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PLC Global Finance Q&A Guide to the Financial Crisis: Japan
Practical Law UK Articles 7-385-5596 (Approx. 11 pages)
PLC Global Finance Q&A Guide to the Financial Crisis: Japan
by Patrick Smith, Ryuichi Nozaki, Takuji Nozaka, Chie Kasahara, Kazumoto Kitamura and Yoshiki Tsurumaki, Atsumi & Partners
| Published on 01 Apr 2009 • Japan |
A Q&A guide on the causes, effects and regulatory impact of the financial crisis in Japan.
General
The impact of the financial crisis was first felt by the Japanese real estate market in the middle of 2007. Investment by foreign financial institutions, private equity houses and other investors in Japanese real estate drastically declined, causing a credit crunch and severe price declines in real estate to occur. From the beginning of 2008, a number of large real estate companies in Japan collapsed.
However, the financial crisis did not impact the general economy until mid-2008.
The US recession and the rapid appreciation of the yen has seriously affected exporters and resulted in a fall in their share prices. Contagion from the export sector has spread to most areas of the Japanese economy. Also, the fall in foreign investment has caused a fall in stock prices generally.
In the short-term money markets, the collapse of Lehman Brothers made market participants more concerned about the solvency of their counterparties, which led to a decrease in the volume of paper being traded and increases in short-term interest rates.
Faced with a decreased ability to raise funds in the stock market and short-term credit markets, Japanese companies were forced to depend more heavily on bank loans and syndicated loans. As a result, the stock price average of the Tokyo Stock Exchange (TSE) fell rapidly, liquidity dried up and the number of bankruptcy cases increased.
An increasing number of contracts of temporary workers (mainly in the manufacturing industry) were not renewed and this became a major social issue in Japan by the end of 2008.
Since November 2008, many of the larger Japanese banks have recapitalised themselves by issuing preferred shares, preferred securities or subordinated bonds to offset declines in their stock price that had placed them in danger of failing to comply with capital adequacy requirements.
The Japanese Government has implemented a number of initiatives to respond to the financial crisis, including:
- Reducing taxes on residential mortgages.
- Supporting fundraising by real estate companies through the Japan Housing Finance Agency.
- Revising the Act on Financial Institutions' (etc.), Limits for Share, etc. Holdings to increase the maximum amount able to be borrowed by the Banks' Shareholdings Purchase Corporation (a government corporation established for the purpose of buying stocks to dilute cross-shareholdings) to JPY20 trillion.
- Reducing employment insurance premiums.
- Enacting a revised Act on Special Measures for Strengthening Financial Functions to make it possible for the government to inject capital into financial institutions (up to JPY12 trillion).
- Increasing the maximum amount that can be lent by the Japan Finance Corporation to companies having temporary cash-flow problems
- Outright purchases of commercial paper (CP) and asset-backed commercial paper (ABCP) through the Japan Finance Corporation.
- Reducing road tolls.
The Financial Service Agency of Japan (JFSA) has taken the following measures:
- Increased disclosure requirements regarding short sales.
- Prohibited naked short sales (where the short sale is not covered by the short seller borrowing stock).
- Relaxed restrictions on share buybacks.
- Relaxed bank regulatory capital requirements.
The following measures have been taken by the Bank of Japan (BOJ):
- Outright purchases of CP, ABCP and Japanese Government bonds (JGBs) in the money markets.
- Lowered the official discount rate.
The effectiveness of the action taken so far is not yet clear. However, real estate companies are still collapsing and the stock price average of the TSE continues to decline. The government is now reviewing additional measures to stimulate the economy.
The government will need to implement further reforms to stimulate domestic investment and consumption in the short term and attempt to move Japanese industry away from its dependence on external demand in the long term.
Corporate loans
Existing loans
Existing loans have been impacted as follows:
- A number of borrowers are distressed and in danger of breaching their financial covenants
- Some borrowers have breached negative pledges by pledging collateral to third parties in secret to obtain emergency funding.
New loans
New loans have been impacted as follows:
- Some lenders are finding that they cannot fund some of their customers' needs due to regulations limiting the amount of credit that can be provided to a single borrower.
- Lenders require more assurances about creditworthiness of borrowers and many banks only lend to highly creditworthy companies.
- Interest rates on loans have increased drastically.
Two important issues that arise if a bank is declared bankrupt are:
- Borrowers remain liable to perform obligations even if a lender is insolvent. For example, commitment fees may still be payable even where one or more lenders in a syndicate enter into insolvency (unless the agreement is cancelled by the receiver).
