Business turnaround following the covid-19 pandemic in Japan


In summary

This article introduces and summarises the current economic circumstances following the covid-19 pandemic in Japan, explains measures relating to business turnaround and provides a brief outlook on anticipated post-covid-19 business restructuring.


Discussion points

  • Overview of the current situation in Japan (2021 to 2022)
  • Outlook on restructuring and insolvency following the pandemic

Referenced in this article

  • SME Vitalisation Council
  • Guidelines for business turnaround of SMEs
  • Guidelines for debt workouts of company managers’ guarantee obligations
  • Turnaround ADR
  • Special conciliation

Following the covid-19 pandemic

It remains uncertain when the covid-19 pandemic will come to an end in the true sense, but with fatality rates gradually falling and vaccination programmes progressing, Japan is trying to find its way back to normality – although what ‘normal’ means has gone through changes in people’s minds over the past few years. In contrast to Europe and the United States, where the restrictions on behaviour and border measures were eased some time ago, in Japan, restrictions and other preventive measures on travel, movement, face masks and other behaviours and actions based on a declaration of a state of emergency largely remained in place until March 2022. With respect to its borders, from March 2022, Japan again started to accept international students and foreign technical intern trainees, as well as business travellers, but to a limited extent. And at the time of writing, only foreign tourists from limited areas, such as Europe and North America, where covid-19 infections are considered settled, are permitted to enter Japan in the form of participation in tours hosted by registered travel agencies under the Travel Services Act. Foreign tourists are not allowed to freely travel to tourist sites or enjoy shopping, and are asked to travel with attendants and to always wear masks in public. It has been hard for the tourism industry, the aviation industry, and the restaurant and hotel industry, which largely relied on revenue generated from certain numbers of foreign tourists coming in.

Overview of the state of the Japanese economy

With respect to the external environment in which the Japanese economy operates, owing to the sharp rise in energy prices due to Russia’s invasion of Ukraine and the plummeting value of the Japanese yen, which is believed to have mostly arisen from the continuing relative deflation and ultra-low interest rates in Japan, contrasting sharply with the recent inflation and higher interest rates in the United States, Japan is beginning to face a more severe economic environment.

In the past, the depreciation of the Japanese yen was generally regarded as an advantage for Japanese companies, as it allowed companies to easily enjoy a trade surplus. However, in recent years, many, if not most, Japanese companies have been shifting to overseas production and manufacturing; therefore, it is more challenging to enjoy the benefits of Japanese yen depreciation. Instead, the rise in procurement costs, which more or less correlate with import costs for many Japanese companies, has resulted in negative consequences for enterprises as a result of the Japanese yen being weaker. Although Japanese companies seem to have delayed passing procurement costs on through sales prices, they can only do so for so long, and in the past months, for example, food prices have risen rapidly to the highest in 10 years. The rising prices of commodities has not only started to squeeze companies but also consumer household budgets.

While Russia’s invasion of Ukraine has yet to end, because Japan lacks fossil fuel resources, it must depend on imports of energy resources or on non-carbon energy or nuclear energy for electricity power generation. However, after the Fukushima nuclear power plant accident, there is a strong sense of caution about restarting nuclear power plants. Further, as a backdrop, some new power companies that emerged following the deregulation as an indirect fallout of the Fukushima accident, as well as emerging renewable energy companies, have recently been experiencing financial difficulties, with some even seeking insolvency protections, as a result of certain pricing mechanisms based on market and business regulations that resulted in their failure to recoup their initial capital expenditures through electricity sales while experiencing challenges in rising procurement and other operating costs. To date, no effective solution has been found for the energy cost issue.

In terms of monetary policy, the United States has increased interest rates to stop inflation, while Japan continues a policy of monetary easing to support Japan’s economic downturn, so it is possible that the Japanese yen will continue to depreciate. Thus, the Japanese economy is now in an uncertain situation, on top of uncertainties arising from the financial challenges that many enterprises and businesses are expected to face in the course of their post-covid-19 recovery.

