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Trends and regulatory climate

Trends

What is the current state of the lending market in your jurisdiction and have any new trends emerged over the last 12 months?

With regard to corporate lending in Japan, in general, secured lending is common, while lending without a security remains rare. 

Lending secured by real estate is the most common form of secured lending in Japan, as it is straightforward for lenders to find out their legal rights in the collateral through the registration system and to conduct a foreclosure sale of real estate. In addition, lending can be guaranteed by the Credit Guarantee Association of Japan (a public organisation established under the Credit Guarantee Association Act, which is designed to complement or enhance the credit of small and medium-sized companies) and secured by the borrower’s business properties (eg, movables and receivables). However, such loans are still small compared to lending secured by real estate.

Recently, the Financial Services Agency (FSA) highlighted problems regarding the business model of Japanese regional financial institutions in light of the nationwide population decline and reduction in the lending market. One of the FSA’s policies in its 2016-2017 Strategic Directions and Priorities was that financial institutions, especially regional financial institutions, need to change their lending practices from lending which relies excessively on the value of borrower’s collateral and guarantees to lending based on an appropriate assessment of the borrower’s future business prospects.

Regulatory activity

Is secured lending a regulated activity in your jurisdiction?

In Japan, there are no specific regulations which apply to secured lending transactions only. However, money lending businesses – whether they provide secured lending, unsecured lending or both – are  regulated by several Japanese laws, including the Banking Act, the Money Lending Business Act and the Interest Rate Restriction Act. In order to conduct a money-lending business, a company must obtain a Japanese banking licence or register with the relevant authority as a money-lending institution.

Are there any specific regulatory issues which a prospective borrower should consider when arranging or entering into a secured loan facility?

In general, there are no particular regulatory issues for a prospective borrower to consider before embarking on a secured loan agreement. However, some regulations restrict a borrower from creating a security interest on its assets, depending on the assets being held. For instance, where a company engages in electricity transmission and distribution and wishes to use its business assets as collateral, it must file a prior notification to the relevant authority under the Electricity Business Act. In addition, local public bodies are not permitted to provide their administrative assets as collateral under the Local Autonomy Act.

Are there any specific regulatory issues which a prospective lender should consider when arranging or entering into a secured loan facility?

A prospective lender which conducts a money-lending business or money-lending arrangement business must have a Japanese banking licence or be registered as a money-lending institution. In addition, it is subject to a number of regulations under the Banking Act and the Money Lending Business Act.

Under the Money Lending Business Act, a money-lending institution is prohibited from engaging in any serious misconduct. The FSA points out in its comprehensive guidelines on the supervision of money-lending institutions that if an institution unreasonably requires a borrower to provide collateral or guarantee a value which significantly exceeds the loan amount, such an action may be deemed as serious misconduct under the act.

Are there plans or proposals for reform or significant changes to the regulatory landscape in this area?

No significant reforms or changes are planned or proposed.

Structuring a lending transaction

General

Who are the active providers of secured finance in your jurisdiction (eg, international banks, local banks or non-bank financial institutions)?

Generally, secured financing in Japan is provided by domestic and international banks, as well as by other financial institutions which are legally allowed to conduct lending.

Is well-established market-standard facility documentation used in your jurisdiction for secured lending transactions?

There is no well-established market-standard facility documentation for secured lending transactions in Japan. If the secured loan is a syndicated loan and is solely a national transaction, it is common to use a form of syndicated loan agreement (not a secured loan agreement) published by the Japan Syndication and Loan Trading Association by modifying it as necessary.

Syndication

Are syndicated secured loan facilities typical in your jurisdiction?

Yes, syndicated secured loan arrangements are common in Japan, especially for project financing.

How are syndicated facilities normally structured? Does the law in your jurisdiction allow a facility agent to be appointed to act on behalf of other banking syndicate members?

Generally, one of the lenders under the loan agreement (usually the bank arranging the transaction) is appointed as an administration agent for all lenders under the agreement.  The administration agent is usually responsible for:

  • communication between the borrower and lenders (including receiving reports or notices from the borrower);
  • receiving payments from the borrower and distributing these to the lenders; and
  • clarifying the intention of the majority or all lenders when necessary.

In a secured loan transaction, a collateral agent is also appointed who is usually responsible for:

  • communication between the security provider and lenders with regard to the collateral;
  • administrative procedures for the establishment, transfer and termination of the security interest; and
  • distributing the amount collected in connection with the security interest without the court’s involvement.

