Although trusts were originally intended to be used primarily as a mechanism for asset administration, the new system of trusts introduced by the amended Trust Law that was promulgated on December 15 2006 and implemented on September 30 2007, which system includes limited liability trusts and declaratory trusts, will probably encourage the increased use of trusts as vehicles for other business activities (business type trusts). As trusts allow for the separation of trust assets from settlers' assets and from the trustees' personal assets, thus eliminating exposure to settler and trustee bankruptcy risks, trusts are very similar to special purpose companies. For this reason, trusts have long been used for business activities in place of companies. For example, trusts have been created to hold rights to loan receivables (loan trusts), to hold land and buildings and distribute the rental proceeds to beneficiaries (real estate trusts) and to manage funds provided by multiple investors, and distribute the profits. Furthermore, while trusts assets are deemed separate from the settlers' assets and trustees' personal assets they are not regarded as separate legal entities. For this reason, formation procedures and corporate governance rules required for companies are not required for trusts. The formation and governance of trusts (and the relevant parties' rights with regard thereto) are dictated by private contract, which facilitates the creation of arrangements tailored to the parties' intentions. The usefulness of trusts arising from their effectiveness for asset partitioning, and their flexibility, is expected to be supplemented in the new trust system with mechanisms encouraging the use of trusts as vehicles for business activity. This article will examine the potential that limited liability trusts, trusts that issue securities as beneficiary rights and declaratory trusts present under the new Trust Law as alternatives to company structures.

Applications of the new trust system

Limited liability trusts

A limited liability trust is a trust in which the trustee's liability for the obligations of the trust are limited to the assets of the trust (Article 2.12 new Trust Law). As trusts are not separate legal entities, the trustee generally stands behind all the obligations of the trust. For this reason, under the previous Trust Law, for trusts in which high risk assets, such as thermal power businesses and oilfield development businesses, were entrusted, the trustee generally executed separate agreements limiting liability with counterparties to transactions relating to the trust assets. The introduction of the limited liability trust under the new Trust Law has made the entrustment of high risk assets and businesses more feasible, as it allows the trustee to limit its liability with regard to the obligations of the trust to the trust assets. As a means of protecting the creditors of the limited liability trusts, those trusts are subject to several regulations to which normal trusts are not subject, such as registration and title regulations (Article 216, 218, and 219 of the new Trust Law), net assets regulations (Article 225 new Trust Law), accounting record-keeping obligations (Article 222 new Trust Law) and a requirement that a trustee have third party responsibility equivalent to that of a director. The limitations on trustee liability permitted by limited liability trusts should weaken the barriers to finding qualified trustees, thus facilitating the engagement of persons possessing special skills to serve as trustees and making it easier to (1) swiftly set up new businesses in response to market trend changes, (2) manage very expensive ventures, leading edge developments or projects such as oilfield development businesses, and (3) manage large scale asset securitisations centred around real estate trusts. For these reasons, it is likely that limited liability trusts will be utilised as alternatives to company structures.

Issuance of beneficiary interest rights

The new Trust Law provides for the creation of certain trusts that issue beneficial interests that constitute securities (Article 185.1, 185.3 Trust Law). Such securities allow for greater transferability of beneficial interests, and are, consequently, subject to disclosure regulations under the Financial Instruments and Exchange Law. This facilitates the procurement of funds from unspecified multiple investors through the issuance of such securities. It is likely that these features will be combined with the limited liability features described above for high risk businesses that require multiple investors and will often be used as vehicles for big management in place of company structures.

