My Japanese Sole Proprietor Client is Insolvent: How Does "Small-Scale Individual Rehabilitation" (Shokibo Kojin Saisei) Apply to Business Owners?

Japanese Attorney at Law - Bengoshi L.L.

• 9 min read

Sole proprietors and individual business owners in Japan who face insolvency often confront a unique set of challenges. Beyond personal financial distress, they may be deeply concerned about the continuation of their livelihood and the potential loss of essential professional licenses if they were to undergo bankruptcy. "Small-Scale Individual Rehabilitation" (小規模個人再生 - Shōkibo Kojin Saisei), a specific track within Japan's Individual Civil Rehabilitation (個人再生 - Kojin Saisei) framework, offers a pathway for these entrepreneurs to restructure their debts, retain their business, and protect their professional standing. This article explores how Shōkibo Kojin Saisei applies to business owners, detailing its eligibility, process, and strategic considerations.

Understanding Shōkibo Kojin Saisei for Business Owners

Individual Civil Rehabilitation, in general, is designed for individuals who have the prospect of earning future income but are unable to meet their current debt obligations. For business owners, the Shōkibo Kojin Saisei variant is typically the most relevant.

Key Eligibility Criteria (Civil Rehabilitation Act, Art. 221(1)):

  1. Individual Debtor: The petitioner must be an individual, which includes sole proprietors.
  2. Prospect of Future, Continuous or Repetitive Income (将来において継続的にまたは反復して収入を得る見込みがあること - shōrai ni oite keizokuteki ni matawa hanpuku shite shūnyū o eru mikomi ga aru koto): This is a critical hurdle for business owners, whose income may not be as regular or predictable as a salaried employee's. The court needs to be convinced that the business can generate sufficient income to meet both ongoing business/living expenses and the payments under a rehabilitation plan. For instance, a real estate broker whose income is commission-based and sporadic (e.g., a significant sale every few months) might still qualify if they can demonstrate a consistent pattern of such earnings over time and a reasonable expectation of its continuance (as seen in one illustrative case where income stemmed from consistent referrals from a former employer).
  3. Debt Ceiling: The total amount of "rehabilitation claims" (再生債権 - saisei saiken—generally unsecured debts, excluding any mortgage treated under a residential mortgage special clause and certain other priority debts) must not exceed ¥50 million.

Why Shōkibo Kojin Saisei over Bankruptcy or Salary Earners' Rehabilitation?

  • License Retention: A primary motivator for business owners to choose Kojin Saisei over personal bankruptcy (jiko hasan) is the preservation of professional licenses. Certain licenses essential for conducting business (e.g., a real estate transaction license - 宅地建物取引士 - takuchi tatemono torihikishi, as in Case 8) can be grounds for disqualification or non-renewal if the holder becomes bankrupt. Civil Rehabilitation generally does not carry these same automatic disqualification consequences.
  • Business Continuation: Kojin Saisei is designed to allow the debtor to continue their economic activities, including their business operations, while repaying debts under a court-approved plan.
  • Inapplicability of Salary Earners' Rehabilitation: The "Salary Earners' Rehabilitation" (Kyūyo Shotokusha-tō Saisei) track is generally not suitable for sole proprietors due to its requirement for highly stable and predictable income, which is uncharacteristic of most business earnings.

The Initial Steps: Consultation and Pre-Filing Preparations for Business Owners

When a sole proprietor consults a lawyer for Kojin Saisei, the initial phase involves a rigorous assessment of both personal and business finances.

1. Assessing Business Viability and Income Stability:
The lawyer must thoroughly evaluate the ongoing viability of the client's business. This involves:

  • Reviewing business financial records, including past tax returns (確定申告書 - kakutei shinkokusho), profit and loss statements, balance sheets, and cash flow projections.
  • Understanding the sources of business income, its regularity (or lack thereof), and the factors influencing it.
  • Identifying the causes of the current financial distress (e.g., business downturn, specific bad debts, over-investment, personal debts draining business resources).

2. Comprehensive Financial Documentation:
Sole proprietors need to gather a more extensive set of documents compared to salaried employees, covering both their personal and business finances:

  • Business Records: Accounting books, bank statements for business accounts, major contracts, lists of business assets (equipment, inventory, receivables), and business liabilities (trade payables, business loans).
  • Personal Finances: Personal bank statements, asset details, household budget, list of personal creditors.
  • Income Proof: Several years of tax returns are crucial for demonstrating an income track record. For income earned since the last tax return, evidence such as client contracts, invoices, and bank deposits may be required.

