Frequency of M&A disputes
The number and value of Korean M&A deals have been continuously increasing since the 1997 Asian financial crisis. In particular, records were broken between 2014 and 2016, with sharp increases in M&A activity in the Korean market resulting from a significant number of inbound deals and many domestic transactions, partly driven by internal restructuring of Korean conglomerates and global and local private equity funds. While there are no published statistics on how many M&A transactions result in litigation or arbitration, market trends show that the number of disputes has grown in proportion to the M&A market. In 2017 and 2018, the volume and value of M&A deals declined considerably but then shifted back to an increase in 2019. The number and value of M&A deals in 2019 reached 456 cases and US$60 billion, respectively, which is a 13.8 per cent year-on-year growth in value and the highest ever number of deals. Notably, the growth in outbound investment appears the highest in overseas direct investment.
With the increasing sophistication of the Korean M&A market during the past 20 years, deal structures and contractual arrangements have become more complex and highly customised to meet the various needs of the parties. As a result, the nature of the claims and disputes has also become more varied, leading the courts and arbitral tribunals to address new and complex issues, and bringing more clarity to some previously ambiguous areas of law in the M&A context.
The outbreak of covid-19 is expected to bring about significant changes in the M&A transaction market in 2020. While it is too early to predict how the pandemic will affect the M&A transaction market in Korea, and it may have a short-term chilling effect, we do not expect this will result in a significant reduction of related disputes. If anything, considering the overall market trend observed since the late 1990s and the seasoned parties in the market, we foresee the number, complexity and variety of disputes related to M&A transactions continuing to increase in the long term.
Form of dispute resolution
While the majority of M&A disputes that involve domestic parties are still predominantly resolved through Korean court proceedings, disputes arising out of cross-border transactions are much more frequently resolved through arbitration. ‘Phased’ dispute resolution, which requires mediation or expert determination prior to litigation or arbitration, is less frequently found in M&A contracts.
Data published by the Korea Fair Trade Commission indicates that the percentage of M&A deals in Korea involving at least one foreign party between 2014 and 2016 was around 22 per cent, which is roughly consistent with our view on the ratio of contracts with arbitration clauses (involving one or more foreign parties) versus contracts selecting court litigation in M&A disputes.
Grounds for M&A arbitrations
The most frequently cited bases for M&A arbitrations are misrepresentations and breach of warranties. As misrepresentation and breach of warranty claims are provided for in most M&A contracts, parties are likely to be familiar with and comfortable raising such claims. Given that most of the operative representations and warranties are provided by the seller, the majority of the claims are asserted by the buyer. Nonetheless, indemnity escrow arrangements are frequently used in Korea, and the seller at times will be the first to initiate a claim for release of the escrow amount, or raise it as a counterclaim.
Claims based on misrepresentation and breach of warranty are often accompanied by claims for breach of covenant. Claims regarding pre-closing covenants are closely aligned with misrepresentation and warranty claims (e.g., continuing obligation on the accuracy of representations and warranties, absence of material adverse change, notice or approval provisions). In situations where the buyer or target company are in the same industry as the seller, claims for breach of post-closing covenants (e.g., non-compete, non-solicitation, intellectual property issues) are also not infrequent.
Claims of tort related to pre-contractual failure to disclose and fraud claims are possible under the Korean Civil Code, but are still rare in Korea. As various limitations on liability for breaches in M&A contracts are increasingly common, claimants are starting to consider ways around the limitation by raising tort and fraud claims either in arbitration together with other contractual breach claims or through parallel litigation.
The post-closing price-adjustment mechanism through use of closing accounts has been a common pricing method in Korea, but claims related to price adjustments (often involving requirements for expert determinations) have been rare and are more generally raised as breach of representations and warranty claims. In cases where buyers retain a holdback as indemnity for price adjustments, sellers have initiated claims or counterclaims for release of the holdback.
