The Restructuring Review: Japan
Overview of restructuring and insolvency activity
i Liquidity and state of financial markets
The Japanese economy continues to be weak due to the covid-19 pandemic. According to recent statistics, there were 6,015 in-court insolvency cases involving debts of 10 million yen or more in 2021 – the lowest number since 2000 (see Section I.iv below for details).2 It is the result of the government's various support measures for businesses in response to the impact of covid-19, such as (1) interest-free and unsecured loans provided by financial institutions and (2) tax deferment. These statistics can be interpreted only as indicating that the timing of bankruptcies is being postponed due to such temporary supports, as the number of insolvency cases is expected to increase in the future.
ii Impact of specific regional and global events
Vaccine rollouts and other factors have eased restrictions on economic activity, and economic measures have stimulated economic recovery around the world, but the future is likely to remain uncertain. Not only is there the risk of future waves of covid-19 infection but also the conflict in Ukraine continues to have a negative impact on the global supply chain, which has already caused an immediate cash crunch for companies with manufacturing facilities around the world. As far as Japan is concerned, the repeated declarations of states of emergency and quasi-emergency issued by the government to prevent the spread of covid-19 have again restricted economic activities that were beginning to normalise. As there is no indication of how long the financial support provided by the government and financial institutions will continue, there is still no prospect for the normalisation of economic activity in Japan.
iii Recent market trends in restructuring procedures and techniques
In recent years, debtors facing financial difficulty have sought to avoid in-court insolvency proceedings by reaching agreements with their creditors on debt rescheduling or discharge outside of court proceedings. Generally, such out-of-court workouts involve only financial creditors, whereas claims held by trade creditors are paid in full, thus preventing the deterioration of the debtors' business value. According to data released by the government, about half of the companies that might consider a turnaround believe that it is imperative that restructuring procedures will not affect their current businesses or transactions.3
iv Number of in-court insolvency procedures entered into or exited in 2021
Out of the aforementioned 6,015 in-court insolvency proceedings during the period from January to December 2021, 5,518 were for bankruptcy proceedings, 195 for civil rehabilitation proceedings, two for corporate reorganisation proceedings and 300 for special liquidation.
General introduction to the restructuring and insolvency legal framework
Japan has two categories of in-court insolvency proceedings: (1) restructuring-type insolvency proceedings (processes for restructuring the debtor's business without extinguishing the debtor's juridical personality, which are based on a restructuring plan that includes changes to the rights of creditors) and (2) liquidation-type insolvency proceedings whereby all of a debtor's assets are liquidated and, if the debtor is a legal entity, the entity itself is extinguished upon completion of the proceedings. Civil rehabilitation proceedings (minji saisei) and corporate reorganisation proceedings (kaisha kosei) fall within restructuring-type insolvency proceedings, whereas liquidation-type insolvency proceedings consist of bankruptcy proceedings (hasan) and special liquidation (tokubetsu seisan). The core features of these proceedings are addressed in Section II.ii.
In addition, out-of-court workouts are becoming more commonly used to restructure the debtor's financial debts without starting the aforesaid in-court insolvency proceedings, which usually damage companies' going-concern value. We have seen some successful out-of-court corporate workout cases in which the debtors are large, worldwide companies with subsidiaries all over the world.
Although unanimous consent from all participating creditors (usually limited to financial creditors) is required to achieve restructuring, a majority rule principle may be introduced in out-of-court workouts subject to future discussions (see Section VI.i).
ii Main features of each type of in-court insolvency proceeding
Civil rehabilitation proceedings (minji saisei)
Civil rehabilitation proceedings, governed by the Civil Rehabilitation Act, are the most common form of in-court restructuring-type insolvency proceedings in Japan that can be used for any type of company.
In general, civil rehabilitation proceedings are a debtor-in-possession (DIP) process: the debtor's management remains in control of the debtor and its assets throughout the process unless there are exceptional circumstances to take over the management's control. However, that does not mean that management's control is completely unaffected by the commencement of civil rehabilitation proceedings. Courts may and usually do require the debtor to obtain prior permission of the court before the debtor engages in certain types of activities, typical examples of which include disposal of property and accepting the transfer of property if it is out of the ordinary course of the debtor's business, borrowing money, filing an action, settling a dispute and waiving a legal right. In addition, courts usually appoint a supervisor, who monitors the debtor's activities throughout the process and gives consent to the debtor to engage in the aforesaid permission-required activities on behalf of the court.
