Corporate Insolvency & Restructuring Report 2020: Covid-19 Special Focus: South Korea
Junsang Lee, Joon Oh Jo and Myung-Ahn Kim, Yoon & Yang
Unlike in the US or Europe, Korea has not implemented drastic measures against Covid-19, such as compulsory lockdowns, and whether Covid-19 has significantly dented Korea's economic activity remains unclear. However, the country's manufacturing sector relies heavily on exports and these are declining, rendering any likelihood of an economic rebound in the second half of the fiscal year rather uncertain. Some believe that it may well take two or three years for the global economy to recover. The existing quantum of previous orders, together with government subsidies in the first half of 2020, helped Korean businesses to sustain themselves, but as the economy continues to face downside risks, the long-term future remains murky.
Most corporations are experiencing a liquidity crunch. Generally, corporations start to take rehabilitation into serious consideration when they are, or are likely to be, unable to secure the necessary operating funds due to a decline in sales, recovery in account receivables and/or an increase in costs. Covid-19 has forced management teams to tighten control over costs to reduce expenditures to a degree, but the decrease in sales and the recovery of claims appears to be a larger challenge.
While the emergency disaster relief provided by the government has triggered a temporary increase in sales, the impact is inevitably limited, as well as unclear for corporations. If the Covid-19 pandemic continues into the second half of the year, further eroding sales and recovery prospects, corporations are highly likely to encounter serious problems in securing liquidity and operating funds.
Given the above, the number of applications for rehabilitation and bankruptcy will likely increase in the second half of 2020. Management teams may be well advised to closely analyse their financial condition; for example, is it a temporary financial constraint as opposed to a structural problem with deeper roots? Management will need to decide whether to continue relying on government subsidies or to restructure via rehabilitation. Merely continuing to exist without implementing a fundamental solution will be counterproductive.
In general, since the restructuring of Hanjin Shipping, there have not been any major insolvency cases in Korea. However, recent trends show an increased in the number of rehabilitation applications for business entities operating golf courses. The number of M&As for rehabilitation companies involving stalking horse bids is also on the rise. Industry experts also expect that the number of the bankruptcy and work-out proceedings will increase and that necessary preparations should be made to manage this.
The Debtor Rehabilitation and Bankruptcy Act (DRBA) prescribes procedures for either rehabilitation proceedings or bankruptcy proceedings. Workout programmes (work-out proceedings) are prescribed under the Corporate Restructuring Promotion Act (CRPA).
Previous orders, together with government subsidies in the first half of 2020, helped Korean businesses to sustain themselves
Insolvency proceedings under the DRBA (rehabilitation and bankruptcy) are led by the court, while rehabilitation proceedings are creditor-led. While insolvency proceedings are uniform procedures that proceed according to the prescribed law, work-out proceedings are based on private agreements. Additionally, insolvency proceedings encompass all creditor claims, while work-out proceedings cover financial institutions' the creditor claims only.
Of the two proceedings (bankruptcy and rehabilitation) comprising insolvency proceedings, rehabilitation proceedings aim to reduce / exempt the creditors' claims on the debtor under financial constraints so as to rehabilitate the debtor. Bankruptcy proceedings on the other hand aim to liquidate the debtor's assets and distribute them to the creditors before dissolving the debtor. Once rehabilitation proceedings terminate, the debtor company is released from the supervision of the court, receiver or custodian and resumes its ordinary business. Once bankruptcy proceedings terminate, the debtor company ceases to exist.
Corporations generally resort to rehabilitation proceedings. However, in the event a corporation is unlikely to be rehabilitated and the reasons justifying its bankruptcy exist, an application for bankruptcy may be filed. Once an application for rehabilitation is filed, the court renders a preservation order for the purposes of freezing the debtor's assets until the decision on the application is rendered. Under the preservation order, the debtor is prohibited from disposing its assets and/or repaying its existing debts.
The directors of a corporation are not subject to any increased or decreased level of duty during the pendency of the corporations' financial constraints. The fiduciary duty under the Commercial Act continues to apply.
