Since the era of the IMF bailout plan of 1997, the leveraged buyout (LBO) has become more common in the Korean market for large-scale M&As. In Korea, LBOs were implemented in many cases for the purpose of collateralising assets of the target companies to finance the funds to acquire the target companies rather than being motivated by financial leverage effects and corporate income tax implications. In most LBO cases, an acquiring company either provides the target company's assets as collateral to finance its acquisition or pays off its acquisition loan by using the cash reserve of the target company after merging with the target company. In such case, the breach of fiduciary duty of the target company management may become an issue where the management agrees to or decides on placing the risk and burden of the acquisition loan on the target company.
The first touchstone case for the LBO traces back to November 2003 when an acquirer who, upon taking office of the target company's representative director, implemented collateralisation of the target company's assets to secure repayment of the loan the acquiring company borrowed to finance the deal was found guilty of breach of his/her fiduciary duty. While the conclusion of the case provoked a significant stir in the Korean M&A market, the judgment reflected the Korean court's distinction between the interests of the company and its interested parties (shareholders and creditors) as well as its view of the director's duty to advance the interest of the company itself. In short, this decision stemmed from the Korean court's long-standing viewpoint that a company and its shareholders are separate legal entities even in the case of sole shareholder.
After the 2003 ruling, a wide variety of deal structures have been attempted in efforts to avoid the breach of fiduciary duty issue, and accordingly a handful of court precedents on LBO cases have accumulated over the years. The Korean courts appear to have reached different conclusions in different cases on the issue of the breach of fiduciary duty depending on the type of LBO implemented, the nature of the parties concerned and the level of risk borne by the acquirer itself in the course of leveraging the assets of the target company, as is discussed below in more detail.
Pledge-type LBO
In an effort to acquire the target company T1 which was undergoing a bankruptcy reorganisation proceeding, an entrepreneur X established a special purpose company (SPC) with paid in capital of W300 million ($273,400), and had the SPC receive a loan equal to 220-times the amount of the SPC's paid in capital by agreeing to provide T1's real estate and cash deposits as collateral to secure repayment of the SPC's loan upon the SPC's acquisition of T1 (see Chart 1). X took the office of T1's representative director after acquiring T1 through the SPC, and as agreed, collateralised T1's real estate and cash deposits to secure repayment of the SPC's loan.
Chart 1: a pledge-type LBO |
|
The Supreme Court of Korea was of the view that a funding structure under which an acquiring company obtains an acquisition loan to finance its acquisition and afterwards collateralises the assets of the target company to secure that loan would only be permitted where an appropriate consideration is provided by the acquiring company to the target company in return for the risk the target company is to bear by its assets being collateralised, because the target company may possibly lose its assets if the repayment of the loan is not timely made. In this pledge-type LBO case, the Supreme Court decided that X was in breach of his/her fiduciary duty since it failed, as the representative director of T1, to procure an appropriate consideration for T1 in return for collateralising its real estate and cash deposits.
Based on this ruling, a Korean court may typically hold the management of a target company responsible for breach of its fiduciary duty in a pledge-type LBO case unless appropriate consideration is provided for the target company in return. In addition, the court may also take into account the ratio of debt financing on the part of the acquiring company when determining the breach of fiduciary duty case since the risk level of the target company will increase as the acquiring company resorts to debt rather than equity financing.
Merger-type LBO
Company Y that actively operates and maintains its businesses on a large scale established an SPC with paid in capital of W100 billion and financed W466.7 billion in debt, with a view to acquiring the target company T2 which was undergoing a bankruptcy reorganisation proceeding. After the SPC acquired T2, Company Y merged the SPC (Merger #1 in Chart 2) and assumed the SPC's obligation to repay the acquisition loan. In turn, Company Y merged T2 (Merger #2) which had a cash reserve of W180 billion. Upon completion of Merger #2, Company Y used the cash reserve of W180 billion to repay a portion of the acquisition loan.
Chart 2: a merger-type LBO |
|
Chart 3: a distribution-type LBO |
|
The Korean court found the director of Company Y who took the office of T2's representative director not to be in breach of his/her fiduciary duty. Holding that it could not conclude that Company Y acquired T2 for the sole purpose of repaying its acquisition loan rather than managing and operating the business of T2, the court opined that, as long as the mergers were validly effected under the applicable laws and regulations, a deference could be given to the business judgment of the surviving company to make repayments of the acquisition loan with the cash reserves of the target company.
Based on the above case, it is generally said that the Korean courts would acknowledge the limited legitimacy of merger-type LBOs. The court explained as part of its reasoning that a breach of fiduciary duty could not possibly be ruled out if T2 merged to a shell company (the SPC) instead of the company with actual assets and operations (Company Y), because T2 presumably would have become only liable for the acquisition loan without any actual increase in its assets had T2 merged with the SPC. In other words, if a target company merges with an SPC that does not hold any assets other than the shares of the target company and does not operates an actual business, it will as a result only bear the debt of the SPC and not be able to anticipate gaining any synergy in business from the merger, making the merger economically implausible.