There are some differences between a bank's insolvency and that of other companies:
- The JFSA may apply to the court for the corporate reorganisation procedure under Corporate Reorganisation Law.
- If a court receives an application for the corporate reorganisation procedure of a bank, it must notify the JFSA.
- Each depositor in a failed bank that is authorised by JFSA can recover up to the first JPY10 million of their savings.
- Distressed banks can apply for government capital injections under the Act on Special Measures for Strengthening Financial Functions.
Capital markets
The financial crisis and the resulting fall in stock prices have led companies to move their fund raising activities from the equity markets to the debt markets. The principal amount of corporate bonds issued in 2008 exceeded JPY9 trillion and wholesale issues are on the increase.
On the other hand, investors have tended to seek early redemption of convertible bonds. For example, JPY500 billion yen-euro convertible bonds issued by Softbank (a major telecommunications company) in 2003 will be redeemed six years before the maturity date in accordance with their terms.
The JFSA decided in October 2008 to take additional measures to strengthen the restriction on short selling of stocks. Under the new measures:
- Naked short selling is prohibited.
- Security companies must report holders of a short position of 0.25% or more of outstanding stocks to exchanges and exchanges must publicly disclose such information.
These measures may be changed in the near future as they were intended to apply only until March 2009. However, the government is considering whether they should remain valid after that.
Financial institutions
The JFSA amended the relevant manuals to help banks to lend to small and medium-sized enterprises (SMEs) (for example, increasing forbearance periods for reform from three years to five years).
The government also decided to expand the amount of the safety-net loans that can be made by the Japan Finance Corporation to about JPY10 trillion, and to reduce the rate of interest payable (especially by companies in difficulty).
The JFSA also recently decided to oblige institutions that deal in foreign exchange margin transactions to segregate client funds into separate trust accounts with trust banks.
Section 2. Restructuring and insolvency
If a company's customer or supplier is in financial difficulty, the company should stop credit sales, re-financings, transfer credits, step-ins, and/or enforce mortgages.
After bankruptcy proceedings have been initiated, a company's options are very limited: it can make claims to the administrators or receivers of privileged rights on property, such as the right to retrieve assets from a bankrupt estate (Betsujo-ken) and statutory lien (Sakidori-tokken).
Under Japanese law the following are useful methods of restructuring:
- Merger.
- Corporate demerger.
- Share-for-share exchanges.
- Share transfers.
- Reductions or increases in capital.
- Debt for equity swaps.
- Debt for debt swaps.
- Asset sales.
Since May 2006, the new Corporate Code has permitted greater flexibility in what may be received in exchange for restructuring. This has led to more options (such as cash-out merger, triangular merger and squeeze out) being available than before.
A company may also choose civil rehabilitation and corporate reorganisation (similar to Chapter 11 proceedings in the US) to continue in business or bankruptcy proceedings in cases where recovery is rather difficult.
11. What steps should a company take when entering into a new customer or supplier agreement to protect against the risk of the customer or supplier having financial difficulty?
New customer
When entering into an agreement with a new customer, a company needs to consider various possible steps including the following:
- Requiring upfront payments.
- If the customer's payment is to be made after the company has delivered goods or services or if the supply is ongoing and each payment (or the transaction) is intended on credit:
- Investigating the creditworthiness of the customer before entering into the transaction agreement;
- Requiring a down payment or shortening the term from the date of the company's supply of goods or services to the payment date;
- Obtaining security from the customer or a third party, or a guarantee or insurance from a third party. The type of security could include mortgages, retention of title of the delivered goods and assignment of trade receivables (including future receivables) held by the customer. The company should note that security interests may be subject to change in the customer's corporate reorganisation proceedings, or subject to provisional remedy in various insolvency proceedings. The company cannot circumvent these rules by providing for retroactive cancellation of the agreement and a return of goods in case of the customer's delinquency;
- Obtaining representations and warranties from the customer relating to its ability to make payments in the future, or covenants about monitoring and controlling its business which may affect its ability to make payments in the future.
New supplier
When entering into an agreement with a new supplier, a company needs to consider various possible steps including the following:
- If the credibility of the supplier in the future is in issue (for example, if its ability to continuously deliver goods or perform services or its ability to indemnify the company for any loss caused by delays in delivery or performance are in doubt), similar steps those for dealing with customers (see above, New customer) can be taken. The type of security could include mortgages, assignment of collective inventory and assignment of trade receivables (including future receivables) held by the supplier.
- Ensuring that there is no ground of voidance of the transfer of goods if the supplier enters into insolvency proceedings (see Question 12).
