The scope for modifying or reshaping substantive law in light of the realities of insolvency law

When watching the news, you may come across headlines such as “Company X has gone bankrupt” or “Company Y has entered insolvency proceedings.”

The term insolvency or bankruptcy refers to a situation in which a company’s management has failed, forcing it to choose between liquidation and reorganization.

The subsequent insolvency proceedings begin when the debtor, facing severe financial distress, is no longer able to make payments to creditors.

Their purpose is to distribute the debtor’s limited assets fairly and equitably among all creditors.

However, “fair and equitable distribution” does not mean that each creditor receives the same amount of money.

Rather, the substantive nature of each creditor’s claim and the amount of the claim are taken into account.

As noted above, the framework of insolvency law is, in principle, based on substantive law (essentially the Civil Code), which defines the content of rights and obligations as well as the conditions under which they arise, change, or are extinguished.

At the same time, the commencement of insolvency proceedings means, as previously explained, that the debtor has only a small pool of assets remaining, which must be distributed fairly and equitably among all creditors. This is an urgent and pressing situation.

In such circumstances, there is room to consider whether the strict framework and logic of substantive law need not always be respected. They may justifiably be modified or reshaped in accordance with the particular realities of insolvency law.

The theory known as insolvency law reconstruction affirms such modification and transformation.

Potential Challenges in Substantive and Insolvency Law After Legal Reforms

One example of a situation in which such modifications or reshaping of substantive law become problematic is the treatment of atypical security interests in insolvency proceedings.

Atypical security interests are those not expressly provided for in the Japanese Civil Code as typical security rights, such as mortgages or pledges, but which, by agreement between the parties, function in much the same way as a security interest.

Examples include security by way of assignment and retention of title (though these have since been codified by statute).

At least in formal legal terms, these arrangements take the form of attributing ownership of the property to the creditor.

For instance, under a retention of title, the seller retains ownership of the object of sale (for example, a car) until the buyer has paid the purchase price in full—in other words, ownership does not pass to the buyer until payment is complete.

In the past, some emphasized this formal legal structure and argued that, when insolvency proceedings were commenced against the buyer, the seller should be treated as entitled to reclaim the property.

Today, however, the prevailing view is that such arrangements should be treated as security interests (the right of separate satisfaction theory).

The revisions to the Civil Code and related legislation sought to align, as far as possible, the framework of substantive law with that of insolvency law—for example, in the treatment of the avoidance of fraudulent acts and the right of avoidance.

Nevertheless, even after the revisions, there remain situations in which discrepancies can arise between a substantive law framework and an insolvency law framework —for example, in cases involving set‑off or finance lease contracts. How should these conflicts be resolved through interpretation? Or, if the two frameworks are not aligned, what grounds can justify that divergence? Such difficult and complex questions still remain.

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Department of Law and Politics, Graduate School of Law and Politics

Assistant Professor
Kaito Kato

He completed coursework and withdrew from the Doctoral Program, Waseda University, Faculty of Law.