I would like to write a column about Special Committees in Japanese M&A at this time.
The points are,
- The presence of special committees significantly grows in Japanese M&A.
- Group restructuring of listed subsidiaries cannot be completed within the company group.
- The committee plays an important role in negotiating phase.
While this is not common in M&A among unlisted companies in Japan, when it comes to M&A among listed companies, an objective evaluation of the M&A transaction with a parent company is required in order to protect minority shareholders' interests and has to be conducted by Special Committee, which are composed of independent directors in a targeted company.
Becuase the importance of special committees has increased in recent years, they have been so prominent that transactions are no longer just between the buyer and seller. Adding to the special committee fully involved, three-way communication takes place. It is no longer the case that an M&A is completed simply by the buyer and seller giving their approval.
I briefly explain why special committees appear in M&A transactions and what role and position they play.
1. What is a Special Committee?
Under the rules of stock exchanges in Japan, listed companies are recommended to establish a special committee as a measure to ensure fairness and avoid conflicts of interest when engaging in transactions with controlling shareholders.
This is particularly relevant for a subsidiary company that is totally acquired by a parant company and is delisted in such transactions.
Consequently, in cases that a parent company seeks to fully acquire a listed subsidiary in Japan, a special committee is almost established.
Frankly speaking, the purpose of the special committee is to prevent a parent company from making a listed sublidiary forcibly accept its buyout proposal with unfavorable terms. During the process, the committee reviews whether the terms of the transaction, such as the takeover bid price or the share exchange ratio, are fair for their minority shareholders and not disadvantageous to the subsidiary.
Previously, these committees were often composed of external experts. However, according to the so-called M&A Guidelines issued in 2019 by the Ministry of Economy, Trade, and Industry (METI), it is now considered preferable (and in many cases mandatory) for the special committee to include independent outside auditors and directors who have no conflicts of interest. This shift reflects a growing emphasis on the accountability of board members to shareholders, especially minority shareholders, rather than relying solely on external experts like lawyers or certified accountants. However, given the complexity and specialized nature of M&A transactions, it is generally permissible to also include external experts as committee members or to engage financial advisors (FAs) and legal advisors for additional support.
The special committee, set up by the board of directors in a targeted company, serves as an independent third party to objectively review the buyout proposal and transaction process. Its primary goal is to confirm the fairness of the proposal and the process from the perspective of minority shareholders. Ultimately, the committee submits a report to the board, stating "whether the proposal is reviewed and M&A transaction in question is conducted fairly". The board then signs the final agreement based on the contents of this report.
2. What Does a Special Committee Do?
When a special committee is convened, it typically addresses four main tasks below as directed by the board of directors:
(1) Rationality of M&A Transaction's Purpose => Is M&A a good idea?
(2) Fairness of the M&A Transaction Terms => Are the terms not disadvantageous to minority shareholders?
(3) Fairness of the M&A Transaction Procedures => Is the process fair?
(4) Report to be submitted to Board => A report to confirm that the M&A transaction is not disadvantageous to minority shareholders.
The special committee usually operates over a 3 to 4-month period and is held around 10 times before the M&A transaction is made public. This frequency has increased compared to 10 years ago, reflecting the emphasis on enhancing the operation of special committees in light of new M&A guidelines.
Committee members typically meet weekly or bi-weekly. Due to the significant workload involved, it's common for external directors and auditors who participate in the committee to receive additional compensation, usually as a fixed fee rather than a success-based payment, to avoid any bias toward achieving a particular outcome.
The flow of the process is generally as follows: in the early stages, the committee focuses on confirming (1), then moves on to (2) in the middle to later stages, while reviewing (3) throughout the entire process.
(1) Rationality of the M&A Transaction's Purpose
The committee first examines whether the M&A transaction's purpose is rational, especially considering the potential synergies between the buyer and seller. The transaction should ideally maximize synergies while minimizing negative impacts (e.g., potential loss of business partners if acquired by a competitor).
If the positive outcomes significantly outweigh the negatives, the committee can justify the M&A's purpose. However, if the negatives outweigh the positives, the transaction may lack rationality, and the committee may not approve it. Therefore, even in parent-subsidiary transactions, a serious evaluation of synergy effects is necessary. (If you simply list generic purposes and consider the details afterward, the purpose won't be accepted by the committee)
(2) Fairness of the M&A Transaction Terms
Historically, only the involved parties and their financial advisors (FAs) negotiate the transaction terms. However, nowadays, the special committee is fully involved. Before negotiations, the company and its FA have to explain their negotiation strategy to the committee and in effect obtain approval. The committee may even be granted negotiation authority by the board, allowing it to negotiate directly with the buyer if needed. Thus, if the subsidiary's board of directors attempts to settle for less favorable terms, the committee may not approve, prolonging negotiations until acceptable terms are reached.
(3) Fairness of the M&A Transaction Procedures
The committee reviews the entire M&A process for fairness. For example, it scrutinizes the business plan that forms the basis for valuation, ensuring that the business plan hasn't been deliberately understated at the parent company's behest to result in a lower valuation. Similarly, the committee checks if the parent's business plan is unrealistic and could unjustifiably inflate a valuation.
The committee also investigates potential conflicts of interest, such as advisors with ties to the parent company or former parent company employees who work on the subsidiary's side. However, practical judgments are made as not all individuals with a connection to the parent company are excluded.
(4) Report to the Board
Finally, the special committee compiles its findings into a report, which is submitted to the subsidiary's board of directors either the day before or on the day the M&A transaction is announced. The report outlines the specifics of the committee's assessments and concludes with a statement that the transaction is not disadvantageous to minority shareholders.
In recent years, this rigorous process has become standard for the group restructuring and full acquisition of listed subsidiaries, highlighting the importance of working with experienced FAs and legal advisors who can navigate these procedures smoothly.
While other measures, such as obtaining a fairness opinion from an M&A advisor / investment bank or a legal opinion from a lawyer, are also recognized under the stock exchange rules, these do not fulfill all the criteria required by the special committee.
Therefore, establishing a special committee remains the most reliable approach to ensure fairness in the process. For large-scale reorganizations, such as mergers, it is common to combine the establishment of a special committee with other measures like a fairness opinion.
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