Where a corporation is undergoing rehabilitation proceedings, the right to manage and to dispose of the assets is transferred exclusively to the receiver or custodian. Under the DRBA, the existing managing director of a corporation undergoing rehabilitation proceedings is appointed as the receiver/custodian, unless any extraordinary circumstances dictate otherwise. A receiver/custodian is subject to certain obligations. As is the case for a director, a receiver/custodian bears his/her fiduciary duty to the corporation including the duty to conduct adequate investigation of the claims reported per the rehabilitation proceedings; and the duty to settle the reported claims in accordance with the rehabilitation plan. A receiver/custodian is required to obtain the court's approval in order to dispose of the corporate assets and/or to obtain loan.
Once an application for rehabilitation proceedings is made, the court may render an order prohibiting all rehabilitation claim creditors and secured rehabilitation claim creditors from compulsory enforcement, provisional attachment and auctions to enforce their security interests. This is referenced as a "comprehensive prohibition order".
By way of reference, an Ipso Facto Clause refers to a contractual provision whereby an application filed for the rehabilitation of a contractual party is deemed as the basis for the contract termination or an event of default. As for the validity of the Ipso Facto Clause, the Supreme Court of Korea has ruled that the clause in principle may not be invalid as the contracting parties' freedom to include such term/condition of the contract should be upheld. However, it has also stipulated that an Ipso Facto Clause may be rendered invalid if it contravenes the general principle of public order and decency (Supreme Court of Korea 2005Da38263, September 6 2007).
Priority, dissenters and asset sales
A public-interest claim is the main example of a claim that prevails over other claims in priority. Under the DRBA, a "public interest claim" refers to a type of claim prescribed under the DRBA and is incurred by the receiver/custodian after commencement of the rehabilitation proceeding – such as a claim for employment wages. Unlike the rehabilitation and secured rehabilitation claims, a public interest claim is paid on a rolling basis and prevails in priority over any rehabilitation claim or secured rehabilitation claim.
DIP financing is a type of a post-petition credit whereby a debtor-company, upon applying for the commencement of rehabilitation proceedings may, per the court approval, obtain a loan in order to facilitate the procurement of funds
Cramming-down a credit or class of creditors is also possible. During rehabilitation proceedings, the debtor-corporation prepares and submits its rehabilitation plan for approval at the meeting of the interested parties/creditors. A rehabilitation plan requires a two-thirds vote from rehabilitation claim creditors and three-quarters of the vote from secured rehabilitation claim creditors (based on the quantum of claim amount). Subsequently, if the court approves the plan, it becomes valid and effective. Once the court approves the rehabilitation plan, it becomes applicable to all creditors including those who did not consent, and the provisions of the plan take compulsory effect on the respective rights of the creditors.
Corporations have delayed filing for rehabilitation in fear of the stigma surrounding the proceedings, only worsening their chances of rehabilitation
In June 2020, the government promulgated its plans to operate the Corporate Asset Disposal Assistance Programme, in order to facilitate corporations undergoing liquidity problems in the midst of Covid-19 to sell/dispose of their assets. The programme applies to large corporations as well as mid-to-small size corporations wishing to facilitate the disposal of their assets. The Korea Asset Management Corporation (KAMCO), which has expertise in corporate asset acquisition and management, assists corporations on asset disposals in lieu of the programme. It is expected that corporations applying for the programme will be able to dispose of their assets based on reasonable terms and conditions.
There is no sector or industry with its own modified insolvency and restructuring regime. Corporate insolvency proceedings are regulated under the DRBA whilst the Work-out Proceedings are regulated by the CRBA. Rehabilitation and bankruptcy proceedings are regulated and monitored strictly under the court provision. As the courts take charge of these proceedings, other stakeholders such as the governmental or regulatory institutions do not have a material impact on the outcome. Work-out proceedings are handled and monitored by the relevant financial institutions. Given that financial institutions are regulated by the authorities in the financial sector (namely, the Financial Services Commission – FSC), the opinion of such authorities may be reflected substantially during work-out proceedings.
