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Japanese Usury Regulation Not Applicable to Corporate Bonds

Article 1 of the Interest Rate Restriction Act of Japan (Act No. 100 of 1954) provides to the effect that the interest rate on a loan of money may not exceed:

1. 20% per annum, if the principal amount of the loan is less than JPY100,000;

2. 18% per annum, if the principal amount of the loan is JPY100,000 or more but less than JPY1,000,000; or

3. 15% per annum, if the principal amount of the loan is JPY1,000,000 or more.

It is generally held that these maximum interest rate restrictions are intended to protect borrowers from an unduly high interest rate. In January 2021, the Supreme Court of Japan held that such restriction shall not in principle apply to corporate bonds (Judgment of 26 January 2021, Supreme Court of Japan; the "2021 SC Judgment"), which means that bonds may bear interest at a rate higher than the maximum rate permissible under Article 1 of the Interest Rate Restriction Act (the "Maximum Permissible Rate"). This article analyzes the 2021 SC Judgment.

Facts

The facts of the 2021 SC Judgment are as follows:

1. Company X (the "Issuer") is a Japanese corporation (kabushiki kaisha) that engages in the development of systems relating to financial investment.

2. The Issuer offered to issue bonds in order to raise funds for the development of new systems. The Issuer allotted the bonds (the "Bonds") to Person Y (the "Defendant"), who purchased the bonds and subscribed JPY20,000,000 therefor in 2012. Thereafter through 2015, the Issuer paid interest on the Bonds in an amount in excess of the amount calculated at the Maximum Permissible Rate (15% per annum, in this case) as well as redeemed the principal of the Bonds to the Defendant.

3. During the period from March 2012 to November 2015, the Issuer issued 203 series of bonds (including the Bonds) in total. Each series of bonds was issued to a single purchaser only. Most of such bonds provided for an interest rate higher than the Maximum Permissible Rate.

4. In April 2016, the Issuer was declared bankrupt, and the bankruptcy trustee (the "Trustee") was appointed in respect of the Issuer.

The Trustee alleged that any interest amount the Issuer paid to the Defendant in excess of the amount calculated at the Maximum Permissible Rate may not be treated as lawful interest payment but should be applied to partially redeem the principal of the Bonds. If an excessive amount is so applied to the principal, the Bonds would have been entirely redeemed before their stated maturity and there would have been a surplus amount (i.e., overpayment of interest). The Trustee sued the Defendant to demand that the Defendant refund such surplus amount to the Trustee. The lower court (the Tokyo High Court) dismissed the Trustee's claim. The Trustee filed an appeal with the Supreme Court of Japan.

Supreme Court Judgment

The Supreme Court affirmed the appellate court's judgment, noting the following points:

1. While a bondholder's claim under corporate bonds is similar to a lender's claim under loan transactions, corporate bonds are different from loans in that bonds are issued in accordance with the formalities provided under the Companies Act of Japan (Act No. 86 of 2005). In addition, corporate bonds are "securities" within the meaning of the Financial Instruments and Exchange Act (the "FIEA") of Japan (Act

No. 28 of 1948) and their issuance and distribution are regulated thereunder to ensure the fairness of the transaction.

2. The maximum interest rate limit on a loan under the Interest Rate Restriction Act is intended to prevent a lender from exploiting a debtor (who is assumed to be in an economically weaker position) by charging an unduly high interest rate. On the other hand, corporate bonds are issued by a company to raise operational funds in accordance with the terms and conditions established by the company. The issuer of bonds does not need to be protected by the Interest Rate Restriction Act. As such, the issuer should be able to freely design the terms and conditions of bonds and, in particular, determine the interest rate without restriction under the Interest Rate Restriction Act.

3. However, in an exceptional case where bonds are deemed to have been issued to circumvent the restriction on the maximum interest rate under the Interest Rate Restriction Act (for example, if a prospective bondholder has induced a company to issue bonds for the purpose of earning interest at a rate higher than the Maximum Permissible Rate), such restriction would apply to bonds.

4. In the case at hand, no such exceptional circumstance as stated in item (3) above is found. Accordingly, the restriction under the Interest Rate Restriction Act does not apply to the Bonds. Therefore, there would be no overpayment of interest and the Trustee's claim for the refund of any surplus amount should be dismissed.

Analysis

There has been a controversy as to whether the restriction on the maximum interest rate under the Interest Rate Restriction Act would apply to bonds issued by a corporation. Some law scholars say such restriction should apply to bonds as well, since the obligation of a bond issuer to redeem the principal thereof and pay interest thereon is similar to the borrower's obligation under a loan transaction. Others say, however, such restriction should not apply to bonds, which are "securities" and are different types of products from loans.

In the 2021 SC Judgment, the Supreme Court emphasized the difference between corporate bonds and loans. In particular, the court noted that bonds (which are "securities") are regulated by the FIEA. By contrast, loans (which are not "securities") are not regulated by the FIEA. However, it may be argued that the FIEA regulation is primarily intended to protect investors, which refers to bondholders/creditors (not issuers/debtors) in the case of bonds, so bond issuers/debtors still need to be protected by the Interest Rate Restriction Act, given its purpose of protecting those assumed to be in an economically weaker position.

Also, the court noted that a bond issuer should be able to freely determine the terms and conditions of bonds (with no restriction under the Interest Rate Restriction Act), depending on its business needs. This reasoning is persuasive if the issuer is a large-sized company. However, not all bond issuers are large-sized companies with sufficient negotiating power to determine terms and conditions as they would like. Rather, small-sized bond issuers would need to be protected by the Interest Rate Restriction Act.1

In addition, because both bonds and loans are characterized as debt, it may seem strange that bond interest would be treated differently from loan interest. Especially, in the case of the 2021 SC Judgment, the Issuer issued every series of bonds (including the Bonds) to a single purchaser. As bonds are generally supposed to be offered to multiple investors, the issuance of bonds to only one investor may be deemed to be more similar to a loan transaction and should arguably be treated in the same way as loans are treated for the purposes of the Interest Rate Restriction Act.

In any event, in the 2021 SC Judgment, the court ruled that, in the absence of any exceptional circumstances, corporate bonds may provide for an interest rate that is higher than the Maximum Permissible Rate. This would probably make it easier for bond issuers to flexibly structure profit participating bonds or indexed bonds, as the effective interest rate of these types of bonds may well exceed the Maximum Permissible Rate, depending on the business performance of the issuer or the level of underlying index. By contrast, loan transactions (which are always subject to restriction under the Interest Rate Restriction Act) may not be flexibly structured as profit participating loans or indexed loans if the effective interest rate might exceed the Maximum Permissible Rate. Incidentally, the court noted that in an exceptional case where bonds are deemed to have been issued to circumvent the restriction under the Interest Rate Restriction Act, such restriction would apply to bonds. If a company intends to issue bonds of which the interest rate may exceed the Maximum Permissible Rate, it is advisable that the deal be carefully organized so that the bonds would not be deemed to have been issued to circumvent such restriction.


1. By contrast, in the case of loan transactions, it is clear that the restriction on the maximum interest rate under the Interest Rate Restriction Act applies irrespective of whether the borrower/debtor is a large-sized or small-sized company. No one would argue that such restriction should not apply if the borrower is a large-sized company.