South Korea: Fundamental changes

Author: | Published: 1 Apr 2012
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The Korean M&A market in 2011 witnessed the consummation of large deals in the construction sector pursued by industry investors and private funds. Hyundai Motor Group acquired a 34.88% stake in Hyundai Engineering & Construction for W4.96 trillion ($4.4 billion), setting the record as the largest Korean M&A transactions ever completed, and KDB PEF struck a deal with Daewoo Engineering & Construction to acquire 37.16% of its shares for W2.17 trillion.

In the transportation and logistics industry, CJ Consortium Group acquired a 40.02% stake in Korea Express for W1.85 trillion. The restructuring need in various industries, the strategic increase of size and scale of the Korean chaebols and the rise of domestic private funds in recent years are the elemental forces behind these deals.

Restructuring efforts have also triggered various transactions in the financial industries. Hana Financial Group's proposed acquisition of 51% of Korea Exchange Bank shares from Lone Star for W3.91 trillion eventually was finalised in early 2012 after being delayed due to the pending approval by the Korea Financial Supervisory Service.

In 2011, efforts have been made in vain to privatise Woori Finance Holdings by divesting 57% of its shares held by the Korea Deposit Insurance Corporation, and such efforts are likely to continue in 2012 with possible involvement of private funds and further attempts to relax regulatory requirements applicable to financial holding companies. Sales of distressed savings banks by way of P&A under the approval of the Financial Supervisory Commission have been one of the notable trends in the financial sector in 2011. Seven savings banks were sold in 2011 and similar deals for the remaining eight are underway.

Last year's M&A market was also marked by growth in the volume of cross-border transactions. The largest transaction was Seagate's purchase of Samsung Electronics' HDD business at W1.5 trillion, followed by Fila Korea's acquisition of Acushnet (owner of the Titleist and Footjoy golf brands) for W1.32 trillion, which was backed by a domestic private funds consortium. The remarkable increase in cross-border transactions coupled with the growth in number and size of domestic transactions most likely has resulted from the relatively rapid recovery of the Korean economy despite the continuing downturn of global economy since the 2008 financial crisis.

Besides the mega deals in 2011, some high-profile deals targeting Hynix Semiconductor, Daewoo Electronics, Daewoo Shipbuilding and Ssangyong Engineering & Construction have been in progress since 2011. The majority shareholders of these companies are often groups of creditors, mostly consisting of financial lenders backed by strategic investors, seeking to strike a deal to sell their stakes to competent strategic buyers.

Regulations and reforms: the Korean Commercial Code

M&A activities in the Korean market are mainly regulated by the Korean Commercial Code (KCC), which applies to virtually all transactions involving change of control; (ii) the Financial Investment Services and Capital Markets Act, which regulates M&A of public companies, tender offers, public disclosure requirements, proxy solicitations, financial investment activities, collective investment and private funds; (iii) the Monopoly Regulations and Fair Trade Act, which regulates anticompetitive business combinations and acquisition of Korean companies; and (iv) the Foreign Investment Promotion Act and the Foreign Exchange Transaction Act, each of which governs the legitimate flow of funds in and out of Korea in connection with foreign investors' attempt to acquire Korean companies.

Industry-specific regulations such as the Banking Act, the Telecommunications Business Act and the Broadcasting Act may also apply to the mergers of banks, news agencies and broadcasting companies. Among various laws governing M&A activities in Korea, the most basic and fundamental law is the KCC which provides general provisions on, among other things, mergers, sale and purchases of shares, issuance of new shares, business transfers, spin-offs, stock swaps and comprehensive stock transfer.

Since its enactment in 1962, the KCC has been amended several times including its most recent amendment on April 14 2010, which take effect starting April 15 2012. The amendments to be implemented are expected to affect matters relating to corporate governance and financial structures of chusik hoesa (joint-stock companies), and to bring forth considerable changes and check points in structuring M&A transactions. Foreign investors with an interest in investing in Korean companies should be aware of the regulatory changes under the KCC.

When acquiring controlling shares in a target company, investors may purchase target shares from existing shareholders in a negotiated private transaction, launch a tender offer if the target is a public company, or subscribe for the newly-issued shares through a private placement. Since offering new shares by way of private placement may infringe upon the pre-emptive rights of the existing shareholders, the KCC provides that the private placement of new shares may be allowed only when it is deemed necessary to achieve business purposes as specified in the company's Articles of Incorporation such as introduction of new technologies or improvement of the company's financial structure.

Under the KCC, however, the board of directors generally has the authority and discretion to determine the issuance of new shares, number of shares issued and who the shares will be issued to without having to convene a shareholders' meeting. As a result, the existing shareholders of the target are frequently unaware of the management's attempt to privately place the newly-issued shares. Existing shareholders may bring a claim to nullify the issuance of new shares by no later than six months after the new shares are issued, and thus existing shareholders of a non-public company often face difficulties in bringing a suit to nullify the private placement of the newly-issued shares for the management may have issued the new shares unbeknownst to the existing shareholders.

