In Japan, the corporate law regime has recently been revised, amendments to the Securities and Exchange Law are in draft form, and the government is discussing proposed guidelines for a law providing for the electronic registration of claims. These legal changes are expected to impact various transactional fields, including securitization transactions.

The Corporate Law and securitization

The Corporate Law (which took effect on May 1 2006) revises regulation of corporate entity types, improves management flexibility, and enhances internal controls. The Corporate Law combines stock companies (kabushiki kaisha) and limited companies (yugen kaisha) into one stock company type, abolishes minimum capitalization requirements, and creates a new limited liability company type (godo kaisha).

Selecting a securitization vehicle

The Corporate Law's greatest impact on securitization is likely to be the selection of securitization vehicles. Before the Corporate Law, limited companies were often used to hold beneficial trust interests, particularly in real estate securitizations. The advantages of limited companies as securitization vehicles include advantages in bankruptcy situations and low minimum capitalization requirements.

The limited company entity has been abolished, although limited companies in existence at the time of the law's enforcement will continue to exist as special limited companies (tokurei yugen kaisha).

Special limited companies have characteristics of stock companies, but their management and operation are substantially the same as the limited company. This entity is easier to manage and operate, providing for restrictions on share transfer, requiring only a shareholders meeting and a board of directors, and having no publication requirement for the settlement of accounts. Because special limited companies have the characteristics of a stock company, the Corporate Reorganization Law that applies to stock companies is considered to apply, which raises bankruptcy remoteness concerns when using them as securitization vehicles.

The limited liability company

The Corporate Law provides for stock companies, incorporated limited partnerships (goshi kaisha), partnership corporations (gomei kaisha), and limited liability companies. Only the limited liability company is new.

The Japanese limited liability company is said to follow the US model. It is a limited company in essence, and internal governance is widely left to the control of members. Unitholder general meetings are not necessary, and, in principle, unitholders have executive authority. There is no requirement to establish other internal bodies, no obligation to publish the settlement of accounts, and the Corporate Reorganization Law does not apply. For bankruptcy remoteness and ease of management and operation, the limited liability company is a superior securitization vehicle.

Scheme selection

In the past, the limited company structure was used as an asset holding vehicle, particularly in Japanese real estate securitizations. With the Corporate Law, however, limited companies become special limited companies, similar to stock companies and subject to the Corporate Reorganization Law. If corporate reorganization procedures are commenced against a special limited company, risks for the lender holding security interests against that company could arise, because the repayment terms and conditions of the security interests might change under a rehabilitation plan.

In the time leading up to the Corporate Law taking effect, lenders attempted to minimize the risks to their security interests by providing that the special limited company could be reorganized into a limited liability company at the lender's request.

With the Corporate Law, limited liability companies have become popular asset holding vehicles in securitizations. The special limited company and the stock company cannot avoid the Corporate Reorganization Law. They are also required to hold shareholders meetings, publish settlement of accounts, and are subject to large company regulations. So the limited liability company is easier to manage and operate.

Cayman special purpose company

In a securitization, a special purpose company (SPC) organized in the Cayman Islands is frequently used as an asset holding, bond issuing, and share holding vehicle, as it carries tax advantages while assuring bankruptcy remoteness.

Before the Corporate Law, any company whose main purpose was to conduct business in Japan was held to the same provisions as companies incorporated in Japan, despite being incorporated in a foreign jurisdiction (pseudo-foreign companies). For pseudo-foreign companies, the dominant view was that the representative had personal liability for transactions of the company, the corporate status of these companies was not recognized, and rights and obligations were not attributed to the entity. In practice, a Cayman SPC, normally used in securitization, was not considered to constitute a pseudo-foreign company, and the representative's liability, corporate status, and rights attribution issues did not apply, although the legal basis for this treatment was unclear.

The Corporate Law recognizes corporate status even for pseudo-foreign companies and has clarified that the representatives are joint and severally liable for the company's debt obligations. However, it is unclear whether a Cayman SPC constitutes a pseudo-foreign company. According to the view of the official in charge of the enactment, if, for example, there is an officer outside Japan and officer meetings are held outside Japan, or assets are acquired and financing is received continuously in a systematic way, the SPC is not a pseudo-foreign company.

Ex-post facto establishment regulations

When an SPC acquires assets in a securitization scheme, ex-post facto establishment regulations often apply. Before the enactment of the Corporate Law, it was necessary to hold a meeting to pass a special resolution of the shareholders (or a unitholder general meeting in the case of limited company) and an inspection by a court-appointed inspector or certification by an attorney, certified public accountant, or other professional of the fairness of the price of the assets was required.

Under the Corporate Law, this burden has been reduced. A special shareholder resolution is now only required for stock companies, and ex-post facto establishment regulations do not apply to limited liability companies.

