In the past, securitization transactions originating in Japan
faced a combination of difficulties, including an unwieldy
framework for perfection of transfers of receivables, a corporate
law regime that did not welcome special purpose companies and
multiple ministries with overlapping jurisdictions for financing
activities by companies in different industries.
In the past year, the Japanese Diet has passed a number of
statutes aimed at alleviating some of these obstacles and
facilitating securitization. In this article, we will briefly
survey certain key legal issues addressed by these new laws and
recent judicial and regulatory developments. As in other
jurisdictions, the primary objective of securitization in Japan is
to establish a structure which eliminates the bankruptcy risk of
the originator of securitized assets so that investors can rely
solely on cashflow from such assets for repayment of the
securities.
Perfection of Transfer
Financial assets used for securitization transactions in Japan
are predominantly receivables. The general requirements for
perfection of the transfer of receivables are given in Article 467
of the Japanese Civil Code, which provides that, in order to
perfect the transfer of receivables against the obligor (obligor
perfection), notice of assignment must be provided to the obligor
by the assignor, or the consent of the obligor to such assignment
must be obtained. Furthermore, in order to perfect such transfer
against third-party creditors — including a trustee or receiver if
the originator were subsequently to become subject to bankruptcy or
reorganization proceedings (third-party perfection) — notice or
consent must be given by an instrument bearing an authenticated
date (kakutei hizuke), that is, a notarized instrument or content
certified mail.
Because of the high cost and administrative burden for giving
such individual notice, where numerous receivables are transferred
for securitization, and because of originators' concern that the
giving of such notice of transfer to their customers may have an
adverse impact on their future business relationships with
customers, a number of transactions have been structured without
requiring such notice unless long-term debt of an originator is
downgraded to a certain level (typically, BBB¯ or Baaa3). In this
case, the assignee would normally procure from the assignor, in
advance, a number of pre-signed (or sealed) copies of the
assignor's notice along with a power of attorney authorizing the
assignee to deliver such notice to the obligors as an agent of the
assignor in case such delivery were to become necessary, and
maintain such pre-signed notices and power of attorney current at
all times during the period of the financing. Although a bankruptcy
trustee has the power to avoid an act of perfection if such
perfection is effected within 30 days before the filing for
bankruptcy or the stoppage of payment, it is generally understood
that the perfection would not be avoidable if effected pursuant to
an automatic trigger clause that was agreed before such financial
difficulties arose (ie, at the time of the offering of securities)
and was disclosed to the public (ie, in a public offering).
However, the number of transactions using this structure is
expected to decrease significantly in the future in light of the
fact that off balance-sheet treatment is likely to become
unavailable for this contingent perfection structure under the new
financial component approach the Corporate Accounting Board adopted
in January 1999.
The Law concerning Regulation of Business Relating to Specified
Claims, etc (the Specified Claims Law), which came into force in
1993, created a less cumbersome perfection system for Japanese
lease and credit card companies transferring their lease and credit
card receivables (specified claims). Under the Specified Claims
Law, if a transfer is made in accordance with a plan pre-confirmed
by the Ministry of International Trade and Industry (the MITI), the
originator may give public notice of a transfer in a daily
newspaper and, for purposes of Article 467 of the Civil Code, from
the date of publication the originator is deemed to have given
notice with a kakutei hizuke to the obligor of the receivables
transferred.
The Law regarding Special Exceptions to the Civil Code with
respect to Perfection Requirements for Assignment of Claims (the
Special Perfection Law), effective October 1 1998, established a
new filing system for transfers of all types of monetary
receivables owed to corporations, including, without limitation,
loan receivables of banks and other finance companies and other
general account receivables that were not eligible for perfection
under the Specified Claims Law. Under the Special Perfection Law an
application for the registration of the transfer must be filed
jointly by both the assignor and the assignee, and there is no
registration tax for a transfer of receivables thereunder. Unlike
the Specified Claims Law, the Special Perfection Law distinguishes
between obligor perfection and third party perfection. Once the
registration for a transfer is made, a kakutei hizuke notice within
the meaning of Article 467 of the Civil Code is deemed to have been
given against any third party (ie, any party other than the obligor
of the receivable so transferred). However, the registration of a
transfer has no effect as against the obligor of the receivable to
which the registration pertains unless either the assignor or the
assignee gives the obligor notice of the transfer, accompanied by a
certificate of the registration issued by the registration office,
or the obligor consents to such assignment. Accordingly, if the
obligor of an assigned receivable acquires an offsetting claim
against the assignor after the registration of the transfer, but
before such notice or consent is given under the Special Perfection
Law, the obligor may assert a defence of set-off against the
assignee. While it is commonplace in some jurisdictions to require
obligors of receivables to waive the right of set-off in the
underlying documents that give rise to such receivables, there is
some doubt whether such a provision would be enforceable in Japan
and the standard form for general banking transactions used by
Japanese banks does not contain such a waiver clause.
