South Korea: Post-M&A Disputes In Korea

Last Updated: 12 November 2006

By Kap-You (Kevin) Kim* and John P. Bang**

Korea has seen a dramatic increase in international commercial disputes in recent years. Among these, post-M&A deal disputes have become increasingly common and acrimonious. As the authors detail below, a historically unique set of circumstances set the stage for this swift rise in international disputes in Korea. The authors, leading the International Arbitration and Litigation team at Bae, Kim & Lee, one of Korea’s preeminent law firms, have had the opportunity to see and be involved in the process firsthand, and share their perspectives below.

I. M&A Boom Of The Asian Financial Crisis

The recent spike in international disputes in Korea has roots that go back to the latter half of 1997, when the Asian Financial Crisis, constituting the greatest economic crisis in Korea’s history, hit the nation. The Korean government had run out of its foreign currency reserves and had no choice but to seek a substantial bail-out by the IMF. In an attempt to achieve the BIS capital ratio requirements imposed by the Korean government and the IMF, commercial financial institutions in Korea undertook self-rescue measures by demanding the prompt repayment of corporate loans and even ceasing to grant new corporate loans to those corporations with poor credit standing. These strict lending and repayment policies imposed heavy financial costs and liquidity demands on Korean companies, pushing many to the verge of insolvency.

These desperate times demanded desperate measures at every level of Korean business. The conditions forced even the Chaebols – Korean conglomerates – to restructure their businesses to reduce debt by various means such as selling non-core businesses, inducing foreign capital and downsizing subsidiaries. In the vortex of this corporate business restructuring process, scores of foreign companies entered into M&A transactions with Korean companies, often purchasing outright, or securing a majority interest in, various Korean enterprises. As a result, foreign investment levels more than doubled between 1997 and 2000, rising from US$7 billion to US$15.7 billion.

II. Resultant Wave Of M&A Disputes

Through this flashflood of restructuring and M&A deals, by the end of 2000, Korea was able to meet most of the structural performance criteria in the timeframe specified in the three-year IMF-supported program, thus averting an economic collapse. Since then, the Korean economy has made a solid recovery. But regardless of the overall economic success, a significant number of the M&A transactions that occurred during the crisis period have, in recent years, given rise to a variety of disputes between the corporate parties. We explain below several common problems that have led to such disputes, and offer some examples from our experience.

1. Conflict between boilerplate provisions and negotiated terms

One common feature of the current genus of M&A deal disputes is inconsistency between contractual terms. Perhaps due to the high-pressured nature of the economic environment existing when such deals were negotiated and drafted, occasionally some discrepancy between provisions found in standard boilerplate provisions in the contract and those specifically negotiated for the deal has given rise to conflicting expectations. This discrepancy often forms the basis for a legal dispute.

By way of example, the authors recently represented the creditors of a former Korean passenger vehicle manufacturer and distributor in an ICC arbitration, seeking the return of escrow account funds against, among others, a large foreign automobile manufacturer and distributor. The dispute in this arbitration started when, due to natural land subsidence, cracks developed in the walls and floors of the automobile manufacturing plant acquired by the purchaser, necessitating millions of dollars in repairs. As a result, the purchaser refused to disgorge the multi-million dollar (USD) escrow fund held in reserve pending satisfaction of representations and warranties in the contract. The boilerplate language in the asset purchase contract included a representation by the seller that the purchased assets were to be in good operating condition and repair, subject to normal wear and tear consistent with the age and use of assets. Although the subsidence would seem facially to be in violation of such a general representation, as we successfully argued to the tribunal, the land subsidence had been factored into the negotiations, drawing down the plant’s value and ultimate sale price. Nonetheless, had the parties made an express provision acknowledging the subsidence and exempting it from the general "good working condition" representation, the dispute would likely never have arisen. Numerous examples could be cited demonstrating a comparable complication.

2. Disclosure problems

Another common source of conflict is the tension between the obligation of a seller to disclose material problems and the due diligence obligation of the buyer to make itself aware of discernible problems through a reasonable inspection. Frequently, parties will prepare a schedule of known problems or liabilities and declare in their general representations and warranties that the seller will be responsible for all liabilities except as set out in that schedule. Problems arise when a liability that was apparent to any reasonable due diligence inspection is not included on the schedule of exempt liabilities. For instance, the same arbitration concerning the Korean automobile maker mentioned above involved a claim for a multi-million dollar (USD) key money (lease) deposit to a lessor which went bankrupt over two years before the asset purchase. The car maker was not able to recover its money and had to simply accept it as a financial loss. The loss was apparent in the financial documents provided by the seller for the buyer’s due diligence review, but not expressly reflected in the schedule of excluded liabilities. Our argument, once again accepted by the tribunal, was that if the buyer had failed to note the liability, which was by no means concealed, then it had been reckless in its due diligence review.

