Insolvency proceedings in Japan consist of civil rehabilitation and corporate reorganisation for restructuring businesses, and bankruptcy and special liquidation, which are primarily aimed at liquidation. Both civil rehabilitation under the Civil Rehabilitation Act (Act No. 225 of 1999) and corporate reorganisation under the Corporate Reorganisation Act (Act No. 154 of 2002) are the procedures commenced by a court in response to a petition filed by a debtor or applicable interested party for the purpose of restructuring the business of a debtor. These procedures are collectively known as rehabilitation-type legal proceedings, under which restructuring of a debtor and distribution to creditors are implemented pursuant to a plan approved by a statutory majority of creditors and confirmed by the court.
Bankruptcy, under the Bankruptcy Act (Act No. 75 of 2004) and special liquidation, under the Stock Company, Liquidation section (Part II, Chapter IX) of the Companies Act (Act No. 86 of 2005) are also procedures commenced by a court after the appropriate petition and are collectively known as liquidation-type legal proceedings. While bankruptcy and special liquidation are pursued for liquidation as such, in practice, these proceedings also provide a useful means for restructuring the business.
Further, disciplines for private arrangements are also available, by which a debtor could carry out debt restructuring without potential disadvantages associated with the legal proceedings.
With respect to cross-border insolvency cases, foreign insolvency proceedings can be effective within Japan by obtaining a recognition order under the Act on Recognition and Assistance for Foreign Insolvency Proceedings (Act No. 129 of 2000), which was established in 2001, referring to the UNCITRAL Model Law on Cross-Border Insolvency. In addition, a debtor of a foreign insolvency proceeding may file a petition for Japanese statutory insolvency proceedings and once such petition is granted, Japanese and foreign proceedings can be initiated in coordination.
The first comprehensive bankruptcy law established in Japan was the Bankrupcty section (Part III) of the former Commercial Code (Act No. 32 of 1890), which was modelled on French law. The Bankruptcy section was soon claimed to be insufficient in providing means of monetising debtors' assets, and accordingly, the Bankruptcy Act (Act No. 71 of 1922) was established under the influence of German law. The 1922 Bankruptcy Act was in force for more than 70 years until the current Bankruptcy Act took effect. The revised Commercial Code of 1938 introduced, as an alternative to bankruptcy, special liquidation, by which liquidation of a stock company could be conducted in an effective manner.
With respect to rehabilitation-type proceedings, the Composition Act (Act No. 72 of 1922) was enacted together with the 1922 Bankruptcy Act. However, the Composition Act was not always fully functioning because of shortcomings such as that the grounds of commencement of composition were too limited, the requirements to approve the conditions of composition were too strict, and the implementation of the composition was not ensured.
The former Corporate Reorganisation Act (Act No. 172 of 1952) was established by referring to the US bankruptcy laws at the time. A reorganisation trustee had the exclusive power to control, administer and dispose of debtors' assets and also to manage the business of the debtor. By taking advantage of a reorganisation plan by which modification of both creditors' rights and organisational matters of the reorganisation company could be accomplished, the former Corporate Reorganisation Act functioned as a powerful tool in revitalising the business.
After the burst of Japan's economic bubble in 1991, many corporations went bankrupt and this became a social issue to be addressed. In response to the changes in the economic circumstances, an overall revision of the legislative insolvency regime was initiated in 1996. First, the Civil Rehabilitation Act was enforced on 1 April 2000 to overcome the shortcomings of the Composition Act. Second, the Corporate Reorganisation Act was significantly revised in 2002, with the intention of introducing speedier and more effective reorganisation proceedings and providing the reinforced reconstruction method to a reorganisation company. The current Bankruptcy Act was enacted in 2004, and finally, special liquidation was amended by the newly established Companies Act in view of streamlining the proceedings.
Rehabilitation-type legal proceedings
Civil rehabilitation and corporate reorganisation share their primary purposes (ie, enabling a distressed debtor to rehabilitate or reorganise under the procedure); however, they have distinguished characteristics, particularly in the following aspects.
Form of subject company
Corporate reorganisation is only available for stock companies established under the Companies Act, while civil rehabilitation is also available for other types of companies, legal entities and individuals.
