The European Lawyer

Japan Banking/Finance

11 Mar 2010

International Acquisition Finance - Japan

Editors: Nagashima Ohno & Tsunematsu - Ryo Okubo

1. MARKET
1.1 Early period
In Japan, the history of acquisition finance is short with the first transaction occurring in 1998. In the first deal, the total deal volume of 3.8 billion yen (approximately 36.8 million USD) consisted of 1.9 billion yen of senior loans, 0.8 billion yen of subordinated corporate bonds and 1.1 billion yen of equity. The financial sponsor was JAFCO, a domestic venture capital firm, and senior lenders were a domestic bank and a domestic insurance company. The acquired company was ICS International Culture and Education Center, a domestic company providing assistance services with respect to overseas study. Following this first deal, however, acquisition finance stayed a niche market until 2003. In this early period, the players were limited.

1.2 Growth period
In 2003, the acquisition finance market suddenly entered the growth period and started to expand in every aspect.

1.2.1 Expansion in number and volume
The number of transactions per year first exceeded ten in 2003 and has continued to increase in following years. 2003 also marked by far the largest deal at that time by volume of transaction. Ripplewood, a U.S. private equity firm, acquired Japan Telecom, a domestic telecommunications company, with a deal volume of 260 billion yen (approximately 2.5 billion USD). The senior loan, which exceeded 200 billion yen, was syndicated by leading arrangers consisting of three major domestic banks and eight foreign banks. In 2004, three more acquisition finance transactions with deal volumes of over 100 billion yen were completed. The largest of the three was acquisition of DDI Pocket, a domestic mobile telephone company, by The Carlyle Group, a U.S. private equity firm. For this deal, a group of major domestic banks and foreign banks arranged the finance. In 2006, SoftBank, a domestic IT company, acquired Vodafone, Co. Ltd, a domestic mobile phone company, which was a domestic subsidiary of Vodafone Group PLC, with a deal volume of 1.1 trillion yen (approximately US$10 billion).

1.2.2 Expansion in variety of deals
In addition to the number and volume, acquisition finance transactions started to vary in this period.
Overall, management buyout transactions (MBOs) increased. For example, in 2005, the management of World, a domestic clothing company, completed a 200 billion yen MBO without involvement of any financial sponsor. In recent years, the primary purpose of these MBO transactions is 100% privatisation as a preemptive defensive measure against possible hostile takeovers.

Secondary leveraged buyout transactions and joint deals also appeared. An example of the former is the 2004 acquisition by SoftBank of Japan Telecom. An example of the latter is the 2006 joint acquisition by Advantage Partners, a domestic private equity firm, and Bain Capital, a U.S. private equity firm of MEI/Conlux, a domestic company.

As the number, volume and variety of acquisition finance deals expands, more players have entered the market.
 
1.3 After the global credit crunch
The Japanese acquisition finance market was also affected by the global credit crunch which originated in the U.S. in 2007. While there have been a few large deals such as the acquisition of Arysta Corporation, an agrichemical company headquartered in Japan, by Permira, a U.K. private equity firm, the market has been slow and some acquisition deals have failed to close due to lack of financing.

Albeit the currently slow market, since more domestic banks become interested in acquisition financing due to its high profitability and more U.S. and European commercial banks and investment banks become aware of the growth of Japanese acquisition finance market, it is expected that the market will continue to grow.

2. DOCUMENTATION
The applicable law is almost always Japanese law. The controlling language is typically Japanese, but English is used when most of the lenders are foreign banks. Forms of finance documents have not been standardised and vary bank by bank. Still, they share similar language because many of the forms used by Japanese banks are originally derived from the model syndicated loan agreement published by the Japan Syndication and Loan-trading Association (JSLA). LMA documents are not used in Japan.