In terms of how voting for the restructuring plan works, there is only one class who can vote, consisting of holders of rehabilitation claims, which are, roughly speaking, claims that existed before the commencement of the proceedings. The rehabilitation plan must be approved by:
- a majority in number of rehabilitation claims holders voting at the meeting (or in writing); and
- a majority by value of all rehabilitation claims, the holders of which have voting rights.
Under the standard schedule of the Tokyo District Court, the entire process of civil rehabilitation proceedings takes about five months; however, the actual length might vary depending on the complexity and circumstances of each case.
Corporate reorganisation proceedings (kaisha kosei)
Corporate reorganisation proceedings, another type of in-court restructuring-type insolvency proceedings, governed by the Corporate Reorganisation Act, have a similar procedure to civil rehabilitation proceedings, although there are some key differences between the two proceedings, such as:
- corporate reorganisation proceedings are available only for stock corporations (various other corporate forms, such as unlimited partnerships, limited partnerships and limited liability companies, cannot use these proceedings);
- a trustee takes over possession and control of the debtor's business and assets; and
- secured creditors cannot exercise their security interests outside the proceedings.
Corporate reorganisation proceedings are used mainly in complex cases with a large amount of debts.
Although the trustee who is appointed by the court with the exclusive right and authority to manage the debtor's business and to administer and dispose of the debtor's assets throughout the process is usually an attorney who has expertise in insolvency cases (administrative corporate reorganisation), there have been some cases in which the court appoints trustees from the current management (DIP-type corporate reorganisation).
As for voting, unlike in civil rehabilitation proceedings, classes are separated in corporate reorganisation proceedings for each type of creditor, such as secured claims, general unsecured claims and shares. Plans need to be approved by each class (with different thresholds for each class), and cramdown is available only in limited cases.
In the Tokyo District Court's standard schedule, administrative corporate reorganisation takes about eight to 11 months, whereas DIP-type corporate reorganisation typically takes around five months.
Bankruptcy proceedings (hasan)
Bankruptcy proceedings, governed by the Bankruptcy Act, are the most commonly used form of liquidation for insolvent companies. Broadly speaking, the main purpose of bankruptcy proceedings is to liquidate the debtor's assets (including sales of the debtor's businesses) into cash and distribute it equitably to creditors.
Upon commencement of the bankruptcy proceedings, a trustee is appointed by the court and takes over control and possession of the debtor's property, unless the debtor does not have enough assets to fund the expenses of the process (in which case the bankruptcy procedure is closed immediately with the juridical personality of the corporate debtor being diminished). Reflecting the purpose of bankruptcy proceedings above, the primary task of trustees is to convert the debtor's assets into as much cash as possible and distribute it equitably to creditors, and the trustee may operate the debtor's business to the extent necessary and appropriate to sell the debtor's assets at maximum value.
Special liquidation (tokubetsu seisan)
Special liquidation proceedings, governed by the Companies Act, is a form of liquidation that is available only to stock corporations that have been placed into a voluntary liquidation process by the corporation's shareholders. Special liquidation is a simpler, less onerous and more expeditious form of liquidation than bankruptcy. It is frequently used by a parent company to liquidate loss-making subsidiaries.
In special liquidation, the liquidator who has been appointed by the debtor continues to hold control and possession of the debtor's property. The liquidator's activities are subject to the court's supervision. The liquidator must obtain the court's permission if it plans to, inter alia, dispose of an asset, borrow money, file an action, enter into a settlement or an arbitration agreement, or waive the rights of the corporation.
iii Overarching issues relating to Japanese in-court insolvency proceedings
There is no automatic stay as in US Chapter 11 in Japan. Payment of existing debts is prohibited upon the commencement of in-court insolvency proceedings, not upon the petition for them. However, the court may issue a temporary restraining order that prohibits the disposition by the debtor of its property, including paying existing debts. In practice, it is very common that the debtor obtains this pre-commencement stay order upon the filing to legally stop paying its existing debts, even before the commencement of the proceedings. Thus, something similar to an automatic stay usually takes place in Japanese in-court insolvency proceedings in a sense that the stay occurs at the time of filing, though there is still a big difference between such a stay compared with an automatic stay, particularly in secured creditors' enforcement (see below).
Enforcement of security
In corporate reorganisation proceedings, secured creditors cannot enforce their security interests and are involved in the proceedings, whereas security interests can be enforced in civil rehabilitation proceedings, bankruptcy proceedings and special liquidation. However, even when secured creditors are allowed to enforce or foreclose outside of the proceedings, they may separately be subject to a court's discretionary stay order in certain circumstances.
In civil rehabilitation proceedings, corporate reorganisation proceedings and bankruptcy proceedings, transactions carried out before the commencement of the proceedings that (1) favour one creditor over other creditors or (2) unjustly diminish the debtor's assets may be set aside and the assets or money at issue can be clawed back, under certain statutory requirements.
