Debtor Hiding Assets in Japan? How the 'Fraudulent Act Revocation Action' Can Help Creditors Recover

Creditors worldwide face the risk of debtors attempting to shield assets from collection efforts. When a debtor in Japan transfers assets or engages in acts that diminish their estate to the detriment of creditors, Japanese law provides a powerful remedy: the Action for Revocation of a Fraudulent Act (詐害行為取消訴訟 - saigai kōi torikeshi soshō). This judicial proceeding allows creditors to nullify certain transactions made by the debtor and, in many cases, recover the transferred property or its value, thereby restoring the debtor's estate.

Understanding the Fraudulent Act Revocation Action

The primary purpose of this action is to preserve the debtor's general assets, which serve as the common security for all creditors. When a debtor undertakes an act knowing it will harm their creditors—typically by rendering themselves insolvent or worsening their insolvency—this action allows a creditor to seek its cancellation.

The legal nature of this right, as understood under the current Japanese Civil Code (especially after the 2017 revisions effective April 2020), is generally considered a combination of:

1. A right to revoke (取消権 - torikeshi-ken) the fraudulent act itself, which is a type of "right of formation" (形成権 - keisei-ken) that changes the legal status of the act.
2. A right to demand the return of property (財産返還請求 - zaisan henkan seikyū) that was improperly transferred due to the fraudulent act, or its monetary equivalent if return is not feasible.

This action must be pursued through court proceedings; it cannot be exercised extrajudicially. The plaintiff is the creditor whose claim is being impaired (the "preserved claim"). The defendant is typically the beneficiary of the fraudulent act (受益者 - juekisha) or a subsequent acquirer of the property (転得者 - tentokusha).

Core Requirements for Revoking a Fraudulent Act (Civil Code Article 424)

Several conditions must be met for a creditor to successfully revoke a debtor's act as fraudulent:

1. Existence of the Preserved Claim (被保全債権 - hihozen saiken)

The creditor must have a valid monetary claim against the debtor. This claim is referred to as the "preserved claim."

2. Timing of the Preserved Claim's Origin

Crucially, the cause of the preserved claim must have arisen before the debtor committed the alleged fraudulent act (Article 424(3) of the Civil Code). For example, if the claim is based on a loan agreement, the loan agreement must have been concluded before the fraudulent transfer. However, the preserved claim does not need to be due and payable at the time the fraudulent act was committed or at the time the revocation action is filed.

3. The Debtor's Act Concerning Property Rights (財産権を目的とする行為)

The act targeted for revocation must be a legal act by the debtor concerning their property rights (Article 424(1) of the Civil Code). Acts that are not primarily aimed at disposing of property, such as marriage or adoption, or the debtor's refusal to accept an inheritance, generally cannot be the subject of this action (Article 424(2) of the Civil Code). The act must relate to the debtor's assets that would otherwise be available to satisfy creditors. If the property was not owned by the debtor at the time of the act, this can be a defense.

4. The Act Harms Creditors (債権者を害すること - Debtor's Insolvency)

The debtor's act must be objectively detrimental to the creditors. This is generally interpreted as meaning the act caused the debtor to become insolvent (無資力 - mushiryoku), or if already insolvent, worsened their insolvency. Insolvency here means the debtor lacks sufficient assets to cover all their debts.

This condition of harming creditors (i.e., the debtor's insolvency resulting from the act) must typically exist both at the time of the fraudulent act and continue until the conclusion of the oral arguments in the revocation lawsuit. If the debtor's financial situation improves sufficiently after the act but before the conclusion of the lawsuit, the right to revoke may be lost (this constitutes a defense for the beneficiary).

• Example: Debtor A owes Creditor X a significant sum. Debtor A’s only substantial asset is a piece of real estate. Debtor A then gifts this real estate to Beneficiary Y. If this gift leaves Debtor A with insufficient assets to pay Creditor X (and any other creditors), the act of gifting is considered harmful to creditors.

