The Recent Trend of Volume and Velocity of Financial Restructuring and Insolvencies in South Korea
The COVID-19 crisis has had a significant impact on the South Korean economy, leading to noticeable increases in the volume and velocity of restructurings and insolvencies.
In line with the downward trend in economic situations in South Korea, bankruptcy filings in South Korea surged in the first half of 2020. Corporations filing for bankruptcy were up to 522 cases in total, an increase of approximately 10% compared to the previous 485 cases during the first half of 2019. However, the number of corporate workout applications in the first half of 2020 were up to 448, approximately 10% less than that of the last year’s 497.
Many mid- to small-sized corporations as well as specific businesses that were hit hard by the COVID-19 crisis in South Korea are facing difficulties with liquidity. However, as the Korean government paid out emergency disaster relief funds totalling USD11.65 billion to all households to cope with the economic shortage by assisting households’ consumption, the economic crunch has been temporarily slowed down to some degree. In light of this, the companies suffering from a short-term liquidity crunch appear to be controlling their expenditure to sustain their business in the hope that the COVID-19 crisis will soon diminish.
Industry Sector-Specific Restructuring Trends or Other Factors Influencing the Incidence of Financial Restructurings and Insolvencies in South Korea
South Korea’s manufacturing industries have grown over the years, based on overseas markets, rather than domestic consumption. However, as exports have decreased significantly for many manufacturing items, manufacturing industries in general are faced with an overall decline. The following specific sectors have been severely damaged and devalued by the current COVID-19 disaster.
Motor vehicle plants suspended their operations due to the drastic decline in export volumes. South Korean car manufacturers such as Hyundai and Kia and their numerous suppliers expect their sales volumes this year to be 25% lower on average than those from a year ago. The South Korean government has presented its industry-specific policies to the automobile parts' industries, such as the establishment of a Private Debt Fund, debt-rollovers, government subsidies, aid, and tax graces as relief measures to avoid the domino effect of insolvency among automobile parts' manufacturers.
South Korea’s travel agencies and prominent duty-free shops experienced serious declines in the first half of 2020 and beyond, due to the ongoing standstill in air travel. More than 900 travel agencies closed their businesses, accounting for 5% of the total. It is estimated, however, that nearly 80% of local travel firms and small-sized businesses in the travel industry have simply closed their doors to save rents and labour costs without a formal bankruptcy filing, as formal bankruptcy filings incur costs. The Korean government attempted to promote domestic travel from June 20th to July 19th by offering one million discount tickets for domestic accommodations; however, the resurgence of COVID-19 infections in August 2020 precluded the promotion of this policy.
In efforts to help the severely cash-strapped airlines, the state-run Korea Development Bank and the Export-Import Bank of Korea injected approximately USD2.5 billion into the nation’s top two airlines, Korean Air and Asiana. In addition, it provided support of approximately USD250 million to various low-cost carriers. One of those low-cost carriers, Eastar, is currently undertaking drastic measures to keep its head above water, cutting more than half of its employees after its plans to sell the business to Jeju Air collapsed, leaving the company with fewer than 500 employees and only six carriers. Asiana and its two affiliated low-cost carriers, Air Seoul and Air Busan, are also subject to severe restructuring efforts, as the planned sale to Hyundai Industrial Development, which had been agreed prior to the COVID-19 crisis, has collapsed.
Changes in Credit Markets, Recent Economic Cycles, and Recent or Expected Legal, Tax or Regulatory Developments.
South Korea’s major banks extended the due dates on interest payments and loan instalments worth more than USD32.8 billion for six months, in an effort to prevent large-scale insolvency. Under the Financial Services Commission’s guidance, the major banks in South Korea have agreed to a further extension of due dates for another six months from 1 October 2020.
The Ministry of Economy and Finance announced it would revise the tax codes to facilitate activating businesses, not only to overcome the COVID-19 pains but also to cope with a post-COVID-19 recovery in the long term. For instance, whereas companies are currently subject to the tax credit only if they invest in facilities, research, and development centres related to eco-friendly plants, these requirements would be abolished under the proposed revision, allowing companies to benefit from the tax credit if they invest in any business facilities. The tax credit rate is set at 1% for big corporations and up to 10% for small- and medium-sized corporations.
The Debtor Rehabilitation and Bankruptcy Act (DRBA) was enacted to rehabilitate debtors facing financial difficulties efficiently, to revive their businesses through co-ordination of legal relations among interested parties, including creditors and equity holders, and to realise and divide a debtor’s asset fairly when deemed difficult to rehabilitate. Insolvency proceedings stated in the DRBA are controlled and led by the court.
The Corporate Restructuring Promotion Act (CRPA) was originally enacted during the Asian Crisis as a temporary law. Since then, the CRPA has been re-enacted multiple times to facilitate out-of-court restructuring and to promote the stabilisation of financial markets, as well as the development of the national economy, by promptly and efficiently implementing corporate improvement measures to enterprises with signs of insolvency. The workout procedures prescribed in the CRPA are led by financial creditors.
The Act on Structural Improvement of the Financial Industry (SIFI) prescribes laws to contribute to the balanced development of the financial industry and stabilisation of financial markets by promoting sound competition between financial institutions and supporting the structural improvement of the financial industry.
The Commercial Act provides a legal framework for voluntary liquidation of companies, whereas the Civil Act provides for voluntary liquidation of non-profit corporations. Relevant provisions include procedures regarding the appointment of a liquidator by the court, the duty of the liquidator, repayment of obligations and distribution of residuals, etc.
