Procedures for issuing new shares

Three types of issuance procedures

There are two ways for a stock company to raise funds: direct financing by issuing shares or subscription rights, and indirect financing by issuing bonds or borrowing from banks. The characteristic feature of bonds and bank borrowing is that there is an obligation to repay the borrowings, whereas there is no obligation to return the investment in shares or subscription rights. There are three ways for a stock company to issue new shares: third-party allotment, shareholder allotment, and public offering. The difference is who the shares are issued to. In the case of privately held companies with restrictions on the transfer of shares, most cases are considered to be third-party allotments.
-Third-party allotment
A third-party allotment is a case in which shares are allotted to a specific third party. Even if the allottee is a former shareholder, it is a third-party allotment unless the shares are allotted equally to all shareholders.
-Shareholder Allotment
Shareholder allotment is a method of allotting shares to all existing shareholders in proportion to the number of shares they hold.
-Public Offering
A public offering is a method of soliciting investment from the general public and allocating shares to those who have applied for them.

Capital increase by way of third-party allotment in a private company

When a privately-held company (a stock company with restrictions on the transfer of shares) conducts a third-party allotment, it is necessary to obtain a special resolution of the general meeting of shareholders (with the attendance of shareholders holding a majority of shares and the approval of shareholders holding two-thirds or more of those shares) (Article 199, Paragraph 1 and Article 309, Paragraph 2, Item 5 of the Companies Act). In a private company, each shareholder is interested not only in the right to receive economic benefits such as dividends, but also in maintaining control over the company by maintaining his or her shareholding ratio. This is because it is necessary to ensure that the shareholding ratio cannot be reduced without a special resolution of the shareholders’ meeting. A third-party allotment of new shares without a special resolution of the shareholders’ meeting is invalid. Therefore, the procedures for a third-party allotment of new shares in a privately held company (a stock company with restrictions on the transfer of shares) are as follows.

Determination of matters to be offered and convening of a general meeting of shareholders

In the case of a privately held company, the board of directors decides on the matters to be offered and convenes a general meeting of shareholders for approval. The following are the matters to be offered:
-Class and number of shares to be offered (Article 199, Paragraph 1, Item 1 of the Companies Act)
-The amount to be paid for the offered shares or the method of calculation thereof (Article 199, Paragraph 1, Item 2 of the Companies Act)
-If any property other than money is to be contributed, a statement to that effect and the details and value of such property (Article 199, Paragraph 1, Item 3 of the Companies Act)
-The date or period of payment or delivery of assets in exchange for the offered shares (Article 199, Paragraph 1, Item 4 of the Companies Act)
-Matters concerning capital and capital reserve to be increased (Article 199, Paragraph 1, Item 5 of the Companies Act)

Special resolution at a general meeting of shareholders

A special resolution of a general meeting of shareholders is required for a third-party allotment of new shares in a non-public company. Shareholders holding a majority of the total number of shares issued and outstanding must be present, and shareholders holding two-thirds or more of the total number of shares must approve the resolution. The resolution for a favorable issue and the resolution for a third-party allotment can also be combined.

Delegation to the Board of Directors

A special resolution of the shareholders’ meeting at which the resolution to issue shares is passed may delegate the decision on the offering to the board of directors (Article 200, Paragraph 1 of the Companies Act). In this case, the maximum number of shares to be offered and the minimum amount to be paid in must be determined by a special resolution of the shareholders’ meeting. The period of the mandate is limited to one year from the date of the resolution (Article 200, Paragraph 3 of the Companies Act). In this case, the Board of Directors, having received the delegation from the General Meeting of Shareholders, is free to issue new shares at any time within the conditions set by the General Meeting of Shareholders within one year after the resolution. The maximum number of shares to be offered and the minimum amount to be paid in are specified in order to avoid excessive dilution of existing shareholders’ shares by issuing an excessive number of new shares at a low price.

