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General structuring of financing

Choice of law

What territory’s law typically governs the transaction agreements? Will courts in your jurisdiction recognise a choice of foreign law or a judgment from a foreign jurisdiction?

In terms of a financing transaction in which the financing will be provided in Japan, financing agreements are typically governed by Japanese law. The governing law of collateral agreements is determined based on several factors, such as location of the collateral and governing law of the underlying assets. Japanese law does not have any exclusive jurisdiction over matters in this context other than security created over assets located in Japan or receivables governed by Japanese law, and parties are otherwise free to agree on what governing law should apply.

A court will recognise a choice of foreign law to the extent that its application will not violate the Japanese doctrines of public policy or good morals. Notwithstanding the above, regardless of the choice of governing law, certain Japanese laws will have mandatory application with respect to Japanese entities (eg, Japanese insolvency laws and the Foreign Exchange and Foreign Trade Act).

A final, conclusive and unsatisfied judgment of the courts of a foreign jurisdiction would be permitted to be enforced in Japan, provided that the requirements of article 118 of the Code of Civil Procedure are met and, in particular, that:

  • no applicable law or treaty denies subject matter jurisdiction to the court that rendered the relevant judgment;
  • in the event that the debtor did not appear to defend the relevant suit, action or procedure, the debtor was personally served with a summons commencing the action while within the jurisdiction of the relevant court, under Japanese concepts, or process was served on the debtor in Japan with the assistance of the judicial authorities of Japan;
  • recognition of the relevant judgment is not contrary to public policy or good morals as applied in Japan; and
  • reciprocity exists at such time as to the recognition by the courts of the foreign jurisdiction of final and conclusive judgments obtained in the courts of Japan.

Restrictions on cross-border acquisitions and lending

Does the legal and regulatory regime in your jurisdiction restrict acquisitions by foreign entities? Are there any restrictions on cross-border lending?

Yes. Inward foreign direct investment is restricted in many jurisdictions and Japan is no exception. First, for reasons of national security and public safety, certain maximum foreign ownership restrictions may apply to foreign investments exceeding certain thresholds (broadly speaking, up to one-third or one-fifth ownership interest in the relevant company) in limited industry sectors (eg, telecommunications, airlines and broadcasting).

As well as the industry-specific regulations, the regulations under the Foreign Exchange and Foreign Trade Act will broadly apply to investments by a foreign investor in a Japanese company.

Cross-border lending to a Japanese company is restricted. Only banks licensed in Japan (including Japanese branches of foreign banks) or registered money-lending business operators are permitted to arrange or extend loans in Japan as a business.

Types of debt

What are the typical debt components of acquisition financing in your jurisdiction? Does acquisition financing typically include subordinated debt or just senior debt?

While it varies from transaction to transaction, typically between 60 and 70 per cent of the cost of an acquisition takes the form of a long-term senior loan, with the remaining portion being funded by equity. In large transactions, when the senior loan is not sufficient to fully finance the acquisition, mezzanine finance is often used to bridge the gap. Such mezzanine finance is typically provided in the form of a subordinated loan or preferred shares. In addition, a revolving working capital facility is commonly provided by the senior lenders, and sometimes other specific facilities, such as an acquisition facility or capex facility, are also provided as senior debt. In Japan, bonds are not commonly used in acquisition finance transactions.

Certain funds

Are there rules requiring certainty of financing for acquisitions of public companies? Have ‘certain funds’ provisions become market practice in other transactions where not required?

In Japan, there is no requirement for ‘certain funds’ in acquisition finance transactions relating to public companies. However, a bidder is required to demonstrate that it has sufficient funds to settle the takeover bid (TOB). This disclosure document is required to be attached to the TOB registration. Where the TOB is financed by debt, the financial institutions providing the loan will provide a certificate of funds, which will include a description of any conditions attaching to their obligation to lend. This is so that existing shareholders can understand the conditionality of any such financing.

Notwithstanding the above, ‘certain funds’ provisions are becoming more common in Japan, not only in connection with the acquisition of public companies, but also for the acquisition of private companies. This is especially true for cross-border transactions documented in English.

Restrictions on use of proceeds

Are there any restrictions on the borrower’s use of proceeds from loans or debt securities?

In Japan, there are no legislative restrictions on the borrower’s use of proceeds from loans or debt securities.

