Global Restructuring Review - Cross-border restructuring and insolvency legal news, features and events

The Asia-Pacific Restructuring Review 2019

Korea

Introduction

There are two categories of insolvency proceedings in Korea – court-administered proceedings and out-of-court proceedings. The former category relates to bankruptcy proceedings, rehabilitation proceedings and personal rehabilitation proceedings under the Debtor Rehabilitation and Bankruptcy Act of Korea (DRBA). As regards consensual out-of-court restructurings, there are two types:

  • voluntary restructuring through a workout process (workout), provided for under the Corporate Restructuring Promotion Act (CRPA); and
  • a voluntary workout accord between the debtor and creditors to which the CRPA is not applied (voluntary workout accord).

Such out-of-court restructurings are often preferred by restructuring market participants, particularly debtor companies, because they afford more flexibility and generally cause less disruption to the debtor.

A rehabilitation proceeding is a reconstructive insolvency proceeding that seeks to rehabilitate debtors in financial distress via such means as debt rescheduling. A personal rehabilitation proceeding, another type of reconstructive insolvency proceeding, is directed towards individual debtors who earn regular income and bear small amount of debts; it repays part of the liabilities with the debtor's income and excludes the rest. In contrast to these two procedures, a bankruptcy proceeding is a liquidating insolvency proceeding that takes into custody and realises the entire property of a debtor deemed to have no possibility of rehabilitation, which is then distributed fairly to the creditors. Workouts and voluntary workout accords are reconstructive insolvency proceedings distinguished from their rehabilitation counterparts in the sense that the creditors administer the procedures rather than a court.

This article will elaborate on insolvency proceedings to which corporate entities may be subjected. It will first explain the rehabilitation proceeding, and the bankruptcy proceeding and the workout will be discussed briefly by comparing them to the rehabilitation proceeding. Given the nature of this report, the explanation of a personal rehabilitation proceeding will be omitted. It will, however, explain voluntary workout accords, and examine Korean cross-border insolvency policies.

Rehabilitation proceedings

Persons entitled to file for commencement of rehabilitation proceeding and cause of commencement

The following persons may file for the commencement of a rehabilitation proceeding: the debtor, the creditors whose total amount of claims equal or exceed one-tenth of the debtor's capital, and shareholders who own more than one-tenth of the debtor's capital.

In order for a rehabilitation proceeding to commence, either the debtor is unable repay a matured debt without causing significant encumbrance to the continuation of its business, or there is a concern that a cause for bankruptcy may arise with the debtor. Here the cause for bankruptcy refers to:

  • the debtor's inability to repay the debt in an ordinary, continuous manner due to the lack of the capacity to effect performance; or
  • the amount of the debtor's liabilities exceeds the value of the assets.

Asset preservation order and a comprehensive stay order

In a Chapter 11 proceeding in the United States, an automatic stay takes effect immediately when a petition is filed, thereby preserving the debtor's assets and preventing creditors from exercising their rights. In a rehabilitation proceeding in Korea, however, such a stay is not automatic and, after filing a petition for commencement, upon filing of an application or by its own motion, the court will issue a preservation order to preserve the debtor's assets, as well as a comprehensive order to prevent creditors from exercising their rights against the debtor.

Effect of commencement of rehabilitation proceedings

A rehabilitation proceeding formally commences when the court issues a decision to commence a rehabilitation proceeding in respect of a debtor.

When there is a decision to commence a rehabilitation proceeding, all compulsory enforcements are automatically stayed, and assets provided as security cannot be sold by a secured creditor without a court order. Further, rehabilitation claims and rehabilitation-secured claims can only be repaid as set out in the rehabilitation plan.

The court must appoint a receiver at the same time the court issues a decision to commence a rehabilitation proceeding. A receiver is authorised to take charge of the management and disposition of the debtor's assets. The Korean government implemented a debtor in possession (DIP) policy in 2006. However, in exceptional circumstances, when the cause of the debtor's financial deterioration can be attributed to existing management of the debtor, as a matter of legal principle, the court must appoint a third-party receiver.

Differences between rehabilitation claims and public-interest claims

In a rehabilitation proceeding, a creditor's claims are divided into three categories:

  • a rehabilitation claim;
  • a secured rehabilitation claim; and
  • a common benefits claim.

