Corporate reorganization

Author: | Published: 5 Jan 2004
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Until recently, corporate reorganizations and restructurings using legal insolvency procedures was not active in Japan. One reason may be the traditional Japanese economic culture, which took a harsh view on insolvent companies, meaning those facing financial and economic difficulties were concerned with the negative impact of initiating legal insolvency procedures. In turn, M&A procedures, which have been commonly used for corporate reorganization and restructuring, were not actively used in connection with such procedures.

The environment surrounding corporate reorganization and restructuring changed in the latter half of the 1990s, leading to a gradual increase in M&A activity in connection with legal insolvency procedures. In this period some of notable cases (such as the Crown Leasing case and Okura Shoji case in 1997 under bankruptcy procedure, and the Japan Lease case in 1998 under corporate reorganization procedure) showed a business recovery could be expeditiously implemented by acquiring a business even under legal insolvency procedures despite the fact that acquiring a business was traditionally considered impractical and difficult under such procedures because the value of the insolvent company's business deteriorates immediately after procedures start.

As a sign of changing attitudes and general practice regarding corporate reorganization and restructuring using legal insolvency procedures, the Civil Rehabilitation Law (minji-saisei-ho) became effective on April 1 2000. The rehabilitation procedure is designed with a high regard for speed and has several advantages over previous insolvency procedures as a means for corporate reorganization and restructuring. Since its enactment, the rehabilitation procedure has increasingly become recognized as a valuable tool for this and has been implemented by many distressed companies. (The rehabilitation procedure has proven useful for large and complex companies, for example, Sogo Department Stores, as well as small and medium-sized companies and sole proprietors that were initially thought to be the main beneficiaries of this new law.)

Civil Rehabilitation Law

The purpose of the rehabilitation procedure is to rehabilitate the business of a distressed company based on an agreement between a debtor and its creditors. Subject to acceptance by a super-majority affirmative vote of creditors at the creditors' meeting and confirmation by the court, the terms of the rehabilitation plan could bind the minority creditors that disagree with the plan. Under the Civil Rehabilitation Law, a typical case at, for example, the Tokyo District Court, for which the supervisor (kantoku-iin) is appointed, is expected to follow the following steps:

M&A methods in the rehabilitation procedure

There are two major methods used for the business recovery in the rehabilitation procedure as follows (Discussion below is made on the assumption that the debtor is a joint-stock company (kabushiki kaisha) incorporated under the Commercial Code.)The traditional method for corporate reorganization and restructuring adopted in legal insolvency procedures was a combination of 100% capital reduction without compensation and issuance of new shares to the sponsor. This method may have given the sponsor control over the insolvent company, and is also commonly used in the rehabilitation procedure.

When using this method, the Civil Rehabilitation Law has made an exception for the procedure of capital reduction under the Commercial Code. The Commercial Code requires the debtor resolution by a two-thirds majority affirmative vote of shareholders present at a shareholders meeting to reduce its capital. But, because existing shareholders have no incentive to cast an affirmative vote at a shareholders meeting for the capital reduction - which will eventually deprive existing shareholders rights as a shareholder of the debtor - this requirement is unrealistic in the rehabilitation procedure. Thus, the Civil Rehabilitation Law has made it clear that if a debtor's debts exceed its assets, the capital reduction of the debtor can be set out in the rehabilitation plan with court approval. And the debtor may reduce its capital without satisfying the requirements under the Commercial Code once the rehabilitation plan is accepted and confirmed. This is intended to prevent shareholders from blocking capital reduction and make the finding of a sponsor easier by enabling the sponsor to take a 100% equity interest in the debtor.

However, the Civil Rehabilitation Law has made no exception for procedures issuing new shares under the Commercial Code. In this regard, it should be noted that the cooperation of existing shareholders is required to consummate this method if the debtor is a so-called closed company whose articles of incorporation provide that transfer of shares is subject to the approval of the meeting of the board of directors. This is because, under the Commercial Code, shareholders of such a closed company are entitled to pre-emptive rights, and issuing new shares to a third party other than existing shareholders requires resolution by a two-thirds majority affirmative vote of shareholders present at a shareholders' meeting. Considering that existing shareholders have no incentive to attend the shareholders' meeting or to accept the issuance of new shares to the sponsor, in practice, the debtor and the sponsor need to make arrangements to encourage cooperation to pursue this method.

