Japan’s government said last month it wanted Toshiba Corp and partner Western Digital Corp to cooperate, expressing concern about an escalating dispute between the two that threatens to upend the sale of Toshiba’s chip unit.

The two are at loggerheads over the sale of the unit – the world’s second-largest producer of NAND chips – that the Japanese conglomerate values at least $18 billion.

Toshiba is depending on the auction to cover billions of dollars in cost overruns at its now bankrupt U.S. nuclear unit Westinghouse. Western Digital has sought international arbitration to stop Toshiba from selling the unit without its consent, arguing that the Japanese conglomerate has violated contracts relating to their joint venture that operates Toshiba’s main semiconductor plant.

“It’s very important for Toshiba and Western Digital to cooperate,” Trade Minister Hiroshige Seko told reporters at a regular briefing last month, although he added that the ministry did not intend to intervene in the dispute.

His comments come after media reports that one of the proposed deals under discussion among government circles is to have the chip unit – which is valued by Toshiba at at least $18 billion - brought under control of the state-backed Innovation Corporation of Japan (INCJ) fund.

INCJ and U.S. private equity firm KKR & Co are widely expected to be the main players in a consortium which will take part in a second round of bidding.

However, some INCJ offi cials are cautious about making a large-scale deal, sources familiar with the matter said, declining to be identified as they were not authorized to speak publicly about the matter.

The fund has just 1 trillion yen ($8.8 billion) in its war chest for acquisitions and investment. The Financial Times also reported that some senior members in Prime Minister Shinzo Abe’s administration have privately discussed offering up to $8 billion in government loan guarantees to support an INCJ-KKR bid.

Japan government spokesman Yoshihide Suga said, however, that there was no truth to the report. Shares in Toshiba, which is depending on the sale of the chip unit to cover billions in dollars in cost overruns at its now bankrupt U.S. nuclear unit Westinghouse, slid to end down 12 percent.

The cost of insuring against default for Toshiba’s five-year yen debt rose 10 basis points. “While we believe that the successful sale of its chip business is indispensable for Toshiba to remain a going concern, hurdles to realizing such a goal are increasing,” said Masako Kuwahara, a senior analyst at Moody’s Investors Service.

Other suitors for the chip unit include Taiwan’s Foxconn and U.S. chipmaker Broadcom, but are seen as less attractive options. Foxconn may face opposition due to its deep ties to China as the government has said it will block any deal that risks key technology leaving Japan.

Meanwhile, Western Digital has said it is vehemently opposed to Broadcom.

BARBS TRADED

Western Digital said recently it was still seeking arbitration in a dispute with Toshiba Corp over the auction of its prized chip unit, arguing that a transfer of assets by the Japanese firm had not resolved what it calls a serious breach of contract.

In a letter to the U.S. firm’s lawyers dated May 31 and seen by Reuters on Thursday, Toshiba’s lawyers said joint venture interests had been moved back to the parent company from the chip unit, adding that this addressed Western Digital’s concerns and put the dispute to rest.

The assets transferred back were, however, financing vehicles for manufacturing equipment and account for less than 5 percent of Toshiba’s memory chip business. Western Digital countered that nothing had been resolved.

A separate source familiar with the matter said that Western Digital is considering fresh investment to build another flash memory chip plant in Japan to show its commitment to the country and that CEO Stephen Milligan will visit Japan in June for talks with Toshiba to resolve the spat.

The two firms operate four memory chip plants in Yokkaichi through their joint ventures. Their fifth plant is currently under construction.

The amount of investment and a timeline for the plant’s construction have not been decided, said the source, who was not authorized to speak on the matter and declined to be identified.

Sources have said that Milligan may meet with Japanese government officials to discuss a plan to join a government-led consortium of state investors and KKR.

AUDITOR SUED

Additionally, Japan’s giant Government Investment Pension Fund (GPIF) has sued the local affiliate of global accounting firm Ernst & Young, claiming $31 million for losses on investments in Toshiba stemming from the conglomerate’s accounting scandal in 2015.

Toshiba has been on the Tokyo Stock Exchange’s supervision list since mid-March as it has failed to clear up concerns about its internal controls after the $1.3 billion accounting scandal.

That scandal preceded the crisis now engulfing Toshiba over billions of dollars in cost overruns at Westinghouse.

The world’s biggest pension is seeking 3.5 billion yen ($31.40 million) in damages from Ernst & Young ShinNihon, saying the auditor failed to properly monitor Toshiba.

An investigation of the accounting scandal found widespread accounting errors throughout the conglomerate, and blamed a corporate culture in which employees found it difficult to question their superiors.

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Most Japan firms favour cautious approach to any Toshiba delisting: poll

Most Japanese firms believe the Tokyo bourse should be cautious in its approach to any delisting of embattled Toshiba Corp, concerned about the potential impact on its clients, subcontractors and financial markets, a Reuters poll showed.

The conglomerate, whose products range from TVs to semiconductors to nuclear reactors, has already breached several regulatory rules that have put it at grave risk of a delisting.

But the Tokyo Stock Exchange has so far shown little sign of taking an immediate hard-line stance against Toshiba as the company and the authorities grapple with the fallout from huge cost overruns at now bankrupt U.S. nuclear unit Westinghouse.

The results of the Reuters Corporate Survey, conducted May 9-19, suggest strong support in the business community for a go-slow approach in tackling the thorny question of whether to delist, and if so when and how to proceed.

While 37 percent of firms were in favor of a delisting, 58 percent said they wanted the issue to be dealt with cautiously, and another 5 percent said it should remain listed.

“The impact of a delisting – not only on Toshiba, which itself is a gigantic company, but also on the companies around it – needs to be considered,” wrote a manager at metal products firm.

Toshiba has been on the Tokyo bourse’s supervision list since mid-March after failing to clear up concerns about its internal controls after a 2015 accounting scandal.

Although Toshiba submitted a report on its internal controls to the exchange at the time, it has since reported earnings reports late and without endorsement from its auditor.

If the bourse finds Toshiba’s efforts to improve its internal controls wanting, then it can move to delist the conglomerate. There are, however, no set rules governing how long the bourse should take to come to a conclusion.

A spokeswoman for the exchange said its examination of Toshiba’s internal management system is still ongoing and declined to comment on the results of the survey. Toshiba also declined to comment.

Nicholas Benes, head of The Board Director Training Institute of Japan, who reviewed the survey results, said that hasty moves towards a delisting would do more harm than good in restoring market confidence.

“The most important thing is that the TSE rules support governance so that companies self-cleanse and don’t have to be delisted,” he said.

Toshiba would, however, have to face an automatic delisting if it does not manage to claw its way out of negative net worth – where liabilities exceed assets - by the end of this financial year in March.

With 540 billion yen ($4.8 billion) of negative shareholder equity, its ability to do so hinges on the sale of its semiconductor unit, the world’s second-biggest producer of NAND memory chips.

The survey found that the vast majority of firms, 87 percent, support the government’s pledge to block any sale that would risk highly prized chip technology leaving the country.

The government’s stance is likely to favor Western suitors such as KKR & Co LP, which is expected to join hands with a state-backed fund, the Innovation Network Corp of Japan and make it difficult for bidders such as Taiwan’s Foxconn, which has deep ties to China, to win. 

Other suitors for the unit, valued by Toshiba at $18 billion at least, include Broadcom, South Korea’s SK Hynix as well as Western Digital Corp. – Sam Nussey of Reuters