A rehabilitation claim is one that arises from grounds that existed before commencement of a rehabilitation proceeding, and a secured rehabilitation claim is a rehabilitation claim secured on any assets of the debtor. These can be repaid only in accordance with the rehabilitation plan. A common benefits claim, however, is paid on a rolling basis, regardless of the rehabilitation plan. A good example of a common benefits claim is one incurred by the receiver with approval of the court after commencement of the rehabilitation proceeding.

Unless specified otherwise, the explanation below about claims is relevant to rehabilitation claims and secured rehabilitation claims.

Executory contract

An executory contract refers to an agreement wherein obligations relevant to both parties have not been performed in their entirety at the time of the commencement of the rehabilitation proceeding. This type of contract receives special treatment from the said proceeding; the receiver may choose to assume or reject an executory contract. The receiver may exercise the rejection right only until the closing of the meeting of interested parties that is convened for reviewing the rehabilitation plan proposal (normally the second meeting).

The counterparty may issue a notice to the receiver urging for a decision on whether to reject the contract. Should the receiver fail to provide confirmation within 30 days of said notice, the receiver will lose the rejection right.

In the case of performance, the other party may enforce the contract as a common benefits creditor. By contrast, if the receiver chooses to reject the contract, the other party's damages claims arising from such rejection are rehabilitation claims.

In order to protect the receiver's right to choose, numerous scholars have argued that an ipso facto clause, which states that filing a petition for the commencement is an event of termination of the contract, should be deemed invalid. Although Korean courts have judged ipso facto clauses to be invalid in the past, there have been cases wherein it was ruled that said clause was valid in relation to contracts that require mutual trust.

Investigation and confirmation of claims

When a rehabilitation proceeding is commenced, the receiver prepares a list of creditors. Separately, each creditor may file his or her respective proofs of claims with the court within the reporting period designated by the court. Even if the reporting period had lapsed, however, there are exceptions whereby the proofs of claim can be filed afterwards. In any event, the latest point in time when a proofs of claim can be filed is before the interested parties' meeting for reviewing the proposal for the rehabilitation plan (normally the second meeting). If any (secured) rehabilitation claims are not included in the list of creditors and reported by the creditor, such rehabilitation claims are discharged upon approval of the rehabilitation plan.

As for the claims for which proofs of claims have been filed, the receiver or other interested parties (eg, other rehabilitation creditors) may file an objection to claims included in the creditor list or filed with the court. In such an event, the creditor whose claims are contested should file with the bankruptcy court an application for allowance of the claim, and the scope of the contested (secured) rehabilitation claims are determined during the claim inspection and confirmation procedure by the bankruptcy court.

Limitation on set-off

Once a rehabilitation proceeding commences, creditors may offset claims (receivables) with debts (payables) if their claims are due before expiry of the claim reporting period. The exercise of the set-off right must take place towards the receiver within the aforesaid term.

The creditors may not offset receivables or payables acquired before a certain point in time. (Depending on the type of claims or obligations, this may be the time of the petition requesting the commencement of a rehabilitation proceeding or the commencement of the said proceeding.)

Restructuring through a rehabilitation plan

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 mergers and acquisitions, and revisions to the articles of incorporation of a debtor.

After commencement of a rehabilitation proceeding, the court generally appoints an examiner to review the overall status of the debtor's assets, liquidation value and value as a going concern. In practice, the receiver prepares and proposes a rehabilitation plan based on the report prepared by said examiner. A rehabilitation plan is proposed and reviewed at the meeting of the interested parties, and may be accepted by a quorum of:

  • three-quarters or more of the total amount of secured rehabilitation claims;
  • two-thirds or more of the total amount of unsecured rehabilitation claims; and
  • a half or more of the total number of shares present at the meeting (provided that if the total amount of debt exceeds the total amount of assets on the date of commencement, the shareholders do not have a right to vote).

When the proposed rehabilitation plan is accepted by a resolution passed at a meeting of the interested parties, the court may confirm such rehabilitation plan. Exceptionally the court may also confirm a rehabilitation plan that was not passed in the meeting; in this case the court may reinforce the terms pertaining to the protection of creditors in the rehabilitation plan.

