Corporate Insolvency Proceedings in South Korea

In summary

This chapter is an overview of the Korean insolvency proceedings available to a corporate entity, and also covers recent trends in the Korean corporate insolvency market.

Discussion points

• Korean rehabilitation proceedings
• Korean bankruptcy proceedings in comparison with rehabilitation proceedings
• Out-of-court restructuring
• Recent trends in corporate rehabilitation proceedings
• Cross-border insolvency

Referenced in this article

• Debtor Rehabilitation and Bankruptcy Act
• Corporate Restructuring Promotion Act
• Seoul Bankruptcy Court
• UNCITRAL Model Law on Cross-Border Insolvency

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). The latter category consists of consensual out-of-court restructurings, which include:

• 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 relatively small amounts of debt; the debtor repays part of the liabilities with his or her income and has the rest discharged. In contrast to these two procedures, a bankruptcy proceeding is a liquidation proceeding where a court-appointed trustee 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 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. A workout will be discussed briefly by comparing them to the rehabilitation proceeding. Given the nature of this report, an explanation on personal rehabilitation proceedings will be omitted. It will, however, briefly cover recent trends in the Korean corporate rehabilitation market and examine Korean cross-border insolvency policies.

Rehabilitation proceedings

Persons entitled to file for commencement of a rehabilitation proceeding and causes for commencement thereof

The following may file for the commencement of a rehabilitation proceeding: the debtor, the creditors whose total amount of claims is equal to 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.

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. The cause for bankruptcy refers to:

• the debtor’s inability to repay its debt in an ordinary, continuous manner owing to the lack of the capacity to effect performance; or
• the amount of the debtor’s liabilities exceeds the value of its 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. To be more specific, the court, upon filing of an application or by its own motion, separately issues a preservation order against the debtor to prevent the debtor from dissipating its assets, and a comprehensive stay order to prevent creditors from enforcing their claims against the debtor until a rehabilitation proceeding is formally commenced. The Korean court’s response at the time of filing is relatively fast, and when necessary, asset preservation orders and comprehensive stay orders may be issued on the same day the petition is filed or the day after. Therefore, in practice, asset preservation orders and comprehensive stay orders function similarly to an automatic stay in the United States.

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 the court issues an order to commence a rehabilitation proceeding, all compulsory enforcements are automatically stayed, and the secured creditor cannot foreclose on assets of the debtor provided as security 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 it issues an order to commence a rehabilitation proceeding. A receiver is authorised to take charge of the management and disposition of the debtor’s assets under court supervision. In principle, the existing management of a debtor company is appointed as the receiver. However, in exceptional circumstances, such as when a material cause of the debtor’s financial deterioration can be attributed to the existing management of the debtor, 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, 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 perform or terminate an 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 proposed rehabilitation plan.

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 the notice, the receiver will lose the termination right. The court may shorten or extend this 30-day period upon request from the receiver, the counterparty or by the court’s own motion.

If the receiver decides to perform the contract, 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 are treated as rehabilitation claims.

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 of a rehabilitation proceeding is an event of termination of the contract, should be deemed invalid. The Korean court’s position on this matter has not been very clear, although there have been cases wherein it was ruled that the clause was valid in relation to contracts that require mutual trust.^[1]

Investigation and confirmation of claims

When a rehabilitation proceeding is commenced, the receiver prepares a list of creditors (and their claims). 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 proposed rehabilitation plan. If any (secured) rehabilitation claims are not included in the list of creditors and reported by the creditor, the rehabilitation claims are discharged upon approval of the rehabilitation plan.

As for the claims for which proofs of claims have been filed or included in the creditors’ list filed by the receiver, the receiver or other interested parties (eg, other rehabilitation creditors) may file an objection to those 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 investigation 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 after 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 (usually an accounting firm) to review the overall status of the debtor’s assets, liquidation value and value as a going concern. If the debtor’s liquidation value is higher than its value as a going concern, the court may terminate the rehabilitation proceeding, and the case closes without the filing of a rehabilitation plan. In practice, however, it is becoming more and more common for debtors with higher liquidation value to seek out investors who are willing to inject fresh cash into the corporation, with a view to revive its business and increasing the debtor’s overall value as a going concern. In those cases, the receiver may seek the court’s approval to proceed with a merger and acquisition process before confirmation of a rehabilitation plan and avoid dismissal.

A merger and liquidation process in this case usually includes:

• engagement of professionals to manage the public bidding process;
• distribution of bid proposals;
• a public bid; and
• signing of the merger and acquisition contract by the parties.

