As of December 1 2006, the Japanese Diet is deliberating a bill (the Trust Bill) that seeks to amend Japan's Trust Law. The new Trust Bill would introduce forms of trusts previously not permitted under the Trust Law. One such new form, the business trust, has attracted much attention from the business community.
In Japan, under a business trust (jigyo shintaku) an entire business is entrusted as a trust asset. Although the entrustment of a business, by its very nature, should include the entrustment of the debts relating to the business, under the Trust Law the entrustment of assets is restricted to only positive assets and neither the entrustment of the debts alone nor the entrustment of all components of business (including its positive assets and debts) is permitted. So it is generally understood that the entrustment of a business is not possible under the Trust Law.
However, because the business trust has recognized practical benefits as a means of fundraising and for various other purposes, the Trust Bill makes it clear that business trusts are now possible by expressly providing that debts owed by the settlor before the trust is set up will become debts of the trust if so provided in the trust agreement or the declaration of trust (Article 21(1), item 3).
Examples 1 to 3 show the practical uses of business trusts and the benefits that can be realized through them.
Example 1: Revitalization of a product division
With the intent of revitalizing one of its product division's uncompetitive businesses (Business X), Company A may elect to entrust Business X to another company engaged in the same type of business, Company B. In this case, Company A, as trust beneficiary, will receive the profits derived from Business X being administered by Company B, as trustee. Company B, on the other hand, will receive a trust administration fee from Company A, as settlor. Upon termination of the trust term, Company B will return Business X to Company A, as beneficiary.
Example 2: Use as quasi-tracking stock
A company may, by way of a declaration of trust, establish a self-settled business trust with respect to a portion of its business, and sell beneficial interest rights in that trust, as securities, to investors to raise funds, with future dividends to be paid to investors based on the economic success of the entrusted business.
Example 3: Engaging in high-risk business
A company may, by way of a declaration of trust, establish a self-settled business trust with respect to a high-risk portion of its business (Business Y) and, by making the self-settled business trust a limited liability trust, may also limit the risk arising from the operation of Business Y by restricting recourse for the payment of debts arising from the operation of Business Y to the assets of the trust. Afterwards the company may sell a portion of the trust's beneficial interest rights to third-party investors.
Business trusts and the Trust Law
A self-settled trust is a trust established by the settlor by separating specific assets from its own assets and declaring that the settlor, as trustee, will administer the assets itself. As a result of the Trust Bill's authorization of self-settled business trusts, a company will be able to establish a business trust without changing the operating entity of the entrusted business. Because the Trust Law does not contain an express provision permitting self-settled trusts and because of various concerns, including the concern that self-settled trusts can be used to defraud the settlor's creditors, it is generally believed that they are not permitted under the Trust Law. But the various potential uses of self-settled trusts have long been recognized, so the Trust Bill expressly provides for their establishment (Article 3, item 3), with measures to prevent self-settled trusts being used to prejudice the settlor's creditors, such as requiring a notarial deed etc for self-settled trusts to be effective (Article 4(3)) and special measures in the case of execution by settlor's creditors against trust assets held by a self-settled trust (Article 23(2)). Under the Trust Bill, the provisions relating to self-settled trusts will not apply until one year after the effective date of the new law.
Regulation of self-settled trusts
Companies may combine a business trust with a self-settled trust. However, if a continuous pattern of repeated establishment of self-settled business trusts by a company were to be categorized as engaging in a trust business, under the Trust Business Law's regulatory regime regarding matters such as licensing, concurrent businesses and corporate trade name will apply, making it practically impossible for a company to engage in such activity. So, pursuant to a pending bill that will revise the Trust Business Law, an entity establishing a self-settled trust will be required to register with the Financial Services Agency of Japan only if a certain fixed number of persons (reportedly 50 persons) or more will acquire beneficial interest rights in the trust (Article 50-2 of the revised Trust Business Bill). In all other cases, the regulations under the Trust Business Law will not apply. However, if an entity registered with the Financial Services Agency of Japan intends to establish a self-settled business trust by way of a declaration of trust and cause persons of or beyond the certain fixed number to acquire beneficial interest rights, the entity will, to protect its beneficiaries' interests, be obliged to undergo an inspection by a third party with respect to the condition of its trust assets (Article 50-2(10) of the revised Trust Business Bill).