Subscription and Allotment of Offered Shares

In the case of a third-party allotment or public offering, the company shall notify those who wish to subscribe for shares of (1) the trade name of the stock company, (2) matters to be offered, (3) the place for payment of money, (4) the total number of shares authorized to be issued and other matters specified in Article 41 of the Enforcement Regulations of the Companies Act, to which the person who wishes to subscribe for shares shall provide a document stating his/her name, title, address, and the number of shares he/she intends to subscribe for (Article 203, Paragraphs 1 and 2 of the Companies Act). The company will determine the persons who will be allotted the offered shares and the number of offered shares to be allotted from among those who applied by the allotment date, and notify those who applied by the day before the payment date (Article 204, Paragraphs 1 and 3 of the Companies Act). Since a stock company has the principle of freedom of allocation, it can decide how much to allocate to its applicants.

Total Subscription Agreement

If a company subscribes for all of the shares to be issued by way of a third-party allotment, it may omit the procedures for subscribing for and allotting shares by concluding a total number subscription agreement with this person (Article 205, Paragraph 1 of the Companies Act). In the case of a third-party allotment of new shares in a privately held company, it is likely that in most cases an aggregate underwriting agreement will be executed since it is likely that the party who will underwrite the allotment will be decided from the beginning.

Payment of capital contribution

The share underwriters are required to make payment for their investment by the payment date. If the subscription is not paid by the payment date, the shareholder loses the right to become a shareholder.

Application for registration

When new shares are issued, it is necessary to register a change in the total number of shares issued and the amount of capital within two weeks of the payment date at the Legal Affairs Bureau with jurisdiction over the location of the head office of the stock company (Article 915, Paragraph 1 of the Companies Act).

In the case of a change of controlling shareholder in a public company

In principle, a public company can issue new shares by a resolution of the board of directors within the scope of authorized shares. However, in the case of an issuance of shares for subscription that involves a change in controlling shareholder, the name, title, and address of the subscriber, the number of voting rights that the subscriber will have after the subscription to be issued after the subscription, and the number of voting rights of all shareholders must be notified or publicly announced to shareholders at least two weeks prior to the payment date (Article 206-2, Paragraphs 1 and 2 of the Companies Act). In this case, if shareholders holding one-tenth or more of the voting rights of all shareholders express their opposition within two weeks, approval by an ordinary resolution of a general meeting of shareholders must be obtained, in principle, by the day before the date of payment of the money (Article 206-2, Paragraph 4 of the Companies Act).

In the case of a capital increase through shareholders’ allotment

When a company gives existing shareholders the right to receive an allotment of shares in proportion to their shareholding ratio, the shareholding ratio of the shareholders is maintained. Therefore, if the articles of incorporation of the company stipulate that the board of directors can decide on a capital increase through a shareholder allotment, the company can issue new shares by a resolution of the board of directors alone, without a special resolution of a general shareholders meeting (Article 202, Paragraph 3 of the Companies Act). However, shareholders who have been given the right to receive allotment can maintain their shareholding ratio by making payment, but they will be forced to decide whether to maintain their shareholding ratio by paying for the new shares or accept a decrease in their shareholding ratio without paying for the shares. Therefore, while there is no problem if all shareholders agree, conducting a capital increase through a shareholder allotment in the presence of dissenting shareholders is not desirable because it may invite complaints from dissenting shareholders.

