Japanese commercial transactions and sanctions revisited: Sumitomo v. UFJ.

• Author: Taylor, Veronica L.

INTRODUCTION

As Japan's "bubble economy" collapsed in 1989, Japanese government and industry turned to deregulatory policies as a way of restructuring the economy. As part of that process, formal law, legal institutions, and lawyers were all elevated as regulatory techniques. Rule-based, hierarchical controls became more visible, (1) At the same time, informal regulation through changing social norms, industry practices, and self-regulation tools such as codes of conduct and ethics emerged in new forms. I call this process the "re-regulation of Japan. (2)

My approach to understanding the last two decades of regulatory reform in Japan owes much to John Haley's theories of the Japanese legal system. (3) Haley argues that, despite its highly developed legal system, the Japanese state has relied heavily on informal social ordering and norm enforcement in order to achieve its policy goals. (4) Moreover, he argues, this mix of formal and informal legal sanctions is the result of strong historical continuity in the evolution of social, economic, and legal institutions in Japan. In his depiction of mutually interdependent formal and informal modes of ordering within Japan, Haley seems to anticipate the pluralism that is the focus of much contemporary regulatory theory. (5) However, he articulated this paradigm in Authority Without Power (6) at precisely the time when Japan's high growth economy began to slump and many modes of regulation thought to be distinctively Japanese started to unwind. What has followed is a series of debates across different disciplines about whether, and to what extent, Japanese regulation since the 1990s represents a paradigm shift, and, if so, towards what. Within the field of law, Haley argues that the twenty-first-century legal and regulatory mechanisms of governance in Japan represent, on balance, continuity, rather than a dramatic rupture between the present and past. (7)

In this essay I examine Haley's claim that we see more regulatory continuity than change in Japan, testing it against a case study of the failed banking merger between Sumitomo and UFJ financial groups (as they were then known) in 2004. The breakdown of this transaction made international headlines when Sumitomo sought a court injunction against UFJ and, when that failed, sued UFJ for breaching its agreement to negotiate. (8) On appeal from that lawsuit in 2006, the parties settled, with Sumitomo receiving ¥ 2.5 billion (USD 21 million) in damages. (9) On one hand, the failed merger illustrates the salience of Haley's paradigm of Japanese law. Two major Japanese banking groups wind up in atypical litigation, and, as the attempted merger unravels, we see them choosing from both the "informal" and the "formal" sides of Haley's model of strategies and sanctions. The courts, in turn, invoke familiar legal and social norms as they frame the dispute. Consistent with Haley's thesis, we also see a "private" commercial transaction overlaid with a "public" concern about the future shape of a key Japanese industry and debates about the appropriate form and pace of deregulation. On the other hand, the transaction underscores the limitations of Haley's model when applied to a globalized and now re-regulating Japan. The parties to this dispute operate in a financial market that is subject to both global and domestic regulation at multiple levels. New elements emerge from the transaction, including a host of new regulatory actors, such as foreign investors and lawyer intermediaries. These new elements, in turn, prompt the parties to turn to the courts as arbiters of the dispute--a move that is both deliberate and likely to endure. Together these elements suggest that Haley's "law without sanctions" needs to be re-thought in twenty-first-century Japan.

HALEY'S JAPAN AND LEGAL AND REGULATORY REFORM SINCE 1989

Haley's Japan is a complex place, full of light and shade. His Japanese state is characterized by "authority without power," possessing a highly developed system of legal rules, standards and mechanisms for formal adjudication but choosing to harness social norms and rely heavily on informal social ordering and norm enforcement in order to achieve its policy goals:

Legislators, bureaucrats and judges may continue to articulate and apply, and thus legitimate, new rules and standards of conduct. The norms thus created and legitimized may have significant impact. To the extent that legal sanctions are weak, however, their validity depends upon consensus, and thus as "living" law, they become nearly indistinguishable from nonlegal or customary norms. (10) The weakness of legal sanctions is thus a feature of the system and the corollary to the "myth of the reluctant litigant," which holds that relatively low levels of litigation can be explained by the state's rationing of formal legal adjudication and sanctions through institutional design. (11) A highly credentialed and independent Japanese judiciary, procuracy, and bar are deliberately constrained by the state so that both their capacity to deliver formal sanctions and their accessibility to citizens is limited. This, in turn, feeds the social stigma associated with using litigation as a dispute resolution mechanism. Haley argues that this controlled mix of formal legal sanctions and informal social ordering represents a strong historical continuity in the evolution of social and legal institutions in Japan. While stressing these historical antecedents, Haley also acknowledges that culture is fluid and that the norms underpinning these policy decisions and institutional design choices are subject to change.