3. ACQUISITION/FINANCING STRUCTURES
3.1 Typical structure
The typical acquisition structure is a stock transfer. A new joint stock company (kabushiki kaisha) is usually formed as the acquiring vehicle (“Newco”), which becomes the borrower of the debts as well as receives equity investment. Newco acquires the shares of the target company (“Target”) with the fund financed by way of equity and debt. Following the purchase of the controlling shares of Target, typically a post-acquisition merger between Newco and Target follows to push down the debt to Target where cash flow is generated. In occasional cases where such a post-acquisition merger is not preferred because of a tax issue or difficulty in continuing approvals and permits, Target becomes a guarantor or joint borrower of the debt.

Newco is often financed through senior loans and equity investment. Especially in larger deals, the addition of mezzanine financing is becoming more common.

Senior loans usually consist of Term Loan A and Term Loan B and a revolver. Term Loan A is fully amortised and Term Loan B is paid at maturity. Term Loan A and Term Loan B are used to finance closing of the acquisition and refinancing. The revolver is used to finance working capital.  The tenor is typically 5 to 7 years. Financial convents typically include leverage ratio, debt service coverage ratio, interest coverage ratio, minimum net worth, maximum capex, minimum EBITDA and so on. A slightly eccentric trait of the Japanese syndication market is that typically investors participate in all tranches on a pro rata basis, although this phenomenon may change in future. Credit rating for acquisition finance loans by rating agencies is not common yet in Japan.

Mezzanine financing is provided by way of non-voting preferred shares, subordinated loans or subordinated bonds. A high-yield debt market has not been developed yet in Japan.

Japan has specific restrictions on the timing of entering into loan agreements. The Law Concerning Certain Commitment-line Agreements exempts facility fees from being counted towards the maximum interest rate permitted under Japanese law on the condition that the borrower falls under certain categories of companies. One such category typically used is companies whose paid-in capital is 300 million yen or more. In a typical acquisition financing scheme, equity investors do not inject equity into Newco until about three days before the closing. Accordingly, Newco has to wait entering into the loan agreements until the equity injection to enjoy the exemption under the commitment-line agreements law.

Senior loans and mezzanine loans are secured by a security package after Target becomes wholly-owned by Newco to avoid the issues surrounding the fiduciary duty of directors of Target (see Paragraph 11).

3.2 Alternative acquisition structures
3.2.1 Asset transfer
One advantage an asset deal has over a stock deal is that Newco basically can be released from Target’s hidden liabilities. However, as in other jurisdictions, an asset deal is a more difficult process. For example, Target needs to obtain the consent of the counterparty to each of its contracts which are transferred to Newco. These contracts include employee agreements, and it is often difficult to obtain the consent of all key employees. In addition, Target needs to separately transfer each asset to Newco and perfect each of such transfers, which may become very time consuming and costly. Licenses and permits usually need to be re-acquired by Newco. Accordingly, asset transfer is rarely used to acquire a controlling stake in Target.

3.2.2 Merger
Traditionally, cash-out mergers and triangular mergers were restricted under Japanese law. In May 2007, however, the Company Law made both cash-out and triangular mergers generally available. While their introduction cleared the path to alternative acquisition schemes, they are rarely used yet for acquisitions because mergers usually need more time to complete and cash-out mergers are not treated as tax-favourable mergers (tekikaku gappei) which allows for succession of loss carried forward.

4. REGULATED TARGETS
4.1 Business law
Financial institutions such as banks, insurance companies and asset management companies and infrastructure related companies such as broadcasting companies and electricity companies are heavily regulated in Japan. Many of the laws which regulate these businesses often require prior approval from, or advance notice to, the regulator in case of a merger or other type of acquisitions.

4.2 FX law
In addition, the Foreign Exchange and Foreign Trade Law requires a foreign acquirer of shares in a Japanese company whose business relates to national security, public order, public security and certain protected businesses (such as agriculture, petroleum, leather, aviation and marine transportation) to obtain advance approval from the government. There had been no example of disapproval under this law until 2008, when The Children’s Investment Fund (TCI), a London based hedge fund, was ordered to refrain from acquiring up to a 20% stake of J-Power, a domestic electricity company which operates power plants, including nuclear power plants, because TCI’s shareholding may affect the stable provision of electricity and nuclear power policy in Japan and, thereby, potentially endanger the public order.

