M&A Report 2023: South Korea

The Korean M&A market, like other global markets, is experiencing a cool-down due to interest rate pressures and an overall increase in economic uncertainty. According to Dealogic, a financial information platform, the total Korean domestic M&A volume for 2022 was estimated to be $49.6 billion, which represented a 46.4% reduction from $92.7 billion in 2021.

As a result, the Korean domestic M&A market is witnessing an oversaturation of targets that remain unsold and IPOs that remain unfinished, while domestic strategic and financial investors are signalling that they will curtail their activities at least during the second half of 2023, in view of the general economic uncertainty. This may present market opportunities for overseas investors.

The Korean M&A market is driven by both private and public M&A transactions. Deal dynamics tend to be similar, with the overall process for both involving extensive negotiations. Some key considerations in public M&A transactions that do not exist in private ones are public disclosure requirements for listed companies under Korean law and real-time movement of target share prices.

Deal certainty has become a hot topic in Korea, due to recent cases in which parties refused to close.

In 2021, the controlling shareholder of Namyang Dairy, one of the largest dairy companies in Korea, holding 52.63% of the company’s shares, entered into a definitive agreement with private equity firm Hahn & Company for the sale and purchase of those shares. However, the controlling shareholder refused to close the transaction, alleging that, among others, closing conditions under a separate implicit agreement between the controlling shareholder and Hahn & Company were not satisfied. On September 22 2022, the Seoul Central District court ruled in favour of Hahn & Company, dismissing the controlling shareholder’s allegations, and ordered the sale of shares.

Another notable deal that failed to close in 2022 was the transaction between Brookfield (seller) and Mirae Asset (purchaser) for the sale and purchase of International Finance Center Seoul. The deal did not close, and the matter was referred to arbitration in Singapore in September 2022. Market speculation is that the failure to close is a result of the higher interest rates and demonstrative of general market uncertainty.

As a result, sellers are more regularly seeking the protection of contractual mechanisms that would ensure deal certainty, while some purchasers are demonstrating a growing appetite for contractual contingencies that would provide a way out in the event of sudden downturns in market conditions.

In 2021, the Korean M&A market experienced a dramatic upswing, with an 85% increase from 2020 (according to Invest Chosun, a financial news platform), due to the COVID-driven liquidity expansion in 2021. As a result, the aforementioned slowdown of the market in 2022 was more drastic and pronounced.

At the end of 2022, Gangwon Jungdo Development, the developer for Legoland Korea, defaulted on its bonds. Especially because the bonds were guaranteed by a local government of the Gangwon Province, the default raised concerns with respect to the general fiscal health of the market and resulted in a widespread contraction in not only the bond market, but also the wider capital market in Korea.

The current market expectation is that increased deal flow will largely depend on the availability of liquidity and on the resolution of factors contributing to general economic uncertainties, such as the war in Ukraine. There is speculation that once market conditions improve, there will be an upturn in deal activity in the second half of 2023, as investors with liquidity may look to seize opportunities in undervalued assets.

As discussed above, the recent headline cases involving attempts to thwart closing have increased sensitivity to closing certainty for parties and counsels alike.

The trend is reflected in contract drafting, and more sellers are demanding deposits at signing (such deposit to be forfeited on the purchaser’s failure to close) or reverse termination fees that are higher than pre-2022 levels.

On the other hand, purchasers are paying more attention to any material adverse change (MAC) to the target company between signing and closing. Until recently, the number of cases in which Korean courts allowed the purchaser to walk away from the deal due to a MAC was close to none, but recently, a court upheld the purchaser’s right to terminate based on a MAC, thus setting a precedent. As a result, it is expected that the scrutiny on MAC-related provisions will become even more heightened than before.

While the M&A deal flow in 2021 was driven mostly by financial investors, tighter liquidity conditions in 2022 led to a significant slowdown in their deal activity in 2022. It is expected that financial investors will remain wary of liquidity conditions, and become more active once conditions improve.

Meanwhile, activist funds are becoming more active in the Korean market.

Most recently, Align Partners, a financial investor known for its shareholder activism in Korea, successfully led a campaign urging retail investors to put pressure on the management of SM Entertainment, one of the leading K-Pop management companies, to overhaul the company’s business structures, with Align Partners only holding 1.1% shares of the company.

