Directors’ Duties and Liabilities in Corporate Control and Restructuring Transactions: Recent Developments in Korea*

Hwa-Jin Kim**

(2006) Oxford U Comparative L Forum 2 at ouclf.law.ox.ac.uk | How to cite this article

I. Introduction

In order for the directors of a company to effectively carry out their duties, they need clear guidance on the scope of their fiduciary duties and liabilities. This is particularly true for contests and shifts in corporate control, where conflict of interests is most likely to occur. Duties imposed on directors also tend to be stricter in corporate control and restructuring transactions because greater shareholder value is at stake. However, laws on the rules of the board room, either at peace or “at war”, in particular, and corporate governance, in general, are only in the early stage of development in Korea because no strong need was felt for legal norms governing the conduct of corporate directors and managers before the financial crisis of 1997, prior to which no single derivative suit had been filed in Korea. It could be said that the Korean history of a market for corporate control started only in April 1997, when a previous ceiling of ten percent share ownership for public companies was abolished. This article describes the most important recent court cases in Korea, with special reference to corporate control and restructuring cases, in which the directors’ liabilities and business judgment rule were discussed.
In a country where civil law based, sophisticated mandatory rules are interpreted by conservative judges, can we expect the business judgment rule to shape and develop the liability of corporate directors?1 The answer may be a surprising “yes” as far as Korea is concerned. While the current Korean law on corporate directors’ fiduciary duties is characterized by a hybrid of case law and statute, there is a trend toward refinement of applicable rules and principles through a gradual recognition of the business judgment rule2 as it was developed in the United States. Korean courts have begun to apply those rules to corporate control and restructuring transactions which are filed more frequently as the mergers and acquisitions market is growing fast.
Taken from a comparative corporate law perspective, the Korean case also proves to be interesting. Korea, a German civil law country, has been influenced greatly by Continental Europe. Since its promulgation in 1962, Korean corporate law in particular has been developed under the influence of Continental European corporate law statutes, cases, and scholarly works3. However, the cases in this article will show that Korea’s system of corporate governance and financial markets is undergoing significant changes strongly influenced by that of the United States. Korea could be a test case for the convergence thesis and also may be a good starting point for studying whether civil and common law systems can converge with each other through a globalizing market.4

II. Directors’ Fiduciary Duties and Liabilities in Korea

A. Legal Sources

The primary corporate entity in Korea is the stock company, which can exist as a private or as a public company such as a “Korea Exchange-listed company” or “KOSDAQ-listed company.” In addition to the requirements of the Korean Commercial Code related to the corporate governance of companies, public companies are also subject to provisions of the Korean Securities and Exchange Act (KSEA) which are generally not applicable to private companies. Certain companies engaged in a specialized business (such as banking, securities, or insurance business, etc.) will be subject to additional regulations and requirements under the relevant laws.
In September of 1999, the Korean Committee on Corporate Governance adopted the Code of Best Practice for Corporate Governance which has been revised in early 2003. The code, however, remains as an informal guideline for the corporate governance of public companies. There is no “comply-or-explain” obligation5 imposed on public companies in Korea.

B. Basic Rules

With respect to general duties and liabilities of directors to the company, the Korean Commercial Code (KCC) provides that where a director (1) has acted in violation of any laws and regulations, or of the company’s articles of incorporation or (2) has neglected to perform his or her duties, such director shall be jointly and severally liable for damages to the company resulting from such acts or omissions.6 If any such act has been done in accordance with a resolution of the board, the directors who have assented to such resolution shall take the same liability, and the directors who have participated in such resolution and whose dissenting opinion has not been entered in the minutes shall be presumed to have assented to such resolution.7 In addition, a director may also be held liable for damages to the company resulting from the lack of supervision or oversight of employees.
With respect to general duties and liabilities of directors to third parties, the KCC provides that a director may be held jointly and severally liable to third parties for any damages incurred by such third parties resulting in the failure of such director to perform his or her duties, either willfully or by gross negligence.8 The KCC provides that if a director has obtained, or made a third party obtain, any pecuniary benefit by acting in breach of his duty and has thereby inflicted loss on the company, he/she will be deemed to have committed crimes of special misappropriation, and may be punished by imprisonment and a monetary fine.9
As directors are obliged to use utmost care when discharging their fiduciary duties,10 statutory liability enforces a rather high standard of duties regardless of the fact that this liability is negligence based.

C. Outside Directors

The role of outside directors, i.e., non-executive directors, of a public company is recognized by the KSEA and the KSEA requires that public companies maintain a minimum number of outside directors on their board. The number of outside directors of a public company must be not less than one fourth of its total number of directors.11 In addition, the KSEA provides that public companies with total assets of 2 trillion Korean won (approximately 2 billion US Dollars) or more at the end of the immediately preceding business year must have at least three outside directors and at least half of the total number of directors of the public company must be outside directors.12
Outside directors are generally subject to the same duties and potential liabilities as executive directors.13 However, according to the case law and leading scholarly opinions, outside directors are subject to the slightly mitigated duties of care in monitoring the employees of the company.14

D. De Facto Director

Pursuant to the KCC, a third party who is not a director of a company may be held personally liable as a de facto director of such company where: (1) such party instructs a director of the company to conduct business by using his/her influence over the company; (2) such party conducts business in person under the name of a director; or (3) such party conducts the business of the company by using a title which may be recognized as authorized to conduct the business of the company, such as honorary chairman, president, director, or others.15
The KCC provision regarding the liabilities of the de facto director has not been widely utilized by shareholders yet.16 However, the December 2003 amendments to the KSEA impose liabilities on the de facto director for damages arising out of false or misleading statements in or material omissions from any public disclosure documents.17
Contrary to the situation in the United States, where corporate law makes no distinction between the duties of directors and officers,18 the basic liability rules described above are not applicable to non-director officers of Korean companies. As more Korean companies try to comply with the outside director requirements by reducing the number of executive directors, more responsibility and authority fall on non-director officers. The Korean government is considering expanding the coverage of the liability rules to non-director officers through an amendment of the KCC.

E. Audit Committee

The December 1999 amendments to the KCC introduced an audit committee.19 This internal committee is not mandatory, and Korean companies may instead opt for the conventional statutory auditor. However, if they introduce the audit committee by charter provision, such a committee must have at least three directors, of which the number of officer-directors may not exceed one-third.20 The audit committee is mandatory for certain large listed companies, banking institutions and certain large securities companies, securities investment trust companies, insurance companies, and merchant banks. The December 2003 amendments to the KSEA require certain large public companies to have at least one expert on accounting or finance in their audit committees.21
According to the leading scholarly opinions, the legal effect of the resolution made by a sub-committee of the board of directors is equivalent to the same by the entire board unless revoked by the entire board afterwards.22 Therefore, the liability of a member of the audit committee member can potentially arise from a resolution of that committee. Also, the audit committee members are liable for the breach of their fiduciary duties based on the KCC provisions on the statutory auditor.23 As the non-audit committee member directors are obliged to monitor the resolutions of the audit committee24 and call the entire board meeting to revoke the resolution of the audit committee if needed, they will be held liable if they do not discharge such obligation to monitor and rectify.

F. Directors’ Liabilities and the Securities Law

With respect to public companies, the KSEA provides that a director of a public company may be held liable to any party for any damages incurred as a result of the false or misleading statements in or material omissions from any public disclosure documents.25 They have a due diligence defense.
The controversial Securities Class Action Act (SCAA) was passed by the Korea’s National Assembly in December of 2003 with the aim of providing a more effective means of relief for small investors while at the same time enhancing the transparency of corporate management. The SCAA came into effect on 1 January 2005, but for companies whose total assets, as of the end of the fiscal year immediately prior to 1 January 2005, amount to less than 2 trillion Korean won, the law will apply starting from 1 January 2007.26 Claims for damages under the SCAA are limited to the recovery of loss arising from false statements in the registration statements, business prospectuses, annual, semiannual and quarterly reports, insider trading, stock price manipulation, and faulty auditing.27
Modeled after the U.S. Sarbanes-Oxley Act of 200228, the December 2003 amendments to the KSEA have introduced the CEO/CFO certification. The representative director or other relevant officers are obliged to confirm and sign the disclosure documents, including registration statements, annual, semi-annual and quarterly reports.29

