the receivables, obtaining the third-party debtor's consent is also required to validly create a pledge or a security interest by way of assignment.

There are three ways to perfect either a pledge or a security interest by way of assignment against third parties (other than third-party debtors):

There is no additional requirement for notice or consent with notarisation to perfect either a pledge or a security interest by way of assignment against the third-party debtor. However, delivering a certificate of registration to the third-party debtor is necessary to perfect either the pledge or a security interest by way of assignment against the third-party debtor.

If the third-party debtor is located in a foreign jurisdiction, it is recommended that perfection be made both in Japan and in the foreign jurisdiction. This is because it is possible that the local conflict of laws rules in the foreign country require the security holder to comply with the perfection process in the jurisdiction to enforce the security interest in that jurisdiction.

It is possible to create a security interest by way of assignment over future receivables. However, under a series of Supreme Court decisions, creating a security interest on future receivables by way of assignment is valid only if the scope of receivables to be assigned is clearly specified in the security agreement by specifying, among other things:

In addition, although there is no specific Supreme Court decision, it is widely viewed that creating a pledge over future receivables is also possible.

Intellectual property rights. Intellectual property rights are included in the security package by use of a pledge or by creating a security interest by way of assignment.

For trade marks and patents, execution of a pledge or assignment agreement and registration of such pledge or assignment is required to create the security interest. However, for copyrights, only execution of a pledge or assignment agreement is required to create the security interest, and registration is required for perfection against third parties. The registration tax of 0.4% of the amount of the secured claim to be imposed when registering the security interest over registrable intellectual property rights tends to be costly, and therefore measures to mitigate the registration tax are often used in practice.

Real property. Lenders typically create mortgages (teitou-ken) over owned real property.

Execution of a mortgage agreement is sufficient to create a mortgage, and registration of the mortgage is required to perfect the mortgage against third parties. The mortgage agreement is typically drafted to additionally create security interests over the proceeds from the real property. For example, a typical mortgage agreement creates a pledge over any future claim of fire insurance proceeds in connection with the real property. The registration tax of 0.4% of the amount of the secured claim to be imposed when creating a mortgage over a real property asset tends to be costly, and therefore measures to mitigate the registration tax are often used in practice.

Movable assets. Movable assets (including inventory) are typically included in the security package by creating a security interest by way of assignment.

Execution of an assignment agreement is sufficient to create a security interest by way of assignment. To perfect the assignment against third parties, the borrower must deliver possession of the movable assets to the security interest holder, but the borrower can constructively deliver them by:

As an alternative, under the Registration Act, the security interest holder can perfect the assignment against third parties by registering the transfer with the competent legal affairs bureau.

The lenders can perfect a security interest by way of assignment over not only particular assets but also a group of movable assets (including future ones, such as inventory in a particular storehouse), provided that the scope of the movable assets subject to the security is clearly specified.

In the case of movable assets, perfection is not sufficient to block a bona fide third party from obtaining the right to the movable asset from the borrower by statute (sokuji shutoku). To avoid this, the security interest holder should have a notice indicating the creation of the security interest attached to the movable assets.

Joint and several guarantees are typically provided by each credit party other than the borrower because they extinguish any structural subordination and make it possible to collect the loans from each credit party by way of set-off.

Providing a guarantee is subject to the directors' general fiduciary duty. In principle, providing guarantees for the benefit of directly or indirectly wholly owned or wholly owning companies does not raise a fiduciary duty issue because the guarantee receiver's and guarantor's interests are deemed to be aligned. However, providing a guarantee for the benefit of another group company without receiving corresponding benefits (such as guarantee fees) or obtaining consent from all the shareholders raises a fiduciary duty issue. Other than the directors' general fiduciary duty, there are no specific restrictions such as restrictions on upstream guarantees and financial assistance as seen in other jurisdictions.

As Japanese law has historically not been clear on whether security trusts are permitted, each lender either has a separate security interest or shares with all the other lenders a singular security interest. In either case, a security agent is still appointed but serves only as a proxy for all the lenders. This makes the process for syndication or subsequent transfer more complicated and time-consuming than where a security trust is used.

In 2006, the amended and restated Trust Law (Act No. 108 of 2006) first confirmed the validity of security trusts under Japanese law, but use of security trusts has not yet become prevalent because:

As an alternative, parallel debts are often used in cross-border transactions. However, parallel debts are not common in domestic transactions.

Japanese thin capitalisation rules are applied only to cross-border financing. Generally, the portion of interests paid to the foreign controlling shareholders and foreign lenders corresponding to the excess amount is not deductible if both:

There is no statutory financial assistance restriction in Japan. However, providing guarantees or security interests to a majority shareholder at the expense of minority shareholders can contradict the directors' general fiduciary duty. Therefore, only the wholly owned subsidiaries of the borrower provide guarantees or security interests, except where certain corresponding benefits such as guarantee fees are provided, or all of the shareholders consent.

In the typical leveraged buy-out structure, the target does not provide any guarantee or security interest to the lenders until the target becomes the wholly owned subsidiary of the borrower acquisition vehicle.