5. LISTED TARGETS
When Target is a company which has disclosure obligation under the Financial Instruments and Exchange Law (“FIEL”), the securities law of Japan, and the acquirer is going to purchase 33.33% (one-third) or more of the shares of Target outside the securities market, barring certain exemptions, Newco is required by the FIEL to make a tender offer for Target in accordance with the tender offer rules under the FIEL. As listed companies have disclosure obligation under the FIEL, Newco must make a tender offer when Newco intends to purchase controlling stake in a listed company from one or more particular sellers.

In case a tender offer is made, acquisition finance structure is also affected. The typical structure is that Newco first receives a bridge loan to finance closing of the tender offer and squeezing-out after the closing of the tender offer. The bridge loan is secured with the shares of Target acquired by Newco and the Newco shares held by the financial sponsor. A commitment letter with term sheets attached is signed by each bridge loan lender and equity investor prior to the commencement of the tender offer. The tender offer bidder is required to attach to the Tender Offer Statement financing certificates issued by lenders and investment certificates issued by equity investors to support the existence of funds to close the tender offer. Once squeezing-out is completed and Target becomes wholly-owned by Newco, the bridge loan is replaced by the permanent loan, which is secured with the assets of Target. The permanent loan finances the repayment of the bridge loan, refinancing of Target’s existing loans and working capital.

6. MEZZANINE DEBT AND INTERCREDITOR ARRANGEMENTS
6.1 Mezzanine market in Japan
The mezzanine finance market is still in its initial growth period in Japan, and many deals consist of only senior loans and equity investment. However, mezzanine financing is becoming more popular, especially in larger deals. The main players in the mezzanine market are domestic mezzanine funds, banks, insurance companies and some leasing companies.

6.2 Typical structure
Most typical mezzanine financing is provided as preferred shares, but subordinated loans or subordinated bonds are also used. High yield bonds have not been used in Japan yet, but the high yield bond market might emerge as the number and volume of acquisition financing deals increase.

6.2.1 Preferred shares
The terms of preferred shares must be provided in the articles of incorporation of the issuing company and the issuance and detailed terms of preferred shares must be approved at a meeting of the board of directors. Preferred shares used for acquisition financing are usually non-voting, cumulative and non-participating because the intention of mezzanine investor is to secure the agreed spread.

Since dividends to shareholders are paid out after the company repays creditors of the company, the mezzanine investor as a preferred shareholder is structurally subordinated to the senior lender. Still, an intra-investor agreement is sometime entered into between the senior lender and the mezzanine investor in order to entitle the senior lender to assert direct contractual rights against the mezzanine investor. In addition, a shareholder agreement is sometimes entered into between the mezzanine investor and the sponsor in order to provide for the mezzanine investor’s tag along right, the sponsor’s drag along right, and other arrangements.

6.2.2 Subordinated loans/bonds
In the case of subordinated loans or subordinated bonds, one way to achieve subordination is through an intercreditor agreement between the senior lender and mezzanine lender. This so-called contractual subordination is valid only between the senior lender and mezzanine lender and cannot be claimed against third parties such as general creditors and the bankruptcy trustee of the borrower.

Another way to achieve subordination which is popularly used is to provide in the mezzanine document that the mezzanine loan or bond is suspended upon the occurrence of a trigger event such as bankruptcy of the borrower.  The mezzanine loan is typically provided as subordinated only to the senior loan. This so-called contractual absolute subordination can be claimed against the bankruptcy trustee of the borrower. However, since this contractual subordination provides subordination only after a trigger event occurs, an intercreditor agreement is needed anyway to provide subordination during the time when there is no trigger event.