One way of categorising insolvency proceedings in Korea is to divide them into two types of procedures: court-administered proceedings and out-of-court proceedings. The former category relates to bankruptcy proceedings, rehabilitation proceedings and personal rehabilitation proceedings under the DRBA. The latter category consists of voluntary restructuring through a workout process (workout), provided for under the CRPA; and a voluntary workout accord between the debtor and creditors to which the CRPA is not applied (voluntary workout accord).
Article 79 of Civil Act prescribes that, if the legal entity has become incapable of discharging its obligations in full, the directors shall immediately file a petition for bankruptcy. However, there are no liabilities, penalties or other implications imposed upon the directors if they do not commence mandatory insolvency proceedings.
Creditors and equity-holders (in the case of companies) may commence involuntary insolvency proceedings against the debtor. However, between rehabilitation and bankruptcy proceedings there are noticeable differences in the requirement for commencement.
In a rehabilitation proceeding, creditors, whose accumulated amount of claims is at least one tenth of the debtor’s paid-in-capital for corporations or KRW50 million for other entities and individuals, may file a petition for commencement of rehabilitation proceedings. Equity-holders whose accumulated number of shares is at least one tenth of the total number of shares issued may also file a petition for commencement.
In a bankruptcy proceeding, any creditor, regardless of the pecuniary amount of their claim, may file for commencement of bankruptcy proceedings. In the case of corporations, a director, and for corporations that are undergoing a voluntary liquidation process, the liquidator, may also file for bankruptcy.
Insolvency is not required to commence rehabilitation proceedings in Korea. In a voluntary petition, the debtor must show that either (i) the debtor is unable repay a matured debt without causing significant encumbrance to the continuation of its business, or (ii) there is a concern that a cause for bankruptcy may arise with the debtor in order for a rehabilitation proceeding to be commenced. In an involuntary proceeding, only the latter requirement – where there is concern that a cause for bankruptcy may arise – applies. A cause for bankruptcy includes insolvency, which is defined as “inability to repay a debt”; and in the case of corporations, when the total amount of its liabilities exceeds the total value of its assets.
To commence a bankruptcy proceeding, insolvency is required. For corporations, it is also possible to commence insolvency proceedings when its liabilities exceed its assets. In a voluntary proceeding, the debtor is not required to show that any cause for bankruptcy exists. However, when a creditor files the petition for bankruptcy, the creditor must show that the debtor’s claim exists and that there is a cause for bankruptcy with the debtor. When a director or liquidator files a petition for bankruptcy against a corporation, which is not a joint filing with all of the other directors or liquidators, the director must show that there exists a cause for bankruptcy with the debtor corporation.
Insolvency, or other causes for commencement of insolvency proceedings would clearly exist in cases when a check or a promissory note is bounced, or when it is clear, based on the financial statements, that the debtor’s liabilities exceed its assets. In cases where a cause for bankruptcy does not yet exist, requirements for commencement are determined based on an evaluation of the debtor’s contingent liabilities, or a review of materials such as a schedule of liabilities and their maturity dates, recent monthly financial balance sheets and predicted monthly financial balance sheets for the coming months, as well as any background facts that lead to the filing of the petition for commencement.
Financial institutions, such as banks, investment traders or brokers, collective investment business entities, investment advisory business entities, insurance companies, trust business entities and financial holding companies, etc, are restructured under the SIFI, which provides specific restructuring procedures that apply to financial institutions. If, however, the Financial Services Commission (FSC), a financial supervisory authority, determines that it is not possible for the financial institution to be revived, existing contracts will be moved to another financial institution and the remaining bank will become subject to a bankruptcy proceeding based on the DRBA.
The DRBA also applies to rehabilitation and bankruptcy proceedings for corporations and individuals in general, and there are no laws that would govern the restructuring and insolvency proceedings of specific industry sectors.
During the past decade, due to the global financial crisis that began in 2008 and the consequent economic recession, an unprecedented number of companies, particularly in the shipping and ship-building industries, sought to revive their businesses through a voluntary accord or a corporate workout. These industries were especially wary of utilising court-administered rehabilitation proceedings because it would trigger default clauses in core contracts, trigger calls on refund guarantees, and hinder the companies from procuring additional funds necessary for the continuation of their operations.
However, voluntary accords apply only between the debtor and participating creditors, and corporate workouts allow for free-riders (ie, non-financial institution creditors who are not subject to the CRPA) to benefit from the concessions made by those financial institutions. In that regard, the CRPA has expanded the scope of applicable creditors to encompass all financial creditors, including foreign creditors, in order to minimise free-riders in a corporate workout process.
That said, when and if a corporate workout is commenced, financial institutions, which still make up the majority of participating creditors in most cases, are generally supportive of debtor companies, sometimes for their own benefit. As such, some critics have been wary of allowing financial creditors, especially commercial financial institutions such as banks, to control freely the financial matters of the borrower, including when the borrower files for bankruptcy.
Recently, the DRBA was revised in part, and the courts have also tried to establish new practices, which would make court-administered processes more flexible and therefore attractive to debtors and creditors that are in favour of the CRPA. The courts have somewhat succeeded in promoting the rehabilitation proceeding as a more flexible process that might accommodate various needs of each individual debtor, but due to the ongoing pandemic, bankruptcy filings, as opposed to rehabilitation proceedings, are now on the rise.
Competent laws in South Korea do not require mandatory consensual restructuring negotiations before the commencement of a formal statutory process.
A workout process under the CRPA includes the following procedures.