The Lawyers Act and the Act on Special Measures Concerning Claim Management and Collection Businesses generally prohibit any person other than a lawyer or a legal professional corporation from conducting legal services concerning a legal case for profit. Provisions concerning an administration agent and a collateral agent under the loan agreement and any other agreement related to the security interest should be set out in a way that conforms with these acts.

Does the law in your jurisdiction allow security and guarantees to be held on trust by a security trustee for the benefit of the banking syndicate?

Under the Trust Law, the security interest can be held on trust by a trustee for the benefit of the banking syndicate. However, the law does not allow a trustee to be a guarantee for the benefit of the banking syndicate. Thus far, there have not been many cases where security trusts have been used by banking syndicates.

Special purpose vehicle financing

Is it common in secured finance transactions for special purpose vehicles (SPVs) to be used to hold the assets being financed? Would security generally be given over the shares in the SPV or would lenders require direct asset security?

Using an SPV is uncommon in typical corporate finance transactions. However, SPVs are often used as borrowers in order to have the SPV hold the assets subject to securitisation or liquidation in structured or project finance transactions. In such cases, a lender generally requires the SPV to provide its shares as collateral and to provide direct asset security such as a mortgage or pledge over the SPV’s assets.  

Interest

Is interest most commonly calculated by reference to a bank base rate or a market standard variable reference rate (eg, LIBOR, EURIBOR or HIBOR)? If the latter, which is the most commonly used reference rate in your jurisdiction?

Interest is usually calculated based on market standard variable reference rates. In domestic transactions, the Tokyo Interbank Offered Rate (TIBOR), formerly published by the Japan Bankers’ Association (JBA), is often used, especially by so-called ‘mega banks’ or other larger banks. Following the LIBOR scandal, the JBA no longer publishes TIBOR; instead, this role has been taken by a third-party non-profit organisation established solely for this purpose (ie, the General Incorporated Association JBA TIBOR Administration). In international transactions, LIBOR is usually used.

Under the existing situation where the Bank of Japan maintains a negative interest rate policy, the JPY LIBOR now regularly becomes negative and TIBOR may become so as well. In order to deal with this situation and for banks to avoid paying interest to borrowers, many Japanese banks now adopt the TIBOR/LIBOR plus margin with zero floor, meaning that if the interest rate obtained by referring to the published TIBOR/LIBOR adjusted by the margin rate turns to be negative, the applicable interest rate will be zero instead. Some banks also adopt TIBOR/LIBOR with zero floor plus margin; therefore the lowest applicable rate will be the margin rate.

Are there any regulatory restrictions on the rate of interest that can be charged on bank loans?

The Interest Rate Restriction Act stipulates that the maximum interest rate chargeable on a loans varies depending on the principal amount of the loan, whether by banks or otherwise. Under the act, although the maximum rate itself is rather high (eg, 15% per annum if the principal amount is ¥1 million or more), any amounts received by the lender in connection with the loan from the borrower will be deemed ‘interest’. Accordingly, the total costs may exceed the limitation under the act, especially in the case of structured or project finance transactions where various fees will be involved with the financing.  Some statutory exemptions apply to certain types of credit facility agreement, where the maximum interest rate regulation under the act will not apply.

Use and creation of guarantees

Are guarantees used in your jurisdiction?

Guarantees are generally used for loans to companies. In particular, operators of small or medium-sized enterprises often become joint and several guarantors for a loan made to such operator’s company.  Parent companies also generally provide guarantees for loans made to their subsidiaries. In case of loans made to a so-called ‘holding company’, there are also cases where the operating company, which is a subsidiary of such a holding company, provides guarantees for such a loan. Further, upstream guarantees are valid under Japanese law.

What is the procedure for their creation?

Guarantees are created when a guarantor and a lender execute a guarantee contract. Under the Civil Code, a guarantee contract will be invalid unless it is executed in writing (Article 446(2)). The ‘contract for revolving guarantee on loans’ defined in Article 465-2(1) of the Civil Code will become null and void if the maximum amount is not provided in such contract (please see our answer to the next question).

Do any laws affect or restrict the granting or enforceability of guarantees in your jurisdiction (eg, upstream guarantees)?

Guarantee obligations are established when the principal obligation is established and extinguished when the principal obligation is extinguished. If the burden of a guarantee obligation is more onerous than the burden of principal obligation, the burden of guarantee obligation will be reduced to the limit of the principal obligation (Article 448 of the Civil Code).

