Contributed By Kim & Chang (Seoul - HQ)
Filings of bankruptcy and rehabilitation proceedings (collectively defined as insolvency proceedings) by corporations in South Korea have continued to increase each year despite the broader economy emerging from the 2007-08 financial crisis. The table below presents data collected by the South Korean Supreme Court about the number of insolvency proceedings filed by corporations.
Year/insolvency proceedings 2008 2009 2010 2011 2012 2013 2014 2015 2016
Rehabilitation 366 669 627 712 803 835 873 925 936
Bankruptcy 191 226 253 312 396 461 539 587 740
Restructuring and insolvency activity has been concentrated in the steel, construction, leisure, shipping and shipbuilding, and second-tier financial sectors. Since 2017, second-tier automobile suppliers have suffered from a liquidity problem due to a depression in the car-making industry; most recently, there has been insolvency activity in connection with the local shipbuilding industry due to increased global competition.
Among the factors that may have contributed to the elevated level of insolvencies and restructurings have been the recent slowdown in economic growth in China (South Korea’s largest trade partner) and devaluation of the Japanese yen, which has hurt the relative competitiveness of South Korean exports. Further, recent Supreme Court decisions regarding the definition of "ordinary wage", which is used to calculate various employment-related entitlements, and the minimum wage has resulted in a significant increase in labour costs for many South Korean companies and in particular sole proprietorships.
The Bank of Korea has reduced the benchmark interest rate to a record low, which may have helped some companies to avoid restructuring by lowering their debt-servicing burden. However, economic growth has fallen below the longer-term trend in recent years and corporate and household debt levels remain a concern. The Bank of Korea recently reported that the number of companies that cannot repay the interest on their loans with their operating profits for more than three years increased from 2,698 in 2009 to 3,295 in 2014 and to 3,126 in 2016, highlighting the continuing financial difficulties faced by many South Korean companies. The interest rate rise by the Federal Reserve in 2017 will adversely affect individuals who took out loans for houses at relatively low interest rates.
The main purchasers of non-performing loans (NPLs) in South Korea have traditionally included the United Asset Management Company (UAMCO), a temporary “bad bank” funded by six domestic banks for purchasing and managing NPLs, and the Korea Asset Management Corporation (KAMCO), a quasi-public corporation established in response to the effects of the Asian financial crisis of 1997-98 that is dedicated to purchasing and resolving NPLs from financial institutions. However, interest in South Korean NPLs has been growing among private investors as the size of the NPL market has increased. According to the Financial Supervisory Services (FSS), the total value of NPLs extended by banks reached KRW23.2 trillion in the third quarter of 2015, which was almost equal to the amount for the whole of 2014.
In addition to the traditional market for NPLs, where South Korean banks sell pools of NPLs to investors, there have also been a growing number of investors, including foreign private equity funds, interested in directly investing in unsecured or secured claims against large listed companies undergoing rehabilitation proceedings under the Debtor Rehabilitation and Bankruptcy Act (DRBA) and in the shares issued through debt-to-equity swaps under such proceedings. The growing interest in distressed debt and securities among private investors has made the market increasingly competitive.
After the 1997 financial crisis, the South Korean government reformed the nation’s bankruptcy law by revising the Corporate Reorganisation Act, the Composition Act and the Bankruptcy Act. Nevertheless, it was apparent that there was a need for a unified bankruptcy law. In 2000, the legislature passed a comprehensive bankruptcy law, the DRBA. The DRBA supersedes the Corporate Reorganisation Act, the Composition Act and the Bankruptcy Act and is divided into six chapters:
South Korea also offers out-of-court workouts under the Corporate Restructuring Promotion Act (CRPA), which enacted into law the corporate workout procedures that had previously been used by financial institutions for restructuring debtor companies on the verge of insolvency through an out-of-court workout arrangement.
The current CPRA is the fifth version of the sunset law and expired on 30 June 2018. There is considerable consensus to re-enact the CRPA in its sixth version.
The Seoul Bankruptcy Court was established on 1 March 2017. If the creditors of a debtor company exceed 300 and the amount of debt exceeds KRW50 billion, the Seoul Bankruptcy Court will have concurrent jurisdiction over the insolvency proceeding even if the debtor’s main business or place of incorporation is outside Seoul.
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There are no particular circumstances whereby companies are obligated to commence insolvency proceedings within a specific timeframe.
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There are no specific penalties under the law for not commencing insolvency proceedings. Failure to file for court protection could theoretically raise a fiduciary duty issue for the debtor company’s directors in certain circumstances, as explained below in section 12 Duties and Personal Liability of Directors and Officers of Financially Troubled Companies.
For a rehabilitation proceeding which is analogous to Chapter 11 of the US Bankruptcy Code, a debtor company, creditors holding claims amounting to 10% or more of the debtor company’s paid-in capital or shareholders holding 10% or more of the debtor company’s total issued and outstanding shares may file for the commencement of the rehabilitation proceeding against the debtor company. The inability to pay debts as they become due (cash flow insolvency) or the liabilities (including contingent) exceeding assets (balance sheet insolvency) are grounds that may prompt a petition to be filed.
Rehabilitation proceedings commence with the filing by debtor, creditors or shareholders. The filing of a petition for rehabilitation proceedings has a number of important legal effects, such as restricting the right of set-off against the debtor and the suspension of trading of shares of a listed company. The filing is thus an important yardstick for the determining avoidance issues at a later stage in the proceedings. Unlike the commencement of proceedings pursuant to Chapter 11 of the US Bankruptcy Code, however, the filing of the petition for rehabilitation proceedings does not give rise to an automatic stay but instead gives rise to a power of the court to grant provisional orders prohibiting the disposal of assets. Other important legal effects, such as the prohibition on creditors to assert claims against the debtor and the vesting in the trustee of the right to deal with and dispose of the rehabilitation debtor's assets, take effect upon the court issuing a separate rehabilitation commencement order, which is the next step in the proceedings in response to the filing of the petition.
For a bankruptcy proceeding which is analogous to Chapter 7 of the US Bankruptcy Code, a petition for the bankruptcy proceeding may be filed by the debtor company itself or by a creditor. Shareholders do not have standing to file bankruptcy of the debtor company, and there is no 10% threshold for creditors to file.
