Although the concept of a trust exists under Japanese law, it
differs from the equivalent common law concept. Most notably, in
Japan there is no concept of equitable ownership and thus no
separation of the legal and equitable ownership of trust assets.
The differences have led to confusion, particularly in cases where
practitioners have tried to apply common law principles to a
Japanese trust or vice versa.
What is a Japanese trust and who can conduct trust banking in
Japan?
The nature of a Japanese trust
In essence, a
Japanese trust is a creature of contract and statute. The Trust Law
(Shintaku-hou; Law 62 of 1922, as amended) defines a trust as an
arrangement in which the owner of property rights transfers such
rights to a third party on the understanding that the transferee
will administer, manage and/or dispose of the property in
accordance with specific guidelines established by the
transferor.
A trust agreement is usually necessary to set up a Japanese
trust (a trust can also be created by a will, but this is rare).
The trust agreement must comply with the mandatory requirements of
applicable statute including the Trust Law and the Trust Business
Law (Shintakugyou-hou; Law 65 of 1922, as amended).
The concept of a trust was introduced into Japanese law from the
common law about 100 years ago. But Japan was, and remains, a civil
law country, and the mixture created by a common law concept in a
civil law context has always been somewhat volatile. Professor
Shinomiya, one of the leading commentators on Japanese trusts,
described the concept as being "unique and isolated in the Japanese
legal system, like a drop of oil floating on a pool of water".
Scholars have been trying to explain the nature of the Japanese
trust in a manner which would lead to consistency with the other
parts of the Japanese legal system. So far, none of these
explanations has found unanimous support.
Ownership of the trust assets
Most fundamentally,
there is no concept of equitable ownership under Japanese law and
thus no separation of legal and equitable ownership of trust
assets. Under a Japanese trust, it is the trustee that is the sole
owner of the trust assets and, similarly, the Japanese trustee is
the true counterparty in any transactions conducted in the name of
the trust. But the trustee's ownership is subject to certain
restrictions imposed by the trust agreement and by statute. For
example, the trustee should not benefit from the trust assets
(Article 9 of the Trust Law), the trust assets do not belong to the
trustee's personal estate (Article 15) and the trustee should not
acquire any proprietary interest in the trust assets (Article
22).
Conversely, although the beneficiary is not, as a matter of
Japanese law, the owner of the trust assets, the beneficiary does
enjoy some quasi-ownership rights under the Trust Law. For example,
the beneficiary can object to the attachment of the trust assets by
a court in proceedings against the trustee (Article 16(2)), the
beneficiary has a right to request the return of the trust assets
upon the bankruptcy of the trustee (based on an interpretation of
Article 16(2)), and the beneficiary can apply to the court to
nullify a disposal of the trust assets made by the trustee in
violation of the tenor and purport of the trust agreement (Article
31).
In many ways, the quasi-ownership rights of a beneficiary in
Japan resemble those of a beneficiary under a common law trust.
But, in Japan, the beneficiary's interest comprises statutory and
contractual rights against the trustee and the trust assets.
Japanese law does not recognize a beneficiary as being the owner
(or an owner) of the trust assets. It is critical to keep this
distinction in mind when analyzing ownership and other issues under
a Japanese trust.
Perfection of the trust
For a beneficiary to enforce
its quasi-ownership rights with respect to the trust assets,
including the right of separation on bankruptcy of the trustee, the
trust must be perfected as a matter of Japanese law. The rules for
perfection vary depending on the nature of the asset, but in
general:
- for assets capable of registration (other than securities),
the trust is perfected by notation of the trust in the
appropriate register;
- for securities, the trust is perfected by segregation by
means of booking in a separate account and, where possible,
physical separation from the proprietary assets and other trust
assets of the trustee; and
- for physical assets (other than assets that are capable of
registration), the trust is perfected by actual or constructive
delivery of possession of the assets to the trustee.
In addition to the requirements for perfection, the Trust Law
requires that the trustee separates assets held pursuant to a
particular trust from its proprietary assets and assets held in
relation to other trusts. This additional separation requirement
does not affect the quasi-ownership rights of the beneficiary, but
does aim to make it easier for the beneficiary to identify the
trust assets and to enforce its quasi-ownership rights if a dispute
arises.
Contracting with trusts
As the trustee is regarded
as the legal owner of the trust assets, third parties contract with
the trustee as principal (and not as agent or representative of the
trustor or the beneficiaries). This principle creates liability
issues for the trustee.