III. Two Landmark Cases

A. The Samsung Electronics Case30

On 27 December 2001, the Suwon District Court held nine former and current directors of Samsung Electronics, the largest company in Korea, jointly and severally liable for 90.28 billion Korean won (approximately 70 million US dollars) for having neglected their duties.31 On 20 November 2003, however, the Seoul High Court rejected some of the alleged breaches of duty and at the same time reduced the amount of damages. These landmark decisions show how Korean courts engage with the business judgment rule, on which the defendants had relied.
This was not a Supreme Court case. The impact of the decisions, however, was significant because of the amount of damages as well as the fact that it was rendered against the largest solvent company in Korea. We will now look at the most important legal issues raised by this case.
1. Acquisition of Majority Stake in a Financially Troubled Affiliate Firm
In early 1997, the directors of Samsung Electronics decided that their company would acquire a majority stake in Lechon Electric by purchasing existing shares from the then controlling shareholder, and by subscribing to newly-issued shares. Lechon Electric was in serious financial difficulties at the time when Samsung Electronics acquired their shares. Lechon Electric’s financial conditions deteriorated further, and when it was all but bankrupt by the end of 1998, Samsung Electronics sold its stake in Lechon at a huge loss. Samsung Electronics’ total losses resulting from the acquisition, including subsequent cash injections, totaled almost 200 billion Korean won.
In defending their decision to acquire, the directors argued that the Lechon Electric takeover was at the time beneficial to Samsung Electronics in three ways. First, Lechon Electric had an abundance of skilled engineers which Samsung Electronics lacked in an industry into which it was trying to expand. Second, by acquiring Lechon Electric’s base of expertise, Samsung Electronics could drastically reduce its product development time. Third, the Lechon Electric purchase would ultimately allow Samsung Electronics to substantially increase its overall market share in the industry.
The Suwon District Court rejected these assertions and their business judgment defense. The court ruled that, although there may have been several compelling reasons in favor of acquiring Lechon Electric, the directors had failed to analyze the risks of the acquisition, and hence their decision-making process was not prudent. The directors had decided to acquire Lechon Electric after reviewing a poorly-prepared report that had not been made available in advance of the board meeting, which lasted no longer than one hour.32
The court found the directors liable for 27.62 billion Korean won (a proportion directly relating to the acquisition itself, out of the approximately 200 billion Korean won of total losses) for neglecting to exercise the level of care required to decide whether a takeover of Lechon Electric was truly beneficial for Samsung Electronics. The court stated that the Samsung directors should have analysed Lechon Electric’s financial position more thoroughly, and should also have considered other options available to Samsung Electronics.
Reversing the district court’s decision, the Seoul High Court found that the directors were not negligent in performing their fiduciary duties owed to Samsung Electronics and, thus, were not liable to pay damages to the company. The court stated that the director of a company has the discretion to make business judgment to the extent such judgment is made in compliance with the laws and regulations and the articles of incorporation of the company. Furthermore, the court stated that the management of a company necessarily involves taking a certain degree of risk, and therefore, as long as the directors have diligently and reasonably performed their duties, they should not be liable to the company for any adverse consequences of their business judgment – unless self-dealing was involved. The court found that when the directors decided on the acquisition of Lechon Electric or other related matters, they made a reasonable decision within the scope allowed for them to make a business judgment.
2. Losses for Payment Guarantee
In June of 1998, after Lechon Electric’s financial position became increasingly serious, Samsung Electronics’ directors decided to guarantee Lechon Electric’s debt payments and provide Lechon Electric with 170.9 billion Korean won in the form of a new share purchase in order to prevent Samsung Electronics’ guarantee from being called in. The directors’ decision was based on the fact that, had they not done so, Samsung Electronics would have been blacklisted by its own creditor banks as a dangerous credit risk, since it was the controlling shareholder of a subsidiary that would have defaulted in loan repayments.
The Suwon District Court absolved the directors of any liability for their subsequent decision to guarantee Lechon Electric’s debt payments and purchase its new shares, despite the fact that this subsequent decision was the direct result of the initial decision, for which they were held liable. The court found that the directors had exercised reasonable care in making their subsequent decision to guarantee Lechon Electric’s payments and purchase its new shares and thus, the directors’ subsequent decision can be protected “as a business judgment.”33
The Seoul High Court affirmed the district court’s finding.
3. Sale of Shares at Below Market Price
On 17 December 1994 the directors decided to sell 20 million shares of Samsung General Chemicals (SGC) to two other Samsung Group affiliates. Although the selling price of the shares was 2,600 Korean won per share, their market value was estimated to be around 5,733 Korean won per share. In addition, Samsung Electronics had originally purchased the shares over the course of six years (between July of 1988 and April of 1994) at the price of 10,000 Korean won per share.
The directors argued that the 2,600 Korean won per share was justifiable, given that it was calculated on the basis of a reputable accounting firm’s share appraisal report and in accordance with a formula prescribed by the Inheritance Tax Act. The Suwon District Court noted that the formula prescribed by the Inheritance Tax Act was one of several ways in which the directors could have calculated the share price and that a more accurate method should have been chosen after reviewing every available method.34 The actual share price could not be readily quantified, since the shares were not listed on any exchange, but the court listed several other factors which, in totality, led to the directors’ liability.
These factors were as follows: (1) the directors’ decision to sell the shares was made in a very short time and it caused Samsung Electronics to lose its majority stake in SGC; (2) between July of 1988 and April of 1994 Samsung Electronics had consistently purchased the shares at the price of 10,000 Korean won per share; and (3) in June of 1993, Hansol Paper, an affiliate in Samsung Group, sold its holding of SGC shares to another affiliate of Samsung Group at the price of 6,600 Korean won per share and SGC’s profitability had improved since then.
The directors submitted two other arguments in their defense, namely that the proceeds of sale were sorely needed for investment purposes and that they were protecting Samsung Electronics from possible anti-trust prosecution. The Suwon District Court rejected these arguments and held the directors to be jointly and severally liable for a total of 62.66 billion Korean won, as the difference between the price for which the court felt Samsung Electronics should have sold the shares less the price for which they were actually sold. The court stated again that the directors’ decision cannot be protected as a business judgment, partly because the decision was made in a meeting that lasted for only one hour.
The Seoul High Court also stated that the directors failed to demonstrate any cause that might have justified the sale of the shares at such a low price. Consequently, the court found that the directors who had voted for the resolution to sell the shares had failed to perform their duties diligently.
Although the Seoul High Court agreed with the district court that Samsung Electronics suffered a loss of 62.66 billion Korean won from the sale of the shares, it opined that the directors’ liability should be limited. According to the court it would be proper for the company and the directors to fairly apportion the loss suffered by the company in connection with the directors’ performance of their duties, in light of such factors as the type and size of business in which the company was engaged, the performance of the directors, and other circumstances. In this case, under the circumstances, the court viewed that it would be proper to limit the liability of the directors to 12 billion Korean won, approximately 20 percent of the loss suffered by Samsung Electronics.35
4. Criminal Act and the Business Judgment Rule
Another issue considered by the Suwon District Court concerned a series of payments in the aggregate amount of 7.5 billion Korean won made between March of 1988 and August of 1992 to the then president of Korea. The chairman of Samsung Group, who was a director of Samsung Electronics, allegedly ordered them to be paid on behalf of Samsung Electronics.
In his defense, chairman of Samsung Group argued that the payments were made to enhance Samsung Electronics’ business development and were well within the amounts normally allowed by Samsung Electronics’ established internal accounting regulations. In addition, he argued that such amounts were approved by Samsung Electronics’ shareholders as part of the financial statements presented to them at their annual general meetings.
The Suwon District Court noted that bribery is a crime, and that a director who commits criminal acts cannot be regarded as acting reasonably and in the best interests of any company. In other words, the court refused to protect a director’s criminal act under the business judgment rule. Consequently, the defendant was ordered to repay the full amount. The Seoul High Court basically affirmed the district court’s view and ordered the repayment of 7 billion Korean won, excluding the portion for which the statute of limitation has elapsed.
5. Implications
The court’s ruling marks a potential turning point in the way in which corporate governance will be conducted in the future. The Seoul High Court’s decision has been confirmed by the Supreme Court36, and directors are no longer safe to make blind decisions (often based solely on the whims of the chairman of a conglomerate) without exercising their reasonable judgment.
The courts discussed the directors’ fiduciary duties and business judgment (rule) in this case. However, this case may have to be analyzed as a self-dealing case. In this case, transactions between affiliated companies essentially resulted in the transfer of value from a more successful affiliate to a less successful one, obviously to benefit the less successful company.37 The District Court should then have focused its discussion on the directors’ duty of care and negligence in an attempt to let the plaintiff prevail without having to prove all the elements of a wrongful self-dealing transaction as is quite often the case in the United States.38 It should be noted, though, that the High Court stated that this was not a case of self-dealing, and then granted the defendant directors the protection afforded by the business judgment rule.
Another issue to be noted is that outside directors were not sued even where this would have been possible. Also, those directors who were absent in the relevant meeting were held not liable because they did not know, and were not able to know, of decisions the board would take at those meetings.39

