Corporate Insolvency Proceedings in South Korea

In summary

This article is an overview of insolvency proceedings available to a corporate entity in Korea. It also includes recent trends in the Korean corporate insolvency market, as well as the cross-border insolvency regime in Korea.

Discussion points

• Korean rehabilitation proceedings
• Korean bankruptcy 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 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’s business.

A rehabilitation proceeding is a reconstructive insolvency proceeding that seeks to rehabilitate debtors in financial distress via means such 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, who is deemed to have no possibility of rehabilitation. The proceeds from the sale of the debtor’s property are then distributed fairly to the creditors.

This article will elaborate on insolvency proceedings to which corporate entities may be subjected. It will first explain rehabilitation proceedings and bankruptcy proceedings. A workout will be discussed briefly by comparing them to rehabilitation proceedings. 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 rehabilitation proceedings and causes for commencement

The following may file for the commencement of rehabilitation proceedings: 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.^[1]

For rehabilitation proceedings 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 when the debtor’s inability to repay its debt in an ordinary, continuous manner owing to the lack of the capacity to effect performance or when the amount of the debtor’s liabilities exceeds the value of its assets.

The Supreme Court of Korea held that filing for the commencement of rehabilitation proceedings by a debtors’ representative director requires a board resolution as it is not within the representative director’s scope of ordinary affairs.^[2]

Asset preservation order and a comprehensive stay order

In Chapter 11 proceedings 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 rehabilitation proceedings in Korea, however, such a stay is not automatic; 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 rehabilitation proceedings are formally commenced.^[3] The Korean court’s response at the time of filing is relatively fast, and when necessary, the asset preservation order and the comprehensive stay order can 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

Rehabilitation proceedings formally commence when the court issues a decision to commence rehabilitation proceedings in respect of a debtor.

When the court issues an order to commence rehabilitation proceedings, all compulsory enforcements are automatically stayed, and the secured creditor cannot foreclose on assets of the debtor provided as security without court approval.^[4] 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 rehabilitation proceedings. 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.

In principle, the court’s decision to commence rehabilitation proceedings is issued within one month of the filing of the petition; however, the Seoul Bankruptcy Court recently introduced the Autonomous Restructuring Support (ARS) programme, which allows the court to defer the commencement of rehabilitation proceedings for up to three months, during which the court will issue temporary stay orders to allow the debtor to attempt to negotiate a deal with its creditors or otherwise try to obtain debtor-in-possession (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 (P-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 rehabilitation proceedings.

Since the introduction of the ARS programme, 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.

Differences between rehabilitation claims and common benefits claims

In rehabilitation proceedings, a creditor’s claims are divided into three categories:

• a rehabilitation claim;
• a secured rehabilitation claim; and
• a common benefits claim.^[5]

A rehabilitation claim is one that arises from grounds that existed before the commencement of rehabilitation proceedings, and a secured rehabilitation claim is a rehabilitation claim secured by collateral that is under title of the debtor. These can be repaid only in accordance with the rehabilitation plan. A common benefits claim, on the other hand, 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 rehabilitation proceedings. Common benefits claims are similar to allowed administrative expenses under the US Bankruptcy Code and include the following, among other things:

• wages, salaries and commissions for services rendered by the receiver, their proxies, examiners and advisers, etc;
• claims against the debtor arising from the receiver’s borrowing of money or other actions conducted on behalf of the debtor;
• claims arising from delivery of products within 20 days prior to the filing of the petition;
• certain tax claims; and
• certain wages, severance payments and compensation for industrial accidents claims of employees.

In this regard, 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 its filing of a petition for the commencement of rehabilitation proceedings, and the rehabilitation proceedings are later converted to bankruptcy proceedings, 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) and bankruptcy claims.

The purpose of this revision is to provide the DIP lender with priority not only during the life of the rehabilitation proceedings, which had already been available, but also when restructuring fails and the proceedings are converted to bankruptcy proceedings. 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; however, since the DIP lender does not have priority over wage claims and severance payment claims, it is yet to have super priority, and DIP financing in Korea has yet to become the general trend.

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 proceedings.^[6] This type of contract receives special treatment from those proceedings; 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 the 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 rehabilitation proceedings 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 where the court has held that the clause was valid in relation to contracts that require mutual trust.^[7]

The DRBA provides a similar provision for treating an executory contract in bankruptcy proceedings. The bankruptcy trustee may choose to perform or terminate an executory contract. The Supreme Court of Korea recently issued a detailed decision discussing the bankruptcy trustee’s right to terminate an executory contract involving a public-private partnership.^[8] In the decision, it held that article 335 of the DRBA would be applicable to an implementation agreement in a public-private partnership, even if the partnership has the nature of a public law relationship.

The Supreme Court divided the partnership into three phases: the planning phase, the implementation phase and the management phase. It went on to state that in determining whether there is an executory contract, the court should examine the parties’ obligations at the specific phase concerned rather than comparing the parties obligations throughout the relationship as a whole.

The Supreme Court concluded that there was no executory contract at the management phase as both parties’ obligations were not legally and economically intertwined in terms of their formation, performance and existence to function as security ensuring the other’s performance.

