Corporate Insolvency & Reorganisation Report 2018: South Korea

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There are two restructuring procedures available in the Republic of Korea for a financially troubled debtor: (i) workout arrangements under the Corporate Restructuring Promotion Act (CRPA) and (ii) rehabilitation procedures under the Debtor Rehabilitation and Bankruptcy Act (DRBA). While the workout is an out-of-court restructuring procedure led by financial institutions holding claims against the debtor, the rehabilitation is a procedure supervised by the court.

The current CRPA is the fifth version of the original CRPA enacted in 2001 and, as was the case of earlier CRPAs, contains a sunset clause and is scheduled to expire on June 30 2018. Although an extension of the current CRPA is again under discussion, objections have also been raised. The objections are mainly based on the court's stance that it is more appropriate to consolidate the diverse restructuring schemes into a single rehabilitation procedure managed by the court, rather than acknowledging, and thereby encouraging, the private workout arrangement led by financial institutions. There has been a long-standing criticism in Korea that the private workout arrangement does not properly function as one of the restructuring schemes, and such criticism further objects to the extension of the CRPA.

If a bill extending the CRPA does not pass by June 30 2018, the CRPA will become void. However, this does not mean that the workout arrangement will no longer be available, because the financial institutions may opt to voluntarily agree upon executing a workout agreement by adopting the provisions of the CRPA. There have been occasions in the past where the earlier CRPAs indeed expired for a certain period of time, but during those times, the financial institutions voluntarily carried out workout arrangements nonetheless.

While the rehabilitation procedures noted above are designed to rehabilitate or normalise the debtor with creditor consent by providing debt reductions and/or grace periods for the payment of debts, bankruptcy under the DRBA is a process for liquidation of an insolvent corporation and equitable distribution of liquidated assets to the creditors.

Korea adopts and applies the Uncitral model law for cross border cases, and as such, provides a favourable environment for recognising the insolvency proceedings of foreign countries in accordance with global standards.

In February 2017, the court terminated Hanjin Shipping's rehabilitation procedure and declared it bankrupt. Hanjin Shipping's collapse is by far the largest container shipping bankruptcy in the world. One of the matters of international concern is the amount the foreign bankruptcy creditors would end up recovering.

Recently, in the field of rehabilitation, a pre-packaged plan method and a stalking horse bid are drawing much attention, and the number of cases is increasing where either of these methods is actually adopted.

The pre-packaged plan, stipulated in article 223 of the DRBA, refers to a rehabilitation procedure where the rehabilitation plan is submitted to the court in advance (ie together with the motion to commence the rehabilitation procedure) by creditors holding claims equal to at least half of the total debt amount or by the debtor with such creditor's consent. The advantage of a pre-packed plan is that the entire procedure can considerably be expedited and that the rehabilitation plan will likely reach its necessary approval quota with ease. In comparison, during an ordinary rehabilitation procedure, the rehabilitation plan will not be submitted to the court until approximately three to six months after the commencement of the rehabilitation procedure.

During rehabilitation proceedings, debtor companies often seek to be revived through an M&A. Recently, an M&A through a stalking horse bid has been preferred over public bids. In the past, in an attempt to maintain fairness and transparency, the court did not allow closed (privately negotiated) bids in managing M&A during rehabilitation. It insisted on open (competitive) bids only, where the bids are submitted by all interested contractors and the debtor is sold to a bidder offering the most favourable terms. However, especially in cases where the market is not particularly interested in the debtor company, the debtor's M&A often failed as no two bidders would participate (a bidding is considered as uncompetitive and rendered invalid unless there are two or more bidders participating). Further, such failure of M&A often resulted in subsequent impairment of the debtor's rehabilitation efforts altogether.