B. The Korea First Bank Case40

On 15 March 2002, the Korean Supreme Court held four former directors of the Korea First Bank (KFB) jointly and severally liable for 1 billion Korean won (approximately 800,000 US dollars) for breaching their duties as directors. According to this landmark ruling, directors of banks and other financial institutions must conform to higher standards of fiduciary duties than directors of other companies. To the author’s best knowledge, this was the first case of derivative litigation in Korea.41 Although the KCC promulgated shareholders’ derivative action in 1962, not a single derivative action had been filed until this case.42
1. Background
Between November of 1993 and January of 1997, the directors of KFB decided to grant several loans to Hanbo Steel without obtaining any collateral security. Hanbo Steel was already in serious financial difficulties when KFB provided its first loan, and in early 1997 it defaulted on the loans, which totaled approximately 1.08 trillion Korean won (approximately 830 million US dollars). By the end of 1997, Hanbo Steel still had not repaid any of the outstanding amounts, prompting KFB to sell the non-performing loans to the Korea Asset Management Corporation at a heavily discounted price, resulting in losses of nearly 270 billion Korean won (approximately 208 million US dollars), excluding interest. After defaulting, Hanbo Steel underwent corporate restructuring.
In April 1998, the minority shareholders of KFB filed a derivative suit on KFB’s behalf at the Seoul District Court. The shareholders claimed 40 billion Korean won (approximately 30 million US dollars) against the former directors of KFB for breaching their fiduciary duties under the KCC.
2. Decision
The directors argued that their decision to grant the unsecured loans fell within the scope of the business judgment (rule).
The Seoul District Court rejected this defense and ruled that the directors had breached their fiduciary duties in failing to: (1) properly analyze the risks of default; (2) secure the loans with adequate collateral; (3) properly manage the loans after granting them; (4) monitor changes in Hanbo Steel’s business plans; and (5) prevent employees from forging inspection reports relating to Hanbo Steel’s loan qualification (in fact, it turned out that some of the directors had ordered the employees to do this).
The court’s focus was not on the correctness of the decision to grant the loans, but rather on the decision-making process occurring before, during and after the decision had been taken. Initially, the directors were held liable for the entire loss to KFB of 270 billion Korean won (approximately 208 million US dollars). However, the court went on to recognize only the extent of the minority shareholders’ claim of 40 billion Korean won.
The Seoul High Court rejected the directors’ appeal. However, KFB (by then the sole plaintiff) reduced its claim from 40 billion Korean won to 1 billion Korean won (approximately 800,000 US dollars), which was awarded. The minority shareholders lost their status as KFB shareholders due to a capital reduction and were removed from the suit.
The Supreme Court upheld this ruling. The Supreme Court did not mention the business judgment rule directly but recognized the rule by stating that the failure of bank directors to get the loans repaid per se does not constitute a breach of their fiduciary duties. However, the role of banks differs from that of other companies. Banks are required to contribute to the stability of the financial markets and to the development of the national economy in the following ways: bank directors must fulfill their fiduciary duties with utmost (enhanced) care in (1) the protection of the properties of depositors; (2) the maintenance of credit systems; and (3) the promotion of efficiency in finance brokering.
The court set out the following criteria which the directors of the banks were to assess when they decided on whether to grant loans: (1) the terms and conditions of the loan; (2) the loan amount; (3) the repayment plan; (4) the existence of collateral and its substance; (5) the status of the debtor’s assets and business operations; and (6) the debtor’s future business prospects. This ruling enhanced for the first time the standards of fiduciary duties of directors of financial institutions and established standards to which financial institutions must adhere when deciding whether to grant loans. The Korean courts have increasingly emphasized the fiduciary duties of directors since the Korean financial crisis of 1997,43 and this case highlighted the trend.44
The Restructuring of Financial Institutions in Korea 1997 – 1999

Number as of the end of 1997 Revocation of Business License Merger Bankruptcy Number as of Sept. 1999
Commercial Banks 33 5 5 – 23
Merchant Banks 30 17 2 – 11
Securities Companies 36 5 – 1 30
Insurance Companies 50 4 1 – 45
Mutual Savings & Finance 231 25 4 7 195
Securities Investment Trust 31 2 – 5 24
Leasing Companies 25 – – 5 20
Total 436 58 12 18 348

Source: Korea Financial Supervisory Commission

IV. Restrictions of Directors’ Liabilities

A. Indemnification and D&O Insurance45

The KCC provides that the liability of directors to their company may be released by the unanimous consent of the shareholders of the company.46 However, such a release with respect to a public company is unrealistic since the unanimous shareholder consent of a public company is almost impossible to obtain. Therefore, as recommended in the Report and Legal Reform Recommendations to the Ministry of Justice prepared by a group of international experts, the liability of at least the outside directors should be limited in cases in which they have acted in good faith. The Report recommended that the KCC should be amended “to provide that the personal liability of an independent director will be limited, in the case of non-willful breaches of duty not involving personal benefit to the director or the director’s family, to a multiple (such as 5 times) of the director’s total annual compensation from the company (including the value of non-cash compensation).”47 By way of comparison, the 2001 revision of the Japanese Commercial Code introduced the three-way exoneration mechanism. It provides that the directors’ liability can be released by (i) a supermajority (2/3) vote of the shareholders’ meeting; (ii) a decision of the board of directors when authorized by the articles of incorporation; or (iii) a contract signed by the company and director when authorized by the articles of incorporation.48
As the validity of indemnification of directors’ liability by their companies is being disputed more frequently by legal scholars in Korea, it is becoming common practice among public companies to purchase liability insurance for directors and officers (D&O insurance) for their directors. According to the insurance industry sources, the public companies in Korea paid in 2002 a total of 67 billion Korean won in D&O insurance premiums.49 Directors can obtain D&O insurances from a number of Korean insurance companies against certain civil (but not criminal) liabilities. Coverage provided by such insurance usually includes damages resulting from such wrongful acts of directors (as well as legal fees resulting thereof) but generally will not include damages resulting from a director’s pursuit of illegal personal profit, willful misconduct or compensation claimed by major shareholders of the company. It has recently been reported that 34.4 percent of all public companies purchased a D&O policy as of December 2004.50

B. No Caremark Yet

Under the so-called Caremark rule, directors are liable if, and only if, they failed to prevent a loss as a result of a systematic failure to attempt to control potential liabilities. Directors can be sued derivatively by the shareholders when the company vicariously pays a huge fine for the illegal acts of employees. In the case from which this rule has taken its name, though, the Delaware Chancery Court held that the board of directors of Caremark International satisfied its responsibility through exercising a good faith judgment that the company’s internal control system was adequate to assure it that appropriate information would come to its attention in a timely manner even though they could not prevent some employees from paying illegal commissions to doctors.51
Although, there are generally no formal requirements on Korean companies relating to the internal control of business risks, certain specialized companies are subject to such formal requirements. For example, the KSEA provides that securities companies are required to establish internal control standards to ensure that its officers and employees (1) observe the KSEA and subordinate statutes in the course of the performance of their duties, (2) operate the assets of the company in a sound manner and (3) protect customers. In addition, securities companies are also required to have at least one compliance officer responsible for ensuring that such internal controls are being observed.52 The compliance officer shall also investigate any violations of internal control standards and report the results of such investigation to the auditor or the audit committee.53 Banking laws and insurance laws also provide similar internal control obligations on banks and insurance companies.54
The KSEA is silent on the legal effect of the well-functioning compliance system. But the Insurance Act provides that the insurance companies with good compliance system could enjoy certain benefits in terms of governmental supervision.55 The Korea Financial Supervisory Commission’s internal guideline also provides that the securities companies with good compliance system may enjoy certain benefits in terms of governmental supervision.56
Perhaps it is too early to see a Korean version of the Caremark case. It would be highly doubtful whether Korean judges would be willing to render a decision that the Caremark court rendered even if the directors of a qualified company appear as defendants before the court. However, an effective board in Korea would also need a Caremark protection especially when it is subject to enhanced level of fiduciary duties.57

V. Is Takeover Defense Business Judgment?

There is no reported court case in which a particular takeover defensive tactic was evaluated in terms of the business judgment rule. It is too early to predict whether takeover defensive tactics would be contested in terms of directors’ fiduciary duty and business judgment rule in Korea.58 However, two recent lower court decisions dealt with the legality of the takeover defensive tactics59, and it has been reported that the defendants argued that their tactics were legal and also justified as business judgment. Perhaps, the U.S. takeover law would be imported and adapted to the Korean circumstance in the future.60

A. Hyundai Elevator Case

In November 2003, Kumgang Korea Chemical, having acquired, directly or indirectly, approximately 44.39 percent of the issued and outstanding shares of Hyundai Elevator, the flagship company of the Hyundai Group, announced its plan to acquire the control of Hyundai Elevator and other companies of the Hyundai Group. The board of directors of Hyundai Elevator, in an attempt to defend Kumgang’s hostile takeover attempt, resolved to issue 10 million new shares, which was 178 percent of the then outstanding shares, at a 30 percent discount, with a condition that the number of the newly-issued shares to which any one person may subscribe cannot be more than 300 shares. Kumgang sought a preliminary injunction of the proposed issuance of new shares by Hyundai Elevator arguing that the proposed issuance was improper as it infringed on the preemptive rights of the existing shareholders and is an attempt only to perpetuate the current management.61
The Suwon District Court found that the proposed issuance of new shares was in breach of the KCC and infringed on the preemptive rights of the existing shareholders, and it granted the requested preliminary injunction.62 The court reasoned that since any attempt to defend a takeover bid should be made within the confines of the laws and regulations and the articles of incorporation of the company concerned, Hyundai Elevator’s proposed issuance of new shares, which would be allowed only to the extent necessary to raise funds for the business of the company under the KCC and the articles of incorporation of the company, was not proper for the apparent purpose of perpetuating the status of the existing controlling shareholder(s) or management.
Notwithstanding the foregoing decision of the court with respect to Hyundai Elevator board’s action, the court did not completely rule out the possibility of issuing new shares as a means of takeover defense. Specifically, the court stated that the following scenarios may be an exception to the general rule in which the company concerned may issue new shares in an attempt to avert a hostile takeover: (1) if preserving the existing controlling shareholder(s) and/or the existing management of the target company is beneficial to the company itself or the shareholders in general, or there are other specific public reasons and (2) if the target company has taken all reasonable steps in making the decision to issue new shares, such as soliciting the opinions of the disinterested shareholders or independent experts. According to the court, if these conditions were met, the issuance of new shares may not be invalidated because it would have been done for the proper business purposes as stipulated in the company’s articles of incorporation and the KCC.63

