Can My Small to Medium-Sized Japanese Business Be Saved? An Overview of Civil Rehabilitation (Minji Saisei) for SMEs in Japan

Japanese Attorney at Law - Bengoshi L.L.

• 10 min read

When a small to medium-sized enterprise (SME) in Japan faces severe financial distress, the prospect of closure can be daunting for its owners, employees, and creditors. However, Japanese law provides a robust framework for business reorganization known as Civil Rehabilitation (民事再生 - Minji Saisei). Unlike bankruptcy, which leads to liquidation, Civil Rehabilitation aims to allow a financially troubled but potentially viable business to restructure its debts, streamline operations, and continue as a going concern. This article provides an overview of the Civil Rehabilitation process for SMEs in Japan, from initial assessment to the implementation of a recovery plan.

When is Civil Rehabilitation a Viable Option for an SME?

The decision to pursue Civil Rehabilitation is a significant one and should be made after careful consideration and professional legal and financial advice.

1. Early Warning Signs and Timely Consultation:
SMEs often exhibit warning signs before a crisis hits: declining profitability, tightening cash flow, difficulty meeting supplier payments, or increasing reliance on short-term debt. Recognizing these signs early and seeking legal consultation promptly is crucial. Delay can erode the company's value and reduce the chances of successful rehabilitation.

2. The Core Viability Test: Path to Sustainable Operating Profit:
The fundamental question a lawyer and the SME's management must address is whether the business, despite its current difficulties, has a core operational viability. Can it, through restructuring and debt relief, return to generating sustainable operating profit (営業利益 - eigyō rieki)?

  • Identifying Root Causes: This involves a deep dive into the company's financials (often reviewing the last three years of financial statements - 決算書 - kessansho, trial balances - 試算表 - shisanhyō, and cash flow statements - 資金繰表 - shikingurihyō). Lawyers must be cautious of potential "window dressing" (粉飾決算 - funshoku kessan) and strive to understand the true financial picture.
  • Restructurable Problems: If losses are due to specific, addressable issues—such as underperforming divisions or stores (as in one case study involving a restaurant SME that overextended with new, unprofitable locations ), burdensome contracts, or temporary market disruptions—rehabilitation may be possible.
  • Lack of Fundamental Viability: If the core business model is obsolete, or if there's no realistic prospect of returning to profitability even with debt relief, then Civil Rehabilitation may not be appropriate, and bankruptcy might be the more realistic, albeit painful, alternative.

3. Management Commitment and Capability:
Successful rehabilitation requires strong, committed leadership willing to make difficult decisions, such as closing unprofitable units, reducing workforce if unavoidable, or even accepting changes in ownership or control if a sponsor is involved. The creditors' perception of the existing management's competence and integrity also plays a significant role in their willingness to support a rehabilitation plan.

4. Comparing with Alternatives:

  • Private Workout (私的再建 - Shiteki Saiken): An out-of-court restructuring negotiated directly with key creditors (usually financial institutions). This is less disruptive but requires the consent of all major creditors. If such negotiations have failed, or if the creditor base is too diverse and fragmented, Civil Rehabilitation becomes a more effective tool due to its ability to bind dissenting minority creditors to an approved plan.
  • Bankruptcy (破産 - Hasan): Leads to liquidation and cessation of the business. Civil Rehabilitation is chosen when there's a belief that the business as a going concern is worth more than its piecemeal liquidation value.

The Initial Steps: Preparing for a Civil Rehabilitation Filing

Once the decision to pursue Civil Rehabilitation is made, meticulous preparation is essential.

1. Strategic Timing and Preservation of Funds (資金の保全 - Shikin no Hozen):
The petition should be filed when the company still possesses sufficient funds to cover the significant upfront costs, including the court deposit (yonōkin - 予納金) for administrative expenses and the petitioning lawyer's fees, as well as essential operating expenses in the immediate post-filing period.

  • In one illustrative case, the filing was strategically timed to occur just after the company received a large collection of accounts receivable but before major month-end supplier payments were due.
  • Crucially, before filing, it's standard practice to move essential operating funds to a bank account with an institution to which the company owes no debt, or into the lawyer's client trust account. This is to prevent creditor banks from exercising a right of set-off against the company's deposits upon learning of the impending filing.

2. Maintaining Secrecy (秘密裏の準備 - Himitsu-ri no Junbi):
The preparation for a Civil Rehabilitation filing is almost always conducted in strict confidence. Premature disclosure can lead to:

  • Panic among suppliers, who might halt deliveries or demand cash on delivery.
  • Pre-emptive actions by creditors, such as attempts to seize assets.
  • Loss of employee and customer confidence.
    Typically, only a small circle of key individuals—such as the president, the chief financial officer or accounting manager, the company's lawyer, and possibly its external tax advisor—are involved in the pre-filing preparations.