Although the process may differ significantly in detail, in essence, it is akin to a 363 sale process in the United States. The process may even involve a stalking horse bidder, as is often the case in 363 sale processes in the United States.

In the more common cases where the debtor’s going concern value is higher than its liquidation value, 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 the 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 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 by operation of law.^[2]

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;
• if a rehabilitation plan proposal is not submitted; or
• if 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.

Workouts (comparison to rehabilitation proceedings)

Workouts differ from rehabilitation proceedings in the sense that they are directed and conducted by creditors who hold 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 distress 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.

Recent trends in corporate rehabilitation proceedings

Recent trends in corporate rehabilitation proceedings can be summarised into two parts, namely a focus on providing easier access to insolvency and other restructuring procedures for 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 to 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 as the one-stop centre for available government support programmes, as well as connecting the debtor with lenders and investors for debtor-in-possession (DIP) financing. The court has also adopted the Equity Retention Plan to rid small enterprise owners of their reluctance to file for rehabilitation owing to their fear of losing their share in the enterprise.

To enhance the flexibility of the corporate rehabilitation proceedings, the Bankruptcy Court introduced the P-Plan, which is a programme that utilises the provision in the DRBA that allows the debtor to file a proposed rehabilitation plan at the time of filing the petition for commencement of the rehabilitation proceedings, or any time thereafter until the court issues an order to commence the 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 the petition for commencement of a rehabilitation proceeding, it may choose to apply for use 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 in negotiating a deal with its creditors, then the court will issue an order to commence the rehabilitation proceeding. Since its introduction, the P-Plan and the ARS programme have been utilised in many proceedings and, in many cases, 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.

More recently, in February 2020, the DRBA was revised to provide priority for DIP financing. In other words, if a DIP lender, with court approval, extends loans to a debtor after the filing of a petition for the commencement of a rehabilitation proceeding for the debtor, and the rehabilitation proceeding is later converted to a bankruptcy proceeding, the claims of the DIP lender are treated as an estate claim, which has priority over other estate claims (except for wage claims and severance payment claims) as well as bankruptcy claims. The purpose of this revision is to provide the DIP lender with priority not only during the life of the rehabilitation proceeding, which was already available, but also when restructuring fails and the proceeding is converted to a bankruptcy proceeding. This much-awaited revision was made with the purpose of providing more assurance to the DIP lenders to encourage them to inject more fresh cash into distressed companies, thereby facilitating faster recovery and normalisation.

Cross-border insolvency

The DRBA has incorporated the UNCITRAL Model Law on Cross-Border Insolvency (the Model Law) as section 5 of the DRBA.

A rehabilitation proceeding has universal effect, reaching beyond the borders of Korea. For a Korean rehabilitation proceeding or a bankruptcy proceeding to be effective in a foreign country, the receiver (as the foreign representative of the Korean rehabilitation proceeding) may apply for recognition of the rehabilitation proceeding in the competent court of that country, and seek other necessary support. Such measures proved to be especially beneficial for shipping companies in Korea, which obtained recognition from various countries to preserve the debtor company’s vessels and other operating assets. Notable cases include the STX Pan Ocean case in 2013, where STX Pan Ocean sought recognition of the Korean insolvency in 14 jurisdictions and obtained recognition from at least 10 jurisdictions, namely the United States, the United Kingdom, Japan, Canada, Mexico, Australia, New Zealand, Belgium, Singapore and the Philippines. A few years later in 2016, Hanjin Shipping also filed for the commencement of the rehabilitation proceeding in Korea and obtained recognition from at least eight jurisdictions, namely the United States, the United Kingdom, France, Japan, Canada, Australia, Belgium and Spain.

Likewise, the representative of a foreign insolvency proceeding may file an application for recognition of the proceeding with the Korean court, and ask the Korean court for relevant relief to preserve the debtor’s assets in Korea. Since the adoption of the Model Law, Korean courts have been proactive in recognising foreign insolvency proceedings and granting assistance to the foreign representatives, such as authorising the foreign representatives to dispose of the foreign debtors’ assets that are located in Korea and allowing for the movement of funds from Korea to the country where the foreign insolvency proceeding is pending, thereby facilitating fair distribution of funds between creditors.^[3]

In an effort to facilitate coordination in cross-border cases, the Seoul Bankruptcy Court has signed memoranda of understanding with the US Bankruptcy Court for the Southern District of New York and the Supreme Court of Singapore. The Seoul Bankruptcy Court has also adopted the Judicial Insolvency Network Guidelines and its Modalities of Court-to-Court Communication.

Notes