B. SK Corporation Case

The directors of SK Corp., one of the major shareholders of SK Telecom, in response to a demand by the then largest shareholder of SK Corp., Sovereign Asset Management, to replace the existing management and to suspend the subsidization of an affiliated company, decided to sell 13,208,860 treasury shares (accounting for approximately 10.41 percent of the issued and outstanding shares) to certain parties friendly to the existing management.64 Sovereign sought a preliminary injunction of the directors’ decision. It claimed that SK Corp.’s decision to sell its treasury shares to friendly parties caused the dilution of Sovereign’s voting rights, and therefore, it was being prevented from fairly exercising its voting rights in the 2004 general meeting of shareholders of SK Corp.
The Seoul District Court, however, refused to grant the preliminary injunction.65 The court opined that the disposal of any treasury shares should not be prevented even in the midst of a dispute for control of the company, provided however, that the shares have not originally been acquired to perpetuate the existing management and the controlling shareholder(s). The decision to sell the treasury shares in the court’s view was justified as a business judgment which the directors may exercise in the face of a hostile takeover threat.66

C. Current Developments

In March 2006, a control contest over KT&G Corporation opened up the legal controversy surrounding the issue of selling treasury shares to friendly parties in order to fend off hostile takeover attempts. In the course of the takeover defense against Carl Icahn and a couple of hedge funds, KT&G, the Korean cigarette and ginseng maker, was considering selling treasury shares to friendly local banks. It was reported that Icahn and his allies would take legal actions against the board of directors of KT&G if they were to have pushed ahead with such a sale. A sale of treasury shares to the banks “would constitute a breach of the board’s fiduciary duties to the shareholders.”67 The case has not been litigated because the dissident shareholders were successful in appointing one outside director onto the board of directors of KT&G through the proxy contest.
Also in March 2006, after the largest shareholder of Dealim Trading maneuvered the company so that he could buy the treasury shares himself, the second largest shareholder successfully blocked the largest shareholder’s exercise of the voting rights attached to the shares sold. The Seoul District Court Western Branch held68 that the sale of the treasury shares to a specific person violated other shareholders’ proportional interest in the company’s shareholding. This was a first instance decision that was not about the director’s fiduciary duty and business judgment. However, given that the sale of the treasury shares to friendly parties have been the most popular takeover defensive tactic so far adopted by the Korean companies, the impact of the decision will be far reaching and constrain the directors’ course of action.

VI. Fairness Opinion

It is too early to predict what role the fairness opinion would play in terms of directors’ duties and liabilities in mergers and acquisitions in Korea. It is not common practice to obtain a fairness opinion from an investment banker before closing a deal because there is no legal requirement to do so, and it is not certain whether the directors could obtain any comfort from such an opinion.69 However, there is a reported case where a fairness opinion was issued by a reputable investment banker to the board of directors of a Korean bank in a tender offer. This concerned a tender offer made in April 2004 for the common shares of KorAm Bank by Citibank Overseas Investment Corporation, a subsidiary of Citigroup.
Citibank Overseas Investment Corporation has entered into an agreement with certain of KorAm’s largest shareholders led by The Carlyle Group and JP Morgan Corsair, to acquire their KorAm shares held in the form of Global Depositary Shares, representing approximately 36.55% of the shares issued by KorAm, at the purchase price of 15,500 Korean won per share. Citibank Overseas Investment Corporation was obliged to close the transaction only if shareholders, excluding the sellers of GDSs, holding approximately 43.45% or more of the shares validly tender their shares so that, together with the sellers of GDSs, Citibank Overseas Investment Corporation would own a minimum of 80% of the shares. The board meeting which followed the announcement of the deal expressed unanimous support for the tender offer, and recommended shareholders to tender their shares.
Goldman Sachs (Asia) L.L.C., which acted as the financial advisor to the board of directors of KorAm, delivered its opinion to the board of directors of KorAm, dated 23 February 2004, that, as of the date of such opinion and based upon and subject to the factors and assumptions set forth therein, the 15,500 Korean won per share in cash to be received by the holders of the shares pursuant to the tender offer and the GDS purchase agreement was fair (as understood by the custom and practice of Goldman, Sachs & Co. in the United States for opinions of this type) from a financial point of view to such holders.70
Korean courts have not yet addressed the impact of a fairness opinion in connection with the director’s exercise of his or her fiduciary duties. However, it is likely that a fairness opinion will be considered by the court as evidence that the directors made an attempt to make a well-informed decision based on objective data and advice (including the fairness opinion).

VII. Directors’ Criminal Liabilities and the Business Judgment Rule

A. The Crime of Bae-Im and the Business Judgment Rule

In Korea, an officer or a director of a company might end up in prison for his or her failure in business judgment in respect to the investments and the operation of the company. At issue is the crime of Bae-Im.71 The elements of the offense, according to the law, are that the wrongdoer (1) owes a fiduciary duty to an entity, (2) breaches that fiduciary duty with intent, and (3) obtains pecuniary gain or causes a third person to obtain it, (4) thus causing financial harm to the entity. Courts have interpreted the “intent” requirement so as to mean “reckless disregard” for the probability of one’s action causing financial harm to the company.
The concept of Bae-Im may not be a foreign concept to many jurisdictions. For instance, German Criminal Code and Japanese Criminal Code have even wider provisions on criminal breach of trust (Untreue in German).72 With the additional requirement of pecuniary gain, Bae-Im is narrower than the German and Japanese provisions and brings this crime closer to fraud. However, the crime of Bae-Im does not involve intent to defraud the company. In fact, the law does not require that one take or convert another’s money or property to one’s own use. This is why Korean courts can impose much stricter criminal liability than courts in many common law countries to directors and officers of companies who have failed to manage their business organizations. Consequently, the courts have been criticized by legal scholars for applying the Bae-Im case so widely that the judiciary ended up creating a separate crime based upon an unconstitutional ‘Auffangstatbestand.’73
The crime of Bae-Im, thus, has important practical implications for corporate governance in Korea. In a country where the possibility of facing shareholders’ derivative suits and/or a hostile takeover attempt has been not as substantial as in other jurisdictions, the crime of Bae-Im has been utilized in challenging corporate managers and/or officers’ business actions. For example, in one case, the CEO of a large corporation was found guilty of committing the crime of Bae-Im for acquiring the newly issued shares of a financially distressed company at their face value.74 In essence, what was challenged was the CEO’s business judgment.
However, in July of 200475, a sign of change was detected in the Korean court’s willingness to tolerate the use of the crime of Bae-Im as a tool to challenge the business judgment of the officers and/or directors of a company. In particular, the Supreme Court of Korea rendered a judgment that departed from its previous decisions on the crime of Bae-Im. The factual background of the case is as follows. A representative director of a company was charged with the crime of Bae-Im for issuing an insurance coverage to an entity that subsequently went bankrupt. In fact, the director’s company was in the business of serving as a guarantor, in return for certain premium payments, for entities that needed to borrow money for business purposes. According to the company’s business model, if everything went well, the borrower paid off the loan and the company made money from the premium payments received thus far. On the other hand, should the borrower go bankrupt, the company had to pay off the loan on behalf of the insured and as a result possibly suffer a financial loss. The latter was the case at bar. The borrower went bankrupt and the company, as the borrower’s guarantor, was forced to pay off the loan in the amount that would cause financial harm to the company. Subsequently, the representative director was accused of committing the crime of Bae-Im for allegedly breaching his fiduciary duty owed to the company by issuing the insurance coverage to the borrower and causing financial harm to the company as a result.
The Supreme Court, however, acquitted the representative director in the case and stated the rationale for its decision in a language that surprisingly resembles that of a U.S. court applying the business judgment rule. Specifically, according to the Supreme Court, it is in the nature of any business that even when a director/officer of a company with care, diligence and prudence makes a corporate decision, the results show that what he or she did was unwise and as a result the company suffers financial losses. Therefore, to employ the crime of Bae-Im to challenge such business decisions, otherwise made with care, diligence and prudence without any conflict of interests, is to stifle the spirit of entrepreneurship and to violate the legislative intent of the law. This in return will be a loss to society as a whole, stated the Court. In the end the court stated that “[j]ust because a company suffered a financial loss due to what turned out to be a poor business judgment of a director, this Court, without more, shall not find a director of a company guilty of committing the crime of Bae-Im.”
The Court thus reduced the threat to corporate managers in Korea of facing a criminal charge based on their unwise business decisions, which can result in financial harm to the companies. The implications of the decision on the Korean corporate governance structure, however, remain to be seen.