In the commercial sphere, the paradigm involves a kind of legal dualism: Japanese domestic transactions need a relatively small number of legal professionals, if any, and rely on minimalist design in contract transactions and avoidance of commercial litigation and arbitration. "International" transactions, by contrast, are export-oriented and have controllable international inputs of standards, services, and capital. Haley represents the duality thus:

The demand for ways to reduce the risk and costs intrinsic to a volatile social and economic environment is also manifest in the prevalence of dependency and relational contracting. The oft-repeated Japanese penchant for informal, long-term contractual relationships, in which "goodwill" and personal trust are more important than written contracts, is symptomatic of transactional relationships in which the parties rely more on morals and markets than laws for enforcement.... On the other hand, when contracting abroad within legal systems Japanese believe are likely to enforce their agreements, they negotiate and draft with extreme care. Similarly a Japanese firm will assiduously abide by adverse commitments to its contract partners in cases where sanctions-either informal, arising out of either their relative bargaining positions or the promise of an ongoing relationship, or formal, such as the likelihood of legal action--are perceived to be strong. (12) This observation raises the question whether, as Japan's high growth economy began to slump after 1989 and policy-makers began to rethink regulation, these dualist transactional preferences and practices changed. The Sumitomo v. UFJ dispute described below suggests that they have.

The 1990s were called the "lost decade" by many Japanese and foreign scholars because of the perceived failure by the governing triumvirate of the Liberal Democratic Party, career bureaucrats, and big business to deregulate a stalled economy. (13) By 2008 many commentators agreed that the Japanese government and industry had significantly restructured key political, economic and social institutions since 1989,14 but they continue to disagree about the pace and effect of regulatory reform and whether Japan has been "remodeled," (15) "reprogrammed," (160 or has adopted "aggressive legalism" (17) in spheres such as industrial policy, technology, and trade.

My own hypothesis is that Japan has shifted from being a "developmental state" to being a "new regulatory state" (18) and the interesting question is how the contours of the new regulatory arrangements are being laid in different areas of the economy. For the purposes of this Essay, I limit this argument to the Sumitomo v. UFJ case study and four regulatory shifts that it seems to illustrate: (i) diffusion of state regulatory functions to private actors or quasi-state actors; (ii) new modes of corporate self-regulation; (iii) the impact of globalization on factors (i) and (ii); and (iv) a turn to formal law, or juridification. Below I outline the facts and the legal strategies used in Sumitomo v. UFJ and then consider how this dispute may illustrate these regulatory shifts.

THE PROPOSED SUMITOMO-UFJ MERGER

The transaction began as a consensual merger negotiation between two major financial institutions in Japan in the wake of its banking crisis of 1997-1998. (19) This crisis had prompted the government to re-regulate the industry by stripping banking supervision from the Ministry of Finance in 1998 and creating an independent regulator, the Financial Supervision Agency ("FSA," later known as the Financial Services Agency). (20) The FSA was charged with applying stringent global standards, including new accounting rules to implement the Basel capital adequacy requirements for banks. (21) A wave of industry restructuring followed: between 2000 and 2002 seven mergers had occurred among major banks. (22) In 2004, at the tail end of this process, Sumitomo and UFJ were looking for merger partners, and the stakes were high. Within a domestic banking industry that had chalked up ten consecutive years of losses, UFJ was one of two city banks at the time that was severely undercapitalized (and possibly substantively insolvent).23 Analysts predicted that the Japanese market could only support a finite number of truly global banks.

On May 21, 2004...