Limitation on exercise of secured claims
In civil rehabilitation, security interests are treated as rights of ‘separate satisfaction', which means that secured creditors may generally exercise their secured claims regardless of the pending civil rehabilitation proceedings. In contrast, in corporate reorganisation, secured claims exercised prior to the commencement are stayed and further exercise is prohibited. Secured creditors shall also be bound by the reorganisation proceedings and their secured claims may be impaired in accordance with the reorganisation plan.
Status of management personnel
In corporate reorganisation, the court appoints a trustee who handles the operation of business, as well as the administration and disposal of assets of the reorganising company, and management personnel (ie, directors) of the company loses their managerial rights. Usually, an attorney with extensive experience in insolvency practice is appointed as a trustee.
In this respect, since 2009, the Tokyo District Court has introduced the so-called ‘DIP-style' corporate reorganisation, in which the incumbent management personnel may be appointed as a trustee under certain conditions (ie, inter alia, the management personnel shall not be a person who has been involved in any unlawful management and the involvement of such personnel in management of the reorganising company shall not be objected by major creditors). After the introduction of the DIP style, the other cases are often referred to as ‘administered-type' corporate reorganisation.
In civil rehabilitation proceedings, a trustee is generally not appointed, and the existing management personnel will continue to manage the company (debtor-in-possession).
Corporate reorganisation is designed for large companies, and it provides a powerful mechanism for reorganisation with the involvement of all interested parties to the distressed company. As a trade-off, the procedures in corporate reorganisation are generally complicated, strict and require much time and expenses to comply. However, as an effort to reduce these disadvantages in practice, the Tokyo District Court released the standard schedule, as shown in Chart 1, and the proceedings are currently proceeded in accordance therewith. The Tokyo District Court has also announced that the DIP style can be completed in a shorter time.
As for civil rehabilitation, the process from the petition to the confirmation of the rehabilitation plan is generally completed in approximately five months, as shown in Chart 2, which is the standard schedule issued by the Tokyo District Court. In comparison with corporate reorganisation, the procedures in civil rehabilitation are simpler and require shorter time and smaller expenses to comply. As such, also thanks to its feature that directors of a debtor company generally keep their position, civil rehabilitation is generally regarded as being a more debtor-friendly procedure, and, accordingly, debtors are often inclined to use civil rehabilitation rather than corporate reorganisation. Meanwhile, corporate reorganisation is used where it is necessary to bind secured creditors, or where more strict proceedings are required to cause management personnel to resign, such as where the company has become insolvent as a result of fraud, misconduct or similar. A recent trend has been the increase of the proportion of cases initiated by a petition filed by creditors among overall corporate reorganisation cases.
Standard schedule of corporate reorganisation (Tokyo District Court)
Overview of the proceedings
Petition for commencement
A debtor may file a petition with a court for the commencement of either corporate reorganisation or civil rehabilitation if there is: (i) a suspicion that the factual basis that constitutes the grounds for the commencement of bankruptcy (insolvent or unable to pay debts) would occur; or (ii) a suspicion that a significant hindrance to the continuation of debtor's business will occur, if the debtor repays its debts that are due. A creditor may also file a petition for the commencement of either procedure if there is a suspicion referred to in (i) above; provided that, with respect to corporate reorganisation, creditor(s), either individually or collectively, are required to hold claims that account for one-tenth or more of the amount of the stated capital of the stock company to file the petition. Shareholders, either individually or collectively, holding one-tenth or more of the voting rights of all shareholders may also file a petition in corporate reorganisation.
Orders issued prior to commencement
Temporary restraining order - To prevent the debtor's assets from being dispersed and to protect the assets from any preferential repayments prior to the commencement, the court may order a provisional seizure or provisional disposition or issue any other necessary temporary restraining order concerning the debtor's business and property, such as an order to prohibit the debtor from making repayments to creditors.
Supervision order - The court, when it finds it necessary, may issue an order of supervision by a supervisor. The responsibilities of a supervisor cover various matters, such as giving consent to certain actions by the rehabilitation debtor, conducting investigation on the business and property of the rehabilitation debtor, preparing an opinion letter on a proposed rehabilitation plan and supervising the implementation of the rehabilitation plan. In practice, a supervisor is generally appointed from among experienced insolvency attorneys.
