The New Japanese Reorganization Procedures

Journal Issue

Oct 2001

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In April 2000, the new Civil Rehabilitation Law (Minji Saisei Hou, or CRL)
came into effect in Japan. Before its enactment, there were three types of
reorganization systems in Japan: corporate reorganization (kaisha kousei), composition
(wagi) and corporate arrangement (kaisha seiri). CRL was to reform composition by,
roughly speaking, providing a speedy and reliable reorganization mechanism. Since its
effective date, CRL has been very popular with more than three times the number of
filings than under Composition Law.<a href="#1" name="1a">1</a> This article is intended to outline the main
features of CRL dealing with business debtors.<a href="#2" name="2a">2</a>

<h3>The Players</h3>

CRL, in principle, allows the pre-filing management of a debtor to remain in
operation and take carriage of the proceedings, like a debtor-in-possession in a
U.S. chapter 11 case. In most cases, the court oversees the case through a
court-appointed supervisor.<a href="#3" name="3a">3</a> The supervisor's main roles are (1) to grant or reject
certain conduct of the debtor, (2) to investigate the debtor's business operations
and/or assets, (3) to exercise avoidance powers and (4) to supervise
implementation of the plan.<a href="#4" name="4a">4</a> In the Tokyo area, a certified public accountant is
appointed as an investigator to check the accuracy of the debtor's financial
information. Creditors' committees can be organized, but very few have been organized
in practice so far.<a href="#5" name="5a">5</a>

In rather rare cases where the old management's misconduct is relatively clear, the
court will appoint a trustee. Subject to [the] court's supervision, the trustee is
empowered to exercise all of the power and authority of management in place of the
old management.

<h3>Substantive Concerns</h3>

Treatment of Secured Creditors, Setoff—In principle, secured creditors are, to the
extent that their claims do not exceed the value of the collateral, outside the CRL
proceedings. This means that secured creditors are free to foreclose on the collateral
in satisfaction of their claims. However, there are two important exceptions.
First, the debtor may ask the court to order a temporary injunction against a
creditor's foreclosure if it can show that the injunction will serve the general benefit
of the creditors and that the injunction is not likely to cause undue damage to the
foreclosing party.<a href="#6" name="6a">6</a> Second, the debtor may ask the court to determine the amount of
the secured claim and the value of the collateral.

The debtor may then pay the determined value of the collateral to the secured
creditor, and thereby protect the collateral that is essential for the business from
foreclosure.<a href="#7" name="7a">7</a> By contrast, the Corporate Reorganization Law prohibits, without
exception, foreclosure by secured creditors.

A creditor may set off its claim against its obligations to the debtor unless the
creditor's obligation accrued or arose after the commencement order or after the creditor
knew that the debtor had generally ceased making payments to its creditors, or unless
some other conditions are met. Such "allowed" setoff rights can be exercised only until
the deadline date for filing proofs of claim.<a href="#8" name="8a">8</a>

Avoidance Actions—Under the CRL, the debtor itself may not avoid its own conduct.
When a supervisor is appointed, he/she is authorized, to the extent empowered by the
court in each case, to avoid certain preferential transactions.<a href="#9" name="9a">9</a> A trustee, when
appointed, always has the avoidance power.

<h3>Flow of Procedure</h3>

A CRL case is triggered by the filing of a petition. It should be noted,
however, that the court strongly encourages pre-filing consultations by the petitioner
(usually the debtor) with the court in order for the court to manage the case
smoothly immediately after the filing. A commencement order will normally be issued
within a week after the filing.<a href="#10" name="10a">10</a> The automatic stay has not been adopted in Japan,
and it is the commencement order that stays pending and future litigation, enforcement
and provisional attachments against the debtor. Between the filing and the commencement
order, an injunction to stay these proceedings may be ordered by the court.

After the commencement order, creditors file their proofs of claim, and the debtor
will either admit or object to them. The debtor then normally submits its
rehabilitation plan.<a href="#11" name="11a">11</a> Under the plan, share redemptions can be carried out without
satisfying certain conditions that are otherwise available under the Commercial Code,
while the issuance of new shares must follow the provisions of the Commercial
Code.<a href="#12" name="12a">12</a> The plan must be approved at the creditors' meeting by a majority of the
creditors, both in number and in the amount of claims. If the plan is so approved,
court confirmation will be given unless (1) the plan is unlikely to be performed,
(2) the plan provides for less to creditors than in a bankruptcy (straight
liquidation) case, or (3) some other conditions are met. Some of the steps above
can be omitted with the approval of three-fifths of creditors in order to speed up
the procedures. An insolvent debtor's business may also be sold with the court's
approval after the commencement order.<a href="#13" name="13a">13</a>

One of the new features of the CRL that contrasts with the Composition Law is
the supervision mechanism provided in connection with plan implementation. In current
practice, where a supervisor is appointed, the court and the supervisor will supervise
performance of the rehabilitation plan for three years after confirmation.

