The most active parties in the South Korean acquisition finance market have been local commercial banks and domestic securities companies on the lender side. International banks are fairly inactive in the Korean acquisition finance market because, firstly, the acquisition price is usually paid in the Korean currency, Won, and therefore loans extended for the purpose of financing acquisitions are usually made in Korean Won; and secondly, because loans taken out by Korean companies from non-resident lenders are subject to Korean withholding tax in relation to interest payments and foreign exchange reporting requirements.
Traditionally, corporate purchasers have mostly financed their acquisitions by issuing bonds or obtaining bank loans, in each case relying on their own credits. It was not until private equity funds became active in the Korean M&A market that the leveraged buyout structure became widely used for acquisitions.
Corporate purchasers continue to rely primarily on the issue of equity, bonds or bank debt (on their own credit), while private equity funds actively seek financing from domestic banks and domestic securities companies.
Recently, there have been fewer strategic investors but a growing number of private equity firms acting as buyers in the Korean M&A market. This has led to an increase in the demand for acquisition financing. The COVID-19 pandemic, however, has had a negative impact on the overall acquisition finance market.
As the Korean economy slowly pulls itself out of the COVID-19 pandemic, the M&A and acquisition financing markets will likely continue their recovery going into the post-pandemic era.
The governing law of the loan documents is almost always Korean law.
Typically, the loan documentation is drafted by the lender’s legal counsel. No particular standardised forms are used (eg, the Loan Syndications and Trading Association standard provisions or Loan Market Association templates are not typically used). The law firm acting as counsel to the lenders uses its own templates for producing the loan documents. However, the contents of the loan documents used in the Korean acquisition finance market do not differ materially from those governed by the laws of England and Wales or the State of New York.
Loan documents are usually written and negotiated in Korean, although they can be prepared in English in cases where the sponsor is a non-Korean entity.
Similar to other financing transactions, a legal opinion in an acquisition finance transaction will cover whether the borrower is validly existing under the laws in which it has been incorporated, and whether the financing documents have been duly authorised and executed and are legal, valid and binding upon the borrower pursuant to the terms of the financing documents. In addition, lenders would typically want their counsel to opine on the following:
A typical debt financing structure involves extending senior loans to a newly formed company that acts as the acquiring vehicle. In larger deals, mezzanine financing in the form of mezzanine loans or redeemable shares is often used. At syndication, most of the investors participating in the senior loan also participate in the mezzanine loan. A secondary market for subordinated bond/high-yield debt is not active in Korea.
The amount of the senior loan is usually around 50% of the total acquisition cost, which may be adjusted based on the target’s earnings before interest, taxes, depreciation and amortisation (EBITDA). Senior loans usually consist of one or more term-loan facilities and a revolving facility. The purpose of the term-loan facilities is to pay the acquisition cost together with the equity investment amount, and the purpose of the revolving facility is usually to pay the financing cost and other working capital requirements.
The bullet repayment of the senior loans on the final repayment date is most common. The term of the senior loans is usually four to five years. A prepayment fee is usually charged on the voluntary prepayment of the term-loan facility within 12 to 18 months from the closing date.
Mezzanine loans are usually term-loan facilities for paying a portion of the acquisition cost. As previously discussed, since the investors participating in the senior loans and mezzanine loans are usually the same or a similar group of financial institutions, the length of the mezzanine loan may often be the same as the senior loan, with the same security package given to the senior lenders provided in favour of the mezzanine lenders.
Furthermore, the documentation for mezzanine loans is often similar to those for senior loans (although certain financial covenants or events of default are more lenient than for senior loans). Also, the upfront fee, interest rates and prepayment charges are usually higher for the mezzanine loans than for those for senior loans.
Payment-in-kind (PIK) interest for mezzanine loans is quite common in the Korean acquisition finance market.