Licensing requirements for financing

What are the licensing requirements for financial institutions to provide financing to a company organised in your jurisdiction?

Only banks licensed in Japan (including Japanese branches of foreign banks) or registered money-lending business operators are permitted to arrange or extend loans in Japan as a business. This restriction applies equally to bilateral and syndicated facilities. However, other entities are permitted to acquire outstanding loan receivables as long as they are not coupled with any obligation to lend additional amounts. In this way, lending syndicates can sometimes include non-banks or non-money-lending business operators after the loans are fully drawn.

Withholding tax on debt repayments

Are principal or interest payments or other fees related to indebtedness subject to withholding tax? Is the borrower responsible for withholding tax? Must the borrower indemnify the lenders for such taxes?

Cross-border interest payments made by a Japan-resident borrower to a non-Japanese lender without a permanent establishment in Japan will generally be subject to withholding tax. The current domestic withholding tax rate on such payments is 20.42 per cent, but this rate may be reduced or exempted under applicable tax treaties.

However, if a non-Japanese lender has a permanent establishment in Japan, such as a Japan branch, and the loan transaction is booked through the Japan branch, (ie, attributable to the Japan branch), it will be exempt from Japanese withholding tax if it can obtain a withholding tax exemption certificate from the relevant tax authority in Japan and present it to the borrower before the relevant interest payment is made (the withholding tax exemption treatment is available on the condition that the Japan branch pays Japanese corporate taxes on its net income derived from interest revenue received from the Japanese resident borrower). Otherwise, without obtaining and presenting the exemption certificate, even if a non-Japanese lender has a Japan branch to which the interest is attributable, the borrower will be required to withhold at the time of payment and pay the amount withheld to the National Tax Agency (at the Japan branch level, net income is subject to Japanese corporate tax, and in calculating corporate tax liability, interest withholding tax paid can be credited against corporate tax liability).

Although there is no statutory requirement that the borrower must indemnify the lenders for any withholding taxes, gross-up clauses are typically included in all transactions in Japan to ensure that the lenders receive all payments free and clear of any withholdings or deductions.

Restrictions on interest

Are there usury laws or other rules limiting the amount of interest that can be charged?

The Interest Rate Restriction Act sets the following rate ceilings:

  • 20 per cent per annum for loans with a principal amount of less than ¥100,000;
  • 18 per cent per annum for loans with a principal amount of between ¥100,000 and ¥1 million; and
  • 15 per cent per annum for loans with a principal amount of ¥1 million or more.

Any interest exceeding such ceilings shall be void.

In addition, any lending with an annual interest rate above 20 per cent may trigger criminal sanctions under the Act Regulating the Receipt of Contributions, Receipt of Deposits and Interest Rates. This Act specifies that any money received by a lender in connection with a loan that is not principal shall be deemed to be interest, regardless of the formal designation of such money (eg, commission). However, it is generally understood that arrangement fees and agency fees are not characterised as interest, as these are considered to be paid in exchange for arrangement services and agency services. Note that if an arrangement fee, to be paid to an arranger as compensation for arranging a financing, amounts to more than 5 per cent of the loan amount, such fee may breach the Act Regulating the Receipt of Contributions, Receipt of Deposits and Interest Rates and trigger criminal sanctions thereunder.

In respect of commitment fees, the Act on Specified Commitment Line Contracts expressly excludes the application of both the Act Regulating the Receipt of Contributions, Receipt of Deposits and Interest Rates and the Interest Rate Restriction Act in relation to commitment fees if the relevant borrower satisfies certain requirements under the Act on Specified Commitment Line Contracts.

Indemnities

What kind of indemnities would customarily be provided by the borrower to lenders in connection with a financing?

Borrowers in Japanese acquisition finance transactions are typically expected to indemnify the lenders against any losses incurred in connection with a breach of:

  • representations and warranties;
  • undertakings or other events of default;
  • break costs;
  • increased costs;
  • taxes; or
  • any required currency conversions.

Assigning debt interests among lenders

Can interests in debt be freely assigned among lenders?

Anyone is permitted to acquire outstanding loan receivables as long as they are not coupled with an obligation to lend additional amounts. In this way, lending syndicates can sometimes include non-banks as well as non-money-lending business operators after the loans are fully drawn. When additional lending obligations remain (eg, for a revolving working capital facility), only banks licensed in Japan (including Japanese branches of foreign banks) or registered money-lending business operators are permitted to acquire such commitments.

