This content is from: Local Insights

Elpida to set a precedent

Ryuji Sakai

In late February 2012, Elpida Memory, one of the key Japanese players in the DRAM integrated circuit global market, filed an application with the Tokyo District Court for commencement of corporate reorganisation proceedings (the statutory insolvency proceedings under Japanese law for use by large-scale businesses). A temporary restraining order has been granted by the court to maintain the status quo during the court's examination of the merits of Elpida's application.

This turn of events may not have been predicted by the market since the financial results announced by Elpida in early February 2012 for the third quarter ending December 31 2011 showed a positive net asset value for the company of approximately ¥280 billion ($3.37 billion) on a consolidated basis. There are several unique aspects of Elpida's case.

In Japan a corporate reorganisation is typically used to rescue and rehabilitate a company with negative net asset value and provides for various drastic measures to accomplish this goal. For example, appointment of a trustee or trustees (kanzainin) to manage the company during the pendency of the corporate reorganisation is mandatory, and the reorganisation plan proposed by the trustee(s), once approved by the various classes of stakeholders (most importantly, the company's creditors) and approved by the court, can effectuate the write-off and/or rescheduling of significant amounts of outstanding debt (including secured debt), cancel and/or reduce equity interests, and implement various other corporate transactions by skipping or abbreviating otherwise required corporate law procedures.

Normally, the incumbent management is deprived of its authority for the management of the company. Customarily, two trustees are appointed in a corporate reorganisation: one being an experienced business person to manage business operations and the other being a practising lawyer to deal with legal issues.

Debtor-in-possession reorganisation

In the case of Elpida, however, it appears that the company may be seeking extraordinary treatment such that the incumbent management will continue to manage the company's business operations even after Elpida's corporate reorganisation application is granted by the court.

The Tokyo District Court itself has suggested the possibility of such a debtor-in-possession (DIP)-type corporate reorganisation proceeding with the trustee(s) being appointed from the incumbent management of the company where, among other things: (i) major creditors are not expected to object; (ii) the incumbent management has not engaged in any misconduct; and (iii) the expected sponsor (the provider of new money in the form of equity), if any, agrees. While no formal announcement of a DIP-type arrangement in the Elpida case has been made thus far, the possibility can be inferred from the fact that a practising attorney was appointed as a supervisor and examiner (kantokuiin ken chousaiin) when the temporary restraining order was granted.

A supervisor and examiner is not usually appointed in a conventional type of corporate reorganisation, and one of his or her primary functions is to thoroughly examine whether or not incumbent management is qualified to continue to manage the company. There have been precedents for DIP-type corporate reorganisations in the past, but the Elpida case, if conducted as a DIP, would be the largest by far.

Positive net asset value

Another noteworthy aspect of the Elpida case is that the company's net asset value appears to have been positive at the time of the filing of the application for the corporate reorganisation. Once the trustee(s) have been appointed, they will undertake a formal evaluation of the business and there is a possibility that they may ultimately conclude that the total amount of Elpida's debt exceeds the total value of its assets.

However, assuming that its net asset value has been and will likely continue to be positive, the most important consequence of such positive net asset value would be that the shareholders of Elpida will be entitled to vote, as a class, for or against the reorganisation plan, unlike in the case of a corporate reorganisation where the net asset value of the company is negative. This would suggest that although the Tokyo Stock Exchange announced that the shares of Elpida will be delisted as of March 28 2012, such shares may still be worth trading outside of the stock market and a potential acquirer could even consider launching a tender offer by following required securities law procedures.

In addition, if the net asset value of Elpida is indeed positive, it may not be easy to convince the company's creditors to permit a significant write off of their claims, although they may be amenable to a rescheduling of payment on their claims.

Complexity of treatment of contracts

Elpida conducts a large-scale, worldwide business, and thus there is every reason to believe that the contractual arrangements for its operation are probably quite complex. How to properly deal with contractual arrangements (including cross-border contracts) in the context of a corporate reorganisation often raises complex legal issues.

For example, in the case of a corporate reorganisation, a counterparty to an executory contract with the company undergoing reorganisation will not be able to terminate the contract, even if the contract provides that commencement of reorganisation proceedings constitutes a cause for termination of the contract, and the trustee(s) will be entitled to continue such contract if they determine that such contract is necessary for the successful rehabilitation of the company.

There would certainly be conflict of law issues in the case of cross-border contracts. The Elpida case could indeed become a rich experimental laboratory for various legal theories and techniques for dealing with such contract law issues on a large-scale basis.

The Elpida case has just started and there are still many uncertainties. One thing is certain, however: because of its size and complexity, this case will become a very important precedent for the future. Therefore, one should carefully watch how things will evolve going forward.

Ryuji Sakai

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