JFTC Issues Survey Results on Trade Practices Involving Startups

The Japan Fair Trade Commission (JFTC) on November 27 published its final report on the survey (Survey) it conducted since November 2019 regarding trade practices involving startup companies. The Survey was conducted for the stated purposes of ensuring a fair and free competition environment for startup companies, and to collect information on potentially problematic business practices by large companies towards startups. This LawFlash provides a brief overview of the Survey’s methodology and results, as well as the JFTC’s view from the perspective of the Antimonopoly Act of Japan (AMA).

Survey Overview

The Survey consisted of written questionnaires and interviews. The questionnaires were distributed to 5,593 startup companies, out of which 1,447 companies provided responses (for a response ratio of approximately 25.9%). For the Survey the following standards were used to identify “startup companies:”

• Companies that have been in business for less than 10 years
• Non-listed companies
• Companies conducting innovative businesses in emerging business sectors

In support of the Survey, the JFTC conducted interviews with 144 companies and individuals (126 startup companies, five investors, 10 intellectuals, and three trade associations).

JFTC Findings

According to the results of the questionnaires, 242 startup companies (approximately 17% of 1447 respondents) responded that they experienced “unreasonable” treatment by larger business partners. Examples of such practices included the imposition of unreasonable information disclosure provisions, nonpayment of compensation, establishment of unilateral obligations, and “most favored national” clauses.

The Survey also noted startup companies typically execute, in addition to investment agreements, the following with larger business partners (in order of commonality): (i) nondisclosure agreements, (ii) proof of concept agreements, (iii) research collaboration agreements, and (iv) license agreements. The breakdown by type of agreement for which unreasonable treatment reportedly occurred is as follows:[1]

• Nondisclosure agreements (30.6%)
• Investment agreements (26.9%)
• License agreements (22.7%)
• Research collaboration agreements (21.5%)
• Proof of concept agreements (18.2%)

Among the 242 startup companies claiming “unreasonable” treatment, approximately 79% responded that they accepted (or partially accepted) terms of agreement. The primary reasons identified for doing so were:

• Startup companies sought to avoid anticipated negative impact on future transactions with their business partners even in the absence of express indications from business partners (44.5%)
• Startup companies believed they had no choice but to accept what they claimed was “unreasonable” treatment because business partners indicated there would be negative impact on future transactions by non-acceptance (35.1%)
• Startup companies accepted what they claimed was “unreasonable” treatment because they considered a business partnership with reputable companies would be beneficial for them on an overall basis (28.8%)
• Claimed ”unreasonable” treatment was related to an ongoing project and startup companies needed to accept such claimed treatment in order to continue the project (18.3%)

Among the startup companies that reported they received what they considered “unreasonable” treatment, approximately 56% responded that they suffered actual losses as a result. The breakdown of such claimed losses is as follows:

• Benefit reduction (50.0%)
• Occurrence of unexpected additional costs (20.4%)
• Cash flow deterioration (13.9%)
• Delay in business (7.4%)
• Required provision of intellectual properties or knowhow (6.5%)
• Loss of clients (4.6%)
• Provision of opportunities to develop similar services (3.7%)

In connection with these findings, the JFTC noted differences among startup companies depending on their sales amounts and whether they have a person in charge of legal affairs. According to the Survey, approximately 29% of the startup companies whose annual sales amount is less than JPY 50 million, and which do not have a person in charge of legal affairs, responded that they experienced “unreasonable” treatment from larger partners. On the other hand, only approximately 12% of the startup companies whose annual sales amount reached or exceeded JPY 50 million with a person in charge of legal affairs responded that they experienced “unreasonable” treatment.

JFTC’s View

Under the AMA, prohibited “unfair trade practices” include transactions where (i) one party has a superior bargaining position over the other party, and (ii) such bargaining position impedes fair competition (“abuse of superior bargaining position” doctrine) in the market. In commenting on the Survey results, the JFTC stated that in many instances where startup companies accepted claimed “unreasonable” treatment, business partners and/or investors should be considered as being in a superior bargaining position. The JFTC also commented that some of these situations involved transactions with conditions that unreasonably restrain the business conducted by the startup companies, which is also considered an “unfair trade practice” under the AMA.

Following the survey, the JFTC announced that they plan to take the following actions:

• Disseminate the final report of the survey broadly and promptly in order to help prevent the occurrence of further problematic conduct under the AMA
• Take strict measures against problematic conducts under the AMA through enforcement actions
• Together with the Ministry of Economy, Trade and Industry, prepare guidelines demonstrating problematic cases concerning agreements between startup companies and their business partners, including potential measures to avoid further problematic conduct and summarizing the relevant interpretations of the AMA. This guidance would be released for public comment by the end of 2020.

Recommendations

Many startup companies in Japan’s technology, energy, and medical devices industries conduct transactions with large foreign business partners. In many circumstances, “template” documentation or common negotiating conduct may be involved, and which in hindsight may be considered by the JFTC to be “unreasonable” and potentially an unfair trade practice under the AMA. In light of the new focus of Japanese politicians and regulators on transactions with Japanese startup companies, clients should monitor and, in some cases, modify their contracting practices with these startup companies to mitigate scrutiny in Japan. Such considerations apply for all types of transactions, including mergers and acquisitions, supply and distribution arrangements, research and development engagements, and other collaborations.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Tokyo
Narumi Ito

New York
Richard S. Taffet

London
Frances Murphy