In brief: loan document terms in Japan

Loan document terms

What forms or standardised terms are commonly used to prepare the loan documentation?

The model syndicated loan agreement published by the Japan Syndication and Loan-trading Association is generally used as the basis of the documentation for syndicated loans. The Loan Marketing Association, the Loan Syndications and Trading Association, the Asia Pacific Loan Market Association and other international standardised forms are used mainly in cross-border transactions.

What are the customary pricing or interest rate structures for loans? Do the pricing or interest rate structures change if the loan is denominated in a currency other than the domestic currency?

Both fixed and floating interest rates are widely used. In domestic corporate banking transactions, the Tokyo Interbank Offered Rate (TIBOR) plus spread structure is relatively common. When floating-rate bank loans are denominated in foreign currency, the benchmark to determine the base rate is usually selected among the popular rates for that currency.

Does loan documentation in your jurisdiction incorporate any mechanisms to replace an established, floating benchmark rate in case such benchmark rate becomes, or is expected to become, unavailable?

The publication of the Japanese yen London Inter-Bank Offered Rate (JPY LIBOR) ceased at the end of 2021 and the publication of the US dollar London Inter-Bank Offered Rate (USD LIBOR) ceased at the end of June 2023. As a result, the base rate in almost all bank loan documentation referring to JPY LIBOR or USD LIBOR has been replaced with replacement benchmarks (such as the Tokyo Term Risk Free Rate as the successor rate to JPY LIBOR, and the Secured Overnight Financing Rate as the successor rate to USD LIBOR).

What other loan yield determinants are commonly used?

In some transactions, the applicable margin is determined on the basis of the borrower’s leverage ratio (pricing grid). Sustainability linked loans, which are increasing in the Japanese loan market, also often provide for a margin ratchet based on sustainability performance target results.

Another example of interest determinant is the passage of time. For example, while the applicable interest rate is relatively low in the first years after the drawdown, the rate goes up periodically (step-up clause).

In response to the recent trend of low interest rates in Japan, zero floor provisions have been widely used in Japanese loan documentation, where the base rate (or, occasionally, the applicable rate) will be deemed zero if the rates become negative in the absence of such provision.

Describe any yield protection provisions typically included in the loan documentation.

To ensure the payment of the amount expected from the debtor in the event of an increase in the cost of the loan, loan agreements in Japan often state that the borrower must choose to either assume the increased cost or repay the relevant outstanding loans. Also, if the borrower intends to make prepayments, the borrower must pay break funding costs corresponding to the prospective interest amount to be accrued for the remaining interest period. Prepayment premiums are sometimes required. In cross-border loan agreements, foreign lenders sometimes require tax gross-up provisions.

Do loan agreements typically allow additional debt that is secured on a pari passu basis with the senior secured loans?

In domestic corporate banking transactions, accordion provisions are not very common, and the borrower does not usually have the right to borrow an additional secured loan.

What types of financial maintenance covenants are commonly included in loan documentation, and how are such covenants calculated?

Typically, under financial covenant clauses, the borrower is required to maintain one or more of the following:

• a leverage ratio (outstanding loan amount divided by earnings before interest, taxes and amortisation);
• a debt service coverage ratio (cash flow available for debt service divided by debt service amount);
• a minimum net worth; or
• a minimum profit.

Negotiations are often focused on the level and calculation method of those covenants, based on the borrower’s financial projection. When those financial covenants are breached, it usually constitutes an event of default. An equity cure is sometimes allowed, especially in the context of acquisition financing.

Describe any other negative covenants restricting the operation of the debtor’s business commonly included in the loan documentation.

The borrower is usually prohibited from taking significant corporate actions without the lender’s prior consent. For example, the restricted actions typically include disposing of material assets, incurring additional financial indebtedness and approving mergers, corporate splits or business transfers. In addition, sometimes, a change of control of the borrower is an event of default. The level of the covenants imposed depends on the nature of the loan, the track record of the borrower, the financials of the borrower and many other factors.

What types of events typically trigger mandatory prepayment requirements? May the debtor reinvest asset sale or casualty event proceeds in its business in lieu of prepaying the loans? Describe other common exceptions to the mandatory prepayment requirements.

In acquisition finance transactions, the following are usually subject to mandatory prepayment:

• a certain percentage of the borrower’s excess cash flow (the percentage may decrease as the borrower’s credit improves);
• the proceeds of any asset sale other than sales in the ordinary course of the borrower’s business;
• insurance proceeds and indemnity payments, except if these will be used for repair; and
• funds procured by additional debt or equity. Reinvestment is sometimes allowed for a specified period.

Describe generally the debtor’s indemnification and expense reimbursement obligations, referencing any common exceptions to these obligations.

Typically, all expenses (including stamp duty and attorney’s fees) incurred in connection with the preparation and any revision or amendment of any bank loan documents, together with the creation, maintenance and enforcement of the lender’s rights, are borne by the borrower to the extent those costs are reasonable. One exception is the cost of transfers of loan receivables, which is borne by the transferor or transferee of the receivables.