Insolvency and restructurings

With regard to insolvencies – including bankruptcies – and restructurings, contrary to initial expectations, Japan has not seen a rapid spike in the number of insolvency and restructuring cases; rather, there has been a decrease in the number of insolvencies and restructurings.

According to Teikoku Data Bank, 2021 had the lowest level of recorded bankruptcies (6,015 cases) for any year since 1966. This is believed to be, at least in part, because of government efforts to actively promote measures to aid and support ailing businesses since the start of the pandemic. It is fair to say that those measures have been somewhat successful in allowing enterprises to avoid immediate bankruptcy or insolvency, and that they have prolonged the lives of impacted enterprises. This is especially notable considering that, in Japan, contrasted with other foreign countries and jurisdictions where courts were shut down for extended periods, the bankruptcy courts in Japan did not close for any significant period.

However, the existing measures mostly comprise emergency loans and guarantees, as well as extensions on taxes and other public payments, with only small amounts of grants and subsidies, and such extensions and benefits came to an end in 2021. Hence, it is expected that an increasing number of enterprises are or will be carrying more debt than they can repay, and that those businesses are, or soon will be, facing financial difficulties, despite the small breathing room the government measures have provided. In other words, there is no guarantee that those well-intended measures will be enough to allow troubled enterprises to sustain their business endeavours or maintain manageable debt service levels. If this proves to be true, more likely than not, banks and other financial institutions will accelerate their disposition of non-performing loans, especially once the economy returns to a more normal state. Recently, fraudulent receipts of grants and subsidies have emerged. If distressed businesses have similar issues, it could be a hurdle for future business revitalisation.

Outlook: once the dust settles?

One interesting aspect of the pandemic’s impact on economies worldwide is that the financial markets, and equity markets in particular, have not stagnated. Rather, with most – if not all – central governments taking proactive measures to support their economies, and central banks lowering interest rates to allow more funds to flow through to the economy, stock exchanges and private equity markets are booming in many countries.

This can also be said of the Japanese market. With investors pouring more funds into the market, money has currently become more available to many enterprises, regardless of their fundamental situation. As a result, concerns have been raised that the number of ‘zombie’ companies is increasing, on top of the already high number of zombie companies that resulted from the prolonged, extremely low interest rate market and deflation that existed in Japan for more than two decades prior to the onset of the covid-19 pandemic.

It is expected and desired that government-affiliated financial institutions, private financial institutions and private equity funds will play a significant role in supporting business operators’ financial situations and that enterprises in Japan will experience business transformations and other developments, while simultaneously providing a much-needed boost to industry.

The pandemic has caused immense changes to people’s way of life; however, it is also possible that it merely accelerated some much-needed changes that enterprises could not push themselves to undertake before facing this unprecedented level of difficulty.

We are already starting to see large and medium-sized enterprises responding to these long-awaited changes by withdrawing from unprofitable businesses, returning their focus to core businesses via selection and concentration, and funding these efforts through the use of preferred stock and subordinated loans from financial institutions. Financing to companies in industries affected by the pandemic, such as Japan Airlines (aviation), AIRDO (aviation), Solaseed Air (aviation), JTB (travel), Fujita Kanko (hotel and bridal) and TAKE and GIVE NEEDS (bridal), has been catching the eye of market participants; these companies have been able to avoid in-court insolvency and restructuring procedures through tapping early-stage out-of-court workouts.

The enterprises struggling most in the face of the pandemic are small and medium-sized enterprises (SMEs). According to 2016 statistics, 3.57 million SMEs were operating in Japan – a number higher than most other countries in the world. When looking at SMEs that have received funding support for the pandemic, given that the grace periods for taxes and social security premiums that began being offered in 2020 have lapsed as a general rule, SMEs for which funding is tight will need to begin workouts in the not-too-distant future, owing to the need to resume paying taxes and public duties.

However, difficulties associated with making those payments continue to arise because the business base is still being affected by the pandemic; the sales, cash and revenue flows of SMEs have fallen, and it will continue to be difficult for those enterprises to come up with the funds required to restructure and to establish the workout plans required to come up with the funds to finance restructuring. It may be necessary to adopt more drastic revitalisation measures – as opposed to earlier stage workouts – to assist enterprises that cannot gain access to extended grace periods, other rescheduling or other sources of financing before the economy returns to its normal state. The measures may include severe options, such as liquidating the corporation, transferring a company’s business to a sponsor, offloading any remaining debt and closing businesses. It could well be that the use of rule-based workout initiatives will be a ‘last ditch’ effort to avoid the final option of liquidation.

