This content is from: South Korea

Comparing pre- and post-Covid restructuring & insolvency trends

Chiyong Rim, Jin Yeong Chung and Kevin Todd of Kim & Chang examine the latest iteration of Korea’s restructuring and insolvency resolution framework

Before the Covid-19 outbreak, from late 2019 to early 2020, the market was already witnessing a significant increase in the number of companies applying for court-supervised insolvency proceedings, including bankruptcy, an insolvent liquidation proceeding, and rehabilitation, a proceeding somewhat akin to a Chapter 11 bankruptcy proceeding in the US. The number of distressed companies was significantly higher in 2019 compared to 2018. This trend can be partly attributed to the impact that recent failures of large corporations, notably in shipping and shipbuilding, have had on their vendors and suppliers, most of which were small and medium-sized enterprises (SMEs). SMEs was the category of debtor that made up the brunt of bankruptcy and rehabilitation filers in 2019.

The Covid-19 outbreak severely impacted companies in the aviation, hotel, hospitality and off-line retail industries. Yet it is difficult to find court-supervised insolvency proceeding filings in South Korea by companies in these industries. At least in the short term, we do not expect to see a significant increase in such filings, as many of these companies, including large corporations, have received various forms of support from the Korean government. The Korean government mobilised approximately KRW200 trillion (approximately $169 billion), a part of which went to support large corporations impacted by Covid-19, in an effort to revive the economy. Rather, the more imminent issue will be how companies will restructure and take advantage of the government support.

Overall, the number of insolvency cases in South Korea involving corporate debtors has continued to increase each year. The following table presents data collected by the Supreme Court of Korea showing the number of corporate insolvency proceedings brought in Korean courts from 2011 to 2019.

Year of filing201120122013201420152016201720182019

Statutory framework

After the 1997 financial crisis, the South Korean government reformed the nation's bankruptcy law by amending the Corporate Reorganisation Act, the Composition Act and the Bankruptcy Act. Nevertheless, it was apparent that there was a need for a unified bankruptcy law. The National Assembly passed a comprehensive bankruptcy law, and court-supervised insolvency proceedings are now governed by the Debtor Rehabilitation and Bankruptcy Act (DRBA), which became effective on April 1 2006. The DRBA is divided into six chapters:

  • Chapter 1 – general provision: jurisdiction, notice, service, management committee, creditors' council and update on corporate registry
  • Chapter 2 – rehabilitation proceeding: for all legal entities
  • Chapter 3 – bankruptcy proceeding: liquidation proceedings for legal persons and individuals
  • Chapter 4 – rehabilitation proceeding for individuals with regular income
  • Chapter 5 – cross-border insolvency
  • Chapter 6 – penalties

South Korea also offers out-of-court workouts under the Corporate Restructuring Promotion Act (CRPA), which enacted into law the corporate workout procedures that had previously been used by financial institutions for restructuring debtor companies on the verge of insolvency through an out-of-court workout arrangement.

The Seoul Bankruptcy Court was established on March 1 2017. Under the DRBA, if the number of a debtor's creditors exceeds 300 and the amount of debt exceeds KRW50 billion, then the Seoul Bankruptcy Court will have concurrent jurisdiction over the insolvency proceeding, even if the debtor's main business or place of incorporation is outside Seoul.

The Seoul Bankruptcy Court plays an important role in the insolvency regime in South Korea. Generally speaking, the South Korean legal system is codified and does not adopt the common law principle of stare decisis or binding precedents. However, the precedents of the Supreme Court practically have binding force of the law. With respect to insolvency cases, the decisions of the Seoul Bankruptcy Court, with which about 40% of total insolvency cases are filed, carry significant precedential weight in practice, to the extent that they are within the boundary of Supreme Court precedents. After the establishment of the Seoul Bankruptcy Court, newly implemented concepts such as debtor-in-possession, stalking horse and pre-packaged plans have become more frequently employed by both petitioners and the court, and insolvency procedures have become more expedient and more predictable than before.

