Pre-Packaged Filings And Pre-Filing Arrangements For Sponsorship In Japan
Under current Japanese business recovery practices, the term ‘pre-packaged’ is used more broadly than in Chapter 11 of the US Bankruptcy Code (hereinafter ‘Chapter 11’).This term is used for cases in which sponsorship has already been arranged prior to the filing of corporate reorganisation or civil rehabilitation proceedings.
However, neither the Corporate Reorganization Act nor the Civil Rehabilitation Act has any special provisions for such ‘pre-packaged’ cases.
Summary proceedings and consensual proceedings
As for the Civil Rehabilitation Act, the tools of summary proceedings1 and consensual proceedings2 are available to expedite a civil rehabilitation case, although only after the deadline for filing claims has passed.
Summary proceedings enable a debtor to skip the claim examination and claim approval procedures if, inter alia, creditors holding more than three-fifths of the filed claims (as determined by the court) consent in writing to waive the procedures and to approve the proposed rehabilitation plan. Under summary proceedings, the rehabilitation plan still needs to be approved by a majority of creditors’ votes at a creditors’ meeting.
To bypass this voting process, a debtor in a civil rehabilitation case may use consensual proceedings, provided, inter alia, that all unsecured creditors who have filed claims consent in writing to waive the claim examination and approval procedures and to support the proposed rehabilitation plan. In such a case, the court confirms the rehabilitation plan without the creditors voting.
Unlike plans confirmed through the regular civil rehabilitation process, the confirmation of a plan through summary or consensual proceedings poses some disadvantages to debtors and creditors. For example, plans under summary or consensual proceedings do not discharge unfiled claims and claims recognised in a confirmed plan under a summary or consensual proceedings are not treated as executable judgments.
As regular civil rehabilitation proceeds speedily – plans are usually confirmed within five months from filing – summary or consensual proceedings are rarely used.
Because the Civil Rehabilitation Act and the Corporate Reorganization Act do not have provisions for prepackaged filings, not only other creditors but also the debtor itself may disregard a pre-filing deal once a case is opened on the grounds that the deal is an executory contract. Because of this possibility and the uncertainty, investors could be discouraged from becoming financially supporting sponsors to a debtor before it files for civil rehabilitation or corporate reorganisation.
A notable example of this problem is the Tohato case.Tohato, a confectioner, became financially distressed and conducted an auction to sell its business on February 14, 2003, before filing for civil rehabilitation proceedings. Unison Capital, a private equity fund, won the auction with a bid of ¥135m (approximately US$1.1m at US$1=¥120). On March 14, 2003,Tohato filed for civil rehabilitation with a plan to sell its business to Union Capital. After the commencement of the civil rehabilitation case, a bidder who was unsuccessful at the auction complained about the pre-filing auction process. Since the pre-filing arrangement to sell its business to Unison Capital could be overruled after the commencement of civil rehabilitation proceedings, Tohato cancelled and disregarded the pre-filing deal with Unison Capital and conducted another auction to sell the same business after the filing. In the end, Unison Capital also won this second bid, but this time the price was raised to ¥183m (US$1.5m at US$1=¥120) for the same assets.
Termination of sponsor agreement
Learning form the Tohato case, a sponsor agreement made before filing may be disregarded in civil rehabilitation or corporate reorganisation proceedings.
The DIP (Debtor in Possession) in the civil rehabilitation process, or the trustee in the corporate reorganisation proceedings, has the right to cancel the sponsor agreement made before filing proceedings. The DIP owes an obligation to pursue the rehabilitation process faithfully and impartially, and thus is obligated to cancel such sponsor agreement when the agreement is not beneficial to its other creditors. In the case that there is another candidate for a sponsor offering better terms and support, it may be a violation of such obligation for DIP not to terminate the pre-filing sponsor agreement.
A sponsor agreement made before filing could also be terminated in corporate reorganisation proceedings. It is generally understood that the trustee shall not be bound by a sponsor agreement agreed upon before the filing. Moreover, the trustee owes a species of fiduciary duty to all creditors. As it is very difficult to evaluate the adequacy of the pre-filing agreement, the trustee tends to conduct an auction after the commencement of corporate reorganisation proceedings.