12. What special considerations apply in relation to a company's dealings with:
- A company already in financial difficulty?
- The person responsible for winding-up an insolvent company's affairs?
A company in financial difficulty
Under Japanese insolvency law:
- Where A grants a security interest to B to secure an existing claim held by B, or where A repays its unsecured debt to B, the grant or repayment may be avoided if:
- A did so after it became insolvent and B knew at the time of taking the security or receiving the repayment that A was insolvent or had stopped paying its debts (shiharai-teishi);
- A did so after a petition for insolvency proceedings against it was filed and B knew at the time of taking the security or receiving the repayment that the petition had been filed; or
- A did so, without there being an obligation to do so, less than thirty days before becoming insolvent and B is unable to prove that it did not know at the time of taking the security or receiving the repayment that the grant or repayment was harmful to A's creditors.
- Where A grants a security interest to B to secure a loan which is simultaneously granted by B, the grant of security will not be voidable unless made less than six months before A stopped paying its debts and the value of the collateral exceeds the amount secured by a sufficient degree.
- Where A transfers its assets to B (other than under an existing obligation) the transfer may be avoided if:
- A knew that the transfer would harm A's creditors and B does not prove that it did not know about such harmful effect;
- the transfer was made after A had stopped paying its debts;
- a petition for insolvency proceedings of A was filed and B is unable to prove that it did not know at the time of the transfer that A was not paying its debts; or
- the petition had been filed and that the transfer was harmful to A's creditors.
However, if A receives reasonable value from B, the transaction enjoys protection from voidance risk unless certain conditions are met.
Transacting with a company in insolvency proceedings
The following considerations apply when transacting with a company in insolvency proceedings:
- In bankruptcy proceedings, the power to administer and dispose of assets is vested exclusively in a trustee.
- In most cases of civil rehabilitation proceedings (so called "debtor in possession" (DIP) type proceedings), the debtor may continue to conduct its business and administer and dispose of its assets. However, the court appoints supervisors to oversee and investigate the debtor.
- In a corporate reorganisation proceeding, the power to carry on a debtor's business and administer and dispose of its assets is vested in a trustee
- Trustees in bankruptcy proceedings and corporate reorganisation proceedings, and debtors in DIP type civil rehabilitation proceedings, have power to choose whether to terminate executory contracts or to keep such contracts effective (special rules exist on lease contracts and certain other contracts). When these trustees or debtors chose to keep these contracts effective, the contract counterparties' claims are given seniority over general creditors' claims, tax authorities' claims, and claims ranking equally with those of the tax authorities. However, they are subordinate to paying the costs of the insolvency proceedings. Loans provided to a debtor after insolvency proceedings have begun rank the same as such contractual claims.
Despite the merits of buying back debts or stocks, the general tendency of Japanese companies has been to maintain as much available cash as possible to weather the current credit crunch and real economy recession. Consequently they have been hesitant to buy-back their own debts or stocks. However, some such transactions have been observed, including:
Buying back debts
- Musashi Seimitsu Kogyo Co., Ltd. (listed on the first sections of the TSE and the Nagoya Stock Exchange (NSE), code: 7220), an automobile component manufacturer, announced in March 2009 that it would buy back its JPY1 billion due 2010 yen-denominated "convertible bond type" bonds with share options.
- The Bank of Iwate, Ltd. (listed on TSE, code: 8345) announced in December 2008 that it bought back its JPY5.52 billion due 2017 euro yen-denominated convertible bonds with share options and expected to earn by this buyback JPY552 million profit.
- Geo Corporation (listed on the first sections of TSE and NSE, code: 26810), a nationwide DVD and CD retailer, announced in September 2008 that it would buy back its JPY7.8 billion due 2012 euro yen-denominated convertible bonds with share options and expected to earn by this buyback JPY391 million profit.
Section 3. Dispute resolution
The current financial crisis may cause increases in various types of disputes, including the following:
- Investor claims against securities companies or others that sold financial instruments on the grounds of fraud or insufficient disclosure or explanation of the risks in the financial instruments.
- Investor claims against asset management companies on the grounds of not exercising their duty of care in managing assets
- If the Japanese government nationalises a failed bank (even though this has not happened as of March 2009), the government could bring an action against directors of such a bank for damages caused to it by their breach of their fiduciary duties and duty of care to the bank.
No major litigation has yet arisen. However, it is likely that in the future we will see claims being made against companies along the same lines as those made in the Livedoor case, where shareholders were awarded damages in relation to falls in the price of the company's stock caused by material misstatements contained in the company's annual securities report.
