Security interests and guaranteesCollateral and guarantee support
Which entities in the organisational structure typically provide collateral and guarantee support for bank loan financings? Are there limitations on which entities in the organisational structure are permitted to provide such support?
The borrower, its parent company and its subsidiaries commonly provide assets as collateral. Parent guarantees for subsidiaries (downstream) and subsidiary guarantees for parent companies (upstream) are also commonly used.
There are no specific statutory limitations or restrictions on such securities or guarantees. However, there is an issue with upstream guarantees owing to the general fiduciary duty owed by the guarantor’s directors. If a subsidiary provides an upstream guarantee solely for the benefit of a majority shareholder (owning less than 100 per cent of the shares in the guarantor), and there is no corporate benefit to the subsidiary in providing such guarantee, then the directors of the subsidiary may be accused of breaching their fiduciary duties. To avoid this risk, subsidiaries usually refrain from providing upstream guarantees unless the consent of the minority shareholders has been obtained. The same applies to upstream security, whereby a subsidiary provides security to its parent company’s lenders.
What types of obligations typically share with the bank loan obligations in the collateral and guarantee support? If so, are all such obligations equally and ratably covered by the collateral and guarantee support?
Secured obligations are sometimes designated as a certain group of unspecified obligations (blanket security), such as ‘obligations arising from banking transactions with the secured party’. In those cases, all the secured party’s banking claims are equally secured.Commonly pledged assets
Which categories of assets are commonly pledged to secure bank loan financings? Describe any limitations on the pledge of assets.
There are three major types of security in Japan: pledges, mortgages and security assignments. A pledge is often created over shares and receivables, a mortgage is used for real estate, and a security assignment is often used for movable properties.Creating a security interest
Describe the method of creating or attaching a security interest on the main categories of assets.
The concept of a ‘universal’ security interest for loans (whereby a security interest over all the debtor’s properties, whether present or future-acquired, is granted to the lender) does not exist under Japanese law. Thus, the assets provided as security must be specified in the security documents, and different procedures and requirements for the creation and perfection of security interests apply to different categories of assets (such as real estate, movables and receivables).Real estate
A mortgage is typically used for real estate. The secured obligations can be specified (fixed mortgage) or designated as a certain group of unspecified obligations (blanket mortgage).
A mortgage is perfected by registration at the legal affairs bureau with jurisdiction over the location of the property. The registration fee is 0.4 per cent of the amount of the secured obligation. To reduce the up-front cost, some lenders permit the security provider to make a provisional registration only, on day one, which costs ¥1,000 per property. Once the mortgage is provisionally registered, the priority is reserved for that mortgage over subsequent competing parties, such as other mortgagees. However, provisional registration is of little use unless formal registration is completed.
To upgrade from a provisional to a formal registration, documents (some of which must be provided by the security provider) must be submitted, and registration fees (which are typically borne by the security provider or the borrower) must be paid. Therefore, a lender must consider how to secure the necessary documents and costs until the mortgage is formally registered. Typically, a security provider must submit and update the necessary documents in the lenders’ custody and upgrade to a formal registration before or upon the occurrence of certain trigger events (eg, breach of any financial covenants or the occurrence of an event of default).Movable assets
Pledges and security assignments (also known as ‘security by way of assignment’ or ‘assignment for the purpose of security’) can be used to constitute a security over movable properties. Since actual delivery of the property is required to effectuate a pledge over movable property, security assignment is more often used since it does not require actual delivery. The secured obligations can be specified obligations or designated as a certain group of unspecified obligations.
To perfect a security assignment of movable property, actual or constructive delivery of the subject property (such as an occupant’s manifestation of its intent to occupy the subject assets on behalf of the secured parties) is required. Alternatively, registration of the transfer will also perfect the security assignment.
Aside from the above, special requirements apply to certain categories of movable properties, such as aircraft and automobiles.Receivables
Pledge and security assignment are the most typical forms of security for receivables. The secured obligations can be specified obligations or designated as a certain group of unspecified obligations.
