The Insolvency Review: Japan
Insolvency law, policy and procedure
In essence, for in-court insolvency proceedings, Japanese insolvency law recognises four types of procedures, each of which is governed by separate legislation and can be categorised into one of two general types, depending on whether the aim of the proceedings is to liquidate a debtor (liquidation-type proceedings) or rehabilitate a debtor (rehabilitation-type proceedings). The general and common form of the liquidation-type proceedings is bankruptcy proceedings under the Bankruptcy Act. The purpose of bankruptcy proceeding is to liquidate the company by converting its assets into cash and distributing the cash to creditors in a fair and equitable manner (i.e., on a pro rata basis). Bankruptcy proceedings are usually used only when none of the other insolvency proceedings are viable. The special liquidation proceedings under the Companies Act is the other type of liquidation proceedings, which can only be used by stock corporations and has different characteristics from the bankruptcy proceedings in several aspects such as the special liquidation proceedings not having the claim determination process unlike the bankruptcy proceedings. The rehabilitation-type proceedings consist of civil rehabilitation proceedings under the Civil Rehabilitation Act and corporate reorganisation proceedings under the Corporate Reorganization Act. Civil rehabilitation proceedings apply to all types of companies including stock corporations, partnerships, and limited liability companies whereas corporate reorganisation proceedings are only open to stock corporations. International insolvency law is dealt with by conflict of laws rules in the relevant insolvency legislation and by the Act on Recognition of and Assistance for Foreign Insolvency Proceedings.
Consumer insolvency is not governed by separate rules but a consumer in Japan has the opportunity to apply for insolvency themselves, while at the same time availing of the provisions on release and discharge from residual debt in the Bankruptcy Act. The Civil Rehabilitation Act contains rules on consumer rehabilitation.
Finally, an increasing number of financial restructuring cases have been recently handled out of court in Japan rather than filing for in-court restructurings.
In comparison with the immediate aftermath of the financial crisis in 2008, the number of bankruptcy and civil rehabilitation cases in Japan had been consistently seeing a downward trend until the covid-19 pandemic. Statistics published by the courts suggest that the number of bankruptcy cases in each year from 2014 to 2018 generally ranged from 70,000 to 80,000 cases while the cases in 2009 reached more than 135,000. This is the same with civil rehabilitation cases, where the number of civil rehabilitation cases in each year from 2014 to 2018 was within 200 cases whereas more than 650 cases were filed in 2009. That being said, in 2020, almost all industries are experiencing a sea change in the face of the pandemic, which will presumably lead to a substantially greater number of those cases.
Ancillary insolvency proceedings
All insolvency proceedings also cover assets situated abroad; the strict territoriality principle does not apply. In return, assets situated in Japan can be included in foreign proceedings. However, this is only possible under certain conditions, which must be established in judicial recognition proceedings. Beyond the recognition of foreign proceedings, the Act on Recognition of and Assistance for Foreign Insolvency Proceedings governs what measures can be used to support the performance of proceedings in Japan.
ii Recognition proceedings
Following the ratification by the Japanese government of UNCITRAL Model Law on Cross-Border Insolvency, the Act on Recognition of and Assistance for Foreign Insolvency Proceedings was enacted as of 1 April 2001, to coordinate the liquidation or rehabilitation of debtors that are engaged in international business activities and subject to insolvency proceedings commenced in jurisdictions other than Japan.
Fundamentally, only the foreign insolvency administrator can apply for the recognition of foreign insolvency proceedings. However, if the foreign proceedings leave the debtor with the power to administer and dispose of its assets, then it is also entitled to file an application. The district court in Tokyo has central jurisdiction for all recognition proceedings.
The foreign proceedings must be 'insolvency proceedings'. This is the case if the proceedings settle the debtor's liabilities as a whole, provide for judicial oversight and aim to achieve either liquidation or restructuring. This is undoubtedly the case for German insolvency proceedings. Furthermore, under Japanese law, the foreign court must have international jurisdiction; that is, the debtor must have its place of residence, habitual residence or a permanent establishment in this country.
Among other reasons, the recognition application must be rejected if the foreign proceedings under their domestic law does not cover assets situated in Japan or if they violate the ordre public or public morality. Other reasons for rejection concern the conflict between foreign proceedings and Japanese insolvency proceedings which have already commenced. In this case, the Japanese proceedings generally take precedence. The foreign proceedings can only be recognised if they are commenced in the country in which the debtor has its principal establishment, the order for supportive actions corresponds with the creditors' general interests and there is no concern that recognition in Japan will have a disproportionately deleterious effect on the interests of the creditors.
iii Protective measures
Following recognition, the court can take protective measures, in particular it can interrupt Japanese insolvency proceedings and secure assets belonging to the debtor. Moreover, the court can appoint a lawyer to represent the foreign insolvency administrator in Japan for the purposes of the recognition proceedings.