5. Debtor's Fraudulent Intent (詐害の意思 - sagai no ishi)

The debtor must have performed the act knowing that it would harm their creditors (Article 424(1) of the Civil Code). For typical acts that reduce the debtor's assets, such as a gift or a sale at a grossly undervalued price, this "fraudulent intent" is generally satisfied if the debtor was aware that the act would lead to a state of insolvency or deepen existing insolvency. A specific intent to harm a particular creditor is not necessarily required; awareness of the general prejudicial effect on creditors suffices.

Subjective Requirements for Beneficiaries and Subsequent Acquirers

Even if all the above conditions concerning the debtor and the act are met, the action's success also depends on the state of mind of the person who benefited from the act (the beneficiary) or any subsequent acquirer of the property.

Beneficiary (受益者 - juekisha)

If the beneficiary, at the time of the debtor's act, did not know that the act was harmful to creditors (i.e., the beneficiary was in "good faith" - 善意 zen'i), the creditor cannot revoke the act against the beneficiary (Article 424(1) proviso of the Civil Code). The burden of proving this good faith generally rests on the beneficiary as a defense. If the beneficiary knew of the harm (was in "bad faith" - 悪意 akui), the action can proceed.

Subsequent Acquirer (転得者 - tentokusha)

If the property has been further transferred from the initial beneficiary to a subsequent acquirer, the creditor may, under certain conditions, target the subsequent acquirer with the revocation action (Article 424-5 of the Civil Code). This is generally possible if:

1. There were grounds for revoking the act against the initial beneficiary (e.g., the beneficiary was in bad faith).
2. The subsequent acquirer, at the time they acquired the property, knew that the original act by the debtor was harmful to creditors.

The burden of proving the subsequent acquirer's bad faith rests on the creditor.

• Example involving a subsequent acquirer: Following the previous example, Debtor A gifts land to Beneficiary Y1 (who knew of A's financial troubles). Y1 then sells the land to Y2. If Creditor X wishes to revoke the original gift and recover the land from Y2, X must prove that Y2, at the time of purchasing from Y1, also knew that A's initial gift to Y1 was harmful to A's creditors.

Special Rules for Specific Types of Acts

The Civil Code provides special rules for certain types of transactions that might not appear overtly fraudulent at first glance. These were refined in the 2017 Civil Code revisions.

1. Disposal of Property for Reasonable Consideration (Article 424-2)

Sometimes, a debtor might sell an asset for what appears to be a fair market price. Such an act doesn't directly reduce the debtor's net worth. However, it can still be deemed fraudulent if specific conditions are met, essentially where the act converts an asset (like real estate) into a more easily concealable or expendable form (like cash), with the intent to prejudice creditors.

Article 424-2 provides that a disposition for reasonable consideration can be revoked only if all of the following apply:

• The act involves a change in the type of property (e.g., converting real estate to cash) that creates a genuine risk that the debtor will conceal, make gratuitous dispositions of, or otherwise dispose of the received consideration in a manner prejudicial to creditors.
• The debtor, at the time of the act, intended to engage in such concealment or prejudicial disposal of the received consideration.
• The beneficiary, at the time of the act, knew that the debtor had such an intention to conceal or prejudicially dispose of the consideration.

In such cases, the creditor bears the burden of proving these additional elements, including the subjective intent of the debtor and the beneficiary's knowledge of that intent.

• Example: Debtor A, who is insolvent, sells their only real estate property (worth ¥10 million) to Beneficiary Y for ¥10 million in cash. While the price is fair, if A intended to immediately hide this cash or spend it frivolously to avoid paying Creditor X, and Y knew of A's intent and the general harm to creditors, X might be able to revoke the sale under Article 424-2.

2. Acts Concerning the Extinguishment of an Existing Debt (e.g., Preferential Payments) (Article 424-3)

When a debtor pays off an existing debt to one particular creditor while being unable to pay other creditors, this is known as a preferential payment (偏頗弁済 - henpa bensai). Generally, repaying a legitimate debt is not fraudulent. However, Article 424-3 outlines specific circumstances under which such an act can be revoked:

The act of extinguishing an existing debt (like a payment or provision of security) can be revoked only if both of the following conditions are met:

• The act was done when the debtor was in a state of "inability to pay" (支払不能 - shiharai funō), meaning the debtor, due to a lack of financial resources, is generally and continuously unable to pay their debts as they become due. This is a more acute state than general insolvency (mushiryoku).
• The act was done through "collusion" (通謀 - tsūbō) between the debtor and the beneficiary (the creditor who received the preferential treatment) with the intent to harm other creditors.

