LEGAL UPDATE KOREA. Korea Passes Major Amendments to Company Law. March 29, 2011

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1 Korea Passes Major Amendments to Company Law Revision of Commercial Code, to take effect in 2012, brings significant flexibility in terms of equity structure, debt financing, corporate consolidation and dividends; clarifies directors duties; introduces new electronic registration for securities; introduces new types of business entity Far-reaching amendments of the Commercial Code of Korea (KCC) were passed in the National Assembly on March 11, 2011, and will take effect in The changes to Korea s company law, which largely reflect proposals for liberalization that have been in discussion for years, will expand in several ways the options available to corporations in terms of equity and debt structuring, and dividends. The changes will for example: permit special non- or limited-voting classes of shares; generally permit stock buybacks, from dividendable earnings; eliminate the current net assets-geared limit on bonds; allow dividends to be decided at the board rather than shareholders level; and permit a 95% shareholder to squeezeout minority investors, while also giving the latter a put right. This update is intended as a summary news report only, and not as advice. For legal advice, please inquire with your contact at Bae, Kim & Lee LLC, or the following authors of this bulletin: Jun Kul YOO T E junkul.yoo@bkl.co.kr Other important provisions clarify directors duties and potential liability, systematize the position of executive officer and, for listed companies, newly require a compliance officer. The amended KCC will introduce a system for electronic registration of shares and bonds, including transfers and pledges. The KCC will also provide for two new types of business entity, one a partnership association and the other a partnership-like limited liability company. The amendments are likely to be promulgated in April or May 2011, and will take effect one year from that date, thus probably in April or May Following is a summary of the main changes to the KCC. Hyo Min KIM T E hyomin.kim@bkl.co.kr

2 A. EQUITY STRUCTURE OF CORPORATIONS Under the amended KCC, a corporation (chusik hoesa, often termed a joint stock company ) will have, in several ways, significantly greater flexibility in shaping its capital structure. Note that, in order for a corporation to implement such new features, in most cases this will involve an amendment of its articles of incorporation, which requires a supermajority shareholder approval (typically 2/3 of shares present at a general meeting, and 1/3 of total shares). Features of shares; special classes of shares: Old law until amendments take force in 2012: Non-voting common shares are impossible. Only preferred shares may be defined as nonvoting. Convertible shares are permitted, but they can only be convertible by the shareholder, not the issuer. Every class of shares is required to have a par value. Issuing new shares for a price below par value (including in the convertible bond context) is subject to restrictions including a requirement of court approval. Redeemable preferred shares are permitted, but the redemption price must be payable in cash only. New law from effective date in 2012: Corporations will be able to issue non-voting common shares, as well as non-voting preferred shares. Convertible shares may allow for conversion at the election of the issuer, and not only at the election of the holder. The amended KCC will permit classes of shares with certain types of special features. For example, shares may have voting rights restricted to specified kinds of matters. (Conceivably, voting rights might for example be limited to proposed M&A transactions, but as yet there is no specific guidance on the permissible scope of the limitations.) Corporations will be able to issue shares without par value. A corporation cannot at the same time have both no-par shares and par shares, but the entirety of par stock can be converted into non-par stock, and vice-versa. Naturally, no-par shares will not be subject to restrictions on issuing shares at below par. This will also apply to the issue of shares pursuant to convertible bonds, relaxing a constraint on conversion price and adjustment. (There are of course other parameters for pricing, such as fiduciary-related and tax issues.) However, 50% or more of the proceeds of a no-par issue must go to paid-in capital. 2

3 Redeemable shares may be defined as redeemable in assets rather than cash, based on the book value and provided that the book value does not exceed earnings available for distribution as dividends. Stock repurchases (share buybacks): The KCC prohibits the acquisition or holding of treasury stock, thus prohibiting any stock repurchases, except only in some narrow situations, such as where a shareholder exercises appraisal rights, or where repurchased shares are promptly cancelled (constituting a capital reduction that triggers creditor protection procedures). Under the amended KCC, a corporation will be generally free to repurchase stock from shareholders on a pro rata basis, or in the open market such as on the Korea Exchange, provided that the funds spent must be within the amount of earnings that would be available for distribution as dividends. Payment for shares by setoff: The KCC prohibits payment for new shares by setoff of claims against the issuing corporation. The amended KCC will allow such payment for newly issued shares by setoff of claims, with the issuer s consent. This will probably, among other things, make it easier for corporations to convert debt into equity. B. BONDS No ceiling on bond issuances: A corporation cannot issue bonds exceeding, in aggregate principal amount, four times its net assets as of the latest fiscal year. The amendments eliminate this core constraint upon debt financing under the KCC. Exchangeable, participating and other types of bonds: Currently, only Korea Exchange-listed companies can issue exchangeable bonds (exchangeable for stock or other securities) or dividend-participating bonds, pursuant to the Financial Investment Services and Capital Markets Act. 3