Acquiring businesses is another M&A method commonly used for business recovery in the rehabilitation procedure. However, it was considered impractical or difficult for corporate reorganization and restructuring under legal insolvency procedures, because the value of businesses rapidly declined after the start of these procedures. In addition, the validity of an acquisition of business carried out before the reorganization plan is approved at the creditors' meeting under the former Corporate Reorganization Law was subject to some doubt.

However, under the Civil Rehabilitation Law, a debtor is specifically allowed to transfer its business (or portions of its business) after obtaining the court's approval before the rehabilitation plan is accepted and confirmed. The court approves a business transfer only when it finds it necessary for the rehabilitation of the debtor's business, after hearing opinions from known creditors and the labour union of the debtor. In practice, the court may approve a business transfer unless it finds it clearly unreasonable or unnecessary. This makes acquisition of business a useful means for business recovery, in part because it makes the legal status of business transfers clear. (A business transfer can also be set forth in the rehabilitation plan. However, if the value of the business is fragile, the debtor should carry out the business transfer before the rehabilitation plan is accepted and confirmed.)

The Civil Rehabilitation Law has also made an exception for the procedures of business transfer under the Commercial Code. The Commercial Code requires the debtor resolution by a two-thirds majority affirmative vote of shareholders present at the shareholders meeting to conduct the business transfer. This is difficult to gain because the shareholders have no incentive to attend the shareholders' meeting or to approve a business transfer that may not bring about the recovery of value of their shares. The Civil Rehabilitation Law therefore allows the court to give an approval to the business transfer in lieu of the shareholders' acceptance required by the Commercial Code if a debtor's debts exceeds its assets, and the business transfer in question is necessary for its rehabilitation and continuance of the business in question.

In practice, the court does not strictly review the necessity of the business transfer in this regard and may give approval as long as the debtor's debts exceed its assets. This also makes acquiring a business a useful means for business recovery, in part because it eliminates the risk that the business transfer cannot be conducted because of a lack of shareholders' acceptance.

These rules under the Civil Rehabilitation Law are intended to address the need for prompt disposition of the business to preserve the value of goodwill and thereby maximize the sale proceeds from the business transfer or the probability of the rehabilitation's success. (The acquirer has an incentive to deal with the distressed company under the rehabilitation procedures. If the distressed company chooses to sell its business as a means of reorganization and restructuring outside of legal insolvency procedures, a possible acquirer must always be concerned about the risk of avoidance in a case where the distressed company later undergoes legal insolvency procedures, such as bankruptcy, after the deal is completed. But if the business was acquired in the course of the rehabilitation procedure, the acquirer need not be worried about such risk because the business was acquired after obtaining court approval.)

Speed is essential in distressed acquisitions under legal insolvency procedures, including rehabilitation procedure, because the value of a distressed company's business can rapidly deteriorate after the start of procedures. In this regard, the so-called "pre-packaged" approach has recently become recognized as effective.

The term "pre-packaged" is not defined in the Civil Rehabilitation Law and is not always used with the same meaning. But, in general, it is understood that the distressed company develops the reorganization and restructuring plan using legal insolvency procedures and obtains consents from stakeholders and the sponsor or acquirer candidate to the plan before initiating such procedures, and then files the petition to start such procedures. This ensures smooth and efficient legal insolvency procedures.

By performing a quick sale of its business under the "pre-packaged" approach, the distressed company may maximize the sales proceeds from such business that constitutes a part of fund for future distribution to creditors. Once the sponsor or acquirer candidate announces, simultaneously with the filing, its intention to support the distressed company, this announcement may prevent the credibility of the distressed company, and the value of its business, from deteriorating.

