Summary
Domestic rating agency R&I downgraded the corporate credit rating for Japan Airlines Corporation to CCC junk grade amid reports that Transport Minister Hon. Seiji Maehara may seek special legislation designating the company as "effectively bankrupt" in order to reduce pension payouts, underscoring the threat that unrealistic and inconsistent political directives pose to nation's flagship carrier.
Analysis
Shares in Japan Airlines Corporation rallied on Thursday after the Transport Minister announced plans to cede responsibility for JAL's rehabilitation to a government backed entity without comment on the report submitted by his own task force, which lacked any legal authority or financial resources. R&I then downgraded the company's credit rating by three notches from BB to CCC on Friday, citing uncertainty surrounding the company's rehabilitation plan amid reports the Minister sought legislation designating the "effectively bankrupt" in order to forcibly reduce its pension liability.
Unfortunately, the Honorable Minister can't have it both ways; JAL must either be rehabilitated or allowed to go bankrupt. Three key challenges facing the carrier - bloated payroll cost, underfunded pension liability and unprofitable domestic routes - entail complex legal, financial and political implications. Yet, the Minister's directive to make pension cuts a prerequisite for injection of public funds threatens to derail the entire rehabilitation effort for the second time in as many months.
Japanese law provides at least five avenues for dealing with corporate insolvency, broadly classified in three categories: corporate reconstruction, civil rehabilitation and bankruptcy. In the case of JAL, the Ministry of Transport has announced plans to pursue a corporate reconstruction under the Special Measure for Industrial Revitalization. Benefits of such an approach include preservation of shareholder equity, continued operation as a going concern and the prospect of government support. Bankruptcy, on the other hand, almost always results in a liquidation of assets that wipes out shareholders equity and prevents the enterprise from continuing to operate as a going concern.
Rights to pension benefits under Japanese law are treated consistently to interests in other unit investments, such as life insurance, investment trusts or condominum ownership. Generally speaking, any material change to contractual terms, policies or benefits requires approval by a 2/3 majority by ownership. Moreover, Article 26 of the Japanese Constitution prohibits the State from forcibly depriving citizens of private property rights, depriving the Government of the right to Eminent Domain. As such, there is generally no legal avenue for reducing pension pension benefits owed to current and former employees of a going concern enterprise.
Moreover, claims to pension benefits are considered non dischargeable obligations for the purpose of corporate reconstruction or civil rehabilitation proceedings. Only in the case of a bankruptcy liquidation can pension benefits be reduced in accordance with the hierarchy of claims stipulated under Japanese bankruptcy law. This is why the Honorable Transportation Minister, who is determined to make pension cuts a prerequisite for injection of public funds, is seeking a creative means of designating JAL as "effectively bankrupt" while at the same time protecting the enterprise as a going concern under the provisions of a corporate restructuring law. Needless to say, this presents a legal paradox as well as a moral juxtaposition.
One wonders who convinced the Honorable Minister that the public would oppose a government bailout for JAL that protects its employees pension benefits. Not only did the employees complete years of service in accordance with the terms of the company pension plan, they also made regular contributions. Most of the current retirees receiving benefits joined JAL while it was still a public company. The pension plan itself was crafted by the Government, including stipulations that the portfolio consist primarily of JGBs and local government bonds. Moreover, public finance and interest rate policies crafted by the Ministry of Finance and the Bank of Japan are to blame for inadequate returns on pension fund assets.
So why must JAL employees have their pensions cut in order for the Government to rescue their employer? The Honorable Minister suggests that the public will not be able to understand why public funds would be used to pay lucrative pension benefits to JAL employees. Maybe that's because he never made any effort to explain the situation. Isn't the Minister just creating a self-fulfilling prophecy?
By the way, JAL is not the only major company with an enormous gap between its pension assets and its projected benefit obligation. Most voters are probably nervously watching this scenario play out, wondering whether how the Government would behave if their own pension benefits were at risk. Perhaps whomever advised the Honorable Minister that the public will not be able to understand why public funds are being used to pay pension benefits to JAL employees doesn't want his party to win next summer's Upper House Election. Just a thought...