3. Identifying All Debts:
It's critical to list all debts, clearly distinguishing between those incurred purely for the business, purely personal debts, and those where the distinction might be blurred (e.g., personal guarantees for business loans, or personal loans used to fund the business). In Kojin Saisei, all of the individual proprietor's debts (business and personal) are generally subject to the procedure.

4. Court Costs and Potential Trustee Fees:
The lawyer will explain the anticipated court costs, including filing fees (e.g., around ¥10,000), a court deposit for administrative expenses (e.g., around ¥12,000), and postal stamp fees. If the court (like the Tokyo District Court) routinely appoints a Rehabilitation Trustee/Supervisor (Saisei I'in - 再生委員), a separate fee for this appointee (e.g., around ¥150,000 in Tokyo, potentially payable in installments) must also be budgeted for. The debtor must prepare to make these "performance test" payments to the trustee's account shortly after filing.

1. Filing the Petition:
The petition for Shōkibo Kojin Saisei will include specific details and documentation relating to the business. The lawyer will assist in preparing all necessary forms, including asset schedules that clearly delineate business and personal assets, comprehensive creditor lists, and financial statements for both the individual and their business activities.

2. The Role of the Rehabilitation Trustee/Supervisor (Saisei I'in):
If a saisei i'in is appointed (which is standard practice in some major courts like Tokyo), they will play a key role in scrutinizing the sole proprietor's case. Their focus will include:

  • Verifying Income: Closely examining the evidence of current and future business income. They may request additional documentation beyond tax returns, such as contracts with key clients, evidence of ongoing projects, or statements from regular referrers of business (as was requested in Case 8 regarding the debtor's relationship with a former employer who provided work).
  • Assessing Business Expenses: Reviewing the legitimacy and necessity of claimed business expenses.
  • Evaluating Plan Feasibility: Determining if the business can realistically generate enough net income to cover ongoing business operational costs, the proprietor's personal living expenses, and the proposed payments under the rehabilitation plan.
    The debtor and their lawyer will typically meet with the saisei i'in early in the process to discuss these matters.

3. Proving "Continuous or Repetitive Income":
This is often the most significant challenge for sole proprietors. Unlike salaried employees with regular paychecks, business income can be irregular and unpredictable. To satisfy the court and the saisei i'in, the debtor must demonstrate:

  • A credible track record of past earnings (e.g., through several years of tax returns and bank statements).
  • A realistic projection of future income, supported by evidence such as existing contracts, a stable client base, a strong business plan, or, as in Case 8, an established referral system.
  • That periods of low income are balanced by periods of higher income, resulting in an average income sufficient to support the rehabilitation plan.

Crafting the Rehabilitation Plan (Saisei Keikaku-an) for a Business Owner

The rehabilitation plan is the roadmap for the debtor's financial recovery.
1. Determining the Repayment Amount:
The total amount to be repaid to unsecured creditors is generally the higher of:

  • Statutory Minimum Repayment Thresholds (Art. 231(2)(3),(4)): This is based on a sliding scale related to the total amount of unsecured rehabilitation claims. For example, if total claims are between ¥5 million and ¥15 million, the minimum repayment is one-fifth of the claims. In Case 8, with claims around ¥33.9 million, the statutory minimum was one-tenth, approximately ¥3.4 million.
  • Liquidation Value Guarantee Principle (Seisan Kachi Hoshō Gensoku; Art. 231(1), 174(2)(4)): The plan must provide for payments totaling more than what creditors would receive if the debtor's assets were liquidated in a bankruptcy proceeding. For a sole proprietor, this "liquidation value" includes the net realizable value of both personal and non-exempt business assets. Business goodwill, if it has a transferable market value, might theoretically be included, though this is often difficult to quantify for small sole proprietorships.

2. Repayment Term and "Special Circumstances":
The repayment period is typically three years. However, if "special circumstances" exist that make a three-year repayment unduly burdensome, the term can be extended up to a maximum of five years (Art. 229(2)). For a sole proprietor with fluctuating income, demonstrating that the higher monthly payments required for a three-year plan are not reliably sustainable can constitute such "special circumstances," justifying a five-year plan. This was the approach taken in Case 8, where the debtor opted for a five-year plan to make monthly payments more manageable.