In the stalking-horse bidding sales process, a debtor enters into an agreement in advance with a potential purchaser of an asset and holds an auction where the aggregate of the purchase price and termination costs sets a base-line price for the bid. Unless there is a higher bid in the auction, the sale is concluded in accordance with the prior agreement. The process has the advantage of having a high probability of securing a purchaser through a private agreement while promoting the fairness of the sale procedure through bidding.

In the case of a rehabilitation proceeding that uses a pre-packaged plan, a rehabilitation plan is drafted and approved by a majority of creditors before the debtor files the petition for commencement of rehabilitation. This process is beneficial to accelerate the rehabilitation proceedings and improve chances for a swift recovery. Given there have been demands for accelerated procedures, it is expected that this pre-packaged plan would be implemented more frequently.

The number of insolvency cases in South Korea involving corporate debtors has continued to increase each year

Although the DRBA, in principle, does not recognise priorities among common benefit claims (i.e., generally, claims arising after commencement of a rehabilitation proceeding), loans newly executed with court approval after filing a petition for commencement of rehabilitation proceedings (i.e., DIP loans) are given priority over all other types of common benefit claims. Other common benefit claims are paid pari passu in proportion to the amount of each claim. In the DRBA, there was no provision permitting such priority granted to DIP loans in rehabilitation proceedings to be carried over to bankruptcy proceedings, in case a rehabilitation proceeding is converted into a bankruptcy proceeding, making it more difficult to attract lenders willing to provide new funds to the debtor. This was raised as an issue during the rehabilitation and bankruptcy proceedings of the Hanjin Shipping case.

Article 477 of the DRBA was amended in February 2020 to address this issue, providing that the priority granted to a DIP loan in rehabilitation would carry over to bankruptcy if the rehabilitation proceeding is converted to a bankruptcy proceeding. As a consequence of the amendment, DIP loans are now classified as estate claims in an ensuing bankruptcy, and along with wages, have the top priority over other claims, including other estate claims.

The current CRPA is the sixth version of the law, which includes a sunset provision that designates a specific date on which the law will expire unless it is renewed or re-enacted. The fifth version had expired in June of 2018, after which a sixth version was enacted in response to a considerable consensus in favour of the law. The sixth version is set to expire in October of 2023.

Court-supervised proceedings

Court-supervised insolvency proceedings are governed by the DRBA, which offers two kinds of insolvency proceedings for business entities: (i) rehabilitation proceedings under Chapter 2 of the DRBA, primarily for the rehabilitation of insolvent business entities, and (ii) bankruptcy proceedings under Chapter 3 of the DRBA for the liquidation of insolvent business entities.

The goal of rehabilitation proceedings governed by Chapter 2 of the DRBA is to rehabilitate insolvent debtors by restructuring their debts pursuant to a rehabilitation plan approved by the creditors and confirmed by the court. Rehabilitation proceedings are analogous to the Chapter 11 proceedings of the US Bankruptcy Code. However, filing for a rehabilitation proceeding does not itself trigger the formal commencement of a rehabilitation proceeding. A rehabilitation proceeding commences only when the court issues a separate commencement order in response to the filing.

Upon commencement, the court will, in principle, appoint a receiver. In general, the court will appoint the existing management (for example, a representative director) of the debtor to act as the receiver in the rehabilitation proceeding unless the insolvency of the debtor was caused by any wrongdoing or serious mismanagement committed by the existing management, in which case the court will appoint an independent receiver. In practice, the existing management is appointed (or is deemed appointed) as the receiver in most rehabilitation cases; a third party may exceptionally be appointed as the receiver. The receiver has the power to conduct all the debtor's business and manage all of its property, subject to the court's supervision.

The newly enacted CRPA has widened the net on the types of creditors which it can bind

In rehabilitation proceedings, creditors are classified into three basic categories: (a) creditors with unsecured rehabilitation claims; (b) creditors with secured rehabilitation claims; and (c) creditors with common benefit claims. Creditors with either secured or unsecured rehabilitation claims are subject to rehabilitation proceedings and generally may not receive payment or repayment of their respective claims other than as provided for in the rehabilitation plan (with certain exceptions, including set-off of claims that are exercised within the claim filing period under the DRBA). However, creditors holding common benefit claims – such as wage claims, those claims that arose after the commencement of the rehabilitation proceedings (with certain exceptions) and those claims that were approved by the court – are not subject to the rehabilitation plan, and may, in principle, receive repayment of their claims when due.