Favorable Issue

If a company issues new shares at a significantly lower price, the existing shares will be diluted and the price of existing shareholders’ shares will be reduced. Therefore, if the amount to be paid for the new shares is particularly favorable to those who subscribe for the offered shares, the directors are required to explain the reasons for the favorable issuance at the shareholders meeting (Article 199, Paragraph 3 of the Companies Act). In the case of a private company, a “particularly favorable amount” is defined as approximately 10% below the market price, based on the net asset value per share, past offering prices, and past transaction prices based on trading examples. In principle, a public company can issue new shares only by a resolution of the board of directors, but the provisions regarding favorable issuance also apply to companies without restrictions on the transfer of shares (public companies) (Article 201, Paragraph 1 of the Companies Act), so a special resolution of a shareholders meeting is required for a public company to pass a favorable issuance resolution (Article 201, Paragraph 1 of the Companies Act). Whether or not the issuance of shares by a listed company constitutes a favorable issuance is determined by whether or not the price of the shares is particularly favorable compared to the fair price paid for the shares (the most recent market price of the shares). If the price is equal to or greater than the price on the day immediately preceding the date of the board of directors’ resolution for the issuance of ordinary shares multiplied by 0.9, it is not considered to be an advantageous issuance. However, in consideration of the price or trading volume up to the most recent date or the immediately preceding date, the average price from the date of the resolution to the date immediately preceding the date of the resolution from the date which is backdated an appropriate period (maximum of six months) to determine the amount to be paid in multiplied by 0.9 or more may be set as the amount to be paid in(Japan Securities Dealers Association, “Guidelines for the Handling of Capital Increase by Third Party Allotment”).

Issuance of new shares in a public company

In a public company, the need for flexible financing is greater than the interest of maintaining shareholding ratios, so new shares may be issued only by a resolution of the board of directors (Article 201, Paragraph 1 of the Companies Act). However, in order to give existing shareholders the opportunity to request an injunction against the issuance of new shares, if the board of directors determines the matters to be offered, it must notify the existing shareholders of such matters at least two weeks prior to the payment date. However, in accordance with the Financial Instruments and Exchange Law, if a disclosure document such as a securities registration statement is filed at least two weeks prior to the payment date, the public notice to shareholders is omitted (Article 201, Paragraph 5 of the Companies Act, Article 4, Paragraph 1 of the Financial Instruments and Exchange Law, etc.). In the case of a favorable issuance, the rights of existing shareholders may be prejudiced. Therefore, it is necessary to explain the reasons why a favorable issuance is necessary and pass a special resolution at a general shareholders’ meeting (Article 199, Paragraph 3 of the Companies Act).

Book Building Method

When offering shares, it is necessary to specify “the amount to be paid in for the offered shares or the method of calculation thereof” as one of the offering matters (Article 199, Paragraph 1, Item 2 of the Companies Act), but when a public company is offering subscribes to shares with a market price to subscribers, “the amount to be paid in for the offered shares or the method of calculation thereof” may be substituted for “the method of determining the amount to be paid in that is appropriate to realize payment at a fair price” (Article 201, Paragraph 2 of the Companies Act). This “appropriate method of determining the amount to be paid in” is assumed to be the book-building method (Article 2, Item 16 of the Regulations Concerning Underwriting, etc. of Securities). The book-building method is in which an underwriting securities company surveys investor demand and determines the amount in line with market trends to be paid in based on the demand situation it has identified, taking into account market fluctuations and other factors.

Financial Instruments and Exchange Law

Soliciting 50 or more persons to subscribe for shares constitutes “offering of securities” (Article 2, Paragraph 3 of the Financial Instruments and Exchange Law), and a securities registration statement must be submitted to the Finance Bureau (Article 4, Paragraph 1 and Article 5, Paragraph 1 of the Financial Instruments and Exchange Law). If the total amount of shares issued is 10 million yen or more but less than 100 million yen, a securities registration statement must be submitted to the finance bureau (Article 4.6 of the Financial Instruments and Exchange Law and Article 4.5 of the Cabinet Office Ordinance on Disclosure of Corporate Information, etc.). In addition, when conducting an offering or sale that requires the submission of a securities registration statement (when the total amount of shares to be offered is 100 million yen or more), a prospectus must be prepared and delivered at the time of the offering to solicit the public (Article 13, Paragraph 1 and Article 15, Paragraph 1 of the Financial Instruments and Exchange Law). In the case of a listed company, a third-party allotment is likely to be conducted by filing a notification under the Financial Instruments and Exchange Law, but in the case of a private company, once a securities registration statement is filed, it will fall under the continuous disclosure obligation, which is a significant burden for the company. Therefore, in the case of a privately held company, it is usual for the company to make sure that the solicitation does not fall under the category of “offering of securities,” for example, by limiting the number of persons to be solicited to 50 or fewer.