Duties of directors of the debtor
Unlike some jurisdictions, as a general rule under the Companies Act, the directors basically do not owe fiduciary duties to creditors of the company in addition to their duties to the company and its shareholders and are not obliged to file for in-court insolvency proceedings in financial difficulties. However, if bankruptcy occurs due to the fault or negligence of the directors, and the company's assets are insufficient to settle all of the company's liabilities, then each director will be jointly responsible for the outstanding liabilities of the bankruptcy assets, which indirectly may benefit creditors.
iv Out-of-court corporate workouts
Against a backdrop of the increasing popularity of out-of-court corporate workouts in Japan, we have a variety of out-of-court corporate workout schemes ranging from purely consensual, ad hoc negotiations with financial creditors to more standardised processes with prescribed procedures to ensure fairness and reasonableness of the process.
Among such a variety of schemes, the turnaround alternative dispute resolution process (turnaround ADR) – one of the standardised forms of corporate workouts – has been the most popular in recent years, especially for large companies. Turnaround ADR is a process whereby the debtor tries to restructure its debts owed to the creditors, who join the process based on a consensus of such creditors. The whole process of turnaround ADR is carried out in accordance with the prescribed manner and schedule and is facilitated by mediators (usually consisting of two lawyers and one accountant) appointed by the Japanese Association of Turnaround Professionals to ensure the fairness and reasonableness of the workout process.
Generally speaking, the success rate of turnaround ADR is high, and debtors in many cases successfully restructure their debts without going to in-court insolvency proceedings. Even if the debtor cannot obtain unanimous consent to a turnaround ADR, the Industrial Competitiveness Enhancement Act provides several measures that ensure that the restructuring plan proposed in a turnaround ADR can be approved and carried out in in-court insolvency proceedings much more smoothly and quickly than in ordinary in-court insolvency cases.
Recent legal developments
i Background of 2021 amendment to the Act on Strengthening Industrial Competitiveness
As mentioned in Section II, turnaround ADR is one of the out-of-court workout proceedings in which neutral and fair third-party practitioners who satisfy the qualification requirements act as the mediators and are involved in preparing the rehabilitation plan and obtaining consent from the creditors. The Act on Strengthening Industrial Competitiveness (ASIC) stipulates the details of turnaround ADR.
However, it has long been pointed out that out-of-court workout proceedings, including turnaround ADR, have a high hurdle to overcome: the unanimous consent of participating creditors is required and, if this cannot be achieved, the debtor's business value might be severely damaged by the shift to in-court insolvency proceedings. This is because trade claims as well as financial claims are both subject to debt forgiveness and other modifications of rights under in-court insolvency proceedings, whereas only financial claims are usually subject to the same under an out-of-court workout.
The ASIC was amended in 2018 in response to this situation, and new provisions were established to protect trade claims in cases in which the unanimous consent of participating creditors in the out-of-court workout proceedings cannot be achieved and the restructuring process has shifted to in-court insolvency proceedings. To be specific, the debtor may request the mediators of turnaround ADR to confirm that the commercial claims arising up to the conclusion of the procedure conform to the following requirements: (1) the claim is small in amount and (2) the debtor's business will be significantly hindered if the claim is not repaid promptly. If a shift from turnaround ADR to in-court insolvency proceedings occurs in respect of a debtor who has obtained such a confirmation, the court, by taking into consideration the fact that these two requirements have been met in respect of trade claims, will decide whether to allow priority repayment in a rehabilitation or reorganisation plan.
In 2021, the ASIC was again amended as described in the next section to further facilitate the shift from out-of-court workout, including turnaround ADR, to in-court insolvency proceedings while enhancing the effectiveness of the former.
ii Details of the 2021 amendment
Special provisions for appointment of supervisors
The recently amended ASIC establishes a provision that, when transferring a case from turnaround ADR to in-court insolvency proceedings, the court shall appoint a supervisor by taking into consideration the fact that the mediators of the turnaround ADR have already mediated a settlement. This provision makes it more likely that mediators who understand the circumstances surrounding the debtor will be appointed as supervisors in the subsequent in-court insolvency proceedings, thereby facilitating a smooth transition.
