I.            Introduction
Refinancing can be a good option for parties seeking to gain improved terms and conditions of existing loan arrangements. For example, in order to achieve a better gearing ratio and partial return of capital, a borrower of the project financing of a power plant might consider refinancing for the purposes of lowering the interest rate and the required DSCR after a certain period of time following the commencement of the operation given that the risk profile of the operational phase is different from the development phase.

For the refinancing of syndicated loans, which involves changing some of the syndicate members, some may be familiar with the amendment and restatement (“A&R”) method used in other jurisdictions where the parties and terms and conditions of the existing loan agreement are changed globally and only the increased portion of the loan (if any) is newly extended without the repayment of the existing loan. Despite certain economic benefits of the A&R approach, it has not been widely adopted in the Japanese banking sector. Instead, it is more common to see a traditional physical refinancing approach with the existing loans repaid in full at the same time as the extension of new loans and replacing the original financing documents with new financing documents. This article summarizes the practical characteristics and matters to be considered when adopting the A&R approach to refinancing in Japan.

II.           Why the A&R Approach is Preferable

There are a number of reasons why the A&R approach is more preferable than the traditional physical refinancing. Below are four of the most common:

(i)                Saving of mortgage registration tax

If a mortgage has been given to the lenders under the existing loans, the same is often required by the refinancing lenders. Since the registration tax for the transfer of an existing mortgage is lower than the registration of the establishment of a new mortgage[1], the A&R approach can be more cost efficient.

(ii)               Avoiding break-funding costs

A borrower is usually required to pay break-funding costs to the lenders when the repayment of loans is made on a date other than an interest payment date of the existing loans. That means that the borrower will only be able to refinance at a date which coincides with the interest payment dates – typically three or six months. Under the A&R approach, to the extent that the loan amount after the A&R refinancing is larger than the existing loan amount, no physical repayment of the loans would occur and thus no break-funding costs would be payable. This gives the borrower additional timing flexibility when refinancing.

(iii)             Maintaining capitalized costs

As an accounting matter, certain borrowers may have capitalized the initial financing costs depending on their previous transactions. Unlike under traditional physical refinancing, capitalized costs can be maintained under the A&R approach since the existing loan facility will continue to exist notwithstanding a change to the group of lenders or certain amendments to the financing documents.[2]

(iv)             Efficient negotiations

In contrast to traditional physical refinancing where the scope of amendment to the existing terms and conditions is unlimited and the scope of negotiations could be extensive, under the A&R approach, parties would naturally prefer to maintain the existing terms and conditions to the extent that they are not relevant to the purposes of the refinancing. From a legal point of view, any amendment that could result in a change in the identity of the loans should be avoided in order to maintain the existing security interests. Therefore, taking the A&R approach could greatly enhance the efficiency of negotiations by focusing only on the purpose of the refinancing itself, and save time and costs for all parties.

III.         Why the A&R Approach is not Common in the Japanese Market

Despite the advantageous points mentioned above, the A&R approach is not generally adopted in Japanese market for the following reasons:

(i)                Individual loan transfer required

Under the A&R approach, to the extent that the contemplated refinancing involves a change in the syndicate members, loans will be transferred from existing lenders, whose participation will decrease, to other lenders, whose participation would increase upon the refinancing.

Under the Japanese Civil Code (Act No.89 of 1896, as amended), a sale and purchase (baibai) must be made between an individual seller and an individual purchaser in respect of the exact portion that is to be sold and purchased. Thus the parties have an additional burden to specify each seller and its corresponding purchaser and the amount of the loan to be transferred between each seller and purchaser in the A&R agreement. The settlement method of the sale and purchase price should also be considered as the payment from the purchaser should be made to the corresponding seller in principle.

(ii)               Security created for individual lenders

In some jurisdictions because security is given to a single entity such as the security trustee instead of each individual lender, the transfer of the loans of an individual lender would not necessitate a security transfer depending on how the security is structured. However, under Japanese law it is established market practice that an individual security interest is created for each individual lender.[3] Consequently:

• A conservative and practical interpretation of the perfection method of creating a pledge over contractual rights (which is typically given to the project financing lenders regarding the borrower’s contractual rights under the project documents) would be that it is necessary to obtain a consent letter again from the counterparty to the applicable contract to perfect the pledge after the A&R refinancing. Therefore, under such interpretation, the A&R approach would not necessarily simplify the refinancing process.
• Any increased portion or other new loan (if any) must be secured by a newly created individual security interest that is separate from the security interests created in favor of the existing lenders. Since the priority order of the security interest is determined based on the timing of the perfection, if the parties intend to make the order of priority across the existing and new security interests the same, it would be necessary to change the priority of the already perfected security interests. In this respect, while there is a statutory provision for such change in the order of priority for mortgages (teitou-ken)[4], other kinds of security interests including pledges (shichi-ken) do not have a similar statutory mechanism and there is no established interpretation on how to effectuate such change.[5]

(iii)             Unfamiliarity

As the A&R approach has not been widely used in the Japanese market, some lenders may require more time to evaluate the transaction. Since the A&R agreement will involve all the existing and new lenders[6], the borrowers and the refinancing arrangers also have the task of obtaining the understanding of all the related parties.