Certain industries are heavily regulated in Japan, including financial services, aviation, transportation, telecommunication, broadcasting companies, securities exchanges and utility companies. The laws that regulate these businesses often require prior approval from, or advance notice to, the regulator in case of a change of control or other types of acquisition.

In addition, the Foreign Exchange and Foreign Trade Act (Act No. 69 of 1951) (FEFTA) requires a foreign acquirer to obtain advance approval from the government and to be subject to a 30-day waiting period (unless shortened) before being able to acquire shares in a Japanese company whose business relates to:

The competent Japanese authorities may issue a recommendation or order the amendment of the terms of the acquisition, or even suspend it. The only example to date of a Japanese authority suspending an acquisition occurred in 2008 when The Children's Investment Fund (TCI), a London-based hedge fund, was ordered to refrain from acquiring up to a 20% stake of J-Power, a domestic electricity company that operates power plants, including nuclear power plants. This was because there was a concern that TCI's shareholding could negatively affect the supply of electricity and nuclear power policy in Japan and thereby potentially endanger public order. In addition, the FEFTA more broadly requires post-facto reports for share acquisitions conducted by foreign investors, but such reports are mere formalities.

When the target is conducting a regulated business, it may affect the terms of acquisition finance. For example, it may be added as a condition precedent to obtain necessary regulatory consent, and some of the assets owned by the credit parties may not be provided as security.

Where the target is listed, the acquirer must follow the mandatory tender offer rules under the Financial Instruments and Exchange Act (Act No. 25 of 1948) (FIEA) that apply to the following:

In addition, where the holding ratio of the acquirer reaches two-thirds or more after acquisition, a tender offer is always required, and the tender offeror must purchase all classes of equity securities of the target offered in the tender without setting any limit on the number and the class of shares to be purchased (commonly known as "the two-thirds rule").

If a tender offer is required for an acquisition, the tender offeror must file a tender offer registration statement with the regulator describing a wide variety of matters, including:

To support the existence of funds to close the tender offer, the tender offeror is required to attach to the tender offer statement:

The Financial Services Agency of Japan (FSA) has published its view that such certificates must be supported by a certainty of funding and has provided examples of what will be required of such certificates in order to support a certainty of funding. The FSA also requires full disclosure on such certificates of the conditions precedent provided in the commitment letters. Generally speaking, the FSA's view on certainty of funding is less restrictive than the "certain funds" requirements in the UK. In particular, business and market material adverse change provisions that are usually included in the commitment letters from banks are not viewed as impairing the certainty of funding.

There are two typical methods to squeeze out minority shareholders following a tender offer:

Although a squeeze-out transaction can still be completed by securing two-thirds through a stock consolidation, it does not necessarily mean that the transaction will not be blocked by minority shareholders. While no reliable court precedents yet exist in this regard, the general understanding is that a cash-out transaction can be blocked if the relevant shareholders' resolution was made as a result of an abuse of rights of the majority shareholders, thereby making that resolution extraordinarily unfair. The most important factor to measure such extraordinary unfairness is the fairness of the purchase price offered to the minority shareholders. A high holding ratio of the majority shareholders after the tender offer would also be a significant factor.

Minority shareholders also have appraisal rights under the Companies Act, and exercising such rights is the most practical recourse for minority shareholders who are not satisfied with the purchase price. With an appraisal right, minority shareholders may request the target to purchase their shares, and the courts determine a fair value if the minority shareholders and the target make no agreement.

Japanese courts (as opposed to jurisdictions such as the US) generally consider that such fair value should consider the synergies from the M&A transaction. In its decision in 2016 on shareholders' appraisal rights, regarding a private transaction of Jupiter Telecommunications Co., Ltd. (JCOM), the Supreme Court determined that a fair transaction includes measures to mitigate conflicts of interest. These include:

In such cases, the court should consider the transaction price agreed between the parties to be the fair value in principle.

No special consideration for pension schemes is required in relation to acquisition finance in Japan.

Under Japanese terminology, a lenders' liability in the broad sense means any liability of a financial institution in connection with its lending in the process of negotiation, closing, administration and collection. The lenders' liability in the narrow sense means the liability of a financial institution due to its excessive control of the borrower. There have been many court precedents about the former and a couple about the latter, but these are general obligations of lenders, and no special consideration on lenders' liability in the context of acquisition finance has been actively addressed in Japan.

The secondary market of leveraged buyout loans itself is yet to grow in Japan, and therefore debt buy-back is still uncommon. Legally, the borrower can purchase its own debt, in which case the debt will be extinguished on the purchase due to the legal effect of "commingling", which means the creditor and debtor statuses belonging to the same person.

It is common for the acquisition vehicle and the target to merge after the closing of the acquisition, as the result of which the acquisition facilities are pushed down to the operating company level.

The first major amendment to the Civil Code (Act No. 89 of 1896), since its promulgation 120 years ago, came into force in April 2020. Such amendment related to contractual obligations only. Another major amendment to the Civil Code is planned in the near future and its impact on acquisition finance transactions will be much larger because this amendment will relate to security interest. A special committee within the Ministry of Justice is still discussing details of this amendment as of August, 2022.