Restructurings that takes place as per a rehabilitation plan may be divided into three categories:

  • unsecured claims;
  • secured claims; and
  • shares.

The debt rescheduling for unsecured claims includes partial discharge, partial debt-equity swap and repayment in instalments after deferment. Secured claims, on the other hand, do not allow partial discharge or partial debt-equity swap; only repayment in instalments is permitted. In the case of disposing of collateral securities, it is common to have the rehabilitation plan include terms that provide that the concerned secured claims shall have priority in repayment at the disposed value. A considerable portion of shares ordinarily go through capital reduction via retirement or consolidation.

Implementation of plan and closing of rehabilitation proceeding

When a rehabilitation plan is confirmed, the rights of creditors and shareholders are adjusted according to the rehabilitation plan. Rehabilitation claims and secured rehabilitation claims not included in the approved plan shall be discharged.

If the debtor begins repayment under the rehabilitation plan, and there is no hindrance to carrying out the rehabilitation plan, then the court may issue a final decree to close the rehabilitation proceeding. In that event, the debtor regains its authority over its assets and business.

Termination of rehabilitation proceeding

The court may terminate the rehabilitation proceeding even before the approval of the rehabilitation plan:

  • if the court finds that the liquidation value of the debtor clearly exceeds the value as a going concern;
  • if a rehabilitation plan proposal is not submitted; or
  • if the rehabilitation plan proposal is not accepted.

The court may also terminate the proceeding if, after approval of the rehabilitation plan, it is clearly determined by the court that the rehabilitation plan is incapable of being carried out. In such an event, if the debtor has cause for bankruptcy, the court must declare the debtor bankrupt and convert to a bankruptcy proceeding.

Bankruptcy proceedings (comparison to rehabilitation proceedings)

Since the provisions on bankruptcy proceedings are stipulated by the DRBA as with their rehabilitation counterpart, most of the detail explained above in relation to rehabilitation proceedings is applicable to bankruptcy proceedings as well. However, given the difference between the purposes of the two insolvency procedures, it is worth highlighting notable disparities.

The following table summarises the comparison between rehabilitation and bankruptcy proceedings.

Rehabilitation proceeding Bankruptcy proceeding
Creditors entitled to file a petition May be filed by creditors whose claim amounts add up to at least one-tenth of the debtor's capital Creditors may file for the debtor's bankruptcy regardless of the pecuniary amount of their claims
Effect on the secured creditors A secured creditor is unable to execute the security right; he or she receives repayment as per the rehabilitation plan A secured creditor may execute the security right regardless of the bankruptcy proceeding
Right to manage and dispose of the debtor's property The existing representative of the debtor company is usually appointed to be the receiver An attorney is usually appointed as the bankruptcy trustee
Failure to declare claims Undeclared claims are discharged after the rehabilitation plan is finalised Although undeclared claims are not discharged, no dividend is paid to such claims
Set-off right Limited Unlimited
Restructuring Restructuring occurs in accordance with the rehabilitation plan There is no debt restructuring
Cessation of the juristic personality The debtor's juristic personality continues to exist after the completion of the rehabilitation proceeding The debtor ceases to exist as a company once the bankruptcy proceeding is completed

Workout procedure (comparison to rehabilitation proceedings)

Workouts differ from rehabilitation proceedings in the sense that they are directed and conducted by a person who holds financial claims against the debtor, whereas rehabilitation proceedings are administered by the court. The CRPA defines 'financial claims' as claims that arise from a credit offering such as loans, promissory notes and sureties.

Debtors tend to prefer workouts to rehabilitation proceedings since they have less impact on the debtor's managerial rights in comparison to rehabilitation proceedings. Workouts can be a better means of restructuring than rehabilitation proceedings for debtors that must maintain the relationship of trust with their clients because the procedures do not affect business claims. Many shipbuilding and construction companies in financial difficulty have undergone workouts for this reason.

The current CRPA will expire on 30 June 2018. Although there have been attempts to enact the new legislation to replace the current CRPA, it is proving difficult for such new law to be enacted and become effective before the expiration date of CRPA. However, the existing workout proceedings under CRPA will remain subject to CRPA notwithstanding its expiration.

