Practice on Asset liquidation (Securitization) through Tokutei Mokuteki Kaisha (TMK) (vol. 1)
Asset liquidation (securitization) generally refers to the transfer of assets such as real estate and receivables, by an originator to a special purpose vehicle (SPV), such as a corporation, partnership, or trust, established or operated for the purpose of owning, managing, or/and disposing of specific assets, and raising funds from the future cash flow generated by the management and disposal of those assets.
Corporations and trusts are used as asset holding SPVs. Of these, a corporation used as SPV is generally referred to as "Special Purpose Company" or "SPC". The main types of corporations used as SPC in Japan are Kabushiki Kaisha (KK) under the Companies Act, Godo Kaisha (GK) under the Companies Act, and Tokutei Mokuteki Kaisha (TMK) under the Law Concerning Asset Liquidation (hereinafter referred to as the "Law" or the "Asset Liquidation Law").
For example, in the case of real estate liquidation in Japan, GK is often used as an asset holding SPV. In such cases, so-called GK-TK schemes are often structured as follows.
(i) The originator trusts the real estate it owns to a trust company or trust bank and acquires trust beneficiary interests in real estate.
(ii) The originator enters into a trust beneficiary interest sale and purchase agreement with GK.
(iii) GK procures funds by borrowing from financial institutions and by entering into anonymous association agreements (Tokumei Kumiai agreements/TK agreements) to solicit investments.
(iv) GK uses the procured funds to pay the originator for the trust beneficiary interest and acquires the trust beneficiary interest in real estate.
(v) GK repays the borrowed funds and pays dividends to the TK investors by managing and disposing of the acquired assets.
The features of GK-TK scheme are as follows: (i) GK acquires and holds the trust beneficiary rights, not the actual real estate, for the purpose of reducing taxes and avoiding being required to obtain permits and approvals under the Act on Specified Joint Real Estate Ventures; (ii) investors make contributions by entering into TK agreement under the Commercial Code; and (iii) since the equity interest based on the TK agreement is regarded as securities under the Financial Instruments and Exchange Law, measures to comply with regulations under the Financial Instruments and Exchange Law (e.g., regulations on private placements, regulations on investment management business, etc.) such as consignment of handling of private placements to Type II Financial Instruments Business Operators, notification of specially permitted business for qualified institutional investors, etc., and measures to comply with regulations on investment management business, etc. are required.
Asset liquidation by Tokutei Mokuteki Kaisha (TMK)
In addition to GK-TK scheme, asset securitization using a "Tokutei Mokuteki Kaisha (TMK)" is also actively conducted in Japan.
A TMK is a legal entity established under the Law on Liquidation of Assets for the sole purpose of conducting asset liquidation and business incidental to asset liquidation (Article 2, Paragraph 3 and Article 13 of the Law).
"Asset liquidation", which is the purpose of TMK, refers to a series of actions in which TMK acquires specified assets with funds procured through asset-backed securities such as specified bonds and preferred equity investments, and/or specified purpose borrowings, etc., and uses the proceeds from the management, operation and disposal of the specified assets to fulfill obligations related to asset-backed securities and specific purpose borrowings, as well as to distribute profits and redeem asset-backed securities. "Asset-backed Securities" refers to preferred equity investments and specified bonds, etc. "Specified Assets" refers to assets acquired by a special purpose company as part of operations related to asset liquidation, such as actual real estate and trust beneficiary interests in real estate acquired by a TMK.
A Tokutei Mokuteki Kaisha (TMK) has the following features.
(i) TMK may not engage in any business other than asset liquidation and its incidental businesses.
(ii) The liquidation of assets must be conducted in accordance with a document called an “asset liquidation plan” submitted to the authorities (Article 195 of the Act).
(iii) The method of financing is limited to certain financing methods such as the issuance of the Asset-Backed Securities (preferred equity, specified bonds, etc.) or specified borrowing, etc. (for this reason, a special purpose company cannot acquire Specified Assets with funds from TK investors).
There are a wide range of issues that need to be taken into consideration when proceeding with the liquidation of assets using a TMK, including notification to the authorities at certain stages and restrictions on the scope of business.
Advantages and disadvantages of using a Tokutei Mokuteki Kaisha (TMK)
The advantages of using a Tokutei Mokuteki Kaisha (TMK) as an asset holding SPV for asset liquidation include the following points.
(i) TMKs must conduct asset liquidation in accordance with the asset liquidation plan submitted to the authorities, and there are penalties for violating the plan. Therefore, investors can trust that TMKs would not violate the asset liquidation plan and do anything against it.
(ii) There are preferential tax treatment measures, such as the inclusion of the amount of profit distributed to preferred equity members into deductible expenses under certain conditions, and reduction of registration and license tax and real estate acquisition tax under certain conditions.
(iii) When TMK acquires real estates as Specified Assets, it is possible to avoid the application of laws and regulations that apply to other SPVs (e.g., regulations under the Act on Specified Joint Real Estate Ventures and The Law on the Acquisition of Residential Property) (in other words, it is relatively easy to liquidate the actual real estate).
(iv) Since it is legally planned to be used as a vehicle for liquidation, the risk of denial of legal personality, etc. is small.
On the other hand, there are some disadvantages as follows.
(i) The procedures required under the Law on Liquidation of Assets, such as notification of commencement of business and notification for changes of the asset liquidation plan etc., are more complicated (compared to the GK-TK scheme, for example).
(ii) There are certain restrictions on the acquisition of additional Specified Assets.
Flow of liquidation of assets using a Tokutei Mokuteki Kaisha (TMK)
The general flow of asset liquidation using a Tokutei Mokuteki Kaisha (TMK) is as follows:
(i) Establishment of a Tokutei Mokuteki Kaisha (TMK);
(ii) Conclusion of a purchase agreement for Specified Assets and conclusion of an asset management and disposition agreement (AM agreement);
(iii) Preparation of asset liquidation plan and notification of commencement of business to the authority;
(iv) Application for tax reduction certificate (reduction and exemption of registration and license tax and real estate acquisition tax);
(v) Conclusion of preferred equity subscription agreement, issuance of custody certificate, and registration of preferred equity issuance;
(vi) Conclusion of terms and conditions and underwriting agreement for specified bonds, and issuance of specified bonds;
(vii) Procure funds through specified borrowing; and
(viii) Acquisition of Specified Assets.
The timing of (iv) through (vii) may vary or any of (iv) through (vii) may not be carried out.