Shinichiro Abe examines the current restructuring market in Japan and identifies key insolvency tools and procedures available.
1. What trends, in terms of activity levels, affected industries or investor focus, have you seen in the restructuring and insolvency market in your jurisdiction over the last 12 months?
From April 2014 to March 2015 (FY2014), 9,545 legal insolvency cases were filed in Japan; a 9.4% decline from the previous year. The most recent year in which the number of legal insolvency cases dipped below 10,000 was 1990. Only one listed company filed a legal insolvency case. Further, the most recent data for this year indicates a 13% decline in insolvencies from FY2014.
One of the reasons for the small number of insolvency cases is government policy. Prime Minister Shinzo Abe’s cabinet has been very reluctant to allow an increase in the number of insolvency cases, instead instructing the Financial Services Agency to help distressed companies reschedule their payment terms. The Japanese economy, particularly exporters, is performing very well under the supervision of this cabinet. Only 114 companies filed for rehabilitation in FY2014, the lowest number in the history of the Civil Rehabilitation Law (CRL).
The ratio of Non-Performing Loans (NPLs) decreased to 1.6% in 2015 from 8.4% in 2002; as a result, few NPL transactions have taken place in Japan recently.
2. What is the market view on prospects for the coming year?
We expect the Japanese economy to continue to perform well in 2016. This means that the number of insolvency cases will continue to decrease. The insolvency-related market will be low-key.
3. What are the key tools available in your jurisdiction to achieve a corporate restructuring – are they primarily formal, court-driven processes, or are informal out-of-court restructurings possible? Do you feel that the tools you have available are effective in terms of providing speedy, fair and predictable outcomes?
In 2014, 87% of insolvency cases in Japan were handled by the courts. This indicates that the majority of insolvencies are resolved via formal legal procedures rather than out-of-court workouts. Two insolvency laws govern the restructuring of insolvent companies in Japan: the Civil Rehabilitation Law (CRL) and the Corporate Reorganization Law (CR).
The CRL allows the existing management to retain management authority and run the debtor company. A supervisor can be appointed by the court whose consent is then required for any important management decisions made by the debtor, such as transferring assets or taking out loans. The court must confirm the rehabilitation plan and authorise any business transfer not based on the rehabilitation plan. Debtors tend to use business transfers to rehabilitate their businesses, especially in the Tokyo District Court.
Under the CR, the existing management is usually replaced. The court appoints a reorganisation trustee – usually a lawyer who can handle the restructuring of companies. The trustee usually requests an accountant as an assistant.
Significant differences exist between the two procedures. The CRL only binds unsecured creditors whereas the CR binds both unsecured and secured creditors. Almost all debtor company rehabilitations have been done under the CRL procedure because it accepts a DIP (Debtor in Possession) system and is more streamlined (from the perspective of time and cost) than the CR.
Turnaround ADR is another option. Turnaround ADR refers to a rehabilitation procedure for businesses facing operational failure through mutual consultation between the affected parties rather than an insolvency proceeding in court. It is not a pure non-legally binding procedure, but is based on the procedure described in the Industrial Competitiveness Enhancement Act (ICEA). Turnaround ADR can be conducted by any institution which obtains both ADR certification from the Ministry of Justice and special ADR certification from the Ministry of Economy, Trade and Industry under the ICEA. The publicity associated with a formal legal procedure may damage the corporate value of a debtor company by eroding its reputation and brand value. Trade creditors may then refuse to engage in business with the debtor company. However, under a Turnaround ADR procedure, by contrast, only financial creditors (e.g. banks) qualify as members. Trade creditors are not involved and their claims are unaffected by the procedure. If the debtor is an unlisted company, it can continue to engage in business during the Turnaround ADR without disclosing the procedure to its trade creditors and customers.
An ADR plan allows a debtor to extend payment terms and impose haircuts on existing debts. All qualified creditors (financial institutions) need to approve the ADR plan for it to be executed. Sometimes, a debtor is unable to obtain unanimous consent from the creditors. More than 55 Turnaround ADR procedures have been filed since the procedure was established in 2007.
4. In terms of intercreditor dynamics, where does the balance of power lie as between shareholders and creditors, and as between senior lenders and junior/mezzanine lenders? In particular, how do valuation disputes between different stakeholders tend to play out?
Shareholders are subordinate to creditors and outside the scope of the CRL procedure. Creditors can file a commencement of a case just as debtors can, but shareholders aren’t qualified to do so. The CRL provides that debtors should fulfil their obligations to creditors under the procedure. The most important interested parties now become the creditors rather than shareholders. Creditors are entitled to raise objections to some procedures (e.g. the commencement of the case) and to business transfers, whereas shareholders are not. While the consent of a shareholders’ meeting approving a business transfer is required under the Japanese Corporate Law, the CRL provides an exception for insolvent debtors, who need only obtain the approval of the court.