South Korean insolvency laws do not distinguish between “solvent” and “insolvent” court-supervised rehabilitation proceedings. A company can be subject to a rehabilitation proceeding if it is unable to make debt payments when they become due, even though it might be considered solvent in the sense that its assets exceed its liabilities. See below, 6.1 The Statutory Process for Reaching and Effectuating a Financial Restructuring/Reorganisation. However, with regard to bankruptcy proceedings, insolvency is a ground for bankruptcy proceedings against corporate entities, not individuals. Therefore insolvency must be shown for both voluntary and involuntary bankruptcy proceedings.
Companies in the banking and insurance sectors are regulated and may be subject to orders and management by their regulator to mitigate the risk of their becoming insolvent.
The Financial Industry Restructuring Act (FIRA) applies to South Korean financial institutions, including banks, insurance companies and domestic branches of foreign financial institutions.
According to the FIRA, the Financial Services Commission (FSC) pre-emptively regulates a financial institution’s financial soundness through solvency margin regulations and management evaluations. If a financial institution is found to be potentially distressed based on the solvency margin or as a result of a management evaluation, the regulators will take a proper corrective action. If it is deemed that a financial institution is likely to become distressed, the financial regulators will proactively supervise it through management improvement recommendations, requests or orders gradually. Notwithstanding these corrective measures, however, if the company becomes distressed (ie, having more liabilities than assets), the financial regulators will designate the company as a “distressed financial institution” and determine a method for its reorganisation. The possible methods for reorganisation include:
There are no separate or distinct insolvency regimes applicable to any other sectors or industries (eg, railways). However, companies operating in important or strategic industries – such as public transportation, telecommunications or energy – could potentially be subject to government support in case they become financially distressed.
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There are two types of consensual out-of-court restructurings in South Korea: (i) a voluntary workout accord between the debtor and creditors, and (ii) a voluntary restructuring through a workout process provided for under the CRPA which has now expired by operation of its sunset clause in June of 2018. However, the CRPA will still be discussed here as there is considerable consensus for it to be re-enacted under more or less the same tenets and rules. Such out-of-court restructurings often used to be preferred by restructuring market participants, particularly debtor companies, because they afford more flexibility and generally cause less disruption to the debtor, which is able to receive finance during workout from financial institutions. However, banks have been reluctant to extend credit to the debtor company after a few large enterprises under workout have failed to revive since 2015.
Voluntary agreements and workouts under the CRPA are implemented from time to time and were often preferred over court-supervised insolvency proceedings by publicly held debtor companies because they are more flexible and can cause less disruption to the debtor company.
A voluntary agreement is a restructuring process through a private agreement by a committee of financial institutions (typically banks) of a debtor company that temporarily lacks enough liquidity. The creditor financial institutions voluntarily enter into and implement an agreement to restructure the company following the company’s request. Concluding the agreement requires, in principle, unanimous affirmative votes of the creditors, although decisions made after completing an agreement often require the agreement of creditors whose claims make up three-quarters of the total claims. Creditors may set a period during which they will suspend exercise of their claims and conduct due diligence with a view to preparing the restructuring agreement. The adjustment of liabilities under the agreement typically sets forth a three to five-year grace period, a lowering of interest rates and a conversion into equity of a certain portion of debt that exceeds the appropriate level the company can serve. Although such out-of-court restructurings are not expressly based on INSOL principles, the practice of such out-of-court restructuring more or less corresponds to workouts under INSOL principles, with certain exceptions, such as additional funding not necessarily being guaranteed priority status in such consensual restructurings in South Korea.
The workout under the CRPA is a more formal, statutory process, but one that still takes place out of court. It is applicable to a company that has been granted financial credit as defined under the Enforcement Decree of the CRPA. Pursuant to a 2016 amendment to the CRPA, this also includes financial credit provided by the head offices of foreign financial institutions and their overseas branches in addition to domestic financial creditors including banks and bondholders. The prime bank of a debtor company may notify a company identified as a company showing signs of financial difficulty and inform it that it can file an application for joint administration (so-called "workout") under the CRPA. Following the commencement of the workout, an accounting firm designated by the creditors’ committee conducts due diligence and reports to the creditors’ committee on the going concern and liquidation value of the company. Based upon such a report, the prime bank submits a plan for the business normalisation of the company for approval by the creditors’ committee. The plan may include a three to five-year grace period for the repayment of existing loans, the lowering of interest rates, the conversion into equity of a certain portion of debt that exceeds the appropriate level the company can serve, the extension of new credit to the company and the restructuring of existing business. It may also include split-off, transfer of business, sale of assets, cost reduction and other similar restructuring measures.
Secured creditors who are participating in the process generally also agree to refrain from enforcing their securities during an agreed period.
Creditors may agree to provide additional operating funds as part of the process. Creditors who are not part of the agreement can freely exercise their rights. The debtor company's representative director continues to manage the company during the process, although creditors may request certain consent rights to major decisions and other management rights may also be changed due to changes in shareholding through debt-to-equity swaps. During the process, the participating creditors may request the debtor company to provide relevant information about its financial status.
Super priority is not necessarily accorded to new money during out-of-court restructurings. However, agreement regarding priorities is binding among creditors participating in out-of-court restructurings. Creditors willing to provide new funding may ask for security; however, distressed companies often do not have enough assets left with meaningful security value. New money, if injected, is provided by creditor banks that participate in the out-of-court restructuring in proportion to their claim amounts.
There are no laws that specifically impose obligations on creditors participating in workout proceedings. However, general tort law principles are also applicable to such matters as abusing information related to out-of-court restructurings. Article 219 of the DRBA prohibits debtors from providing special benefits to creditors or shareholders outside of the plan in order to get favourable votes for confirmation of the plan.
In the case of a voluntary accord, concluding the agreement requires, in principle, unanimous affirmative votes of the creditors. It is a process driven by a voluntary contractual agreement and there is no specific cram-down mechanism applicable to such a process under the law. While the lack of a cram-down mechanism may sometimes pose as an obstacle to a restructuring through a voluntary agreement, some debtor companies have nevertheless restructured their debt through such an agreement.
In the case of a workout under the CRPA, the restructuring plan may include an adjustment of claims that is effective upon an affirmative vote of creditors whose amount of credit granted amounts to three-quarters or more of the total credit granted. The CRPA provides for no cram-down mechanism either. The financial creditors who opposed the restructuring under the CRPA are authorised to demand that the assenting creditors buy their claims jointly and severally, whose value is based on liquidation value not on market price. If the opposing creditors do not exercise the demand, they shall be bound by the restructuring plan.
