The Japanese Corporate Reorganization Reform Law of 2002

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Mar 2003

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There are three types of reorganization laws in Japan: the Corporate
Reorganization Law (Kaisya Kosei Ho), the Civil Rehabilitation Law (Minji
Saisei Ho) and the Corporate Arrangement under the Commercial Code (Kaisya
Seiri). The Civil Rehabilitation Law (Minji Saisei Ho) is a new type of
insolvency procedure introduced in 1999 and has been in effect since April 1, 2000.
This is a debtor-in-possession (DIP)type of procedure under the supervision of
the court that has been very popular among distressed Japanese debtors. Almost
1,300 cases were filed between April 2000 and September 2001. The Corporate
Arrangement was introduced in 1938 to allow courts to formulate private
workouts. Since it requires the corporate arrangement plan to be approved by
all creditors, few debtors now file under this procedure. The Corporate
Reorganization Law, which was enacted in 1952 and reformed in 1972, has now
been reformed again and will become effective on April 1, 2003.

<h3>Purpose of Revising the Corporate Reorganization Law</h3>

One
of the main reasons for revising the Corporate Reorganization Law (Law) was to
make it easy to use both for debtors and creditors. The strongest advantage of
a petition under the Law is that it binds secured creditors as well as
unsecured creditors in the procedure. Other procedures, even under the Civil
Rehabilitation Law, cannot bind secured creditors. The number of filings under
the Law, however, ranged from as few as four to at most 57 in each year over
the last 20 years. The reason for this relatively small number of filings is
said to be that the procedure under the Law is too slow, inefficient and
inflexible. In addition, the bankruptcy courts tended to restrict the
debtors' filings: Debtors were obliged, not legally but practically, to
consult the bankruptcy court before filing a petition under the Law
(pre-counsel). The purpose of the pre-counsel was to explore feasible
reorganization options. For that reason, the court carefully scrutinized filing
documents before a debtor filed a petition. Sometimes, the court would refuse
to accept a filing because the debtor, in the view of the bankruptcy judge,
seemed to lack the ability to reorganize. The newly reformed Law eases some of
the legal requirements for filing a petition, and makes the procedure more
efficient and flexible (as discussed below). Whether the bankruptcy courts will
continue the practice of conducting the pre-counsel remains unknown at this
stage.

<h3>Methods to Streamline the Procedure</h3>

The
reformed Law relaxes the requirements for commencing cases—i.e., the court's orders for relief.<a href="#2" name="2a">2</a> Under the prior Law, the
possibility of a successful reorganization was required. The reformed Law
allows the court to issue an order for relief<a href="#3" name="3a">3</a> even when it is apparent that
the debtor either may not be able to formulate a reorganization plan that
includes the continuation of its business, obtain acceptance of the plan or get
a confirmation of the plan. These changes facilitate an earlier filling. The
Law also shortens the period for filing a reorganization plan to a maximum of
one year from the order for relief. In addition, it restricts the period for
installment payments to no more than 15 years after the confirmation of the
plan.<a href="#4" name="4a">4</a> Finally, the reformed Law also makes it possible to shorten the case by
closing the case after the debtor has paid at least two-thirds of the allowed
claims under the confirmed plan.<a href="#5" name="5a">5</a> The shorter the term, the smoother the
debtor-creditor relationship will be.

<h3>Ways to Utilize Corporate Reorganization Procedures</h3>

Almost
all the cases under the Law have been filed either with the Tokyo District
Court or with the Osaka District Court. These courts have accumulated
considerable know-how in cases filed under the Law. To facilitate the filing of
a petition, the Law allows the debtor to file a petition in either court as
well as the court in the district in which the debtor's headquarters are
located.<a href="#6" name="6a">6</a> The court, upon the request of the parties interested or by its own
motion, may order a comprehensive injunction.<a href="#7" name="7a">7</a> This comprehensive injunction
prohibits creditors, including tax authorities, from executing on any of the
debtor's assets during the period from the filing of the petition for the
commencement of the case until the entry by the court of the order for relief.
The comprehensive injunction functions similarly to the automatic stay in the
U.S. Bankruptcy Code §362 and relieves the debtor of the burden of having
to seek individual injunctions in various courts within Japan.

To
protect against the depletion of the debtor's assets, and to facilitate
the reorganization of the debtor, the court can allow the debtor to sell all or
part of its business before the plan is confirmed.<a href="#8" name="8a">8</a> However, the court cannot
allow the sale if more than one-third of the amount of the equities object to
the sale.

The
Law accepts the concept of "current value," instead of
"going-concern value," to value the debtor's assets.<a href="#9" name="9a">9</a> This
eliminates the vagueness of the going-concern value concept and establishes a
clear financial basis for the debtor's reorganization. In the reformed
Law, the debtor's demand for the extinguishment of security interests is
established as it is in the Civil Rehabilitation Law.<a href="#10" name="10a">10</a> The court may allow the
filing for extinguishment before the confirmation of the plan if it is required
to reorganize the debtor.