Under the CR, by contrast, shareholders can file for a procedure. The CR provides that a creditor and/or shareholder who obtains claims (shares) amounting to more than one tenth of the total amount of capital of the debtor can file a commencement of the case.
Regarding the balance of power between various types of creditors, the only distinction made between unsecured creditors under the CRL is that between administrative claims and priority claims. Administrative claims can be paid from a debtor's estate at any time without going through distribution under a rehabilitation plan. Priority claims, which are described in the relevant laws, can also be paid from a debtor's estate at any time. Secured creditors are not bound in principle to this procedure.
Creditors can establish a creditors’ committee. One of the requirements which makes a committee difficult to establish is that it must represent all of the interests of all creditors. It is easy to imagine the complexity of reconciling the interests of the various types of unsecured creditors under such a procedure.
Some differences exist under the CR. Creditors are divided between those with secured claims and those with unsecured claims. Secured creditors, especially banks and leasing companies, sometimes form ad hoc creditors’ committees which can be approved by the court as “official” creditors’ committees under the CR, although this has happened in only two cases. Secured creditors’ committees approved by the court can then negotiate with debtors, especially with regard to their business transfer and reorganisation plans, etc. Difficulty is to make unsecured creditors’ committee like under the CRL procedure.
As to the evaluation of claims, the most common bone of contention is the value of collateral for secured creditors.
5. Have there been any changes in the capital structures of companies based in your jurisdiction over recent years caused by the retreat of banks from loan origination? In particular, have you found that capital structures now increasingly comprise debt governed by different laws (such as New York law governed high yield bonds)? If so, how do you expect these changes to impact on restructurings in the future?
Recently, there have not been any changes in the capital structures of companies based in Japan.
6. Is there significant activity on the part of distressed debt funds in your jurisdiction? How successful have they been in entering the market, and how much has market practice (or law) evolved in response? If funds have not successfully entered the market, can you identify reasons why?
The distressed debt market in Japan is mature. Distressed debt funds first came to Japan in the late 1990s to buy non-performing loans (NPLs) and gradually became a stable part of the market. We suffered through a recession for over a decade in the 1990s and early 2000s. Creditors who are not interested in being involved in restructuring procedures have therefore long been welcome to sell their claims to distressed debt funds which then play an active role in restructuring a company. They seek to buy or control more than half of the claims, which allows them to make an appropriate plan for the claims. To this end they have been actively buying and selling NPLs for years. However, distressed debt funds have not been very active in Japan due to the sheer number of NPLs.
7. Are there any unusual features of your insolvency or restructuring law that an external investor should be aware of (such as equitable subordination, or substantive consolidation)?
Turnaround ADRs usually deal with creditors from financial institutions, like banks. They have some experience in dealing with private placement bonds but no experience with public bonds.
As we mentioned above, unlike Chapter 11 under US law, the CRL deals only with unsecured creditors. Secured creditors are free, in principle, to execute collateral and sell it at public auction.
Regarding priority issues, taxes and a certain portion of any unpaid employee salaries are classified as priority claims and given high levels of protection.
8. Are there any proposals for reform of the legal framework that governs insolvency and restructurings in your jurisdiction?
Turnaround ADR is becoming popular in Japan. One of the most difficult obstacles with regard to the use of this system is obtaining the unanimous consent of creditors. If one creditor objects to the restructuring plan, the ADR may collapse, and all of the debtor's and creditors' efforts will come to nothing. This is not economically reasonable. The Japanese Government announced plans to amend the law (the Industrial Competitiveness Enhancement Act), to allow a plan to be approved without unanimous creditor consent. However, it still remains to be seen how many creditors will need to consent to approve a plan.
9. If it was up to you, what changes would you make?
We need to modify the requirements for approval of creditors’ committees by courts. To date, no committee has been approved by a court under the CRL. The CRL provides that a majority of the unsecured creditors must approve a committee's involvement in the procedure and that it should represent all of the interests of all unsecured creditors. The required approval is difficult to obtain because of the possibility of there being a very high number of creditors, making it difficult to reach them and explain the committee to them within the time available. As the latter requirement can be interpreted to implicitly include the former, we would advocate deletion of the former to make committee approval easier.
We also think that the CRL and CR can be combined into one more streamlined procedure because so many similarities exist between the two procedures.