B. The Leveraged Buyout and Directors’ Criminal Liabilities

A leveraged buyout (LBO) is a purchase of a corporation in which the acquiring company obtains a significant portion of the funding from investors, such as financial institutions, and provides the assets of the acquired entity (“target company”) as security to secure the purchase price. Because it is the assets of the target company that are being provided as security for the LBO, the management and directors of the target company must inevitably be involved. In an LBO, the target company’s asset-liability ratio increases and the possibility of disposition of the secured assets becomes higher because the assets are being provided as collateral for the debt. On the other hand, the direct benefits of or the profits from the funding and the security go to the acquiring company or the financial institutions from which the funding is obtained. Because of this disparity between the burden and the benefits, the transaction raises the issue of whether the directors of the target company may be held liable.76
The Seoul High Court has recently ruled, in its highly publicized judgment of 6 October 200477, that the act implementing a leveraged buyout transaction cannot be viewed as a crime of Bae-Im under certain circumstances. This case involved the issue of the liability of the representative director of the target company for breach of his fiduciary duty in an LBO transaction. In deciding on whether pecuniary loss78 has been incurred on the target company, the court stated that “although the target company provided its assets as security for the LBO and thus created the risk that the secured assets may be disposed of in the future, if existing liabilities of the target company were extinguished through the funding for which the security was established, then such pledging of the assets cannot be said to have caused loss on the company.”
Another element of the crime of Bae-Im is that the director or a third person must obtain pecuniary gain from the director’s actions. In this case, the defendant representative director of the target company had not obtained personal gain from the funding which was secured by the target company’s assets, which funding came into the company’s account as the share purchase price. Thus, the court held that the director of the target company was not guilty of a crime of Bae-Im because the director has never personally obtained any gain and all of the funding was applied toward repaying existing loans of the target company and for the purpose of financial restructuring of the target company, and therefore the actions did not include the element of “pecuniary gain” for purposes of the criminal breach of duty.
In connection therewith, there was another criminal case decided in a Korean district court where the court held that the director was criminally liable for the crime of Bae-Im. In the process of restructuring the affiliated companies of Halla Group, the major shareholder and representative director of the acquired company had established a special purpose vehicle to attract foreign investment. After it had obtained funding, the special purpose vehicle assumed the business of the acquired company and successfully restructured the acquired company. However, the representative director and officers of the acquired company were found guilty of the crime of Bae-Im. The reason was because in the process of establishing the special purpose vehicle, a portion of the equity of the special purpose vehicle was transferred to the major shareholders and the affiliated companies of the prior existing target company free of charge or at a very low price, thus causing unjust pecuniary enrichment. At the same time, it was in fact causing the target company to see the same amount of pecuniary loss.79

VIII. Some Thoughts from the Perspective of Comparative Corporate Law

The recent developments in Korea described in this article may prove to be of interest to the international legal community from a comparative law perspective. What is it that caused Korea, a German civil law jurisdiction, to adapt to an Anglo-American corporate and securities law system? Perhaps, it was the exogenous shocks Korea experienced during the financial crisis in 1997 followed by the involvement of international lending agencies in an unprecedented sweeping reform process. Korea’s efforts to adapt to the changed environment of the global market place must have been driven by the global policy that prefers a U.S./U.K. style ownership and control.80
According to the popular “law matters” proposition put forward by LLS&V,81 the laws and the quality of their enforcement by the regulators and courts are essential elements of corporate governance and finance. They have successfully showed that legal families shape the contents of the law, which in turn influences financial markets. The depth and liquidity of securities markets around the world correlate closely with particular families of legal systems, with common-law systems consistently outperforming civil-law systems. Corporate law plays an important role in the development of corporate governance structures as suggested by the close correlation seen between capital market success and legal system characteristics. Korea also must adopt the rules of common-law legal systems in order to develop their economies because civil-law legal systems provide inadequate protections to minority shareholders.
In this respect, it is interesting to put the Korean situation in perspective with that of Germany, as the recent developments in corporate governance and the capital market in Germany are quite surprising.82 Although Germany is one of the most successful economies of the world, its reform efforts have been sweeping almost like the ones found only in developing nations. German corporate and securities laws are undergoing revolutionary changes introducing inter alia, the business judgment rule,83 various financing options84 and takeover regulations.85 American legal scholars are even talking about a convergence between the U.S. and German corporate governance system which would contribute to the “end of history for corporate law.”86 What made Germany so desperate to reform its corporate governance and financial markets? To be sure, there have been several corporate scandals, but that cannot explain satisfactorily the recent developments in Germany. These developments go far beyond housecleaning, and Germany’s corporate law and financial markets are transforming into something that can be found in common law countries.87 Here, too, the market forces play an important role. Large banks in Germany wish to be transformed into investment banking houses, and German tax law has been changed so that big German banks and companies can now dispose of mega-holdings.88 These may lead to the changes in the ownership structure of German firms and German capital markets. U.S. and U.K. institutional investors89 will quickly fill the vacuum, and corporate governance practices will inevitably change according to their terms. In 1996, the 61st German Lawyers Conference (Deutscher Juristentag) discussed how to reduce the power of banks over other corporations through legal changes. Now, the banks want to unleash the corporations for the banks’ own benefit.
Considering the recent changes in Korea alongside the German trend, the Anglo-American model of corporate governance seems to be the most efficient in the evolutionary process of business organizations, although it may be true that the current Anglo-American model cannot be entirely proven as inherently superior within the market. The Anglo-American model may be the result of a political decision, as Professor Mark Roe explicated.90 But, the conclusion may be different under a radically different environment, i.e., the globalization. The Anglo-American model seems to be the most competitive in today’s environment. It may be so because of its inherent effectiveness or because the new environment itself is created by the firms with the model. In sum, it may not be accurate to describe the German situation as “Anglo-Americanization.”91 Rather, it should be characterized as a sort of globalization. As of now though, the model looks very much Anglo-American.
The difference between Korean and German approaches could be found in each country’s political situation. Both Korea and Germany try to adapt to the globalizing markets, but Korean efforts were initiated by outside disciplinary mechanisms which were designed largely by the international lending agencies dominated by the United States. To the contrary, German efforts were originated largely from market participants’ motivation to thrive in the ever globalizing economy. In the end, however, the legal developments in both of the jurisdictions converge into the Anglo-American system. Rules on directors’ fiduciary duties and liabilities, protection of the investment decisions by the business judgment rule, and the laws that cultivate the capital market, in particular the market for corporate control and restructuring, are needed. Perhaps, these examples can provide further proof to support LLS&V’s “law matters” thesis.

IX. Concluding Remarks

Contrary to the movement in the United States as seen in the Breeden Report92, there is a visible shift of corporate governance paradigm in favor of the board of directors and managers in Korea. At the surface, shareholder rights supremacy is conspicuous. However, the Korean corporate law maintains and consolidates its basic pro-board attitude adopted in 1962. The introduction of the business judgment rule in the wake of the shareholder derivative litigation and securities class action will contribute to the trend.93 Given that the effective board needs the protection of the business judgment rule, among other things, especially when the impacts of the U.S. Sarbanes-Oxley Act of 200294 are slowly being felt in Korea, this can be viewed as a welcoming development. It is ironic that the recent shareholder activism has strengthened the power of the boards of Korean companies.
The business judgment rule is a doctrine of judicial abstention.95 Therefore, application of the rule would sanction virtually all conduct of directors in defending control over and restructuring the company. In the United States, it was reported long ago that “[t]he search for cases in which directors of industrial corporations have been held liable in derivative suits for negligence uncomplicated by self-dealing is a search for a very small number of needles in a very large haystack.”96 As Professor Bernard Black suggests “[t]he case for judicial abstention is even stronger in civil law countries, where judges are often selected through an academic career track and have no practical experience.”97 As seen in the recent cases, the Korean courts seem amenable to such observation although, at the same time, remains reluctant to introduce the U.S. concepts of fiduciary duties of corporate directors. Lawyers and scholars in Korea must be aware, however, that they may be importing a black box that is widely used but not readily understood.98 Perhaps the experience in the United States may be repeated in Korea. Nevertheless, this clearly will open a new chapter for corporate law in Korea. The corporate control and restructuring cases will definitely serve the test field.
This article is a status report that does not purport in-depth theoretical and dogmatic analysis. Korea still lacks data that support such studies. Only a few cases were filed and decided in terms of directors’ duties and liabilities. Even fewer cases are available in which such rules were applied in terms of corporate control and restructuring transactions. However, the descriptions in this article clearly show where the developments are headed. This article has also illustrated that the Korean corporate system gradually adapts to the model accepted by global standards. The common law elements “transplanted” into the Korean legal system would contribute to the development of an advanced corporate governance structure of Korean companies, which ultimately would enhance their competitiveness in the global market.

Endnotes

* The author thanks Professor Gerhard Dannemann, General Editor of the Oxford University Comparative Law Forum, for helpful comments and suggestions, and Daniel Yi and Elizabeth Kim for invaluable assistance. The author also acknowledges the generous financial support of the Korea Corporate Governance Service.

** Member of the New York Bar; Adjunct Professor by University President’s Special Appointment, Korea University Business School; Dr. Jur. (Munich); LL.M. (Harvard).

1 Cf Katharina Pistor and Chenggang Xu, ‘Fiduciary Duty in Transitional Civil Law Jurisdictions: Lessons from the Incomplete Law Theory’ (2002) Working Paper; Hendrik F Jordaan, ‘A Comparative Analysis of Corporate Fiduciary Law: Why Delaware Should Look Beyond the United States in Formulating a Duty of Care’ (1997) 31 Int’l Law 133; Vassil Breskovski, ‘Directors’ Duty of Care in Eastern Europe’ (1995) 29 Int’l Law 77. On the role of the judges in the development of the corporate law, see Brian Cheffins, Company Law (OUP, Oxford 1997) 308 – 363; Luca Enriques, ‘Off the Books, but on the Record: Evidence from Italy on the Relevance of Judges to the Quality of Corporate Law’ in Curtis J Milhaput (ed), Global Markets, Domestic Institutions (Columbia University Press, New York 2003). For the German law of the directors’ duties and liabilities, see generally Marcus Lutter and Gerd Krieger, Rechte und Pflichten des Aufsichtsrats (4th edn Verlag Dr. Otto Schmidt, Köln 2002).