Declaratory trusts and business trusts

Declaratory trusts are trusts in which the settler is the trustee (Article 3.8 new Trust Law). The previous Trust Law was criticised for lacking adequate protections against fraudulent creation of trusts and the use of trusts to conceal assets from creditors, so the new Trust Law includes measures introduced to safeguard the settler's creditors, such as new requirements for trust documentation that specifies the details of the trust's creation (including the date of creation, the assets to be entrusted and the purpose of the trust) and regulations that allow the settler's creditors to invalidate fraudulent declaratory trusts without resorting to legal proceedings. In addition, the new Trust Law allows trustees to assume the liabilities of the settler in connection with the settler's entrustment of positive assets of the settler (Article 21.1.3 new Trust Law). This essentially allows for the entrustment of entire businesses by settlers (trusts in which the positive assets of a specified business are entrusted and the liabilities of that business are assumed by the trustee, business trusts). The use of business trusts combined with declaratory trusts allows for the creation of additional structures similar to some structures available under the company system. For example, a declaratory trust could be used in the recovery of an unprofitable sector of a business as an alternative to corporate separation or business transfer. Using the trust in this context would have the additional benefit of avoiding a change to the business entity, and thus avoiding permit transfer approvals or permit re-issuances, avoiding employee transfers, decreasing the risks of leaks of trade secrets and know-how, and avoiding the application procedures and monetary costs of corporate separation.

In addition, the new Trust Law should allow for the use of tracking stock structures, in which settlers will establish declaratory trust for specific business sectors and sell the resulting beneficial interest or beneficiary security to investors to raise funds. Because of constraints relating to corporate governance of entities, traditional tracking stock lacks certain shareholder checks, such as the ability to ensure that dividends determined by the board of directors really correspond to performance of the underlying business sector. The flexibility regarding the governance of trusts, on the other hand, allows the parties to create arrangements that allow for close scrutiny by the trust beneficiaries of the activities of the trust.

As we have described, the combination of the declaratory trusts with business trusts, each as adjusted under the new Trust Law, provides for flexible alternatives to company structures in the contexts of corporate separations, business transfers and fund procurement. The foundations for new business activity laid down by the revision to the new Trust Law should give rise to diverse trust activity based on the ingenuity of users.

Financial instruments and government ordinances

The Financial Instruments and Exchange Law came into effect on September 30 2007, and a Government Ordinance and Cabinet Ordinance were enacted to implement the law on that date. The purpose of the Financial Instruments and Exchange legislation is to provide a systemic upgrade of financial instruments in response to changes in Japan's financial and capital market environments, and to promote "comprehensiveness and cross-sectoring", "flexibility", and "fairness and transparency" for the benefit of "users (investors)", "the market" and "internationalisation".

This section will discuss the major points related to securitisation schemes under the Financial Instruments and Exchange Law Government Ordinance and Cabinet Ordinance.

Collective investment schemes

Collective investment schemes were not "deemed securities" prior to the amendment to the Securities Law, but are "deemed securities" under the Financial Instruments and Exchange Law (Article 2.2.5 of the Law), and therefore are subject to the Law's investor protection regulations. Collective investment schemes in which all the investors are involved in the business are exempted from being "deemed securities" (Article 2.1.5(1) of the Law). More precisely, this exemption covers businesses in which (i) the business affairs are agreed upon by all investors and the investors are continuously engaged in the business or (ii) the investors possess professional abilities vital for the continuation of the business and are engaged in the business (Article 1.3.2 of the Financial Instruments Exchange Law Enforcement Order).

Financial instruments business

An entity's solicitation on its own behalf or investment for its own account were considered outside the scope of the "securities business" regulations under the previous Securities Law, but under the Law the regulations regarding financial instruments businesses have been expanded to cover the trading of financial instruments (Article 29 of the Law). The procedural regulations have also been changed in a number of ways (Articles 28.2.1, 28.4.3, 2.8.7, 2.8.15 (3) of the Law).