Unlike under the Uniform Commercial Code in the US, there is a
limitation on transfers of future receivables. Since the Special
Perfection Law requires that the registration set forth, among
other things, the identity of the assignor, the assignee and the
obligor of each receivable transferred and the total amount of, and
information necessary to identify, the receivables transferred, it
is not possible to make a filing thereunder for a transfer of a
group of receivables without identifying the obligors thereof (eg,
a statement that "all loan receivables extended by 'A' branch of
'X' bank" without identifying the borrowers is not sufficient).
However, in respect of future receivables the Supreme Court held on
January 29 1999 that as long as future receivables were properly
identified by the amount, type, time period and otherwise, the
assignment of future receivables would be valid, even if it was not
certain that such receivables were to arise. Before the decision,
annual renewal of the assignment and perfection was often made as a
precautionary measure due to uncertainty as to the validity of an
assignment of future receivables arising more than one year after
the assignment.
Special Purpose Company
In a typical Japanese cross-border securitization transaction, a
special purpose company (SPC) that acquires financial assets from
the originator and issues asset-backed securities is organized
under the laws of the Cayman Islands: To insulate the SPC from the
bankruptcy risk of the originator, it is structured as an orphan
company, whose beneficial interest is owned by a charitable trust,
using a declaration of trust. Because a transfer of assets located
in Japan from a resident to a non-resident is subject to Japanese
withholding tax, the SPC will establish a Japanese branch office to
avoid the withholding tax. Since the Japanese branch office
constitutes a permanent establishment of the SPC in Japan, interest
on securities issued by the SPC will be considered Japanese source
income and, therefore, subject to Japanese withholding tax if paid
to investors from a country that is a signatory to a tax treaty
with Japan. Accordingly, a second SPC organized in the Cayman
Islands (or any other jurisdiction which is not party to such tax
treaty) is generally interposed to hold all securities issued by
the first SPC (thereby obviating Japanese withholding) and, in
turn, to issue its own securities to investors, including those
from tax treaty countries.
In a domestic transaction, in which an SPC is established in
Japan, the SPC is often organized as a subsidiary of a Cayman
Island SPC, because it is generally understood that a declaration
of trust is not permitted under Japanese law and, therefore, it is
difficult to establish a bankruptcy-remote orphan company in Japan.
A financial institution (including a foreign trust company) that
wants to hold more than 5% of the outstanding shares of a Japanese
corporation must obtain prior approval from the Japanese Fair Trade
Commission under the Japanese Anti-Monopoly Law.
Under the Japanese Commercial Code, only joint stock
corporations (kabushiki kaisha) may issue securities and, thus, a
kabushiki kaisha is the only entity which could potentially be an
SPC. However, it is difficult to structure an SPC in a cost
efficient manner using a kabushiki kaisha because the form was
intended mainly for large public corporations. For example, the
Commercial Code requires that kabushiki kaisha be capitalized with
at least ¥10 million and have a board of directors with at least
three directors (which must hold a meeting in person at least once
every quarter, and a written resolution in lieu of a meeting or a
meeting via telephone conference is not permitted) and at least one
statutory auditor. Moreover, if the amount of balance sheet
liabilities reaches ¥200 million or more, in addition to the board
of directors, a board of statutory auditors consisting of at least
three members and an independent accounting firm must be
appointed.
Under the Specified Claims Law, an SPC that wants to
engage in the business of acquiring specified claims from leasing
and credit card companies is required to obtain a licence from the
MITI and the Financial Reconstruction Commission (FRC). The SPC
under the Specified Claims Law may not engage in any business other
than the business of acquiring specified claims without approval
from the MITI and FRC, and is required to be capitalized with at
least ¥10 million and, if it acquires specified claims in an
aggregate amount of ¥100 billion or more, the amount of its capital
must be at least ¥100 million. The SPC is either established as a
kabushiki kaisha or a Japanese branch office of a foreign SPC. In
order to alleviate the high cost of establishing the SPC under the
Specified Claims Law a single SPC will normally be used for a
number of securitization programs on the basis of limited recourse
provisions set forth in bonds, in which the liability of the SPC in
respect of bonds issued under each particular securitization
program is limited to the pool of assets acquired by the SPC
pursuant to such securitization program.