Appointment of provisional administrators and provisional order - Usually a petition for a provisional administration order is filed at the same time as a petition for the commencement of the reorganisation proceedings is filed, and the court appoints a provisional administrator, generally from among experienced attorneys, to maintain the status of the company's assets ‘as is'. Upon the appointment, the provisional administrator is vested with the exclusive rights to administer and dispose of the company's estate until the commencement of the proceedings.
Supervisor for DIP-style reorganisation - In case of a DIP-style reorganisation case, the existing management maintains the rights to administer and dispose of the property and manage the business before the commencement of the proceedings; however, to prevent the property from being dispersed, a provisional order, such as an order to prohibit the company from making repayments to creditors, is issued, generally immediately after the petition is filed. In addition, the court generally appoints an experienced attorney who serves as both a supervisor and an investigator.
Where a petition for the commencement of the rehabilitation or reorganisation proceedings is duly filed and the grounds for the commencement are satisfied, the court issues an order of the commencement of rehabilitation or reorganisation proceedings.
With respect to the reorganisation proceedings, the court, upon making an order of the commencement, appoints a reorganisation trustee. The provisional administrator is usually appointed as a reorganisation trustee and continuously manages the company's business. In case of the DIP-style proceedings, the existing management is appointed as a trustee and the attorney who served as the pre-commencement supervisor and investigator is appointed as an investigator for post-commencement proceedings in general.
No trustee is appointed in Civil Rehabilitation other than exceptional cases but the debtor is continuously supervised by the supervisor.
Right of avoidance
In corporate reorganisation, the reorganisation trustee has the right of avoidance to nullify debtor's conduct occurring before the commencement of the proceedings that is detrimental to creditors. Specifically, debtor's conduct that either unduly reduces the estate (fraudulent conduct) or impairs the equality of creditor (preference) are subject to the execution of such right.
In addition, in civil rehabilitation, the fraudulent conduct and preference of the debtor before the commencement can be nullified by the right of avoidance. While the right of avoidance is exercised by a trustee in corporate reorganisation who has the ability to administer and dispose of the estate, in civil rehabilitation it is not exercised by a debtor who has such ability but by a supervisor whose primary duty is to supervise a debtor during the proceedings.
Filing, investigation and determination of claims
An unsecured creditor needs to file a proof of claims with the court under the rehabilitation or reorganisation proceedings. A secured creditor also needs the filing in corporate reorganisation. In civil rehabilitation, a secured creditor is not required to file a proof of secured claims (though it still needs to file a proof of the unsecured portion of a claim) as it may exercise its security interest regardless of the pending proceedings.
A rehabilitation debtor or reorganisation trustee prepares a statement of approval or disapproval providing whether the claims and the amount of voting rights that have been filed are approved or not, and submit the statement to the court.
A creditor who has filed a proof of its claim may make an objection to the court, within the ordinary period for investigation designated by the court, with regard to the content of a claim stated in a statement of approval or disapproval.
For the claims that were approved by a rehabilitation debtor or reorganisation trustee and to which no objection was raised by any creditor, the content and the amount of the voting rights are determined. In contrast, for the claims that were not approved, or to which an objection was raised during the investigation period, an assessment procedure is implemented to determine the claims.
Preparation and submission of evaluation report, etc
A rehabilitation debtor or reorganisation trustee shall evaluate the value of any and all property that belongs to the debtor, and prepare an evaluation report to be submitted to the court. A rehabilitation debtor or reorganisation trustee shall also prepare an inventory of assets and balance sheets based on the evaluation and submit the same to the court.
Submission of proposed plan to the court
A rehabilitation debtor or reorganisation trustee shall prepare a proposed rehabilitation or reorganisation plan specifying matters such as a policy to rehabilitate or reorganise the debtor's business, modification of rights held by the creditors and payment plan, and submit it to the court.
Creditors who filed the claims may also submit a proposed plan to the court.
Resolution of proposed plan
The proposed rehabilitation plan is approved by obtaining the consent of both the majority of the creditors who exercise voting rights and the creditors that account for not less than half of the total amount of the voting rights.
The proposed reorganisation plan is approved, as a general rule, by obtaining approvals by statutory majority from two classes of creditors (ie, (i) more than half of the total amount of voting rights held by reorganisation creditors; and (ii) no less than two-thirds of the total amount of voting rights held by secured reorganisation creditors).