The complexity of each distressed company's situation will affect the feasibility of adopting the "pre-packaged" approach under the rehabilitation procedure. It is therefore important to involve well-informed and experienced financial advisers, legal counsel, tax accountants and other relevant specialists for the parties to complete the deal within a short time period. (Recently, we advised a certain distressed company dealing with auto sales for its restructuring and reorganization using the rehabilitation procedure through the Tokyo District Court. In these procedures, the court ordered the start of the rehabilitation procedure four days after the filing of the petition and granted the approval for business transfer 10 days after the filing. The distressed company could expedite the procedures in this manner because it discussed its reorganization and restructuring plan using the rehabilitation procedures with creditors, shareholders and the acquirer candidate in advance, and obtained the necessary consents.)

For sponsors and acquirers candidate, the "pre-packaged" approach does not necessarily guarantee that they can acquire the business from the debtor after the start of the rehabilitation procedures. The debtor may not freely select the sponsor or acquirer candidate under the rehabilitation procedures because the debtor must select them by considering the benefit of all stakeholders among others, the maximization of the future payment to creditors in accordance with the terms of the rehabilitation plan.

The debtor must submit materials proving the suitability of the "pre-packaged" plan, including the deal price. However, a doubt still remains over whether or not it is reasonable to grant the sponsor or acquirer candidate the benefit to exclusively enjoy the opportunity to acquire the debtor or its business considering there might be a more favourable sponsor or acquirer candidate from the standpoint of all stakeholders. This is known as the transparency issue of the "pre-packaged" approach. Thus, if another party, wanting to acquire the debtor or its business, makes a better proposal than that of the "pre-packaged" plan, it is inevitable for the debtor to conduct a bid to elect the most suitable sponsor or acquirer candidate.

In a recent case, Tohato, a famous company for its confectionary production business that faced serious financial and economic difficulties in recent years, determined to use the rehabilitation procedure for the purpose of its corporate reorganization and restructuring. Before filing the petition to start the rehabilitation procedure, Tohato and a consortium led by Unison Capital agreed to a "pre-packaged" plan, under which Tohato transferred its confectionery production business to the new company to be set up by the consortium. In this original "pre-packaged" plan, the consortium agreed to invest about ?13.25 billion ($12 million), which would be used to acquire such business from Tohato and the running capital of the new company.

However, another consortium, led by Nisshin Foods, volunteered to act as the sponsor for Tohato immediately after the pronouncement of the Unison Capital consortium's intention to be the sponsor. Tohato's supervisor may have doubts about the reasonableness of the "pre-packaged" plan with the Unison Capital consortium, especially regarding the price, and decided to conduct a bid for election of Tohato's sponsor candidate. As a result of this, the Unison Capital consortium won, but had to invest about ?18.3 billion, meaning it had to pay another ?5 billion to acquire the relevant business. This result implies that the original "pre-packaged" plan was not the best available benefit to Tohato's creditors.

This case shows that under the legal insolvency procedures, third parties may interfere with the distressed deal under the "pre-packaged" plan and procure the deal by providing a better proposal.

New opportunities

After the enactment of the Civil Rehabilitation Law, the environment for corporate reorganization and restructuring in Japan has been continuously improving, especially considering Japan's economic stagnation after the crash of the so-called "bubble economy". For example, the Corporate Reorganization Law was substantially amended as of April 1 2003 following criticism that corporate reorganization procedures were not convenient or useful because of its strict and heavy nature. The amended Corporate Reorganization Law will now be a more useful method for corporate reorganization and restructuring.

Since Japan is making progress in its effort to create conditions for effective corporate reorganizations and restructuring, it is expected that business opportunities for distressed companies, and those seeking to acquire these distressed companies or their Japanese operations, will continue to expand in the future.

Consultation with a court
For a speedy and smooth procedure, a debtor or its creditor considering filing a petition to start the rehabilitation procedure is first recommended to informally consult with a court.
Day one Filing a petition to start the rehabilitation procedure
When a case of filing for bankruptcy is likely to arise with respect to the debtor, the debtor or the creditor may file a petition to start the rehabilitation procedure. Further, if the debtor cannot pay its obligations when due without creating a serious problem in continuation of its business, the debtor (not creditors) may file such a petition.