Additionally, the following cases have been excluded from the behaviour falling within the scope of financial instruments business:

1. Trusts are not to be considered to be engaged in a financial instruments business as a result of their issuance of trust beneficial interests, provided that the sale of the trust beneficial interest is completely delegated to the trust's agent or intermediary. In order to qualify for this exclusion, the trust must show that the solicitation has been completely delegated through a business trust agreement (Article 16.1.1 of the Cabinet Ordinance related to the definition of the provision in Article 2 of the Law, or the defined Cabinet Ordinance).
2. Financial instruments firms will not be deemed to be engaged in a financial instruments business as a result of actions taken by them to facilitate the acquisition by a silent partner in a privately offered real estate fund of another silent partner's investment in that fund. Only financial instruments firms conducting "second type" financial instruments businesses qualify for this exclusion, though (Article 1.6 of the defined Cabinet Ordinance).
3. Investment trust companies shall not be deemed to be engaged in a financial instruments business as a result of their receipt of beneficial trust interests in a trust pursuant to subscriptions and private offerings. (Article 16.1 defined Cabinet Ordinance).
4. An entity or trust shall not be deemed to be engaged in a financial instruments business as a result of the management of its business where all the management authority has been entrusted to an investment management business under a discretionary investment agreement and the required notice has been provided to the Financial Services Agency (Article16.1.10 defined Cabinet Ordinance).
5. An entity or trust shall not be deemed to be engaged in a financial instruments business as a result of the management of its business where it constitutes the subsidiary fund in a two-tier property fund for which the parent fund manager (a silent partner who is also a toushiunnyougyou tourokugyousya (registered investment management business), a tokureigyomu todokedesha (special industry notifier) or a special investment management provider under Article 8.1 of the revised special amendment) has provided the required notice to the Financial Services Agency (Article 16.1.11 defined Cabinet Ordinance).

Broadening of the scope of QIIs

The Law provides that private offerings of interests in collective investment schemes to qualified institutional investors are now subject only to notice requirements, rather than registration. Furthermore, the scope of the definition of "qualified institutional investors" has been broadened pursuant to a Cabinet Ordinance (Article 10 defined Cabinet Ordinance) so that offerings now qualify for the qualified institutional investor exception from registration if at least one qualified institutional investor exists and the number of general investors numbers 49 or fewer (Article 17.12 Enforcement Order of the Law).

Planned legal reforms

Japan's planned amendment to the Money Lending Business Law (MLBL) and establishment of an electronic registration of claims system will significantly influence asset securitisation practices.

The Money Lending Business Law

An amendment of the law regarding money lending business regulations was approved on December 13 2006 and promulgated on the 20th of the same month. Implementation of the amendment is divided into stages. The major amendments described below are to be implemented by June 19 2010.

Of the reforms, those effecting a reduction of the interest rate cap will have a particularly large influence on asset securitisation practices. Previously, lenders could receive interest at annual interest rates of up to 29.2% where certain requirements under the MLBL were satisfied. Following the amendment, interest rates will be capped at 20%, and any rate higher than the amended Interest Limit Law maximum interest rate (between 15% and 20% annually) will not be enforceable.

Influence on asset securitisation

Partially as a result of these amendments, there is some confusion concerning the loan receivables-backed ABS market in contexts where the MLBL is applicable. Following the repeated Supreme Court decisions in favour of borrowers seeking repayment of overpayments and the promulgation of the above-described amendments, claims against creditors for repayment of overpayments have increased and the performance of securitised assets has deteriorated. Also, new accounting practices have resulted in large increases in reserve accounts for repayment claim losses. As ABS-related agreements' early redemption provisions are being triggered, and with Credia's application for civil rehabilitation on September 14 2007, it has been reported that parties are considering bringing claims for repayment of overpayments against the trustees holding the loan receivables assets and market participants are reconsidering whether debtors should be provided notice upon assignment of loan receivables in connection with a securitisation (previously, Article 24.3 of the MLBL had generally been interpreted to not require such notice).

It will be important for parties and professionals involved in the loan-receivables ABS sector to keep abreast of these issues, as they are dealt with in the Credia case, in regulatory changes and otherwise.

Electronic Registration of Claims Law

The Electronic Registration of Claims Law, promulgated on June 27 2007 with implementation planned for a year and a half after that date, was enacted to promote the creation of electronic claims registries and provide regulation of the electronic creation and transfer of claims on such registries.