The Law regarding Securitization of Specified Assets through
Specified Purpose Company (the SPC Law), which came into
force on September 1 1998, created a new type of corporation
(specified purpose corporations) to be established in connection
with securitization transactions. The SPC Law requires that the
specified purpose corporation be registered with the FRC and that
it provide in its articles of incorporation a detailed plan of
securitization and submit such plan to the FRC when it applies for
registration. The specified purpose corporation is prohibited from
engaging in any business other than the securitization of specified
assets conducted pursuant to its registered plan of securitization
and the incidental business thereto. Specified assets are defined
as real estate, monetary claims and trust beneficiary interests
relating to real estate and monetary claims. The specified purpose
corporation is authorized to issue asset-backed securities (ie,
commercial paper, bonds and preferred shares) pursuant to the plan
of securitization included in its articles.
The SPC Law relieves certain regulations under the Japanese
Commercial Code. The minimum capital requirement for specified
purpose corporations is reduced to ¥3 million. The minimum number
of directors is reduced to one, but at least one statutory auditor
and, irrespective of the size of liabilities, an independent
accounting firm must be appointed. Under the Commercial Code, if
within two years after its incorporation a kabushiki kaisha is to
acquire for use in business assets that existed prior to its
incorporation at a price of 5% or more of its paid-in capital, a
court-appointed inspector must appraise the value of the assets to
be acquired. The SPC Law exempts the specified purpose corporation
from such Commercial Code requirements if the assets to be acquired
are described in the plan of securitization included in its
articles of incorporation.
In order to encourage asset securitization, a number of tax
incentives are offered under the Law concerning Adjustments, etc of
Related Laws in Conjunction with the Enforcement of the SPC Law. A
specified purpose corporation that has issued bonds or preferred
shares to the public or qualified institutional investors, that
does not engage in any business other than the securitization and
incidental business, that distributes as dividends at least 90% of
its profits, and that satisfies certain other requirements, may
deduct the amount of such dividends to the extent that the amount
of such dividends does not exceed the amount of its profits.
However, preferred shares may not be redeemed until after the
completion of the plan of securitization and the repayment in full
of the bonds and commercial paper. As a result, holders of
preferred shares may only be able to receive return of the full
amount of their invested capital when the specified purpose
corporation is liquidated. The registration tax for the
incorporation of a specified purpose corporation is a flat ¥30,000
(as compared to the general rule of the greater of ¥150,000 and
7/1,000 of paid-in capital).
One of the main purposes of the SPC Law is to encourage
securitization of real estate. For that purpose, various tax
incentives are granted to specified purpose corporations that
acquire real estate pursuant to plans of securitization, but since
these benefits are available only for limited time periods of up to
two years and consist mostly of a reduction of tax rates (and not
exemptions), these measures are generally considered insufficient
to revitalize the depressed Japanese real estate market.
Under the SPC Law, the holders of bonds have a general lien on
the assets of the specified purpose corporation and will be treated
as holders of priority claims in the event of bankruptcy of the
specified purpose corporation. One of the biggest problems
associated with the cost for the use of a specified purpose
corporation relates to the SPC Law requirement that prohibits it
from issuing multiple bonds under different plans of
securitization. Under the SPC Law no new securities may be issued
under a different plan of securitization until the previous plan is
completed and the bonds repaid in full. The SPC Law apparently
adopted this requirement because there is no clear authority as to
the validity of limited recourse provisions under Japanese
bankruptcy law. As a result, in connection with the structuring of
securitization transactions involving lease and credit card
receivables after the enactment of the SPC Law, instead of relying
on limited recourse provisions, the use of the specified purpose
corporations under the SPC Law seems to be increasing. A specified
purpose corporation established under the SPC law is deemed to be
an SPC licenced under the Specified Claims Law and, for purposes of
the Specified Claims Law, a plan of transfer to such specified
purpose corporation is eligible for MITI's pre-confirmation and, if
so confirmed, such transfer may be perfected by public notice in a
daily newspaper.
