@codeotaku Keep in mind this is a Japanese tournament, long before the double elimination bracket was standardized. Running a single-elimination tournament, with also a "second-chance" bracket, isn't out of the question. For instance, the M-1 Grand Prix Manzi tournament arrives at 8 Finalists, then 1 second-chance team emerges from all the losers. And I know I've see a 3rd Strike tournament played with similar rules.
I think your second idea is correct - they had enough entrants for 12 brackets, then ran all the losers through another bracket to arrive at a Top 16. I imagine it will work as a single-elimination tournament from here on out, meaning if Haruo loses he doesn't get his own second chance (unlike a proper double-elimination bracket)
Is it fair? no, not really. But these were lawless days.