In rehabilitation proceedings, the court may cram-down against dissenting creditors by providing a protection clause for them. Unlike the USA, in South Korea debtors do not have the right of cram-down and the court has discretionary power whether to exert cram-down or not. In practice, cram-downs are not infrequently used.
Shares in a South Korean company may be secured in the form of a pledge or "Kun-pledge". With respect to the former method, the Commercial Code provides for two types of share pledges: a registered pledge and an unregistered pledge. The key difference between the two is that the pledgee of a registered pledge is entitled by law to a security interest in (i) the cash or stock dividends declared in respect of the pledged shares, and (ii) the proceeds in respect of the pledged shares, with a priority over other creditors, without attaching such dividends, proceeds or distributions, while the pledgee of an unregistered pledge will not be entitled to such rights.
A security interest is created and perfected by an unregistered pledge when (i) a pledge agreement is entered into by and between the pledgor and the pledgee, and (ii) the certificates representing the pledged shares are delivered by the pledgor to the pledgee. In order to create and perfect a security interest created by a registered pledge, in addition to items (i) and (ii) immediately above, the pledge must be registered in the shareholders’ registry maintained by the issuer of the shares and the pledgee’s name must be registered on the share certificates. There is no other filing or registration requirement other than as described above with respect to the creation and/or perfection of a pledge of shares. A Kun-pledge, as opposed to a general pledge, is a pledge that secures floating debt obligations, which is to be fixed at some future date, up to a maximum amount.
Security over land is typically taken by way of mortgage. To create a mortgage, the parties must first enter into a mortgage agreement and then file a joint application for recordation of the mortgage in the real property registry. A mortgage is automatically perfected upon creation (ie, a mortgage agreement and a public recordation) and no further action is required for perfection. A "Kun-mortgage" is a special but often used type of mortgage and can be used to secure any type of debt. In practice, parties usually enter into a Kun-mortgage (rather than ordinary mortgage), which secures debt up to a certain maximum amount without regard to intermediate increases or decreases in the debt.
The most important type of security over moveable tangible property is a pledge. South Korean law recognises two types of pledges: those over moveables and those over a right in property. South Korean law also recognises the concept of a pledge of moveables represented by documents such as bills of lading. A pledge over moveable property is created by the execution of a pledge agreement and the transfer of possession over the pledged properties to the pledgee. A pledge of a right in property is similar to a pledge of moveable property, but rights are generally pledged by (i) delivery of the documents representing those rights, or (ii) delivery of written notice of the pledge, with a fixed-date stamp (see below, 15.2 Debt Trading Practices) affixed to it (or both), to the third-party obligor.
South Korean legal practice also recognises a special security interest known as "Yangdo-Dambo" by which a debtor transfers title to its property to its creditor for the purpose of granting a security interest over the property while the possession of the property is retained by the debtor, subject to the condition that the title should be transferred back to the debtor upon redemption of the secured debt. The additional procedures of perfecting the security interest by way of Yangdo-Dambo depend on the type of collateral that the Yangdo-Dambo covers. A Yangdo-Dambo can be used for immoveable and moveable property, but the title transfer of immoveable property must be registered like the transfer of any other rights to, or interests in, immoveable property to be effective.
In a rehabilitation proceeding, secured creditors cannot exercise their claims except through the plan that has been duly approved by the interested parties and confirmed by the court. They generally receive payments through the plan in the amount of the value of their security. Secured creditors have voting rights and, in order for a plan to be approved, secured creditors representing three quarters or more of the debtor company’s secured debt also have to approve the plan not counting their heads. Secured creditors may enforce their secured interests against their collateral during the rehabilitation proceedings only if the plan allows.
In a bankruptcy proceeding, secured creditors may enforce their security interests without any restriction imposed by the proceeding, they need to file proofs of claims and to identify the collateral with the bankruptcy court. Failing to file proofs of claim does not deprive them of secured interests, though.
In the case of out-of-court restructuring, whether the creditor holds a security does not matter as much as whether the creditor is bound by the restructuring.
If the debtor company is not under a rehabilitation proceeding, a secured creditor can initiate an enforcement action through the court, which typically consists of a public auction. The holders of Yangdo-Dambo may sell collaterals in their own ways, such as private sales. The time required for the completion of the auction process varies according to the type of property and generally takes more than six months. For pledges over shares, bonds or bank accounts, a secured creditor may obtain an attachment order on the collateral and enforce its security interests through an order of collection from the court, assignment order or special encashment order. Enforcing the security in this manner may take four to 12 months.
Secured foreign creditors are treated the same as local secured creditors under the insolvency proceeding as well as workout under the current CRPA.
Under the rehabilitation proceedings, secured creditors are protected by the best interests of the creditor rule which provides that the secured creditors in rehabilitation proceedings must be repaid more than in bankruptcy proceedings.
Under the rehabilitation proceeding, creditors are classified into four basic categories: creditors with unsecured rehabilitation claims, creditors with secured rehabilitation claims, creditors with subordinate claims, and creditors with claims for the common benefit.
The first two categories of creditors are subject to rehabilitation proceedings and generally may not receive payment or repayment of their respective claims other than as provided for in the plan. Creditors with subordinate claims are usually insiders such as majority shareholders, directors who are responsible for disruption of corporations. Interest claims accrued after the commencement order is issued are treated as subordinate claims. Creditors with claims for the common benefit are not subject to the plan. Common benefit claims include new borrowings after the commencement of the proceeding, administration expenses, tax claims that arose after the commencement of the rehabilitation proceeding, employee salaries and severance pay, and disaster and accident compensation.
In a rehabilitation proceeding under the DRBA, unsecured trade creditors can only exercise their claims through the rehabilitation plan that has been duly approved by the interested parties and confirmed by the court. A 2016 revision of the DRBA provides that the creditors who have supplied goods in the ordinary course of business to the debtor within 20 days prior to the filing of the petition for rehabilitation will be treated as common benefit claim-holders whose priority is higher than unsecured creditors.
