One of the more eagerly, if not heavily, debated topics in Japanese legal circles is the Basic Reform Plan of the Law of Obligations, a proposed blueprint for the overhaul of Japan's Civil Code provisions on obligations. Having been adopted in 1896, the Civil Code has had no major reforms, particularly on the law of obligations in over 100 years. Thus, the necessity for its reform to address economic, business, legal and societal developments, changes and issues of the past century has been discussed for quite some time. These discussions led to the formation of a self-constituted committee of legal scholars called the Japanese Civil Code (Law of Obligations) Reform Committee, committed to study reforms.
The Committee formally announced the Basic Reform Plan in April 2009 (and published it in May), which has since gained much attention from law practitioners, partly because the Committee's members include a number of authoritative scholars, some of whom were expected to be appointed to the official legislative deliberation commission. Following the publication of the Basic Reform Plan, the Ministry of Justice announced that it will start legislative deliberations of the reform. So if the Civil Code is indeed reformed, although the members of the deliberation commission confirmed that the deliberation will start from scratch, the Basic Reform Plan will most likely have great influence on deliberations.
The extensive proposals will have a profound impact on Japanese society and business. In the world of finance, the largest affect will be on assignment of receivables, which for this reason will be the focus of this article.
There are three major changes regarding assignments of receivables, namely contractual limitation of assignment, perfection of assignment and assignment of future receivables.
Contractual limitation of assignment
Under the current statute, the assignment of receivables under a contract with a contractual limitation that requires the consent of the obligor (non-assignable receivables) is generally considered void, unless the assignee has no knowledge of such limitation without material fault on its part.
The Basic Reform Plan reverses this general principle, with the intent of accelerating the transfer of receivables under financing purposes, such as securitisation of receivables or loans with receivables to be pledged or assigned as security. Under the Basic Reform Plan, non-assignable receivables may be assigned validly between the assignor and the assignee and in respect of any third party. However, the obligor may assert the limitation of the assignment and continue to treat the assignor as the creditor, unless (i) the obligor has given its consent to the assignment, (ii) the assignee has no knowledge of such limitation without material fault on its part, or (iii) the assignee has perfected the assignment against third parties and a statutory insolvency proceeding has been initiated in respect of the assignor. The above exceptions (i) and (ii) are in line with current rules. The third exception under item (iii) has been added based on the rationale that the objective of protecting the obligor's interest by keeping the creditor unchanged will not be achieved if the assignor goes bankrupt.
Despite the Committee's intent to stimulate transfers of receivables, lawyers are not satisfied that the proposal dealing with the statutory insolvency proceedings will facilitate securitisation. In a securitisation of receivables where the trustor (who is the assignor) will be the servicer, the termination events of the servicing agreement will normally occur earlier than the commencement of the insolvency proceeding against the servicer, such as upon the servicer's breach of the servicing agreement or its inability to pay debts, in order to replace the servicer before the petition of any insolvency proceeding and to minimise commingling risk of the trust assets (the debt collection amount) with the servicer's own assets. If the assignment of non-assignable receivables cannot be asserted against the obligor, however, the trustee cannot change the servicer and has no other choice but to continue the servicing agreement until an insolvency proceeding. Ratings agencies would probably consider the structure unsatisfactory in terms of trust beneficiaries' protection, as the trust assets might diminish due to the servicer's breach of the servicing agreement or commingling of trust assets with the servicer's assets.
Another concern is the assignment of bank deposits. The number of claims owed by banks is incomparably large and the balance of deposits changes daily. And bank deposit claims are normally non-assignable receivables. Under the proposed amendment, despite these factors, assignments of bank deposits made by a depositor can be asserted against banks at the depositor's insolvency proceeding. This would necessitate banks to check whether any insolvency proceeding has been commenced against a depositor each time an assignee of deposit asserts its right; and this procedure would be too much of a burden for banks.