In order to protect the existing shareholders of the target, the amended KCC mandates a notice requirement compelling the target to disclose information on the private placement of the newly-issued shares (for example, the number of shares newly issued and subscription price per share) to its existing shareholders no later than two weeks before the subscription payment date. Based on the disclosure, the existing shareholders will be alerted and may further obtain material information on the placement of the new shares, which will facilitate the rights of the existing shareholders to take preventive measures to enjoin or to bring a claim against the target to void the issuance of new shares.

In addition, since the target is required to comply with the prior disclosure requirement, the subscription payment date should be at least two weeks after the details of private placement is determined by the board of directors and disclosed to the existing shareholders. Practically, this means that the issuance of shares and payments for the shares cannot be finalised and made on the date of the board resolution even if the acquirer has sufficient funds to do so.

The amended KCC diversified the classes of shares a chusik hoesa (joint-stock company) may issue. Under the current KCC, only preferred shares may be issued with or without voting rights while the issuance of common shares (shares with no preference to dividends) without voting rights are not permitted.

The amended KCC, however, allows a company to issue shares with no voting rights regardless of whether the shares are with preference to the distribution of profits. Additionally, shares with limited voting rights on specific resolutions (for example, amending the Articles of Incorporation or electing a new director) can be issued under the amended KCC. Companies may also issue redeemable shares which can be redeemed at the request of the shareholders, and convertible shares which can be converted at the request of the company, upon occurrence of certain redeemable or convertible events.

These changes will add flexibility to the capital structure of companies, and are expected to allow companies to create and establish well-diversified investment portfolios for its investors. Veto shares that hold veto power to certain matters (for example, business transfer or merger), and shares with rights to dismiss and appoint officers have not been adopted under the amended KCC, however.

The most controversial aspect of the amended KCC is whether redeemable convertible preferred shares (RCPS) can be issued. Under the current KCC, holders of RCPS enjoy an option either to convert them to common shares once the business is successful and the company goes public or to enforce redemption if the business of the company fails. It was due largely to this double sided risk-hedging feature that investors have preferred investing in RCPS. The amended KCC, however, provides that redeemable shares can be issued as class shares other than convertible class shares, making it unclear whether RCPS may be validly issued under the amended KCC.

While efforts exist to construe the statutory language in a way to restrict and limit its application, the current mainstream opinion appears to be that the issuance of RCPS may not be viable under the amended KCC. Therefore, investors interested in RCPS will need to be cautious on making investment decision and must seek professional legal advice until the general practice under the amended KCC is established.

Under the current KCC, a non-listed company can acquire its treasury stocks only in limited circumstances such as where shareholders exercise appraisal rights or when the company intends to cancel or retire its acquired shares, while a public company may freely acquire its treasury stocks as long as the company has distributable profits. The amended KCC, however, allows both non-listed and listed companies to purchase treasury stocks within the limits of their distributable profits. Practically, this means that both listed and non-listed companies may henceforth consider acquiring treasury shares for the purpose of defending or maintaining management control of the company.

Under the current KCC, unlike public companies, non-listed companies cannot use treasury stocks as a defensive measure to fend off hostile takeover attempts. Thus, non-listed companies often issued new shares and placed them with management-friendly white knights to dilute the stake of a hostile shareholder. The Korean courts, however, frequently held that the management could be in violation of its fiduciary duties if the placement of new shares is made for the sole purpose of defending corporate control, which often makes private placement to white knights a non-feasible option.

Yet, the dominant view of the Korean courts appears to be that existing shareholders cannot claim its pre-emptive rights when the company disposes or sells its treasury shares. Therefore, based on the statutory language of the amended KCC, a non-listed company may consider acquiring treasury shares as a defensive measure against threats to management control, though courts may continue to scrutinise the conduct of the management over its fiduciary duties.

Squeeze-outs, cash-outs and more

The amended KCC introduces the so-called squeeze-out rule which permits the compulsory purchase of minority sharers by controlling shareholders. According to the amended KCC, a controlling shareholder, defined as an individual holding 95% or more of the shares issued and outstanding, may squeeze out the minority shareholders by compelling them to sell their stake in the company. When calculating the 95% or more shareholding ratio requirement, the number of shares in the target held by an individual controlling shareholder and the number of shares in the target held by any corporate entity in which such individual controlling shareholder has a majority stake should be aggregated.

If the controlling shareholder is a company, the 95% or more ratio requirement is calculated by aggregating the number of shares in the target held by the controlling shareholder and its parents and subsidiaries. The purchase price for compulsory purchase will be determined by the court unless the controlling shareholder and the minority shareholders mutually agree on a purchase price.

A unique aspect of the squeeze-out rule under the amended KCC is that it does not question how the controlling shareholder came to acquire 95% or more of the target company shares, whether through a tender offer, through purchase of shares in the stock market or by negotiated transaction outside the market.

One of the basic principles of merger under the current KCC is that the shares of the merging company should be distributed to the shareholders of the merged company as merger consideration, and distribution of cash payment would only be allowed when necessary to make adjustments to the merger exchange ratio or to clear fractional shares. Thus, cash-out mergers, where a merging company acquires the target's stock with cash and as a result the shareholders of the merged company do not become shareholders of the surviving company, were not allowed under the KCC.