While not directly attributable to the current financial crisis, this type of litigation may increase.
Section 4. Acquisition finance and private equity
Number of buyouts
The number of buyouts is published by Japan Buy-out Research Institute Corporation (JBRIC). In the first nine months of 2008, the number of buyout deals was 43, compared to 88 for the whole of 2007. It is likely that the number of buyout deals for 2008 will be significantly less than for 2007.
Foreign private equity investors are having significant difficulties in servicing transactions and there is little prospect of this improving; a number have closed their Tokyo operations this year, while others have written-off Japan as a potential source of deals.
Volume of M&A activity
The volume of Japan M&A activity has decreased slightly by 3.8% to US$161.6 billion in 2008 (Thomson Reuters).
Outbound deals
The volume of outbound cross-border M&A deals by Japanese companies has increased by 200% to US$74 billion in 2008 (Thomson Reuters). These deals included Mitsubishi Tokyo UFJ Financial Group's US$7.8 billion investment in Morgan Stanley and Nomura's US$225 million acquisition of Lehman Brothers' European and Asian business. The most likely reason for this increase is a combination of the Japanese Yen's recent surge to a 13-year high against the US dollar and domestic companies with large cash reserves. Both of these factors can be attributed to the financial crisis.
Inbound deals
Inbound Japan cross-border M&A deals have decreased by 71% to US$10.4 billion in 2008 (Thomson Reuters).
Trends in M&A activity in Japan
The following trends have been observed:
- M&A activity by investment funds has been decreasing. Moreover, investment funds have begun to sell some shares which they had previously invested in for strategic purposes.
- The main purpose of M&A activity is disposal of unprofitable businesses and non-core businesses.
- Financial institutions such as insurance companies or banks have accelerated plans for acquisitions to gain market share and improve their balance sheets.
Price
Because due diligence is limited and there is a limited recourse provision in the purchase agreement, the purchase price should be determined carefully. In particular, when it is found that a target company has more losses and the price is too high, directors' decisions about the purchase is likely to become the subject of shareholder action.
Right of avoidance (hinin-ken)
Under the Bankruptcy Act, Civil Rehabilitation Act and Corporate Reorganisation Act, an act that would prejudice a creditor conducted by a debtor after suspension of payments or filing of a petition for commencement of bankruptcy proceedings may be avoided after the commencement of the bankruptcy proceedings (see Question 12).
20. Do any special competition/anti-trust considerations apply to distressed deals? Does the relevant authority have power to waive competition/anti-trust requirements in appropriate circumstances ( if so, please give details)?
Section 5. Directors' duties and liabilities
Liability for breach of fiduciary duty
Lending money to a company in financial difficulty without sufficient collateral could expose the directors to liability to pay damages for breach of their fiduciary duties or their duties of due care as a prudent manager.
In addition, if a director does so to promote his/her own interest or the interest of a third party, or to inflict damage on another, and causes financial loss to the company, a criminal fine and/or term of imprisonment may be imposed.
"Cooking the books"
Recent experience in Japan has once again demonstrated that it is not uncommon for companies to misstate accounts when experiencing financial difficulties. A director who has submitted an annual securities report or other document containing a misstatement on any important matter may face criminal sanctions and/or be required to pay damages.
Other corporate governance issues banks and companies should be aware of include:
- Recent scandals (such as the Kanebo case and the Livedoor case) have highlighted the need for certified accountants to ensure that securities reports of listed companies in financial difficulty are properly audited.
- Whereas in the past, many external directors and external auditors have been viewed as nominal positions, shareholders and other related parties have recently been demanding that such directors and auditors take more responsibility for monitoring the company.
No restrictions have been imposed on executive remuneration.
Partly because many executives are internally promoted from employees in Japan, executive remuneration tends to be relatively low, compared with executive remuneration in the United States or other countries.
In addition, under the Company Law, the remuneration of each executive (or, at least, the total amount of the executive remuneration) is decided at the general meeting of the shareholders. Executive remuneration is therefore under the control of the shareholders and consequently restrictions are unlikely to be imposed on it in Japan.
Contributor information
Atsumi & Partners
T +813 5501 1111F +813 5501 2211W http://www.apap.gr.jp/en/
Patrick SmithE [email protected]
Ryuichi NozakiE [email protected]
Takuji NozakaE [email protected]
Chie KasaharaE [email protected]
Kazumoto KitamuraE [email protected]
Yoshiki TsurumakiE [email protected]