Bridge loans are often used for the acquisition of shares in a listed target. For a public tender offer, the offeror must deposit with a bank an amount sufficient to pay the entire purchase price when the tender offer is submitted. To facilitate this, bridge loans (secured by a pledge over the account on which the loan is funded) are used to finance the transaction. If the tender offer is successful, the bridge loan is paid from the proceeds of the main debt financing and equity investments. Conversely, if the tender offer is unsuccessful, the bridge loan is simply repaid from the proceeds deposited in the pledged account. A bridge loan is usually provided by one lender because:
Corporate purchasers have mostly financed their acquisitions by issuing bonds or bank loans, but otherwise a secondary market for subordinated bond/high-yield debt is not active in Korea.
When corporate purchasers finance their acquisitions by issuing bonds, this takes the form of private placement, as opposed to public offering. In the Korean acquisition financing market, there is no such legal form as loan notes.
Typically, for a share deal where the purchaser acquires the shares in a target company, the purchaser would set up a special purpose vehicle (SPV) for the acquisition, and will inject capital and raise debt from third-party lenders through that vehicle to fund the acquisition. The SPV will have no assets to provide as security to the lenders other than the shares of the target company that it intends to acquire. As further discussed in 5. Security, assets of the target company cannot be provided as security because of a potential breach of fiduciary duty of the target company’s directors under Korean law. However, corporate purchasers that do not utilise a separate SPV or purchasers that directly acquire certain assets or businesses of a target company (rather than acquiring the shares of the target company) may choose to provide their own assets or the acquired assets to secure the debt that they raise for the acquisition.
The contents of the intercreditor agreement used in the Korean acquisition finance market do not differ materially from those governed by the laws of England and Wales or the State of New York, but the forms are relatively simpler.
The usual arrangement in Korea is first to pay off the senior loan in full before payment of the mezzanine loan. It is most common that the interest on the senior loan is paid in cash on a quarterly basis. In the case of a mezzanine loan, a recent market trend is for:
When a corporate purchaser issues bonds, they are unsecured corporate bonds and the bond investors do not receive any security. Therefore, bond investors are rarely a party to an intercreditor agreement.
It is very rare for a hedge counterparty to be a creditor in a Korean acquisition-financing transaction, and therefore, hedge counterparties are rarely a party to an intercreditor agreement.
A general charge or assignment over all assets of a party is not acknowledged in Korea. Therefore, a separate security interest should be created in relation to each type of asset. The three main types of security interest are as follows.
Under the Act on Electronic Registration of Stocks, Bonds, etc, of Korea, all listed companies are required to issue their shares in electronic form instead of physical share certificates. The issuer will need to register all of its shares with an electronic registration institution (the Korea Securities Depository (KSD)), and the shareholders will have their own share custody account opened at their respective account management company (which shall be a bank, securities company or other licensed financial institution authorised under the aforementioned Act). Non-listed companies may choose to register their shares electronically or keep them in physical form.
For shares represented by physical share certificates, a pledge is created and perfected by the delivery of the relevant share certificates, on which the name of the pledgee is endorsed by the pledgor, to the pledgee. To perfect the pledge against the company issuing the shares, the name and address of the pledgee must be registered with the shareholders′ registry of the company.
For shares existing in electronic form, the pledgor must submit an application to its account management company for the creation of the share pledge. The share pledge is created and perfected when the pledgor delivers to the pledgee a copy of the ledger of its share custody account which records the pledge and the name of the pledgee.
Korean law generally requires assets subject to a security interest to be specifically identifiable. Therefore, under Korean law, a valid security interest cannot be granted over a fluctuating pool of assets where each asset within the pool is not specifically identified. However, certain exceptions have been recognised by courts (eg, a valid security interest can be granted in inventories stored in a segregated storage facility).
A bank deposit is considered as the depositor′s claim against the depository bank. The pledge of a claim can be perfected against third parties in the same way as monetary claims. The bank′s deposit agreement will usually prohibit a pledge from a bank account without the bank′s consent, which means consent from the depository bank is required (and should be fixed-date-stamped).
In order to perfect a pledge or yangdo dambo over monetary claims (such as receivables) against any third party (including the underlying obligor), the security provider must either:
If there is a contractual restriction on the assignment or creation of a security interest in the underlying contract, the security provider must obtain the underlying obligor′s consent to the pledge (or assignment) with a fixed-date stamp affixed. In addition, any instruments relating to the monetary claim should be delivered to the secured party.