Trustees and trust business
The Trust Law and the
Trust Business Law contain limitations on who can act as trustee of
a Japanese trust and what types of assets can be entrusted into a
Japanese trust. Only trust banks licensed in Japan are authorized
to conduct trust business and the classes of trust assets which
they are authorized to accept are limited to money, securities,
monetary claims, moveable property, real estate and fixtures
thereon and surface and land lease rights.
Trust banks are unique among Japanese financial institutions in
that they concurrently provide financial services (banking
business) and asset management services (trust business). They also
offer a variety of services ancillary to those two main areas. The
trust business component focuses on money trusts, pension trusts,
loan trusts, investment trusts (including real estate investment
trusts), pecuniary trusts other than money trusts, securities
trusts, monetary claims trusts and special purpose trusts set up in
connection with the securitization of assets. The banking business
component involves accepting deposits, lending and providing
foreign exchange facilities.
Common investment trust structures
Two common types
of trust used in the Japanese market for investment purposes are
the specified money, or tokkin, trust and the designated money, or
shiteitan, trust. The main difference between these two trust
structures is who makes the decision on how and when to invest the
trust assets. Under a tokkin trust, a registered investment adviser
appointed by the trustor instructs the trustee regarding investment
of the trust assets. Under a shiteitan trust the trustee makes such
decisions itself in accordance with the general investment
guidelines provided in the trust agreement.
| Tokkin trust |
 |
| Shiteitan trust |
 |
Trustee's liability and fiduciary duties
Trustee's liability to the trustor, beneficiaries and
joint-trustees
Trustees of Japanese trusts are required to
administer trust assets in accordance with the underlying trust
agreement. The Trust Law expressly provides that in performing such
duties, a trustee must act in accordance with the tenor and purport
of the trust agreement and with the due care of a good manager.
If losses to the trust assets are suffered as a result of the
trustee's mismanagement or disposal of the trust assets (including
the creation of security interests over the trust assets) in
violation of the tenor and purport of the trust agreement, the
trustor, the beneficiaries and any joint-trustee of the trust have
a statutory right to claim against the trustee for indemnification
of such losses or restitution of the trust assets. Further, if the
trustee disposes of trust assets in violation of the tenor and
purport of the trust agreement, the beneficiaries may avoid such
disposal as against even innocent counterparties or subsequent
acquirers if, before the time of such disposal, the trust assets
are registered or recorded as being held on trust (or if the trust
assets are not capable of being registered or recorded, if such
counterparty or subsequent acquirer knew or should have known that
the disposition was in violation of the trust agreement).
Trustee's liability to transaction counterparties
As
the owner of the trust assets and the true counterparty in any
transactions conducted in the name of the trust, the trustee of a
Japanese trust is personally liable for all obligations of the
trust. Trustees typically take two steps to limit their personal
exposure under transactions conducted in the name of a trust.
Firstly, the transaction documentation will usually include a
limited recourse clause, limiting the transaction counterparty's
recourse against the proprietary assets of the trustee or the
assets of other trusts held by the trustee. Secondly, the
underlying trust agreement will usually contain an indemnity
provision whereby the trustor agrees to indemnify the trustee
against any costs incurred or losses suffered by the trustee in
connection with the management of the trust.
The limited recourse language will not affect the transaction
counterparty's right of recourse to the trust assets. But where
limited recourse language is used, the transaction counterparty
will only be able to look to the trust assets as the source for
payment of the trustee's obligations. For this reason, transaction
counterparties generally insist on regular reporting by the trustee
with respect to the trust assets and require the inclusion of a
negative pledge clause that prohibits or limits the trustee's
ability to create security over the trust assets, or take any other
action that may reduce the value of the trust assets.
Further, transaction counterparties often require that any
provision limiting its recourse against the proprietary assets of
the trustee does not apply in cases where: the trustee has acted in
breach of the trust agreement or its agreement with such
counterparty; there has been negligence or misconduct on the part
of the trustee; or the trustee has failed to segregate the trust
assets as required under Japanese law.
Investment adviser's ability to bind trustee
One topical issue in the Japanese market relates to tokkin
trusts and the ability of an investment adviser to bind the
trustee. Because the appointment of the investment adviser and the
scope of the investment adviser's authority are established by
contract, this issue has to be looked at on a case-by-case
basis.
