How Does a Japanese Bankruptcy Trustee Exercise the Right of Avoidance?

In Japanese bankruptcy proceedings (破産手続 - hasan tetsuzuki), the bankruptcy trustee (破産管財人 - hasan kanzainin) plays a crucial role in maximizing the assets available for creditors. One of
the most potent tools at their disposal is the "Right of Avoidance" (Hinin-ken - 否認権), which allows the trustee to nullify certain transactions made by the debtor before the bankruptcy filing if those transactions are deemed detrimental to the creditor body. But how does a trustee actually go about exercising these significant powers? The process involves investigation, negotiation, and, if necessary, formal legal action.

Initial Steps: Investigation and Strategic Assessment

Before initiating any formal avoidance action, the trustee undertakes a thorough investigation and strategic assessment:

1. Duty to Investigate: Upon appointment, the trustee has a legal duty to scrutinize the debtor's pre-bankruptcy transactions. This involves examining the debtor's books and records, financial statements, contracts, and other relevant documents. They also interview the debtor, its management (if a corporation), and other individuals who may have knowledge of relevant dealings. Information provided by creditors can also be a valuable source for identifying potential avoidance targets.
2. Identifying Potential Avoidance Actions: The trustee looks for red flags indicating transactions that might be avoidable. These could include sales of assets at significantly below market value, transfers to related parties for little or no consideration, unusual payments to certain creditors shortly before bankruptcy, or last-minute granting or perfection of security interests.
3. Evaluating Legal Grounds: For each potential target transaction, the trustee carefully assesses whether it meets the specific legal criteria for avoidance under the Japanese Bankruptcy Act (破産法 - Hasan Hō). This means determining if the transaction qualifies as a fraudulent act (詐害行為 - sagai kōi), a gratuitous act (無償行為 - mushō kōi), a preferential transfer (偏頗行為 - henpa kōi), or an act for which perfection was improperly delayed (対抗要件の否認 - taikō yōken no hinin), among others.
4. Assessing Viability and Cost-Benefit: Even if a transaction appears legally avoidable, the trustee must consider the practicalities. This includes:
   • The likelihood of successfully proving all necessary elements of the avoidance claim (including, where required, the debtor's intent or the counterparty's knowledge).
   • The potential value of the recovery to the estate.
   • The solvency and location of the counterparty (the person who benefited from the transaction).
   • The estimated costs and time involved in pursuing the avoidance action, including legal fees if external counsel is required.
     The trustee will generally only pursue an avoidance action if it is expected to result in a net benefit to the bankruptcy estate.

Phase 1: Informal Resolution - Demand and Negotiation (任意の返還請求)

The Japanese legal system, including bankruptcy practice, often emphasizes negotiation and amicable resolution where possible. Therefore, the trustee's first step after identifying a potentially avoidable transaction is typically to approach the counterparty (受益者 - juekisha, or if the property has been further transferred, the subsequent transferee - 転得者 - tentokusha) informally.

• Demand for Voluntary Return (任意の返還請求 - nin-i no henkan seikyū): The trustee will usually send a formal demand letter to the counterparty. This letter will outline the reasons why the trustee believes the transaction is avoidable under the Bankruptcy Act and request the voluntary return of the transferred property or payment of its equivalent value to the bankruptcy estate.
• Negotiation and Settlement: Many avoidance matters are resolved through negotiation at this stage. The counterparty, upon being presented with the trustee's legal position and the potential costs and risks of litigation, may agree to return the asset, pay a sum of money, or reach a compromised settlement. This approach saves the estate the time and expense of formal legal proceedings. For individual debtors, if the counterparty is a relative or acquaintance, the debtor's own interest in obtaining a discharge (免責 - menseki), which could be jeopardized by certain pre-bankruptcy conduct, can sometimes encourage the counterparty to cooperate with the trustee’s request for voluntary return.

Phase 2: Formal Legal Action – Choosing the Appropriate Path

If informal negotiations fail to yield a satisfactory result, the trustee must consider formal legal action to exercise the Hinin-ken. The Bankruptcy Act (Article 173, Paragraph 1) states that the right of avoidance can be exercised by bringing an action, filing a petition, or by way of a defense. The action or petition must be brought before the bankruptcy court that has jurisdiction over the main bankruptcy case (Article 173, Paragraph 2 – this establishes exclusive jurisdiction).

The trustee has two primary procedural options for initiating formal avoidance proceedings:

A. Petition for Avoidance (否認の請求 - Hinin no Seikyū)

Introduced by the current Bankruptcy Act, the "Petition for Avoidance" (Bankruptcy Act, Article 174) is a simplified and expedited judicial procedure specifically designed for avoidance claims within the bankruptcy case itself.