4 The amended KCC will permit corporations, unlisted as well as listed, to issue exchangeable bonds and participating bonds, and also derivative-linked bonds (bonds whose redemption is linked to securities or currency, or certain indices or asset types that are to be determined by supplementary administrative decree). C. DIVIDENDS AND RESERVES Approval of financial statements and dividends: Annual financial statements of a corporation, including the appropriation of earnings and thus the annual dividend, require approval at a general shareholders meeting. The Board approves the financial statements for submission to the shareholders meeting, but does not have the final decision. The amended KCC will allow the Board to finally approve audited financial statements, including the amount of dividends stipulated in them, so long as the financials have an unqualified opinion of the independent auditor and also are approved by the company s Board-level auditors (the statutory auditors ). This must be provided for in the articles of incorporation. In-kind dividends: The current KCC only permits corporate dividends in cash or by stock dividend. The KCC will permit dividends in the form of distribution of assets, where the articles of incorporation so provide. This would appear to allow for, among other things, a distribution of securities owned by the corporation, for example shares owned in a subsidiary. Mandatory reserves: A corporation must set aside a reserve equal to 10% of cash dividends, up to a limit of 50% of paid-in capital (earned surplus), as well as a capital surplus reserve (including e.g. premium on share issuances). These mandatory reserves may only be used to cover impaired capital, or else converted into paid-in capital (by free issuance of new shares). If mandatory reserves exceed 150% of paid-in capital, the corporation will be free to use such excess, upon resolution at a shareholders meeting, for any proper purposes (e.g., to acquire treasury shares or as dividends). 4

5 D. Consolidation: Squeeze-out, Sell-out, Merger Squeeze-out and sell-out rights: Generally, there is no conventional way for a majority shareholder to squeeze out minority shareholders, other than transaction structures that yield fractional shares. Likewise, minority shareholders do not have a put option. Under the amended KCC, a shareholder owning 95% or more of the outstanding stock will be entitled to buy out the shares of minority shareholders. At the same time, each minority shareholder in this situation will be entitled to put its shares to the majority shareholder. Procedural steps are set out in the amended provisions. In such cases, unless agreed between the parties in the first instance, the sale price for the shares must be determined by a court, based on fair value. Cash-out merger; triangular merger: In a corporate merger, as consideration to the shareholders of the extinguishing company, generally the surviving company can issue only its own shares; generally, it cannot issue cash or assets, except cash in compensation for fractional shares. As consideration for the merger, the KCC will permit the surviving company to give, cash or other assets, and also to acquire and give shares issued by a parent company. Basically, this will allow for a cash-out merger. This will also make a triangular merger possible, whereby shareholders of the extinguishing company take shares in the surviving company s parent. E. ELECTRONIC REGISTRATION OF SECURITIES The amendments newly introduce a system for voluntary electronic registration of corporate shares and bonds. Particulars of the system remain to be further decided, and will follow in separate legislation. Resort to electronic registration will obviate the need for physical certificates, including for purposes of transfer and pledge, which will be capable of being validly entered in the registry. F. DUTIES AND LIABILITIES OF DIRECTORS The amendments will reinforce and supplement fiduciary-type restrictions upon directors of corporations, while accommodating a monetary cap on liability. 5

