28 May, 2012


Legal News & Analysis – Asia Pacific – Japan – Insolvency & Restructuring

Chapter 1 Introduction
A Current Situation
After the late 1990s when Japan was in a serious economic depression, series of statutory insolvency procedures were enacted or changed including, but not limited to, the Civil Rehabilitation Law in 1999 to replace previous Composition Law, the Act on Recognition of and Assistance for Foreign Insolvency Proceedings which adopted UNCITRAL Model law in 2000, the new Corporate Reorganization Law in 2002, the new Bankruptcy Law in 2004. In addition to those changes of statutory insolvency proceedings, a new guideline and tools that facilitate out-of-court workouts were set up such as the Guideline for Out-of-Court Workout in 2001, Small and Medium-sized Enterprises Turnaround Associations in 2003, the Enterprise Turnaround Initiative Corporation of Japan in 2009, etc. Because there are so many tools for restructuring a company with financial difficulties and there is no boilerplate rule with regard to which law or tool should be used, it is important for the ailing company to retain skilled practitioners to handle the case.
B Typical Tools for Revitalizing an Ailing Corporation
When an ailing corporation drafts a plan to rehabilitate, it should examine the following means:
  •  Reschedule
  •  Debt Debt Swap
  •  Debt Equity Swap
  •  Business Transfer or Corporate Division (or Corporate Demerger)
  •  Debt Forgiveness
C Source of Japanese Law in English
 English translations of the following laws are available at the website of the Ministry of Justice (http://www.japaneselawtranslation.go.jp/law/?re=02): the Civil Rehabilitation Act, the Bankruptcy Act, Act on Recognition of and Assistance for Foreign Insolvency Proceedings, and Special Liquidation (Chapter 9 of part 2 of Companies Act).  Please note that although these translations are provided by the Ministry of Justice, English translations are unofficial and for reference only. In addition, web-brochures of some out-of-court workouts are also available as mentioned below.
Chapter 2 Series of Out-of-Court Workouts
A Overview of Out-of-Court Workouts
1   Advantages of Out of-Court Workouts
Like in many other countries, many companies in Japan with financial difficulties tend to choose out-of-court workouts, not legal procedures, if they have enough cash to operate their business. The main reason is that because usually only financial creditors participate and trade creditors do not participate in an out-of-court workout, the debtor company can continue to be paid to trade creditors as usual and can keep the secret that the debtor company is in a financial trouble so that this out-of-court work out is free from the stigma of a court proceeding and gives no or much less damages to its business.
2  Disadvantages of Out of-Court Workouts
First, unlike in Korea, an out-of-court workout in Japan needs a unanimous consent. This rule means that if even one creditor does not agree, this out-of-court workout fails. Second, an out-of-court workout is basically dealt with on a private contractual basis, so sometimes the procedure may not be transparent and the out-of-court procedure may not be supervised by a reliable entity. Thus, it could be unclear for creditors who are request to forgive their debts that the said out-of-court workout is feasible or trustworthy so this makes it hard for them to decide whether or not the restructuring plan proposed by the debtor should be adopted. 
B Guideline for Out-of-Court Workout
1 Overview
To provide a transparent and fair tool for out-of-court workouts, the Guideline for Out-of-Court Workout (the “Guideline”) was set up in September 2001 by a committee established by the National Bankers Association, Japan Federation of Economic Organization, and other relevant organizations associated with the Financial Services Agency, Ministry of Finance, Ministry of Trade, and Industry, the Bank of Japan and the Deposit Insurance Corporation. The Guideline, which refers to the INSOL eight (8) principles for international multi-creditor workouts that is originated from a gentlemen’s agreement among banks in London, was set up to deal with a large number of non-performing loans that banks and financial institutions have and to revitalize the workability of debtors.
2 “Main Bank System” in Japan
Before going forward, it is better to have a rough understanding of the idea of the Japanese “main bank system.” In Japan, it was common for corporations to borrow money from two or more financial institutions, but syndicate loan was not popular. There was a strong relationship between a debtor and one specific bank. For example, a main bank supervised and consulted a debtor and sometimes sent personnel such as a chief financial officer to the debtor. This Japanese traditional relationship between a debtor and a bank is called “main bank system.” For the last ten (10) years, the relationship between the debtor and the bank has become more remote, but it is said that “main bank system” considerably exists especially between small and medium-sized enterprises and banks.
3    Main Bank’s Important Role under the Guideline Process
Unlike under the Turnaround ADR, under the Guideline a main bank plays an important role including as follows:
  1. To start the procedure under the Guideline, the debtor submits an application to the main bank together with some requested documents. 
  2. Then the main bank examines the documents and the restructuring plan to decide whether the explanation and statements are accurate and the proposed plan is feasible and reasonable. 
