Japan

Pre contractual negotiations

In Japan, during the early stages of the negotiation of M&A transactions, such as corporate alliances, mergers or acquisitions, parties often conclude an intermediate or preliminary agreement (Intermediate Agreement) before entering into a definitive agreement (Definitive Agreement).

Is there an implied duty of good faith to continue to negotiate?

In Japan, there is no law which explicitly provides for a duty to continue to negotiate. However, Article 1 Paragraph 2 of Japan's Civil Law sets out a common principle stating that the exercise of rights and the performance of duties must be carried out in good faith. This principle also applies to negotiations.

The above principle is reflected in judicial precedents, where courts have ordered the party who unfairly broke from the negotiations to pay damages to the other party under certain conditions. Please note, however, that in these cases damages were limited to the expenses resulting from the innocent party's belief that a Definitive Agreement would be concluded.

As discussed above, a claim of this type for damages relies on the common principle of good faith, stipulated in the Japan’s Civil Law. This, however, means that the requirements for such a claim are very strict. In practice, therefore, parties sometimes expressly provide, in the Intermediate Agreement, in a manner which is legally binding both an obligation of good faith to continue to negotiate and the payment of a break fee or liquidated damages if that obligation is breached.

What are the consequences of termination of negotiations by one party unilaterally?

Parties are generally free to terminate negotiations. However, when there is a legally binding clause stating an obligation to continue to negotiate in good faith contained within the Intermediate Agreement itself, a claim for damages may be enforceable. This is also the case if a court rules that there has been a breach of the common principle of good faith contained in Japan’s Civil Law discussed above, regardless of whether or not there is an express clause in the Intermediate Agreement.

In this regard, it should be noted that, even if there is an express clause of the obligation of good faith to continue to negotiate in the Intermediate Agreement, it could expire if the possibility of concluding a Definitive Agreement has disappeared, due to the impossibility of accomplishing the objective. This principle is derived from one of the judicial precedents which established that the obligation to continue to negotiate in good faith is legally binding.

What is the potential impact on third party rights?

Generally speaking, the aforesaid obligation to continue to negotiate in good faith stipulated under Japan's Civil Law only binds the parties that are involved and contemplating the contract negotiation.

Confidentiality agreements

Are there implied confidentiality obligations where there are no formal confidentiality agreements entered into by the parties?

In Japan, there is no law which explicitly sets out a general obligation of confidentiality. However, if the confidential information in question fulfills the definition of a “trade secret” under the Unfair Competition Prevention Law, it benefits from certain remedies and sanctions, including the possibility of claims for damages or injunctions or even criminal punishment.

The definition of the “trade secret” is very restrictive, therefore, in order to preserve confidential information effectively, parties generally conclude a legally binding confidentiality agreement at the initial stage of a negotiation. Alternatively, parties can include a legally binding confidentiality obligation in the Intermediate Agreement.

What are the consequences of breach?

Even if the confidential information does not fulfill the definition of the 'trade secret', an injunction is generally available if the innocent party has the right to have such information legally protected and it is likely that the future exercise of such a right will be impossible or significantly more difficult as a result of the breach. A claim for damages which would ordinarily arise from such breach will be enforceable as well.

Are specific terms/formalities required for a binding confidentiality agreement?

It is common practice to set out the definition of the confidential information being referred to, any exceptions to the obligation of confidentiality, the purpose of the permitted use of the confidential information and a prohibition on the use of the confidential information for other purposes. Parties usually agree that the confidentiality obligation should be effective for a number of years, even after the agreements are terminated.

Exclusivity arrangements

Can an obligation to negotiate exclusively be implied where no formal agreements are entered into by the parties?

In Japan, there is no law containing an obligation to negotiate exclusively. Therefore, when conducting M&A transactions, in order to conduct stable negotiations, the buyer often tried to impose a legally binding obligation to do so on the seller within the Intermediate Agreement.

However, even if such an obligation is stipulated in the Intermediate Agreement, some exceptions to such an obligation can be provided. This allows the selling party to terminate the agreement by following a certain process and/or paying break fees when an offer from a third party is received and where not considering or accepting such an offer would constitute a breach of the fiduciary duty of the board of directors of the seller.

There is a judicial precedent which states that when the possibility of concluding a Definitive Agreement has disappeared, the obligation to negotiate exclusively likewise disappears.

Are any specific terms/formalities required to make exclusivity arrangements enforceable?

When a legally binding obligation to negotiate exclusively has come into existence, a claim for an injunction is generally enforceable and a claim for damages which would ordinarily arise from such a breach will also be enforceable. However, where there is no express break fee clause in the Intermediate Agreement, it would not be easy for the claiming party to prove the amount which it has incurred.

Therefore, it is important for the parties to state in the Intermediate Agreement that an obligation to negotiate exclusively is legally binding and that break fees will be payable, in order to ensure a successful claim for damages.

Heads of agreement

Are they legally binding?

The Intermediate Agreement is essentially a basic agreement, letter of intent or memorandum of understanding (often called Kihon Goui Sho or Oboegaki, in Japanese), which is similar to a heads of terms document that may be entered into in, for example, England or the US. As the Intermediate Agreement is in principle an independent agreement, it is considered to be legally binding. However, the parties generally stipulate that only certain clauses, such as those containing confidentiality obligations and obligations to negotiate exclusively are legally binding.

Are any specific terms/formalities required to make them legally binding?

As discussed earlier, there is no fundamental rule by which pre contractual agreements are legally binding in Japan. Therefore, parties should include any terms that they want to be legally binding in an Intermediate Agreement.

What are the consequences of breach?

Since an Intermediate Agreement is legally binding, the non breaching party may claim damages from the breaching party to compensate him for any loss incurred as a result of the breach.

Can heads of agreement have any tax implications/adverse consequences?

Generally no.

Break fees

Are break fees usually payable?

If there is a break fee clause in the Intermediate Agreement, it is enforceable by the court. However, note that if the amount of a break fee is too disproportionate to the actual damage incurred by the claiming party, then the clause of break fee could be struck out by the court.

What are the main legal issues to be considered e.g. enforceability?

Where a break fee clause is not contained within the Intermediate Agreement, the amount of damages will be limited to those which would ordinarily arise from such a breach i.e. the only damages payable will be for the amount paid by the other party as a result of believing that the Definitive Agreement could be concluded.