Claims related to earn-outs are rare in Korea but not unheard of, as earn-out mechanisms are not frequently used in sizable Korean transactions other than occasionally in transactions involving start-up companies or where the parties are unable to resolve their differences in valuation.
Disputes regarding failure to complete the transaction, especially related to break-up fees, are frequent in Korea, but the majority have been raised in litigation, as most of the operative agreements did not contain arbitration clauses. We expect to see an increase in arbitration relating to failure to complete in the future; for example, a high-profile dispute between two private equity funds regarding the cancellation of the acquisition of a parcel delivery company was reported to be in arbitration.
Disputes regarding the rights of minority shareholders to exit under shareholder agreements, such as a put option or a drag along, have been on the rise recently. Several high-profile arbitration cases filed by financial investors in relation to their put option execution against the controlling shareholder are currently pending. In an appellate decision in 2018, the court ordered a company to purchase the shares of the investors who were unable to exit using their drag-along rights when the company failed to cooperate in the drag-along process.
With the outbreak of covid-19, we expect to see an increase in disputes focusing on the following issues:
- interpretation of material adverse effect clauses as a prerequisite for closing;
- applicability of force majeure in delaying or refusing to close; and
- valuation changes resulting from fluctuations in the macroeconomy.
Two M&A deals between air carriers in Korea were recently terminated, one reportedly due to the seller’s non-fulfilment of a condition precedent regarding the handling of accounts payable and the other due to the buyer’s request for further due diligence following a sharp drop in the performance of the target company in the first quarter of 2020. It remains to be seen whether these will lead to disputes.
Fraud and failure to disclose
Claims related to failure to disclose or fraudulent misrepresentation in M&A transactions are generally raised by the buyer in connection with the information or representations provided by the seller during due diligence or contract negotiations. These claims are often brought for breach of representations and warranties terms in the contract, and the substantive standards tend to follow the requirements provided in the language of the relevant provisions.
Separately from contractual claims, a tort claim based on fraudulent misrepresentation or failure to disclose could be brought by the buyer. According to general statutes on tort under the Korean Civil Code, the party claiming tort would be required to prove four elements to establish tort liability: unlawfulness of the act, wilfulness or negligence, damage and a causal connection between the act and the damage. However, a tort claim based on fraud is less frequently raised in M&A disputes as it would require an exceptional situation where the failure to disclose amounted to fraud, wilful concealment or deception.
A frequent defence raised by the sellers in responding to claims related to failure to disclose or misrepresentation is that the buyer had actual knowledge of the allegedly undisclosed or misrepresented facts and should not be allowed to claim damages based on the good faith principle. In 2015, the Korean Supreme Court rendered a notable decision regarding the ‘knowledge’ defence. The Supreme Court held that the buyer’s prior knowledge of the seller’s misrepresentations and breach of warranties at the time of the execution of the agreement should not affect the buyer’s right to seek a remedy, unless the parties expressly agreed to exclude matters known to the buyer from the scope of representations and warranties. The Supreme Court added that limitation of contractual right by the application of the good faith principle should only be made in extremely exceptional cases. This decision sets a clear precedent in favour of sandbagging in M&A disputes where the underlying M&A contract does not contain an anti-sandbagging clause.
Burden of proof
The basic rule for burden of proof under Korean law is that each party bears the burden of proving the facts it seeks to rely on. As a result, the claimant must prove the underlying facts that constitute its claim, and the responding party must prove the facts for its defence. Such distribution of burden of proof is consistently applied, unless the burden is switched or alleviated by act of law or established jurisprudence.
Switching or alleviation of the burden of proof is applied in limited circumstances under Korean law. For instance, Korean courts have applied an ‘alleviated’ standard for establishing causation between environmental harm and damages considering its technical and complex nature. However, this alleviation of burden of proof has not often come up in the context of M&A disputes.