As a statutory method to achieve subordination at the time of the borrower’s failure, the amendments to the Bankruptcy Law, the Corporate Reorganisation Law and the Corporate Rehabilitation Law, which became effective in 2005, created what can be called as absolute statutory subordination. However, this method has been rarely used for mezzanine debt so far because it inevitably makes the mezzanine lender subordinated even to general creditors.

Setting up a holding company above Target to become the borrower of the mezzanine loan can be used as another method to achieve structural subordination, but such structure is rarely used in Japan.

7. EQUITY KICKERS
Equity kickers have been commonly provided to mezzanine investors since a couple of years ago. The typical technique is use of warrant. In case the target is a non-listed company, as the shares of the target do not have liquidity, mezzanine investors need to demand tag along rights against sponsors who own the common shares of the target in order to secure an exit of such warrants.

8. SECURITY
8.1 Type of assets included in the security package
8.1.1 General
Once the target becomes a wholly-owned subsidiary of the acquisition vehicle, it is a common practice that all, or substantially all, of the assets of Target and its wholly-owned subsidiaries (the “credit parties”) are offered to lenders as security and the security interest is perfected. Such security package is beneficial to lenders in order to secure financing as well as to indirectly monitor the management of the company. Typically excluded from such security package are assets for which creation of a security interest or perfection is impossible or too complex under the law or does not justify the relevant costs (e.g., low value assets and foreign assets).

A grant of one security interest over all of a borrower’s assets is called corporate collateral (kigyo-tanpo-ken) in Japan, but the use of corporate collateral in an acquisition finance transaction is not common. One reason is that the use of corporate collateral is limited by statute only to a joint stock company (kabushiki kaisha) and only to secure the corporate bonds. Another weakness of corporate collateral is that corporate collateral as general security is subordinated to other types of securities as specific security. Accordingly, a lender who has corporate collateral cannot assert priority over a creditor who subsequently obtains a security interest over particular assets, which makes corporate collateral inappropriate for the purpose of security for acquisition finance.

Due to the foregoing weakness of corporate collateral, an acquisition finance lender in Japan usually creates security interest over each asset of Target and its wholly-owned subsidiaries and perfects such security interest. As opposed to use of floating charges in other jurisdictions, this process incurs extra time and costs in completing the creation of a security interest and the perfection of such security interest.

8.1.2 Stock
The lenders typically creates a pledge (shichi-ken) over (i) the shares of Newco owned by the financial sponsor, (ii) the shares of Target owned by Newco and (iii) the shares of Target’s direct and indirect wholly-owned subsidiaries owned by Target and its direct and indirect wholly-owned subsidiaries. Shares of partially-owned subsidiaries such as joint ventures are often excluded because the shareholders agreement usually provides that creating a pledge over the shares requires the consent of the other shareholders. Shares of small foreign subsidiaries are also sometimes excluded because of the extra cost and time required to accommodate local law.

When the articles of incorporation of the issuing company provide that stock certificates are to be issued, execution of a pledge agreement and delivery of the stock certificates to the pledgee is required to create the pledge and continuous possession of stock certificates by the pledgee is required to perfect the pledge. Usually, the security agent receives delivery of the stock certificates and keeps them as proxy for all the pledgees. When the articles of incorporation of the issuing company do not provide that stock certificates are to be issued, only execution of a pledge agreement is sufficient to create the pledge and simply recording the pledge in the share ledger is all that is required to perfect the pledge against third parties. A new law promuglated in 2004 to streamline settlements of stock transactions will abolish stock certificates of listed companies effective as early as January 2009. After that, creating a pledge over listed shares will take additional procedures involving account management institutions.

8.1.3 Real Estate
Lenders typically create mortgages (teitou-ken) over the real estate assets owned by the credit parties. Foreign real estate assets are sometimes excluded because of the extra cost and time required to accommodate local law.