A guarantee contract will not be valid unless it is executed in writing (Article 446(2) of the Civil Code).

Article 465-2(1) of the Civil Code specifies that a ‘contract for a revolving guarantee on loans’ has special restrictions and defines it as a guarantee contract in which one or more unidentified obligations within a certain specified scope is the principal obligation. It must include a loan obligation (ie, an obligation which is incurred as a result of the transaction of lending money or accepting the discount of a negotiable instrument) within the scope of a guaranteed obligation and the guarantor must be an individual. 

A contract for a revolving guarantee on loans will not become effective unless the maximum amount is stipulated (Article 465-2(2) of the Civil Code). With respect to a contract for a revolving guarantee on loans, in the event that the determination date of the principal obligation under the contract for revolving guarantee on loans arrives or the grounds for determination of principal of principal obligation under the contract for revolving guarantee on loans arise, a guarantor will thereafter assume the guarantee obligation only on the determined principal and its interests and late payment charges. The principal determination date must be within five years of the contract’s execution date. Grounds for principal determination include:

  • where a petition for compulsory execution or for exercise of any security interest against relevant principal obligor or guarantor is filed;
  • where the relevant principal obligor or guarantor has become subject to a ruling to commence bankruptcy proceedings; or
  • where the relevant principal obligor or guarantor has died.

Pursuant to the amended Civil Code, which is scheduled to come into force by June 2020, the provisions on guarantees will also be amended and the regulations on guarantees by individuals will be strengthened. Under the amended code, a contract for a revolving guarantee made by individuals (ie, a guarantee contract in which one or more unidentified obligations within a certain specified scope is the principal obligation and in which a guarantor is not a juridical entity) which fails to stipulate a maximum amount will be null and void (Article 465-2 of the Civil Code). With respect to guarantee contracts in which a loan obligation assumed for a business is the principal obligation or contracts for revolving guarantees which include a loan assumed for business within the scope of principal obligation, where the guarantor is an individual the contract will not become effective unless he or she manifests his or her intention to perform the guarantee through a notarised deed (Article 465-6 of the Civil Code). However, if the individual is a relevant party (eg, a director, officer or controlling shareholder) of the relevant obligor which is a legal entity, he or she is not required to manifest his or her intention to perform the guarantee through a notarised deed (Article 465-9).

Subordination and priority

Describe the most common methods of structuring the priority of debts and security.

There is a method in which a contract is executed between creditors and debtor to agree on the priority of repayment, but the execution of such contracts is uncommon unless the loan is made to a special purpose vehicle. In many cases, a loan is secured by the mortgage of land or a building. Such a mortgage has a set order of priority, with sale proceeds from foreclosure paid first to senior mortgagees with secured claims. It is possible to assign or change the priority rank of mortgage.

Documentary taxes and stamp duty

Are any taxes, stamp duty or other fees payable on the granting of a loan, guarantee or security interest, or on its enforcement?

Stamp duty of between ¥200 and ¥600,000 is imposed on loan contracts depending on the contract amount if the contract amount is ¥10,000 or more.

Stamp duty of ¥200 is imposed on debt guarantee contracts.

No stamp duty is imposed on contracts which create or assign mortgages or contracts concluded on the creation or assignment of a pledge. However, in cases where the contract for the creation of a mortgage includes a provision in which a mortgagor agrees to assign to the mortgagee a claim relating to collateral (ie, mortgaged land or building) – for instance, compensation for the expropriation of mortgaged land – stamp duty of ¥200 is imposed.

Although no stamp duty is imposed on mortgage foreclosure or the enforcement of pledge, it is necessary to pay registration licence tax to register an attachment (if registration is required), as well as a deposit and filing fee to the court.

If the relevant documents are executed outside of Japan, no stamp duty will be imposed even if the rights under such documents are exercised in Japan or such documents are stored in Japan.

Cross-border lending

Governing law

Is it more common for local law to govern the terms of the facility documentation or is the law of another jurisdiction often elected by the parties (eg, English law or New York law)?

Although Japanese banks prefer to have Japanese law as the governing law even for cross-border lending, in reality, English law is popular for international transactions, while New York law tends to be chosen if the transaction will be based in the United States.

Restrictions

Are there any restrictions on the making of loans by foreign lenders or the granting of security or guarantees to foreign lenders?