As a result, unsecured trade creditors often receive only a fraction of their claim, which is paid out over a period not exceeding ten years, with the remaining amount typically being converted into equity or released. In some cases, if the trade creditors are deemed by the court-appointed receiver to be critical to the debtor company’s business (for example, suppliers who refuse to continue to supply raw materials unless they receive payment in full for prior deliveries), it is possible for the receiver to petition the court for and obtain an early repayment order regarding their claim, which can result in the creditors receiving repayment of their claims earlier and in an amount that is greater than they would have received if they were paid out as usual under the plan. However, whether the receiver would petition the court for such an order and whether the court would grant it depends on the circumstances of each case.
Trade creditors are generally not bound by the workout under the CRPA and usually do not take part in any voluntary accord. As such, they are able to enforce their claims as usual regardless of any out-of-court voluntary workout process.
In a rehabilitation proceeding, unsecured creditors can only exercise their claims through a plan that has been duly approved by the creditors and confirmed by the court. Unsecured creditors have the right to vote on the draft plan and, in order for a plan to be approved, unsecured creditors representing two-thirds of the debtor company’s unsecured debt also have to approve the plan. The head of creditors is not counted. If a plan is not duly approved by the interested parties, the rehabilitation proceeding may fail and a bankruptcy (liquidation) proceeding may be commenced with respect to the debtor company, which is called a converted bankruptcy case. Creditor committees comprised of secured and unsecured creditors can access information regarding the debtor’s business and opine on appointment of the trustee, receiver and the plan proposed by debtors.
There is no cram-down procedure in the rehabilitation proceeding per se by which secured creditors can legally force unsecured creditors to accept the terms of the proposed rehabilitation plan approved by the secured creditors. However, if certain creditor groups do not approve the rehabilitation plan, which can include certain unsecured creditors, the court may approve the plan by modifying it to prescribe additional terms that protect the rights of the class of creditors who did not vote in favour of the plan. For example, the court may sell certain properties of the debtor at a fair market or higher price and use the proceeds of the sale to pay the claims of the objecting class of creditors, or it may simply order the debtor to pay a fair price, as set by the court, to the objecting creditor class or otherwise to give fair and equitable protection to that class.
There is a pre-judgment procedure by which a claimant can cause the property of a debtor to be seized in order to secure the satisfaction of such claimant’s future judgments against such debtor in a main action (ie, a preliminary attachment). However, after the commencement of an insolvency proceeding, further enforcement of a preliminary attachment is prohibited and, upon the approval of a rehabilitation plan by the interested parties and the court, the attachment will be nullified. Because there is no concept of judgment lien or judicial lien in South Korea, judgment creditors do not have any lien over the debtor’s immoveables and will be paid out based on a pro rata basis as unsecured creditors.
An unsecured claim must generally be enforced by instituting a lawsuit. It is difficult to explain generally how long it would take to get a judgment in the first-instance court and execute claims in execution proceedings, but the following timeline is a rough explanation.
The process may take eight to ten months to obtain a judgment from the district court. However, the judgment may be appealed to the High Court and again to the Supreme Court. If such appeals are made, the process may take an additional eight to ten months at the High Court and Supreme Court levels, respectively. The judgment rendered by the district court ordering payment of debt may be provisionally enforceable even though the defendant filed an appeal. The enforcement may be conducted by the court to attach and sell the debtor’s assets through the court auction procedure. The attachment and sale of assets and distribution of the proceeds may normally take four to 12 months.
Landlords do not have any special rights such as levying upon the tenant’s goods and right of eviction (as in England). Landlords must follow general civil lawsuit proceedings to evict tenants. Further, the Housing Lease Protection Act (HLPA) and the Commercial Building Lease Protection Act (CBLPA) protect the rights of tenants. In rehabilitation proceedings, the receiver of the debtor company that is a landlord may not terminate a lease contract if such lease contract was perfected in accordance with the HLPA or CBLPA by certifying the lease contract and if tenants preside in the residence or conduct business in the commercial space.
Unsecured foreign creditors are treated the same as local unsecured creditors in the case of insolvency proceedings. Most information and filings relating to such proceedings are in Korean, but the language barrier can be easily overcome with the assistance of local counsel.
A workout under the CRPA binds domestic financial institutions, including a South Korean branch of a foreign financial institution as well as the head office or other branches located overseas. Important information such as the date of commencement order, interested parties meetings and hearing days for confirmation of the plan are public information disclosed via the bankruptcy court website.
Under the bankruptcy proceeding, creditors entitled to distribution are differentiated according to the priority of their claims as follows:
DIP financing claims in rehabilitation proceedings have priority over other common benefit claims. Administration expenses, wages and severance allowance, certain tax claims and remunerations for trustee and court-appointed receiver are common benefit claims. All common benefit claims are treated equally except DIP financing claims.
Generally, common benefit claims are paid at any time during the rehabilitation proceedings but secured creditors have priority over the collateral and are repaid in advance of common benefit claim-holders in an auction process.
The DRBA offers two kinds of insolvency proceedings for business entities: (i) rehabilitation proceedings under Chapter 2 of the DRBA, primarily for the rehabilitation of insolvent business entities, and (ii) bankruptcy proceedings under Chapter 3 of the DRBA for the liquidation of insolvent business entities. The two proceedings and related matters are described below.
Petition for Rehabilitation and Commencement
A debtor company, creditors holding claims amounting to 10% or more of the debtor company’s paid-in capital or shareholders holding 10% or more of the debtor company’s total issued and outstanding shares may file for the commencement of a rehabilitation proceeding against the debtor company. A rehabilitation proceeding commences only when the court issues a separate commencement order in response to the filing and the court should decide within one month from the receipt of the petition whether it will issue the opening order. The proceeding may be commenced (i) when the debtor is unable to pay its debts as they become due and unable to make any reasonable attempt to do so, or (ii) when the corporation cannot pay its debts when they are due without a significant impact on the continuity of its business. A voluntary petition by the debtor, in practice, is easily accepted by the court. A debtor company may file a pre-packaged plan with a petition for a rehabilitation proceeding with the consent of more than 50% of the entire claims.
Appointment of Receiver
Upon commencement of the rehabilitation proceeding, in principle, the court will appoint a receiver. In general, the court will appoint the existing management (for example, a representative director) of the debtor company to act as the receiver in the rehabilitation proceeding unless the insolvency of the debtor company was caused by the fraud, incompetence or gross negligence of the existing management, in which case the court will appoint a disinterested party as the receiver. The receiver has the power to conduct the debtor’s business and manage its property, subject to the court’s supervision.
