Japan is modernising its trust law system. In December 2006, the Japanese Diet passed the Trust Law (law 108 of 2006) and the Law on Amendment to Relevant Laws Applicable upon Enactment of Trust Law (law 109 of 2006). The new trust law, introduced on September 30 2007, replaces the former law (law 62 of 1922), which was enacted in 1922 and has governed Japanese civil trust and commercial trust practice for more than 80 years. When the old Trust Law was enacted, Japan was undergoing rapid urbanisation, and some people used trust companies for illegal purposes. So the old Trust Law included many mandatory or regulative provisions aimed at protecting trust beneficiaries. The old Law has been good enough for a long time, since Japanese citizens rarely used non-commercial trusts, and commercial trust business was solely conducted by Japanese trust banks under the supervision of financial authority pursuant to the Trust Business Law (law 154 of 2004 as amended which replaced the old Trust Business Law (law 65 of 1922)) and the Law on Trust Business Conducted as Side Business by Financial Institutions (law 43 of 1943 as amended).

Recently because of the accumulation of wealth among Japanese citizens and corporations and changes in Japan's ageing and nuclear-family-based population, trust's traditional function as a vehicle for property management has been reevaluated. It has been recognised that trust may be used as a vehicle for new businesses such as land trust, security trust, trust related to asset securitisation or whole business securitisation. The old Trust Law was too simple and too regulative to satisfy new demands. The lack of legal provisions, and the unclear nature of those that existed, sometimes stirred heavy debate about particular issues, and blocked the realisation of new business schemes, even when no one objected to the scheme. So the new Trust Law was enacted, almost five years after the Ministry of Justice commenced discussions.

What is the new Trust Law?

The rules under the New Trust Law are generally (with some exceptions) non-mandatory rules (default rules). The Law's function is enlarged: rather than being a vehicle for traditional property management, it has become a vehicle for various new deals. We should note that a trust's bankruptcy remoteness from the relevant entities (trustor/ trustee/trust beneficiary) has been improved. The introduction of a bankruptcy procedure of trust asset ensures a fair payment among trust creditors should the trust asset fall short of full payment of the trust debt.

Default rules

To make the trust more flexible, each rule (with some exceptions) is stipulated as a default rule that will govern the relations between the relevant parties unless they have agreed on something different; the relevant parties may relax or tighten a statutory rule if they so agree. The compliance with the asset management method that the relevant trust agreement specifies will usually fulfill the trustee's duty to segregate trust assets from other assets. But the trust agreement may not restrict the trust beneficiaries' material rights (the right to review the accounts of the trust, the right to claim for compensation for loss, for example) unless each beneficiary separately agrees to waive its rights. The new Trust Law does not allow the trustee to relax public notice (registration) of trust, since such notice is a fundamental requirement to enable the trust assets to be segregated from the trustee's or other parties' assets. Most commentators think that it will be possible to suspend such public notice until a trigger event occurs – when the trustee becomes financially distressed, for example. In addition, if a trust is created in which the trustee is fully exempted from its duty to manage trust property in good faith or from segregating trust assets from other assets, the trust is negated, since it does not satisfy the minimum requirement.

Under the old Trust Law, the trustee's duty of loyalty was not expressly declared, but conflict of interest in the trustee's conduct was so strictly prohibited that the trustee could not purchase or lease any asset from the trust even at fair market value. The new Law clarifies the trustee's duty of loyalty. Conduct entailing conflict of interest or competition between trust and trustee is banned but will be allowed if the trust beneficiary agrees to such conduct after it has been informed of the relevant facts, for example.

Under the old Trust Law, the commission of the trustee's trust operation may be made only when so stipulated under the trust agreement or in an emergency. In modern society, though, specialisation has increased, and it is not realistic for the trustee to conduct each and every trust operation on its own. Under the new Law, the rule on the commission of trust operations is more relaxed. If the commission is deemed appropriate to fulfill the purpose of the trust (even if the commission is not expressly permitted under the trust agreement), or if it is needed to fulfill the purpose of the trust (even if the relevant trust agreement prohibits such commission), such commission of trust operations may be made.

The old Trust Law has only one article under which the court may dismiss the trustee upon the trustee's breach of duty or the occurrence of another material event. Under the new Law, the trustor and the trust beneficiary may dismiss the trustee by mutual agreement.

Protecting beneficiary interests

The old Trust Law did not make it clear if trust schemes promoted trust beneficiary interests. It did not sufficiently allow a beneficiary to observe or supervise the trustee. To be consistent with a trust's purpose of ensuring its beneficiaries' interests, the new Law strengthens trust beneficiaries' rights. The trustee must send the beneficiary a balance sheet, profit and loss statement and other accounting documents, whether or not the beneficiary so requests, so that the beneficiary may supervise the trustees' operations. If the trustee breaches its duty of loyalty or if a conflict of interest occurs between trust and trustee, the profit gained by trustee or its affiliate will be presumed as the loss suffered by the trust assets, and the trust beneficiary is relieved of having to prove that such a loss has occurred. The new Law enables preliminary injunctions against a trustee's upcoming operation to take place, which are powerful rights to protect trust beneficiaries' interests in addition to existing post-fact remedies. The relevant trust agreement cannot restrict the trust beneficiary's fundamental rights, such as the right of court petition, the right to be informed about the trust, and the right to rectify a trustee's breach of trust; but individual beneficiaries may waive their rights if they wish.

