The Japanese securitization market has seen an increasing
use of sophisticated techniques and structures in relation to
both existing and new asset classes and business operations.
The general desire of the authorities to facilitate the use of
securitization by clarifying legislation and removing legal
uncertainties or inefficient regulation has no doubt helped.
The recognition of the range of purposes for which
securitization may be used - including more efficient use or
financing of assets or business operations, corporate
restructuring and, in the case of financial companies, the
release of finance to smaller and start-up businesses - has
been evident in the various proposals recently announced.
Recent regulatory initiatives
Proposed amendments to insolvency laws
After receiving public comments on its proposals last
year, the Ministry of Justice published a Summary of
Proposed Amendments to the Bankruptcy Law on September 10
2003. The proposed amendments referred to in the Summary
include a number of substantive reforms as well as a general
review of the procedures to be followed in insolvency
proceedings. The proposed reforms of particular relevance for
securitization transactions are summarized below.
The actual drafts of the amended Bankruptcy Law (Law 71 of
1922, as amended), Corporate Reorganization Law (Law 154 of
2002, as amended) and Civil Rehabilitation Law (Law 225 of
1999, as amended) are expected to be made available and
submitted to the Diet next year. Amendments to the existing
proposals set out in the Summary, or new proposals, could be
introduced during the drafting and legislative process.
Sale of an asset at the fair price - judicial
interpretation of Article 72 of the Bankruptcy Law
The Great Court of Judicature (the Supreme Court's
predecessor) determined in a case in 1933 (12 Minshu 637
(Great Court of Judicature, April 15 1933)) that a
trustee in bankruptcy of a seller may nullify the sale of real
estate, pursuant to Article 72 of the Bankruptcy Law, on
the grounds that the transaction is prejudicial to creditors of
the transferor even if the purchase price represents the fair
value of the relevant asset.
The Supreme Court's reasoning was that if the nature of the
asset changed from real estate (non-moveable and not easily
realizable) to cash, the seller would be able to dissipate or
misuse the cash more easily and, depending on the specific
circumstances of each bankruptcy, creditors in bankruptcy may
be prejudiced as a consequence.
Although the courts have subsequently recognized some
limited cases where a sale would be upheld and not nullified,
the burden of proof is on the purchaser to establish whether
any of these limited cases applies. In a separate case, the
Supreme Court confirmed that a trustee in bankruptcy could not
nullify the sale of a movable asset if it could be established
that the purchase price received by the seller represented the
fair value of the asset.
These court decisions relating to real estate pose a
nullification risk in relation to the securitization of real
estate. This has hampered the development of the securitization
market for real estate as an asset class.
In the Summary it is proposed that the Bankruptcy Law be
amended so that a trustee in bankruptcy will not be able to
nullify the sale of any type of asset if the purchase price
represents the fair value of the asset unless the following
conditions are met:
- the nature of the change of asset resulted in a
probability that the seller would conceal or dissipate the
sale proceeds or otherwise prejudice the interests of
creditors of the seller (prejudicial action);
- at the time of the sale, the seller intended to take
prejudicial action; and
- at the time of the sale, the purchaser knew that the
seller intended to take prejudicial action.
If the proposed amendments are enacted, a trustee in
bankruptcy would have to prove that these three conditions are
met to nullify the sale of an asset at the fair price. In
relation to the second and third conditions, the assessment
would be made as at the time of the sale, and subsequent
circumstances would not be taken into account in determining
whether or not the sale may be nullified.
Similar amendments would be made to the equivalent
provisions in the Corporate Reorganization Law and the Civil
If enacted, the amendments would remove the specific
nullification concern in relation to the securitization of real
Bankruptcy of a lessor - Article 63 of the Bankruptcy
Under Article 63 of the Bankruptcy Law, if a lessor has
been declared bankrupt, an assignment of lease receivables by
the lessor to a third party purchaser may not be asserted
against creditors (and thus will not be recognized) in the
bankruptcy of the lessor unless the relevant receivables are
payable in respect of the current and immediately following
rental period as at the time of the declaration of bankruptcy.
Accordingly, except for the rental payments payable in respect
of the current and immediately following rental period, (which
if the rental period were monthly would mean the rental
payments for two months only), the assigned lease receivables
are treated as assets of the lessor in any bankruptcy
proceedings relating to it.
There was concern that this provision jeopardized the
successful securitization of lease receivables in Japan. But
after a Supreme Court decision in 1995 (49 Minshu 4, 1063
(Sup Ct, April 14 1995)), it has been generally accepted
that Article 63 applies only to an ordinary lease and not
to a finance lease. However, this interpretation has not been
free from doubt because the case the Supreme Court addressed
regarded the interpretation of a related, but not equivalent,
provision to Article 63 in the Corporate Reorganization
Law. Also, the Supreme Court was considering the position of a
bankrupt lessee as opposed to a lessor.