When the sponsor arrangement is cancelled, the pre-arranged sponsor only obtains an unsecured claim for damages caused by the cancellation.
Conditions for effective sponsor Agreement
Since there are no rules or judgments regarding sponsor agreements made before bankruptcy filings, it is unclear in what cases a sponsor agreement made before filing is not to be cancelled, and instead to be confirmed as effective. This uncertainty is quite problematic, because investors could be discouraged from cooperating with a debtor to create pre-filing arrangements.
To avoid this uncertainty, conditions for sponsor agreements made before filing to be effective have become an issue of some debate. One approach3, which was the first to be proposed on the matter, requires all of the following conditions:
- The business of the debtor would have continued to deteriorate without the support offered by the sponsor before filing;
- The debtor has invited a number of potential sponsors in order to ensure substantial competition;
- Conditions for the offer of sponsorship do not make the offering price unfairly low (such as promising to keep the same persons in positions of management, or to give benefits to previous owners in addition to paying the sales price);
- The sponsor has been chosen in an unbiased process from amongst potential sponsors;
- The sponsor agreement is not unfair to the debtor;
- A third party opines that the sponsor has been fairly chosen; and
- The sponsor has carried out the sponsor agreement and has fulfilled the expected role as a sponsor.
It is widely understood that if all of these conditions are satisfied, the pre-filing sponsor arrangement should remain on foot. However, it seems rather difficult to satisfy all of these conditions in reality. Moreover, a dispute regarding the conditions may arise, because they include terms that are difficult to define. With an awareness of these problems, a more lenient approach has been proposed4, which requires the following:
- A debtor’s main bank has been involved in the negotiations for the pre-packaged plan;
- The debtor has negotiated with several potential sponsors;
- The value of the debtor which the sponsor agreement was based on is generally reasonable at the time of making the sponsor agreement prior to the rehabilitation or reorganisation filing;
- The sponsor agreement contributed to an early filing for rehabilitation or reorganisation; and
- The sponsor provided the debtor with financial or business support, although this is not mandatory.
As the court has not yet issued an opinion on this issue, it is unclear whether either of these approaches will be adopted by the courts. While there are no clear-cut rules regarding this issue, these approaches will be helpful in understanding pre-filing sponsor agreements.
Advantages for pre-filing arranged Sponsors
As the position of the pre-filing arranged sponsors is unsecured, it is also proposed that some advantages should be given to such sponsors in any auction held de novo after the filing, if one is conducted.
The cooperation or contribution provided by the sponsor to the debtor helps to maintain or raise the value of the debtor or its business. As all creditors can benefit from this, the provision of an advantage to the sponsor can be justified. Moreover, it is desirable to provide incentive to support such debtor companies in financial hardship.
As a pre-filing agreement on sponsorship can be terminated ex parte by the DIP or the trustee, it is also important for the sponsor or potential sponsor to be compensated for such termination. However, under current Japanese insolvency law, it is unclear whether such damages will be fully compensated.
According to Japanese insolvency law, such damages as caused by the termination of an executory contract constitute an unsecured claim in insolvency proceedings.There is, however, an argument that an amount of money outside of the plan should be paid to the previous sponsor as compensation, and should be treated as a priority claim or remuneration.
Although this is not yet common practice, breakup fee provisions in sponsor agreements are becoming more popular. It is, however, unclear whether such provisions will be deemed valid, or how this kind of claim will be treated in civil rehabilitation or corporate reorganisation proceedings.
As one can see from the above discussion, a variety of proposals have been made to facilitate pre-packaged rehabilitation reorganisation plans.The issue remains to be settled in Japanese insolvency practice.
1 Civil Rehabilitation Act arts. 211–216.
2 Id. arts. 217–220.
3 Hideaki Sudo, PREPACKAGED BUSINESS RECOVERY § 2, at 99–192 (JAPANESE ASS’N FOR BUS. RECOVERY, 2004). This approach is called the ‘Odaiba-Approach,’ named after the place where the symposium was held at which the text was first published.
4 Hideki Matsushima and Yoshitaka Hamada, The Problems of Japanese Pre-Packaged Filings, Ginko Homu 21 at 6 (April, 2004).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.