There are two categories of insolvency proceedings in Korea: court-administered proceedings and out-of-court proceedings. The former relates to bankruptcy proceedings, rehabilitation proceedings and personal rehabilitation proceedings under the Debtor Rehabilitation and Bankruptcy Act of Korea (the 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 (the 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 a small amount of debt; 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 article, the explanation of a personal rehabilitation proceeding will be omitted. It will, however, briefly cover recent trends in the Korean corporate rehabilitation market, and examine Korean cross-border insolvency policies.
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 equals or exceeds one-tenth of the debtor’s paid-in capital, and shareholders who own more than one-tenth of the debtor’s paid-in capital.
In order for a rehabilitation proceeding to commence, either the debtor is unable to 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 stay 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 enforced by a secured creditor without court approval. Further, rehabilitation claims and secured rehabilitation 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 a material 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 common benefits 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; 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 of claims below is relevant to rehabilitation claims and secured rehabilitation claims.
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 terminate the executory contract. The receiver may exercise the termination right only until the closing of the meeting of interested parties that is convened for reviewing the rehabilitation plan proposal.
The counterparty may issue a notice to the receiver urging for a decision on whether to terminate the contract. Should the receiver fail to provide confirmation within 30 days of said notice, the receiver will lose the termination right and the contract will be deemed as assumed.
In the case of performance, the other party may enforce the contract as a common benefits creditor. By contrast, if the receiver chooses to terminate the contract, the other party’s damages claims arising from such termination become 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. The Korean court’s position in this matter has not been very clear, though there have been cases in which 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 claim 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 proof of claim can be filed is before the interested parties’ meeting for reviewing the proposal for the rehabilitation plan. 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 claim have been filed or included in the creditor’s list filed by the receiver, the receiver or other interested parties (eg, other rehabilitation creditors) may file an objection to such claims. In such an event, the creditor whose claims are contested may 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 (and not the debtor) 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 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.
The debt rescheduling for rehabilitation claims includes partial discharge, partial debt-equity swap and repayment in instalments after deferment. In the case of disposing of collateral securities, it is common to have the rehabilitation plan include terms that provide that the concerned secured rehabilitation claim 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 order 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;
- a rehabilitation plan proposal is not submitted; or
- the rehabilitation plan proposal is not approved by the creditors or the plan is not confirmed by the court.
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 paid-in capital||Creditors may file for the debtor’s bankruptcy regardless of the pecuniary amount of their claims|
|Effect on the secured rehabilitation creditors||A secured rehabilitation 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 in time as well as in other aspects||Unlimited in time, although limited in other aspects|
|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.
On 30 June 2018, the CRPA expired amid discussions in favour of and against permanent legislation regulating out-of-court restructuring. A new CRPA was finally promulgated on 16 October 2018, with minimum changes to its provisions and with a five-year expiry. Notably, in the new enactment, the National Assembly added an opinion directed to the Financial Supervisory Committee of Korea to evaluate the corporate restructuring policies for their accomplishments and effectiveness, and, after gathering the opinions of the court, relevant institutions and professionals, submit a report to the relevant standing committee within the National Assembly. The project is currently underway and a report is expected to be submitted before the end of term for the current National Assembly, which is in 2020.
The comparison between workouts and rehabilitation proceedings (a restructuring insolvency procedure under the DRBA) is as follows.
|Supervising entity||The court||A committee composed of financial creditors. The main creditor bank represents the committee and performs the actual supervisory work|
|Debtor subject to the proceeding||For both corporate and personal debtors||For corporate debtors only|
|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:||Restructuring occurs in accordance with the decision of the council of financial creditors. The approval of the council of financial creditors requires:|
Recent trends in corporate rehabilitation proceedings
Recent trends in corporate rehabilitation proceedings can be summarised into two parts: a focus on providing easier access to micro, small and medium-sized enterprises (MSMEs); and enhancing the flexibility of the corporate rehabilitation proceedings to facilitate the restructuring process of debtor companies.
With respect to the former, the Seoul Bankruptcy Court is providing rehabilitation consulting services to MSMEs, encouraging corporations to file early, receive customised assistance from insolvency experts without the burden of excessive fees, and complete the restructuring proceedings in the shortest time possible. By using such services of the bankruptcy court, MSMEs are able to restructure their debt and make a turnaround with ease. The court also devised a special programme referred to as the S-Track programme, which is a special rehabilitation track tailored for small and medium-sized enterprises. In this programme, the court takes a more active role in the rehabilitation proceeding, assuming the role of a one-stop centre for available government support programmes, as well as connecting the debtor with lenders or investors for DIP financing. The court has also adopted the Equity Retention Plan, which aims to reduce small enterprise owners’ reluctance to file for rehabilitation as a result of fear of losing their share in the enterprise.
To enhance the flexibility of the corporate rehabilitation proceedings, the bankruptcy court introduced the P-Plan programme, which utilises a provision of the DRBA that allows the debtor to file a proposed rehabilitation plan at the time of filing the petition for commencement of rehabilitation proceedings, or any time thereafter until the court issues an order to commence rehabilitation proceedings. When the debtor is able to negotiate a deal with its creditors, obtain DIP financing or restructure its debt through the sale of its assets, it may prepare and file a pre-packaged plan when filing the petition. This way, the debtor may successfully restructure its debt within months, if not earlier.
More recently, the Seoul Bankruptcy Court introduced the Autonomous Restructuring Support (ARS) programme. When a debtor files a petition for commencement of a rehabilitation proceeding it may apply to utilise the ARS programme, in which case the court will issue temporary stay orders to allow breathing room for the debtor, but defer the commencement of the rehabilitation proceeding for up to three months, while the debtor may attempt to negotiate a deal with its creditors or otherwise try to obtain DIP financing. If the debtor succeeds in negotiating a deal and reaches settlement it may withdraw the petition altogether or file a pre-packaged plan with the court if necessary. If the debtor fails to negotiate a deal with its creditors, the court will issue an order to commence the rehabilitation proceeding.
Since their introduction, the P-Plan and ARS programmes have been utilised in many proceedings and in many cases, and encouraged the debtor to try and negotiate a deal with its creditors, thereby raising the possibility of a successful restructuring of the debtor and early closing of the rehabilitation proceedings.
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.