Perfection requirements
The assignment of receivables will be perfected against third parties either by a date-certified notice sent to, or a date-certified consent obtained from, the obligor or by registration system. Priority will be determined according to the certified date or the registration date. Under this system, the obligor is expected to act as an information centre to enable any potential acquirer to know whether or not the receivable has already been assigned to someone else.
As against the obligor, the current statute requires a notice, together with a certificate of registration (in case of perfection by registration), or a consent for perfection. So if a notice is sent to, or consent is obtained from, the obligor with date certification (and attached with a certificate of registration, in case of registration), perfection against both third parties and the obligor will be obtained.
The Committee criticised this system as being out-of-date, defective and in need of revision. One defect is the fact that even though the obligor is expected to act as an information centre, the obligor has no obligation to disclose whether it has received any notice or has consented to any assignment.
The Basic Reform Plan contains two proposals to simplify and facilitate perfection. For monetary claims, the proposal is to only use the registration system. For non-monetary claims, due to the difficulty of using the registration system and the smaller volume of assignments, the Committee proposes that perfection against third parties be simply made by the date certification of the assignment agreement.
For perfection against the obligor, the Committee proposes to remove obligor's consent as a perfection requirement, so that before receiving the notice of assignment, the obligor not only is deemed to have discharged the obligation when it performs the obligation to the assignor, but is required to perform the obligation to the assignor even if the obligor is aware of the assignment. This change targets cases where the parties to the assignment intend that the assignor should receive the payment from the obligor until certain credit events affecting the assignor occur.
Lawyers have pointed out several inadequacies and issues against the proposal, including:
- The registration system, which does not allow multiple pledges to be registered with the same priority, should allow such registration especially for pledges in syndicated loans.
- The difficulty in differentiating monetary and non-monetary claims should be resolved. There are claims such as trust beneficial interests that have both monetary and non-monetary aspects. If both registration and date certification on the assignment agreement will be required for the assignment of such claims, this new system will be more burdensome.
- The obligor's consent is often used in practice because, with that single act, the assignee can perfect the assignment (and if obtained with date certification, against both third parties and the obligor) as well as obtain consent to the assignment of non-assignable receivables. Furthermore, if the consent was made without any objection, all defences that the obligor may have against the assignor will be severed. In comparison, the proposal under the Basic Reform Plan requires the assignee to register the assignment of monetary claim in addition to obtaining the obligor's consent.
- From a practical point of view, judging from current practice of the registration system, the biggest hurdle is the limited effective period of the registration. The current registration system does not allow for perpetual registration. The registration period for receivables with a specified obligor is 50 years, while the period for receivables with an unspecified obligor is only 10 years. This term limitation has not been addressed.
- For non-monetary claims, the proposal ignores the reluctance of most parties to an assignment to disclose the terms of the assignment agreement to the obligor.
Assignment of future receivables
There are no express provisions in the Civil Code recognising the assignment of future receivables, although well-established case laws have accepted such assignment, albeit with certain limitations. The Supreme Court has stated that an assignment of receivables arising during a future predetermined period will be deemed void partially or in its entirety for being against "public order and morals", if, based on the length of such period and other terms of the assignment agreement, the assignment is construed as (i) too restrictive and the restriction deviates beyond the bounds of socially accepted limits against the assignee's business activity, (ii) an unjustifiable detriment to other creditors, or (iii) a circumstance similar to those described in the preceding clauses (i) and (ii).
Under the Basic Reform Plan, the Civil Code will expressly allow the assignment of future receivables; however, there is no provision that either affirms or negates the limitations on the assignment of future receivables indicated by the Supreme Court cases. The Committee explained that while it is possible that the assignment of future receivables may be deemed void under the "public order and morals" rule, it decided not to tackle this issue in its proposal since it relates not only to the law of obligations but also the bankruptcy laws and legal provisions regarding security assignments of other property, and would be beyond the scope of the Committee's objectives.