Transaction counterparties will often not be provided with a
copy of the investment advisory agreement or the trust agreement.
Consequently, to avoid any confusion regarding the ability of an
investment adviser to bind the trustee, all counterparties entering
into transactions with Japanese trusts through an investment
adviser should ensure that the transaction documentation clarifies
the scope of the investment adviser's authority and confirms that
the trustee will be bound to act on the instructions of the
investment adviser. The inclusion of such provisions will also
clarify to whom the transaction counterparty has recourse in the
case of default.
Trends in Japanese trust banking
Master trusts
In March 1999, the government
promulgated a deregulation schedule as part of the so-called Big
Bang initiative. In this schedule, the government stated that a
"master trust is possible by using a re-trust scheme under a
specified comprehensive trust contract (tokutei houkatsu
shintaku)". The use of master trust by way of re-trust or co-trust
has become increasingly common, particularly in connection with the
combining of pension trust funds that is occurring as a consequence
of consolidation within the Japanese trust banking market.
Market participants are finding that master trust structures
allow them to transfer the operational management of the trust
assets efficiently and smoothly without affecting existing client
relationships. Master trust structures are also being used to
increase efficiency by, for example, separating investment advisory
services from custodian services. In this way trust banks are able
to focus on those services where they have an established
speciality and market presence.
Another area where master trusts are now often used is in the
securitization market. Although initial establishment costs for
master trust structures are higher than single-issue structures,
once established a master trust structure gives originators quick
access to the capital markets, thereby allowing them to take
maximum advantage of favourable market conditions. The higher
initial establishment costs can also be spread over future issues
because the existing programme infrastructure will lower the cost
of such future issues. Despite the clear advantages of master trust
structures in securitization, — especially for originators wishing
to regularly secure pools of receivables such as housing loan
receivables, commercial real estate loan receivables, consumer
finance receivables or auto loan receivables — their use is limited
by the classes of assets that can form the basis of a trust under
Japanese law.
JReits
Changes to the Law Concerning Investment
Trusts and Investment Companies (the Investment Trust Law) in
November 2000 paved the way for setting up real estate investment
trusts in Japan (JReits). Since the first JReits were listed on the
Tokyo Stock Exchange in September 2001, they have proved popular.
All listed JReits are closed-end corporate type entities that can
issue units (shares) and notes. JReit units have been offered in
the Japanese, US and Euro markets. One of the main contributing
factors to this popularity has been the favourable tax treatment
granted to JReits; provided that at least 90% of the profits of the
trust are distributed to investors, such distributions are
deductible by the JReit when calculating its taxable income for
Japanese corporate tax purposes.
As of mid-November 2003, there were eight JReits listed on the
Tokyo Stock Exchange, with a combined asset value of more than ¥1
trillion ($9.2 billion)
(http://www.spc-reit.com/index.html).
Investments in distressed debt (reorganization
claims)
Trusts have also recently started appearing in the
context of corporate reorganization proceedings (kaisha kousei
tetsuzuki). As many distressed debt investors do not want to have
to actively participate in corporate reorganization proceedings,
reorganization claims (kousei saiken) are being placed in trust and
the distressed debt investors are purchasing the beneficial
certificates issued by the trustee. The trustee, as the owner of
the reorganization claims, then directly participates in the
reorganization proceedings and there is no need for the distressed
debt investors to, for example, attend meetings of reorganization
claim holders.
Looking forward
Reform projects
In late July 2003, a working group
of the Financial System Council of Japan submitted a report to the
Prime Minister's Office recommending major changes to Japan's trust
laws and regulations. These changes focus on expanding the scope of
the classes of trust assets that a trustee is authorized to accept
as its business, and revising the trust business licensing system
to provide for more flexibility and greater competition.
Expanding scope of trust assets
Only money,
securities, monetary claims, moveable property, land and fixtures
thereon, and surface and land lease rights are permitted classes of
trust assets. The proposed revision to the Trust Business Law will
provide that this restriction be lifted in full so that any
property rights (including intellectual property rights and carbon
emission rights) may form the basis of a trust.