Following the facts of that case it is assumed that a
finance lease has the following characteristics:
- the lessor will recover all of the funds invested by it
in the purchase of the leased asset by way of lease
- the lessee has no option to terminate the lease;
- the lessor is not obliged to repair or maintain the
leased asset; and
- the lessee assumes all risks relating to the performance
and quality of the leased asset.
It is unclear from this case whether all of such
characteristics are necessary to qualify as a finance lease but
it is generally accepted that this is the prudent approach to
take. In any event, it is clear that Article 63 does apply
to an ordinary lease and the issue has added additional
complexity to the securitization of leased assets and lease
receivables where a finance lease is clearly not involved.
Under the proposed amendments, Article 63 of the Bankruptcy
Law will be deleted. Accordingly, lease receivables sold by a
lessor to a third party purchaser will not be treated as assets
of the lessor in insolvency proceedings unless the sale is
otherwise nullified for fraudulent conveyance or
Similar provisions in the Corporate Reorganization Law and
the Civil Rehabilitation Law will be also deleted.
Bankruptcy of a lessor - Article 59 of the Bankruptcy
Under Article 59 of the Bankruptcy Law, if neither
the debtor nor the third party has completed its performance of
a bilateral contract, the trustee in bankruptcy of the debtor
may choose either to terminate the contract or to perform the
contractual obligation of the debtor and demand that the third
party perform its obligations.
It is arguable whether or not Article 59 of the Bankruptcy
Law applies to a lease. The Supreme Court (49 Minshu 4,
1063 (Sup Ct, April 14 1995)) has held that, before its
amendment in 2002, the then Article 103 (now Article 61)
of the Corporate Reorganization Law (which is the equivalent
provision to Article 59 of the Bankruptcy Law) does not
apply to a finance lease, but has not otherwise addressed this
The decisions of the lower courts are divided on the point.
A material reason for this uncertainty is that it is argued
that Article 59 should not be permitted to operate in any
way that prejudices the general protection afforded to a lessee
under Japanese law. The better view is that Article 59
should not apply to a lease of land or building if a leasehold
right in respect of the land or building is perfected as
against third parties.
In the Summary it is proposed that the Bankruptcy Law be
amended to make it clear that Article 59 does not apply to a
lease if the right to use the asset is duly perfected as
against third parties. It is proposed that similar amendments
will be made to the equivalent provisions in the Corporate
Reorganization Law and the Civil Rehabilitation Law.
Before the Summary was issued it had been suggested that a
new provision should be inserted into the Bankruptcy Law
confirming that Article 59 does not apply to a finance
lease. No such proposal is contained in the Summary. It is
believed that this omission reflects a reluctance to delay the
publication of the Summary in order to determine a suitable
definition of finance lease to include in the legislation as
opposed to any opposition to the general interpretation of the
Article following the Supreme Court decision referred to
Bankruptcy of a lessee - Article 621 of the Civil
Under Article 621 of the Civil Code, when a lessee has
been declared bankrupt, a lessor may terminate a lease. But the
courts have consistently restricted the termination of a lease
by a lessor in the case of a lease of land to protect the
lessee (including the Supreme Court (27 Minshu 9, 1287 (Sup
Ct, October 30 1973)).
In the Summary it is proposed that Article 621 of the Civil
Code be deleted. Thus, if a lessee goes bankrupt, a lessor may
not terminate a lease, but the trustee in bankruptcy of a
lessee may choose to either terminate or continue the lease in
accordance with Article 59 of the Bankruptcy Law.
Limited recourse provisions
In public discussions before the publication of the
Summary it had been suggested that the treatment of limited
recourse provisions and the validity of non-petition clauses
should be specifically addressed and clarified in the new
legislation. These issues are of great importance in the
context of a securitization transaction.
The prevailing view is that a limited recourse provision is
valid and enforceable as against a specific creditor but the
treatment of such clauses by the trustee in bankruptcy in
insolvency proceedings has been open to interpretation and is
thus uncertain. In relation to non-petition clauses, the
prevailing view is that a non-petition clause restricting a
creditor as opposed to a director from taking action to
institute bankruptcy proceedings is valid and enforceable as
against the creditor but there is no statutory confirmation or
judicial precedent for such view.
The publication of the Summary was considered an ideal
opportunity to clarify the position in the Bankruptcy Law and
other relevant legislation but unfortunately the Summary does
not refer to or propose any amendment to the Bankruptcy Law to
address these issues. The reasons for this omission are unclear
but it can only be surmised that it was decided not to delay
the publication of the Summary in order to address this
Proposed amendments to the Trust Business Law
The Trust Business Law (Law 65 of 1922, as
amended) restricts the range of assets that may be transferred
to a trust and requires any entity wishing to conduct trust
business to obtain a trust licence. Rigorous requirements are
required to be met to obtain a trust licence and in practice
principally the Japanese trust banks conduct trust business in
Trusts have been widely used in securitization structures in
Japan because of certain tax advantages, bankruptcy remoteness
and the general flexibility of a trust. But the involvement of
a Japanese trust bank has added to transaction costs and this
involvement has not necessarily been warranted where the
relevant assets continue to be managed and serviced by the
originator or a third party.
