International Law

Korean Bankruptcy Wave Starts to Mount Again

As the credit crunch starts to bite in the real economy, and Korea’s position becomes more precarious, corporate bankruptcies start to mount. Today I saw the following short report in the English Chosun Ilbo:

More Companies File for Protection

An increasing number of recession-hit businesses are going belly-up.

The Seoul Central District Court on Thursday said a total of 73 companies filed for court receivership from January until October, a threefold increase from the corresponding period last year, which was 22. Ten firms filed for receivership in September and 12 in October alone, setting all-time monthly records. Small- and medium-sized manufacturers including electronics makers made up the largest portion (32 companies or 43 percent), followed by construction firms (24 companies or 33 percent).

During the IMF crisis in 1997 and 1998, 200 to 300 companies asked the Seoul Central District Court for debt write-offs each year. The number leveled off to 20 to 30 per year after 2000.

Judicial circles say the increase is a warning sign for a serious surge in bankruptcies. Companies who hit a cul-de-sac face bankruptcy proceedings unless their application for court receivership is accepted. A total of 45 businesses filed for bankruptcy with the Seoul Central District Court from January until October this year, the same number as the whole of last year.

This signals the return of bankruptcy as a practice area. Luckily [?], this will be my second go-round with a Korean recession/economic crisis.

But despite having had some experience with this, we’ll be discovering the practice area all over again. That’s because Korea’s bankruptcy laws underwent a profound change as a result of the 1997-98 Asian Economic Crisis, or as it’s known here in Korea, the “IMF Crisis”.

As part of the IMF’s US$57 billion bailout offered to Korea, the government was directed to undertake a study of the bankruptcy laws and adopt legal reforms. At our former firm Shin & Kim my partner Doil Son and I were associates on the team led by our supervising partner Yong Seok Park (he’s now left Shin & Kim too) that collaborated with Orrick partner (now at Sidley Austin LLP) Duncan Darrow, Hebb & Gitlin (now Bingham Dana) partners Richard Gitlin and Tim DeSieno, and Inha University Professor Soo-Geun Oh on the study.

At the start of the crisis, Korea had three separate (and aged) corporate insolvency statutes—the Composition Act, the Company Reorganization Act, and the Bankruptcy Act—and a statute on personal bankruptcy, all of which were hardly ever used.

Those corporate insolvency statutes were relatively ineffective for a variety of reasons, but mainly because nobody—not the insolvent companies’ management, not the creditors, and certainly not the government—wanted to allow recourse to the courts under those statutes.

Management didn’t want to proceed to a reorganization under the Company Reorganization Act (similar to US Chapter 11 reorganization) because the law provided not only for a mandatory replacement of the company’s management, but criminal prosecution of the company’s Representative Director and/or its “shadow directors” exercising control through indirect means. Existing shareholders faced the cancellation of their equity positions, which meant loss of the company.

For smaller enterprises, whose Representative Directors had also been compelled to provide personal guarantees for company debt, it was easier and simpler to walk away from the company—leaving the keys on the desk, so to speak. For big companies, it was similarly important to keep the firm away from the court.

Creditors didn’t want to see a company go into reorg because the court judgment would mean a write-down of the value of their credits, something nobody (creditors were mostly banks, because getting loans was significantly easier/cheaper for chaebol than raising capital through share or bond issues) wanted to see. Write-downs could have resulted in a wider collapse of the banking system than we saw at the time—which is why the government, too, was glad to keep companies out of formal insolvency proceedings.

As a result, major corporate reorganizations were undertaken not by recourse to the courts under the then-effective insolvency statutes, but rather mainly by means of informal “workouts” led by the creditor banks whose loans were at risk.

The informal workout regime was institutionalized in 2001 by the adoption of the Corporate Restructuring Promotion Act (CRPA), which took effect in mid-September of that same year. CRPA provided a formal structure for the lead creditor bank, or committee of creditor banks, to declare a company to be “showing signs of insolvency” and take it into a mandatory workout process managed by the lead creditor bank.

As a measure of how seat-of-the-pants was the process under CRPA, the statute had fewer than 40 articles.

Replacing the three corporate insolvency statutes, the Debtor Rehabilitation and Bankruptcy Act, a modern statute modelled on American bankruptcy law and the product of the IMF project, was approved by the National Assembly March 31, 2005 to become effective a year after its approval. The statute brought Korea a number of modern provisions, but importantly removed the punitive aspects of the old insolvency laws that made them so ineffective.

Thus, as we face a wave of corporate bankruptcies, Korea’s formal insolvency statute is new. And the court system’s experience with applying it, is just a little more than two years old. The body of precedents under the Debtor Rehabilitation and Bankruptcy Act is correspondingly brief—only 20 to 30 cases per year.

That number is pretty surprising, considering that the Seoul Central District Court has jurisdiction over the headquarters of about 90% of large businesses in Korea, and serves a population of at least 10 million.

Why so few cases? Personally, I would finger (i) a good economy, (ii) social factors discouraging resort to formal insolvency proceedings, and (iii) the lingering effects of CRPA, which was renewed summer 2007 in a surprising move by the National Assembly. We had previously expected that CRPA would be abolished, making way for the Debtor Rehabilitation and Bankruptcy Act that came out of the IMF project.

In the coming weeks and months and the spike in bankruptcies we’ll surely experience, creditors concerned about bankruptcy risks need not only to familiarize themselves with the new bankruptcy law, but also with the CRPA which will apply to the great majority of insolvency and reorganization cases.

Full post as published by Korea Law Blog on November 06, 2008 (boomark / email).