In Japan, the low interest rate environment and the prevalence of deflationary markets resulted in the adoption of a number of rule-based workout initiatives. Among them are two rule-based out-of-court workouts initiatives that can be used by SMEs: guidelines for business turnarounds of SMEs, which was newly introduced in March 2022, and turnaround alternative dispute resolution (ADR). These workouts are designed to be easy to use and provide a moratorium (or stay), and both call for financial institutions to sit at the bargaining table (and government agencies have been asking that financial institutions do so). From the perspective of financial institutions, in addition to the predictability of those procedures, they are easier to accept because they contain explicit statutory grounds for non-taxed write-offs being permitted when financial debts are waived through those procedures.

Turnaround programmes for SME vitalisation

In March 2022, the Ministry of Economy, Trade and Industry, in collaboration with the Financial Services Agency and the Ministry of Finance, formulated the SME Vitalisation Package to develop comprehensive support measures to improve profitability, revitalise and allow rechallenges by SMEs suffering from increasing debt and continue liquidity support for SMEs.

This includes (i) the continued provision of emergency loans and subordinated loans by government-affiliated financial institutions, the flexible operation of the deferral system of tax and social insurance premiums (including reducing delinquent taxes), and (ii) comprehensive support for SME profitability improvement and business revitalisation by the SME Vitalisation Council, expansion of the business revitalisation fund funded by government-affiliated funds, as well as the formulation of new guidelines for SME business turnarounds and guidelines for debt workouts of company managers’ guarantee obligations as another rules-based out-of-court workout process.

Out-of-court workouts based on guidelines for business turnarounds of SMEs are procedures aimed at facilitating the smooth business rehabilitation of SMEs by granting grace periods to repay debts (mainly financial debts) and debt reductions and exemptions, etc, for SME debtors experiencing difficult business conditions, based on agreements between SMEs that are debtors and financial creditors (non-financial creditors such as bondholders or trade creditors can also be included, but that is not the anticipated norm), not through in-court insolvency proceedings, namely bankruptcy proceedings, civil rehabilitation proceedings, corporate reorganisation proceedings or special liquidation proceedings.

In considering the availability of this procedure, SMEs will select candidates for ‘support experts’ (experts such as lawyers and certified public accountants who have obtained qualified accreditation) who are third-party experts, and notify major creditors that they are considering an out-of-court workout based on guidelines for business turnarounds of SMEs; at the same time, SMEs will obtain consent from all major creditors, initially only for the appointment of third-party support experts. After requesting a temporary suspension of loan repayments to the target creditors, SMEs, with the support of a third-party support expert, will formulate a business revitalisation plan that must address the following items:

  • ways or measures by which to resolve substantial excess debt within five years;
  • ways or measuress by which to ensure ordinary income will be converted into a surplus within three years;
  • the business revitalisation plan must result in the cash flow ratio of interest-bearing debt in the final year of the plan being 10 times or less; and
  • shareholder responsibilities (but only if the debtor SME is to call for a debt reduction and exemptions), management responsibilities and a policy for liquidating warranty liabilities when guaranteed by management.

When all target creditors agree to a proposed plan and a third-party support expert confirms this in writing, a business revitalisation plan is confirmed. In addition, third-party experts and major creditors will regularly conduct monitoring in the three fiscal years following the enactment of the confirmed plan.

Interestingly, in addition to restructuring-type out-of-court workouts, these guidelines also stipulate an out-of-court workout processes for business discontinuation, namely discontinuance-type procedures. In the process described above, if a third-party support expert or major creditors determine that the business is unlikely to continue, and if the debtor SME submits an application for business discontinuance, the debtor SME may draft the necessary measures such as the liquidation of assets for business discontinuance and formulate a repayment plan. In this case, the draft plan must also be economically rational for the target creditors, such as the prospect of obtaining a better recovery than the liquidation value to be distributed in the bankruptcy proceedings.