The trust operation must be efficient if the trust has multiple trust beneficiaries and the multiple trust beneficiaries must have appropriate opportunities to determine their intentions. In balancing these concerns, all the trust beneficiaries' consent is required to make decisions; or if any other rule is stipulated under the trust agreement (typically, determination by a majority vote at a trust beneficiaries' meeting), that rule will prevail. The trust beneficiary is not liable for the cost or expenses of the trust, the trustee's fee, or damages and loss suffered by a trustee, unless it has separately agreed to their redemption. In making material amendments to trust agreements, consolidation or splitting of a trust, the beneficiary will be entitled to ask that the trustee purchases the relevant trust beneficiary interest. This statutory option is newly introduced to protect the economic interests of minority trust beneficiaries that objected to such amendments. Lastly, the rule regarding amendments to trusts is relaxed. A trust may be amended without consent of trustor, trustee and/or trust beneficiary in certain situations and under certain procedures.

Special categories of Trust

The new Trust Law amends the definition of trust so that trust of business (including both assets and debt) or security trust will be feasible in Japan. The new Law also provides special categories of trust – declaration of trust, beneficial interest security issuing trust, limited liability trust and purpose trust.

Declaration of trust

Declaration of trust occurs when the trustor of a trust becomes the trustee of the same trust. Under the old Trust Law, entrustment of the operation to third party that is not the trustor itself, was necessary to establish a trust. Some have criticised the declaration of trust, arguing that it might encourage concealment of property from creditors or evasion of civil enforcement procedures. On the other hand, it is potentially useful for many purposes and features frequently outside Japan. The new Law makes it possible, but only if a notarised certificate or certain other form is used. In response to concerns about abuse of such trust, special rules have been put in place. The declaration of trust may not be established until one year after the effective date of the new Trust Law.

Beneficial interest security issuing trust

Under the old Law, trust beneficial interest could not be transferred without the trustee's consent. Only certain types of trust beneficial interests were treated as securities (for civil law purposes) – investment trusts, loan receivable trusts or special purpose trusts – and the relevant laws governed each of these. To enhance the assignability of trust beneficial interest when the trust is a vehicle for raising funds from a number of investors in the market, the new Law creates a new category: beneficial interest security issuing trust. Irrespective of the type of trust asset, the trust beneficial interest certificate may be treated as a security for civil law purposes, if the relevant trust agreements so stipulate. Special treatment will apply to the trust (for example, bona fide purchaser's right, or procedures for invalidation of a lost trust beneficial certificate) based on the high transferablilty of the trust beneficial interest.

Limited liability trust

To enable a variety of entities to become trustees and to promote the use of trusts for various purposes, the new Law provides another new category: limited liability trusts. In such a trust, the trustee's liabilities with respect to trust-related debts will be limited to the value of the trust assets. The trustee's other assets will be exempted from trust creditors' recourse claims. To prevent trust creditors from suffering unpredictable losses or damages, the distribution of trust assets is limited. A party must inform the counterparty of its limited liability on making each deal, and/or registration of such trust shall be required, to claim such limited liability against a third party.

The limited liability trust issuing beneficial interest security is a hybrid of the two trusts outlined above. When a trust owes a debt of more than ¥20 billion ($180 million), it shall hire an accounting auditor. It is expected that this category will function as an alternative vehicle for businesses such as stock corporations.

Purpose trust

The purpose trust is a trust without a specific beneficiary. Under the old Law, such trusts were not established for reasons other than charity or public interest. Because of the potential utility of such trusts – as foundations for scholarships in relation to specific businesses or corporations, or as a holding company for securitisation – the new Law makes it easier to create them. But because of the risk of evasion of civil enforcement, purpose trusts can only be established by contract or will, not by declaration of trust. The maximum term of such a trust is 20 years.

Trust Business Law/Financial Instrument and Exchange Law

When a commercial trust is established, the Trust Business Law will also apply, and only a trust company or trust bank can be the trustee, with some exceptions. In addition, the Financial Instrument and Exchange Law (law 23 of 1948), an amendment of the former Securities and Exchange Law, also became effective on September 30 2007. According to this law, all trust beneficiary interests are deemed to be securities, and a solicitation for sale or purchase of any kind of trust beneficial interest is subject to certain broker/dealer-related regulations. With regard to entrustment of certain investment trusts, sale and solicitation rules under the law shall be applicable mutatis mutandis to the trust under the Trust Business Law.

Author biographies

Masayuki Fukuda Nagashima Ohno & Tsunematsu Masayuki Fukuda is a partner at Nagashima Ohno & Tsunematsu. His practice focuses on financial deals, including debt, real estate and other asset securitisation. He also works on banking, derivatives, intellectual property finance, real estate finance and REIT. He is the author of various books on trust and other aspects of financial law. He was admitted to the bar in 1995 (Japan) and in 2000 (New York). He graduated from the University of Tokyo (LLB, 1990) and the University of Pennsylvania (LLM, 1999), and worked at KMZ Rosenman, New York, between 1999 and 2000. Fukuda is a member of the Daiichi-Tokyo Bar Association and New York Bar Association. Hideaki Suda Nagashima Ohno & Tsunematsu Hideaki Suda is an associate at Nagashima Ohno & Tsunematsu. His practice focuses on securitisation and financial regulation. He graduated in 2005 with an LLB from the Faculty of Law at the University of Tokyo, and began practising in Japan in 2006. He is a member of the Daiichi-Tokyo Bar Association.