  3. If the main bank finds that the documents and the proposed plan meet the criteria above and decides that the plan can be acceptable to the relevant eligible creditors, the debtor and the main bank in their name will issue a standstill notice to all other relevant eligible creditors and convene the first creditors’ meeting. 
  4. At the first meeting, the debtor and the main bank explain how the debtor got into financial difficulty, the summary of the debtor’s financial statement and the contents of the proposed plan.
4    Disadvantage of the Guideline Process
Due to the important role in the procedure of the Guideline stated above and to accept the plan needs to have a unanimous consent in an out-of-court workout, it is said that to acquire consents from non-main banks, a main bank is in fact forced to treat non-main banks unfairly, meaning that a main bank gives non-main banks  advantageous conditions. For this reason, the Guideline is now rarely used.
C  Turnaround ADR (Alternative Dispute Resolution)
1 Turnaround ADR was set up by the Japanese Association of Turnaround Professionals (“JATP”) in 2008 with the approvals of Ministry of Economy, Industry and Trade, and the Ministry of Justice under the Law on Special Measures for Industrial Revitalization. Roughly saying, the rules of the procedure of Turnaround ADR are similar to those of the Guidelines. However, unlike under the Guideline, under Turnaround ADR, not a main bank but mediators, who are professionals specializing in business turnaround and are designated in each case by the selection committee of JATP, control the workout process. This way could settle disadvantages of the Guideline stated above. 
2  Process of Out-of-Court Workout under Turnaround ADR
The outline of the procedure under Turnaround ADR is as follows:
  1. To start the procedure under the Turnaround ADR, the debtor submits an application to JATP together with documents that explain how the debtor got into financial difficulty and a proposed restructuring plan. The plan should contain both a business restructuring plan and a debt restructuring plan.
  2. Then scheduled mediators selected by JATP examine whether the explanation and statements in the documents the debtor submitted are accurate and the proposed plan is feasible and reasonable. In addition, mediators may advise the debtor to make the plan acceptable to target creditors. 
  3. If mediators determine that the documents and the plan meet the criteria stipulated in the laws governing Turnaround ADR and decide that the plan can be acceptable to the relevant eligible creditors, the debtor and JATP in their name will issue a standstill notice to all relevant eligible creditors and convene the first creditors’ meeting. The relevant eligible creditors are those creditors whose claims are requested to be waived by the plan. They are usually banks and other financial institutions, but trade creditors can be a relevant eligible creditor if waiver of their trade claims is necessary to achieve the debtor’s revitalization.
  4. The first creditors’ meeting must be held in principal within two (2) weeks after the standstill notice was issued. At the first meeting, mediators need to be appointed to examine the accuracy of the financial statements and the reasonableness and feasibility of the proposed plan; the debtor and mediators usually explain how the debtor got into financial difficulty, the summary of the debtor’s financial statement and the contents of the proposed plan; by unanimous consent of the creditors, the contents of the standstill and the term the standstill period should be decided.
  5. During the standstill period, the relevant eligible creditors should not do any collection efforts, enforce their secured rights, or improve their exposures in comparison with other relevant creditors, but should maintain the original balance of their claims.
  6. The second meeting will be held to discuss the proposed plan around two (2) months after the first creditors’ meeting. Then the third meeting will also be held to make a resolution on proposal about one (1) month after the second creditors’ meeting. If one or more creditors refuses to adopt the plan, the Turnaround ADR process fails and the debtor should decide whether to submit an application with a court to start a statutory insolvency proceeding or other means.
3  Requirements for a Plan under Turnaround ADR
(1) Some of the main requirements for a plan are as follows:
(i)  Grounds for having a financial difficulty;
(ii) The insolvency and negative earnings of the debtor should be eliminated and turn around within three (3) fiscal years after acceptance of the plan.
(iii) The coordination of the relevant interests under the plan must be done in a fair manner as between creditors.
(iv) The plan shall include contents showing that it may be expected that it will be economically reasonable for the relevant eligible creditors, for example, there is a likelihood of obtaining a return which is equal to or greater than that which would be received from a bankruptcy proceeding.
(2) If the plan contains waiver of claims, in addition to the requirements above, the plan has to contain the following additional requirements:
(i) The interests of the shareholders of the debtor should be divested or be reduced.
(ii) Current managers of the debtor should retire if the retirement does not give a serious impact on the debtor’s business. 
4 Distinctive Advantages of Turnaround ADR
(i) As mentioned above, the third party appointed by JATP presides the procedure of Turnaround ADR.
(ii) To facilitate bridge loans, guarantees for the debtor can be obtained from Organization for Small & Medium Enterprises and Regional Innovation, Japan and priority payment is given to the lender if turnaround ADR procedure transfers to a legal insolvency procedure.
