August 21, 2006

Takeover Attempt May Set Precedent on Pill Adoptions

From the ISS “Corporate Governance Blog“: A controversial takeover battle between two of Japan’s largest paper manufacturers may prompt a legal ruling on how and when Japanese companies can deploy poison pill defenses.

The use of pills has grown exponentially in Japan over the past 18 months, but the legality of their use in some circumstances remains questionable, leaving both issuers and shareholders searching for guidance from Japan’s judiciary. A recent takeover attempt pitting bidder Oji Paper against rival Hokuetsu Paper Mills has invited judicial scrutiny because of the target’s adoption of a pill without shareholder approval and subsequent issue of warrants to a “white knight” investor, legal experts say.

The pill, which would remain in effect until the next annual shareholder meeting when it would be put to a shareholder vote, is relatively standard for Japan. The terms include a 20 percent trigger, the establishment of an independent but non-board level committee (composed of three non-executive statutory auditors) to review the terms of any takeover offer and present a non-binding recommendation on whether to deploy the pill, and a commitment to reduce board terms to one year.

Currently, Hokuetsu’s board has no outsiders (nor does Oji’s), and the terms of the pill do not obligate the board of directors to accept the committee’s recommendation, should the committee favor the takeover offer and thus recommend against deploying the pill. Hokuetsu’s independent committee on Aug. 8 recommended to the board that the pill be deployed.

The committee’s independence is one issue the courts will focus on, experts say. The role of the [independent committee] is “to fairly and impartially determine whether the takeover bid will increase the value of the target company,” notes Waseda University’s Tatsuo Uemura in comments made to the Nihon Keizai Shimbun.

Without shareholder approval of the pill, however, Hokuetsu runs the risk of skeptical judicial scrutiny. According to ISS data, at least 60 other Japanese companies have adopted pills without shareholder approval this year, but few have done so in the face of a takeover bid.

A precedent-setting decision last year by the Tokyo District Court, upheld by the Supreme Court, forced process control equipment maker Nireco to withdraw a poison pill passed by the board of directors without shareholder approval. A Ministry of Economy Trade and Industry and Ministry of Justice white paper published in May 2005 appeared to endorse so-called advance warning takeover defenses. However, while prescribing pill-like defense mechanisms, the paper warned that regulations should not permit poison pills to be used simply to hold off a hostile bid or to entrench management.

Moreover, shareholder opposition of poison pills and other takeover-related defenses is on the rise. Influential pension fund associations have adopted more stringent proxy voting policies against such proposals, including the Pension Fund Association’s policy of voting against directors of companies adopting poison pills that are “structured such that the deployment is left to the discretion of the board of directors,” according to a June 29 Nihon Keizai Shimbun article.

A recent survey by the Japan Securities Investment Advisers Association indicated that 50 percent of respondents either voted against or abstained on management proposals, an increase of 11 percent over the previous year. Those proposals typically resulting in a negative vote or abstentions were executive retirement bonus plans and anti-takeover proposals, the Nihon Keizai Shimbun reported.

Hokuetsu’s white knight tactic may compound the risk of a negative judicial ruling. Two days after announcing its implementation of the pill, Hokuetsu’s board entered into an alliance with Mitsubishi Corp. that included the issuance of shares at a discount to the market price, allowing Mitsubishi to acquire up to a 24 percent stake in Hokuetsu.

One issue being debated in legal circles is disclosure. The Knight Ridder wire service reported that the Tokyo Stock Exchange (TSE) was considering disciplinary action against Hokuetsu for its failure to disclose Oji’s bid when discussing with the TSE its intent to adopt a poison pill ahead of the public announcement. The company also failed to disclose Oji’s offer to the market, as it worked out the deal with Mitsubishi.

In the face of a white knight defense, Oji could seek injunctive relief from the courts, although it has not yet made a move in that direction. Last year, Internet marketer Livedoor’s attempted takeover of Nippon Television led the target’s cross-shareholding partner, Fuji Television, to issue a flood of warrants to dilute Livedoor’s stake. The court issued an injunction to block the issue of the warrants. Should a deal go through, the combination of Oji and Hokuetsu would form the world’s fifth-largest paper company.