Revising trust business licensing system
Under the
current system, only banks licensed under the Law Concerning the
Concurrent Undertaking of Trust Business by Financial Institutions
(Kin'yuukikan no shintakugyoumu no ken'ei-tou ni kan-suru houritsu;
Law 43 of 1943, as amended) are permitted to carry on trust
business. The proposed new system will provide for greater
flexibility and competition by setting up three new categories of
trust business license. The minimum requirements for these three
categories will vary depending on the type of trust business to be
undertaken. This analysis will focus on whether the underlying
trust is:
- a passive administration-focused trust (iji-kanri-gata
shintaku), where the trustee has no discretion regarding the
investment/disposal of trust assets;
- a securitization-focused trust (ryuudouka-gata shintaku),
where the trust was set up in connection with the
securitization of assets; or
- an active administration-focused trust (un'you-kanri-gata
shintaku), where the trustee can invest/dispose of trust assets
at its discretion.
Although the actual minimum requirements for each of these three
new categories are yet to be finalized, it is expected that the
greater the discretion of the trustee, the stricter the
requirements will be.
It is expected that the Financial Services Agency will table the
proposed revisions in the Japanese Diet early in 2004.
Future business opportunities and challenges
The
reforms will provide both business opportunities and challenges.
The expansion of trust asset classes will lead to an increase in
the number of trust-based financial products available to
consumers, thereby offering new business opportunities to both
existing and new market participants. For example, intellectual
property trusts will increase the options available to the many
Japanese companies holding large intellectual property portfolios
to leverage such assets to raise funds.
The proposed revisions to the trust business licensing system
will also offer a broader range of new entities the opportunity to
participate in the market and compete directly with the existing
trust banks. This will create significant challenges for existing
trust banks striving to maintain profitability levels as the
increase in competition may drive down fees and margins. Also, the
ability of large corporations to set up captive trust companies to
manage group pension funds may reduce the need of such corporations
to rely on the services provided by trust banks under the current
regime.
Author
biography
Shinji
Toyohara
Tokyo Aoyama Aoki Law
Office
Shinji Toyohara is a partner of Tokyo Aoyama Aoki Law Office and
divides his practice between transactional work and
regulatory/structured products work. His transactional practice
centres on project finance, PFI and DIP financing. His
regulatory/financial products practice focuses on advice concerning
banking, trusts, insurance and derivatives.
Toyohara is familiar with Japan's financial markets, and
represents foreign banks, securities companies, and insurance
companies in relation to the Japanese legal and regulatory aspects
of a range of structured transactions. In addition, he works with a
wide range of Japanese banks, trust banks, securities companies,
fund managers and insurance companies.
Toyohara is admitted to practice law in Japan and New York. He
received an LLB from the University of Tokyo in 1984 and an LLM
from the Columbia Law School in 1998. He is a member of the Tokyo
Bar Association.
Jeremy Pitts
Baker &
McKenzie
Jeremy Pitts is a partner of Baker & McKenzie and focuses
his practice on financial regulation, product development and
structured financial transactions in Japan. He has extensive
experience acting for foreign financial institutions, and has a
comprehensive knowledge of Japanese financial markets and
practices. Working closely with a team of specialized Japanese
lawyers, he has been actively involved in assisting foreign
financial institutions with regulatory matters in Japan and with
the development of new products for the market.
Pitts is the leader of Baker & McKenzie's Asia Pacific
banking and finance practice group. He is also managing partner of
the firm's Tokyo Office. He was named a leading banking and finance
lawyer for Japan by both Global Counsel 3000 and Asia
Pacific Legal 500 (2003).
Pitts is qualified in New South Wales. He is also admitted as a
solicitor in England and is registered as a foreign lawyer in
Japan.
Gavin Raftery
Tokyo Aoyama Aoki Law
Office - Baker & McKenzie
Gavin Raftery is a foreign associate with Tokyo Aoyama Aoki Law
Office - Baker & McKenzie and focuses his practice in the areas
of loans and credit facilities, JBIC and NEXI supported financial
transactions, derivatives, securitization and other structured
financial transactions, acquisition finance, financial regulation
and product development. He is fluent in Japanese and specializes
in assisting clients in the banking, trust banking, insurance, and
securities industries.
Raftery is qualified in New South Wales and is admitted in
England and Wales. He is not admitted in
Japan.
Tokyo Aoyama Aoki Law Office - Baker & McKenzie
(Qualified Joint Enterprise Offices)
The Prudential
Tower
13-10, Nagatacho 2-chome
Chiyoda-ku
Tokyo 100-0014
Japan
T: + 813 5157 2700
F: + 813 5157 2900
Web: www.bakernet.com;
www.taalo-bakernet.com