Civil Rehabilitation Procedure

Introduction
Filing
Stay
Management
Business Transfer
Creditors and Claims
Rehabilitation Plan

Introduction

The procedures under the Civil Rehabilitation Law are applicable to legal entities and private individuals without distinction. While any corporation may file a petition for civil rehabilitation, the procedure is primarily aimed at rehabilitating small and medium-sized companies under a simplified process (compared with the procedures under the Corporate Reorganization Law). However, in practice, even certain large-sized corporations have chosen to file a petition for civil rehabilitation.

Civil rehabilitation is characterized as a debtor-in-possession type of procedure. In most civil rehabilitation cases filed by companies, the current management of the debtor will continue to operate the business as a debtor in possession. However, the court may appoint a trustee if there has been a failure in management or disposition of the debtor, or if the court recognizes that management by a trustee is necessary for the recovery of the debtor's business.

In a typical civil rehabilitation case, the court appoints a supervisor to oversee post-petition management by the debtor in possession, as well as the development and implementation of the rehabilitation plan. This update outlines the main stages of the civil rehabilitation procedure.

Filing

A debtor or a creditor may file for civil rehabilitation in a competent district court. A petition may be filed if (i) the debtor is likely to go bankrupt (ie, is unable to pay due debts generally and continuously or becomes insolvent), or (ii) cannot pay due debts without causing major difficulties for the continuation of its operations. However, a creditor may not file for civil rehabilitation if the conditions set forth in the first alternative are not satisfied. If the filing is deemed appropriate, the court issues a decision for commencement of the procedure. In practice (at the Tokyo District Court), the debtor must hold a meeting to explain the details of the situation to the creditors after the filing; the court issues a decision immediately after the meeting.

Stay

The Civil Rehabilitation Law provides that a stay of proceedings starts at the commencement of the civil rehabilitation procedure. Before the commencement order, the court - on motion by interested parties or on its own motion for cause - may order a stay of the enforcement, provisional attachment and/or litigation against the debtor. The court - on motion by interested parties or on its own motion - may order a comprehensive stay if the stay of a specific proceeding is considered to be insufficient to achieve the purpose of rehabilitation. In practice, a comprehensive stay order is rarely issued by the court. As a general rule, secured creditors may foreclose on their collateral outside the proceedings under the civil rehabilitation procedure.

Management

Under the civil rehabilitation procedure, the management of the debtor generally remains in place (debtor in possession). The debtor may retain the right to continue its business, unless the court appoints a trustee.

The debtor may also dispose of its assets, among other things, on consent of the court or of the supervisor, except in the case of a sale of inventory or commodities in the ordinary course of business. Further, the law allows the debtor to transfer all or a significant part of its business before the confirmation of the rehabilitation plan.

Business Transfer

Under the civil rehabilitation procedure, two options exist for the transfer of all or a significant part of the business of the debtor: one option is to transfer the business within the performance of the rehabilitation plan, the other is to transfer the business outside the rehabilitation plan with approval of the court. As the value of the business generally decreases rapidly after filing for civil rehabilitation, a debtor often opts for business transfer with court approval in the early stage of the procedure.

The requirements for business transfer under the law are as follows:

• Approval of the court - where the debtor wishes to transfer all or a significant part of its business, it must obtain court approval. The court must seek the opinion of known creditors and of the labour union, if a union formed by the majority of employees and other workers of the debtor exists; if such union does not exist, the court must seek the opinion of persons who represent the majority of the employees and other workers of the debtor under rehabilitation. The court may approve the business transfer only if the transfer of all or a significant part of the business is necessary for the rehabilitation of the debtor's business. In practice at the Tokyo District Court, the debtor generally needs to hold a meeting with creditors to explain the details of the business transfer and hear the opinion of creditors before requesting court approval, as the court takes the creditors' opinion into account and the cooperation of the creditors is indispensable for a smooth business transfer.
  
  
• Approval by resolution of the shareholders' meeting or court approval in lieu thereof - if the debtor is a joint stock corporation, approval by special resolution of the shareholders' meeting is required under the Company Act for the transfer of all or a significant part of the business. However, under the civil rehabilitation procedure, the court may approve the business transfer instead of the shareholders' meeting. The court may approve the transfer only if the transfer of all or a significant part of the business is necessary for the continuation of operations of the debtor's business.
  
