In a recent case concerning shareholders’ contractual rights in rehabilitation proceedings, Korea’s Supreme Court held that a contract which grants the shareholders the right to consent to commencement of rehabilitation proceedings and right to damages if the company violates such right is consistent with the Debtor Rehabilitation and Bankruptcy Act (the “DRBA”), the principle of shareholder equality under the Commercial Code, and the principle of capital protection (Supreme Court Decision 2023Da210670, 13 July 2023). The significance of this judgment (“Judgment”) is explained below.
1. Overview
On 30 August 2013, KOTEC (“Plaintiff”) entered into a Preferred Stock Purchase Agreement (the “Agreement”) to acquire redeemable convertible shares (par value KRW 5,000) issued by the company (“Defendant”) for KRW 56,000 per share.
Defendant, without obtaining prior written consent of Plaintiff, filed an application to commence rehabilitation proceedings on 30 May 2016. Plaintiff subsequently served a notice to Defendant, stating its intention to terminate the Agreement, demand that Defendant’s representative director purchase Plaintiff’s shares, and claim damages against Defendant and its representative director. Defendant did not provide an explanation or cure the breach within two weeks of receiving Plaintiff’s notice.
Plaintiff submitted a damages claim against Defendant in the rehabilitation proceedings. Defendant objected to the claim on the ground that Plaintiff was only a shareholder and not a creditor. The Rehabilitation Court noted that the Agreement included a clause which allowed Plaintiff to claim the stock acquisition price plus certain damages if Defendant applies for commencement of rehabilitation proceedings, but the Rehabilitation Court disallowed Plaintiff’s claim on the basis that the clause was contrary to: (a) the principle of shareholder equality, as Plaintiff has essentially been guaranteed the recovery of the invested capital which is a right that favors Plaintiff over other shareholders; (b) the principle of capital protection, as Plaintiff would be paid the agreed amount even if there was no distributable profit; and (c) Korea’s mandatory laws such as Article 146 and Article 217 of the DRBA which provide that shareholders rights are subordinate to creditors’ rights.
Plaintiff appealed the decision of the Rehabilitation Court, and the case was reviewed by the Supreme Court.
2. Summary of the Judgment
Upon review, the Supreme Court held that the relevant clause does not violate the principle of shareholder equality because there were circumstances justifying Plaintiff receiving treatment different from other shareholders. The Supreme Court also held that the clause does not contravene the principle of capital protection nor the DRBA.
In so holding, the Supreme Court found that:
(i) Plaintiff controlled approximately 5% of the voting shares which gave Plaintiff the right to participate in Defendant’s important decision-making, and the acquisition price paid by Plaintiff would have significantly contributed to securing Defendant’s liquidity and increasing its capital;
(ii) It cannot be presumed that other shareholders have suffered substantial or direct harm or disadvantage as a result of Plaintiff exclusively holding the right to consent – rather, the clause allowed for monitoring Defendant’s compliance; and
(iii) Above all, the claim for damages in this case occurred as a consequence of Defendant’s failure to provide an explanation and cure the breach within two weeks of receiving Plaintiff’s notice, which would have exempted Defendant from liability.
Regarding the principle of capital protection and the DRBA, the Supreme Court held that, as liability for damages arises only when Defendant violates the obligation to seek Plaintiff’s prior consent before applying for the commencement of rehabilitation proceedings, it cannot be said that Plaintiff recovered its investment even though there was no distributable profit, or that Plaintiff, a minor shareholder, turned into a creditor of superior position just because rehabilitation proceedings have commenced.
3. Significance of the Judgment
The principle of shareholder equality provides that shareholders of a company should be treated equally with respect to their rights and obligations in their position as shareholders. This is an overarching principle applicable to any legal relationship between shareholders and the company. In this case, the Supreme Court appears to have looked beyond the text of the contractual clause and considered as a whole the impact it had on Defendant and Defendant’s shareholders. Since the contract only required Defendant to obtain prior consent from Plaintiff and did not give Plaintiff the right to decide whether to commence rehabilitation proceedings, the Court may have construed this clause to benefit the company and its shareholders as a whole and to require Defendant to make management decisions more carefully.
The Supreme Court previously held that a contract by a company promising to compensate a new shareholder the full price of the shares purchased was null and void because it granted a superior right to one shareholder that are not provided to others and thus violated the principle of shareholder equality (Supreme Court Decision 2018Da23641, 13 August 2020). The Supreme Court seems to have distinguished this case on the grounds that the Agreement provided for liquidated damages which happened to be similar in size to Plaintiff’s investment but did not guarantee an absolute recovery.
The Judgment signifies that a shareholder’s contractual rights would not be dismissed simply because the company is undergoing rehabilitation proceedings. According to the Supreme Court, denying Plaintiff the right to file rehabilitation claims simply based on its status as a shareholder contravenes the legislative intent of the DRBA. The Judgment will likely have important ramifications in future shareholder agreements.
