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How to Downsize Your Company

May 26, 2010

How to Downsize Your Company: Legal Issues to Consider 

After the financial crisis in the United States, the world-wide economic recession caused serious damage to many companies. Many companies were trying to survive the crisis by restructuring their businesses by mergers and acquisitions, staff layoffs, etc. Perhaps you are wondering how to downsize your company. 

For domestic Japanese corporations, one of the solutions to survive a recession is to file for Civil Organization (Minji Saisei) or Corporate Reorganization (Kaisha Kosei) under the applicable laws. Since the last recession was so serious, filing such procedures usually caused less reputational damage to companies than before.

Currently, Debtor in Possession (DIP) is one of the main procedures used because the managers usually prefer to stay in their positions and the procedure can be expedited. Please note, the Tokyo District Court recently changed the practice of Corporate Reorganization (usually used for large companys rehabilitation) to allow the courts to order discretionary implementation of DIP.

What about foreign corporations?

On the other hand, foreign corporations tend to choose different paths from domestic companies. Generally speaking, many small or medium-size foreign corporations are sole shareholders of their subsidiaries in Japan. Such corporations often prefer Voluntary Liquidation (Seisan), which in principle is not subject to court supervision. Furthermore, if it becomes clear that the assets of the company being liquidated are not sufficient to pay off its debts, or when it becomes apparent that the company is insolvent, the company has to convert the liquidation to Bankruptcy (Hasan) or Special Liquidation (Tokubeisu Seisan) which is subject to court supervision.

Except in cases of complete retreat from Japan, the company might consider transforming from a Kabushiki Kaisha (K.K.) into a representative office or branch office. Usually, a K.K. may be liquidated and a representative office or branch office established in Japan. But the following potential drawbacks should be kept in mind:

In order to continue conducting transactions in Japan, a foreign company must be registered in the Commercial Registry, and have at least one of its representatives residing in Japan (under Articles 817 and 818 of the Companies Act – “Kaisha Ho).

The new offices sometimes need to obtain new permits from the government even though the Japanese K.K. had already obtained them.

– Reputational risk, e.g. prior business partners might be reluctant to work with the company. If a company wants to understand such disadvantages in detail, the company should seek the advice of experts. In addition, the status of the companys employees has to be taken into consideration.


Generally speaking, liquidation sounds like a good justification for laying off employees. However, if the court finds that the liquidation is merely a pretext for laying off employees, then the court could judge in favor of the employees, if they take court action against the company. Therefore, there must be objectively reasonable grounds for laying off employees (The Labor Contract Act (Rodo Keyaku Ho), Article 16), and the following factors, that the courts have applied in such cases, must be considered:-

  1. The reduction of the number of employees must be necessary;
  2. The company must make best efforts to avoid the layoff(s);
  3. The selection of the employee(s) to be laid off must be objective and reasonable; and
  4. The layoff procedure must be appropriate. (See, for example, Tokyo Court of Appeal decision S54.10.29, October 29, 1979.)

At any rate, if the only aim is to reduce the number of employees, and the company wishes to continue to conduct transactions in Japan, such drastic measures as liquidation are not recommended, because the drawbacks usually outweigh the benefits in terms of cost-savings.

Downsizing a K.K.

In relation to downsizing the K.K., if a company believes layoffs are the only way for that company to cut costs, it will probably face time-consuming conflicts with its employees. There are certain steps to be taken before resorting to such drastic methods as layoffs. Especially in Japan, directors are expected to be self-disciplined enough to reduce their own salaries first. Sometimes, they even return their bonuses to the company. Such sacrifices will create an atmosphere which allows the manager to put some of the burden of cost-reduction on their staff such as by bonus cuts.

Needless to say, companies should consider reviewing the office systems in detail to identify non-essential expenses (for example, travel expense or entertainment and socializing expense) or waste and reduce such expenses. Then, if it is concluded that such expenses cannot be cut any more, the workers overtime allowance, night-shift allowances, and holiday allowances should be reduced.

 If such efforts do not significantly reduce the losses of the company, then cutting employee compensation should be considered. If bonuses (Shoyo) are not regarded as a portion of salary (Chingin) under the Labor Management Collective Agreement (Roushi Kyotei), the Rules of Employment (Shugyo Kisoku), or the Employment Contract (Rodo Keyaku), the company may usually reduce bonuses.  If bonuses are regarded as salary, the company must comply with specific procedures if the company wants to cut them. If the reduction of bonuses does not ameliorate the losses, the company might reduce salaries by a reasonable amount after obtaining the employees consent, or amending the Rules of Employment or the Collective Labor Agreement, unless the reduction will cause the salaries to fall below the national minimum standard, or the employees morale will so deteriorate that the company cannot maintain its business.

Deterioration of morale

The degree of the deterioration of morale must be really severe because employees normally acknowledge that they have to bear some hardships because of their companys losses and usually employees prefer reduction of salary to layoff due to the difficulty in finding a new job in a harsh economic climate. After a  company has taken the actions mentioned above, an atmosphere in which the employees can foresee the risk of layoffs will probably be created, which might cause some employees who are less loyal to the company to leave the office of their own will.

If the company needs to lay off someone, many attorneys will recommend giving all employees a Notice of Solicitation of Resignation from the Office (Kibotaishoku No Boshu).  It is true that the notice might reduce the risk of a finding of abuse of rights. However, if a small company gives such notice, it could cause many able people to leave. This could cause significant deterioration in the performance of the company. Thus, in a small company, the company may try Solicitation of Resignation of Individuals (Taishoku Kansho), under certain conditions. The Solicitation of Resignation of Individuals must be done within reasonable limits. The company cannot persistently attempt to persuade specific employees to quit in an unreasonable way. The company cannot harass the employees who do not comply with the request.

Supreme Court take

The Supreme Court has held that excessive persuasion and methods invalidate the voluntary resignation, and the employees may then seek damages for the companys conduct.  (Supreme Court decision S55.9.10, July 10, 1980.) Dismissals should be seen as a last resort. Dismissals for the purpose of reorganization require the four elements mentioned above (1.-4.)  It is very difficult to determine whether such conditions have been met. Thus, an experts advice should be sought. This is especially so if the manager cannot speak Japanese fluently with Japanese staff, because the manager will probably face difficulties in negotiations, in court, or in Alternative Dispute Resolution (Saibangai Funso Kaiketsu Tetsuzuki), etc.

Most companies probably want to avoid such troublesome procedures and instead pursue the easiest route for laying off employees. However, even if a company uses a complex scheme such as Corporate Division or M&A, without an honest and sincere attitude to employees, such a scheme is likely to worsen the relationship between the company and their employees. If the company cannot keep a trusting relationship with its employees, the company will probably not survive a recession anyway. Thus, it would seem a passion to save the company and honesty are key points to save a company.

This scope of this article is limited to just a few approaches; there are several available alternatives that may be more suitable to a particular business. For more information on this topic, please contact us.

Final Comment

The Japanese economy is much better than it was in the period after the collapse of Lehman Brothers. Thus, this advice will not probably need to be applied as often as last year. But unfortunately, downsizing is always a possibility, even in a better economy. We hope this article will be useful for your reference if you are considering how to downsize your company. 

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