The Main Creditor Bank, as defined in the CRPA, is required to conduct a periodical evaluation of borrower companies in order to determine whether the company shows any “signs of unsoundness.” Based on this risk evaluation, the Main Creditor Bank classifies the company into four grades: capable of normal business (grade A); showing signs of unsoundness is highly expected (grade B); already showing signs of unsoundness, but with a high possibility of business normalisation (grade C); and already showing signs of unsoundness, but with a low possibility of business normalisation (grade D). If the company is classified into grade C or D, the Main Creditor Bank must notify the company of that fact and the reason for its classification. A company that receives such a notice may apply for a corporate workout under the CRPA, or file a petition for commencement of a rehabilitation proceeding.
Financial Creditors’ Committee
If the company showing signs of unsoundness applies for a corporate workout, the Main Creditor Bank must call the First Meeting of the Financial Creditors Committee (First Meeting), convened by the company’s financial creditors. The call for the meeting must take place within 14 days from the date on which the Main Creditor Bank received the application.
During this procedure, the Main Creditor Bank may require the financial creditors to suspend the exercise of rights to make claims against the company until the First Meeting is over. If the creditors do not comply with the requirement, the Main Creditor Bank may later request for restitution against the non-compliant creditor by a resolution of the Financial Creditors Committee (Committee).
Each financial creditor attending the First Meeting shall exercise its voting rights at the meeting in proportion to the amount of credit it has reported. The financial creditors shall deliberate and pass a resolution setting forth (i) the scope of financial creditors who will actually participate in the workout process, (ii) the commencement of the workout, (iii) whether to suspend exercise of their claims and the length of that suspension (up to one month, or three months if due diligence is required, with up to one additional month of suspension if necessary), and (iv) other matters necessary for commencement of the joint administration procedure. An affirmative vote of the financial creditors who have been called to the First Meeting, and who hold three fourths or more of the total amount of represented credit, is required in order to pass the resolution. If a single creditor holds an amount of credit in excess of that proportion, however, the resolution shall be passed by the vote of more than two fifths of the total number of creditors, including the single creditor who holds the largest amount of credit.
The Committee may dispatch representatives to the company, who may receive fees from the debtor upon the mutual consent among the creditors.
The Committee may request an independent third-party expert (such as an accounting firm) to perform a due diligence examination of the company and to assess the company’s ability to remain a going concern. In consideration of the result of that due diligence examination, the Main Creditor Bank shall prepare a business reform plan of the company and submit it to the Committee.
Agreement for Business Reform Plan
The Committee shall make an agreement with the debtor for implementation of a business reform plan within one month from the date the Committee passes a resolution for the plan. If the Committee fails to make an agreement for implementation of the business reform plan within the aforementioned deadline, the workout shall be suspended and readjustment of claims and provision of new credit contained in the business reform plan will become retroactively invalid.
Objecting Creditors’ Rights
If the Committee adopts a resolution on:
any creditor objecting to that resolution through a written statement may file a claim for the consenting creditors to purchase all financial claims of the objecting creditor within seven days from the date the Committee adopts the resolution (the Filing Period).
In such a case, the consenting creditors must purchase the objecting creditor’s claims within six months from the end of the Filing Period, and upon agreement with the objecting creditor, the consenting creditors may have the debtor company or a third-party purchase the objecting creditor’s claims.
Termination of the Workout
The Committee shall terminate the workout by resolution when:
If financial creditors deem it necessary for the debtor who is undergoing a workout or a voluntary accord, they may provide new credit (excluding changes of conditions of the existing credits provided) to the debtor by a resolution of the Committee. Unless expressly provided otherwise in a resolution of the Committee, the amount of new credit provided, in principle, shall be extended to the debtor in proportion to the amount of financial claims each financial creditor reported.
During the course of the workout, repayment of the new credit has priority over other claims except for secured claims in respect of the relevant collateral. However, when a subsequent court-administered insolvency proceeding is commenced, new credit claims will lose their priority.
There are no applicable laws or legal doctrines that explicitly impose duties on creditors to each other, or on the company or third parties in the context of insolvency.
However, as a general rule, the DRBA requires that:
Furthermore, a creditor may be criminally liable if the creditor fraudulently files a petition for insolvency against a debtor with the purpose of harming them, and a rehabilitation or bankruptcy proceeding is commenced for that debtor. A creditor may also be criminally liable for exercising rights falsely for his or her own benefit, the benefit of a third party, or for the detriment of other creditors and a rehabilitation or bankruptcy proceeding is commenced.
The Committee passes a resolution upon a vote of the financial creditors holding an amount of secured credit equal to three fourths or more of the total. Therefore, up to one fourth of dissenting creditors may exist under the CRPA.
The dissenting creditor may choose to opt out by demanding the purchase of all financial claims that the creditor has (including stocks converted into investment in a joint administrative proceeding), through a written statement as mentioned in 3.2 Consensual Restructuring and Workout Processes.
Although there is no law to this effect in voluntary accords, similar rules are usually established by agreement of the participating parties.
Immovable Property (Real Estate)
A mortgage is a security interest that secures the claims from a certain mortgaged property up to an amount that is fixed at the outset. A secured person/entity may apply the proceeds of a judicial sale of the mortgaged property for the satisfaction of its secured claims.
A Kun-mortgage is a security interest that secures the claims arising from certain agreed types of transactions (eg, revolving loan transactions). Unlike for a mortgage, the total amount of claims may fluctuate up to a specific amount, that is, the agreed secured amount.