  
• Treatment of secured creditors - assets included in the transferred business are often provided as collateral for secured creditors. As secured creditors may foreclose on their collateral outside the civil rehabilitation procedure, it is necessary to agree with secured creditors on the treatment of the collateral on transferred assets when the debtor transfers its business. The debtor and the secured creditors usually agree that, in exchange for the payment by the debtor of a monetary amount equivalent to the value of the collateral on the assets, the secured creditors will waive their collateral on the assets.

The statutory redemption procedure established by the law allows the debtor to redeem the collateral by paying its fair market value to the secured creditors on approval of the court, where these assets are indispensable for the continuation of the debtor's operations and represent exceptions to foreclosure rights. If the debtor and the secured creditors cannot reach an agreement, the debtor may seek court approval for statutory redemption. As a matter of practice, statutory redemption is rarely used, as the cooperation of secured creditors is essential for the debtor to proceed with the civil rehabilitation procedure and the debtor generally does not wish to go against secured creditors by seeking statutory redemption.

Creditors and Claims

Claims are classified as follows:

• claims attributable to common benefits (eg, actual and necessary costs, as well as expenses such as post-commencement wages, salaries and debts incurred in the ordinary course of business);
  
  
• senior unsecured claims (eg, taxes, wages or salaries incurred before the commencement of the procedure);
  
  
• post-commencement claims; and
  
  
• unsecured claims.

Unsecured creditors must file proof of claims by a deadline set in the commencement order, which is usually one to two months of the date of the commencement order. Unsecured claims may be subject to a pro rata reduction under the rehabilitation plan, to the extent that the debtor has insufficient funds to satisfy these claims. Generally, claims attributable to common benefits and senior claims are paid in full intermittently outside the rehabilitation plan.

As a general rule, secured creditors may exercise their foreclosure rights on the collateral outside the procedure. Secured claims may be treated as unsecured only to the extent of the undersecured part of the claims.

Rehabilitation Plan

The debtor (or the trustee) must submit a rehabilitation plan to the court within a designated period (typically, three to four months of the commencement order). A creditor may also file a plan within this period.

A civil rehabilitation plan must establish the terms and conditions of the changes affecting all or part of the creditors' rights; these changes must affect creditors equally. In practice, unsecured claims will be reduced on a pro rata basis under the rehabilitation plan. If an obligation exists under the rehabilitation plan or if the obligation deadline is postponed, the deadline shall be within 10 years of the date of confirmation of the civil rehabilitation plan.

The civil rehabilitation plan must be approved by more than half of the attending or voting rehabilitation creditors holding at least half of the total rehabilitation credits. As secured creditors can exercise their rights against the collateral outside the procedure, they are entitled to vote only to the extent of the unsecured part of their claims.

Shareholders of the debtor company cannot vote under the law. It is possible to reduce or cancel shareholders' interests under the provisions of the civil rehabilitation plan if the debtor is insolvent at the time of commencement of the procedure. In practice, shareholders' interests are generally reduced considerably; in many cases shareholders' interests (the capital of a debtor) have been reduced by 100% and new money has been invested.

The civil rehabilitation plan is confirmed two weeks after the court has approved the plan and notified it publicly. The supervisor oversees the debtor for three years to ensure that the plan is implemented. A standard civil rehabilitation procedure at the Tokyo District Court - from the filing of the procedure to the confirmation of the civil rehabilitation plan - lasts six months.

The debtor must implement the rehabilitation plan quickly after the confirmation of the plan by the court. If the debtor fails to meet its payment obligations under the rehabilitation plan, the rehabilitation creditors may carry out compulsory execution. The court may cancel the rehabilitation plan if (i) a petition is filed by either a creditor or creditors holding rights amounting to at least one-tenth of the amount of rights as evaluated under the rehabilitation plan (excluding those that have been performed), and (ii) all or part of the rights in question have not been performed by the deadline for performance of the rehabilitation credits. The court must abandon the rehabilitation procedure when it becomes obvious that the debtor cannot perform the permitted rehabilitation plan. In such case the court may declare the debtor's bankruptcy on its own motion.

For further information on this topic please contact Rika Sato or Sanae Nagata at Asahi Koma Law Offices by telephone (+81 35219 0003) or by fax (+81 35219 0004) or by email (rks@alo.jp or san@alo.jp).