Challenging a debtors' transactions
The DRBA provides for the "avoidance powers" whereby the debtor may recover its assets that had unjustly been disposed of before the commencement of the rehabilitation proceedings, so as to ensure the effective rehabilitation of the debtor. Based on the avoidance powers, the receiver/custodian (upon the commencement of the rehabilitation proceedings) may reject the effect and validity of the debtor's previous actions taken before the rehabilitation including (i) the actions taken with the knowledge that they would adversely affect the rehabilitation claim creditors, etc and/or (ii) the actions harmful to the equity among rehabilitation claim creditors such as repayment and provision of security interests. The avoidance powers are exercised by the receiver/custodian.
The avoidance powers are applied in bankruptcy proceedings in a substantially same manner.
Cross-Border Insolvency refers to an insolvency case entailing a cross-border effect over the relations among the debtors and creditors. Based on the UNCITRAL Model Law on Cross-border Insolvency adopted in May 1997, the DRBA (Chapter 5) contains 15 provisions pertaining to cross-border insolvency. In light of this legal framework, the main points for consideration in case a foreign cross-border entity plans to enter into a work-out proceeding or insolvency proceeding in Korea.
A foreign entity or individual has the equal status as that of a Korean entity or individual (Article 2 of the DRBA). The principle of reciprocity is not applied under the DRBA as it incorporates the principle of equality among domestic and foreign nationals.
Whether a cross-border insolvency proceeding may commence in Korea is determined based on the confirmation of Korean jurisdiction over the applicable rehabilitation or bankruptcy case. Where a debtor's main place of business or office is located in Korean, the Korean court has the jurisdiction over the cross-border insolvency. Even in cases where the main place of business or office is situated abroad, the Korean court may still exercise its jurisdiction if the debtor's assets (in case of creditor claims, the reference is made to the place where the legal claims may be filed) are located in Korea – as per Article 3(1) of the DRBA. In sum, the jurisdiction of the Korean courts is upheld in cross-border insolvency cases if (i) a foreign debtor's main place or business or office or (ii) its assets are located in Korea.
The DRBA recognises the validity and effect in Korea of a cross-border insolvency proceeding abroad. The legislation also prescribes the specific procedures, methods and effect of cross-border insolvency proceedings. It also entails a two-fold system whereby the approval process and the support process for a cross-border insolvency proceeding is stipulated.
For a cross-border insolvency proceeding in a foreign jurisdiction to be recognised by the Korean courts, it must obtain the recognition approval in the first place. Once obtained, the recognition approval has the effect of confirming that the foreign cross-border insolvency proceeding is eligible for the "support process" decision of the Korean courts, provided the approval in itself does not bring about a specific legal effect. The court is required to render its decision on the application for the approval of the cross-border insolvency proceeding in a foreign jurisdiction – within one month after the application.
A "support process" in the context of cross-border insolvency proceedings entails: (i) prohibiting compulsory enforcement or preservation of the debtor's assets and businesses situated in Korea; (ii) prohibiting debtor's settlement or repayment; and (iii) appointing a cross-border receiver/custodian in support of the relevant cross-border insolvency proceedings.
There has not been any substantial change in Korean restructuring and insolvency legislation except for a few minor developments.
The Korean Development Bank Act was amended on May 1 2020 to establish the Period Industry Stabilization Fund, which aims to foster employment stability, allocate corporate normalisation proceeds and prevent moral hazard. As such, corporations undergoing temporary financial constrains are eligible for a subsidy under the Fund. This will be in effect until December 31 2025.
Article 15(3) of the Enforcement Decree for the DRBA was amended on June 2 2020. Under the amended Decree, the upper ceiling for a rehabilitation claim and secured rehabilitation claim required for Simplified Rehabilitation Proceedings (namely, a simplified form of rehabilitation proceedings entailing relatively lower costs than standard rehabilitation proceedings and which is available for small-to-mid business entities with a small amount of operating income) was raised from KRW3 billion ($2.5 million) to KRW5 billion. Unlike in standard rehabilitation proceedings, the approval requirements for the Simplified Rehabilitation Proceedings have become more lenient.
Covid-19 infection rates resurged in August 2020. There is a possibility that, in the future, forceful shutdowns may be implemented as a compulsory measure to prevent a further spike in Covid-19. If the pandemic continues, it may in turn have a substantial impact on the legal regime.
