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Wednesday, June 25, 2003
GUARANTOR LEFT HOLDING THE BAG OF DEBTS
Bankruptcy protection shifts burden to cosigner
By TOMOKO OTAKE
Print shop owner Yoichi Iwasaki let out a deep sigh of relief when he filed for court protection from creditors in April 2002, but little did he realize that was not the end of his troubles.
The action, taken under civil rehabilitation laws, cut his firm's debt by 80 percent while allowing it to keep running. It also freed Iwasaki from the nerve-racking, month-to-month pressure of trying to raise funds.
Iwasaki may have felt he was off the hook, but the buck was instead passed to his wife, his sister, her husband and one of his acquaintances who were joint guarantors for his debts.
The creditor banks now pounced on them.
Iwasaki's sister and her husband were told to repay 13 million yen on his behalf or have their home auctioned off, and they are still in negotiations with creditors.
The brother-in-law suffered a stroke a week later, a calamity Iwasaki blames on his bankruptcy proceedings.
"I know I'm responsible for my own mistakes," said the 58-year-old president of Printon in Koto Ward, Tokyo, a business founded by his father in 1930. "But other people? My wife doesn't even have a job."
As banks scurry to get rid of bad loans, owners of many small and midsize businesses are paying a big price -- both financially and emotionally -- for a clause in their loan contracts that they, their relatives or friends must offer whatever personal belongings are available to repay debts if things go awry.
Some argue that in exercising the clause, banks are being immoral since they are effectively the only game in town. In the absence of venture capitalists and other investors in postwar Japan, smaller companies have had no other means to get funds.
The history of the personal guarantee goes all the way back to the Meiji Era inception of banking in Japan.
The practice usually comes into play in lending to small, unlisted businesses, whose financial conditions are harder to assess than big listed firms.
A survey by the Small and Medium Enterprise Agency last year found that of firms with 20 or fewer employees, 86.8 percent, or 1,032 companies, had agreed to guarantee their loans. The corresponding figure for companies with at least 301 employees was 30 percent, or 173 firms.
Iwasaki, whose business is now getting back on track, himself has cosigned a loan for two business partners.
"It's so common you basically can't say no if someone asks you to become a guarantor," he said. "If you do, people would call you a miser."
Signing on as a guarantor was not a big problem while asset prices were rising. But with the burst of the bubble economy more than a decade ago and chronic deflation following in its wake, many people with failed businesses find themselves incapable of paying off debts, even after liquidating their factories and equipment, emptying out their savings and giving up their homes.
Some are so overcome with guilt over the misery they have caused their guarantors that they commit suicide and let their life insurance policies make up for the shortfall, according to Yoshiteru Iwai, a retired banker with the government-affiliated Shoko Chukin Bank who now advises small businesses.
"Someone once asked me, 'Why do Japanese businessmen commit suicide (when they go bankrupt)?' " he said. " 'Is it because of the stigma?'
"I believe (many) kill themselves not just because their businesses have gone bust, but because their failures would leave them and others penniless."
While there are no statistics to show just how many of the 30,000-plus suicides a year can actually be attributed to loan guarantees, many experts say the long-standing practice at least partly explains why few people in Japan whose business has failed manage to stage a comeback.
Only 13 percent of bankrupt business owners here start anew as entrepreneurs, while the small enterprise agency points to a survey showing that in the U.S., nearly half of those who have failed get a new operation up and running.
Under existing laws, creditors can seize everything but 210,000 yen in cash, plus basic items such as clothing, furniture and kitchenware, from bankrupt business owners.
In the U.S., federal laws mandate that bankrupt entrepreneurs be left with real estate worth $17,000 for living, assuming the property has not been put up as collateral, according to agency officials.
Iwai argued that the personal guarantee system must be abolished both to stem the rise in suicides and to give business owners a second chance. He said this would be the simplest, most cost-effective way to turn around the economy.
"It is unfair that lenders can avoid shouldering risk" for their loans, said lawyer Tateo Shimizu, who also offers support for small firms in trouble. "It is also unfair that smaller enterprises have received little help when many corporate giants -- ranging from general contractors to supermarket chain Daiei Inc. -- have had massive amounts of debts forgiven (by banks)."
Although there is increased awareness of the problem, change is slow. In a set of proposals for early revival of businesses released in February, the Ministry of Economy, Trade and Industry said lenders should limit guarantor responsibility -- both in terms of the amount and the period of time the guarantor should be bound.
Meanwhile, a Financial Services Agency study group plans to unveil in August an alternative style of small- and middle-market corporate finance that "does not overly rely on collateral or guarantee," although details of the scheme are still unclear.
In a March report, the FSA panel noted that joint guarantors are being asked to shoulder excessive burdens, and that troubled businesses are so fearful of banks exercising the guarantor clause that they often end up not seeking outside help until it is too late.
Separately, an advisory panel to the Justice Ministry is looking to revise bankruptcy laws so that owners of failed businesses are left with more money. The panel has agreed to raise the 210,000 yen floor, with specific proposals to come around August.
But government officials say they are reluctant to completely abolish the guarantor system.
Yuya Omokawa of the small enterprise agency's business environment department said a loan contract is a civil agreement and leaves little room for government intervention. He added that, if a practice that is so prevalent is suddenly banned, banks might tighten credit, which would make fundraising even harder for smaller firms.
Even some businesspeople are against changing existing rules. Yoto Hama, a 60-year-old welder in Ota Ward, Tokyo, where many small enterprises are concentrated, said if owners are let off the hook for their failures, "someone will definitely try to abuse the system."
"Business owners should stop whining and think of ways to maintain their competitive edge," he said.
Meanwhile, some experts say banks rely on the guarantor system because of the country's low interest rates.
"The reason we have such a silly custom is because of the flat yield curve," observed Takehiro Sato, executive director at Morgan Stanley Japan. "If banks could charge interest rates that could cover potential credit costs, they wouldn't need a full guarantee. We calculate the break-even point for loans (to smaller companies) to be about 14 percent. Banks currently charge 2 percent."
Junichiro Koshi, a former banker with Industrial Bank of Japan who now holds executive positions at several firms, including Akita-based medical software firm Sigma Solutions Inc., slammed the guarantor system as a "human rights violation."
Yet Koshi, who himself was asked by a bank to guarantee a loan after landing a job at Sigma in 2000, said the practice is part of a bigger problem.
"In Japan, any auditor would admit in private that a majority of firms cook their books," he said. "Because the books are full of lies, banks cannot (accurately) evaluate the financial standings of borrowers. That's why they demand collateral and guarantors."
The problem will only be resolved, he said, when the government abolishes the guarantor system and gets tough on auditors so financial records will be more credible.