Sponsors and borrowers also often contractually limit the pool of potential lender assignees through the introduction of a ‘qualified assignee’ concept. This is to ensure that, for example, no tax gross-up is triggered and also to protect against competitors acquiring interests in the loans.

Requirements to act as agent or trustee

Do rules in your jurisdiction govern whether an entity can act as an administrative agent, trustee or collateral agent?

In Japan, no rules govern whether an entity can act as an administrative or collateral agent. However, trust business is regulated under the Trust Business Act and the Act on Provision of Trust Business by Financial Institutions, so a security trustee role can only be conducted by a licensed trustee (typically licensed trust banks) (see question 20).

Debt buy-backs

May a borrower or financial sponsor conduct a debt buy-back?

A debt buy-back by a borrower or a financial sponsor is not prohibited or restricted under Japanese law, per se. However, in practice, any such arrangement would be governed by the contractual terms agreed between the parties in the loan agreement. In domestic Japanese language transactions, a loan agreement based on the form published by the Japan Syndication and Loan Trading Association (JSLA) is typically used. The JSLA standard does not have any clauses relating to debt buy-backs and it is common to include a provision that prohibits lenders from transferring or assigning their loans to a borrower, affiliate or member of the borrower’s group. However, in English language transactions in Japan, a Loan Markets Association (LMA) based loan agreement is often used, and borrowers are typically permitted, in certain circumstances and subject to a regulated process, to purchase their own debt under the agreement. Under LMA-based loan agreements, sponsors and sponsor affiliates are also generally entitled to conduct debt purchase transactions, subject to being disenfranchised from any lender voting process.

It should also be noted that in the case of a borrower’s debt buy-back, such debt will be automatically extinguished, since the status of borrower and lender are merged into a single person.

Exit consents

Is it permissible in a buy-back to solicit a majority of lenders to agree to amend covenants in the outstanding debt agreements?

It is technically possible in a buy-back to solicit the consent of a majority of lenders to amend covenants; however, such an approach is uncommon in the Japanese market.

Guarantees and collateral

Related company guarantees

Are there restrictions on the provision of related company guarantees? Are there any limitations on the ability of foreign-registered related companies to provide guarantees?

Although there are no financial assistance rules in Japan that would lead to restrictions on the ability of a related company to provide a guarantee, corporate benefit is an issue. The concept of corporate benefit in Japan relates to directors’ ‘duty of care’ and ‘duty of loyalty’. Directors are required to act for the benefit of the corporation. Since the ultimate beneficiaries of the corporation are its shareholders, it is generally understood that any actions that do not harm the interests of the shareholders will not violate the duties of care and loyalty.

Based on this, guarantees (whether secured or unsecured) provided by related companies with a common ultimate 100 per cent shareholder, are not typically restricted by corporate benefit. However, where minority shareholders exist, corporate benefit can complicate any analysis of whether related company guarantees can be provided.

There are no restrictions under Japanese law on the ability of foreign-registered related companies to provide guarantees, whether secured or unsecured.

Assistance by the target

Are there specific restrictions on the target’s provision of guarantees or collateral or financial assistance in an acquisition of its shares? What steps may be taken to permit such actions?

Under Japanese law, there is no statutory restriction equivalent to financial assistance or on the provision of company guarantees in connection with the acquisition of shares in itself. However, the corporate benefit issues discussed in question 14 apply equally to a guarantee from the target.

Types of security

What kinds of security are available? Are floating and fixed charges permitted? Can a blanket lien be granted on all assets of a company? What are the typical exceptions to an all-assets grant?

Japanese law does not provide for a general form of all-asset security interest analogous to a floating charge or blanket lien. Subject to certain limited exceptions (which are not typically relevant in the context of an acquisition finance transaction), security in Japan must be granted on an asset-by-asset basis.

In the context of an acquisition finance transaction in Japan, the security package typically covers all assets of the target group and the acquirer, as well as all shares issued by the target group and the acquirer. However, it is common in Japan for the transfer or other disposal of trade receivables and certain other contractual rights (eg, rent deposits) to be contractually prohibited. In such circumstances, these assets are typically carved out of any security package.

Requirements for perfecting a security interest

Are there specific bodies of law governing the perfection of certain types of collateral? What kinds of notification or other steps must be taken to perfect a security interest against collateral?