Distribution-type LBO
A private equity fund (PEF Z) established an SPC, had the SPC procure an acquisition loan, and acquired the target company T3. Although PEF Z initially planned on post-acquisition merger of SPC and T3, it abandoned its original plan after the merger-type LBO in T2 case was scrutinised under prosecution. Instead PEF Z had T3 proceed with a huge capital reduction and dividend distribution to the SPC which in turn used the funds to repay the acquisition loan.
Although this case is pending before the Supreme Court, the trial and appellate courts held the representative of the SPC, who took the office of a director of T3 upon acquisition, not to be in breach of his/her fiduciary duty. The lower courts held that the SPC would be allowed to repay its acquisition loan with the proceeds received through capital reduction or distribution of dividends pursuant to the legitimate procedures of law: it is reasonable to expect a private equity fund to recoup its investments and no limitations exists as to how the recouped funds are to be used. By way of laying grounds for its conclusion, the courts found it permissible for T3 to reduce its capital since the shareholders in the case did not obtain unfair gains at the expense of the creditors of the company (for example, more monies distributed to the shareholders than the fair value of the shares cancelled as a result of capital reduction) and to pay out dividends since the dividends were distributed within the limit provided under the law and pursuant to the statutorily set procedures.
Conclusion
In a recent LBO case combining a merger-type LBO and a pledge-type LBO where a trial court found breach of fiduciary duty by putting more emphasis on the pledge-type nature of the LBO, the appellate court vacated the lower court's decision on the grounds that: (i) the acquiring company also invested its own funds contrary to cases where the acquiring company provided no consideration while collateralising assets of a target company; (ii) the commercial interest of the acquiring company and the target company became aligned as the acquiring company became the sole shareholder of the target company and the two consolidated into a single legal entity through a merger thereafter; and (iii) the long-term loan collateralised by the real estate of the target company was used for the early repayment of the target company's bonds with warrant held by the acquiring company, which resulted in improving the target company's capital structure. The fact that the appellate court provided the aligned interest of the acquiring company and the target company after the acquiring company became the sole shareholder of the target company as a reasoning behind its judgment shows that the court in this case applied a more lax standard compared to the past cases where the court viewed that the interest of the company and its shareholders were strictly separated.
Ever since the first ruling in 2003, the Korean courts have steadily classified the types of LBOs, resulting in more predictable guidelines on the cases where an LBO could constitute a breach of fiduciary duty. The Korean courts, however, are still in the course of establishing and refining their stance on LBOs, and have yet to structure a concrete framework. Therefore, investors who are contemplating acquiring a company through an LBO in the Korean M&A market should carefully review the legality of the anticipated deal structure taking into account the Korean courts' rulings.
Joon-Woo Lee |
||
|
|
Yoon & Yang LLC 19th, 22nd, 23rd, 34th Fl., ASEM Tower 159 Samsung-Dong, Gangnam-Gu, Seoul 135-798 T: +82 2 6003 7527 F: 82 2 6003 7800 Joon-Woo Lee (also known as Zunu Lee) is a partner in the banking and securities department of Yoon & Yang LLC 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 sales of Korean industry giants under the 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 is also frequently involved in international arbitrations arising out of cross-border transactions. Before he earned his LLM 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 the Korean and New York Bars. |
Sang-Hyun Ahn |
||
|
|
Yoon & Yang LLC 19th, 22nd, 23rd, 34th Fl., ASEM Tower 159 Samsung-Dong, Gangnam-Gu, Seoul 135-798 T: +82 2 6003 7526 F: 82 2 6003 7800 Sang-Hyun Ahn is a partner in M&A department of Yoon & Yang LLC. 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 has counselled private equity clients in making equity investment in M&A transactions, enhancing the corporate governance of the target and making successful exits. He received his LLM 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 Korean and New York Bars. |
Myung Ok Lee |
||
|
|
Myung Ok Lee is a senior associate at Yoon & Yang. Her main practice areas include M&A transactions, corporate restructuring including bankruptcy reorganisation and workout procedures, and general corporate matters. She has represented a wide variety of clients in M&A deals including Eland's acquisition of Carrefour Korea and Prime Development's acquisition of Dongah Construction. She has extensive experience in corporate restructuring in various industries including construction, shipbuilding and finance. Lee received her bachelor's degree in liberal arts from Seoul National University in 2001, graduated from the Judicial Research and Training Institute under the Supreme Court in 2005, and obtained an LLM from Fordham University School of Law in 2011. She is a member of the Korean Bar. |