Investigation and confirmation of claims

When rehabilitation proceedings are commenced, the receiver prepares a list of creditors (and their claims).^[9] 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 that a proof 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 claims for which proofs of claim 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.

The Seoul Bankruptcy Court recently enacted a new practice guideline, which requires the Bankruptcy Court to expedite the claim investigation and confirmation procedure. According to the new rule, the Bankruptcy Court must conclude the claim investigation and confirmation procedure before the meeting of the interested parties if the objection is made within the reporting period. For proofs of claim filed after the reporting period, the Bankruptcy Court must conclude the claim investigation and confirmation procedure within three months of the application for allowance of the claim.

Limitation on set-off and avoidance rights

Once rehabilitation proceedings commence,^[10] 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 aforementioned term.

The creditors may not offset receivables or payables acquired after a certain time. Depending on the type of claims or obligations, this may be the time of the petition requesting the commencement of rehabilitation proceedings or the commencement of those proceedings.

If the debtor has acted in a way that prejudices other unsecured creditors, the receiver may exercise avoidance rights and recover from the party that has benefited from that act, as long as the statutory requirements are met. Generally speaking, a transfer can be avoided if the transfer was made by the debtor with the intention to prejudice rehabilitation creditors, the transfer was made when the debtor was already facing financial crisis, or the transfer was made without any consideration within six months prior to the debtor’s suspension of payment.

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 (M&A), and revisions to the articles of incorporation of a debtor.^[11]

After commencement of rehabilitation proceedings, 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 proceedings, and the case will close 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 reviving their business and increasing their overall value as a going concern. In those cases, the receiver may seek the court’s approval to proceed with an M&A 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 M&A 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 the 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
• 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 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 for the rehabilitation plan to 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.

Generally the rehabilitation plan is a 10-year plan; however, the Seoul Bankruptcy Court adopted a simplified examination report that allows a five-year or a seven-year plan in simplified rehabilitation proceedings for a debtor whose debt is less than 5 billion won.

Implementation of plan and closing of rehabilitation proceedings

When a rehabilitation plan is confirmed,^[12] 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.

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

Termination of rehabilitation proceedings

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

• if it 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.^[13]

The court may also terminate the proceedings if, after approval of the rehabilitation plan, it is clearly determined by the court that the rehabilitation plan cannot be carried out. In that event, if the debtor has cause for bankruptcy, the court must declare the debtor bankrupt and convert to bankruptcy proceedings.

Bankruptcy proceedings (comparison with 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 also applicable to bankruptcy proceedings; 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 with 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 with 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.

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, to submit a report to the relevant standing committee within the National Assembly. While there are more steps to take to introduce permanent legislation regulating out-of-court restructuring, the overall conclusion of the report issued in December 2019 is positive about the permanent legislation.

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

Impact of covid-19 on corporate insolvency

While the number of insolvency cases in Korea had been constantly increasing every year, there was a slight decrease in 2020. This is partly because the government prepared special funds for key industries that would have been impacted by the pandemic. Further, there were moratoriums for businesses affected by the pandemic implanted at various levels and institutions to allow companies to stay afloat. Some examples of announced or imposed moratoriums include:

• financial authorities (the Financial Services Commission and the Financial Supervisory Service) and financial institutions (Korea Federation of Banks, Korea Financial Investment Association, etc) entering into an agreement to provide covid-19-related support, including extensions of loan maturity dates and a moratorium on payment of interest;
• the Korea Deposit Insurance Corporation announcing that it will impose a moratorium of up to one year and discharge interest payment obligations for financially vulnerable debtors, who are currently under instalment repayment plans; and
• the Credit Counselling and Recovery Service (CCRS) announcing a six-month moratorium for debtors who have had their debt adjusted through programmes provided by the CCRS and who are experiencing a decrease in income owing to the pandemic.

Such moratoriums have been further extended a couple of times owing to the continuation of the pandemic.

The Seoul Bankruptcy Court has been open and fully operational during the pandemic, although it has adjusted some of its hearing schedules in accordance with the Supreme Court’s instructions.

Cross-border insolvency

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

Rehabilitation proceedings have universal effect, reaching beyond the borders of Korea. For Korean rehabilitation proceedings or bankruptcy proceedings to be effective in a foreign country, the receiver (as the foreign representative of the Korean rehabilitation proceedings) may apply for recognition of the rehabilitation proceedings in the competent court of that country and seek other necessary support.

Such measures have proved to be especially beneficial for shipping companies in Korea, which have 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: 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 rehabilitation proceedings in Korea and obtained recognition from at least eight jurisdictions: the United States, the United Kingdom, France, Japan, Canada, Australia, Belgium and Spain.

Likewise, the representative of foreign insolvency proceedings may file an application for recognition of the proceedings with the Korean court, and ask the Korean court for 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 foreign representatives by, for example, 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 proceedings are pending, thereby facilitating fair distribution of funds between creditors.^[14]

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. It has also adopted the Judicial Insolvency Network Guidelines and its Modalities of Court-to-Court Communication.

The DRBA Revision Committee is currently considering adoption of more recent insolvency texts adopted by UNCITRAL, namely the UNCITRAL Model Law on Enterprise Group Insolvency and the UNCITRAL Model Law on Recognition and Enforcement of Insolvency-Related Judgements.

Notes