2 According to the rule directors should not be held liable for honest mistakes in judgment that are made in good faith, after exercising reasonable care and within the scope of their managerial authority. See generally Robert C Clark, Corporate Law (Little, Brown and Company, Boston 1986) 123 – 140; Stephen M Bainbridge, ‘The Business Judgment Rule as Abstention Doctrine’ (2003) Working Paper; Henry R Horsey, ‘The Duty of Care Component of the Delaware Business Judgment Rule’ (1994) 19 Del J Corp L 971. See also Bernard Black and Reinier Kraakman, ‘Delaware’s Takeover Law: The Uncertain Search for Hidden Value’ (2002) 96 Nw U L Rev 521.

3 Until 1962, Korea used the Japanese corporate law, which was a chapter of Japanese Commercial Code. Japanese corporate law in 1950 was modeled after the U.S. Illinois Business Corporation Act of 1933. Corporate law experts within the U.S. military occupation authorities were from the State of Illinois. See Mark D West, ‘The Puzzling Divergence of Corporate Law: Evidence and Explanations from Japan and the United States’ (2000) Working Paper (arguing that a likely explanation for the divergence between the corporate laws of Japan and the United States is the tendency of the Japanese system to rely on exogenous shocks to stimulate statutory change).

4 Cf Philip R Wood, Comparative Financial Law (Sweet & Maxwell, London 1995) 51 (characterizing Korea as a mixed Roman/common law jurisdiction).

5 See, eg, Art. 161 Aktiengesetz (Germany).

6 Art. 399 Para. 1 KCC. The director’s basic duty of care is provided in Art. 382 Para. 2 KCC that refers to Art. 681 (fiduciary duty in the agency relationship) Korean Civil Code. In practice, the duty of care shall require the directors of the following actions: duty of attention on the activities of the company; duty to attend meetings; duty to review corporate information and documents; duty to thoroughly discuss major policies and business issues; and duty to review all major filings with the regulatory agencies. Cf NACD, Governance Policy Workbook (Washington DC 2003) 24.

7 Art. 399 Paras. 2 and 3 KCC.

8 Art. 401 Para 1 KCC.

9 Art. 622 Para 1 KCC.

10 See Art. 382-3 KCC. The October 1998 amendments to the KCC included, inter alia, the concept of corporate directors’ duty of loyalty, as well as other concepts such as the de facto director, cumulative voting, and shareholder proposal right. Although the concept of corporate directors’ duty of loyalty had long been recognized by the Korean Supreme Court, the KCC did not clearly introduce the concept into the statute until the October 1998 amendments. Although Korean corporate law scholars’ opinions are split, many of them regard the newly-introduced concept as importation of the U.S. concept of duty of loyalty.
A director may effectuate a transaction with the company for his own account or for account of a third person only if he has obtained the approval of the board and can prove the fairness of the transaction. Art. 398 KCC. The KSEA provides that a public company with total assets of 2 trillion Korean won or more at the end of the immediately preceding business year must obtain approval for transaction between the largest shareholder (quite often a director) of the public company and the public company from the board and report specific matters in connection with such transaction to the first regular general meeting of shareholders held after the board of directors approves said transaction. Art. 191-19 KSEA. The KCC provides that no director shall, without the approval of the board, effectuate for his own account or for the account of a third person any transaction which falls within the class of businesses of the company or become a director of any other company whose business purposes are the same as those of the company. Art. 397 Para. 1 KCC. In addition, a director who has a special interest in a certain matter will not have a voting right in the board resolution concerning such matter. Art. 391 Para. 3 and Art. 368 Para. 4 KCC.

11 Art. 191-16 Para. 1 KSEA.

12 Art. 191-16 Para. 1 KSEA. Effective from 1 July 2004, these companies must have more outside directors than executive directors. Therefore, in theory, their board can resolve with the affirmative votes of outside directors only.

13 See generally Bernard S Black, ‘The Core Fiduciary Duties of Outside Directors’ (July 2001) Asia Bus L Rev 3; Bernard Black and Brian Cheffins, ‘Outside Director Liability Across Countries’ (2003) Working Paper (studying six comparison common-law and civil-law countries and finding “a similar pattern of a tiny but nonzero risk of actual liability”); Bernard Black, Brian Cheffins and Michael Klausner, ‘Outside Director Liability’ (2003) Working Paper (showing that “[the] principal sanction against outside directors is harm to reputation, not direct financial loss”); Cheffins (n 1) 102 – 105.

14 See Chul-Song Lee, Corporate Law (10th edn Pakyungsa, Seoul 2003) 584 – 586 (Korean).

15 Art. 401-2 Para. 1 KCC.

16 See Good Corporate Governance (Korea), Issue Report dated 23 November 2004 (discussing the unsuccessful derivative lawsuit against the former chairman of Daewoo Group).

17 Art. 8 Para. 4, Art. 14 Para 1 No.1-2 KSEA.

18 See Lyman Johnson, ‘Corporate Officers and the Business Judgment Rule’ (2005) 60 Bus Law 439.

19 See Art. 415-2 KCC. It also introduced shareholders’ resolution by written statements, ie, vote by mail, board meeting by audio-visual instruments, and stock options.

20 Art. 415-2 Para. 2 KCC.

21 Art. 54-6 Para 2 No. 2 KSEA. I Mark Defond et al., ‘Does the Market Value Financial Expertise on Audit Committees of Board of Directors?’ (2004) Working Paper (finding significantly positive CARs around the appointment of accounting financial experts to the audit committee, but not around the appointment of non-accounting financial experts or directors without financial expertise).

22 For discussions on the duties and liabilities of the audit committee members in Germany, see Roderich Thümmel, ‘Aufsichtsratshaftung vor neuen Herausforderungen’ (2004) 49 Die Aktiengesellschaft 83. The increased exposure to the legal liabilities of the audit committee members may lead to the use of outside counsel. See Geoffrey Hazard Jr & Edward Rock, ‘A New Player in the Boardroom: The Emergence of the Independent Directors’ Counsel’ (2004) Working Paper.

23 Art. 414 KCC.

24 See Lee (n 14) 553.

25 Art. 14 Para. 1 KSEA.

26 For damages arising out of stock price manipulation, the law applies from 1 January 2005 regardless of the value of the company’s assets. The securities class action is allowed if the following requirements are met: (i) the number of members in the harmed class is 50 persons or more; (ii) the class collectively holds one ten-thousandth of the total outstanding shares of the defendant corporation, (iii) major questions of law or fact are common to all members of the class, and (iv) the class action suit is an appropriate and efficient method for the members in the class to exercise their rights or protect their interests. Art. 12 SCAA. The SCAA mandates that both the plaintiff and defendant appoint a legal counsel to represent them in the suit. Art. 5 Para. 1 SCAA.

27 Art. 3 SCAA.

28 Cf Lisa M Fairfax, ‘Form Over Substance? Officer Certification and the Promise of Enhanced Personal Accountability under Sarbanes-Oxley’ (2001) 55 Rutgers L Rev 1. Currently, the Sarbanes-Oxley Act applies to ten Korean firms listed on the NYSE and NASDAQ. See Hwa-Jin Kim, ‘Cross-Listing of Korean Companies on Foreign Exchanges: Law and Policy’ (2003) 3 J Korean L 1.

29 Art. 8 Para. 4, Art. 14 Para 1 No.1-2 KSEA.

30 Case No. 98-Gahap-22553.

31 For the background of the district court’s judgment, see Hasung Jang & Joongi Kim, ‘Nascent Stages of Corporate Governance in an Emerging Market: Regulatory Change, Shareholder Activism and Samsung Electronics’ (2002) 10 Corporate Governance: An International Review 94. Cf Woo Yun Kang Jeong & Han, ‘Samsung’s Business Judgment Defense Fails’ (4 February 2002) International Law Office Newsletter.

32 Cf Smith v Van Gorkom (1985) 488 A 2d 858 (Delaware); Lynn A Stout, ‘In Praise of Procedure: An Economic and Behavioral Defense of Smith v. Van Gorkom and the Business Judgment Rule’ (2002) 96 Nw U L Rev 675; Charles M Elson and Robert B Thompson, ‘Van Gorkom’s Legacy: The Limits of Judicially Enforced Constraints and the Promise of Proprietary Incentives’ (2002) 96 Nw U L Rev 579.

33 Note that the court does not use the term “business judgment rule” here. In another case, the Supreme Court talks about “business judgment” that could potentially release the bank managers from liabilities arising out of the bankruptcy of debtors. See 2001-Da-52407, 14 June 2002.

34 Cf Weinberger v UOP, Inc. (1983) 457 A 2d 701 (Delaware); Note, ‘Using Capital Cash Flows to Value Dissenters’ Shares in Appraisal Proceedings’ (1998) 111 Harv L Rev 2099.

35 Since there was no statutory basis for this part of the decision, it almost looks like a judgment based upon equity, which represents a peculiarity of the Anglo-American judicial system.

36 Case No. 2003-Da-69638, 28 October 2005. Both parties appealed. However, it has been reported that the directors paid the damages in full to the company in December of 2003 and January of 2004.