Lenders can perfect the pledge or security assignment by giving notice to, or obtaining consent from, the obligor in written form with a notarised date certificate. Alternatively, registration of the pledge or transfer will also perfect the pledge or security assignment.
Receivables may be collateralised without having to obtain the obligor’s consent even if the underlying contract has a transfer restriction clause. However, if receivables are collateralised in breach of a contractual restriction, the obligor may refuse to pay the secured party upon the enforcement of the security if the secured party was aware, or owing to gross negligence unaware, of the restriction at the time of collateralisation. Although the usefulness of this type of security is somehow limited in this regard, some practitioners see new possibilities for secured transactions that utilise receivables with restrictions as collateral. One exception to the foregoing general rule relates to bank deposits, which cannot be collateralised without the bank's consent. Banks are generally reluctant to give consent unless they are a secured party.Shares
A pledge is the most typical form of security for shares. The secured obligations can be specified obligations or designated as a certain group of unspecified obligations.
The method for perfection depends on the type of shares. If the shares are dematerialised, the pledge is perfected by means of electronic book entry. If not, the share pledge is perfected by the delivery of the share certificate representing the pledged shares. If the shares are not dematerialised and share certificates are not issued pursuant to the articles of association of the issuing company, then the share pledge is perfected by recording the pledge in the shareholder ledger.Intellectual property
Pledge and security assignment are available forms of security for intellectual property, such as patents, trademarks, design rights and copyrights. In most cases, a security assignment can be perfected via registration at a lower cost than a pledge. One disadvantage of constituting a security assignment is that it exposes the secured party to a lawsuit for infringement because the secured party becomes the legal titleholder to the intellectual property.Others
The creation and perfection of security interests over other types of assets (such as factory foundations, debt securities and trust beneficial interests) are covered by the rules applicable to each type of asset.Perfecting a security interest
What steps are necessary to perfect a security interest on the main categories of assets? What are the consequences of failing to perfect a security interest?
If the lenders fail to perfect a security interest over an asset, they do not have any priority over the subject asset against a third party. Thus, if the borrower creates a perfected security interest in favour of other lenders, perfects the transfer of the asset to a purchaser, goes bankrupt, or if a borrower’s creditor seizes the asset before the perfection of the security interests, then the lenders with unperfected security interests cannot assert any preferred position against those other lenders, the purchaser, the bankruptcy trustee or creditors.
Also, in Japanese insolvency proceedings, claims with unperfected security interests are usually treated as general claims and are subordinated by law to senior claims.Future-acquired assets
Can security interests extend to future-acquired assets? Can security interests secure future-incurred obligations?
Lenders can capture future-acquired movable properties by designating the collateral as a pool of properties under the security documents. The pool must be sufficiently identified by specifying the type of asset, location and other necessary criteria. Also, future receivables can be subject to a pledge or security assignment, provided that the target receivables are sufficiently identified. On the other hand, if new real estate is acquired or new shares are issued, additional security interests must be established by the security provider.Maintenance
Describe any maintenance requirements to avoid the automatic termination or expiration of security interests.
There is no specific law that automatically terminates security interests. That said, the period for registration of movable properties and receivables may expire after 10 years or 50 years, depending on the case, and subject to exceptions. Thus, even if the lender perfects its security interests over movable properties and receivables by registration to secure long-term loans, it must renew the registration before the expiration of the relevant period.Release
Are security interests on an asset automatically released following its sale by the debtor? If so, are the releases mandated by law or contract?
Security interests are not automatically released, even if the borrower sells the subject asset out of court. However, in the case of a security assignment of a pool of movable properties, if part of the pool is sold and delivered from the specified location, the properties sold will be automatically released from the security interest. In the case of mandatory sales of real estate in the course of judicial foreclosure, security interests are automatically released following the sale, subject to limited exceptions.Non-fulfilment of guarantee obligations
What defences does a guarantor have against claims for non-fulfilment of guarantee obligations? Can such defences be waived?