The importance of appropriate timing in an application for and commencement of rehabilitation cannot be overemphasised. In a number of instances, corporations have delayed filing for rehabilitation in fear of the stigma surrounding the proceedings, only worsening their chances of rehabilitation. An accurate and practical assessment of the appropriate timeline for the application by management is highly recommended.
In light of the above, the courts should also prioritise the prompt handling and completion of rehabilitation proceedings. Where debts are settled/paid under a rehabilitation plan and the purposes of the rehabilitation plan are achievable without hindering the implementation of the plan, then the court has the discretion to apply for, or to directly order, the completion of the rehabilitation. This is typically called an "early termination". Incomplete corporate rehabilitation proceedings that linger in the courts hinder corporations' business activities as they prohibit commercial bidding with public entities during the pendency of the rehabilitation proceedings; this may result in a counter-productive outcome where a corporation which needs to quickly rehabilitate via business activities is unable to do so. Accordingly, it may be recommendable for the courts to more actively seek reasonable means to consider and implement an "early termination".
Flexibility in rehabilitation proceedings is improving in order to facilitate a corporate restructuring. For instance, the Korean Rehabilitation Court has adopted P-Plan (Pre-packaged Plan), which allows for the submission of a pre-pack plan prescribed under Article 223 of the DRBA. Where it is possible to settle debt via share or asset sales before the start of rehabilitation proceedings, a debtor-company, having conferred with its creditors, may prepare a pre-pack plan and submit it to the courts together with the application for rehabilitation – thereby facilitating the rehabilitation and a return to normal business.
Korean exports in the second quarter of 2020 declined by 20.2%. As such, rehabilitation and bankruptcy applications in the second half of 2020 are expected to increase, and the role of professionals with relevant expertise will be critical. We also expect that rules around DIP financing will be strengthened.
These precarious times mean that corporate management teams should tread carefully. Entering rehabilitation proceedings does not automatically mean that existing management must cede control over their businesses. As indicated, the DRBA provides that the existing management shall continue to manage the corporation as the receiver/custodian. On a positive note, the number of corporations that have successfully completed rehabilitation proceedings and resumed business is increasing.
Corporate management teams may be well advised to consider the appropriate timing and measures for rehabilitation rather than simply discount it as an option. Competent professionals with relevant expertise may be of assistance.
Managing partner, Yoon & Yang LLC
Seoul, South Korea
T: +82 2 6182 8512
Junsang Lee is the managing partner at Yoon & Yang LLC. His main practice areas are international arbitration & litigation and cross-border insolvency & restructuring. From 1994 to 2013, he served as a judge for the lower courts and a presiding judge at the Suwon District Court, during which time he handled bankruptcy and administrative cases. He has been constantly recognised as a leading lawyer by various international publications including Chambers & Partners Asia-Pacific, Who's Who Legal Korea, and Benchmark Litigation Asia-Pacific.
Joon Oh Jo
Partner, Yoon & Yang LLC
Seoul, South Korea
T: +82 2 6003 7080
Joon Oh Jo is a partner at Yoon & Yang LLC. His practice focuses on M&A, corporate restructuring and corporate recovery and liquidation. Recently, he has been actively involved in international restructuring/insolvency matters. In particular, during Hanjin Shipping's reorganisation procedure, Joon Oh acted as the legal counsel of a subsidiary of MSC, the world's second-largest shipping group based in Switzerland, and provided legal advice regarding the deal involving the Long Beach Container Terminal in the US. Joon is dual licensed both in Korea and in the State of New York.
Senior foreign attorney, Yoon & Yang LLC
Seoul, South Korea
T: +82 2 6182 8359
Myung-Ahn Kim is a US qualified senior foreign attorney at Yoon & Yang LLC. Her practice focuses on international litigation/arbitration, restructuring, maritime, aviation and trade. Prior to joining Yoon & Yang, she worked at Holman Fenwick Willan LLP (Singapore Office). Myung-Ahn Kim is ranked as a recognised practitioner by Chambers & Partners Asia-Pacific 2020 and Global 2020. She is a member of the California Bar since 2006.