Meanwhile, in a stalking horse bid, a stalking horse bidder with a strong intent to acquire the debtor company (the preliminary buyer) will first enter into a memorandum of understanding or a letter of intent (MoU) with the debtor where the key terms and conditions of the M&A are set forth. The MoU can be regarded as the first bid which will be followed by an open bid where the person presenting the highest bid will acquire the debtor company. However, if no buyer overbids the conditions set forth in the MoU in the open bid, the preliminary buyer will acquire the debtor company. The stalking horse bid is the preferred manner of sale in the M&A context today as it allows a distressed company to avoid receiving low bids and increases the success rate of the M&A while maintaining impartiality in the process.

A key recent event in Korea is the opening of the Seoul Bankruptcy Court on March 1 2017. The Seoul Bankruptcy Court, as the first court specialising only in insolvency matters, announced that it will actively support institutionalising both the pre-packaged plan and the stalking horse bid methods in order to establish a more effective rehabilitation procedure. Further, the court adopted S-Track, ie the rehabilitation proceedings tailored to small and mid-sized enterprises. The Seoul Bankruptcy Court is expected to play a crucial role as a judicial branch specialising in insolvency practices.

In early 2017, Daewoo Shipbuilding & Marine Engineering (DSME) attempted to adopt the pre-packaged plan during its restructuring procedure. This attracted interests from the market, and even though DSME completed its reorganisation by reaching autonomous agreements with its creditors, more companies are using the pre-packaged plan in the rehabilitation procedure after noticing various advantages learned from the DSME experience.

With regard to the stalking horse bid, a recent M&A deal of STX Heavy Industries is worth noting. STX initially attempted M&A with an open bid. However, after failing to procure proper bids, STX immediately adopted the stalking horse method. By doing so, STX is in process of selling the company by dividing its business sectors.

The Korean rehabilitation procedure is designed to rehabilitate or normalise a financially troubled debtor company, and is in many respects similar to the reorganisation procedure under Chapter 11 of the US Bankruptcy Code.

The debtor company will typically file for rehabilitation voluntarily. Creditors with claims equal to at least 10% of the debtor's total paid-in capital, or shareholders owning at least 10% of the total issued and outstanding shares can also file for the rehabilitation. The debtor needs not be insolvent for the rehabilitation procedure to be commenced; the procedure can be initiated as long as there is a legitimate concern that the debtor will be insolvent.

In a rehabilitation procedure, a court-appointed trustee is vested with the authority to control all rehabilitation proceedings and to manage the business operations and assets of the debtor. In general, the representative director of the debtor (ie existing management) will be appointed as the trustee.

The financial creditors' committee, a committee convened by the major creditor bank (ie the bank that holds the largest amount of credits) and composed of financial institutions holding credits against the debtor company, decides whether to commence a workout procedure, once the debtor company submits an application. In order to submit the application, the debtor company must first be acknowledged by the major creditor bank, through a credit risk assessment, as being unable to perform its obligations such as repaying its loan without an additional cash inflow. Unlike in a rehabilitation procedure, the court does not get involved in the workout proceedings, and once the workout plan is resolved by the financial creditors' committee (a consent of the creditors holding 75% or more of the total financial claims is required), the debtor and the financial creditors will execute an 'agreement on performing the workout plan' based on the foregoing workout plan and seek normalisation of the debtor. The existing management controls the workout proceedings, manages and disposes the debtor's properties under the supervision of the financial creditors' committee.

In a broad sense, the workout includes voluntary agreement procedures. The voluntary agreement is a procedure led by the creditor financial institutions based on a prior agreement on executing restructuring proceedings as set forth in the CRPA. The voluntary agreement procedures are similar to the process of workout under the CRPA.

Groups of companies do not receive special treatment in a rehabilitation procedure or in a workout arrangement.

Once a formal filing is submitted, the court, at its discretion or by application of an interested party, may issue a comprehensive stay order. There is no automatic stay as set forth in chapter 11 of the US Bankruptcy Code.