Preservation Order and Stay Order
When an application for the commencement of a rehabilitation proceeding has been filed with the court, the court may issue, upon petition or at its discretion, a preservation order within seven days from the filing and will determine whether to commence the rehabilitation proceeding within one month. During the period between the filing and the commencement, the court may also issue, upon petition by an interested party or at its discretion, a comprehensive stay order or specific stay order against creditors, the effect of which would be that all or specific administrative or judicial proceedings against the debtor will be stayed or prohibited. The commencement order has the effect of staying proceedings and enforcement actions against the debtor and its assets.
The receiver overseeing the rehabilitation has the power to assume or terminate (not reject) any bilateral contract to which the company is a party under which performance remains due on both sides, referred to as an “executory contract”. The counterparty to an executory contract that is terminated by the receiver is entitled to participate in the proceeding as an unsecured creditor for compensation of damages resulting from the company's non-performance of the contract, while, if the executory contract is assumed by the receiver, the claim of the counterparty would qualify as a common benefit claim, payable when due. The counterparty may ask the receiver to choose whether it will terminate or assume the executory contract; if the receiver does not respond to the request within 30 days of receipt of the request, it is deemed that the receiver chose to assume the contract.
Filing of Claims and Types of Claims
The receiver will prepare lists of creditor claims between two weeks and two months from the commencement. If the claims are correctly specified in these lists, the filing of the proof will not be required. However, if the claims are not specified or are specified incorrectly in such lists, a creditor must file proofs of claim within a designated period of time (between one week and one month from the last date of the receiver’s report period) and failure to do so will nullify its claim or fix its claim as specified in the lists. In rehabilitation proceedings, creditors are classified into three categories: (i) creditors with unsecured claims, (ii) creditors with secured claims, and (iii) creditors with common benefit claims. Creditors with secured or unsecured claims are subject to rehabilitation proceedings and generally may not receive payment or repayment of their respective claims (with certain exceptions, including set-off of claims that are exercised within certain periods permitted under the DRBA) other than as provided for in the plan. However, creditors with common benefit claims are not subject to the plan and include those creditors whose claims arose after the commencement of the rehabilitation proceeding (with certain exceptions), and those creditors whose claims were approved by the court during the preservation period. It is possible for a creditor to file its claim on a contingency basis if it is uncertain whether the creditor will have a claim or the claim has not yet crystallised but may subsequently do so.
Claims may be transferred. Prior to the approval of the plan by the creditors and the court, creditors may transfer their claims by executing an appropriate transfer agreement and perfecting the transfer by providing a notice to or receiving an acknowledgement from the receiver affixed with a fixed-date stamp and submitting a report of the transfer to the court together with related documentary evidence of the transfer. After approval of the plan, creditors may transfer their claims in the same way but without the need to notify the court.
Rehabilitation Plan and Termination of Rehabilitation
An examiner appointed by the court investigates the debtor company’s financial status and prepares a report by the date designated by the court, which estimates whether the debtor company’s going concern value is greater than its liquidation value. If the going concern value exceeds the liquidation value, the court generally requests the receiver to prepare a draft plan within a period not exceeding four months. A plan may call for rescheduling of the debtor's debt over a period not to exceed ten years, except when corporate debentures are issued pursuant to the rehabilitation plan. The first interested parties' meeting may be held at the courtroom within four months from the commencement of the rehabilitation proceeding for the purpose of examining creditor claims. In practice, the first interested parties' meeting is omitted; instead, the receiver explains about the debtor’s situation at an appropriate place. A second and third interested parties’ meeting is held to discuss and vote on the draft rehabilitation plan at the courtroom.
Information Made Available to Creditors
At the time of the filing of the petition for rehabilitation proceedings, the debtor company includes information about its financial status in the petition, including its calculation of its going concern and liquidation value. The examiner prepares a report within the period designated by the court on the financial status of the debtor company, whether the going concern value is greater than the liquidation value, assessing the prospects of its future business and operations, and finding grounds for avoidance. A copy of the petition and such reports can be obtained by interested parties, including creditors. Creditors who inject new funds into the debtor after the order for relief under rehabilitation proceedings will have greater access to information and the right to express their opinions regarding the proceedings.
Discontinuation of Rehabilitation
If payment under the plan has commenced, the court shall, upon petition by an interested party or at its discretion, close the rehabilitation case early, unless there is an impediment to the implementation of the plan. However, if it becomes apparent, either before or after the court approves the plan, that the debtor cannot be rehabilitated, the court may, in its sole discretion or upon request by the receiver or a creditor, issue an order to discontinue the rehabilitation proceeding. Once the rehabilitation proceeding is discontinued due to the debtor’s failure to comply with the rehabilitation plan, the court may issue an opening order of bankruptcy proceedings.
The rehabilitation proceeding usually takes up to one year from commencement to confirmation of the plan and the proceeding may continue for up to another ten years while the debtor company makes payments under the plan. Since April 2011, the Bankruptcy Panel of the Seoul Central District Court has begun to implement so-called fast-track procedures under which rehabilitation proceedings proceed according to an expedited schedule. Fast-track procedures are designed to help the debtor company to complete the restructuring plan and return to its normal business operations at the earliest possible time (usually approved within six months), with the support of major creditors, including financial institutions.
Adjudication of Bankruptcy
Bankruptcy proceedings formally begin upon adjudication by the court that the debtor is “bankrupt” after the filing of a petition for the bankruptcy proceeding by the debtor company or its creditors. The adjudication of bankruptcy also has the effect of staying all unsecured creditors from exercising or otherwise enforcing their claims against the bankruptcy estate (with certain exceptions, including set-off claims that are permitted by the DRBA). Even before the formal adjudication of bankruptcy, the court is empowered to issue preservation orders preventing creditors that have unsecured claims from enforcing their claims.
The grounds for bankruptcy exist when the debtor is unable to pay its debts as they become due. Alternatively, the court may place the debtor company into the bankruptcy proceeding following the filing of a petition for rehabilitation on the ground that it has deemed that the debtor company does not have a reasonable chance of being rehabilitated.
