Restructuring and Insolvency of Distressed Businesses in Japan during COVID-19

II.Outline of Japanese Restructuring and Insolvency Proceedings

Japanese restructuring consists of out-of-court proceedings and in-court proceedings.

There are several forms of out-of-court proceedings in Japan that all follow the same fundamental rules. In principle, a debtor will stop making repayments on its bank loans, which will be subject to negotiation and the preparation of a separate repayment plan, but will continue to pay all other debts in accordance with its obligations. The repayment plan will include the forgiveness or rescheduling of debts owed to the banks provided that, if the repayment plan includes the forgiveness of unsecured debts, the total repayment amount for each bank under the repayment plan must be greater than the distribution amount that would otherwise be received in a bankruptcy case. The proceedings are closed with only banks and debtors involved, and the repayment plan only becomes binding if all the banks provide their consent.

On the other hand, in the case of civil rehabilitation proceedings (i.e. a major form of in-court and debtor-in-possession proceedings in Japan), a debtor is obligated to stop essentially all payments including bank loans and all other prepetition debts and obligations with certain exceptions, such as taxes and employee wages. The repayment plan (i.e. rehabilitation plan) will include the forgiveness of the prepetition debts and obligations in relation to which the debtor is obligated to stop payments. The repayment amount pursuant to the repayment plan must be greater than the distribution amount that would otherwise be received in a bankruptcy case. In order for the repayment plan to be binding on the parties, consent from the majority of voting right holders and at least a half of the total amount of the voting rights is required, as well as court approval. The consent of all creditors is not required. Lastly, in-court proceedings are conducted publicly.

As a debtor’s business value is more easily retained due to the closed nature of out-of-court proceedings compared with in-court proceedings, debtors usually try to proceed with out-of-court proceedings in the first instance. If out-of-court proceedings are not possible, then a debtor will consider in-court proceedings. In general, restructuring may involve selling the debtor’s business under both out-of-court and in-court proceedings. In Japan a significant number of restructuring cases proceed with the sale of the debtor’s business.

If the debtor cannot proceed with civil rehabilitation proceedings, it will be forced to enter into bankruptcy proceedings. Under Japanese bankruptcy proceedings, a trustee is appointed by the court to liquidate all assets and make distributions on prepetition debts to the extent possible. The debtor company ceases to exist after the completion of the bankruptcy proceeding.

III.Perspectives from Debtors and Purchasers of Debtor Businesses under COVID-19

(i)Debtor

As a result of the support described above, excessive debts including tax debts and late loans made after the onset of COVID-19 have created additional barriers to restructuring for debtors. For example, a debtor is required to pay taxes under civil rehabilitation proceedings, which means that if a debtor owes excessive taxes, it may not be able to enter into out-of-court proceedings or civil rehabilitation proceedings, and will have no option but to file for bankruptcy.

Late bank loans made after the onset of COVID-19 can also raise issues for debtors attempting to restructure their business. Many banks that provide such late bank loans expect to be treated as a priority creditor. Ideally, the debtor and the banks should agree on the priority ranking and the treatment of the new loan before the execution of the late bank loan; however that is not always the case. This kind of situation may make it difficult for debtors to successfully obtain the required consent of all the banks in out-of-court proceedings.

Additionally, numerous debtors are forced to enter into bankruptcy proceedings because they cannot complete restructuring proceedings due to insufficient capital or their inability to prepare a satisfactory repayment plan to obtain the consent of the required creditors.

In light of the trends above, it is important for debtors to consider their restructuring options and consult with experienced professionals as early as possible. The earlier a debtor begins to consider restructuring, the easier it will be to successfully complete the restructuring process. If a debtor considers restructuring several months before it is unable to make its monthly repayments, it has time for negotiation in out-of-court proceedings; but if a debtor only begins thinking of restructuring one day before it is unable to pay the majority of its debts and obligations, it may be difficult to enter into out-of-court proceedings and, at worst, it will have no option but to file a petition for bankruptcy at that time. The process to sell a debtor business also generally takes several months to complete.

(ii)Purchasers of Debtor Businesses

A debtor’s restructuring is also an opportunity for a purchaser to buy the debtor’s business. Offering the appropriate consideration for the business is important as the debtor will need to pay certain debts and obligations using the consideration paid by the purchaser. Those certain debts and obligations include secured claims, and unpaid taxes and wages.

In the case of out-of-court proceedings, in addition to the payment of the secured claims and unpaid taxes and wages, the debtor is generally required to use the remaining consideration to pay all other debts and obligations (except bank loans) and a certain portion of unpaid unsecured bank loans. The payment for the unsecured bank loans must be at least more than the amount that would be distributed in the case of the debtor’s bankruptcy. Fees and costs for liquidation must also be paid in full if the debtor liquidates and sells all of the business. Generally, consent from all the banks is required to purchase the debtor’s business. The purchaser should also consider the risk of avoidance being alleged in later in-court proceedings occurring after the closing of the business transfer.

In case of the civil rehabilitation proceedings, as mentioned above, the debtor’s unsecured prepetition debts can be partially forgiven provided that the amount repaid is at least more than that what would otherwise be distributed under bankruptcy proceedings. Post-petition claims, however, must be paid in full. The process for obtaining the consents of, or hearing from, the unsecured prepetition creditors for the transfer of the debtor’s business will depend on the structure of the business transfer. If the debtor includes the planned business transfer in the repayment plan, the consent of the majority of the creditors and at least a half of the total amount of voting rights is required. On the other hand, court approval is required if the debtor plans to complete the business transfer before finalizing the repayment plan. The court will decide whether or not to approve the business transfer after convening a hearing with creditors and other certain related parties on the proposed business transfer.

If a debtor cannot satisfy the requirements above to sell the business under out-of-court proceedings or civil rehabilitation proceedings, it may still be able to sell the business under bankruptcy proceedings. However, a business transfer under bankruptcy proceedings tends to have difficulty retaining the value of the business.

If the debtor can identify a purchaser before the beginning of the restructuring proceedings, the debtor’s restructuring becomes much easier because creditors, suppliers, and customers will be less concerned about potential continuity issues resulting from the restructuring. Having said that, care should be taken to ensure that the purchaser is identified through appropriate means, such as an auction process. If the purchaser is identified through other means and the debtor subsequently enters into in-court proceedings, the court and the creditors may require the debtor to take such appropriate means at that time to confirm the suitability of the purchaser. In relation to out-of-court proceedings, it is important that the sale of the business is agreed by all the banks.

IV.Conclusion

Restructuring and insolvency cases are expected to increase in Japan in the near future and, in the current COVID-19 circumstances, restructuring may prove to be more difficult for the various reasons outlined above. Debtors would be well advised to consider restructuring as early as possible to ensure sufficient capital and time to find, negotiate and implement the best restructuring plan with creditors and/or to find the most suitable purchaser.

Purchasers of debtor businesses should carefully evaluate the target business and offer an appropriate price after taking all additional considerations in the current circumstances into account. Purchasers should also be aware that distressed businesses can also be acquired under bankruptcy proceedings as well as out-of-court proceedings and civil rehabilitation proceedings, although there may be additional challenges to doing so under bankruptcy proceedings. Purchasers would be well served to be aware of all available options when considering the acquisition of a distressed business in the current market.