<h3>How the Procedure Has Been Made Easier</h3>

Contrary
to the prior Law, the reformed Law automatically allows debts incurred before
the order for relief but after the filing (in the "gap period"<a href="#11" name="11a">11</a>)
to be treated as administrative claims. These claims take priority over other
claims.<a href="#12" name="12a">12</a> Even if the reorganizing debtor converts to the liquidation procedure
under the Japanese bankruptcy law, these debts keep their first priority
position under the title of "estate claims."<a href="#13" name="13a">13</a> These revisions are
expected to facilitate DIP financing in Japan. Before the revision of the Law,
the debtor's management was always ousted, which explains, in practical
terms, the relatively low number of filings under the Law. It is natural for
the management of the debtor to be reluctant to be fired after it decides to
file a petition.<a href="#14" name="14a">14</a> The reformed Law allows the court to appoint a member of the
debtor's management to be the trustee as long as he or she is free of any
future claims by the debtor. This is similar to a DIP procedure and encourages
the debtor's management to file a petition earlier under the Law. The Law
has also relaxed the vote requirements on reorganization plans.<a href="#15" name="15a">15</a>

<h3>Providing Information for Interested Parties</h3>

In
order for the procedure to be transparent for interested parties, the Law
provides an efficient procedure for the access of documents relating to the
cases that are filed in the court.<a href="#16" name="16a">16</a> The debtor should inform its creditors of
the reason for its filing, about its business, its financial condition and so
on.<a href="#17" name="17a">17</a> The court, upon request of the party interested, may allow the formation
of an unsecured creditor's committee.<a href="#18" name="18a">18</a>

The
reformed Law also provides a procedure for bondholders to vote for or against
the plan.<a href="#19" name="19a">19</a> The debtor's union is also entitled to give its opinion in
connection with the court issuing the order for relief and appointing a trustee.<a href="#20" name="20a">20</a>

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Mr.
Abe is an attorney working at Tokiwa Sogo Law Offices located in Tokyo and may
be reached at <a href="mailto:masayosi@mb.kcom.ne.jp">masayosi@mb.kcom.ne.jp</a>. <a href="#1a">Return to article</a>

<a name="2">2</a> The
procedure under the Law is quite different from that of chapter 11 of the U.S.
Bankruptcy Code. After filing a petition but before the order for relief (we
call this a "gap period"), an interim trustee (a bankruptcy lawyer)
is designated by the bankruptcy court. This person examines the debtor's
business and financial condition and continues to run its business. The Law
does not include an automatic stay. If the bankruptcy court is convinced that
the requirements of the order for relief are met, the court will order the
relief, which will allow the debtor to advance the procedure under the Law. <a href="#2a">Return to article</a>

<a name="3">3</a> See Art. 41. <a href="#3a">Return to article</a>

<a name="4">4</a> See Art. 168. The prior Law allowed a debtor to take up to 20 years to
carry out a plan. <a href="#4a">Return to article</a>

<a name="5">5</a> See Art. 239. Under the prior Law, the debtor was able to close the
case only after the plan had been completely performed or was about to be
completely performed. For this reason, a period of between 10 and 15 years was
said to be necessary to close the case after the confirmation of the plan. This
was too long a time for both a debtor and the creditors to endure. <a href="#5a">Return to article</a>

<a name="6">6</a> See Art. 5. <a href="#6a">Return to article</a>

<a name="7">7</a> See Art. 25-27. <a href="#7a">Return to article</a>

<a name="8">8</a> See Art. 46. The prior Law only allowed the sale of a business through
a reorganization plan. <a href="#8a">Return to article</a>

<a name="9">9</a> See Art. 83. There was a long dispute about the concept of
going-concern value under the prior Law. The current value means the fair value
of the assets. Depending on what the assets are, the fair value will be
measured by their current cost, their net realizable value or the present value
of their future cash flow. <a href="#9a">Return to article</a>

<a name="10">10</a> See Art. 104. The purposes of the demand seem to be different. With no
ability to bind secured creditors under the Civil Rehabilitation Law, debtors
are obliged to negotiate with those creditors not to enforce their rights.
However, secured creditors, such as banks and insurance companies, are
reluctant to give this concession, given the existing economic recession in
Japan. The debtor may demand that secured creditors release their security
interests by paying them the value of the secured assets—i.e., not the amount of their claim. This is especially effective for the
debtor when the value of the asset has declined. The court allows the release
of security interests if the debtor's assets are indispensable to the
continuation of the debtor's business. In contrast, under the Corporate
Reorganization Law, secured creditors are bound by the procedure. They can
enforce their secured interests only through the procedure as under chapter 11
of the U.S. Bankruptcy Code. One of the main reasons to establish this system
was to reduce the administrative costs of retaining unnecessary assets as early
as possible. This is why the requirements under either of the procedures are
different. <a href="#10a">Return to article</a>

<a name="11">11</a> See footnote 1. <a href="#11a">Return to article</a>

<a name="12">12</a> See Art. 128. <a href="#12a">Return to article</a>

<a name="13">13</a> See Art. 11. The Japanese Bankruptcy Law (Hasan Ho) only deals with
liquidation cases. <a href="#13a">Return to article</a>

<a name="14">14</a> The Civil
Rehabilitation Law is a DIP type of procedure. This is why many debtors decide to
file a petition under the procedure, not under the Corporate Reorganization
Law. <a href="#14a">Return to article</a>

<a name="15">15</a> See Art.196. Requirements for acceptance of the plan are (1) a majority
in value of the allowed unsecured claims, (2) more than two-thirds in value of
the allowed secured claims if the plan only extends the payment terms of the
claims, (3) more than three-fourths in value of the allowed secured claims if
the plan includes reduction and/or exemption of the claims, (4) nine-tenths in
value of the allowed secured claims if the plan includes discontinuance of the
debtor's business, and (5) the majority in value of the equities. <a href="#15a">Return to article</a>

<a name="16">16</a> See Art. 14, 15. <a href="#16a">Return to article</a>

<a name="17">17</a> See Art. 85. <a href="#17a">Return to article</a>

<a name="18">18</a> See Art. 117. <a href="#18a">Return to article</a>

<a name="19">19</a> See Art. 43, 190. <a href="#19a">Return to article</a>

<a name="20">20</a> See Art. 22, 85. <a href="#20a">Return to article</a>

Journal Authors

Shinichiro Abe

Journal Date

Saturday, March 1, 2003 - 12:00

Bankruptcy Rule

2003