The bankruptcy trustee appointed by the court will be vested with the exclusive right to manage and dispose of the bankruptcy estate, and to conduct an investigation and assessment of the bankruptcy estate. The trustee is an attorney at law and the incumbent management loses its management authority over the debtor company upon order of commencement of the bankruptcy proceeding.
Subject to certain statutory limitations and approval by the court, the bankruptcy trustee has the power to liquidate the bankruptcy estate and to determine the manner and timing of such liquidation. The bankruptcy trustee distributes the proceeds from the liquidation of the bankruptcy estate to the creditors according to the priority of their claims and, with regard to the claims of the same priority, in proportion to their claim amounts.
The above explanation regarding executory contracts in the case of rehabilitation is also applicable in the case of a bankruptcy proceeding except that it is deemed that the trustee chose to terminate the executory contract if the trustee does not respond within a reasonable time. Since the purpose of the proceeding is to wind up the business of the debtor company, the trustee generally terminates all executory contracts. The counterparty to an executory contract that is terminated by the trustee is entitled to participate in the proceeding as an unsecured creditor for compensation of damages resulting from the non-performance of the contract.
Classification of Creditors and Enforcement of Security Interests
Creditors are generally divided into creditors with bankruptcy estate claims and creditors with unsecured claims. Unsecured claims are subject to the bankruptcy proceedings and repaid from the distributions made by the bankruptcy trustee. However, bankruptcy estate claims are repaid from time to time from the bankruptcy estate. Unlike rehabilitation proceedings, the enforcement of a security interest in the debtor’s assets is not subject to bankruptcy proceedings except for certain procedural limitations.
Creditors may transfer their claims by the same method explained in rehabilitation proceedings.
Information Made Available to Creditors
A petition for a bankruptcy proceeding will include information about the company’s financial status. The trustee then needs to evaluate all the assets as of the date of the declaration of bankruptcy and report at the first meeting of creditors. The trustee periodically reports about its activities to the court, including regarding sales of assets and the status of the bankruptcy estate, a copy of which report may be obtained by creditors with the court’s approval. The trustee or interested parties may also petition relevant institutions such as banks or land registry offices to provide additional information regarding the debtor’s assets.
The bankruptcy proceedings can take several years to be completed, depending on the complexity of the case and the size of the assets and business to be unwound and liquidated. There is no fast-track process.
Permissibility of Set-offs Against an Insolvent Party
The four general requirements for set-off are as follows:
Furthermore, under the bankruptcy proceeding, a creditor is permitted to exercise its set-off rights indefinitely, whereas under the rehabilitation proceeding, a creditor may continue to exercise its set-off rights only until the expiration of the claims filing period as designated by the court.
Under the insolvency proceedings, set-off is further not permitted in certain cases, depending on the circumstances (for example, if the creditor of the insolvent party assumed the obligation to the insolvent party subsequent to the declaration of bankruptcy or commencement of the rehabilitation proceeding).
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In rehabilitation proceedings, the court-appointed receiver has the power to dispose of the debtor's assets as part of the restructuring, although any asset sales usually require approval of the court. Purchasers who purchase any assets sold by the receiver generally receive good title, free and clear of claims. Creditors are not generally permitted to credit bid in such sales due to set-off rules.
In bankruptcy proceedings, the court-appointed trustee has the power to dispose of the debtor's assets under the supervision of the court, which are mostly disposed of by public auction. Purchasers who purchase any assets sold by the trustee generally receive good title, free and clear of claims. Creditors are not generally permitted to credit bid in such sales due to set-off rules. It is also possible for the trustee to dispose of the asset through a private contract as long as the process is transparent and the price is reasonable.
In a rehabilitation proceeding, if the debtor company fails to satisfy its obligations under the plan, the rehabilitation proceeding would be terminated by the court, after which a bankruptcy proceeding may be commenced with respect to the debtor company.
Enforcement actions by rehabilitation creditors are generally stayed during a rehabilitation proceeding. Any secured and unsecured claims that are not recognised under the plan are irrevocably extinguished by approval of the plan even if the rehabilitation proceeding is subsequently terminated, so creditors must take appropriate and timely steps to ensure their claims are allowed.
If new money is injected after the commencement of a rehabilitation proceeding, the claim (DIP financing) relating thereto would be a common benefit claim payable when due regardless of the proceeding. The DIP financing claim has super-priority over other common benefit claims. The new injection can be secured by the assets of the company, if the company still has any unencumbered assets. The receiver must obtain prior court approval to make new borrowings or grant any security.
There are no specific proceedings that can be utilised to liquidate a corporate group on a combined basis in South Korea. However, the court or courts presiding over the separate bankruptcy proceedings of the group companies would have the discretion to co-ordinate such proceedings to some extent, if it is deemed appropriate by them to do so.
Upon the filing of a petition for a rehabilitation proceeding, a creditors’ committee comprised of a maximum of ten of the debtor’s major creditors is established unless the debtor is an SME. The creditors’ committee may present opinions to the court regarding the rehabilitation or bankruptcy procedures; the selection, appointment or dismissal of receivers or trustees; the selection and appointment of an examiner; the recommendation of a chief restructuring officer; or request the court to conduct due diligence on the status of the debtor’s management after approval of the rehabilitation plan. The committee is entitled to receive copies of important documents from the receiver or that are filed with the court regarding the proceeding. The committee may appoint a legal counsel, accountant or accounting firm with the approval from the court to receive advice or assistance. The reasonable costs of such assistance and of other activities for the benefit of the creditors may be borne by the debtor company with the court’s approval.
In rehabilitation proceedings, the receiver has the power to dispose of the debtor's assets as part of the restructuring, although any asset sales require approval of the court in principle. In bankruptcy proceedings, the trustee has the power to dispose of the debtor's assets under the supervision of the court, which are mostly disposed of by public auction.
Payments by the receiver or trustee above a certain threshold amount are also subject to the approval of the court.
Bankruptcy proceedings can be commenced with respect to a foreign debtor if that debtor has assets in South Korea. Theoretically, rehabilitation proceedings might also be possible with respect to a foreign debtor company if the foreign debtor company has business in South Korea. Further, under the DRBA, it is possible for domestic insolvency proceedings (either rehabilitation or bankruptcy) to be commenced against the same debtor separately or in parallel with the foreign insolvency proceedings recognised in South Korea, under a petition by the debtor, a creditor, or any other qualified interested party. Articles 630 and 631 of the DRBA provide that the petition for the recognition of foreign insolvency proceedings can be made by a representative of the foreign insolvency proceedings. Foreign insolvency proceedings can be recognised if there is sufficient evidence of those proceedings having duly taken place and the recognition of those proceedings would not have an adverse effect on public order in South Korea.
