The Real Stage of Business Deterioration 2: Subrogation

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I occasionally exchange opinions with lawyers who specialize in business turnaround. I have even presented a support case I handled in front of such lawyers in the past.

At that time, one of the lawyers said this to me:

“Mr. Kato, you are an expert at stopping subrogation at the water's edge, aren't you?”

I thought to myself, I see, that is one way of looking at it.

“Subrogation” that lies beyond rescheduling

Subrogation can occur after rescheduling, or what is commonly known as a “reschedule.”

Many companies use rescheduling to temporarily stop the repayment of the principal on their loans, changing the terms to pay only interest. However, if they become unable to pay even that interest, the situation becomes even more serious.

If the balance in the repayment account is insufficient on the designated date and the interest cannot be paid, the financial institution determines that repayment can no longer be made as agreed.

Of course, subrogation is not necessarily executed immediately just because the balance was insufficient once. After certain procedures such as contact and reminders from the financial institution and the loss of the benefit of time, the financial institution will request subrogation for loans covered by a Credit Guarantee Corporation guarantee.

When the Credit Guarantee Corporation pays the remaining balance of the loan to the financial institution, the Credit Guarantee Corporation then holds a claim against the company. This claim is called a “right of reimbursement.”

To put it simply, the credit guarantee system is a mechanism similar to insurance.

When a car accident occurs, an insurance company makes payments to the other party on behalf of the policyholder. In the credit guarantee system, if the borrower cannot repay, the Credit Guarantee Corporation makes payments to the financial institution within the scope of the guarantee.

However, this does not mean that the company's debt disappears.

The party to whom the repayment is made simply changes from the financial institution to the Credit Guarantee Corporation.

After subrogation, new financing becomes extremely difficult

Once subrogation is executed, the business is in the final stages of financial distress.

Once this stage is reached, it becomes extremely difficult to receive new loans from financial institutions. Basically, the company must run its business solely on its own sales and cash on hand.

While the Credit Guarantee Corporation becomes the creditor for guaranteed loans, this does not mean that all relationships with financial institutions are automatically severed. Other transactions, such as non-guaranteed loans and deposit accounts, may still remain.

However, it is highly likely that the impact will extend to your entire financial relationship, including other banks. At the very least, it is dangerous to be optimistic and assume that "even if subrogation occurs, I can continue to do business with other banks as usual."

I once heard a story from a business owner.

They said that a bank branch manager had explained to them, "JA Bank is the only one that will be fine," and believing that, they agreed to subrogation.

Coincidentally, I was scheduled to attend a meeting with JA officials on the day I heard that story. So, I decided to ask the following question.

"Even if loans from other banks go into subrogation, will my JA Bank account be okay?"

The answer I received was different from the explanation I had heard.

" No, I cannot say it will be okay. There is a possibility that the account will become unusable"

Just because subrogation has taken place does not mean that all accounts will be frozen uniformly and automatically. It depends on the transaction details, the status of the claims, and the response of the financial institution.

However, there is a possibility that deposits could be offset against loans or that you might not be able to withdraw money freely from your account. Even if accounts receivable are deposited into that account, it is possible that you will not be able to use them for planned payments.

For a company's cash flow, this is an extremely serious problem.

There may be a certain amount of time between when the policy of subrogation is decided and when the procedures are actually carried out. During that time, you may need to reorganize your deposit accounts and payment methods, but moving funds on your own judgment is dangerous. Because there are issues regarding relationships with creditors and legal matters, you should always consult with a professional, such as a lawyer, before taking action.

Even after subrogation, there may still be a path to business revitalization

If there are departments within the business that show promise for future growth or operations that can generate sufficient profit, it may be possible to utilize the "Guarantee System for Extinguishing Claims for Reimbursement" after formulating a business plan.

This is a mechanism that aims to normalize financial transactions by extinguishing the right to reimbursement that arose due to the Credit Guarantee Corporation's subrogation through a new guaranteed loan.

For a company after subrogation, this is a very important system for restructuring financial transactions. However, its use requires a highly feasible business revitalization plan, and not all companies can use it.

From this stage onward, highly specialized knowledge regarding law, finance, and creditor adjustment is required. Therefore, I often pass the baton to experts well-versed in business revitalization, such as lawyers, certified public accountants, tax accountants, commercial and industrial mediators, and the SME Revitalization Support Councils.

Even among experts, their ways of thinking and areas of expertise in revitalization methods differ.