Other than the fact that banking and non-bank lending businesses are subject to the Banking Act and the Money Lending Business Act, respectively, no restrictions apply to cross-border loans and security or guarantee furnishing.

Are there any exchange controls that restrict payments to a foreign lender under a security document, guarantee or loan agreement?

Although cross-border lending (to be precise, the loan transaction between a Japanese resident and a non-resident) and guarantee transactions between residents and non-residents are each defined as ‘capital transactions’ under the Foreign Exchange and Foreign Trade Act, cross-border lending transactions (including the furnishing of any security or guarantee in that connection) are not subject to any restrictions, unless they involve a terrorist or any country that supports terrorism.

Security – general

Security agreements

Is it possible to create a security interest over all assets of an entity? If so, would a single security agreement suffice or is a separate agreement required for each type of asset?

Except for a statutory security interest (eg, a statutory lien), in Japan a security interest can be created only over each asset of an entity; no security interest can be created over all of an entity’s assets. However, as a matter of practice, it is possible to create security interests over almost all the assets of an entity by creating multiple security interests over each asset. Specifically, where a special purpose vehicle (SPV) is used as a borrower, lenders generally require them to create multiple security interests over almost all of their assets by entering into multiple collateral agreements with the SPV or any relevant third party.

Release of security

What are the formalities for releasing security over the most common forms of assets?

In general, security interests are automatically extinguished on full payment of the secured obligation.  Security interests are also released when the relevant collateral agreement expires or terminates or when the relevant parties agree to release the security.

When a security interest is extinguished or released, additional action needs to be taken in order to extinguish the perfected status of such security interest, including:

  • the return of secured movables to the pledgor in case of a pledge created over movables;
  • written notice with a notarisation date to the pledgor’s debtor concerning the extinguishment of a pledge created over receivables, procurement of written consent with a notarisation date from the pledgor’s debtor concerning extinguishment of such pledge or deregistration of such pledge registered with relevant authority; and
  • the deregistration of mortgage registered with relevant authority.

Asset classes used as collateral for security

Real estate

Can security be granted over real estate? If so, what are the most common forms of security granted over real estate and what is the procedure?

Yes, security can be granted over real estate. A mortgage over real estate as collateral for a loan is common in secured lending transactions in Japan.

To create a mortgage, the mortgagor and mortgagee must enter into a mortgage agreement. In order for the mortgagee to prove the creation and existence of mortgage, the mortgage must be registered with the relevant authority. Although it is possible for multiple mortgages to be created and registered over one piece of real estate, priority among mortgagees is determined by the mortgage’s date of registration with the relevant authority.

In addition to standard mortgages which can be created and registered for a fixed amount of secured obligation, a so-called ‘revolving mortgage’ for existing and future secured obligations up to a certain maximum allowable amount specified in the applicable agreement can be created and registered in Japan.

Machinery and equipment

Can security be granted over machinery and equipment? If so, what are the most common forms of security granted over this kind of property and what is the procedure?

Yes, security can be granted over machinery and equipment in Japan. In such cases, a chattel mortgage or pledge is commonly used. 

In order to create a chattel mortgage over machinery and equipment, the mortgagor and mortgagee must enter into a mortgage agreement. In order for the mortgagee to prove the creation and existence of the chattel mortgage, machinery and equipment subject to the chattel mortgage must be transferred to the mortgagee or the chattel mortgage must be registered with the relevant authority. 

On the other hand, to create a pledge over machinery and equipment, it will be necessary for the pledgor and pledgee to enter into a pledge agreement and to transfer the possession of assets. In order for the pledgee to prove the creation and existence of the pledge, it must keep physical possession of the assets.

Factory mortgages may also be created, especially in structured or project finance transactions such as solar power generation project. In order to create a factory mortgage, the mortgagor and mortgagee must enter into a mortgage agreement. In order for the mortgagee to prove the creation and existence of a factory mortgage, the owner of factory (as mortgagor) must first register its ownership of the factory foundation in a factory foundation registry book. Thereafter, the factory mortgage over the factory foundation must be registered in the factory foundation registry book within six months after the registration of the ownership in the factory foundation.

Receivables

Can security be granted over receivables? If so, what are the most common forms of security granted over this kind of property and what is the procedure?

Yes, security can be granted over receivables in Japan. In such case, a pledge or security by assignment is commonly used.