Special provisions regarding confirmation of debt forgiveness and petition for simplified civil rehabilitation proceedings
Under the amended ASIC, (1) the debtor may, in cases in which creditors who hold three-fifths or more of the total amount of claims in turnaround ADR agree to a business rehabilitation plan, file a petition for confirmation that the debt forgiveness to be conducted based on the plan conforms to the criterion of being indispensable for business rehabilitation (confirmation of conformity) and (2) if the debtor files a petition to transfer from turnaround ADR to simplified civil rehabilitation proceedings, the court shall determine whether the proposed rehabilitation plan submitted by the debtor is contrary to the general interests of rehabilitation creditors, taking into consideration the existence of the confirmation of conformity.
Simplified civil rehabilitation proceedings omit the filing procedures and investigation of rehabilitation claims, which is intended to rehabilitate the debtor in a prompt manner. The amended ASIC will increase the possibility that the court, by obtaining confirmation of conformity in turnaround ADR, will consider it at that stage and make a smooth rehabilitation decision based on the same (or similar) plan submitted by the debtor in subsequent in-court insolvency proceedings, even if turnaround ADR is not successful and the debtor has to go into in-court insolvency proceedings.
In the case of simplified civil rehabilitation proceedings, the rehabilitation plan submitted at the time of filing a petition for the proceedings is directly subject to the consent of creditors. Therefore, it is expected that the entire rehabilitation proceedings, including not only the decision of commencing the procedure itself but also the confirmation of the rehabilitation plan, will be facilitated by taking the confirmation of conformity into consideration.
Financial institution obligation
The amended ASIC imposes an obligation on financial institutions that have claims against the debtors to make efforts to cooperate during turnaround ADR proceedings. Turnaround ADR is an out-of-court workout in which the mediator acts as an intermediary for settlement, but creditors are not legally required to participate in the procedure. However, unreasonable non-participation in or withdrawal from turnaround ADR would be an obstacle to business revitalisation efforts through such proceedings. Therefore, the amended ASIC imposes an obligation on financial institutions to make efforts to participate in the proceedings to increase the effectiveness of turnaround ADR by having as many of them participate as possible.
iii Impact of the amended ASIC on out-of-court workout practice
As described above, the amended ASIC provides a useful system that facilitates a smooth transition from turnaround ADR to in-court insolvency proceedings and enhances the effectiveness of the former. However, this facilitation also carries the risk of giving creditors the option of not consenting at the out-of-court workout stage due to the availability of simplified procedures involving the court at a later stage and, further, under the in-court insolvency proceedings after the transition, the petition for commencement of those proceedings will become public knowledge and may damage the business value or creditworthiness, etc., of the debtor. Therefore, it is still considered important for the debtor and its advisers to make their best efforts to conclude the out-of-court workout smoothly and promptly by persistently explaining to creditors that it is important to conclude a business revitalisation plan in an out-of-court workout from the viewpoint of preventing any damage to business value.
Significant transactions, key developments and most active industries
i Significant transactions and key developments
The civil rehabilitation proceedings of MtGox Co, Ltd, a company that operated an online exchange of bitcoins, commenced in June 2018, and the civil rehabilitation plan filed by the rehabilitation trustee with the Tokyo District Court was approved by a large majority of rehabilitation creditors in October 2021 and became final and binding in November 2021.
Because an extremely large number of creditors exist all over the world in this case, the rehabilitation trustee (1) disclosed information necessary for creditors on the website, (2) established a system that allowed for creditors to file proof of claims through the website, and (3) established an online voting system that allowed for creditors to vote for the proposed civil rehabilitation plan through the website. Such an attempt to digitalise insolvency proceedings is considered very important to enable creditors to exercise their rights, and makes the process progress quickly, especially in cases in which a large number of creditors are located overseas.
ii Most active industries
The number of insolvency proceedings of the retail electricity business has been increasing, such as the corporate reorganisation proceedings of F-Power Co Ltd, one of the largest power producers and suppliers in Japan. Fourteen bankruptcies of new power companies occurred from April 2021 to March 2022 (a sharp increase from the two cases in the previous fiscal year). There was also a string of withdrawals from the retail electricity business and suspensions of new applications, with 31 companies, or about 4 per cent of the approximately 700 new power companies confirmed to be operating in April 2021, having gone bankrupt, closed their businesses or withdrawn from operations over the past years.4
In Japan, since the full liberalisation of new entries into the retail electricity business in April 2016, the number of new power producers and suppliers has steadily increased. Many of the new power companies do not own their own power plants but instead procure the power they need on the Japan Electric Power Exchange (JEPX). However, fuel prices have escalated and, with the addition of international risks such as the conflict in Ukraine, the cost of procuring electricity has increased significantly. The situation has had a major impact on the operations of many new power companies that are relying on the JEPX for electricity procurement, and they have needed to take action such as raising their prices. However, because most of the new power companies have differentiated themselves by offering low prices to attract customers, it is difficult for them to pass on the higher prices sufficiently. As a result, an increased number of the new power companies have withdrawn their business or gone bankrupt.
