Expect the unexpected in Japanese joint ventures

Forming a joint venture in Japan presents foreign investors with a unique set of opportunities and challenges. The large Japanese economy offers a stable business environment, advanced infrastructure and a highly skilled workforce. However, careful planning and execution is required to manage the complexities of Japanese regulations on foreign direct investments, particularly the Foreign Exchange and Foreign Trade Act, and the country’s guidelines on business collaboration with various business sectors, including startups.

This article explores critical aspects of the Foreign Exchange and Foreign Trade Act, and practical implications for foreign investors, including recent regulatory enhancements. The article also discusses practical negotiation points for the formation of a JV with Japanese counterparties, and outlines the Ministry of Economy, Trade and Industry’s new guidelines for JV investment in startup companies, published in May 2022.

Strengthened procedures

When acquiring shares in a corporation to set up a JV in Japan, foreign investors must comply with a foreign direct investment (FDI) regime that is mainly governed by the Foreign Exchange and Foreign Trade Act.

The act aims to ensure proper development of foreign transactions in Japanese and international business communities through controls over, and co-ordination of, transactions involving foreign investment. The aim is to contribute to the sound development of the Japanese economy.

The Japanese government’s policies and measures for FDI aim to promote foreign investment while scrutinising incoming investment with the potential to pose national security concerns.

Under Japanese regulations, unlike in other Asian jurisdictions, foreign investment may usually be carried out without restriction, regardless of the intended shareholding ratio – unless the investments are in highly regulated business sectors such as media, telecoms and aviation businesses. However, the act requires certain FDI to be reviewed by the Ministry of Finance and other ministries.

Prior notification

Under the Foreign Exchange and Foreign Trade Act, investment originating from countries without treaties with Japan about inward direct investment may require a clearance from the Japanese government after the submission of a pre-closing FDI notification. Foreign investors must also notify the authorities through the Bank of Japan before investing in certain designated sensitive business sectors.

Following notification, a 30-day waiting period is typically imposed, during which authorities review potential national security implications of the investment. This period may be shortened or extended, depending on the sensitivity of the investment. Even where such prior notification is not required, foreign investors are usually required to submit a post-closing report to the authorities.

The act has come under the spotlight since the latter half of 2019, when Japanese authorities started announcing upcoming changes to FDI regulations. The changes which drew most attention were:

• The scope of transactions requiring the filing of a prior notification has been expanded to include businesses relating to: information and communication technology (equipment, software and services); and manufacture of certain pharmaceuticals and specially controlled medical devices.
• Subject to some limited exemptions, the threshold for the obligation of prior notification has been lowered from 10% to 1% of the listed company’s shares or voting rights.
• There is an obligation to file a prior notification in connection with an appointment of directors and transfer or abolition of businesses in designated business sectors.

These trends correspond to recent movements to strengthen restrictions on foreign investment in the US, EU and other economies. The authors feel it is possible that the Japanese legal framework on foreign investment may continue to be strongly influenced by future policies of other governments.

JV implications. Potential foreign investors in Japan are advised to thoroughly analyse whether their proposed JV may fall within the expanded list of sensitive business sectors and, therefore, be reviewed by the Japanese government. Early identification of these requirements can help avoid delays and ensure compliance with Japanese law.

Practical issues. Japanese regulations on foreign investment are relatively relaxed and do not severely limit potential investment. Nevertheless, having satisfactory contractual arrangements with Japanese counterparties is a material point for potential foreign investors.

Tips for foreign investors

While practical issues with the negotiation of JV contracts do not differ greatly from those in other jurisdictions, some major points of focus for foreign investors include the following:

• Overall structure. A well-known feature of Japanese people and companies is that they are very averse to disputes and conflicts. This feature leads to a unique stance in their negotiation of JV contracts, where they prefer most of the difficult issues to be eventually resolved through good-faith discussions. Foreign investors should give sufficient respect to this mindset, while requesting appropriate provisions to avoid uncertainties for critical matters.
• Management structuring. JV contracts should clearly address whether the foreign investor may appoint any management personnel to the JV company. While it is important for foreign investors to acquire their desired control over the management, it is equally important to ensure their nominees fully understand the unique Japanese business culture.
• Preventing and resolving conflicts. Fostering collaboration and respect among JV employees, who will likely be predominantly Japanese, would be another important point to ensure a practically workable JV. In the event that JV partners clash over differing ideas about management, it is essential to include JV contract provisions to prevent and address such conflicts among the parties – such as a deadlock clause.
• Reflection of JV provisions on articles. In many jurisdictions, provisions in JV contracts are mirrored in the JV company’s constituent documents. Japanese companies, however, usually do not have direct provisions relating to the shareholders’ agreements in their constituent documents, although this is not legally prohibited. Foreign investors should expect their Japanese counterparties’ resistance in having articles of incorporation reflect the provisions in a JV contract, and consider a balanced solution in each specific circumstance.

It is also worth noting that in Japan there are no “model contracts” for shareholders’ agreements, such as the National Venture Capital Association’s model contract in the US. Contracts are often freely negotiated case by case.

Startup investment

JV structures are increasingly utilised in Japan for investing in startup companies. Potential foreign investors should remember that there are practices and provisions which may differ from those in other countries.

As part of its efforts to promote so-called “open innovation”, the Japanese government has been taking measures to promote collaboration between startups and mature companies. In March 2022, the Ministry of Economy, Trade and Industry released the Guidelines for Business Collaboration with Startups and Investment in Startups.

The guidelines outline the several key principles and recommendations for successful collaboration with and investment in startups in Japan, including:

• Fostering open innovation – encouraging the integration of mature companies’ resources with the innovative capabilities of startups.
• Ensuring mutual benefit – structuring agreements to ensure that all parties gain from the collaboration.
• Adopting flexible business models – allowing for agility and rapid adaptation to market changes.

Contractual provisions

The guidelines also discuss typical provisions to be included in investment and JV agreements for startup companies. In addition to the above-mentioned practical issues for JV contracts, the following are some of the guideline provisions for balancing control of businesses and protecting investments:

• Management. In view of the difference in economic position between investors and startups (who receive funding), the guidelines discuss the essential nature of addressing co-ordination of the work and defining the duties and compensation of startups’ management.
• Trade secrets. Due to ambiguity about what information constitutes “confidential information”, investors frequently face a risk of unintentionally leaking a startup’s confidential information to third parties, including other investors. Therefore, it is necessary to thoroughly understand the business and clarify and define the scope of confidential information precisely in the agreement.

Conclusion

Overall, Japan provides a JV-friendly environment, both legally and economically. Nevertheless, understanding and addressing contractual, regulatory and cultural considerations are vital for foreign investors to navigate the complexities of the Japanese market and to foster strong and mutually beneficial JVs in Japan.