37 See Black (n 13) 4.

38 See Clark (n 2) 126 – 128.

39 It is said that many outside directors of Korean companies are tempted to avoid board meetings dealing with sensitive agenda. Cf Barnes v. Andrews (SDNY 1924) 298 F Suppl 614.

40 Case No. 2000-Da-9086. Cf Woo Yun Kang Jeong & Han, Courts Apply Higher Standards to Directors of Banks (29 April 2002) International Law Office Newsletter.

41 On 22 August 2003, the Seoul High Court held that the shareholders of a corporation have standing to file a double derivative action on behalf of one of the corporation’s subsidiaries against the subsidiary’s directors even when they possess no shares therein. Case No. 2002-Na-13746. Cf David W Locascio, ‘The Dilemma of Double Derivative Suits’ (1989) 83 Nw U L Rev 729.

42 For a good description of the Japanese situation, see Black and Cheffins (n 13) 92 – 97. See also Shiro Kawashima and Susumu Sakurai, ‘Shareholder Derivative Litigation in Japan: Law, Practice, and Suggested Reforms’ (1997) 33 Stan J Int’l L 9; Hiroshi Oda, ‘Derivative Actions in Japan’ (1995) 48 Current Legal Problems 161; Kenji Utsumi, ‘The Business Judgment Rule and Shareholder Derivative Suits in Japan: A Comparison with Those in the United States’ (2001) 14 New York Int’l L Rev 129; Mark D West, ‘Why Shareholders Sue: Evidence from Japan’ (2002) 30 J Leg Stud 351.

43 See generally Hwa-Jin Kim, ‘Toward the “Best Practice” Model in a Globalizing Market: Recent Developments in Korean Corporate Governance’ (2002) 2 J Corp L Stud 345; Hwa-Jin Kim, ‘Taking International Soft Law Seriously: Its Implications for Global Convergence in Corporate Governance’ (2001) 1 J Korean L 1; Hwa-Jin Kim, ‘Living with the IMF: A New Approach to Corporate Governance and Regulation of Financial Institutions in Korea’ (1999) 17 Berk J Int’l L 61; Bernard Black et al., ‘Corporate Governance in Korea at the Millennium: Enhancing International Competitiveness’ (2001) 26 J Corp L 537; Amir N Licht, ‘Legal Plug-Ins: Cultural Distance, Cross-Listing, and Corporate Governance Reform’ (2004) 22 Berk J Int’l L 195.

44 In December of 1999, the Korea Deposit Insurance Corporation announced plans to commence legal actions against 764 ex-managers of 86 failed financial institutions, which amounted to a total of 5.4 trillion Korean won in damages. Such actions are based upon Art. 21-2 Korean Depositor Protection Act and most of them is still pending.

45 See generally Joseph F Johnston Jr, ‘Corporate Indemnification and Liability Insurance for Directors and Officers’ (1978) 33 Bus Law 1993.

46 Art. 400 KCC.

47 Black et al. (n 43) 579 – 580.

48 See Art. 266, Para 7, 12 and 19 Japanese Commercial Code. See generally, Tomotaka Fujita, ‘Transformation of Management’s Liability Regime in Japan: A Decade After 1993 Revision’ (20 May 2005) Working Paper presented at 4th Asian Corporate Governance Conference.

49 The Korea Economic Daily Web Edition, 1 December 2003. The international experts’ Report cited above recommends that the directors’ liability limited by a new provision of the KCC should not be further reduced by indemnification or D&O insurance. Black et al. (n 43) 580.

50 Korea Financial Supervisory Service Press Release, 6 December 2005.

51 In Re: Caremark International, Inc. Derivative Litigation Civ. A. No. 13670. Cf Stephen F Funk, ‘In Re Caremark International Inc. Derivative Litigation: Director Behavior, Shareholder Protection, and Corporate Legal Compliance’ (1997) 22 Del J Corp L 311.

52 Art. 54-4 Para. 1 KSEA.

53 Art. 54-4 Para. 2 KSEA.

54 The December 2003 amendments to the Act on External Auditors of Joint Stock Companies requires the relevant companies to prepare internal accounting control regulations and run an operational organization for drafting accounting information and disclosing it publicly. The new law also requires the auditor to evaluate the internal accounting control system each fiscal year and report the results to the board of directors.

55 See Art. 17 Para. 8 Korean Insurance Business Act.

56 See Korea Financial Supervisory Service Press Release, 5 February 2003. See generally Dana H Freyer and Rebecca S Walker, ‘How the SEC Will Credit Compliance Programs in Enforcement Decisions’ in Corporate Compliance Institute 2003 (Practising Law Institute, New York 2003); SEC, ‘Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency Enforcement Decisions’ (23 October 2001) Release No. 44969; Kirk S Jordan and Joseph E Murphy, ‘Compliance Programs: What the Government Really Wants’ in Corporate Compliance Institute 2003 (Practising Law Institute, New York 2003).

57 See Hwa-Jin Kim, ‘A Korean Version of the Caremark Is Needed’, Op-Ed Korea Economic Daily, 5 November 2003, A6 (Korean); Hwa-Jin Kim, ‘Directors’ Liabilities and the Business Judgment Rule’ (Spring/Summer 2004) Korea Association for Chief Financial Officer Quarterly Journal 6 (Korean); Hwa-Jin Kim, ‘Directors’ Liabilities and Internal Control’ (Fall 2003) Korea Association for Chief Financial Officer Quarterly Journal 6 (Korean).

58 Korean companies adopt various pre-offer as well as post-offer takeover defensive tactics, including golden parachute, supermajority vote requirements, staggered board, lock-ups, and rights offering to a friendly party. It is understood that the poison pill and dual-class common stock as they are used in the United States is not allowed under the KCC. The Korean government is considering introducing the golden share in the course of privatization. See Korea Fair Trade Commission Press Briefing Material, 6 April 2004. For takeover defensive tactics in Korea, see generally Hwa-Jin Kim, M&A and Corporate Control (3rd edn Pakyoungsa, Seoul 1999) ch 5 (Korean). Cf Ronald Gilson, ‘The Poison Pill in Japan: The Missing Infrastructure’ (2004) Working Paper.
The March 2001 amendments to the KSEA have lessened procedural requirements for tender offers to facilitate mergers and acquisitions through tender offer. Tender offers appear to be picking up the pace again in Korea as fifteen tender offers have been reported since 2003. Tender offers grew in number recently, but, more notably, the types of and purposes for tender offers have also become more diversified. It is plausible that this trend will continue and tender offers may soon be used in a far more variety of purposes in equally many forms in Korea. Out of those fifteen tender offers launched since 2003, only two were hostile.

59 Cf Center for Good Corporate Governance (Korea), Issue Report dated 12 January 2004 (Korean summary of the two court cases mentioned below).

60 See generally Ronald J Gilson and Bernard S Black, The Law and Finance of Corporate Acquisitions (2nd edn Foundation Press, Westbury 1995); Black and Kraakman (n 2); Ronald J Gilson, ‘Unocal Fifteen Years Later (and What We Can Do About It)’ (2001) 26 Del J Corp L 491; Martin Lipton and Paul K Rowe, ‘Pills, Polls, and Professors: A Reply to Professor Gilson’ (2002) 27 Del J Corp L 1; Ronald J Gilson, ‘Lipton and Rowe’s Apologia for Delaware: A Short Reply’ (2002) 27 Del J Corp L 37. But see Black (n 13) 27 (“[I] would not wish for another country to copy our confused case law.”)

61 Under the KCC, shareholders have preemptive rights. Each shareholder of a corporation has the right to purchase a proportionate share of any new shares of the corporation issued. Notwithstanding the foregoing, the corporation may issue new shares to a third party without first offering them to the existing shareholders if, and only if, (a) such possibility is specified in the articles of incorporation of the corporation and (b) such issuance is necessary for the business of the corporation, e.g., for induction of new technology or improvement of financial structure. Art. 418 KCC. The issuance of new shares for the purpose of perpetuation of the current management, however, would generally not be considered to be necessary for the business of the corporation and would not be allowed, unless the new shares are first offered to the existing shareholders.

62 Case No. 2003-Kahap-369, 12 December 2003.

63 However, the incumbent management of Hyundai Elevator has successfully defended its control over the company through various defensive tactics. By far, this was the largest hostile takeover case in the Korean history with more than ten lawsuits filed, tender offer, several disposition orders issued by the Korea Securities and Futures Commission, and intense proxy contest.

64 The KCC strictly regulates a corporation’s acquisition of its own share. Accordingly, under the KCC a corporation may acquire its own shares for the purpose of capital reduction, in the course of a merger or in other exceptional cases. Art. 341 KCC. However, the KSEA allows public companies to acquire own shares subject to certain regulations under the KSEA, without satisfying the requirements of the KCC. The KSEA allows public companies to acquire own shares only through on-exchange transactions or tender offer. Also, disposal of treasury shares of a public company must, in principle, comply with the procedure laid out in the KSEA. Under the KSEA, the company would first have to obtain approval from its board of directors for the disposal of its treasury shares and then file a report on the disposal of treasury shares with the Korea Financial Supervisory Commission. In case the company disposes of its shares through on-exchange transactions, the order for the shares must be placed in certain way and the asking price will have to be within a certain range. In contrast, if the disposal of the shares takes place off-the-market, there are no restrictions on the asking price and method of the order. To be sure, selling at significant discount may expose the company’s directors to charges of breach of their fiduciary duty and the company to claims for damages. See Art. 189-2 KSEA.
Self-tender offer is allowed under the KSEA and can be used as an effective defensive tactic. In 2001, in connection with the dispute over the control of the management of Union Steel Manufacturing between the largest shareholder and the second largest shareholder, Union Steel faced delisting of its shares from the Korea Exchange because it would be difficult to satisfy the Korea Exchange’s share distribution requirement. As minority shareholders of the company may incur losses from the illiquid stocks of the company due to such development, Union Steel made a tender offer to repurchase its own shares to protect the minority shareholders. This was Korea’s first self-tender offer and launched in the hope that the second largest shareholder would also tender. The dispute was finally resolved through a private sale and purchase made between the largest and second largest shareholders in 2003.