The method for perfection of security interests differs depending on the type of security interest being granted and the type of asset provided as security.

Shares

Under the Companies Act, an unlisted company may, in its articles of incorporation, choose whether to issue physical share certificates.

In the case of a company issuing share certificates, a pledge is established by an agreement between the parties and the physical delivery of the share certificates to the pledgee. The share pledge is perfected by the pledgee’s continuous possession of the share certificates.

In the case of a company not issuing share certificates, a pledge is established by an agreement between the parties and perfected by registration on the shareholders’ register maintained by the issuing company. Lenders generally require the issuance of share certificates when establishing a pledge over shares to ensure their control of any subsequent transactions in the shares.

When transactions involve dematerialised shares of a listed company, transfers of such shares are conducted through a book-entry system maintained by the Japan Securities Depository Center (JASDEC). A pledge over dematerialised shares is created by an agreement between the parties, and the transfer of the shares to the pledge sub-account of the pledgee held with a JASDEC system participant.

Receivables

Security over receivables can be established by a pledge or a security assignment. Essentially, a pledge is generally used for taking security over receivables (eg, bank deposits, insurance proceeds and inter-company loans); however, a security assignment is commonly used for taking security over trade receivables.

There are three options for perfecting a pledge or a security assignment over receivables:

  • date-certified notice to the underlying obligor (generally delivered by certified mail);
  • obtaining the date-certified consent of the underlying obligor (date certification is done by a notary public); or
  • registration of the pledge or assignment at the Legal Affairs Bureau.

Among these options, date-certified consent is generally used (including for bank deposits, insurance proceeds and inter-company loans), while registration is more commonly used for trade receivables, especially where there are a large number of underlying obligors or the security provider does not want the underlying obligors to be aware of such security assignment (mainly from a business perspective). Note, however, that registration of an assignment only perfects the assignment against third parties. Registration does not perfect the assignment against the underlying obligors and notice to the underlying obligors will still be required to perfect the assignment against such obligors.

Movable assets

A security assignment of movable assets is established by an agreement between the parties and perfected either by delivery of the movable assets to the secured party or registration of the security assignment at the Legal Affairs Bureau. Physical delivery of the assets is not required if the parties agree that the security provider has delivered the underlying assets but retains them on behalf of the secured parties. This form of delivery is referred to as ‘constructive delivery’.

Real estate

A mortgage over real estate is established by an agreement between the parties and, to be perfected, must be registered at the local Legal Affairs Bureau in which the relevant property is located. The application for registration is made by both parties to the mortgage, generally through a qualified judicial scrivener acting on behalf of both parties. A registration tax of 0.4 per cent of the secured obligations (ie, the principal amount of the loan) is assessed on initial registration and a nominal charge will apply to any subsequent registrations securing the same obligations.

Intellectual property

Registration at the Patent Office is required for the establishment of a pledge over trademarks and patents. A pledge over copyrights is established by an agreement between the parties and, to be perfected, must be registered at the Agency for Cultural Affairs or the designated registration organisation.

Renewing a security interest

Once a security interest is perfected, are there renewal procedures to keep the lien valid and recorded?

In Japan, perfection of most security interests does not have to be renewed to preserve its effect. One exception to this basic rule is for the registration of a security assignment (or pledge) of receivables and movables, which is subject to expiration after 10 years for movables and receivables against unspecified debtors and 50 years for receivables against specified debtors). In this case, an extension of the underlying registration will be required.

Stakeholder consent for guarantees

Are there ‘works council’ or other similar consents required to approve the provision of guarantees or security by a company?

There are no such requirements under Japanese law.

Granting collateral through an agent

Can security be granted to an agent for the benefit of all lenders or must collateral be granted to lenders individually and then amendments executed upon any assignment?

The basic principle under Japanese law is that security must be granted to all lenders individually and an agent cannot hold security on behalf of or for the benefit of all lenders. If a secured lender assigns all or any of its rights in a secured loan to a third party, the security interest will be automatically or contractually (depending on the nature of the security interest) assigned to the assignee, and perfection of such assignment of security interest will need to be completed.