If the obligation of a guarantor is not joint and several, it has a ‘defence of notice to the borrower’, under which the lender must request that the borrower perform its payment obligation before making a claim against the guarantor. Also, the guarantor is entitled to assert a ‘defence of collecting from the borrower’, under which the lender must try to seize the debtor’s assets before going to the guarantor, if the guarantor proves that the borrower can afford to repay the obligation and that enforcement on the borrower’s assets can be easily achieved. Such a guarantee is not common in business transactions and joint-and-several guarantees are usually required since those defences are not available to a joint-and-several guarantor.Parallel debt requirements
Describe any parallel debt or similar requirements applicable in a secured bank loan financing where an agent acts for multiple investors.
Traditionally, as a generally accepted principle of Japanese law, the holders of secured obligations must hold the security interests. Therefore, all lenders (rather than a single security agent or security trustee) are secured parties in most syndicated loan transactions, even where a security agent is appointed, and a security agent’s role is only administrative. This sometimes leads to burdensome procedures when there is a transfer of loans or collective enforcement of security interests.
The security trust structure is an alternative to the traditional approach. After the amended Trust Act introduced the concept of a security trust in 2007, it became clear that a security trust could be utilised under Japanese law. In practice, however, security trusts have not been very frequently used, partly owing to the increase in transaction costs on account of fees payable to the licensed security trustee and complex documentation.
Another alternative is the use of a parallel debt structure, where a security agent holds security interests to secure parallel debts owed to it by the borrower, rather than to secure loan obligations owed to each lender. Although the concept of parallel debt is novel to the Japanese legal community and there are no widely reported domestic transactions using a parallel debt structure governed by Japanese law, it should be theoretically feasible to create a parallel debt structure under Japanese law.Enforcement
What are the most common methods of enforcing security interests? What are the limitations on enforcement?
There are two types of enforcement of a security interest created in a commercial transaction: a judicial (in-court) procedure and a private (out-of-court) process.
In the case of a real-estate mortgage, the lender may choose judicial enforcement, under which the real estate will be sold to a third party through a judicial auction process, and the sale proceeds will be applied to the repayment of the secured obligation.
One problem with this procedure is that the sale proceeds are likely to be substantially lower than what would be realised through a voluntary sale. Therefore, in most cases, lenders prefer an out-of-court process.
Enforcement of security interests is in some way affected under insolvency proceedings. There are three major statutory insolvency proceedings: bankruptcy, civil rehabilitation and corporate reorganisation. Under bankruptcy proceedings and civil rehabilitation proceedings, security interests are treated as ‘out-of-procedure rights’, and their enforcement is, in principle, not affected by the proceedings.
In a civil rehabilitation procedure, however, there are two notable exceptions. First, the court may issue an injunction to stop the enforcement of a security interest by a creditor, if the injunctive relief would be in the general interest of the creditors, and the relevant secured creditor would not suffer unjustifiable damage as a result. Second, the security interests may be extinguished with the approval of the court in exchange of the debtor’s payment of the fair value of the asset if the collateral is essential for the continuance of the debtor’s business.
Under corporate reorganisation proceedings, secured creditors are prohibited from enforcing their security interests outside the process, and secured creditors can receive repayment only in accordance with the reorganisation plan approved in the reorganisation proceedings, both in terms of timing and the amount of recovery.Fraudulent conveyance and similar doctrines
Describe the impact of fraudulent conveyance, financial assistance, thin capitalisation, corporate benefit and similar doctrines on the structure of bank loan financings.
A debtor’s fraudulent conveyance may be invalidated by the insolvency trustee or the debtor-in-possession, or be subject to rescission by a creditor who might otherwise be impaired by such conveyance.
Japan has no specific regulation on ‘financial assistance’ and has not explicitly adopted the ‘corporate benefit’ doctrine. However, directors of a target company may be accused of breaching their fiduciary duties if the company provides a guarantee or collateral to the purchaser of the company, if the target company still has minority shareholders.
Under the thin capitalisation rule, a part of the interest paid to a non-Japanese lender with a close relationship to the borrower may not be deductible if debt is considered to have been provided instead of a capital contribution.
Law stated dateCorrect on
Give the date on which the above content is accurate.
30 April 2020.