In order to create a pledge over receivables, the pledgor and pledgee must enter into a pledge agreement; in order to create a security over receivables by way of assignment, the assignor and assignee must enter into an agreement on security by assignment. The pledgee or assignee can prove the creation and existence of the pledge or security by assignment through any of the following procedures:

  • notice with notarisation date to a debtor of the pledgor or assignor concerning the creation and existence of the pledge or security by assignment;
  • procurement of written consent with notarisation date from a debtor of the pledgor or assignor on the creation and existence of the pledge or security by assignment; and
  • registration of the pledge or security by assignment with the relevant authority.

Financial instruments and cash

Can security be granted over financial instruments? If so, what are the most common forms of security granted over this kind of property and what is the procedure?

Yes. In establishing security on financial instruments, a pledge is the most common form of security, although security by assignment is also common. The required procedure is also different depending on, among other things:

  • the form of security;
  • the type of financial instruments;
  • whether the financial instruments are tangible or registered securities; and
  • whether the issuer is a closed company or a publicly held company.

For example, in establishing a security over registered bonds or registered stocks, the registration of the security is required in addition to mutual agreement. In case of tangible securities, delivery is required instead of registration. A security over stocks can be perfected against third parties once it is entered into the shareholder register.

Can security be granted over cash deposits? If so, what are the most common forms of security granted over this kind of property and what is the procedure?

Yes, but it is uncommon because prior consent from the bank, which keeps the deposit in its custody, is usually required under the deposit agreement between the depositor and such bank. In establishing security on cash deposits, a pledge is the most common form of security. 

Intellectual property

Can security be granted over intellectual property? If so, what are the most common forms of security granted over this kind of property and what is the procedure?

Yes. Both pledges and securities by assignment are common. Registration is required in addition to mutual agreement in order to establish a valid security over patent and trademark rights, and ensure that security over copyrights and publishing rights are perfected against third parties. In establishing a security on licence, the procedure differs depending on the type of licence and licensed right.

Enforcement

Criteria for enforcement

What are the common enforcement triggers for loans, guarantees and security documents?

There are a variety of enforcement triggers, with the following being common:

  • the borrower’s failure to make required payments on a timely basis;
  • the borrower’s breach of the terms of loan documents or security documents, including provisions in such documents regarding the exclusion of organised crime syndicates;
  • attachments on securities;
  • the disappearance of the borrower or guarantor;
  • the failure to honour cheques or notes, or defaults on the other debts of the borrower or guarantor; and
  • the commencement of bankruptcy or other insolvency proceedings for the borrower or guarantor.

Process for enforcement

What are the most common procedures for enforcement? Are there any specific requirements with which lenders must comply?

The enforcement procedure is different depending on the kind of security, the secured asset and the terms of the security agreement. As for registered real estate mortgages, lenders are entitled to file a petition for a compulsory auction to the court as a judicial foreclosure. However, lenders often choose sale by contract because the sale price can be increased in a contract, which is not the case at a compulsory auction, although the consent of the borrower and other secured parties are necessary for this to go ahead. 

In case of a pledge and security by assignment, lenders may typically either seek a judicial foreclosure or enforce such a pledge or security by assignment through a security agreement. If the secured lender is a bank which keeps the borrower’s deposit in its custody, a set-off is typically chosen instead of exercising the security right. 

In case of the commencement of bankruptcy or other insolvency proceedings for the borrower, its assets will generally become subject to such insolvency proceedings, but the secured claims may be exercised outside of such insolvency proceedings (except in corporate reorganisation proceedings).

Ranking in insolvency

In what order do creditors rank in case of the insolvency of a borrower?

In general, creditors’ claims are paid as follows in borrower’s insolvency proceedings in Japan:

  • A secured creditor which holds a security interest has priority over its secured assets and is entitled to receive preferential payment in the amount up to the value of such secured assets.  Such a secured creditor has a right to enforce its security interest even after the commencement of insolvency proceedings. However, in corporate reorganisation proceedings, the enforceability of a secured creditor’s security interest may be restricted under the Corporate Reorganisation Act.
  • The priority ranking among multiple secured creditors who hold security interests on the same secured assets is determined based on the priority ranking of security interests held by them.
  • If the proceeds from secured assets are insufficient to pay the entire claim of secured creditors then these will be treated as unsecured creditors with regard to outstanding claim.

In general, unsecured creditors’ claims are paid from the insolvency estate after excluding secured assets for the secured creditors and deducting certain expenses, such as insolvency proceeding costs, insolvency administrator fee and remuneration for employees of the insolvent company.