The stay order bars creditors from enforcing their claims in respect of the debtor's assets through compulsory execution, preliminary attachment or preliminary injunction. However, contractual termination rights will not be affected by the stay order.

The court can, after issuing a comprehensive stay order, amend or revoke the order. However, there is no provision in the DRBA setting forth specific cases where the comprehensive stay order may actually be revoked. The comprehensive stay order remains effective until the court decides whether to grant the application to commence the rehabilitation procedure. If the court dismisses the application, the comprehensive stay order becomes void. On the other hand, if the court grants the application, the commencement of the rehabilitation procedure itself prohibits the creditors' exercise of their rights in its entirety, and the comprehensive stay order consequently loses its effectiveness.

In a workout procedure, the court does not render a stay order. The major creditor bank, when convening the first committee meeting, may request the financial creditors to suspend exercising their claims, and a financial creditor who violates such request must, once the workout process is initiated, restore the exercised amount without delay.

In a rehabilitation procedure, not a single creditor, but a class of creditors can be crammed-down. As a prerequisite of the court's approval, the rehabilitation plan needs to be first approved by all classes of creditors. To elaborate, three-quarters, two-thirds and half of total voting rights in each class of the secured rehabilitation creditors, the unsecured rehabilitation creditors, and the shareholders, respectively, need to agree on the rehabilitation plan. However, if a certain class of creditors fails to reach the necessary approval rate, the court still can approve the rehabilitation plan while implementing measures to protect such creditors' rights.

There is no cram-down in a workout procedure.

M&A is actively sought after in rehabilitation procedures, where a buyer acquires new shares and/or bonds. Pre-packaged form of sale or stalking horse bids are allowed and recently preferred.

Neither the DRBA nor the CRPA prescribe any duties of directors of a company in financial difficulties. Accordingly, there is no precedent where a director was found negligent in failing to initiate a timely restructuring measure. Recently however, both among the academia and the practitioners, there are discussions on whether the directors should bear responsibility, as a fiduciary duty to the company, to seek restructuring measures (eg the rehabilitation proceedings or the workout) in early stages of the company's financial distress.

If a debtor commits any acts detrimental to creditors, the debtor's transactions may be subject to claw-back and can be negated after the rehabilitation procedure initiates. Actions subject to claw-back on the grounds of preference include (a) the offering of security or the repayment of debt obligations prior to a due date, which is performed within 60 days prior to the filing date when the application for the rehabilitation procedure is made, and (b) any gratuitous act performed by the debtor within six months prior to the filing date (the aforementioned 60 days and six months are extended to one year respectively in case the beneficiary is a specially related person).

The above equally applies in a bankruptcy procedure. The claw-back is not recognised in a workout arrangement.

In a rehabilitation procedure, common benefit claims have priority over unsecured rehabilitation claims (where claims arise due to reasons occurring before the commencement of the rehabilitation procedure). For example, claims accrued by the trustee's management of the debtor company which took place after the commencement are typically categorised as common claims, which are not subject to the rehabilitation procedure and may be repaid when due with available cash. A loan obligation arising from the financing raised after the commencement of the rehabilitation procedure, ie debtor-in-possession (DIP) financing, is also classified as a common benefit claim.

It should be noted the DIP financing loan does not hold a super-priority and ranks pari passu with all common benefit claims. Thus, if a company under a rehabilitation procedure goes bankrupt, the entire common benefit claims, including the DIP financing loan, will be paid on a pari passu basis, ie in proportion to respective claim amounts. Hence, if the debtor's assets do not cover the total common benefit claim amount, the DIP financing loan will not be repaid in full. This is one of the reasons the DIP financing is not frequently carried out in Korea.

In case the debtor is a financial institution, the Act on the Structural Improvement of the Financial Industry takes precedence over the DRBA and the CRPA. Most financial institutions, eg banks, insurance companies, and securities companies, are subject to the foregoing Act. In case a financial institution is insolvent, financial supervisory authorities will sort out the financial institution's good assets and liabilities, transfer those to a third party (purchase & assumption), and liquidate any remaining assets of the bad company.