As a general rule, the new law provides that a claimant's rights are to be detailed in the registries (Article 9.1) upon request of both the obligor and obligee (Article 4.1) and provides the framework to ensure the safety of electronic registration of claims. This framework includes provisions providing for protections for bona fide purchasers (Article 19.1), immunity of claim assignees against an obligor's defences against claim assignors (Article 20.1), protections for obligors with regard to payments made to a claim assignee where the assignment is invalid but the obligor was not aware of such invalidity (Article 21), and preservation of a claim assignee's claim against an obligor where the original claim is deemed invalid or cancelled (Article 12.1)

Impact on asset securitisation

It has been reported that the values of account receivables held by firms in Japan has exceeded the value of land held by them since 2005. Thus there is a strong need for the capitalisation of account receivables through asset securitisation. While the utilisation of an electronic registry of claims system will help decrease the costs of verifying the creation and existence of claims and decrease the risk of purported transfers of claims by parties who have already transferred their interests in such claims, it does give rise to certain problems.

An obligor may be subject to both electronically registered claims and unregistered claims relating to the same transactions, so there is a risk that competing assignments of claims will exist. It is expected that under such circumstances electronically registered claims will have priority, just as note receivables have priority over claims relating to the origination of the relevant note receivables (Second Petty Bench Supreme Court August 8 1960). In addition, though the rights of the holders of electronically registered claims are established upon registration of the claim (Article 9.1), it is impossible to determine the amount of contingent future claims. This may present an obstacle to asset securitisation.

Another issue is the special stipulation in the Law prohibiting claim transfers that act as obstacles to securitisation. While the institution managing the electronic registration of claims cannot completely prohibit the registration of transfers, it can restrict the number of such registrations through operational regulations (Article 7.2). It is also possible for the party that registers the claim to register a stipulation prohibiting transfer of the relevant claim (Article 16.2.12). Therefore, parties purchasing electronically register claims should first verify that the relevant registry contains no prohibitions on the transfer of such claims.

Author biographies

Fumiko Oikawa Atsumi & Partners Fumiko Oikawa is an associate at Atsumi & Partners. After completing her training at the Legal Training and Research Institute of the Supreme Court of Japan, she joined the Daiichi Tokyo Bar Association in 2003 upon being admitted as an attorney. Between 2003 and 2004, while at Atsumi & Partners, she handled lease credit receivable and residential loan receivable securitisations, including real property securitisations, and PFI matters. From December 2004 to April 2007 she was engaged in the enactment of laws and regulations such as the Insurance Business Law on the modernisation of corporate law, as well as the Trust Business Law, associated with the new Trust Law, and the Law Concerning Concurrent Trust Businesses of Financial Institutions through her assignment at the General Coordination and Policy Planning Division of the Financial Services Agency. She returned to Atsumi and Partners in May 2007. Takafumi Uematsu Atsumi & Partners Takafumi Uematsu is an associate at Atsumi & Partners. He has a bachelor of arts degree from the School of Political Science and Economics of Waseda University. After completing his training at the Legal Training and Research Institute of the Supreme Court of Japan, he joined the Daiichi Tokyo Bar Association in 2004 upon being admitted as an attorney. He handles securitisation, project finance, asset management, fund deals and merger and acquisition matters with an emphasis on structured finance. Recently he has been particularly involved in advice for IPO procedures, disclosure under Securities Exchange Law and anti-trust law in connection with M&A. Koji Kawamura Atsumi & Partners Koji Kawamura is an associate with Atsumi & Partners. He holds an LLB degree from Keio University. After completing his training at the Legal Training and Research Institute of the Supreme Court of Japan, he joined the Daini Tokyo Bar Association in 2004 upon being admitted as an attorney. He handles securitisation and project finance matters based on structured finance, as well as general corporate law, commercial transactions, contracts, and general financial transactions.