In relation to the effectiveness of the security interest over future monetary claims, the following elements are required for the valid creation of the security interest over monetary claims to be generated in the future (based on the views of leading commentators and precedents from the Korean Supreme Court):
Intellectual Property Rights
For the creation of a pledge over a trade mark, patent or any other intellectual property rights, the pledge must be registered with the Korea Industrial Property Office (KIPO).
The KIPO registration fees must be paid. The relevant fees and expenses depend on the number of intellectual property rights subject to the pledge. It usually takes two weeks from the date of submitting the application to the KIPO to complete the registration of the pledge.
The most popular forms of security granted over real property are the following.
An advantage of the collateral trust arrangement is that because the sale proceeds are distributed in accordance with the waterfall set out in the trust agreement, it is easier to administer. However, the kun-mortgage has the advantage that the purchaser can take over the property from the foreclosure auction, free of all liens (subject to exceptions of the super-senior liens).
Security interests over movable assets can be created using either a pledge or yangdo dambo. To create yangdo dambo over movable assets (that are not registrable property), the parties (ie, the assignor and the assignee) must agree to:
There are no particular form requirements regarding security as long as they comply with the requirements for the creation and perfection of security under Korean law.
For the registration process of a mortgage, see 5.1 Types of Security Commonly Used.
An upstream security raises a potential breach of fiduciary duty issue under Korean law for the security provider’s directors. Korean court precedents generally do not recognise a justifiable corporate benefit where a Korean subsidiary provides an upstream security to its parent company. Any benefit that the entire company group receives from the upstream security is treated separately from the corporate benefit given to the Korean subsidiary providing the security. However, it is up to the directors of the Korean subsidiary to determine whether the Korean subsidiary, in fact, enjoys a corporate benefit by providing the security, after taking into account the circumstances in their entirety. This is a factual analysis, and a board resolution simply acknowledging that the security provides a corporate benefit would not automatically prove the existence of a justifiable corporate benefit to the Korean subsidiary providing the security.
There is no explicit financial assistance rule in Korea. However, all actions taken by the directors of the company providing financial assistance must comply with the relevant fiduciary duty restrictions. Under Korean law, the directors can be subject to civil and criminal liability for breach of fiduciary duty if they act with the intent to benefit a particular third party. In this context, a third party includes the shareholders of the company since the prevailing view is that the fiduciary duty of directors runs to the company itself rather than to the shareholders of the company. Therefore, the directors of the target that support the provision of guarantees (or provide the assets of the target as collateral) with respect to the obligations of the target′s parent could potentially be subject to both civil and criminal liability.
There are no other known restrictions besides those set forth in the previous sections.
Due to restrictions on providing an upstream security as previously discussed, the shares of the acquired company being held by the borrower/purchaser is the most common security provided to lenders.
Under Korean law, the pledge over the Korean securities may be enforced by any of the following methods. However, judicial foreclosure is the only method permissible under Korean law unless there is a separate agreement between the pledgor (ie, the borrower/purchaser) and the pledgee (ie, the lender) specifying the other two methods:
Upon the pledgor’s default, a pledgee shall be able to enforce the pledge over the pledged shares by opting for any of methods listed above.
Typically, guarantees will be in the form of a demand guarantee, whereby the beneficiary may seek the guarantor’s performance by written demand and without first having to pursue the borrower. Where the guarantee is governed by Korean law and comprehensively guarantees a debtor’s obligation to certain creditors (ie, the guarantee is not limited to a specific transaction), the Civil Code of Korea requires the guarantee to set a maximum guarantee amount so that the guarantor is aware of the amount of liability it is guaranteeing.
Similar to the provision of upstream security, an upstream guarantee raises a potential breach of fiduciary duty issue under Korean law for the guarantor’s directors. Korean court precedents generally do not recognise a justifiable corporate benefit if a Korean subsidiary provides an upstream guarantee to its parent company. Any benefit that the entire company group receives from the upstream guarantee is treated separately from the corporate benefit given to the Korean subsidiary providing the guarantee. However, whether the Korean subsidiary in fact enjoys a corporate benefit by providing the guarantee is to be determined by the directors of the Korean subsidiary, taking into account the circumstances in their entirety. This is a factual analysis, and a board resolution simply acknowledging that the guarantee provides a corporate benefit would not automatically prove the existence of a justifiable corporate benefit to the Korean guarantor.
