Japan - Insolvency Law and Procedures

Introduction

In view of recent events concerning a major Japanese carrier and the continuing uncertainties in the shipping markets, Members may wish to have some knowledge of the background to Japanese insolvency procedures and in particular how any claims against a Japanese entity which goes into insolvency might be secured.

In that regard the Managers have received the following information. It is intended as a general guide only and Members should take detailed advice from Japanese and other lawyers as appropriate if they have any potential claims impacted by these procedures. They should also contact the Managers.

Overview

There are two main types of insolvency procedure in Japan, liquidation and reorganisation.

In liquidation, bankruptcy law and procedure are applied with a trustee winding up the assets of the debtor and paying a dividend to its creditor proportionally.

The corporate reorganisation procedure dates from the 1950’s and is based on the US Chapter 11 model. It is only available to companies limited by shares and is designed primarily for the rehabilitation of large companies. It is therefore not applicable to individuals.

2002 Amendment and Abolition of the Territoriality Rule

Prior to amendment in 2002 the corporate reorganisation procedure had a unique provision termed the “Territoriality Rule” whereby the restructuring procedure only applied to a company’s assets residing in Japan, leaving assets in foreign jurisdictions beyond the restructuring process and thus exposed to attachment or arrest.

The law for corporate reorganisation procedure was substantially amended in 2002 and it is generally believed – though has not been tested - that this amendment abolished the Territoriality Rule, giving the administrator rights over the assets of the debtor irrespective of location. If correct, mortgagees or lien holders as well as ordinary creditors are prevented from arresting any ship or other asset of the debtor anywhere in the world once the corporate rehabilitation process is ordered by the Japanese bankruptcy court.

However, it may still be arguable that a creditor (including a mortgagee or lien holder) is only prohibited from arresting a debtor’s ship outside Japan after the commencement of corporate reorganisation procedures in Japan if the debtor has also taken some special protective action in a foreign jurisdiction, such as Chapter 15 proceedings in the US (recognition of foreign proceedings). There appears to be some countries - China is considered to be one - whose legal system does not apparently recognises the Japanese reorganisation procedures and in those countries it may still be possible for a creditor to arrest or attach assets of the debtor. It is recommended that before any action is taken against a debtor’s assets in a jurisdiction outside Japan advice is sought from a local lawyer in that country.

The amendment also saw the introduction of the Debtor in Possession (“DIP”) system. Previously the company’s management had lost the power to continue the business and dispose of its assets, which was instead vested in the court appointed administrators. By contrast in the DIP procedure the administrator is chosen from the debtor company’s management and they can continue to manage the company through the corporate reorganisation procedure, again with obvious parallels to the US Chapter 11 system.

Charterparties and Japanese Corporate Reorganisation Proceedings

Under corporate reorganisation law an administrator of the debtor is given an unspecified period in which to choose whether to continue (“assume”) a charterparty or reject it.

Until the charterparty is assumed or rejected the debtor is required to continue to make contractual payments i.e. hire. To the extent these amounts are not paid, they are deemed to be “administrative claims” and as such have the highest priority in terms of payment from the debtor’s estate. Thus an owner should continue to be paid his charter hire earned until the charter is assumed or rejected by the debtor (i.e. charterer).

If in breach of this obligation the debtor/charterer fails to pay hire, there might, depending on the law of the charterparty, be a breach of charter giving rise to a right of cancellation and a claim for damages for the balance of the charter period (typically damages measured at the difference between the c/p rate and the market rate). A notice of cancellation for non-payment of charter hire can be served on the administrator. It is thought likely that the hire accrued until the cancellation will be an administrative claim, whereas any damages claim will be an ordinary unsecured claim and therefore will not have priority over other creditors’ claims.

If the administrator “assumes” the charterparty all defaults (i.e. the non-payment of hire) arising prior to the commencement of reorganisation proceedings must to be “cured” (paid). Should that hire not be paid it is considered that the resulting claim would be given administrative status. Similarly any hire which is not paid after the charterparty is assumed will also be considered as an administrative claim.

If however, following the administrator’s assumption of the charterparty, the hire is unpaid and the owner then cancels the charterparty, whilst the accrued hire may be considered as an administrative claim, any damages the owner may have for the balance of the charter period is likely to be considered as an unsecured claim.

Finally, where the administrator decides to “reject” the charter and ceases payment of hire, such damages will be treated as unsecured.

It is reiterated that the above is intended as a general guide only. Members should seek detailed advice from Japanese lawyers and contact the Managers for further assistance if they believe they might have potential claims affected by these issues.