Under the amended KCC, however, cash is added to the means of merger consideration, which means that cash-out mergers are now permitted under the KCC. As to the question of whether some shareholders can be cashed-out while others remain shareholders of the merging company, many commentators feel that it may not be allowed due to the principle of equal treatment of shareholders.

Furthermore, the amended KCC allows other assets to be used as merger consideration. Practically, this means that triangular merger, under which the merging company distributes its shares in its parent company as merger consideration to the shareholders of merged company, will henceforth be allowed. From the parent company's perspective, it may by using its merger subsidiary avoid the risk of directly assuming any contingent liabilities of the merged company as well as the inconvenience of convening a shareholders' meeting for approval of merger and dealing with the appraisal rights of dissenting shareholders.

Introduction of the poison pill as a defensive measure against hostile takeovers has been expected since 2009. Despite efforts to introduce this defence, it is still unclear whether and when it will be incorporated in the KCC. If the poison pill defence is approved by the National Assembly of Korea in the form it has been discussed so far, it would allow Korean companies to issue options or warrants to its shareholders that would serve as a so-called flip-in pill, which will bestow rights to existing shareholders to purchase additional company shares at a discounted price discriminatorily against the hostile bidder if the hostile bidder's stake in the target company exceeds a certain threshold.

Given that hostile bids have not been common in Korea due to the negative public sentiment towards hostile takeovers, the poison pill defence may end up exacerbating negative effects such as management entrenchment of Korean chaebols, which already are considered to be almost invulnerable to takeover attempts discouraging any possible restructuring efforts, as the reformers and foreign hedge funds put it. However, with the Korea-EU FTA and the Korea-US FTA taking effect in the near future, the introduction the of poison pill defence may be reinstated as a political agenda.

Accelerating the M&A drive

Restructuring needs within the industries in response to economic conditions and creditor initiatives, the public sector's plan to privatise or divest certain government-invested companies, technological developments, the strategic increase of size and scale of the Korean chaebols and rise of domestic private funds all act as elemental factors driving merger waves. Regulatory changes take its role in stimulating the merger process by either providing a corporate-friendly legal environment or triggering changes in other areas of the market.

For example, the Financial Investment Services and Capital Markets Act reshaped the legal landscape for financial investment and spawned the rise of domestic private funds, and changes in the antitrust regulatory scheme will no doubt have direct effect upon the M&A market.

Recent amendment to the KCC also contains fundamental changes to the rules of M&A by redefining share classes, allowing acquisition of treasury shares and introducing the squeeze-out rule and new merger strategies such as the cash-out merger and the triangular merger. These changes will facilitate creations and combinations of innovative deal structures and provide new tactics for acquisition and takeover defences.

With no concrete precedents existing regarding the new statutes, however, implementation of new M&A strategies and defences under the amended KCC should be carefully reviewed in conjunction with current M&A practices.

Joon-Woo Lee
  Joon-Woo Lee (Zunu Lee) is a partner in banking and securities department of Yoon & Yang and handles matters involving acquisition financing, corporate financing, securities and financial regulation, hostile takeovers, corporate governance and all phases of M&A transactions from structuring through post-closing integration.

Starting his career with high-profile cross-border sale of Korean industry giants under bankruptcy reorganisation and workout process back in post-IMF bailout plan era, Lee expanded his practices to restructuring international joint ventures, acquisition financing, private equity formation and investments, and also frequently involves international arbitrations arising out of cross-border transactions.

Before he earned his LLM. degree from New York University, School of Law in 2007, he graduated from the Judicial Training and Research Institute under the Supreme Court of Korea in 2001 and Seoul National University, College of Law in 1993 (LLB). Lee is a member of both Korean bar and New York bar.

Yoon & Yang
19th Fl., ASEM Tower, 159 Samsung-dong, Gangnam-gu
Seoul 135-798, Korea

T: +822 6003-7527
F: +822 6003-7009

Sang-Hyun Ahn
  Sang-Hyun Ahn is a partner in M&A department of Yoon & Yang. His main practice areas include M&A, joint venture transactions, bankruptcy reorganisation, corporate governance and other general corporate law matters.

Ahn advises industry leaders in cross-border and domestic M&A transactions on a variety of issues regarding structuring, general corporate, regulatory and tax matters. More recently, Ahn counsels private equity clients in making equity investment in M&A transactions, enhancing corporate governance of target and making successful exits.

He received his LLM degree from Columbia Law School in 2007. Ahn graduated from the Judicial Research and Training Institute under the Supreme Court of Korea in 2001 and received his first law degree from Yonsei University, College of Law in 1998. He is a member of the Bar of the Republic of Korea and the Bar of the State of New York.

Yoon & Yang
19th Fl., ASEM Tower, 159 Samsung-dong, Gangnam-gu
Seoul 135-798, Korea

T: +822 6003-7526
F: +822 6003-7006