There is no requirement for guarantee fees, although paying guarantee fees would support the argument that there is a corporate benefit to the guarantor for providing the guarantee.
There is no specific provision for or concept of equitable subordination rules in Korea.
With respect to claw-back risk, under Korean insolvency law, payments or other acts (such as granting security interest or sale of assets) performed by the borrower may be avoided by the insolvency official after the commencement of insolvency proceedings if, in general, they fall into one of the following four categories:
In the context of acquisition finance, the application of claw-back rules is not generally seen, but the above principles may apply, depending on facts and circumstances.
Under Korean law, a stamp tax of KRW350,000 would apply to any loan agreement executed in Korea under which a lender agrees to lend KRW1 billion (approximately USD822,000) or more.
Payment of interest by a Korean borrower to a foreign lender would be subject to withholding tax under the Korean tax code. The withholding tax rate will be the lesser of 22% (which includes local income tax) or whatever rate is applicable under the tax treaty between Korea and the country of tax residence of the foreign lender. In the Korean acquisition finance market, the qualifying lender concept will often apply, to avoid any grossing-up of withholding tax.
The deductibility of interest payments in relation to a loan extended by a foreign controlling shareholder (FCS) of the Korean borrower may be restricted under the International Tax Co-ordination Law of Korea. If the amount of the Korean borrower’s debt owed to an FCS or to a third party under a guarantee issued by an FCS exceeds 200% (and 600% if the Korean borrower engages in finance business) of the “net FCS equity‟ in the Korean borrower, interest expenses on the excessive debt are not deductible to the Korean borrower for corporate income tax purposes. In addition, the non-deductible interest amount is treated as dividends if the debt is owed to an FCS.
An FCS is a foreign shareholder who either:
Factors indicating control include (among others):
The “net FCS equity‟ in the borrower for this purpose is defined as its proportionate share of the larger of:
However, if there is any capital increase or capital reduction during the fiscal year, the new FCS equity should be calculated under the average basis. Accordingly, a thin-capitalisation problem cannot be avoided by:
The key regulated industries in Korea include institutions for which applicable laws impose restrictions on the eligibility of major shareholders and/or changes to the composition of the shareholders. These institutions include:
The Bank Act prohibits any one person from acquiring more than 10% of outstanding voting shares of any commercial bank (including any shares held by any specially related persons of that person) unless either approval is obtained from the Financial Services Commission (FSC) or some other limited exception under the Bank Act is applicable.
In addition, if any person acquires more than 4% of the voting shares of any commercial bank, this person must file various reports regarding their acquisition of the interests with the FSC. The FSC’s approval is also necessary for a person to become a major shareholder of insurance companies, securities companies, mutual savings banks or other financial institutions.
Various restrictions are also imposed on the following.
The acquisition of a listed target company must comply with the special provisions under the Financial Investment Services and Capital Markets Act (the FSCMA). Acquisitions of listed target companies are usually conducted by purchasing the shares from the controlling shareholders over the counter. This is done to circumvent the various restrictions under the FSCMA (except for certain disclosure requirements) in relation to the sale and purchase of listed shares.
However, where the number of sellers exceeds ten, the public tender offer procedure must be used. Further, if the seller shareholder is a foreigner, the shares held by the seller should have been acquired as “foreigner investment‟ under Korea’s Foreigner Investment Promotion Law. Otherwise, the shares held by the foreign seller cannot be sold over the counter without the approval of the FSC.
If there are no controlling shareholders in the listed target, a public tender offer under the FSCMA can be used to acquire the controlling shares. For a public tender offer, the offeror must submit an application to the FSC and the Korea Exchange containing certain information regarding:
Under the FSCMA, the offeror must deposit an amount sufficient to pay the total purchase price payable with a bank if the maximum number of shares the offeror offered to purchase is tendered. The deposit must be made before launching the tender offer, and the bank holding that deposit must issue a certificate confirming that the deposit of a sufficient amount to pay the total purchase price has been made.
