Current Developments in Monetary and Financial Law, Volume 6

Chapter 21: Quasi-Governmental Special Purpose Vehicles to Restructure Ailing Business Corporations in Extraordinary Times: A Proposal Based on Japan’s Experiences

International Monetary Fund. Legal Dept.
Published Date:
February 2013
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The downturn of the real economy might have hit bottom but we still have some fear about sinking into a double-dip recession. Many business corporations may have to resolve excess-capacity problems to match reduced consumer demands. Under declining gross-sales conditions, some parts of existing debts owed by many business corporations may become excessive. Without revitalizing these business corporations by means of debt restructuring, another economic crisis may recur.

Insolvency Law Reforms and Expedited Practice in Japan

Significant changes in reorganization occurred in Japan between late 1990s and early 2000s. The Civil Rehabilitation Law was enacted in 1999 to replace the previous Composition Law of 1922. This was followed by a series of changes in bankruptcy related laws, such as (1) the enactment of the new Law for Recognition and Assistance for Foreign Insolvency Proceedings, adopting the UNCITRAL Model Law in 2000; (2) the enactment of the new Corporate Reorganization Law (CRL) in 2002, replacing the previous CRL of 1952; (3) the enactment of the new Bankruptcy Law (BL) in 2004, replacing the previous BL of 1922; and (4) the enactment of the new Company Law, which includes many new tools to facilitate the reorganization of healthy and distressed business corporations in 2005. The new Company Law also revised provisions regarding the Special Liquidation Proceeding. Chapter 4 of the Revised Act on Special Measures for Industrial Revitalization (RASMIR) of 2007 enabled the establishment of the Business Reorganization ADR mentioned below.

Along with the above legal reforms, the Japanese courts have widely opened their gates to rehabilitation and reorganization cases that are being handled more speedily. The handling of bankruptcy cases has been speeded up. In civil rehabilitation cases in Tokyo, a plan will be generally confirmed by the court about six months after the filing of a petition to open the case. In corporate reorganization cases, which are generally larger in size than the civil rehabilitation cases, a plan will be generally confirmed within one year after the commencement of the case.

In the past ten years, a lot of private equity funds that target distressed companies were created and advisory/consulting/turnaround firms specialized in rehabilitating distressed businesses became widespread in Japan.

The Industrial Revitalization Corporation of Japan (IRCJ)

The IRCJ was created in May 2003 by the Japanese Government to dispose of non- and poorly-performing loans, as well as to revitalize ailing companies with excessive debts to overcome a prolonged recession that lasted over ten years.

The IRCJ rescued 41 enterprise groups consisting of nearly 200 companies by March 2005 and dissolved itself in March 2007, one year earlier than was scheduled.

Upon receiving an application made by a company and its main bank holding the biggest exposure to the debtor company, the IRCJ conducted due diligence and developed operational and financial restructuring plans. Then, the IRCJ proposed to buy debts owed to financial institutions or requested acceptance of the debt restructuring plan involving partial debt forgiveness and/or debt equity swaps as stipulated by the proposed plan. After the solicitation made by the IRCJ, most financial creditors either sold their debts to the IRCJ or accepted the plan. Outstanding stocks were wiped out or diluted in most cases and the IRCJ infused new equity into the company. The IRCJ sent hands-on turnaround managers to replace incumbent managers and operated the debtors’ business.

Within one or two years since the opening of each case, the IRCJ sold the purchased debts and/or equities to new owners by means of mergers and acquisitions. The IRCJ was financed by the government guarantee and successfully closed its business with profit.

Newly Started Business Reorganization Alternative Dispute Resolution (BRADR)

The Guidelines of the Out-of-Court Workout were established in 2001 in Japan. It referred to the London Approach and INSOL 8 Principles adopted by the Committee organized by the National Bankers’ Association and others, for which I served as a chair. More than 40 large corporations were reorganized using the Guidelines. The Business Reorganization ADR was created by Japanese Association of Turnaround Professionals (JATP) last November with the approvals of the Minister of Economy, Industry and Trade and Ministry of Justice based on the aforementioned RASMIR. Turnaround experts, who were appointed in each case by the selection committee of JATP that I chaired, preside over workouts using fair rules that are similar to the Guidelines.

The BRADR started its business this March and has been handling several big reorganization cases, including public companies. The government-owned organizations may guarantee a substantial part of debts owed by a debtor during the workout process as DIP financing. In cases where unanimous consent could not be reached, the debtor may file a court-administered mediation proceeding and the Court may issue an order recommending that holdout creditors accept the proposed plan with possible amendments. If the creditors do not object to the order within two weeks, the order becomes effective to bind the relevant parties. If the creditors object to the order, the debtor should convert the case to a statutory reorganization proceeding in which the proposed plan may be treated as a pre-negotiated plan.