Under the Civil Code, while ‘wilfulness or negligence’ is an element of breach of contract, in contrast to tort claims the claimant is not required to prove wilfulness or negligence of the non-performing defendant. It is up to the non-performing party to prove the absence of wilfulness or negligence as part of its defence; for example, by establishing that the non-performance is attributable to circumstances beyond its control. If it is established that the performance became impossible through no fault of either party, the parties are released from their obligations under the contract. The statutory effect is similar to force majeure even if a force majeure clause is not specifically included in the contract.
There are no specific rules or standards on whether the knowledge of management or other representatives of the target can be treated as knowledge of the sellers, who are often shareholders of the target. In practice, terms are often included in M&A contracts to determine the scope of groups’ knowledge. Therefore, the decisions of the courts or the arbitral tribunals largely depend on the facts of the case and the contractual language on the scope of knowledge.
If there is no particular definition or provision in the agreement with regard to the criteria of persons whose knowledge is taken into account, general principles from the Commercial Code will be applied to interpret the agreement. The knowledge of the seller’s directors, who make material business decisions of the company through board resolutions, would be considered as the seller’s principal knowledge, and if any of the seller’s directors were also serving as directors of the target, their knowledge is likely to be seen as the seller’s. Generally, such directors are the registered directors who are official members of the board.
However, in the context of director’s liability, the Commercial Code expands the meaning of ‘directors’ to unregistered directors or persons under various titles that have de facto control or influence over the operations of the company or have active participation in the execution of the company’s business, which means certain persons exercising the authority of an executive officer or ‘management’ may be held to bear the same liability as a registered director. The same approach is likely to be applied in determining the scope of persons whose knowledge could constitute that of the company.
In determining whether knowledge held by certain representatives of the target should be imputed to the seller, the actual role, involvement and responsibilities of the seller in the target’s day-to-day management will be significant factors that the court will take into account. If any of the seller’s directors or executives were appointed as the target’s director or executive, such facts may be used as grounds to ‘pool’ the knowledge of the seller and the target. Also, according to the ‘expanded’ approach under the Commercial Code, participation by the seller in the target’s operation of its business is likely to contribute in establishing the nexus between the seller’s and the target’s knowledge. The actual pooling of knowledge is likely to depend on the facts of the case, including the role and responsibility of the relevant individual according to the by-laws or internal regulation of the company. In the context of M&A transactions, knowledge of the person in charge of the deal on the seller’s side would be particularly relevant.
As remedies for breach of contract in the context of M&A disputes, claimants may seek performance of specific actions, such as transfer of shares or assets as required under the contract, or seek compensation of monetary damages in lieu of performance. In practice, monetary damages claims are more commonly sought by claimants in M&A disputes in accordance with the contractual mechanism agreed between the parties, such as price adjustment and indemnification, or as general damages claims based on breach of contractual obligation or tort. In cases of specific performance, the award will take the form of an order requiring the respondent to take certain action, or of an order that is a constructive statement by the respondent (e.g., to provide consent).
Under the Civil Code, a party may terminate or cancel a contract based on non-performance of a material obligation by the other party. In addition to statutory termination rights, a party claiming fraud may seek to rescind the contract by arguing that the agreement was based on fraud by the other party. If such claim is accepted, the expression of intention to agree to the contract is revoked and the contract is retroactively rescinded in accordance with the Civil Code. However, in practice, statutory rescission claims are rarely accepted in the context of M&A disputes.
Generally, contractual termination terms as defined in the contracts will be given deference, and statutory termination rights are less frequently used. Termination or cancellation of the transaction becomes less of an issue after the closing because most M&A contracts specify that no unwinding of the transaction is allowed after closing.
The statutory interest rate for monetary damages is set at 5 per cent per annum under the Civil Code, unless otherwise agreed between the parties. However, the statutory rate of 6 per cent per annum can be applied under the Commercial Code where the parties are entities or natural persons in commercial business, which would likely apply to most M&A transactions. The Special Act on Expedition of Litigation provides that an interest rate of 12 per cent per annum shall apply to monetary damages claims from the date of filing of the lawsuit. Although this Act applies to litigation in Korean courts, some tribunals have applied this interest rate for arbitrations seated in Korea.