Yangdo-dambo is a security by means of transfer. If the debtor satisfies its obligations against the secured party, the secured party shall return the property in yangdo-dambo to the debtor and release the title. Otherwise, the secured party can either sell the property and acquire the proceeds or acquire the full ownership of the property.
Movable Property (Including Equity Shares, Movable Property, Intangible Property, Intellectual Property, and Accounts)
A pledge is a security interest that allows a secured party to apply for a judicial or private sale of the property for the compensation of its secured claims. A pledge may be taken against tangible property including securities, but also against certain intangible property, such as certain intellectual property rights.
Yangdo-dambo is also available for movable property.
Outside the context of insolvency, secured creditors may generally enforce their rights on collateral, either by applying for a court auction or otherwise, as the case may be.
When a debtor files a petition for commencement of a rehabilitation proceeding, the court may, upon a separate application by the debtor, or by its own motion, issue a comprehensive stay order. In such a case, the secured creditor’s right to enforce the security right is stayed.
A secured creditor cannot disrupt or block the commencement of a rehabilitation proceeding. However, the secured creditor may contest the court’s decision to commence a rehabilitation proceeding for the debtor.
When a rehabilitation proceeding is commenced, the secured creditor’s right to enforcement is stayed until confirmation of the rehabilitation plan. If a rehabilitation is confirmed, the secured creditor is repaid according to the terms of the rehabilitation plan. If a rehabilitation plan is neither filed nor confirmed, the stay is lifted and the secured creditor may enforce its rights against the collateral.
Unlike in a rehabilitation proceeding, the creditor may foreclose outside bankruptcy without resorting to bankruptcy procedures.
A secured creditor may participate in a rehabilitation proceeding based on his or her rights, and have voting rights in proportion to the amount of its claims or the value of the collateral, whichever is lowers. If the value of the collateral is lower than the claim amount, the difference is treated as an unsecured claim. The secured creditor is guaranteed repayment up to the liquidation value of the relevant collateral.
As previously mentioned, a secured creditor in a bankruptcy proceeding may exercise his or her right to foreclose outside bankruptcy.
Claims in a rehabilitation proceeding have the following priority:
Claims that accrue from goods supplied by the debtor through continuous and ordinary business activities within 20 days before the filing of the petition are treated as common benefit claims and therefore are repaid as they become due.
Also, when the receiver chooses to perform a bilateral executory contract, claims of the opposing party arising therefrom are treated as common benefit claims and therefore would generally be paid in full.
Moreover, unsecured trade creditors whose claims are below a certain threshold (depending on the size of the debtor company) may be kept whole. However, there is no general rule or practice to provide full repayment for unsecured trade creditors as opposed to other unsecured creditors.
The Custodial Committee or the court shall establish a creditors' committee composed of major creditors of the debtor after a petition for commencement of a rehabilitation proceeding is filed. The creditors' committee shall be composed of not more than ten persons, provided, however, that the Custodial Committee may cause any minority creditor to participate in the creditors' committee when deemed necessary.
Similarly, in a bankruptcy proceeding, the Custodial Committee or the court establishes a creditors’ committee comprised of not more than ten members.
In both proceedings, a creditors’ committee is entitled to request materials and information relating to the pending insolvency proceedings and to provide their views to the court for certain matters as prescribed in the DRBA.
Unsecured creditors are entitled to exercise their voting rights to adopt a rehabilitation plan.
Creditors can file immediate appeals against the applications for the rehabilitation or bankruptcy proceedings. Also, by filing a petition for commencement of a rehabilitation proceeding, the creditor can stay the bankruptcy proceedings filed by the debtor or another creditor.
Outside the context of insolvency, pre-judgment attachments are available, on condition that the applying creditor posts a bond in the amount and form ordered by the court.
Common benefit claims are claims against the debtor for expenses incurred in implementing the rehabilitation proceeding (eg, legal fees and other expenses incurred for the filing, commencement and conducting of the rehabilitation proceeding, fees and expenses claims of receivers, examiners, advisers and other professionals who are engaged for the rehabilitation proceeding, etc), claims against the debtor arising after commencement of the rehabilitation proceeding, and certain tax claims and wage claims. The DRBA provides a specific list of claims that fall under this category.
In a rehabilitation proceeding, common benefit claims have priority over secured and unsecured rehabilitation claims, in that common benefit claims are paid out of the debtor’s estate as they become due.
In a bankruptcy proceeding, estate claims, which are similar in category to the common benefit claims, have priority over other claims, in that they are paid out as they become due. However, they do not have priority over secured claims to the extent that secured creditors enforce their rights against the collateral outside of bankruptcy.
With respect to treatment of new-money claims that arose after commencement of a rehabilitation proceeding which was later converted to a bankruptcy proceeding, the DRBA was revised in February 2020 to provide super-priority in the sense that such claims will have priority over other estate claims (except for wage and severance payment claims) in that bankruptcy proceeding.
Petition for commencement
A debtor may file a petition for commencement of a rehabilitation proceeding when the debtor cannot repay a matured debt without causing a significant encumbrance to the continuation of its business, or when there is a concern that a cause for bankruptcy may arise with the debtor. Additionally, in the latter situation, the creditor(s) whose claims equal or exceed one tenth of the debtor’s capital, or equity holder(s) who own more than one tenth of the debtor’s capital, may also file a petition for commencement.
Commencement of a rehabilitation proceeding
The court must, in principle, issue a decision as to whether it commences rehabilitation within one month from when the petition was filed. When the court issues a decision to commence the rehabilitation proceeding, the court must also appoint a receiver. The receiver is authorised to conduct business on behalf of the debtor and take charge of the management and disposition of the debtor’s assets.
