On 27 May 2016, South Korea's STX Offshore & Shipbuilding Co. ("STX OS"), once the country's fourth-largest shipbuilding firm by revenue, filed for court-supervised rehabilitation, in the Seoul Central District Court.

The global maritime and shipbuilding industry has been reeling since 2008, hit by what has been called a "perfect storm" of factors such as a glut of vessels and low freight rates. Multi-billion dollar financial bailouts have failed to rescue companies such as STX OS and it appears that until structural changes are implemented to the industry, the wave of insolvency and rehabilitation proceedings will continue.

It is therefore apposite to revisit the effect of such insolvency and rehabilitation proceedings on contractual counterparties.

Can the contract be terminated?

The first step should be to review the terms of the contract to ascertain whether the commencement of insolvency or rehabilitation proceedings constitutes an event of default under the terms of the contract, entitling termination. If no such contractual right to terminate exists, then the counterparty may have to continue performance whilst bearing the risk of not being paid.

However, a recent decision of the Singapore Court of Appeal[1] suggests that, even absent an express contractual right to terminate, a counterparty may be able to argue that the fact of an insolvency or rehabilitation application constitutes an anticipatory repudiatory breach of the contract, entitling the innocent party to terminate.

Statutory moratoriums against proceedings

One key feature of insolvency and rehabilitation proceedings in most legal systems (including Korea) is the freezing of the company's debts and the imposition of a moratorium against proceedings by unsecured creditors.

This means that an unsecured creditor will be unable to recover any uncollected debt directly from the insolvent company, leaving it to prove its debt in the insolvency. Further, an unsecured creditor will typically only receive a distribution in the insolvency after secured and preferential creditors are paid. For companies such as STX OS, which reportedly owes over 6 trillion won (US$5 billion) to financial institutions, an unsecured creditor is likely to receive a fraction (if any) of the total amount owed to it.

Foreign recognition of Korean insolvency or rehabilitation proceedings

For foreign counterparties contemplating proceedings against STX OS outside of Korea, there is an additional question of whether the Korean moratorium against proceedings will be recognized overseas. South Korea has adopted the UNCITRAL Model Law on Cross Border Insolvency ("the Model Law"), which makes it likely that STX OS' rehabilitation order, when granted, will be given recognition in other adopting states e.g. Australia, UK, USA, and Japan. This means that proceedings in these jurisdictions are likely to be stayed by a moratorium.

Singapore is not yet an adopter of the Model Law and is "not bound by any stay of legal proceedings that flows from a foreign winding-up order in the absence of local winding-up proceedings".[2] Whether and how the Singapore court will render assistance to foreign winding-up proceedings through the regulation of its own proceedings will depend on the particular circumstances before it.

China is also not an adopter of the Model Law and will not automatically recognize the Korean rehabilitation proceedings or any moratorium imposed by the Korean courts.

Insolvency set-off

Lastly, if your counterparty is at risk of insolvency but is not yet the subject of a formal insolvency or rehabilitation application, it may be worth considering whether to manoeuver into a position where you can benefit from an insolvency set-off.

For example, if the counterparty owes you US$1 million but you owe it US$750,000, after insolvency set-off takes place, your liability to the counterparty is discharged and you need only prove for the balance US$250,000 in the insolvency. Effectively therefore, you receive the benefit of US$750,000.

To maximize the value of insolvency set-off, subject to the terms of the contract, debt can be assigned from a party who is a net creditor to a net debtor, such that the latter can rely on an insolvency set-off.

Note that any assignment of debt after the commencement of insolvency or rehabilitation proceedings will generally be void. Therefore, it is important to act quickly to effect such an assignment.