As for the time span for CRL proceedings, the court strictly instructs that the
plan be approved within six months from the filing, and does not easily grant
extensions of the original deadline. The maximum time period for repayments under the
plan is 10 years.<a href="#14" name="14a">14</a>

<h3>Provisions Regarding Cross-border Insolvency</h3>

Reform under the CRL also includes cross-border insolvency cases. The CRL abolished
the notoriously strict territorialism of Japanese insolvency proceedings. A CRL
commencement order is now effective over the debtor's assets regardless of where they
are located. Other major reforms are as follows: Foreign trustees (including a U.S.
chapter 11 debtor-in-possession (DIP)) are given standing to file Japanese
insolvency proceedings and to be heard at the creditors' meeting.<a href="#15" name="15a">15</a> Cross-filing of
proofs of claim is explicitly allowed. A Japanese trustee (including a DIP) may
file proofs of claim with courts in foreign parallel insolvency cases on behalf of the
debtor's creditors who filed proofs of claim in Japan, and vice versa for foreign
trustees.<a href="#16" name="16a">16</a> Foreign trustees may file a rehabilitation plan if the original deadline
to file a plan is extended,<a href="#17" name="17a">17</a> and the so-called hotch-pot rule has been adopted
in international parallel insolvency distributions such that if a creditor is partly
repaid from foreign assets of the debtor, the creditor may not receive a distribution
in the Japanese case until the other creditors have received the same percentage on
their claim that the creditor has received.<a href="#18" name="18a">18</a>

<h3>Conclusion</h3>

Among Japanese reorganization mechanisms, the CRL is designed mainly for small-
and medium-sized business, while the corporate reorganization procedure is for larger
corporations. This is because (1) foreclosure of collateral is much more freely
granted under the CRL than under the corporate reorganization procedure, and (2)
the issuance of new shares can be carried out under a corporate reorganization plan,
but not under a civil rehabilitation plan. However, the swiftness and flexibility of
the civil rehabilitation process is sometimes attractive even to large corporations, and
most practitioners believe that the use of the new civil rehabilitation procedures will
continue to increase regardless of the size of the debtor and whether or not the case
involves cross-border concerns.

<blockquote>
Editor's Note:

In last month's column, Steven Golick was misidentified as leading
the team from Osler, Hoskin & Harcourt in the PSINet case; the lead counsel is
in fact Edward A. Sellers.

</blockquote>

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> 906 CRL cases were filed in its first year (April 1, 2000-March 31, 2001), whereas there were only 231 case
composition filings in the previous fiscal year (April 1, 1999-March 31, 2000). <a href="#1a">Return to article</a>

<a name="2">2</a> At the time of its enactment, CRL was mainly designed for small- and medium-sized business. In April 2001, new provisions
regarding rehabilitation of non-business individual debtors were added. <a href="#2a">Return to article</a>

<a name="3">3</a> Under CRL, Art. 54, §1, a supervisor is appointed "when the court considers it necessary." In practice so far, courts
have appointed one or more attorneys as supervisors in probably more than 90 percent of all cases. <a href="#3a">Return to article</a>

<a name="4">4</a> CRL, Art. 54, §2; Art. 59; Art. 56; and Art. 186, §2. <a href="#4a">Return to article</a>

<a name="5">5</a> This is probably because Japanese creditors are not used to the adversary system in an insolvency setting, and they basically rely
on the supervision of the court and a third-party lawyer/CPA. <a href="#5a">Return to article</a>

<a name="6">6</a> CRL, Art. 31. In practice, the term of such an injunction, when granted, is not long. <a href="#6a">Return to article</a>

<a name="7">7</a> CRL, Arts. 148-153. <a href="#7a">Return to article</a>

<a name="8">8</a> CRL, Arts. 92-93. <a href="#8a">Return to article</a>

<a name="9">9</a> The court may not confer avoidance powers if the court considers, for example, that a speedy reorganization is more important than
the exercise of avoidance powers. <a href="#9a">Return to article</a>

<a name="10">10</a> A commencement order can be obtained on the date of filing in a well-prepared case. <a href="#10a">Return to article</a>

<a name="11">11</a> A trustee, when appointed, as well as creditors, has the right to file a plan without any significant restriction. CRL, Art.
163. <a href="#11a">Return to article</a>

<a name="12">12</a> CRL, Art. 161, 166. <a href="#12a">Return to article</a>

<a name="13">13</a> CRL, Art. 42-43. Note that sale of business may be done at any time after the commencement order. <a href="#13a">Return to article</a>

<a name="14">14</a> CRL, Art. 155, §2. <a href="#14a">Return to article</a>

<a name="15">15</a> CRL, Art. 198, §§1 and 2. <a href="#15a">Return to article</a>

<a name="16">16</a> CRL, Art. 199. <a href="#16a">Return to article</a>

<a name="17">17</a> CRL, Art. 198. §3. <a href="#17a">Return to article</a>

<a name="18">18</a> CRL, Art. 89. <a href="#18a">Return to article</a>

Journal Authors

Masafumi Kodama

Journal Date

Monday, October 1, 2001 - 12:00

Bankruptcy Rule

2001