The public tender offer is rarely used for the acquisition of the controlling shares because the procedure is complicated, strictly regulated and the total purchase price must be funded and deposited in advance.
However, after the acquisition of the controlling shares, it is possible for the purchaser to acquire additional shares through tender offers.
Other than as previously discussed, there are no particular issues or considerations regarding acquisition financing in Korea.
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Acquisition Finance in South Korea: an Introduction
Korea’s M&A market saw a dramatic increase in M&A activities in 2021 due to abundance of liquidity in the market, followed by a steep decline by the end of 2022. Korea was not immune from being affected by uncertainties created by interest rate hikes and geo-political tensions which led to a global economic downturn. A significant pick up in the M&A activities in Korea is currently not expected if the general economic outlook in the latter half of 2023 does not improve.
Given the current state of the M&A market, acquisition finance activities have also slowed since the third quarter of 2022. Lenders and borrowers alike have focused on rolling over existing facilities rather than negotiating new loans or refinancing existing facilities.
As for deal terms, lenders are taking a conservative approach, and under the current market climate borrowers are less likely to be successful in asking for terms that are off the norm or have not been tested in the market.
In terms of market players, domestic private equity firms will likely continue to play a significant role as borrowers in the Korean M&A market, along with Korean conglomerates as strategic buyers of businesses. On the lenders’ side, Korean domestic banks and securities houses are likely to remain as the most active lender group in the acquisition finance sector. However, overseas private equity firms and international banks are showing increased interest in filling the liquidity gap created by the domestic financial institutions, taking a more conservative approach to underwriting new loans. The challenge for these institutions will be to find effective means to comply with and navigate through various regulatory requirements, including those found under the foreign exchange regulations, to provide credit to borrowers in Korea.
For acquisition loans, generally a special purpose vehicle (SPV) is newly established by a sponsor as the borrower of the acquisition loan and the acquirer of the target. Upon consummation of the acquisition, the target will become the subsidiary of the borrower. The acquisition loan is usually repaid in one lump sum at maturity. The term of the acquisition loan is usually between two and five years. If the borrower elects to prepay the loan, a prepayment fee will usually apply if the loan is prepaid between 12 and 18 months from the drawdown.
In terms of security, an acquisition facility is generally secured by the target’s shares and the borrower’s bank accounts. The target assets may not be used as collateral to secure the acquisition loan due to breach of fiduciary duty concerns, discussed in more detail below. For the same reason, the target may not provide a guarantee to support the payment obligation of the borrower, as such guarantee will constitute an upstream guarantee.
The acquisition loan agreement in Korea typically contains a robust set of representations, warranties and covenants. The most common financial covenants required by the lenders are the ratio of net debt to EBITDA, and the ratio of the loan to the value of the shares provided as a security (generally in respect of publicly traded target companies).
Lenders may consider covenant-lite documentation, if the financing is provided for an acquisition of a minority equity interest in a target. In the case of acquisition of a minority interest in a listed company, the lenders may forego stringent documentation terms in place of a strict loan to value test (the ratio of a loan to the value of the listed shares granted as a security).
Supreme Court Case on LBOs
Under Korean laws, the directors of every company owe a strict fiduciary duty to their company. In the context of a leveraged buyout (LBO), therefore, the target pledging its assets to support the acquisition loan being obtained by its acquirer gives rise to the question of a breach of fiduciary duty by the target’s directors. To avoid this issue, it is generally accepted that so long as the borrower remains as the parent of the target company, the acquisition loan may not be secured by the target’s assets and the target may not issue a guarantee in favour of the borrower’s lenders regarding the acquisition loan.
The Supreme Court of Korea, however, has taken the position that if the borrower and the target merge after the acquisition and the target becomes the surviving company, the acquisition loan may be transferred to the target without the target’s directors breaching their fiduciary duty. The Court distinguished this type of LBO (a merger-type LBO) from a structure where the target’s assets are provided as collateral to the borrower’s acquisition loans and further went on to hold that the target could not be considered damaged by the merger in such case.
