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Yuichiro Kigawa

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Bankruptcy and law

Yuichiro Kigawa
Professor of Bankruptcy Law, Faculty of Law, Chuo University

When debtors go bankrupt, concerned claimants all attempt to gain reconciliation from the debtor, but all interests must be coordinated in a fair manner. On the other hand, the debtor must be given a chance to start over and be allowed to rebuild their lives and businesses while limiting the benefit of the creditor. The field of bankruptcy law not only regulates the benefits of debtors and creditors, but it must also clarify how the claims of various contents should be dealt with. It is a difficult domain, quite tricky to teach. When I give lectures I make sure I provide enough supplementing and confirming of knowledge related to other legal fields. I am attentive to my students’ expressions as I teach this topic.

1. The field of bankruptcy law

There are two different ways to deal with bankruptcy. They are the so-called partition-type legal procedures with the aim of distributing existing assets among creditors, and the so-called rebuilding-type legal procedures where, not the assets, but the profits earned by managing those assets are distributed among the creditors in the future. In these procedures, the cause of bankruptcy and various differing contents of the rights must be dealt with fairly and evenly. Bankruptcy law is a field that researches on legal procedures that deals with rights fairly and evenly, and at the same time, realizes the recovery of debtors.

It cannot be simply said that if you understand law you can solve all conflicts between concerned parties and in society. In principle, if an agreement is reached between concerned parties, a succession to rights and duties is formed in line with that agreement. However, there are cases when it is extremely difficult to determine whether the succession to rights and duties in specific circumstances are the same as succession to rights and duties set by the existing laws or not. Nevertheless, in society, along with the development of the economy, new terms of legal relationships and legal relationships targeting new values always appear. Once you become bankrupt, all legal relationships or relations of right, including those kinds of rights, must be reconciled through bankruptcy procedures. Furthermore, bankruptcy proceedings cannot be put off until an interpretation is decided on. In that sense, the field of bankruptcy law can be said to be both an extremely exciting and difficult field.

2. Realization of rights and bankruptcy

For example, even if you had the right to demand one million yen, it means nothing if you cannot actually receive the one million yen, even if it is recognized as a right. There, for example, in a case where the debtor won’t pay the other party the one million yen, the value of one million yen can be forcefully seized from the debtor and handed over to the creditors through legal procedures. Those legal fees are to be paid by the debtor, so a profit of one million yen can be secured. However, if the debtor is in a state of bankruptcy, the one million yen and legal fees cannot be taken from the debtor’s assets. In that sense, it is necessary to have rules to distribute assets from a debtor in a state of bankruptcy, but what is more important is to secure the one million yen as much as possible through mechanisms put in place to guard against going into a state of bankruptcy. At first glance, this may appear as a problem of a mechanism for individuals and companies to secure profits and falling under the category of business administration or economics, however in reality, if the determining of rights is the role of law, it must be said that preparing mechanisms that secure profits that correspond to those rights is also the role of law. This is an issue for areas surrounding the field of bankruptcy law, however the debate concerning legal mechanisms to legally avoid bankruptcy becomes equally important.

3. A legal system to avoid bankruptcy

However, when the management of a company gradually begins to worsen, the Japanese legal system does not adequately consider bankruptcy avoidance.

The major stakeholders in a company, in addition to the shareholders, who are substantial owners of that company, are the creditors who deal with the company. If the company goes bankrupt, not only do the creditors dealing with the company face a loss, but the profits for shareholders essentially become zero. That is to say, because the creditors dealing with the company take preference over the dividend rights of claim of the shareholders, at the point of time when positive property becomes lower than negative property, such as debts, in the state of the company’s assets (this is called insolvency in the legal world), dividends to be paid to the shareholders disappear after repayments to the creditors have been made. However, under existing company laws, even after insolvency and the value of shareholder rights becomes zero, the management decision directly connected to whether the company goes into bankruptcy or not remains with the shareholders (executives). As a result, despite shareholders no longer having any profit, if the executives make the decision to keep the business running, insolvency progresses further, and there is the possibility that creditor rights are further infringed upon.

In this kind of case, in order for the creditors to realize their rights of receiving the one million yen, if the creditors themselves, who have stakes in the company, can control management of the company, it can be expected that insolvency progression can be prevented. However no such mechanism exists in existing company laws.