Measure of damages
The Civil Code defines two broad categories of compensable damages in both contract and tort claims under Korean law: ordinary damages and special damages. Ordinary damages are those that are commonly expected to result from a breach of contract or a particular tort. While not specifically defined by law, ordinary damages can be claimed for loss that may be expected to ordinarily flow from the underlying act in question. The claimant needs to prove the amount of loss that was directly or proximately caused by the breach or the tortious act to recover ordinary damages. Special damages arise through circumstances that are specific to the parties’ situation other than ordinary damages. Special damages can be sought only when the breaching party ‘knew’ or ‘could have reasonably foreseen’ such circumstance.
Under Korean law, punitive damages in civil claims are not recognised or recoverable, unless specifically provided by law. (For example, the Product Liability Act prescribes ‘triple’ damages for intentional disregard of defective products.) In fact, if a foreign court judgment or an arbitral award governed by foreign substantive law grants punitive damages, it is possible that a Korean court would reject enforcement. The Civil Procedure Act specifically provides that the court shall reject enforcement of a foreign money judgment on damages if the judgment is in serious conflict with the laws of Korea. There are court precedents where the punitive damages portion of a foreign judgment was excluded from the scope of enforcement, and for this reason, Korean courts may find arbitral awards ordering payment of punitive damages to violate public policy under the New York Convention.
Contractual liquidated damages and penalty provisions are recognised in Korean legal practice. Nonetheless, the Civil Code empowers the court to review and reduce the liquidated damages agreed between the parties if the court finds the amount to be unjustly excessive. In contrast, the court has no power, in principle, to reduce the penalty. Therefore, the claiming party usually attempts to portray the relevant provision as a penalty clause instead of liquidating damages to avoid discretional reduction by the court. This can become an issue with ‘break-up fees’ or ‘guarantee deposits’ in the M&A context, allowing the buyer to terminate the contract by giving up the deposit delivered to the seller, or the seller to terminate by paying reverse break-up fees. Unlike penalties, if a court determines the guarantee deposits to be payment of liquidated damages for early termination, the amounts at issue may be subject to the review of the court.
In 2016, the Korean Supreme Court rendered a noteworthy decision on break-up fees, reversing the lower court decisions in a case brought by the buyer for the return of a performance guarantee deposit in a failed acquisition deal. The key question was whether the guarantee deposit constituted a ‘penalty’ or ‘liquidated damages’. Although the language of the contract expressly specified that the guarantee deposit would constitute a penalty for breach of the underlying agreement, the Supreme Court found that the facts strongly supported the nature of the guarantee deposit as that of liquidated damages for failure to complete the transaction. The Court went on to find the amount of damages to be excessive and accordingly ordered a reduction of the amount. The case demonstrates that Korean courts may be willing to look beyond the contractual language in determining the nature of the break-up fees, depending on the facts and circumstances of the dispute.
Special substantive issues
Korean law provides a wide scope of set-off rights. The right to exercise set-off requires matching mutual obligations that are due and payable between the parties, but these obligations need not necessarily share the same contractual or factual grounds. As a result, most monetary payment obligations are considered to be eligible for set-off under Korean legal practice, unless parties specifically agreed to exclude such obligations from set-off. Set-off rights can be asserted within court litigation or arbitration proceedings and also outside the dispute context by notification of such intention. Set-off is frequently argued in M&A disputes, as parties often hold corresponding payment obligations related to indemnity payments, hold-back or escrow.
Claims of set-off under Korean law may create conflict with the jurisdiction of the tribunal in international arbitration. There is currently no certainty on the jurisdiction of the arbitral tribunal to examine a dispute related to the exercise of set-off rights arising from a contract separate from the contract containing the arbitration agreement. If the responding party rejects the set-off by arguing that the alleged corresponding claim does not exist or is not due and payable, the arbitral tribunal may be asked to examine factual and legal matters beyond its jurisdiction, which may eventually subject the award to challenge. As such, in practice, set-off claims in international arbitrations are generally limited to claims arising from the same agreement or closely related agreements that are subject to arbitration.