Creation of Enterprises Turnaround Initiative Corporation (ETIC)

The bill to establish a new quasi-governmental corporation to assist revitalization of ailing companies became a law on June 19, 2009 and the new corporation started its business on October 16, 2009. The new law is similar to the IRCJ law with minor amendments. The targeted companies are mainly mid-sized corporations the failure of which may have adverse impact on local economies. Other small- and mid-sized companies can be reorganized with the assistance of SMEs Turnaround Associations, which were created in 47 prefectures in 2003, the year when the IRCJ was created. Larger corporations could be reorganized by expedited workout without the purchase of debts by the public sector, possibly assisted by the aforementioned BRADR. To infuse new money in distressed SMEs, there are regional funds that are created to help revitalization of local enterprises in each prefecture as well as private equity funds that are specialized to invest in distressed companies. In addition to the new ETIC, we have several options to restructure business corporations in Japan such as: (1) expedited statutory reorganization procedures supervised by Courts, (2) aforementioned new BRADR, (3) SME Turnaround Associations, (4) Enterprises Restructuring Group of the Resolution & Collection Corporation, (5) local restructuring funds in every 47 prefectures, and (6) private equity funds specialized in investing in distressed corporations, etc. This competitive environment might have contributed to improve professional expertise in the restructuring of distressed corporations in Japan.

Larger corporations are going to be saved through the provision of loans and/or infusion of equities by the Development Bank of Japan (DBJ), which is government owned, under the guarantee of the Japanese Government according to the special emergent legislation.

Japan Air Lines (JAL) Revitalization

The Minister of Land, Infrastructure, Transportation and Tourism appointed five experts as members of JAL Revitalization Taskforce on September 25, 2009 and the Taskforce, which I chaired, started overall due diligence to draft an operational and financial restructuring plan for JAL. Nearly one hundred experts participated in doing the due diligence and formulating the draft plan intensively. Discussions were held countless times with JAL’s management and staff, five major banks that are owed biggest exposures by JAL, including DBJ and other key stakeholders. The Taskforce completed the draft reorganization plan on October 26, 0009. The draft plan contemplated to solicit huge amount of debts forgiveness, debts equity swaps for creditor financial institutions as well as huge amounts of capital infusion as equities to DBJ and others.

The Government-owned JAL started its business in 1951 and was privatized in 1987. JAL owns many obsolete jumbo jet aircrafts which consume a lot of fuel. JAL could not replace these old ineffective planes with smaller more energy-efficient planes due to a cash shortage, and sold air tickets at lower prices to fill vacant seats even at a loss. Japanese central and municipality governments have constructed too many local airports and JAL could not refuse to use these ineffective local airports even if it meant large losses. JAL bears huge amounts of legacy costs including pension payments to retirees, similar to General Motors.

Our draft plan includes strategies and tactics to resolve these problems, such as the replacement of airplanes, closing down unprofitable local operations, and cutting legacy costs mentioned above to make JAL profitable as early as possible. The members of the taskforce were to be co-chief restructuring officers for JAL, who would negotiate with stakeholders including creditors, unions, retirees and others, soliciting them to accept the plan and consummating the plan substantially. However, the Minister of Finance and DBJ refused to infuse new money into JAL and requested us to let the newly established ETIC take over our role on October 26. ETIC is able to raise new money, which will be infused into JAL under the guarantee of the Japanese government. I don’t know the true reason why the MOF preferred the ETIC instead of DBJ as an equity provider to JAL. Currently the ETIC is doing another DD in order to decide whether it will help JAL or not. JAL also filed a petition to commence BRADR on November 13, because BRADR has convenient tools in terms of priority status of emergency loans extended during the pending case. Upon filing a petition made by JAL, the Tokyo District Court commenced the case on January 19, 2010 and ETIC decided to help the JAL on the same day.

It may be good for Japan to have so many tools to accomplish similar goals, but it also becomes difficult to choose the most appropriate ones from among them.

Proposal to Create a Quasi-Governmental Organization to Revitalize Ailing Corporations

In order to save ailing business corporations that are socially useful, providing liquidity and assisting their restructuring effort is essential to restore the health of the national economy in each country. To serve that purpose, it could be effective to establish a government-backed special purpose corporation operated by private sector professionals who possess rich experience and specialized expertise of reorganizing troubled companies in each country. The corporation administers the following workout processes.

The Solution process consists of the following stages:

  • 1. Application is made by ailing companies that are useful for the national economy.

  • 2. After preliminary due diligence, a decision whether to help the applicant is to be made.