Korea’s National Pension Service, which manages Korea’s public pension fund, has also introduced a stewardship code applicable to its shareholdings, with a goal of more transparent and retail investor-friendly corporate governance.

There are several bodies of law that apply generally to M&A transactions:

• The Korean Commercial Code is the primary governing law for corporate matters for a Korean company;

• The Foreign Investment Promotion Act regulates foreign direct investments and grants jurisdiction over such matters to the Ministry of Trade, Industry and Energy, and the Foreign Exchange Transactions Act regulates foreign exchange matters and entrusts the Ministry of Economy and Finance and the Bank of Korea with the responsibility of oversight;

• The Monopoly Regulation and Fair Trade Act regulates competition and antitrust matters and authorises the Korea Fair Trade Commission to evaluate potential anti-competitive issues;

• The Financial Investment Services and Capital Markets Act applies to transactions involving publicly traded companies and private equity funds; and

• If a company is undergoing a bankruptcy or restructuring process, Korean courts will oversee any M&A transaction involving the company.

On January 25 2023, the Korean Financial Services Commission announced a series of measures to improve foreign investors’ access to Korean listed markets.

First, where foreign investors are required to file registrations before investing in Korean listed companies, and are subject to strict trade reporting requirements, such requirements will be eliminated or streamlined.

Second, under the current regulations, listed companies in Korea are required to make disclosures only in the Korean language, which results in a language barrier for foreign investors.

Beginning from 2024, KOSPI-listed companies that have assets of KRW 10 trillion (about $769 million) or more and those with assets of KRW 2 to 10 trillion and foreign ownership of more than 30% (with general exceptions for companies with less than 5% foreign ownership) will be required to make disclosures of certain material information in English.

After a pilot period, the scope of companies subject to English disclosure requirements, as well as the scope of the disclosed information, will be expanded from 2026. This change is driven by foreign investors’ demand for easier market access, rather than by COVID.

COVID has continued to impact deal flow (increasing liquidity in the 2019 to 2021 period, and decreasing liquidity in 2022). A recent trend as part of the aftershock of COVID is the widened valuation gap between sellers and purchasers. Parties that successfully reach an agreement sometimes do so by resorting to an earn-out clause, whereby the ultimate purchase price is determined by the performance of the target company after closing.

As in other global markets, ESG has become a buzzword in the Korean market. The market is paying more attention to ESG-related discussions as global investment funds spearhead ESG-themed investments in Korea (for example, BlackRock in the renewable energy sector) and major players now tend to demand a separate due diligence process for ESG, followed by a set of representations and warranties specifically on ESG-related matters.

On December 21 2022, the Korean Financial Services Commission announced its plan to introduce a mandatory tender offer scheme. The plan is to require a person to make a tender offer to acquire a majority of the shares (50% plus one share) in a company, at a price reflecting the premium for corporate control, if they become the largest shareholder of the company and if they hold 25% or more of the shares in the listed company.

There is no regulation mandating tender offers by controlling shareholders, and most public M&A deals involve bilateral privately negotiated agreement between the controlling shareholder and the purchaser. Critics have raised an issue with there being insufficient protection for retail investors’ interests in public companies, and the new requirement appears to be a response to those concerns, with hopes to encourage retail and minority investment in listed companies in Korea.

While the Korean M&A market and legal system is broadly in line with global market standards, there are idiosyncrasies that foreign investors may need to know:

• Korean employment laws are different from some other jurisdictions in that employee termination is on a for-cause basis rather than an at-will basis. This is a key consideration for active investors who are looking to incorporate corporate restructuring or human resources planning post transaction.

• Korea has relatively strict foreign exchange regulations. Certain transactions (for example, the receipt of foreign currency-denominated loans or a payment guarantee in favour of an overseas party) require filings or approvals under foreign exchange laws.

• While foreign investments are unregulated in most sectors, government approval may be required for foreign investments in certain controlled sectors such as defence and strategic high-tech industries (for example, semiconductors, battery technology, biotech and AI).