3. Balancing Business and Personal Finances in the Plan:
The plan must realistically account for:

  • Ongoing Business Operating Expenses: Rent for business premises, utilities, supplies, etc.
  • The Proprietor's Personal Living Expenses: Household costs, family needs.
  • Plan Payments: The agreed-upon installments to rehabilitation creditors.
    The saisei i'in and the court will scrutinize the proposed household and business budgets for reasonableness.

4. Treatment of Business Assets:
Kojin Saisei generally allows the sole proprietor to retain assets necessary for continuing their business, provided the liquidation value guarantee is met (i.e., creditors receive at least as much as they would if those assets were sold in bankruptcy). If specific business assets are encumbered by secured debt (e.g., a lien on equipment), separate arrangements with the secured creditor (like a betsujo-ken kyōtei - 別除権協定, or separate payment agreement) may be needed if the asset is to be kept and the secured debt is not fully covered by the asset's value.

Creditor Involvement and Plan Approval

1. The Creditor List and "Deemed Filing" (Minashi Todokede):
The accuracy of the creditor list (債権者一覧表 - saikensha ichiranhyō) submitted by the debtor is paramount. Under the "deemed filing" system (Art. 225), if a creditor does not formally file a proof of claim within the court-stipulated period, their claim is generally deemed to be filed in the amount and nature stated in the debtor's list. Any errors or omissions in the debtor's list can therefore have significant consequences. It's common practice for the debtor's lawyer to indicate on the submitted list that the debtor reserves the right to dispute or object to the listed claims (igi no ryūho - 異議の留保).

2. Plan Voting and Approval (for Shōkibo Kojin Saisei):
The proposed rehabilitation plan is sent to all rehabilitation creditors. They are given an opportunity to vote (often by written resolution). The plan is approved if it is not rejected by:

  • More than half in number of the creditors who are entitled to vote and who exercise their voting rights, AND
  • Creditors whose voting rights (generally proportional to their claim amounts) represent more than one-half of the total voting rights of those exercising their vote.
    (Note: The PDF's phrasing for approval in Case 8 on page 300 is based on non-rejection by certain majorities of those who do vote, aligning with the Civil Rehabilitation Act Art. 230(6) which outlines conditions for deemed approval if sufficient objections are not lodged). Active consent from all is not required; rather, a lack of sufficient dissent leads to approval.

3. Court Confirmation:
If the plan receives the necessary creditor approval (or non-rejection) and meets all statutory requirements (including feasibility and the liquidation value guarantee), the court will issue an order confirming the plan (認可決定 - ninka kettei; Art. 231). The confirmed plan is binding on all rehabilitation creditors.

Specific Considerations for Sole Proprietors

  • Intermingling of Business and Personal Debts: Unlike corporate rehabilitation, Kojin Saisei for a sole proprietor addresses all of the individual's debts, whether they arose from business activities or personal life.
  • Continued Business Operation: The debtor continues to run their business throughout the proceedings, subject to certain restrictions (e.g., significant transactions may require court or saisei i'in approval). This requires careful cash flow management.
  • Treatment of Non-Dischargeable Personal Claims: Even as a business owner, the individual remains liable for certain non-dischargeable personal claims (as defined in the Bankruptcy Act and applied to Kojin Saisei via Art. 232(4) and other provisions). For example, if the proprietor has outstanding marital expense obligations (kon'in hiyō - 婚姻費用) or child support, these are generally not reduced by the plan and must be paid. The rehabilitation plan needs to account for how these will be handled, often by providing for their full payment, potentially after the plan period for the reduced debts is completed, or by ensuring the plan payments themselves do not jeopardize these priority obligations.
  • Taxes and Social Security: Business-related and personal taxes and social security contributions are typically treated as priority claims and must be paid in full, often through negotiated installment plans with the relevant authorities, alongside or outside the main rehabilitation plan payments.

Conclusion

Shōkibo Kojin Saisei provides a vital mechanism for insolvent sole proprietors in Japan to restructure their debts while continuing their business and, importantly, often retaining necessary professional licenses. The process demands a rigorous demonstration of future income viability, particularly for those with irregular business earnings, and involves careful navigation of both business and personal financial obligations. With thorough preparation, realistic planning, transparent cooperation with the court and any appointed Rehabilitation Trustee/Supervisor, and skilled legal counsel, it offers a significant opportunity for entrepreneurial individuals to achieve a financial fresh start and sustain their livelihood.