Pursuant to its general desire to facilitate the further use
of securitization techniques, a division of the Deliberation
Council (Kinyu Shingikai, Kinyu Bunkakai, Dai-ni Bukai) set up
by the Financial Services Agency issued a report in June 2003.
It proposed that the Trust Business Law be amended to expand
the range of assets that may be the subject of a trust and to
encourage more participants, including corporate and other
non-financial institutions, to engage in certain categories of
While draft legislation remains to be published, the report
indicates that the limitation on the assets that may be the
subject of a trust will be abolished, thereby permitting assets
such as intellectual property rights to be the subject of a
trust. The report also proposes that new categories of trust
business, including holding assets on trust solely for purpose
of the issue and sale of beneficial interests and holding trust
assets without any discretion as to the management of such
assets, be introduced that may be conducted by a broader range
of participants. The criteria to be met by any such participant
has not been determined but it is expected to be much less
onerous than that required to be met to obtain a full trust
business licence. Equally the form or manner of authorization
remains to be determined.
One proposal is to require an entity conducting a new
category of trust business to be registered with a competent
authority (probably a local finance bureau). Any such
registration procedure would be expected to be relatively
If pursued and enacted, such proposals would be expected to
facilitate the setting up of trust vehicles by originators for
the conduct of securitization transactions as opposed to having
to appoint a Japanese trust bank. This would be likely to
increase the flexibility of securitization structures,
permitting for instance the setting up of trust vehicles by
corporate groups for securitizations by members of the group,
and help in reducing costs.
In a related development, in an interim report issued by a
division of the Deliberation Council (Sangyo Kozo Shingikai
Sangyo Kinyubukai) set up by the Ministry of Economy,
Trade and Industry (METI), it is reported that consideration is
being given to the amendment or repeal of the Specified Claims
Law (Law 77 of 1992, as amended).
The Ministry initially introduced the Specified Claims Law
in 1993 to facilitate the securitization of receivables by
leasing and credit card companies to enable them to diversify
their funding sources and raise further funds to finance new
lending. The Law imposed a number of restrictions on the
structure and implementation of securitizations by leasing and
credit card companies that were initially considered necessary
to protect investors in the new forms of transaction.
If the Trust Business Law is amended to facilitate the
setting up and operation of specific categories of trust
business by new market participants, the Specified Claims Law
would almost invariably continue to impose more onerous
restrictions on the use of such new trusts by leasing and
credit card companies unless it is amended or repealed. It
appears that METI does not see any reason to retain or impose
any more onerous restrictions in relation only to leasing and
credit card companies. In terms of timing it is likely that any
legislation would be introduced to coincide with the amendment
of the Trust Business Law.
The Specified Claims Law also introduced a simple perfection
method in relation to the transfer of receivables securitized
under it. Anecdotal evidence suggests that in recent years,
after the enactment of the Perfection Law (Law 104 of
1998, as amended) that introduced a new registration system for
perfection purposes, the perfection procedure under the
Specified Claims Law has not been so frequently used. While the
authorities have not announced a decision as to the retention
or otherwise of this means of perfection, it may well be
abolished in view of its declining use in practice.
Securitization practitioners will welcome the proposals to
amend the insolvency laws and the Trust Business Law. The
amendments will clarify various legal and structuring concerns
and should present opportunities for the securitization of new
and more problematic asset classes and business operations.
However, these proposals should only be regarded as a
further step in the right direction. The clarification and
review of the legal and regulatory environment in the specific
context of securitization must be a continual process.
Masayuki Okamoto is a partner of Freshfields Law Office. His
specialties include finance and banking, and corporate and
commercial matters. His clients include both Japanese and
international banks and securities companies and large
Okamoto was educated at the University of Tokyo, the Legal
Research and Training Institute of the Supreme Court of Japan
and Cornell Law School. He is a Japanese bengoshi and
a member of the Dai-ichi Tokyo Bar Association and the New York
Bar. He speaks Japanese and English.
Mark Keeler is a partner of Freshfields Foreign Law Office.
He has worked in Asia for more than 20 years, including in
Tokyo, Hong Kong and Singapore. He specializes in all aspects
of international debt and equity capital markets offerings,
structured financings and securitization. His clients include
large Japanese and international financial institutions.
Keeler was educated at King's College London and the College
of Law, London. He qualified as a solicitor in England and
Wales in 1980 and is a licensed foreign lawyer in Japan. He is
a member of the Dai-ichi Tokyo Bar Association and the Law
Society of England and Wales.
Shigeru Kaneko is a senior Japanese associate in Freshfields
Law Office. His practice area covers corporate and finance
transactions, including securities issues and derivative
Kaneko was admitted as a Japanese bengoshi in 1996 and was
admitted in New York in 2002. He was educated at the University
of Tokyo, the Legal Research Institute of the Supreme Court of
Japan and New York University, School of Law. He is a member of
the Dai-ni Tokyo Bar Association and the New York Bar. He
speaks Japanese and English.
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