• Nature and Advantages:
  • It is generally a faster and less expensive process than a full civil lawsuit.
  • It is handled by the bankruptcy court judges who are specialized in insolvency matters.
  • The trustee does not need separate court permission to file a Hinin no Seikyū.
  • There are no court filing fees (stamp duty) for the trustee, reducing costs to the estate.
  • The proceedings are often based on written submissions and evidence. While full proof is ultimately necessary, a lower standard of proof called somei (疎明 - prima facie showing) might be sufficient for certain interim aspects or to initiate the process. Oral hearings can also be held, providing opportunities for settlement discussions.
• Procedure: The trustee files a petition with the bankruptcy court detailing the grounds for avoidance. The court reviews the petition and evidence and gives the counterparty an opportunity to respond.
• Court's Ruling (決定 - kettei): The court issues a ruling (a decision or order) on the petition.
• Counterparty's Recourse – Objection Lawsuit (異議の訴え - igi no uttae): If the court rules in favor of the trustee and orders the avoidance of the transaction, the counterparty is not without recourse. They can challenge this ruling by filing an "objection lawsuit" (igi no uttae) within one month (an unalterable period) of being served with the ruling (Bankruptcy Act, Article 175). This objection lawsuit then proceeds as a regular civil action before the bankruptcy court (though potentially assigned to a different division handling civil cases). A judgment in favor of the trustee in an objection lawsuit can be declared provisionally enforceable.

B. Action for Avoidance (否認の訴え - Hinin no Uttae)

This is a formal civil lawsuit initiated by the bankruptcy trustee against the counterparty.

• Nature and Procedure: It follows the standard rules of Japanese civil procedure and requires the trustee to prove their case with a full standard of proof.
• When Chosen: Trustees may opt for a full "Action for Avoidance" instead of a "Petition for Avoidance" in cases that are particularly complex, involve significant factual disputes, or where it is highly anticipated that the counterparty will fiercely contest the matter and an "objection lawsuit" would likely follow a petition anyway.
• Court Permission and Costs: If the value of the property or claim sought to be recovered exceeds a certain threshold (typically 1 million yen, under the general rules for trustee litigation in Article 78 of the Bankruptcy Act), the trustee must obtain prior permission from the bankruptcy court to initiate the lawsuit. This type of action also involves court filing fees (stamp duty) for the bankruptcy estate, which can be a consideration in cost-benefit analysis.

C. Exercise as a Defense (抗弁としての行使 - kōben to shite no kōshi)

In some situations, the counterparty to a potentially avoidable transaction might themselves initiate legal action against the bankruptcy estate (e.g., to enforce the terms of the transaction). In such cases, the trustee can exercise the right of avoidance as a defense to that action, arguing that the transaction is voidable and therefore unenforceable against the estate.

Provisional Remedies (否認権のための保全処分 - Hinin-ken no tame no Hozen Shobun)

To prevent the counterparty from selling, transferring, or otherwise disposing of the property that is the subject of a potential avoidance action while the proceedings are ongoing, the trustee can apply to the bankruptcy court for provisional remedies (Bankruptcy Act, Articles 171-172).

• These remedies are akin to pre-judgment attachments or injunctions in other legal systems.
• They can be sought from the time the main bankruptcy petition is filed, even before formal avoidance proceedings (petition or action) have commenced.
• The aim is to preserve the status quo and ensure that any assets successfully recovered can actually be returned to the estate.

Effectuating Recovery and Registration of Avoidance (否認の登記)

If the trustee's avoidance efforts are successful, whether through voluntary return, settlement, or a court judgment:

• Recovery of Assets: The trustee takes steps to recover the physical property or its monetary value.
• Registration of Avoidance (否認の登記 - hinin no tōki): If the avoided transaction involved real estate or other assets for which title or rights are publicly registered (e.g., intellectual property rights, registered vehicles), the trustee must apply for a "registration of avoidance" (hinin no tōki) (Bankruptcy Act, Article 260, Paragraph 1).
  • This registration officially records the nullification of the prior, voidable registration (e.g., a title transfer or mortgage registration) and formally restores the property to the bankruptcy estate in the public register.
  • This makes the estate's recovered title effective against any subsequent third-party claims.
  • Once the trustee subsequently sells the recovered property to a new buyer, the registration of avoidance and the avoided prior registration are typically expunged by the registrar as part of the new title transfer process (Article 260, Paragraph 2).

Time Limits for Exercising Avoidance Powers (行使期間の制限)

The trustee's ability to exercise avoidance powers is not indefinite. The Bankruptcy Act (Article 176) imposes strict time limits:

1. Two-Year Limit: The right of avoidance must be exercised (i.e., formal proceedings initiated) within two years from the date of the commencement of the bankruptcy proceedings.
2. Twenty-Year Absolute Limit: Regardless of when the bankruptcy proceedings commenced, no avoidance action can be brought if twenty years have passed since the date the avoidable act itself took place.

These periods are considered "periods of extinctive prescription" (除斥期間 - joseki kikan), meaning that if the trustee fails to act within these deadlines, the right to avoid the transaction is permanently lost. While two years from bankruptcy commencement may seem like a reasonable timeframe, in complex cases or those involving牽連破産 (kenren hasan - bankruptcy following a failed rehabilitation or reorganization, where the starting point for the two years may relate back to the earlier proceeding), careful management of these deadlines by the trustee is essential.

Conclusion

Exercising the Right of Avoidance (Hinin-ken) is a critical function of the Japanese bankruptcy trustee, involving a careful blend of investigation, negotiation, and, when required, formal legal action. From the initial demand for voluntary return to the strategic choice between a simplified "Petition for Avoidance" and a full "Action for Avoidance," the trustee navigates a detailed procedural landscape. The availability of provisional remedies and the mechanism for registering the avoidance of transactions concerning registered assets further strengthen the trustee's ability to effectively recover assets for the estate. These powers, subject to strict time limits, are vital for ensuring that the bankruptcy process achieves its goals of maximizing creditor returns and promoting fairness among all stakeholders.