Under a mortgage agreement, the mortgagor provides representations and warranties concerning the real estate assets. For example, the mortgagor represents and warrants the mortgagor’s ownership, nonexistence of security interests or other types of encumbrances to a third party, nonexistence of border dispute and nonexistence of soil contamination or water pollution. In addition, the mortgagor usually provides certain covenants such as future cooperation to the security agent for perfection, enforcement and addition of new mortgagees. The mortgage agreement is usually drafted to cover the proceeds from the real estate assets. For example, the mortgage agreement typically creates pledge over any future claim of fire insurance proceeds in connection with the real estate assets.
Only execution of a mortgage agreement is sufficient to create a mortgage, and registration of the mortgage is required to perfect the mortgage against third parties.

8.1.4 Receivables
Receivables are included in the security package by use of a pledge (shichi-ken) or by creating a security interest by way of assignment (jouto tanpo).

For a pledge, only execution of a pledge agreement is generally sufficient to create the pledge. For an assignment, only execution of an assignment agreement is sufficient to create the security interest.
There are three ways to perfect either the pledge or assignment: (i) to send a notice with a notarised date (kakutei hizuke) to the third party debtor, (ii) to obtain consent with a notarised date (kakutei hizuke) from the third party debtor, or (iii) to register the pledge or assignment with the competent legal affairs bureau.

If the third party debtor is located in a foreign country, it is recommended that perfection is made both in Japan and in the foreign country, because it is possible that the local law in the foreign country requires the security holder to comply with the perfection process in the country to enforce the security interest in that country.

There are two categories of receivables on which valid creation of a security interest has been at issue in Japan. One such category is future receivables. Whether a credit party can effectively create a pledge over or assign future receivables had been a long standing question in Japan. However, a series of Supreme Court decisions in 1999 and following years cleared the way to create a security interest over receivables by way of assignment. In these judgments, the Supreme Court declared that creating a security interest on future receivables by way of assignment is valid as long as the scope of receivables to be assigned is clearly specified in the security agreement by specifying the period during which the future receivables will arise, the name of creditor, the name of debtor, the transaction to give rise to the future receivables and so on. Another category of receivables on which valid creation of security interest has been at issue is the right to an ordinary savings account. While it is clear that a credit party can validly create a pledge over its right to a fixed deposit account opened at a bank, it has been questionable whether a credit party can validly create a pledge over its right to an ordinary savings account opened at a bank.

8.1.5 Movable Assets
Movable assets are typically included in the security package by creating a security interest by way of assignment (jouto tanpo).

To create a security interest by way of assignment, only execution of an assignment agreement is sufficient. In order to perfect the assignment against third parties, the borrower must deliver possession of the movable assets to the security interest holder, but the borrower can do so by declaring to keep possession for the security interest holder going forward (senyu kaitei). As an alternative, a 2005 amendment to a special law enabled the security interest holder to perfect the assignment by registering the transfer with the competent legal affairs bureau. Under the special law, the lenders may perfect a security interest by way of assignment over not only particular assets but also an ensemble of movable assets including future ones, such as inventory in a particular storehouse, provided that the scope of the movable assets subject to the security is clearly specified.

In the case of movable assets, perfection is not sufficient to block a bona fide third party from obtaining the right to the movable asset from the borrower by statute (sokuji shutoku). In order to avoid this statutory effect, the security interest holder is recommended to have a plate indicating the creation of the security interest attached to the movable assets, thus turning a bona fide third party to a mala fide third party.

8.1.6 Intellectual property
Intellectual properties are included in the security package by use of a pledge (shichi-ken) or by creating a security interest by way of assignment (jouto tanpo).

For trademarks and patents, execution of a pledge or assignment agreement and registration of such pledge or assignment is required to create the security interest. On the other hand, for copyrights, simple execution of a pledge or assignment agreement is required to create the security interest and registration is only required for perfection against third parties.