(iii) Tax advantages.
To obtain more detailed information, a web-brochure in English about Turnaround ADR is available at http://www.meti.go.jp/policy/jigyou_saisei/ADR%20HP_E-virsion_100126.pdf (last visited on April 17, 2012).
D  Small and Medium-sized Enterprises Turnaround Associations
The Small and Medium-sized Enterprises Turnaround Associations were created in all 47 prefectures in Japan for assisting debt restructuring of such kind of enterprises in 2003. Comparing to the procedure of the Guideline stated above, that of the Associations is much more flexible, because the Associations were set up for small and medium sized enterprises that usually do not have enough human resources. Professional staffs at the Associations advise and consult small and medium sized enterprises on how revitalize their businesses and draft debt restructuring plans at the requests of small and medium sized enterprises with excessive debts. The Associations also take the role of a mediator between the debtor and financial creditors to work out the proposed plan. From the many number of cases that the Associations have advised on, they have been playing an important role in small and medium sized enterprises’ out-of-court workouts.
E  Others
1 Enterprise Turnaround Initiative Corporation of Japan (“ETIC”)
ETIC was set up to provide assistance to rehabilitate corporations sustaining local economies in 2009. ETIC is a temporary organization which extends initially for five (5) years from its foundation, but later extends the term. The means to rehabilitate the debtor that ETIC has vary including, but not limited to, supporting debtor’s management, making a loan and/or investment to the debtor, and purchasing debt that other creditors of the debtor have. To have more detailed information, please visit ETIC’s web-brochure in English available at http://www.etic-j.co.jp/pdf/english.pdf (last visited on April 17, 2012).
2  The Resolution and Collection Corporation ("RCC")
RCC was originally set up by the Deposit Insurance Corporation of Japan in 1996 to take over loan assets owned by bankrupt housing loan companies. However, to make use of its know-how about how to deal with ailing companies, advising companies with financially difficulties has become one of the RCC’s businesses. 
3  Special Mediation
Special Mediation procedure is available for the debtor with financial difficulties to settle its creditor(s) under the Civil Conciliation Law, as supplemented by the Special Mediation Law. If the debtor could not have unanimous consents from its creditor in the out-of-court workout, the debtor may file a court-administered mediation proceeding and the court may issue an order recommending the dissenting creditors to accept the proposed plan with possible amendments. If the creditors do not object to the order within two (2) weeks, the order becomes effective to tie the relevant parties.
Chapter 4 Legal Proceedings
A. Overview of Insolvency Law in Japan
The Japanese insolvency laws consist of four different court procedures. Two of the procedures are said to be rehabilitation-type procedures: Civil Rehabilitation and Corporate Reorganization. Other two are traditionally described as liquidation-type procedures: Bankruptcy and Special Liquidation. Each procedure has its own objective, commencement requirements and target entities.
B. Legal Rehabilitation Proceedings
1  Outline of the Procedure of Civil Rehabilitation Law
(i) The Civil Rehabilitation Law is the primary legal rehabilitation law in Japan and its procedure applies to persons and any type of legal organization with some exceptions. The debtor or its creditors may file an application to start a Civil Rehabilitation proceeding to a court. The court examines whether or not the debtor has a ground for commencing a Civil Rehabilitation proceeding.
(ii) If the court finds that the application meets the requirements to start the Civil Rehabilitation procedure, the court orders the commencement of the case. Upon the commencement of the case, the personal debtor or the directors of the debtor are generally not deprived of their right to manage their business. In Japan, this style is called DIP (debtor-in-possession) style. However, to keep an eye on the case, Tokyo District Court usually selects a lawyer as a supervisor.
(iii) After commencement the case, the main jobs of the debtor are investigation and determination of rehabilitation claims, evaluation of property, and drafting and submitting a rehabilitation plan including a business restructuring and debt restructuring plans. The Civil rehabilitation procedure is originally not a liquidation procedure, but it is acceptable to draft a liquidation plan if that plan would be appropriate to the specific case.
Under the Civil Rehabilitation procedure, a classification of claims is as follows:
  •  Rehabilitation claims
  •  Administrative expense (or Common benefit claims) 
  •  Priority claims
  •  Post commencement claims
Administrative expense (or common benefit claims) and priority claims may be paid at any time without going through rehabilitation proceedings whereas post commencement claims are usually not paid.  Rehabilitation claims are paid by the condition of the proposed plan if the plan can have the conditions stated in (iv).
(iv) In order to approve a proposed rehabilitation plan, both of the following consents shall be required: 
(1) Consent of the majority of voting right holders (limited to those who attended a creditors meeting or voted by voting by document, etc. ); and
(2) Consent of persons who hold voting rights that account for not less than half of the total amount of voting rights held by voting right holders.