The COVID pandemic and lockdowns required remote work for many of us and the role of technology in the M&A dealmaking process expanded. Virtual data rooms and negotiations through videoconferencing are now commonly accepted as part of the deal process. There is also increased use of e-signatures, instead of traditional ‘wet ink’ signatures. AI-based machine translations help to increase the speed and cost efficiency of transactions involving two or more languages.

Friendly public M&A typically utilise bilateral deals (between the purchaser and the controlling shareholder) and a new share issuance to buyers. Tender offers are not often used, and there is no requirement for shareholders to launch a tender offer, but this may change in the coming year, as discussed above.

For hostile public M&A, tender offers play a key role, as competing parties seek to increase their respective shareholding. Recently, Korean Air and SM Entertainment became targets for hostile M&A, and shareholders competing for controlling stakes have floated large-scale tender offers.

Public M&A are subject to extensive disclosure obligations, which include the obligation to disclose holdings of more than 5% in a listed company.

Largely due to there being no regulation mandating a tender offer, tender offers are relatively rare in Korea. According to public disclosures available on the Data Analysis, Retrieval and Transfer System (DART) run by the Financial Supervisory Service, there were 25 tender offers from February 2020 to February 2023.

Tender offers are generally conditioned on the maximum or minimum number of shares to be purchased, and if tendered shares exceed the maximum number, the number of shares actually purchased will be determined pro rata based on the number of shares tendered by each shareholder.

If tender offers become mandatory in certain circumstances, as described above, the number of public takeover bids, including tender offers, will increase significantly.

In Bae, Kim & Lee’s experience, the level of break fees for M&A (private or public) is generally within the range of 5–10% of the deal value. As discussed above, closing certainty has come to be of paramount importance, especially to sellers, and sellers are expected to demand higher break fees to deter purchasers from terminating the transaction.

In contracts governed by Korean law, break fees often constitute penalties (wi-yak-beol in Korean). Under Korean law, contractual penalties are generally enforceable, and must be paid out regardless of (and sometimes in addition to) the actual damages suffered. However, courts have sometimes interpreted break fees as effectively being a form of liquidated damages instead of a penalty. In such cases, courts can, sua sponte, adjust the amount to the extent that they deem the break fee excessive in light of the damages suffered.

As discussed above, earn-outs are increasingly being used, to bridge the valuation gap that is becoming wider under the current financial environment.

While the use of purchase price adjustment based on completion accounts has been more typical in the Korean market, more parties are using a locked-box mechanism (with indemnification for certain leakage items between a pre-signing date and closing), which reduces post-closing disputes with respect to the purchase price.

Warranty and indemnity insurance is favoured by sellers as aiding ‘clean’ exits, and a commitment to subscribe to warranty and indemnity insurance is often required from bidders in auction deals.

Private takeover offers are made on a case-by-case basis, but would usually include satisfactory completion of due diligence and merger filing approval.

While not unseen, it is not common to have an agreement governed by the laws of a foreign jurisdiction in private M&A involving targets in Korea. Parties often use Korean law as the governing law of the definitive agreements.

It is more common to see parties agree to dispute resolution by arbitration in a ‘neutral’ forum (i.e., in a country in which neither party would have ‘home ground advantage’). However, many foreign investors are comfortable with Korean courts having exclusive jurisdiction over contractual disputes, as Korean courts are known to be efficient and impartial.

In 2022, exits were challenging due to the reduced liquidity and economic uncertainty. According to the Korea Exchange, 92 companies successfully went public in 2022, a 35% drop from 2021. Furthermore, there was a significantly reduced volume of private exits, including trade sales, in 2022, as reflected in the overall reduction in M&A deal volume. Continuation funds are increasingly being utilised by private equity firms to continue funds nearing the end of their fund life as they wait for a more favourable exit opportunity.

A continued reduction in M&A market activity is expected in the first half of 2023. However, with improved market conditions, the second half of 2023 is expected to be more active, given the significant number of unsold targets and unfinished IPOs from 2022.

With respect to valuation, buyers may have more appetite to meet sellers in the middle once liquidity constraints are loosened, and sellers may try to seize long-awaited exit opportunities if buyers begin offering more attractive valuations.

The authors’ view is that M&A legal practice in Korea will cater to those market trends, including through the evolving use of contractual devices to bridge gaps and ensure deal certainty.