Servicer
In most securitization transactions, the originator continues as
a servicer after it assigns its receivables. Indeed, the
Specified Claims Law provides that the MITI will not confirm
a securitization plan unless the originator is appointed as a
servicer in respect of collection of the receivables the originator
proposes to transfer and that if a transfer of specified claims is
perfected by way of public notice, the service contract may not be
terminated by either party without a "justifiable cause". These
provisions are intended to protect the obligor who paid to the
assignor after the assignment of the receivable is perfected by way
of public notice under the Specified Claims Law, because it cannot
realistically be expected that all the obligors would learn of such
assignment through a public notice made in a daily newspaper.
Recently however, servicer bankruptcy risk has attracted
increasing attention. In connection with the recent reorganization
proceedings of Japan Leasing, the bankruptcy court denied effect to
the trustee's attempted termination of a service contract made on
the day after the filing of the petition under a clause entitling
the trustee to acceleration upon a bankruptcy event. Because the
trustee has the power to either assume or reject executory
contracts, such termination is inconsistent with such power and is
generally understood to be void. In order to withstand such
challenges, it is suggested that the entire amount of service fees
be paid in advance at the time of the contract or that the contract
provide an early termination clause that will be triggered by an
early indication of deterioration of the quality of services of the
servicer, such as downgrading of its credit rating, which is beyond
the reach of avoidance power of a trustee. It remains to be seen
whether such an early termination clause will be considered a
justifiable cause under the Specified Claims Law.
In the past, the Practising Attorneys Law, which prohibits any
person other than an attorney admitted in Japan from taking legal
steps to collect debts on behalf of others, cast doubt as to the
legality of activities of back-up servicers for securitization
transactions. In response to this situation, the Law Regarding
Special Measures Regarding Debt Collection Business (the Servicer
Law) was passed by the Japanese Diet on August 5 1998 and came into
force on February 1 1999. Under the Servicer Law, a corporation
that obtains a licence from the Ministry of Justice (MOJ) is
allowed to engage in the business of managing and collecting
specified monetary claims owned by other parties. As a result of
vigorous opposition by the local bar, "specified monetary claims"
are defined narrowly and include only a limited scope of
receivables, such as loan receivables of certain financial
institutions, such as banks, insurance companies and securities
companies, specified claims as defined under the Specified Claims
Law and corporate loans secured by real estate mortgages held by
financing company subsidiaries of such financial institutions. In
addition, the Servicer Law requires, among other things, that such
servicer corporation have a minimum capitalization of ¥500 million
and that one of its managing directors be a Japanese attorney.
Moreover, the servicer corporation may not engage in any business
other than the business as a servicer of specified monetary claims
and other business incidental or related thereto without approval
of the MOJ.
ACCOUNTING TREATMENT
As mentioned above, on January 22 1999 the Corporate Accounting
Board issued an Opinion regarding the Establishment of Accounting
Standards pertaining to Financial Products, in which the board
rejected the risks and rewards approach widely used in the past.
Under this approach, in case of an assignment with a recourse or
repurchase provision, off balance-sheet treatment would be
justified if substantially all the risks and rewards have been
transferred to the assignee. Instead, the board adopted the
financial component approach in deciding the question of whether
off balance-sheet treatment is appropriate for the originator of
securitized assets. Under the financial component approach, the off
balance-sheet treatment is justified only if:
(i) the assignee's contractual rights with respect to the
financial assets transferred are legally secured beyond the reach
of the transferor and its creditors;
(ii) the assignee can directly or indirectly enjoy in a normal
manner contractual rights in respect of the financial assets
transferred, and
(iii) the transferor does not maintain rights or obligations to
buy back the financial assets transferred before the maturity date
thereof.
Despite enactment of securitization-related legislation in the
past year, there still remain a number of obstacles for structuring
securitization transactions and developing a market for
asset-backed securities in Japan. As securitization is increasingly
viewed as a key solution for revitalizing the Japanese economy by
offering a means for financial institutions to restructure their
balance sheets and improve risk adjusted capital ratios;
non-financial firms to seek non-bank financing and improve return
on equity and assets; and investors to invest in new financial
products, it seems certain that the depth of and activity in this
market will develop at an accelerating speed.
Contact Details:
Cleary Gottlieb Steen & Hamilton
20th Floor Shin Kasumigaseki Building
3 - 2 Kasumigaseki 3 - Chome
Chiyoda-Ku
Tokyo 100-0013
Japan
Tel: (81) 3 3595 3911
Fax: (81) 3 3595 3910