  • 3. Notice of standstill or stay to financial creditors (i.e., moratorium).

  • 4. Facilitating provision of finance by financial institutions under the guarantee of Governmental agencies.

  • 5. Financial and business due diligence conducted by professional experts.

  • 6. Developing business and financial restructuring plans for the companies assisted by professional experts.

  • 7. Soliciting and persuading creditors and other affected parties to accept the proposed restructuring plans.

  • 8. Execution of the accepted plans.

  • 9. In some cases, purchasing debts and infusion of capital may be useful.

Independence from political interference and freedom from corruption is not only critical but also essential for the effectiveness of the organization and its officers.

The staffs must consist of professional experts recruited from the private sector, not of government bureaucrats. Moreover, staff with advanced skills for turnaround management is essential.

Japan up to now is not in a situation where my proposed solution above is in need. But some countries which are struggling with severe economic downturn need a scheme for an expedited workout solution assisted by international organizations. Obtaining unanimous consent would be very difficult in those countries where out-of-court workout solution is not usually used. The majority rule involving the courts or other appropriate authorities may be helpful in these situations.

Rules for Organization and Proceedings

  • 1. Troubled companies (TC) are able to apply for assistance from the corporation (CO).

  • 2. TC must be economically useful for the country and its people.

  • 3. CO should help only those companies whose continued operation is beneficial for the country and its people.

  • 4. Upon the decision by the Board of Directors (BOD), the CO undertakes preliminary due diligence (DD) research on the TC’s usefulness, possibility of survival, financial status and other related matters, within two weeks after the filing of the application.

  • 5. Within a few days after the completion of the DD, the BOD must decide whether the CO will assist the TC or not.

  • 6. Once the assisting decision (AD) is made by the BOD, the CO issues a notice of standstill (NS) immediately by fax or other appropriate devises to all relevant creditors of the CO.

  • 7. The relevant creditors (RC) include banks, financial institutions, bond holders, indenture trustees and other financial creditors to whom the CO owes debts. Trade creditors with huge claims, whose participation is indispensable for sustainable restructuring of the CO, could be included in the RC category.

  • 8. Upon issuance of the NS, all RC are prohibited to take any collection actions against the CO and their co-debtors, including guarantors, to maintain their exposure as of the issuing date of the NS. Prohibitions include:

    • any acts to collect or recover a claim.

    • commencement or continuation of judicial or administrative action or proceeding.

    • enforcement of a judgment.

    • obtainment or repossession of property.

    • realization of secured rights.

    • any acts to create, perfect or enforce any lien or secured rights.

    • setoff of any debts.

  • 9. Within a week after the NS, the CO and the TC must convene a creditors’ meeting and report the present status of the TC.

  • 10. Within two months after the NS, the CO should study the past, present and future financial and operational status of the TC under DD aided by external professional experts, and the TC must draft operational and financial reorganization plans (Plans) assisted by the CO and other professional experts.

  • 11. When the TC is loss making and/or insolvent (i.e., liability exceeds assets), the Plans must provide appropriate means to turn to profitability and dissolve insolvency within three years.

  • 12. The Plans must be equal, fair, equitable and feasible.

  • 13. When the Plans provide for debt forgiveness and/or debt equity swap, claims should be treated on pro rata and/or pari passu principles.

  • 14. When the Plans provide for impairment of claims by any means, the equity of the TC should be wiped out or diluted, if any.

  • 15. Should incumbent managers be responsible for the TC’s difficulty, the Plans must provide for the replacement of the management of the TC.

  • 16. Within two weeks after the Plans are completed and the BOD are satisfied that the Plans meet abovementioned requirements, the BOD should approve the Plans.

  • 17. Within one month after the approval of the Plans by the BOD, the TC and the CO should solicit and persuade the RC to accept the Plans.

  • 18. Within one month after the acceptance of the Plans, the TC must execute and consummate the Plans.

  • 19. Upon the substantial consummation (SC) of the Plans, the process is completed.

  • 20. Anytime before the completion of the process, the BOD can cancel the assistance decision when the Plan does not meet the aforementioned criteria or unforeseeable changes in other circumstances occur.

  • 21. During the period that begins with the AD and ends with the SC or the abovementioned cancellation, the CO may ask financial institutions to provide financing to the TC to defray its overhead costs under the guarantee of the governmental agency.

  • 22. The CO is entitled to purchase and sell the TC’s debts and equities. The CO is also entitled to obtain the TC’s equities by other means and dispose of them.

  • 23. When the case is converted to statutory insolvency proceedings, the loan debts owed to financial institutions by the TC which were provided under the aforementioned Rule 21 will be treated as priority debts in the same way as administration expenses.

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