Limited liability trusts
As a general principle, liability for debts arising in connection with transactions in the course of the trustee's administration of a trust are not limited to the trust assets the trustee will also be personally liable. Under the current Trust Law, the trustee may include a special limited recourse clause in its transaction documents with trust creditors that limits creditors' recourse to the trust assets, but the Law does not specifically provide a form of trust that gives the trustee the benefit of limited liability. However, because there is a need for limited liability trusts in certain cases and because, as a general principle, it is reasonable to permit a trust to allocate risk between the trustee and the trust creditors, the new Trust Bill authorizes the establishment of a trust where recourse for debts arising out of transactions in the course of its administration will be limited to the trust assets (a limited liability trust) (Articles 216 through 247). However, to avoid a transaction counterparty incurring unexpected loss, the Trust Bill requires a trust to be registered to constitute a valid limited liability trust (Article 216(1) and Article 232) and further requires that the trustee clearly indicates to the transaction counterparty that it is the trustee of a limited liability trust when entering into a transaction (Article 219). Also, to protect trust creditors whose recourse has been limited to the trust assets, the Trust Bill provides for a restriction on the distribution of trust assets to the beneficiary (Article 225) and imposes personal liability on the trustee for loss and damage sustained by third parties to the extent caused by the wilful misconduct or gross negligence of the trustee in the course of its administration of the trust (Article 224).
Decision-making among multiple beneficiaries
For various purposes, the beneficial interest rights of a business trust may be structured for acquisition by multiple persons. However, the Trust Law does not contain provisions that contemplate the existence of multiple beneficiaries and, if a trust does have multiple beneficiaries, it is not clear what kind of decision-making process among the beneficiaries would, as a practical matter, be permitted under the Trust Law. To deal with this issue, the Trust Bill specifically addresses the issue of the decision-making process where multiple beneficiaries exist (Articles 105 through 122). Under the Trust Bill, unless otherwise provided for in the trust agreement or the declaration of trust (as applicable), the default rule will be that all decision-making by multiple beneficiaries must be unanimous. However, with exception for decisions involving the release of the trustee or its directors from liability, the Trust Bill affords trusts great flexibility by giving the parties a broad discretion to change this default rule and provide for their own decision-making rules in the trust agreement or the declaration of trust.
Beneficial interest rights as securities
The Trust Law does not contain express provisions regarding the issuance of beneficial interest rights as securities and in practice, except where the issuance of beneficial interest rights as securities is expressly provided under certain laws (for example, investment trusts and the Investment Company Act), the issuance of beneficial interest rights as securities does not take place. However, certain types of trusts, other than investment trusts, need to issue beneficial interest rights as securities to enhance the transferability of these rights. So the Trust Bill contains a provision permitting the issuance of beneficial interest rights as securities if so specifically provided in the trust agreement or the declaration of trust, as applicable (Articles 185 through 215). Beneficial interest rights such as securities will probably be transferable by book-entry under the Law Concerning Book-Entry Transfer of Corporate Bonds, etc.
Company law and business trusts
Shareholders' resolution for business entrustment
If a company intends to entrust a material part of its business pursuant to a trust agreement then, as in the case of a traditional business transfer (jigyo jyoto), the entrustment will need to be approved by a special resolution at a shareholders' meeting in accordance with Article 309(2), item 11 and Article 467(1), item 2 of the Company Law (that is, adoption by two-thirds or more of the votes of shareholders present representing more than one-half of the total number of issued shares). If a company intends to entrust a material part of its business through a declaration of trust (a self-settled trust) rather than through a trust agreement, in principle, the entrustment will also need to be approved by a special resolution at the shareholders' meeting pursuant to Article 266(2) of the Trust Bill, which provides that the provisions regarding a business transfer under the Company Law or other laws will apply if a business is entrusted through a declaration of trust.