Confirmation of plan
The court shall make an order of confirmation of the rehabilitation or reorganisation plan approved by creditors unless any of grounds for disconfirmation stipulated in laws, such as infeasibility to implement the plan, the plan's contents being unfair or inequitable and the like, exists.
Once the order of the confirmation becomes final and conclusive, the rehabilitation plan becomes effective, and the rights of the rehabilitation creditors are modified in accordance with the rehabilitation plan. On the other hand, the reorganisation plan becomes effective upon issuance of an order of confirmation, before it becomes final and conclusive.
Implementation of plan and close of proceedings
A rehabilitation debtor or reorganisation trustee implements the confirmed plan, such as making payments in accordance with the plan.
As a general rule, where a supervisor is appointed under the rehabilitation proceedings, such proceedings are closed after three years have elapsed since an order of confirmation of the rehabilitation plan became final and conclusive. With respect to the reorganisation proceedings, the court shall make an order to close such proceedings, where the payment of the debts in accordance with the reorganisation plan has been completed or where the payment of more than two-thirds of the debt has been made and the court does not find that the reorganisation plan is unlikely to be implemented.
Comparison of corporate reorganisation (DIP and administered) and civil rehabilitation
Liquidation-type legal proceedings
Among the two types of court-based liquidation procedure (bankruptcy and special liquidation), bankruptcy has its emphasis on pursuing the liquidation in an equal and fair manner pursuant to the strict statutory procedures. By contrast, special liquidation was originally enacted for the purpose of mitigating adverse effects that would derive from the strict nature of bankruptcy; namely, the significant amount of time and expenses involved in the proceedings. As such, first, special liquidation is pursued by a liquidator appointed by a resolution of a shareholders' meeting of the company, as opposed to a trustee appointed by a court in bankruptcy. Second, while bankruptcy proceeds pursuant to the statutory procedures, special liquidation is designed to enable a liquidator to implement the proceedings flexibly and swiftly on the basis of the autonomy of interested parties (ie, a liquidating company and its creditors).
For instance, a trustee appointed by a court in bankruptcy makes monetary distribution to creditors on a pari passu basis strictly in accordance with the preferential order of claims designated by the law. Whereas, in special liquidation, the treatment of creditors in a repayment plan may deviate from a pro rata basis if either the creditors agree with such treatment or such treatment is applied only to minor claims in a fair manner, thereby providing a liquidator with flexibility in designing the plan.
A comparison of features of bankruptcy and special liquidation is provided in Chart 4. As indicated in the chart, while the distribution is conducted by following the law in bankruptcy, either executing an agreement with each and every creditor or obtaining the approval of a creditors' meeting on a repayment plan is necessary to implement the repayment in special liquidation. Accordingly, if creditors are unlikely to cooperate with the procedure, a debtor may wish to consider bankruptcy instead of special liquidation. Moreover, in cases where a fraudulent transfer is found, bankruptcy is suitable, as a trustee in bankruptcy is equipped with the right of avoidance, whereas such mechanism is not provided in special liquidation.
Special liquidation is particularly used for liquidation where, for instance, a parent company, management or a major creditor is able to provide the funds or necessary assistance for liquidating the company smoothly. Further, since special liquidation enables interested parties to implement the proceedings by its initiative, it is frequently used as a method of restructuring by combining it with a business transfer or a company split.
Comparison of bankruptcy and special liquidation
Having the court-based insolvency procedures described above as a backbone, many insolvency cases in Japan are also worked out through so-called private arrangements, referring to a process in which a debtor and creditors negotiate and implement a debt restructuring plan on a consensus basis without the involvement of a court. Similar to the workouts conducted in other jurisdictions, notable advantages of the private arrangements in comparison to the court-based procedures are reduction or even elimination of negative impact on corporate value (by not involving trade creditors); the status of being ‘behind the curtain'; the flexibility in designing a restructuring plan; and the increased speed in completing the process. While private arrangements can be conducted without referring to any publicly available mechanism for restructuring (known as ‘genuine' private arrangements), many cases have recently been worked out on the basis of such mechanism. These include:
- special conciliation, in which a debtor and creditors reach an agreement before a court, or otherwise a court can issue a binding resolution, without consensus of the parties under certain circumstances;
- the Guidelines for Out of Court Workouts, which are designed to provide a procedure conducted in a transparent manner for a debtor company and financial creditors to agree on a restructuring plan on a consensus basis;
- restructuring assistance provided by the Small and Medium-sized Enterprise Revitalisation Support Council or the Regional Economy Vitalisation Corporation respectively, both of which are entities established by the law for the purpose of, among others, assisting debt restructuring of a distressed company; and
- turnaround ADR, which is a procedure established by the law for the purpose of helping a distressed company to reach an agreement with financial creditors by the involvement of an impartial third party authorised by the Minister of Economy, Trade and Industry.