One alternative structure is a security trust, where a licensed trustee holds the security interest in trust for the benefit of each lender. In such a case, each secured party will obtain a trust beneficial interest (TBI) representing its interest in the assets of the security trust. When a lender assigns its loan to a third party, the assignor will also assign its related TBI to the assignee, without disturbing the security interest, which remains held by the security trustee. Although there have been a number of acquisition finance transactions in Japan where a security trust has actually been used (particularly in large transactions where active secondary market trading of the secured loan was anticipated), it is still not commonly used in practice due to the fees and time required because of the involvement of a third-party licensed trustee. Another alternative structure is a parallel debt, where a borrower owes the same debt to (i) a security agent and (ii) the secured parties in parallel, and the security agent holds security to secure such parallel debt owed to it by the borrower. To date, parallel debt structures have not been used in Japan despite strong arguments supporting their theoretical possibility. However, a bill for the comprehensive reform of the Civil Code was passed by the National Diet of Japan and will come into effect on 1 April 2020, which recognises, among other things, that joint and several claims may be created by agreement among parties. This change may promote the use of parallel debt structures.

Creditor protection before collateral release

What protection is typically afforded to creditors before collateral can be released? Are there ways to structure around such protection?

In Japan, there are no statutory protections afforded to creditors before collateral can be released.

Fraudulent transfer

Describe the fraudulent transfer laws in your jurisdiction.

Under the Civil Code, a creditor may request (within certain time restrictions) that a court rescind a fraudulent act conducted by a debtor who knew that such action would impair the creditor, unless any person that benefited from such act, or any person that succeeded to such benefit, was a bona fide third party at the time of the act or succession to such benefit and would be prejudiced by such rescission. Such a fraudulent act may include the creation of a security interest over the assets of a target company or its subsidiaries when such persons are under financial distress.

Debt commitment letters and acquisition agreements

Types of documentation

What documentation is typically used in your jurisdiction for acquisition financing? Are short-form or long-form debt commitment letters used and when is full documentation required?

In general, most acquisition finance transactions in Japan are documented in stages. The initial stage typically involves the preparation of a commitment letter with a detailed term sheet covering the material terms of the debt and equity aspects of the financing. Where the capital structure also includes a mezzanine facility or preferred shares, the term sheet will also cover these aspects and any related inter-creditor provisions. Fee letters are also usually executed simultaneously with the commitment letter. The commitment letter, term sheet and fee letters may be prepared in English or Japanese, depending on the requirements of the deal. In addition, where a TOB will be launched, the financial institutions providing the loan will provide a Japanese language certificate of funds, which will include a description of any conditions attaching to their obligation to lend. This is so that existing shareholders can understand the conditionality of any such financing.

In the definitive documentation stage (ie, prior to closing), the senior loan agreement and (if required) a mezzanine loan agreement, a preferred share purchase agreement and an inter-creditor agreement will be prepared.

Security documents are usually prepared in at least two separate packages. The day one security package typically covers (on day one, as a condition precedent to closing) the acquirer’s shares and assets (eg, the acquirer’s bank accounts, rights under the share purchase agreement, rights under any inter-company loan agreements etc) and (on day one, but after closing) the target’s shares. The day two security package will typically cover all of the target group assets and shares not picked up in the day one security package. The timing requirements for the day two security package and the scope and nature of collateral to be picked up are usually agreed in the financing agreement (often by reference to a set of agreed security principles). The lenders are usually very keen to have the day two security granted and perfected promptly following closing.

Level of commitment

What levels of commitment are given by parties in debt commitment letters and acquisition agreements in your jurisdiction? Fully underwritten, best efforts or other types of commitments?

In Japan, fully underwritten commitments are typically provided for acquisition finance transactions, subject to closing conditions. ‘Best efforts’ commitment letters are rarely provided.

Conditions precedent for funding

What are the typical conditions precedent to funding contained in the commitment letter in your jurisdiction?

Conditions precedent included in a commitment letter in Japan often differ depending on the transaction. However, they typically include the lenders obtaining all required internal approvals, execution of definitive documentation, accuracy of the borrower’s representations (including the information representation) with no change of acquisition or equity structure. Business material adverse change (MAC) and market MAC conditions are also sometimes included, but these are often subject to substantial negotiation.

Flex provisions

Are flex provisions used in commitment letters in your jurisdiction? Which provisions are usually subject to such flex?

In Japan, flex provisions are not commonly included in commitment letters. In large transactions requiring broad syndications pricing flex is sometimes seen, but this is still quite rare. Structural flex is not typically requested or granted.