With respect to the rights of foreign creditors in any insolvency proceedings held in Korea, the DRBA expressly provides that any foreigner or foreign corporation must be treated as holding an equal status to that of a national or juristic person of the Republic of Korea.

Accordingly, a foreign debtor can resort to a restructuring or insolvency procedure in Korea; if a foreign debtor owns assets in Korea, the rehabilitation or bankruptcy procedure can be commenced.

Furthermore, an insolvency procedure initiated in a foreign country can be recognised in a Korean court, and any necessary support can be provided without commencing a separate insolvency procedure in Korea. It should be noted, however, that a foreign insolvency procedure can be recognised only when such recognition is found to be in accordance with good customs and other public order of the country.

Once a foreign insolvency procedure is recognised, the Korean court can put a halt to an ongoing compulsory execution or litigation against the debtor and prohibit disposition of the assets or the debtor's performance of obligations. This means that the Korean court can support the foreign debtor in securing resources for distribution required under a foreign insolvency procedure, whereby the debtor may consequently implement the payment plan under the foreign insolvency procedure based on the secured resources.

Given that there are state-owned financial institutions among creditors of conglomerates, and that the government's position is reflected in such state-owned financial institutions' decision-making process, the Korean government's stance on the restructuring has a material impact on the outcome of the reorganisation in Korea.

With the US interest rate hike, Korea is also likely to raise its interest rate. As a result, one can expect that more companies in a marginal business state will actively attempt to initiate a rehabilitation procedure. Considering that the pre-packaged plan and the stalking horse bid are preferred in the recent rehabilitation proceedings, demand for legal services related to the foregoing two methods is expected to increase.

Meanwhile, up until now, financial institutions were mostly in charge of the restructuring of financially distressed companies through the workout proceedings. However, at the end of 2017, the Korean Financial Services Commission (FSC) announced its plan to transform the restructuring practices so as to be led by the capital market rather than the financial institutions. To implement such a plan, the FSC is planning to launch in the first half of 2018 a corporate governance innovation fund, a fund designed to support corporate reorganisation. To establish the fund, the state-owned financial institutions will contribute KRW50 million ($47,000 approximately) while another KRW50 million or more will be contributed by private investors. The fund will be invested for the benefit of small and mid-sized companies that are in need of reorganisation. In light of the foregoing, associated demand for legal services is expected to increase in 2018.

About the author
		Jangho Lim Partner, Bae, Kim & Lee LLC Seoul, South Korea T: +82-2-3404-0183 F: +82-2-3404-0108 E: jangho.lim@bkl.co.kr W: www.bkl.co.kr Jangho Lim mainly represents and advises clients on rehabilitation and workout proceedings, M&A and financial litigation. Since joining Bae, Kim & Lee in 2001, he has successfully handled numerous cases in connection with corporate diagnosis, restructuring and rehabilitation, as well as sale of assets and business transfer of insolvent companies. Mr. Lim graduated from Seoul National University Law School in 1994 and completed the Judicial Research and Training Institute course in 1998. He then earned his LL.M. from Duke University School of Law in 2006 and passed the New York State Bar in the same year.

About the author
		Ugu Choi Associate, Bae, Kim & Lee LLC Seoul, South Korea T: +82-2-3404-7639 F: +82-2-3404-0108 E: ugu.choi@bkl.co.kr W: www.bkl.co.kr Ugu Choi is an associate in the Corporate Reorganization and Bankruptcy Team in Bae, Kim & Lee with a particular focus on bankruptcy and advice on corporate rehabilitation; restructuring. He earned his J.D from the Law School at Korea University in 2012, where he earlier received his bachelor's degree. He served his military duties in the army as a judge advocate and joined Bae, Kim & Lee in 2015.