Fictitious Claims and Plan Approval in Individual Rehabilitation: Japanese Supreme Court on "Improper Means"

Date of Decision: December 19, 2017 (Heisei 29)
Case Name: Permitted Appeal Against Appellate Decision Annulling Rehabilitation Plan Confirmation
Court: Supreme Court of Japan, Third Petty Bench

This blog post examines a 2017 Supreme Court of Japan decision addressing a critical issue in "small-scale individual rehabilitation" (小規模個人再生 - shōkibo kojin saisei) proceedings: whether a court can investigate the actual existence of a procedurally undisputed claim to determine if a rehabilitation plan's approval was achieved by "improper means," particularly when there are suspicions of bad faith by the debtor.

Facts of the Case

Debtor X (appellant before the Supreme Court) filed for commencement of small-scale individual rehabilitation proceedings on September 7, 2016, and the proceedings began on September 20. The list of creditors submitted by X included a home loan (secured by a first-priority mortgage on X's land and building), a damages claim owed to Y (respondent before the Supreme Court, the creditor who ultimately challenged the plan), and a purported loan claim by X's own brother, A.

Y's damages claim against X had been confirmed by a final judgment in a separate lawsuit stemming from X's breach of contract. A's alleged loan claim of 20 million yen was based on a monetary loan agreement dated October 10, 1999. A provisional mortgage registration for this loan claim had been made on X's property while Y's lawsuit against X was pending, but this provisional registration was cancelled shortly before X filed for rehabilitation.

During the rehabilitation proceedings, Y duly filed its damages claim. X's brother, A, did not file his loan claim; however, under Article 225 of the Civil Rehabilitation Act, A's claim was "deemed filed" with the same content as stated in X's initially submitted list of creditors. No objections were raised against either Y's damages claim or A's loan claim within the objection period. Consequently, under Article 230, Paragraph 8 of the Act, the voting rights were determined: approximately 13.45 million yen for Y and 20 million yen for A. There were a total of 10 voting creditors in X's rehabilitation, with total voting rights amounting to about 37.05 million yen.

X submitted a rehabilitation plan that included special clauses for the home loan and proposed a 90% write-off of other rehabilitation claims, with the remainder to be repaid in installments. When the plan was put to a vote, Y submitted a response explicitly disagreeing with it. No responses were received from the other rehabilitation creditors, including A . Under the "negative consent" system of Article 230, Paragraph 6 of the Act (where failure to disagree is treated as consent if certain thresholds are met), the plan was deemed approved because the number of dissenting creditors did not reach half of the total number of voting creditors, and the amount of their voting rights did not exceed half of the total amount of voting rights.

Lower Court Rulings

The court of first instance's first instance (the rehabilitation court) confirmed X's rehabilitation plan. Y filed an immediate appeal, arguing that the plan's approval was based on the creation of a fictitious claim (A's loan claim) and thus fell under the ground for non-confirmation in Article 202, Paragraph 2, Item 4 of the Act: "when the resolution on the rehabilitation plan has been effected by improper means".

The High Court (original instance court for the appeal) requested X to submit objective evidence supporting A's loan claim, but X failed to do so. The High Court found that there was "a suspicion that X intentionally listed a non-existent claim of A in the list of creditors and had it confirmed through the deemed filing mechanism, in order to get the rehabilitation plan approved". It concluded that "it is necessary to fully investigate, ex officio (under Article 8, Paragraph 2 of the Act), whether A's claim exists and whether X engaged in acts contrary to the principle of good faith". The High Court therefore annulled the first court's confirmation decision and remanded the case back to the first court for further investigation.

X then filed a permitted appeal to the Supreme Court, arguing essentially that since A's loan claim was an undisputed claim that had become procedurally confirmed within the rehabilitation process, its existence should be presumed when determining whether there were grounds for non-confirmation of the plan.

The Supreme Court's Decision

The Supreme Court dismissed X's appeal, upholding the High Court's decision to remand the case for further investigation .

The Court's reasoning was as follows:

1. Purpose of Court Confirmation and "Improper Means":
   The Court reiterated the purpose of requiring court confirmation of a rehabilitation plan (even one approved by creditors) as established in its prior jurisprudence (citing its March 13, 2008 decision, Case 93 from this series). This purpose is to allow the rehabilitation court to re-examine whether the plan is suitable for achieving the Civil Rehabilitation Act's objectives (Article 1: appropriate adjustment of rights and rehabilitation of the debtor's business or economic life), and in doing so, to protect minority creditors from a supervisory perspective, thereby protecting the general interests of all rehabilitation creditors.
   Consequently, the ground for non-confirmation in Article 202, Paragraph 2, Item 4 ("when the resolution on the rehabilitation plan has been effected by improper means") is not limited to cases where voting creditors were subjected to fraud, duress, or illicit benefits. It also includes cases where the approval of the rehabilitation plan was achieved through acts contrary to the principle of good faith (信義則 - shingi-soku).
2. Investigating Claim Existence Despite Procedural Confirmation:
   Based on this purpose, the Supreme Court held that in small-scale individual rehabilitation, even if a rehabilitation claim has been filed (including "deemed filed" under Article 225) and no objections were raised against it during the general or special objection periods, when determining whether the approval of a rehabilitation plan (with special home loan clauses) was based on acts contrary to good faith, the court can take into account all circumstances related to the filing of that claim, including the actual existence or non-existence of the claim itself.
3. Application to the Facts of This Case:
   X listed A's alleged loan claim when filing for rehabilitation, and it was deemed filed. However, this loan was supposedly made more than 16 years prior to the rehabilitation filing. A provisional mortgage for this claim was registered only after Y sued X, more than 14 years after the alleged loan, and X failed to provide objective evidence (like a loan agreement or proof of fund transfer) to the High Court despite being asked. These circumstances suggested A's claim might not actually exist. Because no objections were lodged against A's claim, A was able to exercise voting rights exceeding half of the total, leading to the plan's approval.
   The Court found that these facts raised a suspicion that X intentionally listed a non-existent claim by A to manipulate the plan approval. Given that X, as a rehabilitation debtor, has a duty to conduct the proceedings fairly and in good faith towards creditors (referencing Article 38, Paragraph 2 of the Act), there was a suspicion that the plan's approval was based on acts contrary to good faith. The investigation into whether A's claim actually existed was still incomplete.
   Therefore, the High Court's decision to annul the initial confirmation and remand the case for a full investigation into these matters was appropriate .

Supplementary Opinion by Justice Michiyoshi Kiuchi

Justice Kiuchi provided a supplementary opinion further elaborating on the relationship between the procedural finality of claims and the inquiry into bad faith acts by the debtor .

1. Actor of Bad Faith: The core issue is whether the debtor (X) acted contrary to good faith, particularly given the debtor's duty of fairness and good faith towards creditors. The ruling does not mean that any plan approved based on a non-existent claim (regardless of debtor involvement) automatically constitutes bad faith. Small-scale individual rehabilitation procedures in Japan have features like "deemed filing" of claims based on the debtor's list (Art. 225) and "deemed approval" if creditors do not actively dissent (Art. 230(6)). These features mean a debtor's actions alone can potentially lead to plan approval. This case specifically questions whether X's actions in listing A's claim, which led to A (who did not dissent) holding a majority of voting rights, amounted to bad faith on X's part.
2. Procedural Confirmation vs. Good Faith Inquiry: X argued that A's claim, being undisputed, was procedurally confirmed and its existence should be presumed. However, Justice Kiuchi explained that this procedural confirmation does not prevent the court from determining whether X's act of listing the claim (and other related conduct) was contrary to good faith.
   • (a) Meaning of Procedural Confirmation in Individual Rehabilitation: Unlike ordinary rehabilitation proceedings where confirmed claims gain the effect of a final and binding judgment (Art. 180), the "procedural finality" of claims in individual rehabilitation is weaker (see Art. 238). It merely signifies that the claim's amount and voting rights are fixed for the purpose of the procedure and no further appeal on that specific determination is available. It does not carry a substantive conclusive effect that would bar an inquiry into bad faith as a ground for non-confirmation of the plan.
   • (b) Analogy to Plan Revocation: If a rehabilitation plan is later challenged for revocation on the grounds that it was "effected by improper means" (Art. 189(1)(i) – which is interpreted similarly to "improper means" for non-confirmation), a creditor can raise this even if they did not object to a specific claim during the claim investigation period (unless they knew of the improper means at the time of confirmation and failed to object then, see Art. 189(2)). This implies that failure to object to a claim earlier does not preclude later scrutiny if debtor misconduct is involved.
   • (c) Analogy to Bankruptcy Discharge: In bankruptcy proceedings, if a debtor lists a fictitious debt in their creditor list to diminish dividends for legitimate creditors, this constitutes a ground for denying discharge (Bankruptcy Act Art. 252(1)(vii)). Whether creditors had objected to this fictitious debt during the claim investigation phase is not considered relevant to this ground for discharge denial. This shows a broader principle of not allowing debtors to benefit from such misrepresentations. These analogies support the idea that the court can look behind a procedurally undisputed claim when assessing the debtor's good faith in the context of plan confirmation.

Commentary and Elaboration

1. Significance of the Decision

This Supreme Court decision is significant for clarifying that, in small-scale individual rehabilitation, even a claim that has become procedurally "undisputed" (because no objections were filed) can still be subject to judicial scrutiny regarding its actual existence when determining if the rehabilitation plan's approval was tainted by "improper means," specifically acts contrary to good faith by the debtor. It addresses the potential for abuse in systems with simplified procedures like "deemed filing" and "negative consent."

