Extract taken from 'The Lending and Secured Finance Review' – edition 5

Credit support and subordination

i SecurityTaking security generally

The concept of a 'universal' security interest for loans (whereby a security interest over all of the debtor's properties, whether present or after-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).

In addition, there are peculiar issues with respect to creating a security interest for a group of secured parties (such as syndicated lenders).

These are explained further below.

Real estate

Among the forms of security available under Japanese law (i.e., mortgage, pledge and security assignment), 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 upfront 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 the 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 needs to consider how to secure the necessary documents and costs until the mortgage is formally registered. Typically, a security provider is obliged to submit and update the necessary documents in the lenders' custody and to upgrade to a formal registration before or upon the occurrence of certain trigger events (e.g., breach of any financial covenants or the occurrence of an event of default).

Movable properties

Pledge and security assignment (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. Actual delivery of the property is required to effectuate a pledge over movable property. For this reason, security assignment is more often utilised since it does not require actual delivery. The secured obligations can be specified obligations or designated as a certain group of unspecified obligations. Subject properties can be individual properties or a pool of properties. The pool needs to be sufficiently identified by specifying the type of asset, the location and other necessary criteria. This method enables lenders to capture after-acquired movable properties as security.

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. The registration fee is ¥7,500 per filing, in addition to the professional fees of the judicial scrivener.

Aside from the above, special requirements apply to certain categories of movable property, such as aircraft and automobiles.


Pledge and security assignment are the most typical forms of securities for receivables. The secured obligations can be specified obligations or designated as a certain group of unspecified obligations. Future (after-acquired) receivables can be subject to a pledge or security assignment, provided that the target receivables are sufficiently identified.

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. In most cases, the registration fee is ¥7,500 per filing, in addition to the professional fees of the judicial scrivener. The cost of a notarised date certificate is even lower.

Receivables cannot be collateralised without obtaining the obligor's consent if the underlying contract has a transfer restriction clause. One type of receivable with a contractual transfer restriction is a bank deposit. Banks are generally reluctant to give consent unless the bank is one of the secured parties.


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 types 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, the share pledge is perfected by recording the pledge in the shareholder ledger.

Even if the articles of association of the issuer contain transfer restrictions, a share pledge can be constituted by an agreement between the pledgor and the pledgee. However, lenders sometimes request that the target company amend its articles of association to remove any hindrance to the enforcement of the pledge.

Intellectual property

Pledge and security assignment are available forms of security for intellectual property, such as patents, trademarks, design rights and copyrights. A security assignment can be perfected by registration at a low cost – only ¥30,000 or less per right, whereas the cost of registration of a pledge is 0.4 per cent of the amount of the secured obligation. One disadvantage of constituting a security assignment is exposing the secured party to a lawsuit for infringement, because the secured party becomes the legal titleholder to the intellectual property.


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.

ii Taking security for a group of lenders

Traditionally, as a generally accepted principle of Japanese law, security interests must be held by the holders of secured obligations. Therefore, all lenders (rather than a single security agent or security trustee) are secured parties in most syndicated loan transactions. 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 of Japan introduced the concept of a security trust in 2007, it became clear that a security trust can be utilised under Japanese law. In practice, however, security trusts have not been very frequently used, partly due to the increase in transaction costs because 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 reported domestic transactions using a parallel debt structure governed by Japanese law, it is theoretically feasible to create a parallel debt structure under Japanese law.

iii Guarantees and other forms of credit support

Guarantees are commonly used for credit enhancement. There are no specific statutory limitations or restrictions on parent guarantees for its subsidiary (downstream) or subsidiary guarantees for its parent company (upstream). However, there is an issue with upstream guarantees due 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, the directors of the subsidiary may be accused of breaching their fiduciary duties. To avoid this risk, in practice, 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.

In terms of quasi-security arrangements, negative pledge undertakings are widely used in loan transactions in Japan. A typical loan agreement also allows the lenders to exercise set-off rights against the borrower's cash deposits in its bank accounts opened with the lenders. Banks' rights of set-off are strongly protected in that banks are, in principle, entitled to set-off even after a third party seizes the borrower's bank deposit or the borrower goes bankrupt.

iv Priorities and subordination

Several methods of subordination are used in the Japanese loan market. Aside from structural subordination (which involves borrowing entities at different levels, where the subsidiary borrows senior debt and the parent borrows subordinated debt), there are two types of contractual subordination structures: absolute subordination and relative subordination.

Under an absolute subordination arrangement, if the borrower becomes insolvent, the payment of subordinated debt is contractually made conditional upon the full payment of the senior debt. Thus, senior lenders ensure that the subordinated lender does not receive payment in priority to, or at the same ranking with, the senior lender.

The essence of a relative subordination arrangement is an intercreditor agreement between the senior and subordinated lenders. Typically, the subordinated lenders agree to turn over any payment they receive from the borrower to the senior lenders until the senior debt is paid in full, with certain exceptions of permitted payment. This type of arrangement is not intended to bind the insolvency trustee in the case of the borrower's insolvency. If the borrower is insolvent, the insolvency trustee may disregard the intercreditor agreement and make distributions proportionate to the loan amounts held by the senior and subordinated lenders. Senior lenders then have to rely on the subordinated lenders to turn over the distributions to the senior lenders to uphold the priority of the senior debt.

Despite this disadvantage, senior lenders, as well as subordinated lenders, sometimes prefer relative subordination rather than absolute subordination. This is because a relative subordination arrangement could lead to greater distribution to senior lenders if the distributions are turned over by the subordinated lenders. Under absolute subordination, by reason of the condition attached to the subordinated debt, subordinated lenders may not participate in any distribution from the insolvency estate until the unsecured portion of the senior debt, if any, is paid in full. This means that the subordinated lenders are subordinated not only to the senior lenders but also to the general unsecured creditors, such as trade creditors, whose claims rank pari passu with the unsecured portion of the senior debt.

The ranking and priority of competing security interests are determined by reference to the timing at which each security interest is perfected, or the first perfected security is given first priority. Therefore, as a matter of ranking of the security interests, subordination can be created by perfecting the subordinated lender's security after the perfection of the senior lender's security.

Regarding some types of assets, however, there are technical difficulties in creating several security interests with different rankings. For example, it is theoretically unclear whether there can be multiple security assignments at different rankings over one property (unlike multiple pledges giving rise to no such issue). Moreover, the book-entry system does not accept multiple pledges over dematerialised shares. Under security trust and parallel debt structures, these issues can be avoided by creating one security assignment or pledge held by a security trustee or security agent. Otherwise, senior lenders and subordinated lenders need to agree to a special contractual arrangement to circumvent these technical difficulties, or the subordinated lenders simply give up taking security over these types of assets.