When implementing discontinuance-type procedures for SME debts, and the guarantor intends to arrange warranty obligations for such debts, the guarantor must disclose assets in good faith and utilise guidelines for debt workouts of guarantee obligations of the debtor company’s management in an effort to integrate the principal obligations and guarantee obligations.

Until now, the SME Revitalisation Support Council (renamed the SME Vitalisation Council), a neutral third-party organisation, had established separate procedures and supported drafting plans and organised out-of-court workout procedures. From now on, however, even SMEs that are unable to formulate plan proposals required by the SME Vitalisation Council procedures because of the impact of covid-19 or other factors can select third-party support experts and proceed with business revitalisation on their own with the consent of the target creditors. It is hoped that SMEs working to improve their businesses in post-covid-19 climates will accelerate their efforts to revitalise their businesses based on a shared understanding with financial institutions that are eligible target creditors to take steps toward sustainable growth.

Turnaround ADR

Turnaround ADR is another popular rule-based out-of-court workout procedure in which third-party experts coordinate communications between creditors, such as financial institutions, and debtors to support debtor companies’ earlier stage business revitalisation.

The Japanese Association of Turnaround Professionals, as a specific certified dispute resolution business operator, is responsible for conducting the ADR procedures. There is no limit on the size or industry of debtor companies that can apply to use turnaround ADR. The system can be used by SMEs and larger companies, and, as it does not involve any court oversight or supervision, no cramdown is available, either in class or cross-class, and unanimous consent by the relevant creditors is required.

From the preconsultation stage, a debtor contemplating using the procedure is called upon to conduct its own due diligence and develop an outline of its business revitalisation plan. The debtor’s efforts are surveyed and overseen by a third-party expert, who is also scheduled to be retained by the Association to serve as the overseeing expert.

If there is a possibility that the proposed plan will be approved, an official application will then be made, a suspension notice will be sent to target creditors, mainly financial institutions, and a creditors’ meeting will be convened to appoint a third-party expert as a procedural implementer who will explain an outline of the debtor’s proposed business revitalisation plan to the creditors.

If any creditors disagree with the plan, it is assumed that special conciliation, as described below, will be used or a transition to in-court insolvency procedures will occur. In the case of a transition to in-court procedures, to allow for a smooth transition (which, in turn, incentivises relevant parties to do as much as possible within the ADR procedure), the following support measures, which respect the results and actions taken during the course of the turnaround ADR, have been institutionalised and codified:

  • facilitation of priority payment of commercial claims in in-court procedures;
  • facilitation of priority payment of bridging loans (pre-DIP finance); and
  • simplified procedures relating to the expedition of special conciliation procedures, etc.

The three concepts listed above have been introduced statutorily, rather than just in the Association rules, and under the amended Act on Strengthening Industrial Competitiveness, which came into effect in June 2021.

Further, a transition to simplified civil rehabilitation procedures will also be facilitated if more than three-fifths of the creditors whose total claims are covered agree to the plan, even if there are also opposing creditors.

However, the amendment did not function effectively enough in one recent ADR case. Media outlets have been reporting that MARELLI Holdings obtained consent from most of the financial creditors through its turnaround ADR process, but it had to abandon the process because it was not able to obtain consent from a minority of financial institutions, and it filed a petition for a simplified civil rehabilitation procedure with the Tokyo District Court. As mentioned above, the amendment was originally aimed at promoting unanimous consent at the turnaround ADR stage by preventing minority financial creditors holding out and effectively gaining a veto right in an unreasonable fashion, backed up by the transition to a simplified civil rehabilitation procedure. However, the MARELLI case apparently did not go as the amendment intended.