Duty of care and fiduciary duty
The trustee owes the trust's beneficiaries a duty to act with the care of a good manager (zenkan-chui-gimu) (Article 29(2) of the Trust Bill) and a fiduciary duty (Article 30). Under the Company Law, the directors of the trustee company owe this duty of care and fiduciary duty to the shareholders of their company. In the case of a business trust, these duties can sometimes conflict with each other. For example, in Example 1 above, Company B, as trustee, owes a duty of care and a fiduciary duty to Company A, as beneficiary, when Company B administers the business trust's business. On the other hand, because Company B is engaged in the same type of business as Company A and because the directors of Company B owe a duty of care and a fiduciary duty to Company B's shareholders, conflict can arise between the multiple duties of the directors of Company B. This issue has not yet been resolved and should be further considered and analyzed to enable the efficient use of business trusts.
How business trusts will be taxed, especially whether trust profits will be subject to corporate tax at the trustee level, has, as a practical matter, become a point of much concern. The direction in which discussions will head is unclear and needs to be carefully monitored. As a general concept, Japanese tax law treats a trust, in principle, as a conduit. However, subject to certain exceptions, Japanese tax law specifically assesses corporate taxes against the trustee (subject to permitted deductions for distributions if certain requirements are met) for the profits accruing during each trust calculation period in case of a specified trust (tokutei shintaku) defined in Article 2, item 29-3 of the Corporate Tax Law to preserve parity with the tax treatment of specified purpose companies (tokutei mokuteki kaisha) and investment companies (toushi houjin). So it is possible that trustees of certain business trusts will be subject to corporate taxes to preserve balance in the tax treatment of companies.
Business trust and employment
In a usual business transfer, the employment contracts with employees engaged in the business are transferred upon agreement by the transferor and the transferor of the employment contracts, and the employees' consent. Although the issue regarding a trustee becoming a party to an employment contract has not yet been adequately discussed and resolved, the transfer of employment contracts in the case of an entrustment of business by a trust agreement should be treated in the same way as transfer of employment contracts in a usual business transfer context. However, in the case of a self-settled business trust, it is not clear whether a business entrustment should be treated as a transfer of employment contracts because the employer does not change. Further analysis and discussions are required on the issue of whether employee consent should be required for the transfer of an employment contract in the case of a self-settled business trust; at least in the case where the business trust is a limited liability trust, the consent of the employee should be required because recourse for the employee's wages after the transfer of the employment contract will be limited to the trust assets.
Although the new Trust Bill and the revised Trust Business Bill go a long way towards ensuring that business trusts can be used with a reasonable degree of confidence in Japan, some issues still need to be discussed and resolved before the business community will be comfortable with their use.
Nagashima Ohno & Tsunematsu
Motohiro Yanagawa is an associate of Nagashima Ohno & Tsunematsu. His practice focuses on structured financing transactions, project finance and other finance transactions. He graduated in 1996 with an LLB from Waseda University and in 2002 with an LLM from Columbia Law School. He is admitted to practise law in Japan (1998) and in New York (2003). He worked at Sidley Austin Brown & Wood (now Sidley Austin) in New York as a foreign associate from 2002 to 2003.
Nagashima Ohno & Tsunematsu
Ohki Mizuno is an associate of Nagashima Ohno & Tsunematsu. His practice focuses on securitization, structured financing transactions, dematerialized bonds and financing regulations. He graduated in 2000 with an LLB from the University of Tokyo and is admitted to practise law in Japan (2004). He has been a visiting fellow of the Institute for Monetary and Economic Studies, Bank of Japan, since March 2006.