Corporate bonds

The Corporate Law has made revisions concerning corporate bonds, which are often issued in securitization schemes.

Previously, limited companies could not issue corporate bonds. Now, special limited companies and limited liability companies may do so. Limited liability companies are already being used as bond issuing vehicles.

Under the old Commercial Code, when foreign companies issued corporate bonds in Japan there were disputes and uncertainty about the applicability of provisions concerning bondholder meetings. Under the Corporate Law, however, it is clear that corporate bonds issued by a foreign company are not considered corporate bonds under the Corporate Law, even if Japanese law governs the issuing agreement. The Corporate Law does not cover these bonds, so bondholder meeting rules do not apply. If bondholder meetings are provided for in the issuing agreement, the meetings are not effective as bondholder meetings under the Corporate Law.

Under the Corporate Law, the board of directors may entrust decisions for solicitation of corporate bonds to each board member, and it is possible to issue corporate bonds flexibly.

The Financial Instruments and Exchange Law

Amendments to the Securities and Exchange Law and other related laws were introduced in June 2006 and will be enacted within 18 months of introduction. The Securities and Exchange Law will become the Financial Instruments and Exchange Law.

The revisions attempt to improve user protection and user convenience, ensure a market for investment of savings, and to respond to financial and capital market internationalization.

Expansion of deemed securities

Beneficial trust interests and shares of collective investment schemes are not deemed securities under the Securities Law, but under the Financial Instruments Law they will constitute deemed securities subject to investor protection regulations.

Beneficial trust interests refer to the rights to possess the results of managing or investing trust assets under a trust agreement.

Beneficial interests are subject to regulation under the Financial Instruments Law as deemed securities, because they are an investment of money by the purchaser, redeemable in cash or other consideration.

For association agreement rights under the Civil Code, silent partnership agreements under the Commercial Code, investment limited partnership agreements, limited liability partnership agreements, membership rights, and other rights for incorporated associations, where: (i) rights holders invest or contribute money or other consideration; (ii) business is conducted by applying the consideration invested or contributed; and (iii) the investors have the right to distribute profits or assets from the business, such rights constitute shares of collective investment schemes and are subject to regulation under the Financial Instruments Law as deemed securities.

Expansion of financial instruments exchange business

Sales of beneficial trust interests, self-solicitation of shares of collective investment schemes, and self-investment of beneficial trust interests or shares of collective investment schemes were not regulated under the Securities and Exchange Law. Under the Financial Instruments Law, however, these activities will be subject to regulation as financial instruments exchange business and activity regulations.

Under the Financial Instruments Law, beneficial trust interests subject to the Trust Business Law are deemed securities, so sales of these interests (and the agency and intermediation of interests) fall under sales of securities for purposes of the Financial Instruments Law, so it will be necessary to register as a financial instruments exchange business company equivalent to either a securities firm or a beneficial trust interest sales business company.

Justice Ministry ordinances and guidelines governing financial instruments exchange business companies could be imposed on an originator concerning its sale of beneficial trust interests to an SPC (purchaser) at the same time that regulations governing financial instruments exchange might also be imposed on the SPC concerning its sales of beneficial trust interests to its investors. So unreasonable outcomes are possible.

Self-solicitation

Under the Financial Instruments Law, solicitation and private placement are regulated as activities falling under the definition of financial instrument exchange business. Self-solicitation conducted as a business will constitute a financial instruments exchange business. So it would be necessary to register as a financial instruments exchange business company.

If the originator consigns all the services connected to the self-solicitation to a financial instruments exchange business company and it does not perform these services itself, it would not be soliciting securities newly issued by the issuer. So the originator would not be required to register as a financial instruments exchange business company under Justice Ministry ordinances and guidelines.

Self-investment of beneficial trust interests

Under the Financial Instruments Law, several activities will require registration as a financial instruments exchange business: (i) investment in rights related to securities or derivative transactions, pursuant to investment decisions based on analysis of price and other factors for financial instruments; (ii) investments of money or other consideration by persons that have beneficial trust interests or shares of collective investment schemes; and (iii) investment in securities or derivatives mainly composed of collective investment schemes.

If an SPC consigns all authority for investment to a registered financial instruments exchange business company, the SPC would not be investing in securities and derivative transactions mainly composed of collective investment schemes, so the originator itself should not have to register as a financial instruments exchange business company (Article 2(8) and Article 15 of the Financial Instrument Law). Justice Ministry ordinances and guidelines are expected to clarify this point.

Electronic registration of claims

The Electronic Claims Law Committee of the Legislative Council has drafted an interim proposal on the legislation of electronic registration of claims. The Legislative Council is expected to prepare guidelines for a new law in the coming months.

According to the proposal, electronically registered claims are defined as: 1) abstract claims: recognized as valid even if not validly formed; 2) visible claims: those for which registration is required for valid creation and assignment; and 3) various unspecified claims that are not based on notes.