Proving collusion and the specific intent to harm other creditors can be challenging. The ordinary fraudulent intent (knowledge of general harm) is subsumed under this stricter requirement of collusive intent to prejudice other creditors. Even if the debtor was insolvent, if these additional stringent conditions are not met, a preferential payment to a legitimate creditor is often difficult to revoke outside of formal bankruptcy proceedings (which have their own, broader avoidance powers).

• Example: Debtor A has multiple creditors, including Creditor X and Creditor Y. Debtor A is unable to pay all debts as they mature. Debtor A and Creditor Y agree that Y will be paid in full specifically to prevent other creditors, like X, from accessing those funds. This payment to Y could potentially be revoked by X under Article 424-3 if X can prove A's inability to pay and the collusive intent.

Effects and Scope of a Successful Revocation

If a creditor successfully revokes a fraudulent act:

• Return of Property/Value: The primary effect is the restoration of the disposed property to the debtor's estate. If the property itself cannot be returned (e.g., it has been consumed or substantially altered by a good-faith acquirer), the beneficiary or bad-faith subsequent acquirer may be ordered to return its monetary equivalent (価額償還 - kagaku shōkan) (Article 424-6). The value is generally assessed at the time of the conclusion of oral arguments in the revocation lawsuit.
• Scope of Revocation: If the object of the fraudulent act is divisible (e.g., a sum of money), the creditor can generally only demand revocation and return to the extent of their own preserved claim amount (Article 424-8(1)). For example, if the fraudulent act involved a transfer of ¥5 million, but the revoking creditor's claim is only ¥2 million, the revocation is typically limited to ¥2 million.
• Effect of Judgment on Other Parties: A final and binding judgment affirming the revocation of a fraudulent act is effective not only against the plaintiff creditor and the defendant (beneficiary/transferee) but also against the debtor and all other creditors of the debtor (Article 425). This means the recovered assets become part of the debtor's general estate available to all creditors, though the revoking creditor may benefit from direct payment in certain cases.

Time Limitations for Exercising the Right (Article 426)

The right to seek revocation of a fraudulent act is subject to strict time limits:

• The action cannot be filed if two years have passed since the time the creditor became aware of the cause for revocation (i.e., knew of the fraudulent act and the debtor's fraudulent intent).
• Regardless of the creditor's knowledge, the action cannot be filed if ten years have passed since the time of the fraudulent act itself.

These periods are generally considered to be periods of exclusion (除斥期間 - joseki kikan), meaning they are not subject to interruption or suspension in the way typical statutes of limitation might be.

Practical Considerations

• Litigation Notice: When a creditor files an action for revocation of a fraudulent act, they must, without delay, provide notice of the lawsuit to the debtor (Article 424-7(2)). This allows the debtor to be aware of the proceedings.
• Burden of Proof: The creditor generally bears the burden of proving the requirements for revocation, including the debtor's fraudulent act, the harm to creditors (insolvency), and the debtor's fraudulent intent. For specific types of acts under Articles 424-2 and 424-3, the creditor has additional elements to prove. The beneficiary or transferee typically bears the burden of proving their own good faith as a defense.

Conclusion

The Action for Revocation of a Fraudulent Act is a cornerstone of creditor protection in Japan. It provides a vital, albeit complex, legal avenue to challenge transactions designed to improperly deplete a debtor's estate. Understanding its multifaceted requirements—from the nature of the debtor's act and intent to the subjective state of the beneficiary or transferee, along with the special rules for certain transactions and strict time limits—is essential for any party seeking to navigate or defend against such claims. Given its intricacies, expert legal counsel is indispensable when contemplating or facing this type of action.