Where a proposed rehabilitation plan is approved, the court shall make an order of confirmation of the rehabilitation plan, if the court cannot find any disconfirmation event.
(v) A Civil Rehabilitation proceeding will terminate when the court confirms the plan, but if supervisor has been selected, the court will continue for three (3) years after the court’ confirmation. 
2 Corporate Reorganization Law
The Corporate Reorganization Law was very effective tool for rehabilitating large-sized joint-stock corporations the failure of which could give a serious bad effect to the society and the economy. Main differences between Civil Rehabilitation and Corporate Reorganization proceedings are follows:
(1) civil rehabilitation proceeding is initially intended to rehabilitate small and medium-sized enterprises, whereas corporate reorganization proceeding is to reorganize larger companies;
(2) In a civil rehabilitation case, secured creditors' rights cannot be stayed or altered without consent of individual secured creditors, but in a corporate reorganization case, rights of secured creditors are stayed and secured claims can be altered under a corporate reorganization plan accepted by the majority of creditors; 
(3) In civil rehabilitation proceedings, a debtor is not principally deprived of its right to operate the business and dispose of its assets whereas current managers are replaced by a trustee in a corporate reorganization case in principle, The new Corporate Reorganization Law in 2002, however, states that a court is able to appoint one or several current managers as (deputy)    trustee(s) in some cases partly adopting DIP system.
C. Legal Litigation Proceedings
1 Bankruptcy
(i) Bankruptcy Law is a basic litigation procedure whose purpose is to convert assets of the bankruptcy estate into cash and make a fair distribution among creditors. The debtor, its creditors, or some other stake holders stipulated in the law may file an application to commence a Bankruptcy proceeding to a court. The court examines whether or not the debtor has a cause of commencing a Bankruptcy proceeding.
(ii) If the court finds that the application meets the grounds to start the Bankruptcy procedure, the court orders the commencement of the case. Upon the commencement of the case, the court appoints a Bankruptcy Trustee who has the power to manage and transfer the assets of the Bankruptcy Estates from among insolvency lawyers who have no interest with the debtor.
(iii) After commencement of the case, the main jobs of the Bankruptcy Trustee are roughly the determination of the proof of claims, to sell and transfer the assets of the estates, and make distributions to the creditors after he/she finishes converting the assets into cash.
(iv) Please note that even though a Bankruptcy Proceeding is  typically a liquidation type procedure, to use a transfer of the business of the bankrupt company or some other tools, the Bankruptcy case can have a business rehabilitation aspect.
2 Special Litigation
(i) In addition to Bankruptcy Procedure, the other liquidation-type insolvency procedure in Japan is Special Liquidation procedure in chapter 9 of part 2 of the Companies Act.  Special Liquidation only applies to joint-stock corporations that are already in Ordinary Liquidation. Most of the Special Liquidation cases are brought about for restructuring and tax purposes. 
(ii) In Japan, comparing to the Bankruptcy cases, Special liquidation cases are sought to be more modest ways of liquidating companies because no Bankruptcy Trustees are appointed by the courts. Instead liquidators are appointed by the said companies preside the procedures.
(iii)Like the Bankruptcy procedure mentioned above, a Special liquidation procedure can also have a business revitalization aspect if the bankrupt company uses a corporate division (corporate demerger) or a transfer of the business that is used for the purpose of picking out a good business of the liquidating company and winding up the ailing company after receiving the value of the transferred business. 
D New Acts in relation to the Great East Japan Earthquake
The terrible disaster on March 11, 2011 caused extensive damages to many companies. To aid them, new acts have been created in Japan. Thus, if the reasons of the financial difficulties of the ailing company were something to do with the Great East Japan Earthquake, it is better to check whether or not a new act aiding the debtor was made. 
E Financial Institutions and Insurance Companies
The existing insolvency laws were considered inappropriate for financial, securities and insurance companies, because of the special nature of their businesses. Act on Special Treatment, etc. of Corporate Reorganization Proceedings and Other Insolvency Proceedings of Financial Institution was enacted deal with this matter. 
F  Act on Recognition of and Assistance for Foreign Insolvency Proceedings
Since 2000 when this act was established, only a few cases were related to this act. English translations of this act are available at http://www.japaneselawtranslation.go.jp/law/detail/?ft=1&re=02&dn=1&co=01&x=71&y=9&ky=act+on+recognition+of+and+assistance+for+

Miyake Imai & Ikeda Law Offices

For further information, please contact:
Yasushi Ikeda, Partner, Miyake Imai & Ikeda Law Offices
Toshiaki Aiba, Partner, Miyake Imai & Ikeda Law Offices


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