8.2 Security Agent
Since Japanese law had not been clear on whether security trusts are permitted until recently, security trusts had not been used as in the U.K. or the U.S. where a security agent holds and administers the security package for all the lenders. Instead, in Japan, each lender has had a separate security interest or shares with all the other lenders a singular security interest. In either case, a security agent is appointed but serves only as a proxy of all the lenders. This makes the process for syndication or subsequent transfer more difficult than in a case where a security trust is used. In 2008, however, the amended Trust Law first confirmed the validity of security trusts under Japanese law. It is expected that security trusts will become more common, but they have not been widely used yet.

9. CORPORATE THIN CAPITALISATION RULES
Japanese tax law adopted thin capitalisation rules in 1992. The current rules are applied only to cross border financing. If (i) the gross amount of interest-bearing debts owed by Newco exceeds three times the amount of capital of Newco and (ii) the gross amount of debts owed by Newco to its foreign parent and foreign lenders exceeds three times the amount of capital of Newco multiplied by the ownership percentage of the foreign parent, then the portion of interests paid to the foregoing parent and foreign lenders which correspond to the excess amount is undeductable.

10. FINANCIAL ASSISTANCE
Unlike in EU jurisdictions, there is no statutory financial assistance restriction in Japan. Therefore, the acquisition facility is paid with the cash flows generated by Target, usually by pushing down the debt to Target through a post acquisition merger with Newco. However, providing loans, guarantees, securities or any other financial assistance to the majority shareholder at the expense of the minority shareholders will contradict the general fiduciary duty of directors (see Paragraph 11). Accordingly, Target cannot provide any financial assistance for the acquisition to Newco until Target becomes the wholly-owned subsidiary of Newco.

11. DIRECTORS' LIABILITY
Each director owes to the company (i) the duty of due care and diligence (zenkan chui gimu) derived from the general obligation of a delegated person under the Civil Code and (ii) a fiduciary duty (chujitsu gimu) under the Company Law. Some scholars believe that the former duty is similar to the duty of care in the U.S. and the latter duty is similar to the duty of loyalty in the U.S. On the other hand, Japanese courts have considered that the latter duty is the same as the former duty and is provided in the Company Code only to remind and confirm the existence of the former duty, while in any event the courts consider that these duties are similar to the duty of care and the duty of loyalty in the U.S.
Such duties of directors (going forward, just referred to as “fiduciary duty”) must be fulfilled for the benefit of the company, which is defined by the Company Law as the benefit of all shareholders. Therefore, the fiduciary duty of directors leads to the duty of impartial treatment of all shareholders.

Since providing loans, guarantees, securities or any other financial assistance to the majority shareholder is preferential to the majority shareholder and detrimental to the minority shareholders, it would breach the fiduciary duty of directors. Due to this restriction, Target typically withholds providing any financial assistance to Newco until Target becomes the wholly owned subsidiary of Target, when the benefit of Target equals the benefit of the only shareholder, i.e., Newco.

In addition, in the context of MBOs, the directors must overcome an issue of conflict of interests. The fiduciary duty of directors includes restriction on conflicting transactions by the directors. Under the Company Law, when a director, on behalf of his/her own, intends to enter into a transaction with the company, the approval of the board of directors or shareholders is required, and even when such approval is obtained, the director who causes damage to the company due to the transaction is liable for the damage. If the company incurs damage is determined based on whether the transaction was necessary and at arm’s length. An MBO transaction inevitably includes a conflict of interests because the directors as management of the seller desire a higher purchase price while they as acquirer desire a lower purchase price.

To address this issue and other issues surrounding MBOs, the Corporate Value Study Group, a private study group within the Ministry of Economy, Trade and Industry, published the August 2007 “Report on Acquisitions by Management in Order to Increase Corporate Value and Secure Fair Process”. This report suggests measures (i) to provide shareholders with an opportunity to appropriately judge the fairness of the transaction (e.g. more disclosure of the reason and process of the MBO to the shareholders), (ii) to exclude arbitrary decisions of the directors (e.g. setting up a third party committee and acquisition of a fairness opinion from a third party evaluation institution) and (iii) to create a situation which secures the fairness of the purchase price (e.g. setting a lengthy tender offer period).