Bankruptcy proceedings governed by Chapter 3 of the DRBA are court-administered proceedings designed to liquidate an insolvent debtor's assets. These are analogous to the Chapter 7 proceedings of the US Bankruptcy Code.

In bankruptcy proceedings, creditors are generally divided into creditors with bankruptcy estate claims and creditors with unsecured bankruptcy claims. Unsecured bankruptcy claims are subject to the bankruptcy proceedings and repaid from the distributions made by the bankruptcy trustee. However, bankruptcy estate claims are repaid from time to time from the bankruptcy estate by the bankruptcy trustee.

Unlike rehabilitation proceedings, in bankruptcy proceedings creditors with secured claims are generally not prohibited from enforcing their security interests in the debtor's assets except for certain procedural limitations. Thus, the proceeds recovered from such enforcement may be applied to the repayment of the secured claims regardless of the bankruptcy proceeding.

Out-of-court restructurings

There are mainly two types of out-of-court restructurings in South Korea: (i) a voluntary workout between the debtor and creditors, and (ii) a voluntary restructuring through a workout process under the CRPA. Until recently, such out-of-court restructurings were preferred by market participants, particularly debtor companies, because they afford more flexibility and generally cause less disruption to the debtor, which could count on receiving financing during the workout from its creditor financial institutions.

Restructuring by means of a voluntary agreement is a restructuring process whereby creditor financial institutions and the debtor voluntarily enter into and implement a private agreement to restructure the terms of existing debts and business of the debtor following a request from the company. In principle, concluding the agreement requires a unanimous affirmative vote of the creditors, although decisions made after entering into the voluntary agreement often require the agreement of creditors holding claims totalling at least three-quarters of the total claim amount. Creditors may set a period during which they will suspend exercise of their claims and conduct due diligence with a view to preparing the restructuring agreement. The restructuring of liabilities under the agreement typically provides for a three to five-year grace period, a reduction of interest rate and a conversion into equity of a certain portion of debt that exceeds the appropriate level the company can service.

Restructuring pursuant to the CRPA is similar to a restructuring by voluntary agreement, especially because the CRPA includes the provision of a three to five-year grace period to restructure liabilities, lower interest rates and convert a certain portion of debt that exceeds the appropriate level the company can service into equity. However, the workout under the CRPA is a more formal, statutory process which still takes place out of court.

Previously, only companies that had received "financial credit" as defined under the Enforcement Decree of the CRPA were eligible for a workout under the CRPA. It was argued that the narrow scope of "financial credit" caused the unsuccessful result of a workout.

Therefore, the newly enacted CRPA has widened the net on the types of creditors which it can bind. Pursuant to the latest version of the CRPA in 2020, workout provisions under the CRPA are binding if there are creditors that hold financial claims against a failing company. To elaborate in detail, a financial claim is defined by Article 2 of the CRPA as a claim that may be exercised vis-à-vis a failing company as a result of the extension of credit to the debtor or a third party. Based on the above definition, even corporate bondholders, in principle, are classed as applicable creditors. Indeed, the exact scope of applicable creditors remains uncertain under this article; further guidance or precedent is required to specify it. In the meantime, non-financial creditors such as trade creditors and tax creditors, are explicitly excluded.

Workout procedures

The main creditor bank of a debtor is required to evaluate the credit risk of the debtor, determine whether the debtor shows signs of financial distress, and if so, may designate such company as a failing company.

Upon being designated as a failing company, the debtor may file a petition with the main creditor bank for either (a) commencement of joint management proceedings under the CRPA or (b) management by the main creditor bank only. For joint management proceedings, a rescue plan and the list of financial creditors is required by the financial creditors' council (Council), a council composed of financial creditors of the failing company.

The main creditor bank must give a notice of the first meeting of the Council within 14 days of receiving the debtor's petition for joint management, and the first meeting of the Council must be held within 14 days of the date of the notice. At the first meeting, financial creditors resolve to begin joint management and determine the list of participating financial creditors. The Council may decide whether to suspend the exercise of creditors' rights (including enforcement of security) and, if so, the period for such suspension. After the first meeting, the Council may engage an accounting firm or a third-party expert to conduct due diligence on the debtor's assets and liabilities and assess its viability as a going-concern in consultation with the debtor. Taking into account the outcome of the due diligence investigation, the main creditor bank must submit to the Council a joint management plan.

