How not to lose your home when going bankrupt in Japan

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Entrepreneurs are an optimistic bunch. Why then would those considering launching a Japanese startup first wish to consider the implications of going bankrupt? The odds are heavily weighted against entrepreneurial success: 8 out of 10 business startups fail. Where management has guarantied company debt, personal bankruptcy may follow. That could lead to seizure of personal wealth including one’s home. In this article, Beacon Reports explores the consequences of going bankrupt in Japan.

Here in Japan it is common for senior managers of unlisted companies to guaranty corporate debt. If they don’t, the banks won’t loan to them. One reason is that banks can’t easily determine if small to medium sized firms (SMEs) will make enough money to repay the debt. The financial statements of SMEs are often unreliable. Owners routinely co-mingle personal with company assets. Startups are even more risky. Therefore company directors typically must guaranty corporate debt to obtain it.

When an SME goes bankrupt those who co-signed the corporate debt must file for personal bankruptcy if the amounts are too large to repay. Then they are likely to lose their home and most of their personal assets.

Should an individual file for personal bankruptcy in Tokyo, the Tokyo District Court appoints a trustee to manage the affairs of the bankrupt person for the benefit of the creditors. The trustee takes control over the bankrupt person’s bank account and personal assets except for small amounts. The home is sold-off to a third-party. He or she may keep any furniture along with 3 months living expenses equivalent to about $10,000. Also free from seizure are the individual’s private car and life insurance policy where the cumulative value does not exceed about $2,000.

It all sounds draconian until you consider the history of bankruptcy. In ancient Greece, a man was forced into slavery if he could not pay his debt. In England before 1572, bankruptcy was a criminal offense. The sentence was incarceration or death by hanging. Today in modern countries, people can seek protection from creditors under the law. Courts typically grant debt forgiveness on amounts above the level of one’s existing wealth.

Many people believe Japan’s bankruptcy laws are out-dated. Some think that those who face bankruptcy lose their voting rights. This is not true. In the past such individuals were barred from being company directors during bankruptcy proceedings. This recently changed. While the employment agreement between a company and a director legally terminates upon the commencement of bankruptcy proceedings, a bankrupt individual can be immediately rehired as a company director by another firm. In that regard Japan’s bankruptcy laws are more progressive than the UK’s, where a bankrupt person may not manage or promote a company without court permission (see link).

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Some people believe the US is more lenient than Japan in matters of bankruptcy. They think US managers are released from personal guaranties on corporate debt. This too is nonsense. Those who file for a straight bankruptcy in the US (under Chapter 7) obtain debt relief only on amounts above the debtor’s existing wealth, just as in Japan. In each case the bankrupt individual can keep limited assets. The two countries are philosophically similar. He or she is entitled to a “fresh start” in both nations. Debt that cannot possibly be repaid is discharged. In the US those in bankruptcy may keep limited assets of around US$ 30,000 in cash along with house and property up to a certain amount or acreage. The specific exclusions vary state by state.

The Abe government is now debating possible reform of the Civil Code to revitalize Japan’s economy. The Administration wants to encourage greater risk taking by providing a cushion to managers who would otherwise be forced into bankruptcy when their firms collapse. Under the proposed reforms, managers of SMEs could in part be released from personal guaranties on corporate debt under certain yet to be determined conditions.

Reformation of Japan’s Civil Code involves lengthy discussions that will take years. As a stop-gap measure, the Administration issued guidelines to banks on December 5th 2013. The guidelines, basically a gentlemen’s agreement among Japan’s major banks, request that managers be released from personal guaranties on corporate debt without triggering personal bankruptcy. Debtors who make full disclosure of their personal assets and pay what debts they can might be entitled to loan forgiveness. In theory they could keep their homes, furniture, life-insurance and some cash in amounts greater than under the current exemptions. As they would not declare bankruptcy, the managers’ credit ratings might not be affected. The guidelines do not carry the force of law and it is still too early to determine how the banks will interpret or act upon them.

Although reform of Japan’s Civil Code raises the potential of introducing yet another form of moral hazard into Japan’s economy, there are upsides: In addition to encouraging entrepreneurship, it could pave the way to cleaning up Japan’s sea of zombie companies. With a cushion in place for managers of failed businesses, the Administration could buffer the impact to the greater economy when it finally acts to pull the plug on Japan’s insolvent companies.

Note: In the US 816,271 individuals filed for personal bankruptcy under Chapter 7 in 2012 versus 92,552 ‘equivalent’ filings in Japan. 

Applying for bankruptcy is quick, easy and inexpensive. When the CEO files for bankruptcy together with the company in Tokyo District Court, the total filing cost is about $2,000. Along with legal fees amounting to about $8,000, the total cost can be less than $10,000. Proceedings take about 6 months.

There are, of course, disadvantages to filing. Those in bankruptcy need to explain to their colleagues and relatives why they chose their course of action. In Japan, especially among those middle-aged and older, the stigma of being bankrupt is severe. This is a country where bad debt is nearly nonexistent. CEOs have been known to commit suicide rather than face the shame of bankruptcy.

Once a filing is made, the status of the bankrupt individual is entered into the database of various credit agencies. He or she will be unable to use a credit card or borrow money. Further, banks may be reluctant to extend a loan to a company that is managed by a director who has filed for bankruptcy in the past.

If you are thinking of guarantying corporate debt, here is one legal measure you can take to protect an important asset – your home. It is difficult or impossible for a trustee to seize property held in joint ownership by husband and wife. That’s because no one will buy a home which has shared ownership. The trustee has the burden of either trying to buy the non-bankrupt spouse’s portion or to sell the bankrupt spouse’s estate portion to the non-bankrupt spouse. The spouse does not need to cooperate. Trustees typically give up trying.

If title to the property is not already in your spouse’s name why not take advantage of the one-time spousal allowance under Japan’s gift tax legislation to make it so? Under this law about $200,000 (¥20 million) of property can be gifted by one spouse to another free of gift tax provided the donee uses the gift as its primary residence in Japan. Alternatively, a cash gift may be given if the funds are used to buy the donee’s primary residence. To take advantage of this tax concession, the donor must have been married to the donee for at least 20 years. Be certain to make the gift early, preferably before you guaranty the company’s debt, to avoid the trustee claiming the gift ‘fraudulent’.

 

 

 

 

 

 

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