Corporate restructuring in Japan
Kohei Okawa of Nagashima Ohno & Tsunematsu provides a guide to the two main types of restructuring procedures in Japan, and explains the merits of each one
Japanese restructuring procedures are broadly divided into (a) out-of-court workouts and (b) in-court proceedings. This article first explains the differences between these two categories and then summarises the procedures of each. Finally, the article provides an outline of the sale of a business in the restructuring phase.
Restructuring generally refers to a situation where a financially distressed company (the debtor) takes measures to reorganise in order to continue its business, such as reducing production and labour costs, liquidating underperforming lines of business, or selling its business.
Liquidation is the cessation of the entire business of the debtor.
Japanese out-of-court workout procedures are predominantly used for restructuring (but they are also sometimes used as a flexible means of liquidation). With regard to in-court proceedings, Japanese laws provide two procedures – civil rehabilitation and corporate reorganisation – and one major in-court liquidation procedure – bankruptcy.
Differences between out-of-court workouts and in-court proceedings
Which creditors are “involved”?
In an out-of-court workout, the involved creditors are only financial institutions (i.e., banks) that have outstanding loans to the debtor. Trade creditors (e.g., the debtor’s suppliers) are not involved in the workout and the debtor must still pay them by their original due payment date.
In contrast, all trade creditors with claims that accrued before the filing of a petition for the commencement of an in-court restructuring of the debtor are involved in and subject to an in-court restructuring.
Consent from creditors
The debtor must obtain unanimous consent to the restructuring plan from all creditors involved in an out-of-court workout. If there is just one involved creditor that refuses the restructuring plan, the debtor cannot complete the workout and will have to consider in-court restructuring proceedings if it desires to pursue its restructuring further.
For in-court restructurings, only consent to the restructuring plan from specified creditors is necessary. This is explained further below.
Closed versus open proceedings
Out-of-court workouts are typically closed to the public so have less negative impact on the debtor’s credit standing.
In contrast, the commencement of an in-court restructuring is widely disclosed, so the debtor’s creditors and customers immediately become aware of the proceeding and some customers and suppliers may cease trading with the debtor due to a perceived risk of non-delivery or non-payment.
Management of debtor’s business
In out-of-court workouts, the debtor continues to operate its business as a debtor-in-possession and its business continues to be managed by its existing management. A trustee is not appointed to manage the business.
In contrast, in in-court restructurings, whether a trustee is appointed to manage the debtor by the court depends on which in-court proceeding the debtor selects.
Debtors typically prefer out-of-court restructuring because of the flexibility and less onerous characteristics
In a civil rehabilitation proceeding, in general, the debtor remains a debtor-in-possession and a trustee is not appointed. Thus, the existing management of the debtor continues to operate the debtor’s business.
In corporate reorganisation proceedings, a trustee is appointed by the court to manage the debtor. Typically, an independent lawyer having no stake in the debtor is appointed as the trustee.
However, the court may appoint the existing CEO of the debtor as the trustee if (i) the major creditors and the purchaser of the business of the debtor (if any) agree to the appointment, (ii) the existing CEO is not responsible for the debtor’s deteriorating business situation, and (iii) there are no other issues in appointing such an officer as the trustee.
Many out-of-court workout procedures are supervised by third-party mediators (e.g., lawyers and/or accountants). Such mediators may be appointed by public organisations, or by the involved creditors after recommendation from private associations with the authority to operate out-of-court workout procedures. However, debtors often proceed with out-of-court workouts without supervision by such mediators.
In the case of in-court restructurings, the court supervises the proceedings. For example, the debtor must obtain approval of the court or the supervisor appointed by the court (i.e., an independent attorney) to conduct substantial activities such as disposal of important assets and borrowing money. The debtor must also periodically report its financial and business status to the court.
Flexibility of proceedings
Japanese law does not prescribe detailed rules regarding how out-of-court workouts should be conducted. Thus, debtors have more flexibility to negotiate with the involved creditors regarding the details for out-of-court workouts than for in-court restructurings.
Criteria in selecting out-of-court or in-court proceedings
Debtors typically prefer out-of-court restructuring because of the flexibility and less onerous characteristics described above.
However, the debtor may be unable to obtain consent from all involved creditors in an out-of-court workout, or the rescheduling and partial discharge of trade creditor claims may also be necessary for the debtor’s restructuring. In such cases, the debtor would select in-court restructuring.
Summary of each proceeding
Although there are several out-of-court workout procedures in Japan, they are similar to each other, and have certain shared features.
Unanimous consent to standstill of debtor’s debts
Unanimous consent from all creditors involved in the workout is required for a standstill (e.g., suspension of repayments and enforcement of security interests) of the debtor’s debts during the workout.
If even one of the involved creditors disagrees with such a standstill, the debtor cannot commence the workout.
The debtor drafts the restructuring plan, which includes details regarding how its business will be restructured, the terms and conditions of rescheduling and/or partial discharge of debt payments. The debtor must obtain unanimous consent from all involved creditors for the restructuring plan to become binding.