Investigation and allowance of claims
When a rehabilitation proceeding is commenced, the receiver is required to submit a list of creditors, including the amount of their respective claims. After the list is submitted, if a creditor finds that a claim was omitted or does not agree with the amount or categorisation of a claim, that creditor may file “proofs of claim” within the period designated by the court.
When a proof of claim is filed and/or a claim is included in the creditors’ list, the receiver and other creditors may file an objection. In that event, the creditor whose claims are contested may file an application for allowance of the claim against all parties that filed an objection.
A rehabilitation plan typically includes the basics of the debtor’s rehabilitation, such as adjustment of claims, repayment methods, adjustment of shareholder rights, matters regarding M&A, and revisions to the articles of incorporation of the debtor company. Re-prioritisation of claims is not allowed without consent from creditors who are adversely impacted.
A rehabilitation plan is reviewed at the creditors’ meeting, and passed by a quorum of (i) three quarters or more of the total amount of secured claims, (ii) two thirds or more of the total amount of unsecured claims, and (iii) one half or more of the total number of voting shares at the meeting (if, however, the total monetary amount of debt exceeds the total monetary amount of assets on the date of commencement, the shareholders do not have a right to vote). When the proposed rehabilitation plan is passed at the creditors’ meeting, the plan can be confirmed by the court.
Even if the rehabilitation plan does not obtain enough votes from a class of creditors, however, the court has authority to cram down a plan if it deems it necessary, provided that the dissenting creditors’ rights are protected.
Implementation of the plan and closing of the rehabilitation proceeding
When a rehabilitation plan is confirmed, the rights of creditors and shareholders are adjusted according to the rehabilitation plan. Unsecured and secured claims not included in the confirmed plan are discharged, even after the debtor’s dismissal of or the exit from the rehabilitation proceeding.
If a rehabilitation plan has already been carried out, or if the court finds that there is no hindrance to carrying out the rehabilitation plan and its purpose is considered achievable, the court may issue an order to close the proceedings and allow the debtor to exit from the rehabilitation proceeding. In that event, the debtor regains control over its assets and business.
Stay of Claims Asserted against the Company
When a petition for commencement of a rehabilitation proceeding is filed, the court may, at the request of an interested person or by its own motion, issue a comprehensive stay order for the suspension of bankruptcy proceedings of the debtor, auction proceedings, litigation, and procedures with an administrative agency, as well as any disposition on default in accordance with the National Tax Collection Act or the Local Tax Collection Act. The stay remains in place when a rehabilitation proceeding is commenced, until confirmation of a rehabilitation plan as explained in 6.1 Statutory Process for a Financial Restructuring/Reorganisation.
Operation of Business
The debtor company, in principle, continues to operate its business, but in exceptional cases, a liquidation plan may be prepared.
The incumbent management may continue to manage the company via the principle of "debtor in possession" (DIP), but for most important matters of the debtor company, a court’s authorisation is required. In some cases, a third-party receiver is also appointed so that the receivers may perform their duties jointly.
After the commencement of a rehabilitation proceeding, the receiver can borrow funds in order to manage the debtor's business and properties. In obtaining such loans, the receiver must obtain the court's approval. In approving such loans, the court must consult with the creditors' committee and take into consideration the overall circumstances of the debtor.
When it is later found that the debtor’s assets cannot satisfy the full amount of common benefits claims, the funds newly borrowed for operation of the debtor’s business must be repaid first.
Types of Creditors
The creditors are categorised into unsecured creditors and secured creditors, and a creditor can be categorised as both of these in the same rehabilitation proceeding.
The Custodial Committee, or the court in some cases, establishes a creditors' committee once a rehabilitation proceeding is commenced as explained in 5.3 Rights and Remedies for Unsecured Creditors.
The creditors' committee may present non-binding opinions with respect to:
The agenda of the creditors' committee is decided by a concurring majority of the total members present. The court may allow the expenses necessary for the creditors' committee to carry out its activities to be borne by the debtor.
The rehabilitation plan only requires the consent of two thirds of the unsecured creditors and three quarters of the rehabilitation secured creditors. Therefore, in theory, a rehabilitation plan may modify claims of at least a third of dissenting unsecured creditors and a quarter of dissenting secured creditors. Furthermore, as elaborated in 6.1 Statutory Process for a Financial Restructuring/Reorganisation, the court may cram down a rehabilitation plan, even if a class of creditors does not consent to the plan. In this respect, claims of dissenting creditors may be modified without their consent.
For the minority dissenting creditors, no additional requirements and limits apply, but for the fact that the plan must be fair and equitable. In the case of a cram-down, the court is required to ensure the class of dissenting creditors’ rights are sufficiently protected.
Claims against the debtor company can be traded in accordance with the Civil Act.
If a claim is assigned after the table of creditors has been recorded, but before plan confirmation, the parties may request the court to change the creditor in the table of creditors. However, if assignment takes place after plan confirmation, serving a notice to the debtor advising of the assignment as prescribed in the Civil Act is necessary.
Multiple companies within a corporate group may file a petition for commencement of a rehabilitation proceeding simultaneously, and if the court deems it necessary, the court may in practice consolidate certain procedures in the rehabilitation proceeding, for procedural economy as well as for efficient restructuring of the corporate group.
However, there are no legal grounds for the court to allow substantive consolidation of rehabilitation proceedings for a group of companies.