To avert such scenario, one additional amendment to possibly address the issue is to allow a cramdown through votes by the relevant creditors, effectively allowing the majority vote to cause the proposed restructuring plan to become effective. In the New Capitalism Grand Design and Implementation Plan approved by the Cabinet of Japan in June 2022, the government clearly stipulated ‘the establishment of legislation for out-of-court workouts for business restructuring’ while indicating that ‘in other countries, there is a system to change creditor’s rights (eg, reduction of financial debts) by majority vote with the approval of the court.’ So there is a possibility that there will be additional amendments to turnaround ADR processes allowing a cramdown in the course of the process to further facilitate the use of, and in turn the resultant business restructuring through, the out-of-court turnaround ADR processes.

Special conciliation

Special conciliation is a conciliation, the process for which is governed by the Act on Special Conciliation Proceedings for Expediting Arrangement of Specified Debts, that pertains to an adjustment or arrangement of debts to contribute to the economic rehabilitation of debtors who are likely to become unable to pay debts. It thereby aims to expedite the arrangement of interests pertaining to the monetary debts of the debtors.

From April 2020, the Tokyo District Court has launched a programme to expedite a special conciliation process, within the court divisions that handle civil rehabilitation cases and corporate reorganisations, when only a certain creditor or set of creditors oppose a plan presented in a prior out-of-court workouts. The target companies are those whose proceedings have been converted from formal, rule-based out-of-court workouts or who already have held creditors meetings for their financial creditors and have had property assessment reports evaluated by certified public accountants or rehabilitation plans based on those assessments.

According to article 17 of the Civil Conciliation Act, if an agreement among the parties is unlikely to be reached, the court may issue a necessary order to resolve the case. The order has the same effect as a successful conciliation if no parties object within a certain period, and the court announces positive use of the order as necessary.

If out-of-court workouts using the rule-based procedures outlined above or special conciliation do not work (eg, owing to an inability to obtain the unanimous consent of the creditors) or if the transition from turnaround ADR to simplified civil rehabilitation does not meet the relevant requirements, conventional civil rehabilitation procedures and corporate reorganisation procedures must be used to restructure a business, as those in-court restructuring processes are usually the only remaining choices.

Closing remarks

At the earlier stages of the covid-19 pandemic, people in Japan anticipated that the number of insolvencies, especially bankruptcies, would increase rapidly; however, the number of insolvencies and restructuring cases did not spike dramatically. For example, bankruptcies triggered by the pandemic have reached neither the number arising from the global financial crisis stemming from the Lehman shock, nor those triggered by the Tōhoku earthquake and tsunami. This is owing to quantitative easing and the cooperation of financial institutions.

However, attempts at solutions have been provided only in the context of postponements and tentative rescheduling, which merely prolong the life of struggling enterprises by delaying the problems rather than offering real resolutions; this causes a lot of groping in the dark, with no exit clearly visible.

In Japan, as in other parts of the world, the path to economic recovery will gradually become clearer. Moreover, there is probably no way around the fact that a clear divide will grow between enterprises that adapt to the new way of life, often referred to as the ‘new normal’, and those that are less successful in adapting to the new normal. For example, even in industries where overall sales recover to pre-pandemic levels, there will be enterprises that are unable to return to pre-pandemic sales levels owing to their failure to adapt to the changing times; on the other hand, there also will be enterprises that will have gained more momentum than they had pre-pandemic.

Some economists and market participants are calling this phenomenon a ‘K-shaped economic recovery’, where there will be a mix of companies that return to successful performance and those that do not return to pre-pandemic sales levels. Importantly, in terms of insolvencies and restructuring, as we move towards this anticipated K-shaped economic recovery, we anticipate a wave of accelerated restructuring, both in terms of operational restructuring and financial restructuring (to finance operational restructuring) as, more likely than not, there will be an abundance of enterprises that unfortunately will be left behind in adapting to the new normal.

In addition to responding to post-pandemic ways of life and changes in how our societies function, changes in the business environment, such as digital transformations and responses to sustainable development goals, will be constant and will continue to grow in importance. Recent economic challenges arising from the spikes in commodity prices, energy costs, import procurement costs and the weaker Japanese yen will all compound the importance of, as well as the difficulties in achieving, the goals. In that respect, we expect that insolvencies and restructuring will place more importance on facilitating and accelerating each enterprise’s business metabolism, as well as that of the industries and the economy overall, as we move into an ever- and faster-changing business and commercial landscape.

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