The comparison between workouts and rehabilitation proceedings (a restructuring insolvency procedure under the DRBA) is as follows.

Rehabilitation proceeding Workout
Supervising entity The court A council composed of financial creditors. The principal creditor bank represents the council and performs the actual supervisory work
Debtor subject to the proceeding For both corporate and personal debtors For both corporate and personal debtors
Person entitled to file a petition The debtor, the creditors with a certain volume of claims, or shareholders with a certain shareholding ratio The debtor
Right to manage the debtor's property The court-appointed receiver has the right to manage and dispose of the debtor's property The existing management continues to manage the debtor company. However, the debtor ordinarily enters into an agreement with the council of financial creditors, under which the council or the principal creditor bank may control the management of the debtor
Scope of affected creditors Business claims as well as financial claims Financial claims only
Failure to declare claims Undeclared claims are discharged after the rehabilitation plan is finalised Undeclared claims are not discharged
Set-off right Limited Offsetting with financial claims is prohibited
Restructuring Restructuring is decided by the meeting of interested parties and occurs as per the court-approved rehabilitation plan. The following conditions are the requirements for the approval of the meeting of interested parties: by a quorum of:

• three-quarters or more of the total amount of secured rehabilitation claims;

• two-thirds or more of the total amount of rehabilitation claims; and

• a half or more of the total number of shares present at the meeting

Restructuring occurs in accordance with the decision of the council of financial creditors. The approval of the council of financial creditors requires:

• the consent of financial creditors that own at least three-quarters of the total value of the financial claims; and

• the consent of financial creditors that own at least three-quarters of the secured claims

Restructurings under a voluntary workout accord

Restructurings that occurs in accordance with a voluntary workout accord is not governed by a specific law but by an agreement executed voluntarily by the debtor and the creditor.

In the past, restructurings based on a voluntary workout accord were not widely used when compared with insolvency proceedings under the DRBA or the CRPA. However, voluntary workout accords can virtually be the only means of restructuring for companies that expect to suffer a significant business loss when they enter the insolvency proceedings that operate under the DRBA or the CRPA. For instance, a container merchant ship corporation may not be fully protected by an insolvency proceeding that takes place in a particular country because of its worldwide business network. A notable example can be found in the case of Hanjin Shipping; the rehabilitation proceeding, which took place only recently, failed and the company was declared bankrupt.

There have been cases in Korea recently, wherein a company has successfully restructured debt through a voluntary accord. In the case of Hyundai Merchant Marine, the company undertook extensive negotiation with the creditors in July 2016 and resolved the urgent problem in management. Hyundai Merchant Marine stands out as a case in which the successful agreement of debt rescheduling with various types of creditors was the prerequisite for agreement with financial institution creditors. The debtor company agreed on individual debt rescheduling with charterage creditors and bondholders respectively, and thereafter successfully induced debt rescheduling for financial obligations. The Hyundai Merchant Marine case serves as an excellent precedent for other companies that seek to reschedule debt through voluntary accords. Daewoo Shipbuilding & Marine Engineering afterward engaged in a similar type of debt rescheduling.

Due to the expiration of CRPA, there have been attempts between financial institutions that regulate voluntary workout processes to conclude a common agreement. If such agreement is executed, it will replace the current CRPA among financial institutions that have agreed to be covered by this agreement. However, if any of the financial institutions object to the performance of such agreement regarding certain debtor, the voluntary workout under such agreement cannot be pursued.

Cross-border insolvency

The DRBA has incorporated the UNCITRAL Model Law on Cross-Border Insolvency.

A rehabilitation proceeding has universal effect, reaching beyond the borders of Korea. In order for a Korean rehabilitation proceeding to be effective in a foreign country, the receiver (as a representative of the Korean rehabilitation proceeding) may apply for recognition of the rehabilitation proceeding, as well as other necessary support. In practice, when rehabilitation proceedings have been commenced for shipping companies in Korea, many foreign countries have recognised the Korean rehabilitation proceeding in order to preserve the debtor company's vessels and other assets.

Likewise, the representative of a foreign insolvency proceeding may file an application for recognition of the foreign insolvency proceeding with the Korean court, and ask the Korean court for relevant relief in order to preserve the debtor's assets in Korea.