IV.          How to Achieve A&R Refinancing

The A&R approach remains a practical and preferable option in certain circumstances. Entities interested in adopting the A&R approach would be well advised to keep the following points in mind.

(i)                Agreement on individual loan transfers

An A&R agreement will list the details of the individual loan transfers including each seller, purchaser and the amount to be transferred between each seller and purchaser. The settlement of the sale and purchase price will be made collectively through a paying agent appointed by each purchaser.[7]

The risks concerning the repayment of the loan itself should be borne by the borrower in the same manner as in traditional physical refinancing, including conditions precedent to the A&R agreement, representations and warranties, events of default and similar standard provisions.[8]

(ii)               Re-establishment of security interests excluding those concerning registration tax

Considering the legal and practical factors described in Section III (ii) above, instead of taking a universal approach across various kinds of security interests, parties can take different approaches to how mortgages and other security interests are managed. This means that, on the one hand in respect of a mortgage, parties can have the registered mortgage transferred from one lender to another and, if a new mortgage is established, create and register that new mortgage and implement the change in the order of priority under the aforementioned statutory mechanism in the Civil Code. On the other hand, as there is no similar mechanism for other security interests, parties may elect to cancel the existing security interests first and then re-establish new security interests in favor of each of the continuing and new lenders after the A&R refinancing and follow the perfection procedures anew.[9]

V.           Additional Considerations

There are several other points to be considered and documented when A&R refinancing is implemented. For instance, as the A&R structure requires the participation of all the existing and new lenders, further consideration may need to be given to what options are available if one or more of the retiring lenders rejects the A&R refinancing proposal. Managing the existing interest rate swap is also another area that requires careful consideration. Entities considering adopting an A&R approach to refinancing are recommended to take into account all the practical benefits and risks under the Japanese legal system and market practice in the Japanese banking sector.

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[1] Registration of the establishment of mortgage: 4/1,000 for a real estate mortgage, 2.5/1,000 for a factory foundation mortgage (based on the loan amount to be registered).

Transfer of the existing mortgage: 2/1,000 for a real estate mortgage, 1.5/1,000 for a factory foundation mortgage (based on the registered amount and not the remaining balance; thus a borrower may want to reduce the registered amount to the amount of the remaining balance before the application for registration of transfer).

[2] It is recommended to closely consult with accounting and tax advisers when considering A&R refinancing.

[3] Security trust is legally achievable under the Japanese Trust Act (Act No. 108 of 2006, as amended); however, it is not widely used due to certain practical reasons.

[4] Article 374 of the Civil Code.

[5] As a matter of contract, parties may agree on changes in the order of priority of security interests other than a mortgage. However, such agreement may not be honored in a Japanese court if the security is foreclosed. If parties are to make such an agreement, they should also consider whether to include an equalization clause under which the proceeds from the foreclosure of the securities are shared by the existing lenders, who the court has determined has the higher priority ranking and who actually receives the proceeds, with the new lenders who the court has determined has the lower priority ranking. Under this arrangement, the new lenders assume part of the credit risk of the existing lenders. However, this remains a practical option to the extent that the new lenders consider that (i) in-court foreclosure is a highly unlikely scenario, and (ii) it is also a highly unlikely situation that an existing lender receives the enforcement proceeds while it is insolvent and it goes bankrupt before it delivers the enforcement proceeds in accordance with the equalization provision.

[6] All the retiring lenders are required to be party to the A&R agreement since they are the transferor lenders. All of the remaining lenders are also required to be party to the A&R agreement since it typically involves matters that require all lenders’ consent under the existing financing documents, such as the repayment of loans to only a part of the lenders and lowering the interest rate.

[7] It is not common for the existing agent to serve as the paying agent of a lender in respect of its sale and purchase transaction under the financing documents. Thus the A&R agreement needs to provide the authorization by each purchaser to the agent to make the payment of the purchase price to the corresponding seller.

[8] Theoretically, a transferee lender of the existing loan may bear the risk that a bankruptcy or rehabilitation proceeding is commenced with respect to the transferor lender after the A&R refinancing and the transfer is avoided (hinin) by a bankruptcy trustee (hasan kanzai-nin) or other administrator. However, to the extent that the transferor lender is a bank, such transferee lender should generally be able to consider that the practical risk is low and the legal requirements for a bankruptcy trustee or other administrator having rights of avoidance to effect an avoidance of a transaction that is conducted for a “reasonable value” (soutou no taika) are generally not easily met. Generally, it must be established that (i) the actual risk that the debtor would conceal, gratuitously convey or otherwise dispose of the property in a manner prejudicial to bankruptcy creditors existed, (ii) the debtor intended to carry out such disposition, and (iii) the other party had been aware of such debtor’s intent.

[9] Re-establishment of the security interests would be accompanied by an avoidance (hinin) risk unlike the transfer of the security interests which is irrelevant to the borrower’s solvency. However, such risk would also be present in traditional physical refinancing and is not unique to A&R refinancing.