Relevant Deal Issues
Case Study of a Failed Purchase

A $2 billion deal was suddenly terminated by a Japanese seller! What happened? What went wrong?

The broker, investors, and sideline American observers all point to the same basic reason for the failure of this and other attempts at acquiring Japanese properties. They claim the prices offered were much lower than what the seller expected to receive, so it pulled the portfolio from the market. This philosophy, while accepted conventional wisdom, is blatantly incorrect. It is the product of several years of continuous but faulty advice from uninformed, yet widely followed experts, repeating over-and-over, the same myths they have postulated. Unrealistic expectations may be common among Japanese property owners, but attributing those expectations as the reason for the low number of successes is sheer folly.

The succinct reason for the failure is that the broker's selling strategy was faulty because it ignored the Japanese issues surrounding the contemplated sale. The Asian economic upheaval, Japanese legal issues pertaining to almost all current sales transactions, and cultural issues prevalent among Japanese businessmen all worked independently against the broker's selling strategy.

Because of the crisis in the Asian banking system, the seller's lenders could not afford to discount the seller's mortgage by the amount required for the delivery of clear title. The sale of any property could be consummated only if the seller utilized it's own funds to pay the anticipated mortgage deficiency balance, up to $700 million, well beyond the seller's immediate reach. Notwithstanding the seller's inability to pay a substantial deficit, had the banks discounted the mortgage consistent with the offers, the forgiveness of indebtedness would be classified by the Japanese government as taxable income (phantom income). Instead of owing the lenders, the seller would instead owe taxes to a revenue-deprived government. It was also incorrect to presume that just because the seller is Japanese, it was forced to divest the portfolio at a loss. The seller in this case was under no extreme pressure to sell.

There are several fundamental Japanese legal issues pertaining to the seller's sale of the portfolio. One principal issue relates to the mortgage deficiency balance that would have resulted had the seller moved forward with the sale without the ability to pay the deficit. This scenario would arise if the seller simply 'walked' from the property, e.g., handing the lenders the properties and a deed in lieu of foreclosure. Under Japanese law, lenders are required to pursue the borrower to collect the deficiency until they have no further avenue of pursuit, i.e., the seller's bankruptcy.

The peculiarities of the Japanese business culture are widely recognized and misunderstood and almost always disregarded by U.S. businessmen. The newspaper articles were designed to condition the seller to realize the portfolio's true value. An American seller would probably react to the newspaper stories by acquiescing to the fact that it could rationally expect to receive only $1.5 billion. Instead of reacting to the articles by lowering the expectations inspired by the broker's assurance of $2 billion, the seller became livid. The seller, a typical Japanese businessman, without even knowing the news articles were an element of the broker's strategy, found the articles insulting, slanderous, and challenging. The seller was livid at being publicly labeled a cash-needy loser. It was angered at the suggestion it had agreed to accept a low price, or that it had better sell before it was too late. When the seller saw the articles, it quickly decided that if these investors chose to challenge it by offering prices that would lead to financial ruin, the selling process would stop. Perhaps the broker's strategy may have worked with an American seller, but predictably it failed miserably with a Japanese businessman. Similar strategies have, and will always fail.

Had the broker and investors understood the lenders situation, and the laws governing deficiency balances, it is doubtful they would have attempted to implement a strategy that could only result in the seller's economic disaster. The development of a strategy that is untenable in light of Japanese issues clearly indicates that the broker did not possess appropriate knowledge to deal effectively with Japanese transactions. The investors, unwittingly following the broker as they did, indicates their similar knowledge deficit. Had they understood the issues, the inappropriateness of the broker's strategy would have been recognized and an alternative approach attempted. Unfortunately, for buyers and sellers alike, this scenario is repeated in almost every Japanese-American transaction. The same set of mistakes are unknowingly repeated time after time.

With only a rudimentary understanding of the Japanese business system, it is retrospectively easy to see why this transaction ended before it had a chance to begin, as has almost every attempt by Americans to purchases Japanese assets. An understanding of the issues is not necessary to realize that something is radically wrong. Almost every American attempt to conduct a Japanese-American transaction fails. Why? American businessmen, without realizing it, continuously repeat the same mistakes. Recognizing that they have, and understanding why they do, is an essential step toward rectifying the situation.