The recognition order has no automatic effects, but rather serves as the basis for individual assistance measures which the court orders at its discretion. Of significance is the power to interrupt or cancel enforcement proceedings and disputes of all kinds which concern the debtor's assets in Japan. Moreover, the court can issue the debtor with a ban on disposals and performance, prohibit the exercise of security rights and specify actions for which the debtor requires its prior consent in order to perform. Finally, the court can revoke the debtor's administrative power and transfer it to the foreign insolvency administrator or to a specially appointed Japanese trustee.
v Amendment to Japanese insolvency law
In response to the enactment of the Act on Recognition of and Assistance for Foreign Insolvency Proceedings, an amendment to Japanese insolvency law was also made to incorporate the following concepts:
- under the principle of national treatment, a foreign entity incorporated under the laws of a foreign jurisdiction is granted the same status as a Japanese entity in the Japanese insolvency proceedings;
- if an insolvency proceeding is commenced in a foreign jurisdiction with respect to a debtor, the presumption will be that a valid cause exists for commencement of Japan insolvency proceedings;
- if there are insolvency proceedings concurrently pending in more than two jurisdictions, the Japanese trustee may ask a trustee in the foreign insolvency proceeding to cooperate and provide such information as is required to properly carry out the Japan insolvency proceeding, and vice versa; and
- the trustee in the foreign insolvency proceeding may file a motion to commence the Japanese insolvency proceeding which corresponds to such foreign insolvency proceeding.
The foreign trustee is entitled to present its own opinion at the creditors' meeting and to file a rehabilitation or reorganisation plan with the court. Further, the foreign trustee may, in its capacity as a representative representing those creditors who have filed proof of claims in their foreign insolvency proceedings but who have not done so in the Japanese insolvency proceedings, participate in the Japanese insolvency proceeding, and this applies to the Japanese trustee in the foreign jurisdiction in the same manner.
A distressed debtor commonly and recently seeks to reach a negotiated agreement with its creditors outside the court to avoid statutory insolvency proceedings. It is generally perceived by restructuring practitioners that an out-of-court restructuring or workout is preferable to statutory insolvency proceedings to preserve a debtor's going-concern value and reduce the costs for restructuring. Out-of-court workout, by its nature, is not backed up by any statute or procedural rules as it doesn't relate to 'in-court' restructuring but it is beneficial for both debtors and creditors if workout procedures can be standardised to facilitate out-of-court workout and from this perspective a standardised out-of-court workout scheme called the 'Turnaround Alternative Dispute Resolution (ADR)' was introduced and has been commonly used in Japan.
ii Turnaround ADR
Turnaround ADR was introduced in 2008 through an amendment to the Act on Special Measures for Industrial Revitalization and Innovation (currently the Act on Strengthening Industrial Competitiveness) to facilitate financial restructuring of a debtor outside the court at an earlier stage. Turnaround ADR is designed to help facilitate negotiations between a distressed debtor and its financial creditors under mediators licensed by the Ministry of Economy, Trade and Industry and the Ministry of Justice. The Japanese Association of Turnaround Professionals (JATP) is the only licensed organisation that can mediate Turnaround ADR cases thus far. The general information of the JATP is available at http://turnaround.jp.
Turnaround ADR can be defined by several important aspects. First, by its nature as out-of-court workout, no court is involved in the process. Instead, usually three disinterested, experienced mediators chosen by the JATP preside over the whole process, by scrutinising a restructuring plan made by a debtor and chairing multiple creditors meetings. Second, as opposed to in-court restructuring, only financial creditors, typically banks, get involved in the process. After the standstill is agreed on by participating financial creditors as stated below, a debtor is not required to pay loan principals during the turnaround ADR process, which can stabilise the debtor's liquidity during the process. However, a debtor can, and is also expected to, pay trade creditors in the ordinary course of business and operate the business in the same way as before to keep the going-concern value. Third, contrary to in-court, turnaround ADR proceeds in secret except for some cases involving listed companies. This confidentiality can minimise potential deterioration of a debtor's business through public disclosure. Fourth, and most importantly, a debtor needs unanimous consent from all participating banks to cut a deal, which is practically the biggest challenge when going along with turnaround ADR. No majority voting is implemented here.
After the debtor makes a formal application to the JATP and the JATP accepts it, the debtor and JATP sends a 'standstill' notice in their joint names to the financial creditors whom the debtor wants to involve in turnaround ADR. The standstill notice is a unilateral notice sent from the debtor and the JATP to ask financial creditors to refrain from collecting loan principals even due and payable by, among other things, exercising set-off, requiring collateral or guarantee, receiving payment, enforcing their security interest, and filing a petition for compulsory execution, provisional attachment or any insolvency proceedings. The standstill notice expires at the time of the first creditors' meeting, as explained below, but with the creditors' consent, it is usually extended until the third creditors' meeting. The standstill notice is not generally deemed to be default.
There are three types of creditors' meeting that are held under turnaround ADR. At the first, creditors meeting three mediators chosen by the JATP are approved by participating financial creditors if they are satisfied with those mediators supervising the process. Also, at the first creditors meeting, the notice of standstill sent by a debtor needs to be confirmed by participating financial creditors and they decide when the standstill will expire. In almost all cases, participating financial creditors agree to extend the period of standstill until the end of the third meeting. Then, at the second meeting, the debtor will propose the plan details to participating financial creditors. The mediators scrutinise the plan details from an objective viewpoint and submit a report to participating financial creditors on how fair and economically reasonable the mediators think the plan is. Upon receiving the report, participating financial creditors think of whether to accept the plan and at the third meeting there are final votes on the plan. If all of them vote for the plan, the plan is approved and the debtor will execute it accordingly. But if any of them voted against the plan, turnaround ADR ends in failure. The debtor has two alternatives if any of them objects to the plan. The first is to use in-court 'special mediation' proceeding presided over by a judge to reach a consensus with respect to the dissenting creditor but the dissenting creditor is not compelled to accept the plan. The second is to file for in-court insolvency proceedings – civil rehabilitation proceedings or corporate reorganisation proceedings.