The proposed electronic registration system would provide a new system with greater claims visibility, among other benefits.

Claim liquidity and securitization schemes

The securitization-related legal merits of the registration system would be the mitigation of four types of risks:

Reducing fraud risks: If a company securitizes a pool of receivables, the existence and contents of the claims must be verified against those in the contract.

However, if there are multiple contracts between the company and its debtors, or if a comprehensive contract exists without the individual contracts, verifying the individual claims might require inordinate amounts of time and expense, and potentially prevent the verification of the claim's information.

Upon electronically registering the claim, the debtor's declaration of intent must also be registered electronically. If there is a defect in the declaration, a third party would be protected if the transaction were rescinded. So third party safeguards, recommended under the Mental Reservation Special Rule to Civil Code, would be effected, reducing fraud risks. Additionally, the claims of the securitization and the costs of verifying the existence, contents, and assignment of the registered claims could be mitigated by presenting documentation certifying the particulars of the registration to the originator.

Avoiding the risk of personal defence: When, for example, a bank's loan receivables are securitized, an underlying transaction exists between the bank and the obligor of the receivables. The claims of the transaction are likely to carry a right of first defence through set-off or a non-assignability agreement. Securitization transactions would be enhanced by electronically registering such claims as non-originating claims. The effectiveness of the electronically registered claims would not be affected even if the originating claims were invalidated or cancelled, because the obligor's right of defence is severed as a rule by the electronic registration.

If the free assignability of electronically registered claims is provided for, the claims' liquidity would be systematically enhanced and the claims' securitization could be promoted.

Avoiding the risk of double assignment: Perfection against obligors is often not provided for due to a lack of notice and consent (the silent method). However, should one wish to rely on electronically registered claims for the transaction, an obligor's declaration of intent is required. Moreover, for the creation and assignment of the electronically registered claims, registration within the applicable registry shall be the requisite for their coming into force, so that perfection against third parties and obligors occurs simultaneously, and the double assignment risk inherent within the current system can be avoided.

Avoiding the risk of co-mingling: Through the silent method system, claims are serviced by the originator after entrustment to the SPV. If the originator goes bankrupt before delivering the funds from the obligors to the SPV, the SPV only possesses the rights of an ordinary creditor. So the fear of insufficient satisfaction persists, particularly if the originator co-mingles the claims with other assets.

For electronically registered claims, servicing is performed through the register, and each individual claim is segregated. Registry assignment of the payment method (including account transfers) for the parties is also possible on a voluntary basis. This method could eliminate the risk of co-mingling.

New securitization schemes

The electronically registered claims system will make new securitization schemes possible.

Previously, for account receivables held by medium- and small-sized companies, contents of non-assignability provisions varied widely, and it was thought that these claims were therefore ill-fitted to securitization. However, if electronically registered claims come into use, the particulars of the electronically registered claims become verifiable, and for medium- and small-sized companies access to securitization as a financing vehicle could grow.

The regulatory authorities have started to allow electronic registration of matters within the scope set in their business regulations. Compared with corporate bonds, the flexibility provided concerning the contents of the claims, as well as management structure, is far greater. As a multitude of products become possible, prospects for the use of asset-backed lending securitizations will grow. And through the establishment of a registry guarantee system independent of the principal obligor, together with the registry guarantee, banking institutions will have the potential to sell the electronically registered claim to investors.

Author biographies

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 Dai-ni Tokyo Bar Association in 2004 upon being admitted as an attorney. He handles securitization and project finance matters relating to structured finance, as well as general corporate law matters, commercial transactions, contracts, and general financial transactions. Takafumi Uematsu Atsumi & Partners Takafumi Uematsu is an associate at Atsumi & Partners. He has Bachelor of Arts 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 Dai-ichi Tokyo Bar Association in 2004 upon being admitted as an attorney. He handles securitization, project finance, asset management, fund deals and merger and acquisition matters with an emphasis on structured finance. Recently he has involved in advice for IPO procedures, disclosure under Securities Exchange Law and antitrust law in connection to M&A. Fumiko Oikawa Atsumi & Partners Fumiko Oikawa is an associate at Atsumi & Partners. She holds an LLB and LLM degree from Gakushuin University. After completing her training at the Legal Training and Research Institute of the Supreme Court of Japan, she joined the Dai-ichi Tokyo Bar Association in 2003 upon being admitted as an attorney. From 2003 to 2004, while at Atsumi & Partners, she handled lease credit receivable and residential loan receivable securitizations, including real property securitizations, and PFI matters. She is assisting in the enactment of laws and regulations such as the Insurance Business Law accompanying the modernization 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 current assignment at the General Coordination and Policy Planning Division of the Financial Services Agency.