The recognition order is merely a basis for subsequently granting relief orders. Therefore, the foreign insolvency proceedings would affect South Korean business and assets only through relief orders issued by the Seoul Bankruptcy Court, which has exclusive subject matter jurisdiction regarding recognition cases upon a petition by an interested party (including the representative of the foreign insolvency proceedings) or at its discretion. The cross-border insolvency receiver appointed by the South Korean court will have the exclusive authority and power to control and dispose of the debtor’s business and assets in South Korea (including the transfer of assets to a foreign country, disposition of assets and distribution), subject to the approval of the South Korean court. Since 2006, US, Japanese, Dutch and Hong Kong insolvency proceedings have been recognised.
A number of South Korean companies have sought recognition of their South Korean insolvency proceedings in a foreign jurisdiction or commenced parallel proceedings in a foreign jurisdiction. There is no knowledge of any South Korean companies that have commenced insolvency proceedings in a foreign jurisdiction as the primary proceedings.
In 2017, in connection with a rehabilitation proceeding of Hanjin Shipping, a South Korean judge and a US bankruptcy judge had a conference call for the first time. Such co-ordination is also provided for under Chapter 5.
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The South Korean insolvency law applies to foreign creditors on the same basis as it applies to domestic creditors; foreign creditors tend not to suffer any specific disadvantages (or enjoy any special privileges) in court-supervised insolvency proceedings in South Korea.
Bankruptcy and rehabilitation proceedings are handled by the bankruptcy panel of the relevant district court having jurisdiction over the head office of the debtor company. The Seoul Bankruptcy Court was established in 2017. There are no separate bankruptcy courts in other regions
The qualification of judges in the Seoul Bankruptcy Court is the same as with other judges.
The district court handles all kinds of civil and criminal cases. The bankruptcy panel of the district court or the Seoul Bankruptcy Court focuses on presiding over insolvency proceedings.
Generally, courts may not interfere with matters subject to arbitration. However, after an arbitral tribunal has been constituted, parties may file a petition for provisional relief with the tribunal or directly with the court. If there is an arbitration agreement but the arbitral tribunal is not yet constituted, parties may request provisional relief from the court.
An arbitral tribunal cannot issue provisional relief with respect to a third party that is not participating in the arbitration proceedings. Unlike provisional orders of the court, the application for provisional relief under the arbitration proceedings cannot be made ex parte.
A party may challenge an arbitral award on the ground that recognition or enforcement of the award would be contrary to public policy. A party may also challenge an award on the basis that the award has been obtained fraudulently. However, the recognising court may not review the propriety or impropriety of the award itself. South Korean courts have generally recognised foreign arbitral awards. South Korea ratified the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention) on 8 February 1973. On the same day, it also ratified the Convention on the Settlement of Investment Disputes between States and Nationals of Other States. A foreign arbitration is recognised in South Korea according to these treaties. South Korea also entered into a bilateral treaty with the USA: the Treaty of Friendship, Commerce and Navigation between the Republic of Korea and the United States of America. Section 5 of the treaty states that both countries guarantee the validity of arbitration clauses in agreements and in the execution of arbitration awards. The issue of revocability of an arbitration award rendered abroad is determined by the laws of the place of arbitration, not the laws of the enforcing forum.
Generally, litigation proceedings, including arbitration proceedings involving the debtor company, are stayed during insolvency proceedings. If a debtor company undergoes insolvency proceedings, foreign proceedings – including arbitration proceedings – may be stayed, depending upon the debtor company’s applications for a stay in the proceedings to the relevant foreign jurisdictions where the receiver or trustee considers it necessary to do so and whereby the South Korean rehabilitation proceedings are recognised under such jurisdictions.
However, the creditor can obtain a relevant foreign judgment or an arbitration award in the foreign jurisdiction even where the South Korean insolvency proceedings are recognised if such a stay is lifted by the relevant foreign court, or where the South Korean insolvency proceedings fail to be recognised. Nevertheless, the enforcement of such a foreign judgment or an arbitration award may not be automatically allowed in general and will be considered as one of the significant evidences confirming the validity and presence of the creditors’ claims that will be paid in accordance with the rehabilitation plan or as a bankruptcy claim, as the case may be, in the relevant South Korean insolvency proceeding
Certain judges at the district court are appointed to a bankruptcy panel at the court, and the judges who preside over insolvency proceedings are selected from the judges appointed to the panel. In most courts, the judges on the bankruptcy panel handle primarily insolvency proceedings. Arbitrators can be selected by the parties and any person who has no legal and monetary interests impacted by the outcome of the arbitration can be an arbitrator.
Directors owe a fiduciary duty to their company under the Civil Code of Korea (the "Civil Code"). If the directors act in contravention of the requirements of law, government regulations or the company’s articles of incorporation, or if they neglect to perform their duties, they will be jointly and severally liable for damages incurred by the company as a result. A breach of fiduciary duty can also potentially raise a criminal issue under South Korean law.
In order to protect third parties, the Commercial Code provides that a director will be jointly and severally liable to a third party for any damages incurred by the third party as a result of a director’s neglect of his or her duties to the company if such neglect results from wrongful intent or gross negligence, even where such negligence does not constitute a tort against the third party under the Civil Code.
The directors are liable not only for ordinary damages, but also for special damages suffered by a third party. Special damages are those that a third party incurs indirectly as a consequence of damages incurred by the company due to neglect of a director’s duty. Special damages require that the underlying factual background, which could result in the damages, was known or could have been known to the director.
If a company is financially distressed and continuing business without obtaining court protection would only increase the company’s losses, it would be in compliance with the directors’ fiduciary duty for the directors to take measures to protect the company, such as by filing a petition with the court for a bankruptcy or rehabilitation proceeding. There is, however, no case precedent to date where the directors’ failure to apply for a bankruptcy or rehabilitation proceeding has been deemed to be a breach of their fiduciary duty to the company.