6 Restrictions on self-dealing: The KCC restricts self-dealing transactions, but defines these as transactions between a company and a director, and requires, to authorize such a transaction, only an ordinary approval by the Board (minus the director concerned). The amendments expand the scope of self-dealing to include any transaction of the company with (i) a director or major shareholder, (ii) any of their spouses, or their or their spouses (grand)parents and (grand)children, or (iii) a company (including subsidiaries) in which the foregoing persons, alone or combined, have a 50% or greater stake. Also, to authorize such transactions, the KCC will require supermajority Board approval, 2/3 of the incumbent directors. Usurping of business opportunity: Current law does not specifically forbid a director from usurping a business opportunity for the corporation. (The conduct may, however, be restricted by fiduciary duties under other company law provisions, or other obligations.) The amended KCC specifically forbids a director from usurping a corporate business opportunity, either directly or indirectly through a third party, except upon Board review and supermajority approval, 2/3 of incumbent directors. Limitation or release of liability: A limitation of directors civil liability to the corporation, or a waiver or release of such liability, is possible but only upon unanimous consent of all the shareholders. The amendments permit a corporation to limit a director s liability to the amount of six times his/her annual remuneration, except in case of intentional misconduct or gross negligence. The limitation must be set out in the articles of incorporation, and thus it requires supermajority (but not unanimous) approval of the shareholders. G. EXECUTIVE AND COMPLIANCE OFFICERS Executive officers: The Board of Directors is responsible for the management of the company. Among the Board members, one will serve as the representative director, who has the authority to represent the company in its external affairs and to administer the day-to-day business. 6

7 The Board may appoint one or more executive officer(s), to be responsible for the company s management. Where executive officer(s) are appointed, the company cannot appoint a representative director, and instead the executive officer(s) will represent the company and handle the business. As before, however, the Board will have the authority to monitor performance. New compliance officer requirement (for listed companies): There is no particular requirement that a listed company adopt internal compliance regulations or appoint a compliance officer. Listed companies, falling within criteria that are to be later decided by supplementary decree, will be required to adopt internal compliance regulations, and appoint a legal compliance officer, with qualifications to be specified in a later decree. H. NEW TYPES OF BUSINESS ENTITY; CHANGES TO LIMITED COMPANY Two new entities: The amended KCC provides for two new types of business entity, on top of the existing ones. Currently there are the following entities under the KCC: (i) the chusik hoesa or corporation (often translated as joint stock company ); (ii) the yuhan hoesa or limited company (sometimes limited liability company ), derived from the German GmbH; (iii) the hapmyung hoesa (often general partnership ); and (iv) the hapja hoesa (often limited partnership ). Also recognized, under the Korean Civil Code (rather than Commercial Code), is a johap or association, which is a contractual group rather than a juridical entity. The amended KCC introduces the following two types of entity: 1. The yuhan chaekim hoesa, literally limited liability company or LLC (but not to be confused with the limited company or yuhan hoesa), is based on the American limited liability company and the Japanese godo kaisha. This is roughly akin to but differs from the limited company. In internal matters such as formation, governance, and investors entry and exit, the new LLC resembles a limited partnership (hapja hoesa). However, like a limited company, the LLC may be subject to two-tier taxation: At present there is no sign that tax laws will be revised to accord it the pass-through treatment of a partnership. The LLC will have a manager (similar to a director of the yuhan hoesa), who may be an investor or member, and who may be a corporation or other juridical entity. 2. The new hapja johap or partnership association, inspired by the American limited partnership, is in some ways similar to the hapja hoesa or limited partnership. However, like the johap or association under the Civil Code, the hapja johap of the amended Commercial 7

8 Code is not a juridical entity. Further, in this partnership association, unlike the hapja hoesa, the charter may authorize limited partners (that is, those association members with limited liability) to participate in management, and they (like members with unlimited liability) may make their contribution in credit or labor, in lieu of cash or tangible assets. It seems probable that the partnership association, like the existing johap, will allow pass-through tax treatment for its members, but the question must await proposals to amend the tax laws. Limited company (yuhan hoesa) requirements revised: The amended KCC relaxes constraints upon the existing limited company (yuhan hoesa), with the effect of rendering it more like a corporation. Under current law, a limited company is confined to a maximum of 50 members or unitholders, and they may not transfer units without approval at a unitholders meeting. The amendments eliminate both these constraints: There will be no ceiling on the number of investors, and, unless the charter says otherwise, the units will be freely transferrable. It will also be easier to convert a limited company into a corporation: Currently this requires unanimous approval of the unitholders, but, under the amended KCC, the company s charter may permit conversion with only a 2/3 supermajority approval. CONCLUSION The amendments passed on March 11, 2011 represent the most important set of revisions to the Commercial Code since They enlarge the scope of possible strategies for investment, and techniques of corporate structuring and finance, as well as control and consolidation. Thus, the changes may be of keen interest to many businesses and investors in Korea. Supplemental administrative decrees, clarifying important particulars, are expected to follow in coming months, ahead of the effective date of the amended Commercial Code in