The Basic Reform Plan, however, proposes to clarify the relation between an assignment of future receivables under any contract (this can be more than one contract and does not have to exist at the time of the assignment of the future receivables) (underlying contract) and a subsequent succession of contractual status under that underlying contract.
The general rule is that the assignor does not have the power and authority to dispose of future receivables that belong to someone other than the assignor (a third party). As an exception to this general rule, the Committee proposes that the assignment of future receivables can be asserted against the subsequent successor of the contractual status of the underlying contract; in other words, even if a receivable under the assigned underlying contract arises after the succession of the contractual status, the assignee of the future receivables can claim the assignment of such receivable (or its right over such receivable) against the successor of the contractual status.
For example, in the case of lease agreements, consider if apartment building owner A assigned the future rents for the next five years to B, and later on sold the apartment building to C. According to case law, the real property purchaser will automatically succeed to the contractual status of the previous owner as the lessor of the transferred property upon the perfection of the property. In this case, applying the Committee's proposal, B will have the right to the rents arising under lease agreements existing when C acquired the building, because C has succeeded to A's contractual status.
However, the Committee's proposal does not take into account the effects of insolvency in securitisation or similar deals. If the assignor of future receivables becomes insolvent and a trustee is appointed, the trustee will succeed to the contractual status of the insolvent assignor under the underlying contracts existing at the commencement of the insolvency proceeding. While the Committee assumes that the trustee is a third party in respect of any assignment of future receivables made by the debtor company, under the proposal, future receivables arising from contracts executed by the trustee do not belong to the assignee of receivables since these new contracts were executed by the trustee itself. Therefore, the trustee cannot be said to have merely succeeded to its contractual status under these new contracts and the new receivables are not within the scope of the prior assignment of receivables. If such future receivables, under new contracts created by an insolvency trustee on behalf of the insolvent assignor in an insolvency situation, are not covered by the assignment of receivables made by the assignor prior to insolvency, and do not belong to the assignee, then the feasibility of transactions such as whole business securitisation and asset-backed loans of future receivables will greatly diminish.
As for limitations on assignments of future receivables, even though providing a clear cut standard or requirement would not be appropriate as transactions should be assessed on a case-by-case basis, case law's "public order and morals" rule is too ambiguous. In order to facilitate the use of future receivables as securities or underlying assets for securitisation, some kind of safe harbour rule is desirable.
Conclusion
The Ministry of Justice started legislative deliberations of the planned reform of the Civil Code last November. The members of the deliberation commission consist of law practitioners, government officials and scholars, and five out of eight scholars were former members of the Committee. The commission plans to consolidate an iterim proposal and solicit public comments by April 2011.
That the Basic Reform Plan will most likely be used as an important reference, if not the basis, for the deliberations has been the subject of rumors. However, as demonstrated above, there are several issues that need to be seriously tackled, including those narrowly covered by this article. Hopefully there will be ample time for discussion, and the comments from the business community and practising lawyers will be fully considered.
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About the author
Sawako Miyauchi is an attorney with Mori Hamada & Matsumoto. Her main areas of practice are corporate and financial transactions, with a particular focus on structured finance, acquisition finance, banking and other debt financings. Miyauchi was admitted to the Bar in 2003 in Japan and in 2009 in the State of New York. She graduated from the Hitotsubashi University (LLB, 1997) and Columbia University School of Law (LLM, 2008). She worked at Kanematsu Corporation from 1997 to 1999 and at Shearman and Sterling LLP, New York office from 2008 to 2009. |
Contact information
Sawako Miyauchi
Mori Hamada & Matsumoto
Marunouchi Park Building
2-6-1 Marunouchi,
Chiyoda-ku Tokyo 100-8222, Japan
Tel: +81 3 6212 8330
Fax: +81 3 6212 8230
Email: sawako.miyauchi@ mhmjapan.com
Web: www.mhmjapan.com |