The major issues in a South Korean LBO raises concerns for the fiduciary duties of the directors of the acquired business, as they participate in the decision for the sanctioning of LBO structuring. Specifically, the practice of funding the LBO transaction by collateralising assets of the target company, has been perceived to be in violation of the directors’ fiduciary duties owed to their company as they approve this form of transaction. In this context, these directors might be held under criminal and civil liability under the South Korean law.
The Korean Commercial Act abstractly evaluates duty of directors with the word of “violation of his duty” while the German Commercial Code provides prerequisite of abuse of authority and violation of trust. In Germany, there are many cases in which directors are accused due to violation of their duty, there is no case regarding an LBO. Because German law strongly guarantees the subscription right of new stocks, and severely restricts financial support provided by the acquired company, most cases are of the merger LBO type.
It should be noted that the occurrence of LBO by itself does not amount to a violation of the fiduciary duties in South Korea. The practice of the South Korean courts has been to evaluate the particular actions of directors on a case-by-case basis, so as to establish the reality of any violation. However we must ask ourselves, how can the court examine each case? If the directors of the target company took decisions after serious consideration of all aspects of business conditions and environment, and the result of the decision was not successful, is it possible that a court could evaluate in each individual case whether the business expert made a right decision or not?
Since the South Korean Courts adopted the Business Judgement Rule in 2004, there have been some problems in its application compared to other jurisdictions. One of these problems that is South Korean Courts actively evaluate the ‘reasonableness’ of actions, the other is a lack of explicit procedural regulations, meaning that courts still need to form their own opinion on whether protection from liability should apply.
5.1 Evaluating rationality
Essentially, Business Judgement Rule is derived from the expression of judicial restraint i.e. Courts do not judge the substantial rationality of business decisions. South Korean Courts have adopted the Business Judgement Rule, however South Korean Courts still enumerate considerations for business decisions, and rule that directors should have decided differently in that situation. It is contradictory that courts appraise the cogency of directors’ decisions in their judgements.
South Korean Courts evaluate cases based on the condition and scale of loan, repayment plans, securities and contents, growth potential and etc. themselves, though how would courts judge cogency of the decisions of business experts? South Korean courts should only fulfil the roles to point out if directors were not prudent enough when the decisions were made, or if they acted for someone else’s benefit other than the company and shareholders. Target companies’ directors should be only judged and liable for damages if there was excessive credit offering, false disclosure, disconformities of procedure, or unfairness, etc.
In the previously mentioned examples, Shinhan managed to achieve some startling results after completing its LBO transaction. Total liability which was 100 billion Korean-won (approx. €79.6M) in 2001 at the time of the LBO, was reduced to 70 billion Korean-won (approx. €55.7M). Industry ranking was increased from 55th to 47th by 2003. Net asset value was also increased from €70.7M to €100.5M in the same 2 years. Whereas the other example case, Tong Yang group, sold 46.5% of holding shares in its subsidiary Tong Yang Insurance to solve its liquidity crisis after only 1 year of its LBO transaction, and then again sold off some company owned land to obtain €30.3M cash 1 month later.
Surely, bringing different judgements of directors’ liability depending on business performance is discrepant from the principle of liability. However, it is interesting to see that for Shinhan, whose LBO transaction resulted in the target company directors ultimately being convicted by the Supreme Court, achieved remarkable business performance within 2 years. In Tong Yang’s case, the acquired company’s directors were acquitted, but it got into a liquidity crisis within a year. In other words, the South Korean regulation to validate LBO seems isolated from economic reality. It also reflects that there is a limit to the effectiveness of the current South Korean law and judicial implementation to promote economic objectives through the punishment of directors.
Furthermore, cases such as a class action by shareholders against Samsung Electronics, shows that South Korean Courts adjust the amount of compensation for damages. Parties who have suffered damages are legally entitled to seek compensation for their losses, and the amount being claimed should not be adjusted by the courts unless the principles of either ‘offset of profits and losses’ or ‘comparative negligence’ can be shown to apply to the case. However, South Korean Courts have developed their own legal principles for limiting the compensation for damages when dealing with directors’ liabilities, based on a concept borrowed from the compensation system for damages called the ‘equitable liability rule’. Essentially this approach attempts to spread the burden of liability more fairly among the directors involved.
Since this principle was introduced in 2003, South Korean Courts not only judge breach of directors’ duties, but also decide the amount of compensation and adjust liabilities of each directors based on their level of contribution. However, the equitable liability rule does not have an explicit legal basis, and thus the amount of compensation is entirely at the judge’s discretion and should not be seen as a mechanism to limit liability as an extension of business judgement rule.
5.2 Lack of explicit procedural regulations
A noted scholar has previously suggested that South Korean Courts should not prohibit buyouts, but instead make necessary changes to the regulation to assist in the better protection of the shareholders’ interests. For instance, they could impose restrictions on the debt-to-equity ratio, which would oblige better disclosure of information so as to mitigate conflicts of interest.
While regulating for all potential eventualities is impossible, procedural provisions can set down minimum requirements to prevent common abuses. This is in fact, by definition, the main focus purpose of legislative bodies. Content should be left to the domain of management judgment, while Courts should concentrate on establishing whether procedural provisions have been correctly fulfilment of requirements.
Authorizing body
The South Korean Commercial Act regulates that the resolutions need to be approved at a formal general meeting of directors. Directors are required to deliver an ex post facto report to the first formal shareholders’ meeting following the approval of an LBO transaction . This structure means that shareholders are not able to observe or control the decision in advance. This shows that there is a big gap between South Korean and British and Germany approaches, which require approval at a formal general meeting of shareholders to provide financial support for LBOs in advance of the formal decision.
Securing fairness
To be approved by formal general meetings of shareholders in Germany and UK, directors of the acquired companies should report preliminary plans including conditions of loans, their background and purpose, detailed financial benefit, proof of liquidity/solvency, and the memorandum is required to be presented at the registered office of the company. The resolutions of the general shareholders’ meeting are not only just a formal procedure, but a measure to ensure the fairness and truthfulness of the resolution. The formal approval of the resolution of the general meeting of shareholders is not sufficient enough to secure the duty of director, the objectivity and impartiality of the judgment materials needs to be prepared in advance.