12. LENDERS' LIABILITY
Under Japanese terminology, a lenders’ liability in the broad sense means any liability of a financial institution in connection with its lending in the process of negotiation, closing, administration and collection. The lenders’ liability in the narrow sense means the liability of a financial institution due to its excessive control of the borrower. In Japan, there have been many court precedents about the former and a couple about the latter, but none of them discussed lenders’ liability in the context of acquisition finance. The obligation of the financial institution to close the deal when a MAC (a material adverse change) occurs may be included in the lenders’ liability in the broad sense, but that issue has yet to be litigated.

13. LEGAL OPINIONS
Legal opinions issued by the borrower’s Japanese law counsel are similar to those issued in the U.K. or the U.S. except they are subject to certain country specific limitations and qualifications. Those limitations and qualifications include, among other things: validity of the security interest over the ordinary savings account (see Paragraph 8.1.4 above), validity of the floating security interest (ne tanpo ken), which means a security interest the receivables secured by which are identified but not fixed, whether the scope of future receivables subject to the security package is sufficiently specified (see Paragraph 8.1.4 above), whether the scope of ensemble of movable assets subject to the security package is sufficiently specified (see Paragraph 8.1.5 above), availability of specific performance, validity of severability clauses, insolvency situations, statute of limitation, piercing the corporate veil, court procedure, application of general doctrine such as good faith doctrine, abuse of rights and public order and good moral doctrine. In addition, transaction specific carve-outs may be added.

14. POST-ACQUISITION RESTRUCTURINGS
14.1 Post-acquisition mergers
As we explained in Paragraph 3.1, typically, a post acquisition merger is implemented in order to push down the debt. The typical legal form of Newco (before the post-acquisition merger) and Target (after the post-acquisition merger) is a joint stock corporation (kabushiki kaisha).

14.2 Squeeze-outs
When Newco fails to acquire 100% of the shares of Target, which typically occurs in a tender offer process, Newco needs to undertake a slightly complicated process to squeeze out remaining minority shareholders to achieve 100% privatisation of Target.

The most popular method is to take advantage of a special class of stock with a complete redemption clause (zenbu shutoku joukou tsuki shurui kabushiki). Newco can acquire this special class of stock with a super-majority approval of a shareholders meeting (usually two-thirds) and deliver common stock with a different par value in exchange. As fraction shares can be cashed out in this exchange, Newco sets the par value of the new common shares large enough for all the remaining shareholders to be cashed out as fraction shareholders.

Regardless of the method of squeezing out, the legality of doing so when Newco has not obtained more than 90% of the shares in Target is not clear. A complete privatisation of Target by Newco is necessary to overcome issues relating to the directors’ liability and creation of a security interest over the assets of Target (see Paragraph 11).

15. DEBT RESTRUCTURING
15.1 Out-of-court debt restructuring
Under Japanese law, out-of-court debt restructuring is regarded as a settlement agreement among the parties involved. Accordingly, it is practically difficult when the deficit is very large and many lenders must waive their receivables by a substantial amount or when even repayment to general small creditors becomes difficult, because the consent of all relevant involved parties is required for such restructurings. Otherwise, the restructuring cannot be asserted against any third party who has not provided its consent to such restructuring.

15.2 In-court debt restructuring and bankruptcy
Japanese law provides four types of insolvency proceedings. Two of them, bankruptcy (hasan) and special liquidation (tokubetu seisan), aim to liquidate the company, and the other two, civil rehabilitation (minji saisei) and corporate reorganisation (kaisha kousei) aim to rehabilitate the company. As special liquidation is an exceptional proceeding used only by a joint stock company already in liquidation process, we summarize below only the other three proceedings.