Only the receiver has the power to dispose of the debtor’s assets during a rehabilitation proceeding. Even then, the receiver is required to obtain the court’s prior approval for (i) repayment of any rehabilitation claims and rehabilitation secured claims regardless of their amount, (ii) any expenditures and disposal of assets that are not made in the ordinary course of business, and (iii) expenditures and disposal of assets that are made in the ordinary course of business and exceed a certain threshold as set by the court. There may also be other business affairs of the debtor, such as initiating a legal proceeding and obtaining DIP financing, that require approval of the court.
In order for the receiver to obtain court approval, the receiver must clearly show the court the amount or value of the expenditure or disposal, the balance of the debtor’s funds, and the reason why such expenditure or disposal is necessary, and/or that such expenditure or disposal would not harm the creditors. The court will authorise the expenditure or disposal if the court deems the reasons for such actions to be reasonable.
The receiver may execute a sale of assets or the business upon the court’s approval within a certain period prescribed in the plan. When the receiver fails to execute the sale of assets within that period, creditors may do so, as the case may be, upon the court’s approval.
Unless the rehabilitation plan specifically provides for a provision that the relevant asset shall be relieved of any and all encumbrances, the collateral that is subject to the sale is not automatically released. However, in practice, the debtor’s assets are generally acquired free and clear of claims when a sale is executed within the rehabilitation proceeding.
Creditors are not allowed to credit-bid for assets being sold. However, when the process of sale involves the stalking horse bid method, a creditor may act as the stalking horse.
It may be possible to effectuate during the rehabilitation proceedings any sales and similar transactions that have been pre-negotiated prior to the commencement of the rehabilitation proceeding, usually by utilising a pre-packaged plan procedure. In order to ensure a fair opportunity to interested parties, however, the court tends to conduct an open-bid process, albeit with a pre-negotiated stalking horse in place.
Secured creditor liens and security arrangements are released when a rehabilitation plan is confirmed, unless the rehabilitation plan specifically provides otherwise. Claims are also in principle discharged if they are not included in the rehabilitation plan. Claims that are included in the rehabilitation plan are modified in accordance with the plan, and become subject to the terms provided therein.
Priority new money can be made available to a debtor company pursuant to the DRBA, and they may be secured by assets of the company if the court so approves. In the event that the new money is secured by assets encumbered by pre-existing secured creditor liens/security, however, the new money will not have priority over the pre-existing secured claims, unless the assets are released by confirmation of the rehabilitation plan, in which case the priority new money may step up.
It is not possible to use the statutory process as a forum for determining the value of claims and those creditors with an economic interest in the company, as any such petition will be dismissed on grounds of bad faith. See 3.4 Duties on Creditors.
A rehabilitation plan requires confirmation of the court. In order for the plan to be confirmed, the plan must be (i) in compliance with the law, including that the creditors are guaranteed the liquidation value of their claims; (ii) fair and in conformity with the principles of equality, and (iii) feasible. The court may not confirm the plan if these requirements are not met, even if the plan is approved by a vote of the creditor.
The receiver has the power to assume or terminate a bilateral executory contract, until the closing of the second meeting of interested parties, which is convened for review of the rehabilitation plan. If the receiver does not terminate a bilateral executory contract by this point in time, the receiver shall be deemed to have assumed the contract.
In order to avoid the uncertainty that arises from the receiver’s termination powers, the opposing party may send a notice to the receiver, asking for a definitive response on whether the contract will be assumed or terminated. If the opposing party does not receive a response from the receiver within 30 days (which can be extended or shortened by the court) from the date the receiver received the notice, the contract will be deemed to have been assumed.
When the contract is assumed, claims of the opposing party will be treated as common benefit claims. When the contract is terminated, any damages and claims of the opposing party that arise out of that termination shall be treated as unsecured claims in the rehabilitation proceeding.
The rehabilitation proceeding cannot release non-debtor parties, such as a guarantor, from liabilities.
When a creditor has obligations against the debtor at the commencement of a rehabilitation proceeding, and that obligation can be offset against the creditor’s claim prior to the expiry of the proof of claims' filing period, the relevant creditor may offset those claims without resorting to the rehabilitation proceeding.
The offset is prohibited when the liability of the creditor arose after commencement, or the liability was obtained with the knowledge that a petition for commencement of a rehabilitation or a bankruptcy proceeding had been filed.
When it is evidently impossible to implement the confirmed rehabilitation plan, the court shall issue a decision to discontinue the rehabilitation proceeding by its own motion or at the request of the receiver or a creditor that is listed in the table of secured or unsecured creditors. If there is cause for bankruptcy with the debtor, the court must declare the debtor bankrupt.
If the rehabilitation proceeding is closed, the debtor can become subject to compulsory execution, based on the table of secured or unsecured creditors.
Although it is possible for existing equity owners to receive or retain ownership during and after a rehabilitation plan is confirmed, in many cases, equity owners’ rights are at the least diluted as a result of a debt-equity swap or issuance of new shares as provided in the rehabilitation plan, or equity-owners’ rights are sometimes cancelled altogether to ensure that the debtor’s paid-in capital is of an appropriate size for it to be attractive to the new investor or purchaser of business, or as a penalty for major equity-holders that have caused or aggravated the financial situation of the debtor company.
In Korea, when a debtor is insolvent and deemed difficult to rehabilitate, the court, upon petition, declares the debtor bankrupt and a court-administered liquidation proceeding, which is more often referred to as a “bankruptcy proceeding,” will be commenced.
In contrast, the liquidation process under the Civil Act or the Commercial Act provides a legal framework for a voluntary dissolution of solvent companies.
