Radical change looms for Japanese legal sector

Over the past 18 months, global investors have caught up with the idea that Japanese companies are changing at a scale and pace unprecedented in modern times. Their lawyers, too, are in flux.

Corporate instinct and behaviour in the country are shifting. Inflation has returned after many decades; a shrinking population and geopolitics are both forcing broad changes to corporate strategy; governance and stewardship codes afford ever fewer places to hide faults; and shareholders flex their muscles with open government approval. 

These same forces, say some of Japan’s largest law firms, have big repercussions for the legal industry. And, within the industry, some clear trends are emerging, as the country’s dominant quartet of firms, their foreign rivals and the large middle ground of medium-sized firms attempt to light the way for clients.

First, many firms are thinning their supply chains operating out of China and, in fact, throughout south-east Asia. Second, several are increasingly aggressive in pursuing M&A deals and joint ventures in the region. Both of these trends are strategic and practical changes by Japan’s law firms, as some domestic clients radically reposition their businesses.

The biggest firms find themselves in fierce competition for lawyers with international experience

Third, the larger Japanese law firms are following their clients into south-east Asia, opening substantial offices in Singapore, Bangkok and elsewhere. The biggest firms find themselves in fierce competition for lawyers with international experience. That includes recruiting from the once shunned cohort of Japanese who have been educated abroad and returned, only to find they do not quite fit in.

But the fourth and biggest trend, say senior M&A lawyers in Tokyo, is the growing likelihood that Japanese businesses will be the target of unsolicited or potentially hostile takeovers.

They are under growing pressure to improve returns on equity and to pay greater attention to their cost of capital. Some of the country’s biggest companies — including 7&i Holdings, Dai Nippon Printing and Keisei Electric Railway — have had to contend with activist investors. And several law firms were closely involved in the protracted battle between activists and the management of Toshiba, which was ultimately brought under private ownership in a deal led by a private equity firm.

Senior partners say it is important not to underestimate how big a shift this trend represents, particularly for law firms accustomed to defending the status quo. Japan’s equity market has, by and large, plodded along for years without companies being routinely considered or priced as takeover targets or buyers.

The persistence of the “bigger is better” sentiment in Japanese boardrooms has ensured that companies remain reluctant to sell even peripheral or underperforming businesses. Even when deals are under consideration, boards have tended to ignore unsolicited offers in their general failure to check whether the terms they are approving are the best.

Shareholder activism — no longer taboo and, now, increasingly domestic as well as foreign — has significantly changed that. Assets and even entire businesses are being put up for sale, and the process by which they are acquired is becoming more competitive, under shareholder duress. To keep investors happy, companies must be assertive if they see a good asset up for sale. And, if that means turning hostile, even a large, traditional Japanese company now plays that once distasteful game.

The overall effect is that domestic M&A deals are more likely to be blown off-course by unsolicited bids from other buyers, such as Brother Industries’ recent unsolicited bid for Roland DG in competition with Taiyo Pacific. Lawyers must adapt quickly, but knowledge of hostile deal tactics is relatively scant, and many firms are now looking to the US and UK for guidance.

Private equity firms’ role

Yet another related trend is also emerging: private equity firms are launching tender offers for listed target companies, instead of their previous tactic in Japan of securing a large or controlling stake from a single seller.

Senior M&A lawyers say this is happening because global private equity firms see Japan as the largest, and probably the most persistent, source of acquisition opportunities in Asia. The Chinese market remains too risky, Australia is too competitive, and India and Indonesia are often too challenging. Capital, raised in large sums by private equity to fund deals across Asia, is naturally turning to Japan.

As private equity firms enter the competition in Japan for available assets with tender offers, their activities, say their legal advisers, are coming ever closer to unsolicited offers and even hostile takeovers. Previously avoided as a tactic, this is now another source of pressure on Japanese law firms to build their legal expertise.