4. Creditor indifference toward insolvency

On the contrary, there is the problem that Japanese creditors are unconcerned about insolvency. There isn’t that much insolvency in large Japanese corporations, but the actual situation is, in small to medium-sized companies which make up most of the companies, the smaller the scale of the company, the more insolvency there is. Also, it has been pointed out that the equity ratio of Japanese companies is extremely low. This type of situation is very rare in developed nations. From a legal point of view, what I pay most attention to as a major cause of creditor indifference is our tax system. For example, In Japan, 100% of the credit amount that is subject to exemption under bankruptcy procedures and rebuilding procedures is waived without compensation and is taxed with the knowledge that it will be deducted from profits. Because the profit is extraordinarily high through the uncompensated waiving, there is no incentive for creditors to earn more satisfaction through exercising their rights. Furthermore, as a result of employing this legal system, expectations to gain satisfaction through realization of rights are low and the need to select a client whose rights seem to be able to be upheld disappears.

As long as that type of situation remains a domestic problem, possibility of coexistence and co-prosperity of companies through a give and take philosophy can be envisaged, but companies which set up headquarters in nations that don’t recognize 100% repayment, would, in no way, think of dealing with Japanese companies that have weak basic assets. Also, in Japan, even if bankruptcy procedures take place, on the assumption that almost all creditors do not participate in proceedings, abuses appear that creditor protection of due process of law in bankruptcy procedures being forced back through legal stipulations.

In order to recover incentives related to creditors exercising their rights, we can think of the method of greatly reducing the repayment rate. However, in doing so, small to medium-sized businesses will need to conduct detailed investigations of the state of assets of their trading partners. With this, they must be prepared to burden the costs, in turn having a negative impact on international competitiveness.

5. Duty of executives to avoid bankruptcy and prevent expanding insolvency

In order to deal with the unfortunate case of falling into bankruptcy, I believe development of laws is necessary to ensure appropriate action is taken by companies at the time.

First, when a company gradually nears insolvency, in order to protect the profits of investors including the shareholders, and in order to avoid entering a state of bankruptcy, bankruptcy avoidance procedures should be set up for the company to reschedule the management with the cooperation of a third party organization. The introduction of this kind of procedure can actually be seen in developed nations, and there it has been reported that, under the guidance of trustworthy legal organizations, low cost and speedy pre-rebuilding results are on the rise.

Second, when executives such as directors confirm the fact of insolvency, an obligation is imposed to immediately take rescheduling steps to resolve the insolvency or, when it is determined that it is impossible to resolve the current situation, to immediately declare rebuilding-type legal procedures (civil rehabilitation procedures or corporate rehabilitation procedures) or liquidation procedures (bankruptcy procedures or special liquidation). This obligation is called the so-called bankruptcy procedure declaration obligation. Actually, this obligation was stipulated in the form of the bankruptcy declaration obligation in the former Japanese Commercial Law, but when the rebuilding-type reconciliation procedures were enacted, it was erased in the 1938 revision through a legislative error. It can be said that the foundations of the fall in Japan's equity ratio were laid then. Whereas, in German and Australian law, where the roots to Japan's bankruptcy law lay, when the same reconciliation procedures were introduced, it was amended to an obligation to declare bankruptcy or reconciliation, and that has been retained to this day. If this type of legal system was restored, mounting insolvency that is created through a breach of obligations would become the individual responsibility of the executives. If the focus is put on profits from the realization of creditor rights, we can also think that it will lead to punitive measures in certain malicious cases. If that is the case, it will become possible to curb progression of insolvency, and the situation where dividend rates (or liquidation rates) are no more than a few percent when a company becomes bankrupt, as is the current situation, can be prevented, not only remarkably improving the possibility of rebuilding, but also leading to the strengthening of the international competitiveness of Japanese corporations.

6. Conclusion

To a student, when turning one's eyes toward the surrounding parts of bankruptcy law, the forecastability of the realization of rights rises, and this becomes a good opportunity to think about how bankruptcy can be avoided. Also, at first glance the bankruptcy law may appear to be a dull field lined with procedural stipulations, but to students who have studied hard in each field of civil law, it can be said that every piece of information is useful and it is a thoroughly enjoyable academic field.

Yuichiro Kigawa
Professor of Bankruptcy Law, Faculty of Law, Chuo University
Born in Chigasaki in1958. Graduated from the Faculty of Law, Chuo University in 1981. Doctor of Law. Head of the Correspondence Division, Faculty of Law, Chuo University since 2009. Major publications of his research include An Introduction to German Bankruptcy Law Research (sole author, 1999, Seibundoh), Law School Bankruptcy Law (coauthor, 2005, Yuhikaku).