15.2.1 Bankruptcy
In a bankruptcy proceeding, the debtor or creditors can file the application for commence-ment of the proceeding in the event of the debtor’s deficit or inability to pay. A bankruptcy trustee is appointed by the court and the authority to dispose of the assets and manage the business is transferred from the debtor to the bankruptcy trustee. All the creditors are automatically subject to the statutory bankruptcy process and are prohibited from enforcing their rights by themselves, provided that a valid and enforceable security interest entitles the secured creditor to enforce the security interest outside of the bankruptcy proceeding. Ultimately, all the assets of the debtor are disposed of and the general creditors receive equal distributions.

15.2.2 Civil rehabilitation
In a civil rehabilitation proceeding, the debtor or creditors may file an application for commencement of proceeding earlier than debtor’s deficit or inability to pay. The authority to dispose of the asset and manage the business stays with the debtor (i.e., debtor-in-possession) and a trustee is basically not appointed. Security interest holders are satisfied on a priority basis from the assets of the debtor subject to the security interest. However, the debtor may seek permission to extinguish the security interest over any assets indispensable to the continuation of business. In addition, the court may order a suspension of an auction initiated by a particular security interest holder. Changes to the rights of creditors such as waiver, debt-equity swap and extension of debt maturity date are made by the approval of the majority of creditors and the court.

15.2.3 Corporate reorganisation
Corporate reorganisation proceedings are available only to joint stock corporations (kabusihiki kaisha). In a corporate reorganisation proceeding, the debtor or creditors may file an application for commencement of a proceeding earlier than debtor’s deficit or inability to pay as in a civil rehabilitation proceeding. However, a trustee is appointed by the court and the authority to dispose of the assets and manage the business is transferred from the debtor to the trustee as in a bankruptcy proceeding. The most important characteristic of this proceeding in the context of acquisition finance is that enforcement of security interests outside the proceeding is prohibited and a security interest may be reduced or totally extinguished within the proceeding. Changes to the rights of creditors such as waiver, debt-equity swap and extension of the debt maturity date are made by the approval of the majority of creditors and the court.

15.3 Forum shopping
If the debtor is a company, the district court covering the address of the debtor’s primary business office has exclusive jurisdiction over the insolvency proceeding. There are a couple of exceptions to this rule. For example, in case of bankruptcy and civil rehabilitation, (i) if the number of creditors is 500 or more, the debtor or creditors can also file in the district court located in the same city as the high court which supervises the district court covering the address of the debtor’s primary business office and (ii) if the number of creditors is 1,000 or more, the debtor or creditor can also file in the Tokyo District Court or the Osaka District Court. In case the debtor is a foreign company, Japanese courts have jurisdiction over the insolvency proceeding of such foreign companies if it has an office (in case of bankruptcy, civil rehabilitation and corporate reorganisation) or assets (in case of bankruptcy and civil rehabilitation) within Japan.

16. ENFORCEMENT OF SECURITY
As the security agent in Japan is only a proxy of all lenders, each lender, as an independent security holder, has the statutory right to enforce their security. The security agreement therefore provides that each security holder cannot enforce the security interest without the consent of the majority lenders. The security agent must avoid conducting any collection or administration activities which require a license under the Servicer Law. Since such collection activities include enforcement, any enforcement should be made under the name of all security holders, not just that of the security agent.

The statutory method of enforcement is different between types of security interests. For example, in case of a mortgage over real estate assets, the statutory method of enforcement is in-court auction. However, the borrower and the security holder can agree to out-of-court enforcement methods in the security agreement such as private sale or forfeiture with settlement of the balance. On the other hand, in the case of a pledge, the Civil Law prohibits provisions in the pledge agreement of non-statutory enforcement methods such as forfeiture of the pledgor’s asset subject to the pledge. However, in case the pledge is created over receivables, the security holder may directly collect the receivable from the third party debtor as one of the statutory enforcement methods.