A bankruptcy proceeding usually involves the following processes:
Petition for Bankruptcy
Any creditor and debtor can file the petition for commencement of a bankruptcy proceeding. In a rehabilitation proceeding, if a cause for bankruptcy is found before plan confirmation, the court may convert the proceeding to bankruptcy. If the cause for bankruptcy arises after plan confirmation, the court must convert the proceeding to bankruptcy.
A creditor may file a petition for commencement of a bankruptcy proceeding, regardless of priority or claim amount. See 2.4 Commencing Involuntary Proceedings.
The FSC may file a petition for the bankruptcy of a financial institution, credit union, or a mutual savings bank.
Declaration of Bankruptcy
A bankruptcy petition may be filed on the basis of insolvency or excess debt. See 2.5 Requirement for Insolvency for the meaning of insolvency. Upon declaration of bankruptcy the court must appoint a bankruptcy trustee, set a deadline for filing proofs of claims and designate a date for the first creditors’ meeting and for the investigation of claims.
When a debtor is declared bankrupt, all assets of the debtor (that are generally eligible for attachment) become part of the bankruptcy estate, regardless of whether the assets are located in Korea or abroad. All managerial and dispositive rights to such assets are transferred exclusively to the bankruptcy trustee.
When any bankruptcy creditor has a liability towards the debtor at the time that the debtor is declared bankrupt, that liability may be offset without resorting to bankruptcy procedures. The offset shall be limited under the conditions as described in 6.14 Rights of Set-Off, but without a time limit, unlike in the case of the rehabilitation proceeding.
Bankruptcy claims are repaid in proportion to its amount from the whole of the bankruptcy estate’s assets in the bankruptcy proceeding. In principle, bankruptcy claims arise from grounds that were in existence before the filing of the petition for bankruptcy.
Bankruptcy estate claims have priority over bankruptcy claims and are repaid as they become due from the bankruptcy estate. See also 5.5 Priority Claims in Restructuring and Insolvency Proceedings.
First Creditors’ Meeting
The court designates the date for the first creditors’ meeting at the same time it declares the debtor bankrupt. The designated date of the meeting must be within four months from the date of declaration for bankruptcy. During the first creditors’ meeting, the creditors may decide whether to continue/discontinue the business and how valuable items should be stored.
Liquidation and Distribution
In principle, all of the debtor’s assets will be liquidated and then distributed to the creditors, and it is the bankruptcy trustee’s role to take charge of this liquidation process.
Although the liquidation and distribution methods are, in principle, conducted in accordance with the Civil Execution Act, private sales are sometimes considered and executed upon the court’s approval, as private sales usually yield more cash than court auctions. The liquidation process consists of disposition of assets within the bankruptcy estate, and claiming against third parties who owe to the debtor.
A distribution procedure is a procedure where the bankruptcy trustee liquidates the assets belonging to the bankruptcy estate and distributes the proceeds to creditors equally, in proportion to their priority and the amount of their respective claims.
After a final distribution has taken place, the court orders a creditors’ meeting be held for presenting the accounting report to creditors, and the court then will issue a final order to close the bankruptcy proceeding. The duty of the bankruptcy trustee ends when the final order is issued.
Liquidation Process under the Commercial Act
The liquidation process under the Commercial Act does not require the company to be insolvent; in fact, if during a liquidation the company is found to be insolvent, the liquidator must file for bankruptcy. The same applies in the case of a liquidation under the Civil Act.
The bankruptcy trustee takes sole charge for the management and disposition of the debtor’s assets, but only under the court’s supervision. In a liquidation process under the Civil Act or the Commercial Act, the liquidator has the duty to wind up pending affairs, to collect debts and to repay obligations, to dispose of assets, and to distribute residual property. The liquidator is also authorised to carry out all judicial or extrajudicial acts in connection with the duties.
When the debtor’s assets are acquired by a purchaser within a bankruptcy proceeding, they are not necessarily free and clear of liens and other encumbrances. The purchaser may negotiate with the trustee to cope with any such encumbrances in a sale of assets.
Whether to utilise a stalking horse bid method in a bankruptcy sale would depend on the trustee and any party that is willing to act as the stalking horse. Court approval must also be obtained. There are no statutory grounds to allow credit bids in a bankruptcy sale process.
A creditors' committee is formed in a similar fashion as in a rehabilitation proceeding. See 6.3 Roles of Creditors for details.
South Korea has adopted the UNCITRAL Model Law on Cross-border Insolvency (Model Law) as part of the DRBA. This is in line with the abolishment of territorialism and the adoption of modified universalism in the DRBA.
Accordingly, the cross-border insolvency provisions in the DRBA are based on the notion that Korean insolvency proceedings have a universal effect, and likewise, foreign insolvency proceedings would take effect in South Korea.
Today, South Korea is one of the very few countries in Asia that actively recognises foreign insolvency proceedings and provides assistance as necessary in order that the purposes of the foreign insolvency proceedings may be achieved.
The Seoul Bankruptcy Court recently signed MOUs, related to the support for foreign bankruptcy procedures, with the US Bankruptcy Court for the Southern District of New York and the Supreme Court of Singapore. Also, as a member of the Judicial Insolvency Network (JIN), the Seoul Bankruptcy Court has adopted the JIN Guidelines, which provide a framework for parties in cross-border restructuring and insolvency to customise protocols to facilitate court-to-court communication and co-operation in cross-border cases.
Neither the DRBA nor the Act on Private International Law provides for rules, standards or guidelines that determine which jurisdiction’s decisions, rulings or laws will govern or are paramount.