Special conciliation is included in the mechanism for private arrangement, even if the procedure is done before a court, because it does not have the effect of prohibiting creditors from enforcing their rights, nor does it provide a binding effect of a restructuring plan on a majority basis. The Guidelines for Out of Court Workouts have not been used recently, as the procedure must be commenced by the initiative of both a debtor and the ‘main bank' of the debtor, thereby often resulting in a significant burden on such bank in practice. Turnaround ADR functions as a substitute to the Guidelines to a certain extent; however, it is generally regarded as the suitable procedure particularly for large companies.
Effect of foreign insolvency proceedings in Japan
In case of a debtor whose insolvency proceedings have commenced outside Japan and who has its business office or assets in Japan, such debtor may obtain a decision of the Tokyo District Court, which has exclusive jurisdiction over recognition cases, to recognise the foreign insolvency proceedings so as to give effect to them within Japan, or may separately file a petition for commencement of insolvency proceedings in Japan concurrently with the foreign insolvency proceedings.
Recognition and assistance proceedings
In Japan, the Act on Recognition of and Assistance for Foreign Insolvency Proceedings was established referring to the UNCITRAL Model Law on Cross-Border Insolvency and enforced in April 2001.
The recognition and assistance proceedings under the aforementioned act are the proceedings to recognise foreign insolvency proceedings so as to give effect to them within Japan. However, the order to recognise foreign proceedings in Japan does not have any specific effect in itself and only works as a precondition for assistance order; ie, it allows the court to order proceedings such as stay of compulsory execution, or prohibition of repayment.
Concurrent insolvency proceedings
A debtor whose insolvency proceedings have commenced outside Japan may file a petition for bankruptcy or civil rehabilitation if it has either its business office or assets in Japan, or for corporate reorganisation if it has its business office in Japan. A trustee of foreign insolvency proceedings is allowed to file a petition for these proceedings in Japan. For the case that insolvency proceedings is concurrently commenced in Japan, the relevant Japanese laws prescribe the provisions concerning mutual cooperation and provision of information between a trustee in Japan (a debtor) and a foreign trustee.
In this regard, in the case that insolvency proceedings are being processed both in and outside Japan, the hotchpot rule is applicable under Japanese laws, pursuant to which, if a creditor has received any repayment under foreign insolvency proceedings after the order of commencement of Japanese insolvency proceedings, such creditor may not receive any repayment under the Japanese insolvency proceedings until any other creditor with the same priority has received repayment in the same proportion.
Recognition of Japanese insolvency proceedings in foreign countries - Re Elpida Memory Inc.
Laws to recognise foreign insolvency proceedings have been enacted in many jurisdictions based on the UNCITRAL Model Law on Cross-Border Insolvency. Japanese insolvency cases utilising the recognition proceedings in other jurisdictions have been increasing in cases where the debtor has its assets located outside Japan and needs to protect them from foreign creditors' actions for recovery. However, while the recognition of Japanese insolvency proceedings in other jurisdictions prohibits creditors from exercising their rights against assets located in that jurisdiction, modification of creditors' rights made under the rehabilitation or reorganisation plan does not become effective or binding in that jurisdiction by the recognition of the proceedings.
In this regard, reorganisation trustees of Elpida Memory Inc, a major DRAM manufacturer in Japan, obtained, in addition to an order to recognise the reorganisation proceedings, an order to recognise the reorganisation plan confirmed in Japan from the Delaware bankruptcy court under the proceedings stipulated in Chapter 15 of the United States federal bankruptcy code, thereby enabling the trustees to implement the plan in the United States accordingly.