Securities demands

Are securities demands a key feature in acquisition financing in your jurisdiction? Give details of the notable features of securities demands in your jurisdiction.

In Japan, securities demands are not a key feature.

Key terms for lenders

What are the key elements in the acquisition agreement that are relevant to the lenders in your jurisdiction? What liability protections are typically afforded to lenders in the acquisition agreement?

The key elements in the acquisition agreement that are relevant to the lenders in Japan include:

  • the structure of purchase price adjustment provisions;
  • the scope of any indemnities;
  • the conditions precedent to closing (including the definition of material adverse effect); and
  • the closing logistics.

Public filing of commitment papers

Are commitment letters and acquisition agreements publicly filed in your jurisdiction? At what point in the process are the commitment papers made public?

In Japan, there is no statutory requirement to publicly file commitment papers except where an acquisition is conducted through a TOB (see question 4). Where an acquirer will use bank debt to finance the TOB, they must file a certificate of funds issued by the lenders. This certificate needs to include a summary of any conditions precedent to the funding. This information will be publicly disclosed through the Electronic Disclosure for Investors’ Network system.

Enforcement of claims and insolvency

Restrictions on lenders’ enforcement

What restrictions are there on the ability of lenders to enforce against collateral?

Secured lenders are usually free to enforce against collateral in Japan, even where bankruptcy proceedings, civil rehabilitation proceedings or special liquidation proceedings have been commenced. In such proceedings, creditors can exercise their rights by disposing of the collateral, through court auction or by voluntary sale, outside of such insolvency proceedings, with the consent of all other secured creditors having an interest in the collateral. The exception, however, is where reorganisation proceedings are commenced under the Corporate Reorganisation Act. In corporate reorganisation proceedings, security may not be enforced outside of the reorganisation proceedings. Furthermore, in corporate reorganisation proceedings and civil rehabilitation proceedings, the court may extinguish the security interest by allowing the debtor or the trustee to pay the value of the collateral in order to retain important assets (eg, a factory or raw materials) and ensure the continuation of the debtor’s business. In bankruptcy proceedings, the court may also extinguish a security interest and allow the trustee to sell an asset free and clear of any security interest if it is in the creditors’ general interest to do so (eg, where the collateral can be sold at a value much higher than that of the secured claim and the residual value may be included in the bankrupt estate).

Debtor-in-possession financing

Does your jurisdiction allow for debtor-in-possession (DIP) financing?

In Japan, financing to debtors who have commenced civil rehabilitation or corporate reorganisation proceedings is allowed as DIP financing.

Stays and adequate protection against creditors

During an insolvency proceeding is there a general stay enforceable against creditors? Is there a concept of adequate protection for existing lien holders who become subject to superior claims?

In Japan, an automatic stay does not arise upon the filing of a petition for insolvency; however, a court customarily issues stay orders during the period from the filing to the issuance of the commencement decree. These orders generally prohibit the debtor from paying, or otherwise fulfilling its obligations.

There is no concept of adequate protection (or any equivalent or analogous concept) under Japanese law.

Clawbacks

In the course of an insolvency, describe preference periods or other reasons for which a court or other authority could claw back previous payments to lenders? What are the rules for such clawbacks and what period is covered?

If a transaction is deemed to be preferential (eg, because one or more lenders received a non-pro rata payment from the borrower when those lenders were aware that the borrower was unable to pay its debts as they fell due) or fraudulent (eg, when the transaction took place while the relevant parties knew that it would be harmful to the debtor’s creditors), the transaction may be void (and the amount of which clawed back).

Ranking of creditors and voting on reorganisation

In an insolvency, are creditors ranked? What votes are required to approve a plan of reorganisation?

Yes. Creditors are ranked depending on the nature of their claims. Creditors’ claims are classified into several categories for repayment. In the case of bankruptcy proceedings, claims with the highest priority include administrative costs and expenses, certain taxes and salaries and severance pay accrued within the three months prior to the commencement decree (order for relief). Claims with priority receive the second priority and include claims such as other unpaid salaries, bonuses and severance pay. Third priority is given to ordinary bankruptcy claims, which include trade claims and other claims without priority. Subordinated bankruptcy claims receive fourth priority and include interest, default interest and other penalties that accrue after the decree of bankruptcy commencement. The lowest priority is given to contractually subordinated bankruptcy claims.