At the commencement of a rehabilitation proceeding, although in principle the court should appoint the incumbent representative director as the receiver of the debtor company, the court has discretion to appoint a third party if the representative director’s gross mismanagement or malfeasance is deemed to have been responsible for the company’s poor financial condition and its petition for the rehabilitation proceeding.
If a creditor is harmed by the directors’ duties to the company, the creditor could potentially bring a direct claim against the directors, who would be jointly and severally liable. In the event the harm was caused as a result of a resolution of the board of directors, the directors who voted for such resolution will be jointly and severally liable. However, the case laws prohibit creditors or shareholders from filing a derivative suit or civil suit against directors after the opening of insolvency proceedings.
Recently, there has been a practice by the courts to appoint a chief restructuring officer (CRO) after the commencement of rehabilitation proceedings in the case of larger companies. The CRO is a third party who acts as an intermediary between the debtor company’s receiver and its creditors, and helps to facilitate the communications between the creditors and the receiver to help to ensure that their interests are duly reflected in the rehabilitation proceeding. The CRO does not have any formal authority, although he or she may make suggestions to the receiver and the court. The traditional concept of a CRO in the USA is that the CRO is a turnaround specialist appointed prior to the commencement of insolvency proceedings, but the South Korean concept is somewhat different by appointment after the commencement of rehabilitation proceedings.
There is no concept of “shadow directorship” under South Korean law. Creditors can request that the debtor company appoint a creditor-nominee to the debtor’s board of directors while the debtor company is not subject to a court-supervised insolvency proceeding.
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Prior to the onset of a formal insolvency proceeding, under Article 406 of the Civil Code, a creditor of a company may apply to the court for cancellation and restitution of any "legal act" as a fraudulent conveyance if (i) such act is detrimental to the company’s creditors, and (ii) both the company and the counterparty of such act had knowledge that such act would be detrimental to the company’s creditors. A transaction is deemed "detrimental to creditors" if the company becomes insolvent due to the relevant transaction, if the company was already insolvent at the time of the relevant transaction, or the financial condition of the insolvent company worsens due to the transaction.
Certain transactions entered into by a debtor may also be challenged after the debtor enters into an insolvency proceeding on the grounds that preferential treatment of certain creditors by a debtor may be a basis for avoidance under the DRBA. In this regard, the DRBA allows a trustee or a receiver of the insolvent debtor to avoid certain legal acts taken by the insolvent debtor before the commencement of insolvency proceedings. Such avoidable acts include:
The Lending Business Registration and Consumer Protection Act (the “Lending Business Act”) applies to commercial lending transactions with South Korean borrowers. Under the Lending Business Act, an entity that intends to engage in (i) the business of providing loans to South Korean residents, (ii) the business of acquiring claims arising from loan agreements and collecting them, or (iii) the loan “brokerage” business in South Korea must register with the relevant municipal government. If an entity holds a lending licence issued under other relevant laws, such as a banking licence or a credit specialty business licence, under the Lending Business Act, a separate registration is not required to engage in the lending business. In addition to the foregoing requirements, under the Foreign Exchange Transaction Act, engaging in the foreign exchange business (including the sale and purchase of foreign currency loans in South Korea) requires registration with the Ministry of Economy and Finance (the “FX Business Licence”). The FX Business Licence, however, is available only to South Korean financial institutions (including South Korean branches of foreign banks).
Under the Civil Code, any right to payment held by a party (the “creditor”) can be assigned to a third party unless there is an agreement between the creditor and the party who is obligated to make the payment (the “debtor”) that prohibits such assignment. If the creditor assigns the right to payment to a third party in violation of the agreement for non-assignment, the assignment would still be valid if the assignee was not aware of the non-assignment and was also not grossly negligent when receiving the assignment. Guarantees and security relating to a loan may also be transferred together with the right to payment under the loan.
Transfers of loans are most often accomplished by means of an assignment. South Korean law does not prescribe any specific method or means of making an assignment by the creditor. However, in order for an assignment by the creditor to be effective as to the debtor and any third party, certain methods prescribed by the Civil Code must be followed. Specifically: (i) for the assignment to have effect as to the debtor, the creditor is required to send a notice to the debtor regarding the assignment of the creditor’s right to payment, or obtain from the debtor a consent to the relevant assignment; and (ii) for the assignment to have effect as to third parties, the above notice by the creditor or the consent by the debtor must have a so-called "fixed-date stamp" affixed thereon. This could be done by sending the creditor’s notice or obtaining the debtor’s consent by way of a contents-certified mail or receiving the debtor’s consent that has been notarised.
The loan to be transferred often has its own form of transfer attached as an exhibit to the loan agreement. If the form has not been attached, the parties may prepare their own form, but the use of the Loan Market Association (LMA) forms is not common in South Korea.
There are generally no limits under South Korean law on the ability of transaction participants to trade debt on the basis of inequality of information, although intentionally misleading a counterparty may constitute fraud.
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Loan agreements in South Korea do not generally require the debtor’s consent for transfer of the loan.
Trusts or synthetic structures, such as total return swaps, can be used to navigate transfer restrictions.
In rehabilitation proceedings, the court-appointed examiner, which is usually an accounting firm, gives an opinion on the propriety of continuing the proceedings by determining whether the debtor’s going-concern value exceeds the liquidation value, considering the future debt-repayment ability of the debtor and various assumptions about the debtor’s future sales and business profits.
In workout under the CRPA, the accounting firm retained by the debtor upon the creditors’ request evaluates the debtor’s going-concern and liquidation value, and the appropriate measures needed for business normalisation.
Upon the commencement of a rehabilitation proceeding, the court appoints an examiner who examines the debtor company’s financial condition.
During workouts under the CRPA, the accounting firm retained by the debtor upon the creditors’ request evaluates the going-concern and liquidation value of the company.
In the event that an examiner has found that the company’s liquidation value is greater than its going-concern value, the examiner will recommend that the rehabilitation proceeding be discontinued and the court usually follows the examiner’s recommendation.
Although there is no provision in the law that describes how the examination should be conducted, the examiner usually takes the expected losses from liquidation of assets into account and calculates the liquidation value by applying the average bid ratio prevailing in the district court in which the debtor’s land or assets are located, to the value of the debtor’s assets as determined through the examiner’s due diligence. In most cases, the going-concern value is calculated through a discounted cash flow method. The examiner typically looks forward ten years and notes various assumptions and contingencies in its calculations.