This update summarizes the rules that apply to mergers and acquisitions of financially troubled companies based on the practices of the Korean courts and the Practice Guidelines on Mergers and Acquisitions of Companies Under Court Protection promulgated on January 31 2000 (most recently amended on October 9 2001 by the Seoul District Court).
Since the International Monetary Fund crisis hit Korea in late 1997, a number of companies have sought court protection pursuant to the provisions of the Corporate Reorganization Act. Under the act, financially troubled companies may be reorganized and returned to economic viability pursuant to court-approved plans which reduce, delay or continue the interests of their creditors, shareholders and other relevant parties over an extended duration. Under these reorganization plans, a large number of troubled companies' assets, particularly commercial real estate, have been sold to foreign investors.
Recently, however, the Korean courts have become more enthusiastic about sales of financially troubled companies to new investors, subsequently disqualifying the companies from court protection under the reorganization plans. It is reported that the Seoul District Court successfully oversaw the sale of two companies in 2000, 14 in 2001 and six in the first quarter of 2002, and wound down the reorganization proceedings for each, subsequent to sale.
Where financially troubled companies are sold, new investors become controlling shareholders by subscribing for newly issued shares, coupled with a capital reduction without consideration by way of either redemption or consolidation of existing shares. This mechanism can help companies to reduce their debt load and find new owners who are interested in the continued and successful operation of such companies. In addition, if the sale of a company to new investors is approved at a creditors meeting, the company can bypass the need for court protection, thereby reducing the workload of the country's courts.
The Seoul District Court has established several guiding principles for the sale of financially troubled companies, according to which the key players are the trustee, the court and the new investor.
Court-appointed trustees initiate all sales efforts. Under the court's supervision, trustees have authority over the business operations of financially troubled companies, and can decide whether and how sales of companies are made. The sale of a company involves a capital reduction without compensation by way of redemption or consolidation. However, the company need not adopt a shareholders' special resolution or notify creditors of any filing period for objections. Thus, neither shareholders nor creditors have any voice regarding the sale. In contrast, if a company or its assets are sold other than through a plan of reorganization, the creditors do have a say in approving an amended plan reflecting the sale and allocation of sale proceeds, although the court must ultimately confirm the amended plan.
The court has wide scope in approving any amended plan of reorganization. According to the court's practice, investors are encouraged to subscribe for a majority interest in the financially troubled company. The cash procured by issuing new shares to investors is used to pay the pre-petition creditors. In selecting the investors, the court tends to emphasize the investors' commitment to the continued management of the company. Thus, in practice, investors are required to allocate at least one-half of the acquisition price to the company's shares. The Korea Securities Depository holds the relevant stock certificates for one year after acquisition in order to prevent any transfer. The other half of the acquisition price can be injected into the troubled company in the form of loans. Investors have priority over the pre-petition creditors, since their investments can be fully secured against the company's assets.
The amount of investment depends on the company's financial status. While not necessarily more than the company's debt, it is more than the company's liquidation value. As the company's debt after the commencement of court protection proceedings is not affected by the amount of investment, the actual investment amount includes the amount of assumed debts. In order to raise the maximum funds to be introduced to a troubled company, the court and trustee generally proceed with a sale by public auction under the court's established rules.
Once the court and trustee decide to auction the company, the court advises the trustee to work with a financial adviser who:
- evaluates the company's value;
- prepares a sales strategy and information memorandum;
- approaches potential investors;
- evaluates bids received;
- produces a debt restructuring plan; and
- attempts to persuade creditors to approve the sale.
The financial adviser is selected through a public bidding process, which the court supervises and approves.
The financial adviser starts with the vendor's due diligence for valuation and then prepares the sales strategy with the court and trustees. General rules are prepared governing the auction and the criteria for selecting an initial and favoured bidder. The information memorandum is mailed to potential investors to solicit non-binding indications of interest, detailing:
- the amount of secured and unsecured debts;
- guaranteed debts and trade debts under the reorganization plan;
- the amount of debt incurred after court protection commenced and to be assumed once the protection is lifted; and
- a confidentiality agreement and draft letter of intent for signing or comment.
Potential investors are given limited access to the data necessary to prepare bids. The court, trustee and financial adviser consider the bid amount and the financial and management capability of the bidder, among other things. Once a bidder is selected, a letter of intent is signed which is binding but subject to further negotiations regarding detailed terms of investment. Usually the trustee requests a deposit of 10% of the investment as liquidated damages, in case a definitive contract is not finalized.
Once the letter of intent is executed, the investor has full access to the company's books and records. Based on the due diligence, the investor and trustee discuss the final figure as well as the possibility of restructuring outstanding debt. The letter of intent tends to try to limit the scope of post due diligence adjustment. Then an investment agreement is signed. The amount of investment can be a combination of equity and loans but is subject to several conditions,including:
- approval of the debt restructuring at a meeting of creditors, shareholders and other relevant parties;
- deregistration of any security interests over the company assets; and
- subsequent release from the court protection procedure.
Generally, the debt restructuring includes an additional redemption/consolidation of outstanding shares, conversion of debt into equity and additional reduction of secured debts.
The gross national product of the Korean economy is estimated to increase by more than 5% in 2002. On this basis, many Korean companies appear to be attractive targets for investments. However, pitfalls remain, as general rules and practices have yet to be fully developed by Korean jurisprudence. One example is the approval process of the creditors and court; it is difficult to assess any potential return on investments without a clear picture of a company's debt restructuring and future debt service burdens. Accordingly, the ground rules for the auction process should be expanded to clarify the investor's role. Nonetheless, mergers and acquisitions of financially troubled companies represent a challenging and potentially rewarding investment opportunity.
For further information on this topic please contact Young-Cheol Jeong or Sung Wook Eun at Woo Yun Kang Jeong & Han by telephone (+822 528 5200) or by fax (+822 528 5228) or by email ([email protected] or [email protected]).