Certain types of claims receive different treatment from the above order of priority. In the case of insolvency proceedings (with the exception of corporate reorganisation proceedings), secured creditors have the right to exclude their claims from the proceedings and generally will not be affected by it. Secured creditors may receive payments on the security interest and they may initiate foreclosure procedures to obtain the value of the collateral. However, the trustee may ask the court to allow extinguishment of a security interest and sell an asset free and clear if it is in the creditors’ general interest to do so.

Intercreditor agreements on liens

Will courts recognise contractual agreements between creditors providing for lien subordination or otherwise addressing lien priorities?

The nature of the contractual subordination determines whether it will be recognised by a court. There are three forms of contractual subordination that may be applicable.

Contractual subordination under insolvency laws

The Bankruptcy Act, Civil Rehabilitation Act and Corporate Reorganisation Act provide for contractual subordination under an agreement between a creditor and a borrower by which the claims of that creditor are subordinated to the claims of the general unsecured creditors of the borrower in the event of bankruptcy. This type of contractual subordination will be recognised by a court or bankruptcy administrator. Nonetheless, it is rarely seen in acquisition finance transactions. The effect of this type of contractual subordination is that the priority of the subordinated creditors’ claims will fall between the general unsecured creditors’ claims and the equity holders’ claims.

Contingent claims

Under this type of contractual subordination, the loan agreement will stipulate that the claims of the mezzanine or junior lender will, if a certain trigger event occurs (eg, an event of default or acceleration), become contingent on the payment in full of the claims of the senior lender. This means that the claims of the mezzanine or junior lender essentially cease to exist until the claims of the senior lender are satisfied. A court or bankruptcy administrator will, in effect, recognise this type of contractual subordination as the claims of the mezzanine or junior lender will not exist (or will exist contingently) at the time of the insolvency. This arrangement is sometimes used in Japan for the purpose of effectively securing the priority of the senior lender, but it is not popular among mezzanine and junior lenders as it may yield perverse results for them.

Subordinated claims

Where the claims of the mezzanine or junior lender remain but are contractually subordinated to the senior lender under an inter-creditor agreement, a court or bankruptcy administrator will set aside the contractual subordination and, in the case of secured creditors, distribute the proceeds from the secured assets in accordance with the order of registration or, if registered simultaneously, pro rata between the secured lenders. While a senior lender may rely on the clawback provisions of the inter-creditor agreement, where the court or bankruptcy administrator has made payments to a mezzanine or junior lender prior to the satisfaction of the senior claims, the senior lender will then be taking on both the performance risk and credit risk of the mezzanine and junior lenders.

Discounted securities in insolvencies

How is the claim of an original issue discount (OID) or discount debt instrument treated in an insolvency proceeding in your jurisdiction?

The value of claims is generally determined based on their face value, even if it is issued on a discount basis.

Liability of secured creditors after enforcement

Discuss potential liabilities for a secured creditor that enforces against collateral.

Secured creditors will not be exposed to any potential liabilities relating to collateral unless they acquire a direct ownership interest in the collateral (eg, through enforcing against the collateral).

Update and trends

Recent developments

Updates and trends

In terms of recent market trends, Japanese regional banks have become more active in the acquisition finance market in Japan. This trend stems from the negative interest rate policy introduced by the Bank of Japan in relation to deposits held by banks at the Bank of Japan. In addition, insurance companies have shown increasing interest in the acquisition finance market. This trend is driven by falling interest rates for Japanese government bonds, in which insurance companies have historically invested.

Clauses prohibiting assignments are often included in commercial contracts in Japan. Without a waiver, a contractual prohibition on assignment would currently invalidate the creation of security over the contractual rights in such a contract. This rule will be relaxed in favour of assignees (ie, the secured parties) under an amendment to the Civil Code, which will take effect from April 2020, but an assignee or secured party that was actually aware (or should have been aware) of such prohibition will not be protected under the amended Civil Code and the underlying obligor will have the right to refuse to perform its obligations as regards that assignee or secured party. Given that lenders will usually be aware of (and are expected to investigate) such prohibitions on assignment in the ordinary course of their due diligence, the current practice of obtaining waivers from the underlying obligor as to the creation of security interests is expected to continue, notwithstanding the 2020 amendment to the Civil Code.