Meanwhile, even though the Korean courts’ requirements for establishing the elements of force majeure are similar in substance with many other jurisdictions, the courts have traditionally interpreted the standards very strictly due to the concern that exempting a party’s obligations by citing force majeure has the practical effect of shifting the damage or loss to the other party. While possible in principle, it is difficult to find a case precedent in which a court exempted a party’s contractual obligation due to force majeure. For example, in a 2002 Supreme Court decision, the Court did not recognise the 1997 Asian financial crisis and the resulting setbacks affecting the supply of materials as a force majeure event, finding it to be a foreseeable event without clarifying the reasons for such a view. Thus, we expect any international arbitration claims of force majeure under Korean law to give rise to various theories and arguments in its interpretation and application.
Special procedural issues
The scope and procedure of document production in international arbitrations with a Korean nexus are not significantly different from the generally accepted practice in international arbitration proceedings. However, arbitrations under the Korean Commercial Arbitration Board (KCAB) domestic rules tend to follow Korean court litigation procedure, which allows a substantially narrower scope of document production compared with the generally accepted standard in international arbitration proceedings. As in litigation, in KCAB domestic proceedings, there may not be a separate step for ‘document production’ and, instead, a party may need to ask the tribunal to order the other party to produce certain documents during the arbitral proceedings. The party making the request must specify the documents being requested and provide the grounds for such request. In practice, production requests are usually limited to a narrow scope of specific documents with clear relevance.
Multiparty arbitration can be particularly relevant, as many M&A transactions involve more than two parties. While the KCAB International Arbitration Rules were amended in 2016 to enable arbitral tribunals to allow third parties to be joined in certain conditions, there are, as yet, no specific provisions in the Arbitration Act and no clear court precedent on multiparty arbitration issues, such as consolidation of multiple arbitral proceedings or joinder of additional interested parties. It remains to be seen whether the changes in the KCAB Rules will spur further changes in the practice of international arbitration and the courts’ acceptance of multiparty proceedings in Korea.
 Chul-Won Lee is a partner, Una Cho is a senior foreign attorney and Hye Won Chin is an associate at Kim & Chang.
 Mergermarket South Korea Trend Summary Q1–Q4 2019.
 M&A Trend Reports issued by the Korea Fair Trade Commission for 2014 to 2016. See www.ftc.go.kr/www/selectReportUserView.do?key=10&rpttype=1&report_data_no=7199; www.ftc.go.kr/www/selectReportUserView.do?key=10&rpttype=1&report_data_no=6583; and www.ftc.go.kr/www/selectReportUserView.do?key=10&rpttype=1&report_data_no=6116.
 Seoul High Court Decision 2017Na2016899 rendered on 21 February 2018.
 G Song and M Choi, ‘Collapsed M&A deal adds to Asiana Airline’s woes while easing uncertainty for HDC’, Pulse by Maeil Business News Korea, 14 September 2020, available at www.mk.co.kr/news/english/view/2020/09/947558/; and J Jun, ‘Jeju Air abandons acquisition of Eastar Jet’, The Korea Times, 23 July 2020, available at www.koreatimes.co.kr/www/tech/2020/07/774_293299.html.
 Supreme Court Decision 2012Da64253 rendered on 15 October 2015.
 The purpose of this Act is to award higher delay interest on successful monetary claims once court litigation is commenced so as to avoid intentional delay in litigation. It is arguable whether the Act also applies to arbitration seated in Korea.
 The interest rate under the Special Act on Expedition of Litigation was lowered from 15 per cent per annum to 12 per cent per annum in June 2019.
 Article 3-2, Product Liability Act, as amended by Act No. 14764 of 18 April 2017.
 Supreme Court Decision 2012Da65973 rendered on 14 July 2016.
 Supreme Court Decision 2001Da1386 rendered on 4 September 2002.