Court's issuance of a preservation order
In practice, the court almost always issues a preservation order to prohibit the debtor from paying pre-filing claims or granting security interest to secure these claims immediately after the filing. (A petition filed under the Civil Rehabilitation Law does not operate as an "automatic stay".)

Appointing a supervisor
In practice, the court always appoints a supervisor to oversee the debtor's actions that are designated by the court, such as transferring the right of, or title to, grant security interest in, rent or otherwise dispose of, assets owned by the debtor. Despite the appointment of the supervisor, the debtor may continue to operate its business. Thus, the supervisor is expected to ensure that the rehabilitation procedure is fair for creditors.

Week one Court's decision to start the rehabilitation procedure
The court will review the petition to start the rehabilitation procedure and will make a decision to start the rehabilitation procedure unless the court finds a cause for dismissal. In practice, the court usually makes this decision no later than one week from the filing. Creditors are then prohibited from exercising their respective rights against the debtor other than in accordance with the rehabilitation procedure. However, a holder of security interests (betsujyo-ken) is, unless individually prohibited by the court, free to foreclose its security interests without being restricted by the rehabilitation procedure. A holder of general senior claims (ippan-yusen-saiken), such as wages and tax claims accrued before the start of the rehabilitation procedure, may also receive payment and enforce such claims. Those accrued after the start of the rehabilitation procedure constitute a common benefit claim (kyoeki-saiken) and a holder thereof may receive payment at pleasure.
Month one and week one Report of creditors' claims
Creditors must report their claims against the debtor by the date the court specifies. If the creditor fails do this without a justifiable reason, it will lose its right to the future payment by the debtor in accordance with the terms of the rehabilitation plan.
Month two Report on debtor's business, assets and any other relevant matters
The debtor must evaluate its assets at the start of the rehabilitation procedure and report this to the court. The debtor must also submit to the court: the report describing the reason why the petition for the start of the rehabilitation procedure is filed; the past and present condition of the debtor's business and assets; and any other circumstances relevant to the rehabilitation procedure.
Month two and week one Approval/disapproval of creditors' claims
The debtor must conduct an investigation of creditors' claims and submit to the court the document describing which claims are approved or disapproved.
Month three Preparation of the plan for rehabilitation
The debtor must submit its proposal of the rehabilitation plan to the court by the date the court specifies. The creditor is also allowed to submit its own proposal of the rehabilitation plan to the court. The court may not postpone the submission deadline more than twice without a special reason. (The Tokyo District Court has an administrative policy that the court may postpone the deadline up to one month per each postponement.)
Month five Acceptance of the rehabilitation plan at the creditors' meeting
The proposed rehabilitation plan will have to be submitted to a meeting of creditors for their acceptance. Affirmative votes of: (i) the majority of the number of creditors present at the meeting; and (ii) creditors, the aggregate amount of whose claims constitutes the majority of the total amount of creditors' claims that are subject to the rehabilitation procedures, are required to the proposed rehabilitation plan accepted at the creditors' meeting.

Confirmation of the rehabilitation plan by the court
After the creditors' acceptance, the proposed rehabilitation plan needs to be confirmed by the court, which will review whether or not the proposed rehabilitation plan satisfies requirements under the Civil Rehabilitation Law such as fairness among creditors.

Performance of the rehabilitation plan
The debtor is expected to carry out the rehabilitation plan in good faith. For the first three years, the supervisor will continue to oversee the debtor. The court must issue an order to close the rehabilitation procedure when this period ends. The rehabilitation procedure will be closed earlier if the debtor has carried out the rehabilitation plan to completion.

Author biography

Yuichiro Mori

Jones Day Showa

Yuichiro Mori is an associate at Jones Day Showa. He has a lot of experience in international and domestic commercial transactions, international and domestic dispute resolution, and business reorganization and restructuring. He is regularly appointed by the Tokyo District Court to act as a bankruptcy trustee. He was admitted to the Japanese Bar in 1993 after graduating from the Law Faculty of Waseda University (LLB 1991) and the Legal Training and Research Institute of the Supreme Court of Japan (1993). He also graduated from the University of California, Davis, School of Law (LLM 1998).

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