3. Assembling the Petition Documents:
The petition for Civil Rehabilitation is a comprehensive set of documents submitted to the competent district court (often a specialized insolvency division, such as Civil Division 20 of the Tokyo District Court). Key documents generally include (as per the Civil Rehabilitation Rules, Arts. 12, 13, 14):

  • The formal petition (再生手続開始申立書 - saisei tetsuzuki kaishi mōshitate-sho).
  • Company's certificate of registered matters (commercial registration).
  • Articles of incorporation (定款 - teikan).
  • List of shareholders (株主名簿 - kabunushi meibo).
  • Detailed list of all creditors (債権者一覧表 - saikensha ichiranhyō).
  • Financial statements for at least the past three fiscal years.
  • Current cash flow statements and projections.
  • Company's employment rules and wage regulations (if applicable).
  • Resolutions of the board of directors authorizing the filing.
  • A petition for preservative measures (保全処分申立書 - hozen shobun mōshitate-sho) to protect the company's assets and stay debt payments.

In jurisdictions like Tokyo, it is common practice to provide a "Rehabilitation Case Contact Memo" (再生事件連絡メモ) and a draft of the petition to the court a few days before the formal filing. This allows the court to prepare for the case and facilitates the prompt issuance of crucial initial orders.

Key Features and Stages of the Court-Supervised Process

Once the petition is filed and the court deposit is paid, the formal Civil Rehabilitation process commences.

1. Immediate Court Orders:
Shortly after filing (often on the same day), the court typically issues:

  • Supervisor Appointment Order (監督命令 - Kantoku Meirei; Civil Rehabilitation Act, Art. 54): The court appoints a supervisor (kantoku i'in - 監督委員), usually an independent lawyer with insolvency experience. The supervisor's role is not to run the company but to oversee the debtor's management of its affairs and assets, and to ensure the process is fair to creditors. Certain actions by the debtor require the supervisor's consent.
  • Preservative Measures (保全処分 - Hozen Shobun; Art. 30): These measures are critical. They generally include:
    • A stay on payments of pre-petition debts.
    • Prohibitions on the debtor disposing of assets outside the ordinary course of business without court or supervisor approval.
    • A stay on enforcement actions (e.g., seizures) by individual creditors.

2. Managing Stakeholder Communications:

  • Employee Notification: One of the first post-filing tasks is to inform employees about the Civil Rehabilitation filing. It's crucial to explain that this is a reorganization process aimed at saving the business, not a liquidation like bankruptcy. Assurances about the payment of wages (which are generally treated as priority claims) are vital to maintain morale and operational continuity. If certain divisions are being closed and layoffs are unavoidable (as occurred in the restaurant SME case ), this difficult news must be communicated with sensitivity and clarity.
  • Creditor Notification and Information Meeting (債権者説明会 - Saikensha Setsumeikai): All creditors are formally notified of the filing, the supervisor appointment, and the preservative measures. The company typically hosts a creditors' information meeting within a few days of filing. At this meeting, the company's president and lawyers explain the reasons for the filing, the basics of the Civil Rehabilitation process, and the anticipated path forward. The court-appointed supervisor often attends this meeting. This is an important opportunity to manage creditor concerns and begin building support for the rehabilitation effort.

3. Business Operations Under Supervision (Debtor-in-Possession - DIP):
Japan's Civil Rehabilitation law is based on the Debtor-in-Possession (DIP) principle. This means that, in most cases, the existing management remains in control of the company's day-to-day operations and is responsible for developing the rehabilitation plan, albeit under the oversight of the court-appointed supervisor.

  • Securing Essential Supplies: Maintaining business operations requires ongoing relationships with suppliers. Pre-petition claims from suppliers are frozen. To induce them to continue supplying goods or services post-petition, payments for these new transactions are typically treated as "common benefit claims" (kyōeki saiken - 共益債権; Art. 119), which are paid in full and in preference to pre-petition rehabilitation claims. The debtor must often seek the supervisor's approval to designate specific post-petition supplier claims as common benefit claims (共益債権化の承認申請 - kyōeki-saiken-ka no shōnin shinsei; Art. 120) to ensure the continuity of critical supplies.

4. Formal Commencement Decision (開始決定 - Kaishi Kettei):
After an initial review and often after the creditors' information meeting, if the court finds that the requirements for Civil Rehabilitation are met (e.g., threat of insolvency, prospect of rehabilitation) and no grounds for dismissal exist, it will issue a formal "commencement decision," officially starting the rehabilitation proceedings.

5. Claims Process:

  • Claims Filing Period (債権届出期間 - Saiken Todokeide Kikan): The court sets a period during which creditors must file proofs of their pre-petition claims.
  • Debtor's Review and Statement of Approval/Rejection (債権認否 - Saiken Ninpi): The debtor reviews all filed claims and submits a statement to the court indicating which claims (and amounts) it accepts or disputes. Disputed claims may lead to a claims determination process.

6. Submission of Financial Reports and Draft Plan:
The debtor must prepare and submit to the court:

  • A property valuation report (財産評定 - zaisan hyōtei; Art. 124), which assesses the value of the company's assets as of the commencement decision date. This is crucial for the "liquidation value test."
  • A report detailing the circumstances that led to the rehabilitation filing and the progress of the business and assets since commencement (the "Article 125 Report").
  • A draft rehabilitation plan (再生計画案草案 - saisei keikaku-an sōan).