Some lawyers recommend bankruptcy, while other experts examine the viability of the business and aim for revitalization by utilizing tools like the guarantee for extinguishing claims for reimbursement.

The important thing is not to panic and seek advice after subrogation has been decided, but to consult with an expert before that happens.

Because it is before subrogation occurs, there are still many moves you can make. Companies currently undergoing loan rescheduling must never underestimate the balance of the account used for interest withdrawals.

What happens to a company after subrogation occurs?

A company does not necessarily go bankrupt after subrogation.

While some companies choose bankruptcy proceedings, bankruptcy requires significant costs such as attorney fees and advance payments. Some small business operators cannot afford these costs and continue to operate on a small scale without being able to liquidate the corporation.

Some people earn daily cash through peddling or similar means, somehow maintaining their livelihood and business. There are also cases where people continue to operate small businesses from their homes while living there through a leaseback arrangement.

I have also seen cases where subrogation occurred even though the interest on the loans was being paid properly.

This happens when another company related to the representative or director fails, or when a major shareholder goes bankrupt. Like a so-called chain reaction bankruptcy, the business failure of one company can spread to related companies.

Therefore, you cannot judge that your company is safe just by looking at your own repayment status. It is necessary to understand the financial relationships involving the representative, officers, shareholders, and related companies.

Some companies are able to generate profits properly after rescheduling debt

Not all companies that reschedule their debt continue to decline.

Some companies manage to rebuild their cash flow by temporarily stopping the repayment of the loan principal, and during that time, they improve their business and become profitable again.

However, the state of continuing to pay only interest while the principal remains frozen is extremely painful for a business owner.

No matter how much interest is paid, the principal of the debt does not decrease. Sometimes, this state seems to me like a 'modern slavery system'.

That is precisely why I want to restore profits as quickly as possible and reach a state where principal repayment can be resumed—in other words, the normalization of financial transactions.

A company that took six years to normalize

Among the companies I supported over ten years ago, there is one that took six years to normalize its financial transactions.

About a year after I started supporting them, that company reached a state where it could generate an operating profit of over 10 million yen per year.

The biggest factor was the hard work of the young successor.

I taught him the concepts of marketing and sales methods utilizing the internet in detail.

He was a young man who learned very quickly and possessed both patience and the ability to take action. He also diligently completed the large amount of homework I assigned each time.

We selected the service with the highest profit margin and used Meta ads, which were just beginning to spread as an advertising method at the time, to narrow down potential customers and increase sales volume.

As a result, we were able to generate an annual operating profit of 10 million yen in just one year.

However, even with that much profit, the financial institution was reluctant to agree to resume principal repayments.

The company continued to generate operating profits for the next six years.

One day, I received a consultation call from the president.

“Operating profits have been growing ever since. When I asked the main bank to allow us to resume principal repayments, they gave me a condition for exchange.”

The offer was that they would allow the resumption of principal repayments if we paid 3 million yen to the financial institution's affiliated consulting firm to receive management consulting.

When the president said that 3 million yen was too much, he was then presented with a condition that a young employee at that branch would create a business plan for 1 million yen.

Hearing that, I felt indignant at the sheer unreasonableness of it.

When I consulted with my company's tax accountant, I received the following opinion:

“It is a better strategy to normalize the situation and have principal repayments resumed, even if it means making the bank money.”

The president also consulted with his company's tax accountant and said he received the same opinion.

While all the experts judged it that way, I was the only one who remained indignant for a long time.

The company only did business with one main bank. Therefore, it was difficult for them to have the option of refusing the presented conditions and consulting with other financial institutions.

In the end, it became a case that made us realize the fear of having only one bank relationship.

I want you to act before subrogation happens

Subrogation may seem to happen suddenly, but in reality, there are several signs before it.

These include a decrease in sales, deterioration of cash flow, arrears in taxes and social insurance premiums, suspension of principal repayments, the burden of interest payments, and insufficient balances in repayment accounts.

If you overlook these one by one, you may find that by the time you notice, there are almost no moves left to make.

It is not that there is absolutely no path to recovery after subrogation. However, that path is narrow, and the systems that can be used and the experts who can provide support are limited.

That is why I want companies currently rescheduling their debt to always check their interest withdrawal dates and account balances.

Furthermore, if even interest payments are becoming precarious, I urge you not to wait until the brink of subrogation, but to consult with an expert in business turnaround as soon as possible.

Business restructuring is a race against time.

The sooner you act, the more options remain available to you.