Filing a petition for commencement of rehabilitation is often listed as an event of default

The Council may convene a meeting to consider the joint management plan submitted by the main creditor bank and pass a resolution to approve it. In principle, such resolution requires the approval of financial creditors holding at least three-quarters of the total amount of financial claims against the debtor.

After the joint management plan is approved, the Council and the debtor must enter into an agreement to implement the plan. This agreement is commonly referred to as a memorandum of understanding (MOU). In addition to the joint management plan, the MOU includes a detailed implementation plan, management goals, consent from interested parties (including shareholders and/or the labour union), matters concerning improvement of the debtor's corporate governance structure, and measures to be taken if the debtor fails to perform the MOU, among others. The joint management plan and the MOU usually include matters such as a grace period for exercise of claims, a debt-equity swap and a reduction in interest rates, new credit support, and self-rescue including restructuring of existing business by spin-off, transfer of business, sale of assets and cost reduction.

The joint management process will be terminated under several scenarios. First, if the Council fails to pass a resolution on the joint management plan within the period when the exercise of creditors' rights is suspended, the joint management process is deemed to be terminated. Second, if the joint management is not completed within three years after the MOU is signed, a management evaluation committee will be organised to evaluate the efficiency of the joint management process, and based on the result of the evaluation, the process may be discontinued. Third, if it is determined that the debtor has been relieved of its financial trouble through joint management or that the MOU has been fully performed, the process under the CRPA will be closed.

Thorny issues

A financial creditor that objects in writing to the commencement of joint management under the CRPA or to a debt restructuring by means such as debt-equity swap, reduction of interest rate or extension of new credit, has the right to require assenting financial creditors to purchase its claims. In this case, the purchase price paid for the claims held by a dissenting financial creditor may not be less than the amount that may be recovered by that creditor through liquidation of the failing debtor. In practice, this purchase price tends to be much lower than the face value of the claims.

A workout may help guarantors due to the resulting reduction in principal, which in turn alleviates the guarantors' liability based on the accessory relationship between the principal and the guaranty obligations. In contrast, filing a petition for commencement of rehabilitation is often listed as an event of default, and reducing the amount of debts owed by a corporate debtor under rehabilitation does not affect the liability of a guarantor.

Chiyong Rim
Senior attorney, Kim & Chang
Seoul, South Korea
T: +82 2 3703 1403

Chiyong Rim is a senior attorney at the firm and practises in a wide range of insolvency and restructuring areas, with a focus on corporate liquidation, M&A in reorganisation proceedings, and cross-border insolvency cases. He represents private equity funds, corporate clients and both foreign and domestic financial institutions in various reorganisation proceedings. Chiyong also has extensive experience in advising clients on issues relating to personal bankruptcy, corporate reorganisation and workout proceedings, and has used this experience to write books on the topic in both Korean and English.

Jin Yeong Chung
Senior attorney, Kim & Chang
Seoul, South Korea
T: +82 2 3703 1108

Jin Yeong Chung leads the cross-border litigation practice and the insolvency & restructuring practice. He is a senior attorney at Kim & Chang and has successfully represented various foreign and domestic clients in numerous contentious disputes, involving financial products, derivatives, corporate matters, M&A, competition and others. He has also advised numerous large corporations, creditors and investors with regard to various insolvency and corporate restructuring matters.

Kevin Todd
Senior foreign attorney, Kim & Chang
Seoul, South Korea
T: +82 2 3703 1271

Kevin L Todd is a senior foreign attorney with the firm. He practises primarily in the areas of insolvency & restructuring, insurance, investment management, labour & employment, and international arbitration & cross-border litigation. Kevin has extensive experience in advising both domestic and foreign clients, including creditors, investors, and other interested parties, on issues relating to bankruptcy, company rehabilitation and workout proceedings, and has published extensively and spoken on such issues in a number of forums.

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