7. Developing and Submitting the Definitive Rehabilitation Plan (再生計画案 - Saisei Keikaku-an):
This is the heart of the Civil Rehabilitation process. The plan must detail:

  • Operational Restructuring: Measures to restore profitability (e.g., closing unprofitable units, cost-cutting, business model changes).
  • Treatment of Debts: How different classes of claims will be treated. This typically involves a significant "haircut" (reduction) on unsecured rehabilitation claims, with the reduced amount to be repaid over a period (often up to 10 years, though shorter periods are common for SMEs).
  • Funding Sources: How the plan payments will be funded (e.g., future operating profits, sale of non-core assets, capital injection from a sponsor).
  • Liquidation Value Test (清算価値保障原則 - Seisan Kachi Hoshō Gensoku): The plan must provide creditors with a recovery that is no less than what they would receive if the company were liquidated in bankruptcy. This is a fundamental principle of fairness.
  • Feasibility and Economic Rationality: The plan must be demonstrably feasible and economically rational.
  • Management Responsibility (経営責任 - Keiei Sekinin): The plan may also need to address how management is taking responsibility for the company's past difficulties (e.g., through personal financial contributions, salary cuts, or, in some cases, management changes, though DIP is common).

8. Negotiating Plan Support and Creditor Voting:
Before formally submitting the plan, the debtor (and their lawyer) will typically engage in extensive negotiations with major creditors, especially financial institutions, to secure their support.
The rehabilitation plan is then put to a vote at a creditors' meeting (or sometimes by written resolution). Approval generally requires:

  • A majority in number of the voting creditors present who agree with the plan.
  • Creditors representing more than one-half of the total amount of voting rights (debt) agreeing with the plan (Art. 172-3).

9. Court Confirmation of the Plan (認可決定 - Ninka Kettei):
If the creditors approve the plan, and the court finds it fair, equitable, and compliant with the law, the court will issue an order confirming the plan. The confirmed plan is binding on all rehabilitation creditors, including those who voted against it.

10. Implementation and Conclusion:
The company then implements the terms of the confirmed rehabilitation plan. This involves making the agreed-upon payments to creditors over the specified period and executing any operational changes. The court's supervision typically continues for a period (e.g., three years after plan confirmation, even if plan payments extend longer - Art. 188(2) ). Successful completion leads to the company emerging from the process as a restructured, healthier entity.

Understanding Claim Classifications in Civil Rehabilitation

A key aspect for creditors is how their claims are classified and treated:

  • Rehabilitation Claims (再生債権 - Saisei Saiken): These are generally pre-petition unsecured claims. They are subject to the terms of the rehabilitation plan, including potential principal reductions and rescheduled payments (Art. 84, 85).
  • Common Benefit Claims (共益債権 - Kyōeki Saiken; Art. 119): These claims arise post-petition from the necessary continuation of the business or administration of the rehabilitation process (e.g., supervisor's fees, post-petition wages, payments to essential suppliers for post-petition goods/services if approved by the supervisor). These are paid in full, as they accrue, outside the constraints of the rehabilitation plan.
  • General Priority Claims (一般優先債権 - Ippan Yūsen Saiken; Art. 122): Certain pre-petition claims that have statutory priority (e.g., some unpaid employee wages, certain tax claims) are also paid in full, usually before or alongside payments under the rehabilitation plan.
  • Secured Claims (別除権付再生債権 - Betsujo-ken-tsuki Saisei Saiken; Art. 53): Claims secured by collateral (e.g., mortgages, pledges). Secured creditors can, in principle, enforce their security rights outside the rehabilitation process. However, often the debtor will negotiate a "buy-back" agreement (betsujo-ken kyōtei - 別除権協定) to retain essential secured assets by paying the secured creditor an amount equivalent to the asset's value, or the process may involve a stay of enforcement to allow for such negotiations.

The Lawyer's Critical Role

The debtor's lawyer is central to the entire Civil Rehabilitation process. Their responsibilities include:

  • Conducting the initial viability assessment and advising on the suitability of filing.
  • Meticulously preparing the petition and supporting documentation.
  • Guiding the company's management through the complexities of operating under court supervision.
  • Negotiating with the supervisor, creditors (especially key financial institutions and essential suppliers), and potentially sponsors.
  • Drafting the rehabilitation plan.
  • Representing the company in all court hearings and creditors' meetings.
    As noted in legal commentaries, the lawyer must often possess strong judgment and decisiveness, sometimes needing to guide or even firmly direct a distressed and hesitant management team towards necessary but difficult decisions (like closing unprofitable stores, as seen in the SME restaurant case ).

Conclusion

Civil Rehabilitation (Minji Saisei) offers a structured and legally binding framework for SMEs in Japan to address financial distress while aiming to continue their business operations. It is a complex and demanding process, requiring careful planning, transparent communication with stakeholders, skilled legal representation, and a genuinely viable core business. While challenging, it provides a critical opportunity for struggling but fundamentally sound SMEs to restructure their finances, address operational weaknesses, and work towards a sustainable future, thereby preserving jobs and economic value that would be lost in a liquidation.