However, a potential buyer in an acquisition should carefully approach the merger-type LBO. In 2021, the Supreme Court of Korea found a target’s directors guilty of breach of fiduciary duty in respect of certain merger-type LBO transactions. The Court held that the target provided its assets to secure the borrower’s debt financing without obtaining any profits, and further emphasised that the mortgage established on the target’s real estate could be viewed as also securing the borrower’s debt financing. The Court also held that the borrower did not engage in any business other than serving as a special purpose vehicle, whereas the target owned tangible and intangible assets with substantial monetary value and generated actual operating profits.
Transaction parties to an acquisition financing will need to stay current on the evolving issue of fiduciary duty obligations in structuring the financing. Korean courts will likely consider all the facts and circumstances of the financing to determine whether a particular LBO involves a violation of such duty.
Syndicated Facilities and Interest Rates
A financing institution may choose to underwrite the entire acquisition loan facility and engage in multiple sell-downs after the closing or invite other lenders to form a syndicate in order to finance the acquisition. Although syndicated acquisition loans are common in the market, there has been an increasing trend towards a single leader or a small group of arrangers fully committing to the entire facility followed by post-closing sell-downs.
In order to facilitate sell-downs, the lead arranger may offer interest rate options in the financing terms which allow a loan transferee to select either a fixed rate or floating rate of interest within a certain designated period of time after the initial utilisation of the loan.
Floor rate and market flex provisions were seldom included in acquisition financing terms prior to 2022. However, due to the recent interest hikes and liquidity crunch, more lenders prefer to have these interest rate protection options reflected in the financing terms for increased chance of successful syndication.
A bridge loan is one of the popular ways to finance large M&A. Bridge loans are generally put in place to bridge the gap between the initial funding of the acquisition and the borrower obtaining the longer-term funding of the acquisition. There are various types of bridge financing depending on the types or the value of the collateral provided by the borrower or the sponsor.
One of the most common bridge loan types is a short-term bridge loan where a private equity buyer incurs a financing to bridge the gap between the acquisition closing until the buyer can secure equity financing from its limited partner (LP) investors. Such bridge loans are temporary loans with a maturity of one year or less.
These bridge loans are secured by the equity commitment issued by the general partner (GP) investor or the private equity (PE) sponsor, which provides that the GP investor or the PE sponsor is responsible for repayment of the loans should there be a default. Such equity commitment usually provides that at maturity or upon acceleration of the bridge loan due to an event of default:
Prior to the amendment of the Financial Investment Services and Capital Markets Act in 2021, it was unclear whether a PE fund could issue an equity commitment under the Act in connection with a financing. However, the amendment clarified that a PE fund is able to issue an equity commitment in connection with a loan, so long as a certain leverage ratio limit is complied with.
Obtaining an acquisition financing to fund tender offers has become a trend in the Korean market. A tender offer made for Ostem Implants in the earlier part of 2023 is an example of such trend, where the sponsor contemplated using the acquisition loan proceeds to partially fund the tender offer.
Under the Financial Investment Services and Capital Markets Act, a tender offer report must be filed with the Financial Supervisory Service and the Korea Exchange before a tender offer is made. The filing must be accompanied by documents evidencing that the funds necessary for the tender purchase have been secured.
Until recently, Korean financial regulators required the potential tender offeror to deposit cash in a tender purchase account and submit documents relating to the account as evidence of secured funds. Such cash deposit requirement meant that the mechanism of securing and releasing loan proceeds for the tender offer had to be carefully negotiated and documented to ensure that the transaction could proceed without any hiccups.
However, in recent years, regulators have been willing to take a more flexible approach to securing tender purchase funds before filing a tender offer report. More recently, financial regulators have announced that a letter of commitment issued by financial institutions may be recognised, under certain circumstances, as evidence that the tender offer funds have been secured. Given such announcement, the authors expect that potential offerors will more frequently use a letter of commitment to evidence that funds needed for tender purchases have been secured in the future.
The Act on Protection of Financial Consumers
With the implementation of the Act on Protection of Financial Consumers in 2021, the majority of financial institutions participating in domestic acquisition financing have also become subject to the provisions of the Act.
In light of the Act, the factors below should be considered in the context of acquisition loan documents.
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