Relationship between the Companies Act and the Financial Instruments and Exchange Act

While the Companies Act requires that the subscription must be notified to shareholders at least two weeks prior to the payment date (Article 201, Paragraph 3 of the Companies Act), the Financial Instruments and Exchange Act states that notification of securities shall not become effective until 15 days have elapsed after receipt by the Prime Minister (Article 8, Paragraph 1 of the Financial Instruments and Exchange Act). Shares may not be acquired until after the notification becomes effective (Article 15, Paragraph 1 of the Financial Instruments and Exchange Law). As a result, a securities registration statement must be submitted at least 15 days (not two weeks) prior to the first day of the payment period or payment date.

Foreign Exchange and Foreign Trade Law

Article 26 of the Foreign Exchange and Foreign Trade Law defines inward direct investment, etc., as the acquisition of shares or equity in a Japanese company by a foreign individual or corporation, and requires that, in certain cases specified by Cabinet Order, the business purpose, amount, and timing of such inward direct investment must be notified in advance to the Minister of Finance and the minister having jurisdiction over the business (Foreign Exchange and Foreign Trade Act, Article 27, Paragraph 1). In addition, an investor who has made an inward direct investment is prohibited from making such an inward direct investment until 30 days have elapsed from the date of receipt of the notification by the Minister of Finance and the minister having jurisdiction over the business (Article 27, Paragraph 2 of the said Law). However, the 30-day period may be shortened if it is determined that an examination is not required.

Request for Injunction against Issuance of Shares for Subscription

If the issuance of shares for subscription (1) violates laws and regulations or the Articles of Incorporation, or (2) is made in an extremely unfair manner that may cause disadvantages to shareholders, shareholders may demand that the company stop the issuance of shares for subscription (Article 210 of the Companies Act). Cases of violation of laws and regulations or the Articles of Incorporation include cases where shares are issued in excess of the total number of shares authorized to be issued, and cases where shares are issued without a special resolution of a general meeting of shareholders even though the issuance constitutes an advantageous issue. In addition, the issuance of shares in a grossly unfair manner refers to cases where shares are issued as a means to achieve an unjustified purpose, and where new shares are issued solely to allow directors to maintain control of the company. Whether or not the issuance of new shares is for an unfair purpose is judged in accordance with the principal purpose rule in judicial precedents (Inageya and Chujitsuya case, Bellsystem24 case).

Action for Invalidation of Issuance of New Shares

The invalidation of a new share issuance can only be done by filing an action for invalidation of the new share issuance. Since the issuance of new shares affects a large number of interested parties, in order to ensure legal stability, the invalidity of the issuance of new shares can only be asserted by filing an action for invalidation of the issuance of new shares. Only shareholders, directors, corporate auditors, liquidators, etc. may file an action for invalidation of new share issuance. In addition, there is a time limit for filing an action within six months for public companies and within one year for private companies from the date when the issuance of new shares took effect (Article 828, Paragraph 1, Item 2 of the Companies Act). There is no legal provision regarding the grounds for invalidation in an action for invalidation of new share issuance. The grounds for invalidation include a defect in a special resolution of a general shareholders meeting of a non-public company or the issuance of new shares without notice or public notice to shareholders of a public company (i.e., depriving shareholders of the opportunity to demand an injunction).

Action for non-issuance of new shares

In cases where there are no facts that would constitute the issuance of new shares, or where the procedures for issuing new shares are extremely flawed, an action for non-issuance of new shares may be filed (Article 829 of the Companies Act). The action for non-issuance of new shares is a suit for confirmation, and any interested party may file the suit at any time. Unlike the case of invalidation of the issuance of new shares, there is no time limit for filing a lawsuit.