In Japan, where most electricity is generated by thermal power, electricity prices, which are already high, are likely to rise further, and the number of bankruptcies of electricity retailers is expected to increase further in the future.
Japan adopted a territoriality principle in the past, under which the validity of domestic insolvency proceedings was denied outside the country and, correspondingly, the validity of foreign insolvency proceedings was also denied inside the country. However, in 1997, the United Nations Commission on International Trade Law (UNCITRAL) enacted the UNCITRAL Model Law on International Insolvency, and then in 2001 Japan enacted the Act on Recognition of and Assistance for Foreign Insolvency Proceedings (ARAFP), which adopts the extra-territoriality principle and has since established a legal system to address international bankruptcy.
The purpose of the ARAFP is to (1) ensure that foreign insolvency proceedings are properly effected in Japan in respect of corporations, whether domestic or foreign, that have insolvency proceedings pending in foreign countries and (2) achieve internationally harmonised liquidation of assets or economic turnaround. The law provides procedures for recognition of foreign insolvency proceedings and for making dispositions for various types of assistance.
Under the ARAFP, as the decision to recognise insolvency proceedings pending in foreign countries itself has no specific effect, the court shall, upon petition from the foreign trustee or on its own authority, make the necessary dispositions on a case-by-case basis. Specific dispositions include (1) suspension of compulsory execution and court proceedings already conducted in respect of property in Japan, (2) suspension of execution of security interests or other such proceedings already conducted in respect of property in Japan, (3) prohibition of disposition and payment in respect of businesses and property in Japan, (4) prohibition of execution of security interests or other such proceedings in respect of property in Japan, and (5) issuance of an administration order exclusively conferring the right to dispose of the business and property in Japan to the recognised trustee (it should be noted that court permission is required for the disposal of property or taking it out of Japan).
i Introduction of majority rule principle in out-of-court workouts
As mentioned above, in out-of-court workouts in Japan, the unanimous consent of creditors is required for amending the rights of creditors. The Headquarters for the Realisation of New Capitalism established by the Japanese government on 15 October 2021 indicates that although European countries have certain systems (e.g., the scheme of arrangement in the UK and StaRUG in Germany) to restructure businesses by amending certain rights of creditors, including debt forgiveness by a majority vote with court approval and without requiring the consent of all lenders, there is no such system in Japan. Depending on future discussions, a new system might be established in Japan whereby creditors' rights can be amended based on the principle of majority rule.
ii Introduction of comprehensive collateral system
In the Japanese collateral system, comprehensive security interests over entire businesses of the debtors essentially do not exist. On 25 December 2020 and 30 November 2021, the Study Group on the Loan and Rehabilitation Practices Supporting Businesses established by the Financial Services Agency, by referring to the UNCITRAL Model Law on Secured Transactions and the US Uniform Commercial Code, among other laws, discussed the introduction of comprehensive security interests over entire businesses, including intangible assets such as know-how and customer base, to compensate for the current security interests that are limited to tangible assets such as real estate and movable assets. The discussion is ongoing and thus needs to be closely monitored.
iii Digitisation of in-court insolvency proceedings
The digitisation of all civil procedures is currently under way in Japan with the aim of speeding up and streamlining court proceedings. With regard to in-court insolvency proceedings, the Study Group on Digitalisation for Insolvency Proceedings, whose members are insolvency practitioners and scholars, was established in November 2018 and has since been studying the digitisation of those proceedings. The group has released interim discussion summaries twice, in September 2019 and October 2021, and it has made the following three recommendations for in-court insolvency proceedings: (1) the use of a new procedure whereby creditors' meetings are not convened, (2) the use of e-mail or other online means to conduct proceedings, and (3) the use of a new procedure whereby claims investigations are not held.
1 Dai Katagiri is a partner, Ryo Kawabata is a senior associate and Takashi Harada is an associate at Mori Hamada & Matsumoto.
2 For more information, please refer to 'Japan's Business Failures during January to December 2021', published on the Teikoku Databank's website (https://www.tdb-en.jp/news_reports/backnumber/brr21nen.html).
3 For more information, please refer to the material uploaded to the Cabinet Secretariat's website (https://www.cas.go.jp/jp/seisaku/atarashii_sihonsyugi/kaigi/dai5/shiryou1.pdf).
4 For more information, please refer to 'Survey of 'New Electric Power Company' Bankruptcy Trends', published on the Teikoku Databank's website (https://www.tdb.co.jp/report/watching/press/pdf/p220310.pdf).