Third-party mediator report
Third-party mediators (if any) will prepare and submit to the involved creditors a report that examines whether the restructuring plan satisfies certain requirements (e.g., fairness, equality, feasibility, and economic rationality as compared to a bankruptcy scenario).
The involved creditors use this report in their own internal decision-making processes.
Meetings with involved creditors
Several meetings between the debtor and the involved creditors are held during the workout to explain the debtor’s business and financial status, the selection process of the purchaser of the debtor’s business (if any), and the restructuring plan.
Out-of-court workouts typically take three to six months to complete, or longer for difficult cases.
Japanese in-court restructuring consists of civil rehabilitation proceedings and corporate reorganisation proceedings.
Corporate reorganisation is a stronger measure (as described in more detail below) than civil rehabilitation, but civil rehabilitation has become more widely used by debtors because it is faster, provides more flexibility and the debtor continues as a debtor-in-possession. The following analysis mainly covers civil rehabilitation proceedings.
The debtor typically files the petition for the commencement of the proceeding and the date of the filing is the petition date.
If the petition meets all requirements, including the potential for a restructuring plan which is to be subsequently drafted by the debtor to become binding, the court issues an order to commence the proceeding. The date of this commencement order is the proceeding commencement date.
The standstill of claims against the debtor that arose prior to the petition date, i.e., prepetition claims, becomes effective pursuant to an order by the court on the petition date in most cases. However, the debtor’s obligations to pay taxes and employee salaries are not subject to the standstill so the debtor must continue to pay them on the due date. In contrast, in corporate reorganisation proceedings, some specified taxes and salaries are subject to the standstill.
Any self-restructuring debtors should begin the process early
Security interests are not subject to the standstill in civil rehabilitation proceedings, so the debtor has to negotiate the value of the security interests and the repayment schedule of the secured amount with the secured creditors separately from the proceeding. In contrast, secured creditors cannot enforce their security interests in corporate reorganisation proceedings and the treatment of secured claims is provided in the restructuring plan. Thus, debtors often select corporate reorganisation if they need to avoid the enforcement of security interests.
In general, the debtor must pay all claims that arose after the petition date on their due date. If the debtor fails to do so, the in-court restructuring will transition to a bankruptcy proceeding.
Prepetition creditors must file a proof of their prepetition claims within approximately one month from the proceeding commencement date, and the debtor must accept or reject the filed claims within approximately two months from the proceeding commencement date. Disputes regarding any rejected claims are eventually determined in a separate lawsuit.
Within approximately three months after the proceeding commencement date, the debtor must draft the restructuring plan, including the terms and conditions of the rescheduling of payments and the partial discharge of prepetition claims in relation to which the debtor is obligated to stop payments due to the standstill.
The prepetition creditors can vote on the draft restructuring plan and typically do so within approximately two months from the court order referring the restructuring plan to the vote of the prepetition creditors. In deciding how to vote, they refer to the supervisor’s report on the draft restructuring plan, which is sent to the prepetition creditors with the draft restructuring plan.
In order for the restructuring plan to become binding, consent from the majority of the voting right holders and at least a half of the total amount of the voting rights is required, as well as approval of the court.
Generally, civil rehabilitation cases take approximately six months from the petition date to complete. However, larger cases and corporate reorganisation cases can take longer to complete.
Sale of a debtor’s business
Many Japanese restructuring cases involve the whole or partial sale of the debtor’s business due to the debtor’s serious cash flow and/or deficit problems and its inability to restructure without carrying out such a sale.
Sale of the business enables the debtor to obtain cash which it can use to repay its creditors and reduce deficits. It also allows the business to survive, albeit under the purchaser.
An important aspect of the sale is ensuring a fair selection process of the purchaser. In an out-of-court workout, this selection process needs to be agreed by all creditors. In an in-court restructuring, the process needs to be agreed by the major creditors as well as the court, depending on the purchase scheme and structure.
In out-of-court restructurings, the creditors and, in in-court restructurings, the creditors and the court, consider whether the selection process fairly maximises the consideration to be paid for the debtor’s business. An open auction is ideal and usually possible in an in-court restructuring because the in-court restructuring is itself open.
In many out-of-court workout cases, the debtor privately invites candidates to participate in the auction and manages the closed auction process. The debtor may need to determine the purchaser without any bidding process if the debtor has no time due to serious cash-flow or other pressing issues. Even in such cases, the creditors in an out-of-court workout, or the creditors and the court in an in-court proceeding, may agree to such a sale if they understand the severity of the debtor’s situation and assess the consideration to be paid by the purchaser to be acceptable.
If the sale of the debtor’s business is included in the restructuring plan, the debtor may sell its business in accordance with the restructuring plan after the restructuring plan becomes binding. Alternatively, if the debtor needs to sell its business earlier, the sale can be completed separately from the restructuring plan. In an in-court proceeding, however, this is only possible if the court approves the sale after first confirming the intent of the creditors through a court hearing process.
In other cases, debtors try to restructure themselves without such a sale. In such cases, the debtor strives to reduce costs, liquidate underperforming business lines, and improve profits. Such self-restructuring itself incurs the debtor’s time and resources, so any self-restructuring debtors should begin the process early.