Japan to introduce long-awaited majority voting rule for out-of-court workout
In Japan, any out-of-court workout requires the unanimous consent of all creditors to a restructuring plan. On 4 October 2022, the Japanese government announced that it is considering introducing new out-of-court workout rules. Under the proposed new rules, a restructuring plan will be binding if a majority vote of creditors is obtained and the plan is sanctioned by the court. Such a majority rule is a common feature amongst schemes of arrangement in many other countries.
Direction released by the Japanese government
According to the Japanese government's announcement, it is planning to submit a bill for the new legislation in the coming Diet session in 2023. To this end, on 15 October 2022, the Cabinet Secretariat of Japan established the New Form of Capitalism Realization Headquarters (the "HQ") in the Cabinet alongside the New Form of Capitalism Realization Committee, which contains a study subcommittee on this new workout system.
Although the details of the proposed new law are yet to be unveiled, the HQ released the Direction of the New Legal System for Business Restructuring (the "Direction") setting forth the direction in which the new system is headed. The public consultation process for the Direction was completed in December 2022. According to the Direction, it is expected that a majority voting rule for the out-of-court workout will be introduced for the first time in the history of Japanese restructuring law.
Whilst the Direction itself does not have any legal effect, it is noteworthy that the Direction envisions the new system as follows:
- The purpose of the new system is to facilitate the restructuring of businesses that are at risk of facing financial difficulties. It will do so by establishing a mechanism for the restructuring of debts necessary for certain business activities that seek to improve profitability. Such mechanism will require a court-sanctioned restructuring plan, the consent of a majority of eligible creditors and the involvement of a third party organisation designated by the competent minister (the "Designated Firm").
- The restructuring plan under the new system will focus on business activities that seek to improve profitability such as the development of new business areas, any changes in the line of business, the reforming of business structures, etc., as well as any debt restructuring necessary to carry out such activities (the "Business Restructuring").
- Certain claims that need to be repaid to restructure the business (e.g., claims in connection with ordinary trade transactions, employee salaries, tax liabilities and tort liabilities) will be excluded from the claims subject to the restructuring plan (the "Subject Claims").
- The general restructuring process under the new system will be as follows:
An application is lodged by a company (the "Applicant") to the Designated Firm for the commencement of the process by filing an outline of the proposed restructuring, a list of creditors, and a written statement setting out reasons for the proposed scope of the Subject Claims.
(b) Assessment of restructuring outline and Subject Claims
The Designated Firm will consider whether: (i) the proposed restructuring constitutes Business Restructuring; (ii) the proposed scope of the Subject Claims is reasonable; (iii) the Applicant is in need of debt restructuring (i.e., whether it is likely to encounter financial difficulties); (iv) the proposed restructuring plan is likely to be approved (e.g., major creditors do not object to the commencement of the process); and (v) the proposed restructuring plan likely conforms to the common interests of the holders of the Subject Claims (the "Subject Creditors") (i.e., whether the Subject Creditors are likely to be entitled to debt repayments in amounts not less than the amounts they would receive in the case of the Applicant's liquidation).
(c) Subject Creditors' meeting
Once the Designated Firm has confirmed the foregoing matters, it will convene a Subject Creditors' meeting. The Designated Firm will monitor the meeting process and voting, and provide the Subject Creditors with an investigation report analysing whether the restructuring plan complies with applicable laws, etc., in advance of the voting.
At the Subject Creditors' meeting, the Applicant may provide certain information to the Subject Creditors. The Subject Creditors will be given an opportunity to state their opinions.
Then, the restructuring plan may be approved by the votes of Subject Creditors above a certain threshold (e.g., votes in favour by the Subject Creditors holding 2/3 or more of the total voting rights).
(d) Court's sanction
After the resolution of the Subject Creditors' meeting to approve the restructuring plan is passed, the Applicant will file a petition to the court requesting that the court sanction the restructuring plan.
The court will, taking into account statements of opinion by the Designated Firm and the Subject Creditors, determine in hindsight whether there are any issues with the resolution of the Subject Creditors' meeting (whether there was any violation of laws in the proceedings or whether fraudulent methods or other issues that undermine the fairness of the resolution have been identified) and whether the resolution conforms to the common interests of the Subject Creditors.
The restructuring plan will take effect upon the court's sanction. In the case that the unanimous consent of the Subject Creditors is obtained, however, the plan will take effect without the need for the court's sanction. Dissenting Subject Creditors may challenge the court-sanctioned restructuring plan by filing an objection called an 'immediate appeal'.
Background of the proposed reform
Nowadays, many countries with developed restructuring systems have majority voting rules for out-of-court workouts, such as the following: (i) the pre-packaged Chapter 11 plan of the US; (ii) the scheme of arrangement and restructuring plan of the UK; (iii) the accelerated safeguard of France; (iv) StaRUG in Germany; (v) the Dutch scheme of arrangement under the WHOA; and (vi) the pre-pack scheme of arrangement of Singapore.
To date, such a rule has not been introduced in Japan despite a long-running debate among academics and practitioners. It is a view commonly shared by Japanese restructuring practitioners that the absence of such a majority decision-making process and the unanimity requirement have been preventing efficient and successful out-of-court restructurings.
In a recent case, a major Japanese auto-parts supplier first tried to turn itself around using an out-of-court workout procedure called Turnaround ADR (Turnaround Alternative Dispute Resolution), but was unsuccessful due to a failure to obtain consents from some of its financial creditors. Consequently, the debtor had to file for formal civil rehabilitation with the Tokyo District Court, which resulted in a few-months-long delay in the overall restructuring process.
Prospects and challenges
The upcoming legislation will be, if successfully passed by the Diet, a ground-breaking reform of the Japanese corporate restructuring system and may make out-of-court workouts much easier, faster and more effective. In particular, with the increasing number of corporate insolvency cases, especially of small- and medium-sized enterprises (SMEs) due to excessive debt, attention is being focused on whether the new system can facilitate and accelerate the relief process during the pre-insolvency phase.
We must be cognizant of the hurdles to be overcome in the drafting of the new law before such legislation comes into effect. We should carefully assess the new rules, including, for instance, whether: (i) the terms Business Restructuring and Subject Claims are appropriately defined; (ii) the rules on protection of dissenting Subject Creditors are well-designed; (iii) the requirements for the approval of the Subject Creditors' meeting and the voting procedure are fairly and orderly structured; and (iv) the demand for accelerated business restructuring or turnaround and the fairness of the new procedure are well-balanced.
Whilst it is expected that foreign financial creditors will be able join the proceedings, we do not expect Japan to allow foreign debtors to have access to the workouts nor to allow parties to use the English language throughout the proceedings under the new regime. As such, it is unclear as of now whether the new workout process will be a useful tool for cross-border restructurings.
As the new rule is anticipated to have a huge impact on the Japanese corporate restructuring practice, we need to keep a cautious and close watch on the upcoming bill to be submitted to the Diet by the government.
(*) This article is an updated version of the original post by the authors titled "Japan to introduce long-awaited majority voting rule for out-of-court workout", released on 11 October 2022 on the Global Restructuring & Insolvency Blog by Baker McKenzie.