The Korean courts, however, have confirmed through case precedents that the universal principle of lex fori concursus shall apply. Therefore, as a general rule, the law of the jurisdiction where the relevant insolvency proceeding was commenced shall apply, for procedural matters as well as for substantive matters that are “typical effects of an insolvency.” For all other matters, the governing law, as provided by agreement of the parties or by applying the conflicts of laws' provisions, shall apply.
As for the determination of the governing law or a ruling under specific conflicting circumstances, however, the Korean courts have yet to accumulate a sufficient number of case precedents that would amount to established rules, guidelines or practices in relation to this matter.
The DRBA explicitly provides that foreigners and foreign corporations shall have the same status as that of the peoples of South Korea or corporations of South Korea. Therefore, foreign creditors are not dealt with in a different way in South Korean proceedings at all; nevertheless, since all proceedings are conducted in Korean there may inevitably be some practical difficulties. To overcome such practical differences, the court has exerted efforts to facilitate foreigners’ participation in the proceedings, by providing English instructions and notices to foreign creditors, encouraging the debtor to disclose information to its foreign creditors in English and, for some of the largest cases involving numerous foreign creditors, posting updates on the website in English.
In a workout, the existing management continues to manage the debtor company. However, the debtor ordinarily enters into an agreement with the Committee, under which the financial creditors may dispatch personnel to oversee and control the financial management of the debtor.
In a rehabilitation proceeding, the court appoints a receiver, usually from the existing management of the debtor or, in some cases, the court issues a decision not to appoint a receiver, in which case the representative director shall be deemed as the receiver. Also, the recent trend is for the court to appoint a chief restructuring officer (CRO) to assist in the restructuring of the company that is undergoing a rehabilitation proceeding.
Upon a declaration of bankruptcy, the court appoints a bankruptcy trustee, who manages all assets of the debtor (that are generally eligible for attachment).
In a rehabilitation proceeding, the receiver has the duty of disposing of property, the transfer of property, the borrowing of funds, etc, cancelling or terminating bilateral contracts that have not been fulfilled by either party, filing a lawsuit, approving common benefit claims or redemption rights, and performing other acts designated and approved by the court. A receiver is not a representative of the debtor but a public trustee who is entrusted with the management of the interested parties. A receiver’s fiduciary duty is owed to creditors as a whole. A receiver must report to the court on a regular basis.
A CRO acts as an adviser assisting in the restructuring of the debtor in addition to acting as watchdog. The CRO owes fiduciary duties to the debtor.
Trustees in bankruptcy have duties of managing the liquidation and distribution process, convoking a creditors’ meeting, conducting avoidance actions, etc. A trustee’s fiduciary duties are owed to the creditors as a whole, and a trustee must report to the court periodically, as well as to the creditors when a creditors' meeting is convened.
A receiver is usually the representative director of the debtor, but third-party receivers may also be appointed in lieu of or in addition to the existing management of the company. A receiver is subject to court supervision and may be dismissed by the court, or may resign from its position after obtaining permission from the court. The court must consult with the creditors’ committee when appointing or dismissing a receiver.
A trustee is appointed by the court, usually from a pool of lawyers. The trustee is subject to supervision from the court. Any trustee in bankruptcy may resign after obtaining permission therefor from the court. Also, the court may dismiss a trustee, if there is a violation of its duties as a bankruptcy trustee.
There is no specific obligation imposed on the company’s directors to apply for the commencement of a rehabilitation proceeding, even if the company is financially distressed or nearly insolvent; however, the director/liquidator must file a petition for bankruptcy immediately if he or she realises that the assets of the debtor cannot repay the full amounts of the debts during the liquidation process.
An examiner, which is usually an independent accounting firm, is appointed by the court in a rehabilitation proceeding to conduct an investigation on the debtor to determine whether the debtor’s going-concern value exceeds its liquidation value. In the process, the examiner also reviews whether the debtor's executives and controlling shareholders are responsible for the management of the debtor company.
When a director or other members of the management are found liable for causing or aggravating the financial failures of the debtor, they may become subject to damages' claims, as provided in the Commercial Act or the Civil Act. In such a case, the court, by its own motion, or upon the receiver’s filing of an application, will commence confirmatory proceedings against the director or other members of the management. This is a special procedure in the DRBA, with a view to facilitating a quick recovery of losses incurred by the debtor due to the mismanagement by the director or other members of the management.
Aside from the damages' claim, the director may be penalised in other ways, such as losing their position or losing their rights to a severance payment, subordinating the directors’ claims against the debtor. If the director or other management’s acts amount to a crime, such as embezzlement or a breach of trust, they may also face criminal liabilities.
However, once rehabilitation or bankruptcy is commenced, the directors’ duties are suspended, and therefore, the directors are generally released from their duties post-commencement.
The confirmatory proceedings can only be initiated by the court or by application of the receiver. A creditor cannot assert direct fiduciary breach claims against the directors in the confirmatory proceeding, or in any other proceeding, for that matter. However, if any act of the director has had a direct impact on the relevant creditor and the creditor has incurred losses as a result, that creditor might pursue its rights outside of the insolvency proceeding.
According to the DRBA, the receiver may avoid acts performed by the debtor (i) in the knowledge that such an act is detrimental to its creditors; (ii) under circumstances where the debtor was already in a critical situation; or (iii) without any consideration.
The look-back period may differ, depending on the basis for avoidance, as well as the opposing party to the act that is being avoided:
Only the receiver or the debtor can exercise avoidance powers. Creditors and other interested parties may only apply to the court for an order compelling the receiver to exercise the avoidance powers against the relevant party.