65 Decision of 23 December 2003.

66 The incumbent management of SK Corp. was successful in the proxy contest and, consequently, has prevailed in the general meeting of shareholders. See The Korea Economic Daily, 13 March 2004, A13.

67 ‘Icahn Threatens to Sue KT&G Board’ Financial Times, March 15, 2006, 22.

68 Case No. 2006-Kahap-393, decision of 24 March 2006.

69 See generally Lucian Bebchuk and Marcel Kahan, ‘Fairness Opinions: How Fair Are They and What Can Be Done About It?’ (1989) Duke L J 27.

70 The meaning of “fair” or “fair from a financial point of view” in a fairness opinion has not yet been established under Korean law. Therefore, it could be recommend spelling out in detail what “fair” or “fair from a financial point of view” means. The board of directors may have an obligation to look at a transaction from a “legal” and “all other relevant business” perspectives as well as “financial” point of view. For purposes of the board’s review of fairness in the context of a tender offer, the primary focus would be on the “financial” aspects of the terms and conditions of the tender offer.

71 A person who, in administering another person’s business, by an act in breach of one’s duties obtains pecuniary gain or causes a third person to obtain it and thereby causes pecuniary loss to that other person, is punishable for criminal “breach of duty of occupation.” (“Bae-Im” in Korean) Art. 356 Korean Criminal Code. There are special laws which will strengthen the penalty under certain circumstances.

72 Art. 266 German Criminal Code; Art. 247 Japanese Criminal Code.

73 See, eg, Sang-Don Yi, ‘Business Failure and Criminal Liabilities’ (2003) 560 Korean Law Ass J 61 (Korean).

74 The Supreme Court, Case No. 2004-Do-520, 24 June 2004.

75 Case No. 2002-Do-4229, 22 July 2004.

76 For two recent Delaware Chancery Court cases about directors’ duties in going-private deals, see David Leinwand and David Moss, ‘Liability Rulings Sound Alarm for US Directors’ (October 2004) Int’l Fin L Rev 31 (examining In re Emerging Communications, Inc Shareholders Litigation and In re Cysive, Inc Shareholders Litigation).

77 Case No. 2003-No-3322.

78 In proving pecuniary loss in terms of the crime of Bae-Im, the loss need not be ascertained specifically, nor does the loss have to be immediately realized. Pecuniary loss is interpreted as including the case where the “risk” of pecuniary loss is increased.

79 Seoul Criminal District Court, Decision of 4 October 2002.

80 See Ronald J Gilson, ‘Controlling Shareholders and Corporate Governance: Complicating the Comparative Taxonomy’ (2005) Working Paper 7.

81 Rafael La Porta et al., ‘Investor Protection and Corporate Governance’ (2000) 58 J Fin Econ 3; Rafael La Porta et al., ‘Legal Determinants of Outside Finance’ (1997) 52 J Fin 1131; Rafael La Porta et al., ‘Law and Finance’ (1998) 106 J Pol Econ 113; Rafael La Porta, ‘Corporate Ownership Around the World’ (1999) 54 J Fin 471.

82 See, eg, articles and reports published in the recent issues of Die Aktiengesellschaft (one of the leading corporate and securities law journals in Germany).

83 Walter G Paefgen, ‘Dogmatische Grundlagen, Anwendungsbereich und Formulierung einer Business Judgment Rule im künftigen UMAG’ (2004) 49 Die Aktiengesellschaft 245; Johannes Semler, ‘Zur aktienrechtlichen Haftung der Organmitglieder einer Aktiengesellschaft’ (2005) 50 Die Aktiengesellschaft 321.

84 See York Schnorbus, ‘Tracking Stock in Germany: Is German Corporate Law Flexible Enough to Adopt American Financial Innovations?’ (2001) 22 U Penn J Int’l Econ L 541, 612-614.

85 Johannes Semler and Rüdiger Volhard (eds), Arbeitshandbuch für Unternehmensübernahmen (Verlag C.H.Beck, München 2003).

86 Henry Hansmann and Reinier Kraakman, ‘The End of History for Corporate Law’ (2001) 89 Geo L J 439, 456.

87 For the current discussions on corporate governance and finance in Germany, see generally Stefan Prigge, ‘A Survey of German Corporate Governance’ in Klaus J Hopt et al. (eds) Comparative Corporate Governance: The State of the Art and Emerging Research (OUP, Oxford 1998); Peter Ulmer, ‘Aktienrecht im Wandel – Entwicklungslinien und Diskussionsschwerpunkte’ (2002) 202 Archiv für die civilistische Praxis 143; Brian R Cheffins, ‘The Metamorphosis of “Germany Inc.”: The Case of Executive Pay’ (2001) 49 AJCL 497; Theodor Baums, ‘Changing Patterns of Corporate Disclosure in Continental Europe: the Example of Germany’ (2002) Working Paper; Peter Ulmer, ‘Der Deutsche Corporate Governance Kodex – ein neues Regulierungsinstrument für börsennotierte Aktiengesellschaften’ (2002) 166 Zeitschrift für das gesamte Handelsrecht und Wirtschaftsrecht (ZHR) 150; Marcus Lutter, ‘Die Erklärung zum Corporate Governance Kodex gemäß §161 AktG’ (2002) 166 ZHR 523.

88 ‘German Utilities Get Back to Their Roots’ Business Week (Aug. 6, 2001) 27. Cf Peter O Mülbert, ‘Bank Equity Holdings in Non-Financial Firms and Corporate Governance: The Case Study of German Universal Banks’ in Klaus J Hopt et al. (eds) Comparative Corporate Governance: The State of the Art and Emerging Research (OUP, Oxford 1998); Gary Gorton and Frank A Schmid, ‘Universal Banking and the Performance of German Firms’ (2000) 58 J Fin Econ 29; John Cable, ‘Capital Market Information and Industrial Performance: The Role of West German Banks’ (1985) 95 Econ J 118.

89 See Robert Monks, The New Global Investors (Capstone Publishing Ltd, Oxford 2001) 79-110.

90 Mark J Roe, Political Determinants of Corporate Governance – Political Context, Corporate Impact (OUP, Oxford 2002); Mark J Roe, ‘Political Preconditions to Separating Ownership from Corporate Control’ (2000) 53 Stan L Rev 539; Mark J Roe, Strong Managers, Weak Owners: The Political Roots of American Corporate Finance (Princeton University Press, Princeton 1994).

91 Cf R Daniel Keleman and Eric C. Sibbitt, ‘The Americanization of Japanese Law’ (2002) 23 U Penn J Int’l Econ L 269.

92 Cf Cleary Gottlieb, MCI and the Emerging Extra-Regulatory Approach to Governance (22 September 2003); Richard C Breeden, Restoring Trust: Report to the Hon. Jed S. Rakoff, the U.S. District Court for the Southern District of New York, on Corporate Governance for the Future of MCI, Inc. (2003).

93 See Black, Cheffins and Klausner (n 13) 61 (“When other countries adopt US style duties, will they also adopt our liability-mitigating rules? If not, they are adopting a very different regime. Conversely, if other countries limit actual liability, will they have the complementary institutions that, in the US, produce vigilance despite the low risk of actual liability?”) See also Bernard Black, ‘The Legal and Institutional Preconditions for Strong Securities Markets’ (2001) 48 UCLA L Rev 781 (arguing that strong securities markets depend on a host of interconnected legal and market institutions).

94 Sarbanes-Oxley Act of 2002 was enacted on 30 July 2002, and broadly covers accounting and corporate governance reform. Most provisions of the law apply to U.S. and non-U.S. companies required to file periodic reports with the United States Securities and Exchange Commission. See generally Roberta Romano, ‘The Sarbanes-Oxley Act and the Making of Quack Corporate Governance’ (2004) Working Paper.

95 Ronald J Gilson, ‘A Structural Approach to Corporations: The Case Against Defensive Tactics and Tender Offers’ (1981) 33 Stan L Rev 819, 823.

96 Joseph Bishop, ‘Sitting Ducks and Decoy Ducks: New Trends in the Indemnification of Corporate Directors and Officers’ (1968) 77 Yale L J 1078, 1099.

97 Black (n 13) 16.

98 See, eg, Bainbridge (n 2) 1-2; Henry G Manne, ‘Our Two Corporation Systems: Law and Economics’ (1967) 53 Va L Rev 259, 270 (noting that the business judgment rule is “one of the least understood concepts in the entire corporate field”). See also Franklin A Gevurtz, ‘The Business Judgment Rule: Meaningless Verbiage or Misguided Notion?’ (1994) 67 S Cal L Rev 287.

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