Under the Companies Act, a company split is often used when reorganising a company in Japan. However, in recent years, abusive use of the company split has been problematic, and there have been cases in which the legal effect of a company split has been disputed. There are several methods by which the effect of a company split can be disputed, including rescinding a fraudulent act under Article 424 of the Civil Code. This involves an obligee demanding that a court rescind any juristic act which an obligor has committed knowing that it will prejudice the obligee, except where any party which benefitted from such an act, or any party which succeeded to such benefit, did not know at the time of the act or succession that the obligee would be prejudiced.
Several lower court level judgments have discussed whether a company split can be rescinded as a juristic act. On October 12 2012 the Supreme Court handed down its first judgment in this area of law, indicating that an obligee may demand the court to rescind a company split regarding the transfer of rights in accordance with the Civil Code.
In December 2000 a bank loaned Y560 million to a debtor company; another company acted as guarantor to the debtor company's payment obligation. In August 2004 the guarantor merged with another company, which automatically succeeded the liabilities for the guarantee.
The bank assigned the remaining amount of the loan – Y455 million – to another company (a creditor), which then entrusted recollection of the money to a loan servicer in September 2005.
The guarantor company intended to proceed with an incorporation-type company split and prepared a company split plan in September 2007. The plan provided that new corporation Newco, with a capital amount of Y1 million, would be incorporated; all of the shares issued by Newco would be allocated to the guarantor company, and the substantial business, assets and debts (other than liabilities for guarantee) would be transferred from the guarantor company to Newco. The plan also provided that together with Newco, the guarantor company would assume a certain category of debts that were transferred from the guarantor company through the company split.
While proceeding with the company split procedure, the director of the guarantor company visited the servicer to discuss ways to repay the loan and promised to submit a payment schedule to the servicer.
In October 2007 the company split was completed and Newco was incorporated in accordance with the company split plan. On completion of the company split, the guarantor company's real property – its sole valuable asset – was transferred to Newco, and this transfer was registered. Thus, after completion of the company split, although the obligee of the liabilities for guarantee was still the guarantor company only, the guarantor company's sole assets were the shares issued by Newco at the time of incorporation.
Regarding the company split procedure, the Companies Act provides certain creditor protection measures, where creditors may raise an objection before expiration of the relevant objection period. However, such measures are unavailable to creditors that continue to hold claims against the splitting company. Thus, for a company split of the guarantor company, creditor protection measures are not afforded to the creditor regarding liabilities for guarantee under the Companies Act.
The servicer sued the guarantor company, demanding payment of the loan liabilities as a guarantor; it obtained a favourable judgment at the district court in January 2008.
The servicer then sued Newco, demanding rescission of the company split regarding the transfer of the real property and cancellation of the registration of ownership transfer of the property according to the right to rescind a fraudulent act under Article 424 of the Civil Code.
At first instance, the Osaka District Court upheld the servicer's demands. The court stated that as the purpose of a company split is to transfer assets, liabilities, rights and obligations to the transferee company from the splitting company, in essence a company split is subject to the right to rescind fraudulent acts as a juristic act. In this regard, the Companies Act provides certain measures for creditor protection; creditors which are given such protection measures under the Companies Act are not entitled to exercise the right to rescind fraudulent acts under the Civil Code. However, creditors which do not enjoy such protection measures are entitled to exercise the right to rescind fraudulent acts.
In circumstances where, during an incorporation-type company split, shares are allocated to the splitting company from the corporation which is incorporated through the company split, even if there is no change of value of assets in calculation, generally, the realization of shares of assets is not easy for the shares of closed companies or the listed company. Thus, even if the shares are issued to the splitting company from the entity incorporated through the company split, and there is no change to the value of assets in calculation, if the property of the splitting company is converted to assets that are difficult to realise, and the value is substantially decreased, the incorporation-type company split can be subject to the right to rescind fraudulent acts.
The Osaka High Court upheld the district court's judgment and reasoning. It additionally stated that there is no reason to deny the right to rescind fraudulent acts under the Civil Code when a creditor is not afforded the creditor protection measures under the Companies Act, considering that even if the splitting company has obtained the shares issued by the entity incorporated through the company split, and the value of such shares is equivalent to the assets transferred to the entity incorporated through the company split in calculation, realisation of shares except for the shares of the listed companies is not easy, In addition, often obtaining the shares of the entity incorporated through the company split is not enough reserve for the creditors of the splitting company.
It would be difficult to foresee a situation in which a company split that is appropriate for restructuring of the business would be rescinded because:
- the juristic act that is rescinded as the fraudulent act is the act of individual asset transfer and the legal effect of rescission is relative to the transferee;
- the legal effect of rescission does not extend to the company split itself; and
- the right to rescind a fraudulent act is allowed only when the subjective and objective conditions are satisfied.
Newco appealed to the Supreme Court.
On October 12 2012 the Supreme Court dismissed the final appeal by Newco. It stated that:
"In case of the incorporation-type company split, the creditors who may not raise an objection to the company split (under the Companies Act) because the splitting company's obligation regarding their claims is not transferred to the corporation incorporated through company split may rescind the incorporation-type company split through exercising the right to rescind fraudulent act. Thus, to the extent it is necessary to preserve its claim, the effect of transfer of the rights to the corporation incorporated through company split can be negated."
It is likely that this Supreme Court judgment will have a substantial impact on reorganisation of companies utilising the company split.
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