III. Arbitration as the chosen method for dispute resolution

In a large percentage of cases, the parties to such M&A transactions concluded between a Korean enterprise and a foreign counterpart during the financial crisis of the late 1990s opted for international arbitration as the method of dispute resolution. The likely reasons for this are several. First of all, dispute resolution is typically one of the final points discussed in negotiations, after the parties have settled on the material terms concerning the substance of the contract. It seems an afterthought to parties who, in forging a deal, do not have in the forefront of their minds the possibility of disputes. Moreover, the parties would rather not have such an "afterthought" arise as a sticking point that threatens to derail the substance of a deal that has already been agreed to in essence. Thus, they tend to be reasonably acquiescent on this point, as parties are often willing to accept what is perceived as a neutral venue – international arbitration under an established set of rules like the ICC – rather than demand litigation in the courts of their home country.

There is no question that arbitration can offer distinct advantages and a level of party-control that court-based litigation does not. The parties often fail to realize, however, that if not properly drafted, an arbitration provision – along with related clauses establishing governing law, locus, arbitration system and even language – can often not only be the source of unnecessary costs, but can often be determinative of the outcome of a dispute. For instance, the site of arbitration has implications aside from just travel expenses for one or both parties. Generally, even if the parties have selected a set of arbitration rules for disputes, many countries have their own statutes which apply to certain procedural matters, particularly if the parties have not decided such matters. For instance, the Korea Arbitration Act, which applies to any arbitration brought in Korea, calls for the law of the State most closely connected with the subject-matter of the dispute to be applied in the absence of party agreement on that point. Occasionally, parties will fail to designate governing law in the contract, and this oversight can be outcome-determinative, since the applicable law can make or break a party’s case. The Arbitration Act also places strict limits on discovery and establishes the role of courts in matters such as enforcement. Such matters are obviously vital to successful prosecution of a case and should be researched thoroughly by the parties’ counsel so they understand the exact ramifications of their arbitration provision.

Clearly, an arbitration clause must be drafted carefully, even specifying such details as the language in which the arbitration is to be conducted or the number and method of choosing arbitrators. If not, costs can very easily skyrocket in the resolution of such procedural uncertainties.

IV. Succeeding In The Korean Arbitration Trend

As summarized above, the number of international arbitration and litigation cases has risen sharply in Korea in connection with the M&A deals executed during the Asian Financial Crisis. This has been a remarkable trend witnessed in Korea in the field of cross-border disputes, and such post-completion M&A disputes calling for arbitration as the dispute resolution method are expected to continue in the foreseeable future. Knowing some of the common issues giving rise to such problems is helpful not only to the arbitration practitioner, but also to contract drafters who seek to avoid pitfalls. The authors hope the information shared here can be of assistance, and invite further inquiries from readers.

* Partner and head of the International Arbitration & Litigation Practice Group, Bae, Kim & Lee, Seoul, Korea. Mr. Kim is also an Adjunct Professor of Law, College of Law, Seoul National University and College of Law, Sogang University.

** Senior Foreign Legal Consultant of the International Arbitration & Litigation Practice Group, Bae, Kim & Lee, Seoul, Korea

THE AUTHORS have been at the front lines of the international arbitration trend in Korea. Their firm, Bae Kim & Lee, was in the vanguard of law firms through the Asian Financial Crisis and even today is unique among major Korean law firms in having a dedicated International Arbitration and Litigation Practice Group, consisting of 8 dedicated, full-time lawyers and support staff. Heading that practice, the authors have represented numerous major corporate clients, both domestic and foreign, in arbitration proceedings in number of different locations around the globe and under the rules of all major international arbitral institutions including, among others, the International Chamber of Commerce (ICC), United Nations Commission on International Trade Law (UNCITRAL), London Court of International Arbitration (LCIA) the Korean Commercial Arbitration Board (KCAB), the Japan Commercial Arbitration Association (JCAA) and the Singapore International Arbitration Commission (SIAC). Over their years of experience, they and their team have represented clients, domestic and foreign, in a broad range of industries.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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