2. Fictitious Claims and the "Improper Means" Ground for Non-Confirmation

• The Supreme Court's 2008 decision (Case 93) had already established a broad interpretation of "improper means" under Article 174(2)(iii) (the equivalent provision for ordinary rehabilitation) to include acts contrary to good faith.
• This 2017 decision applies that interpretation to small-scale individual rehabilitation (Art. 202(2)(iv)). It does not broadly state that any plan approval involving a fictitious claim is automatically a result of bad faith. Instead, as Justice Kiuchi's supplementary opinion emphasizes, the focus is on the debtor's conduct, especially where the system's features (like deemed filing of claims listed by the debtor and deemed approval if creditors are silent) allow the debtor's actions alone to largely determine the outcome of the vote.
• If the debtor's listing of a dubious claim (especially one held by an insider who then does not object) is a key factor in achieving plan approval, this can be scrutinized as a potential breach of the debtor's duty of fairness and good faith (Art. 38(2)). The decision clarifies that the court can investigate the existence of such a claim in this context.
• The commentary suggests that even if a debtor induces a third party to file a fictitious claim (rather than listing it themselves for deemed filing), this could still fall under the debtor's breach of good faith. The Supreme Court's language, referring to deemed filing as "including" such cases, does not preclude scrutiny of actual filings of fictitious claims orchestrated by the debtor.
• Cases where a fictitious claim is filed entirely independently of the debtor would fall outside the debtor's duty of fairness and might be addressed under general good faith principles applicable to all parties (see Civil Rehabilitation Act Art. 18, Code of Civil Procedure Art. 2) or other grounds for non-confirmation, such as the plan being impracticable or grossly unfair (Art. 174(2)(i) or Art. 202(2)(i) for plans with home loan clauses).

3. Procedural Finality of Claims vs. Scrutiny for Bad Faith

A key legal question is whether allowing the court to investigate the existence of a procedurally "undisputed" claim (in the context of assessing "improper means") contradicts the concept of the claim's finality within the rehabilitation procedure.

• The Supreme Court explicitly permits such investigation for the purpose of determining bad faith in plan approval. Justice Kiuchi's supplementary opinion provides several reasons for this:
  • The "procedural finality" of claims in small-scale individual rehabilitation is not as strong as the substantive finality (akin to a final judgment) that attaches to confirmed claims in ordinary corporate rehabilitation. It primarily means the claim's amount and voting rights are fixed for procedural purposes within that rehabilitation.
  • An analogy can be drawn to the grounds for revoking an already confirmed plan. Even if a creditor did not object to a claim during the initial investigation, they may still be able to seek plan revocation if it was passed due to improper means involving that claim (unless they were aware of the issue and failed to raise it).
  • Another analogy is to bankruptcy discharge proceedings, where listing a fictitious creditor to harm other creditors is a ground for denying discharge, irrespective of whether anyone objected to that fictitious claim earlier.
• While the Civil Rehabilitation Act provides mechanisms for vetting claims during the claim investigation phase, these checks might not always function perfectly, especially if there's manipulation by the debtor or collusion. The Supreme Court's approach allows a later check at the plan confirmation stage to ensure the integrity of the process. Theoretical support for this includes viewing debtor-creditor collusion as akin to grounds for a third-party retrial, or that the court's supervisory role at plan confirmation is distinct from, and can override, earlier procedural determinations if fundamental fairness is at stake.

4. Scope and Implications of the Decision

• This decision specifically concerns small-scale individual rehabilitation plans that include special clauses for home loans (to which Article 202(2)(iv) applies). However, its reasoning regarding "improper means" and acts contrary to good faith is likely applicable to small-scale individual rehabilitation plans without such clauses as well (where Article 174(2)(iii), via Article 231, would be the relevant provision).
• The decision is not directly applicable to "salaried workers, etc. rehabilitation" (kyūyo shotokusha tō saisei), a different type of individual rehabilitation that does not involve creditor voting on the plan.
• Whether the core reasoning extends to ordinary corporate rehabilitation proceedings is a subject of debate, given that claim confirmation in such proceedings has a stronger, judgment-like effect. However, situations where a debtor might illicitly induce the filing of fictitious claims to manipulate voting outcomes can also arise in corporate cases. Since even in ordinary rehabilitation, the determination of voting rights is often described as having "procedural finality" within the context of that proceeding, the fundamental principle against bad faith manipulation might still apply.
• This case brought to light potential vulnerabilities in the simplified procedures of small-scale individual rehabilitation but also reaffirmed the critical "safety net" function of the court's plan confirmation stage. It has also spurred discussions on the roles and responsibilities of professionals involved in these cases, such as individual rehabilitation commissioners and the debtor's legal counsel, in preventing such abuses.

Conclusion

The Supreme Court's 2017 decision is a significant affirmation of the court's power to ensure fairness and good faith in small-scale individual rehabilitation proceedings. It clarifies that even if a claim becomes procedurally undisputed, the court can still investigate its actual existence if there are credible suspicions that the debtor listed or utilized it in bad faith to improperly secure the approval of a rehabilitation plan. This ruling strengthens the court's supervisory role in protecting the integrity of the rehabilitation process and the rights of legitimate creditors against manipulative tactics.