Pursuing Creditors’ Protection for the Improvement of
the Korean Restructuring Legal Framework:
Implementing the Absolute Priority Rule as a Creditors’
Protection Tool
Yongjoo Rho (12647845)
Faculty of Law: Amsterdam Law School, University of Amsterdam Master’s in Law & Finance
Supervisor: Ms M. (M) Malakotipour Jul. 17, 2020
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Table of Contents
Abstract ... 4
Chapter 1. Introduction ... 5
1.1 Research question ... 5
1.2 Background on Korean bankruptcy law ... 7
Chapter 2. Assessment Framework ... 8
2.1 Trade-off between creditors’ protection and flexibility ... 8
2.2 Creditor protections and flexibility in restructuring... 10
2.3 Assessment Framework ... 12
Chapter 3. Korean bankruptcy law based on the law and practice ... 13
3.1. Initiation of the restructuring case in Article 34 and its effect ... 13
3.1.1. Initiation by debtors and creditors ... 13
3.1.2. Law and finance mechanism in the initiation ... 14
3.1.3. Incentives for debtors in the DRBL ... 15
3.1.4. Debtors-in-possession (DIP) ... 15
3.2. Filing of a proposed plan ... 18
3.2.1. Who can draft a plan? ... 18
3.2.2. Elements of a plan ... 19
3.3. The classification of creditors and rules regarding voting and cramdown ... 20
3.3.1. Creditors classification ... 20
3.3.2. Rules regarding voting and cramdown ... 20
3.4. Priority rule in the DRBL... 22
3.4.1. Fair and equitable in the DRBL context ... 22
3.4.2. Shareholders in the RPR of the DRBL ... 24
3.4.3. Fast-track and pre-packaged plan... 25
3.5. The analysis of the DRBL and the objective that needs to be prioritized ... 26
Chapter 4. The U.S. and the EU approaches – use for the Korean law ... 28
4.1 The APR under 11 U.S. Code § 1129. ... 28
4.1.1. The development of the APR in the U.S. ... 28
4.1.2. Shortcomings of the APR: Disputes between creditors and shareholders ... 29
4.2 The RPR in the EU Directive on Preventive Restructuring Frameworks ... 30
4.2.1. Critics of the EU RPR and possible problems from the DRBL experiences ... 30
4.2.2 Impacts on bondholders protections and SMEs in the EU RPR ... 32
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4.3.1. The failed attempt of APR adoption ... 34
4.3.2. The APR as an alternative in the DRBL ... 36
Chapter 5. Conclusion ... 38
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Abstract
The Debtors Rehabilitation and Bankruptcy Law (DRBL) was one of the important reforms for modernizing the Korean economy after the Asian Crisis in 1997. The law enhanced the restructuring legal framework by introducing new concepts and unifying several codes. However, it still lacks the element that addresses the main dispute between creditors and shareholders in restructuring under the Relative Priority Rule (RPR). This paper discusses the possibility of adopting the Absolute Priority Rule (APR) as an alternative for the RPR under the DRBL.
To analyze this topic, the paper firstly visits the trade-off theory between creditors’ protection and flexibility as well as indicators of the assessment framework to prioritize the objection of restructuring. The DRBL is discussed in the context of creditors’ protection and flexibility to reach the main argument, which is the priority rule, by looking at landmark court cases of the Supreme Court of Korea. Afterwards, the comparative research of the U.S. APR and the EU RPR for improvement of Korean DRBL to achieve creditors’ protection will be analyzed. The expected result of the adoption of the APR as replacing the RPR in the DRBL includes enhancing bond markets, decreasing funding costs of businesses and the systemic risk, and preventing overinvestment and risky behaviors by management that may occur as a result of applying the RPR. The lack of ex-post efficiency due to the flexibility in the DRBL can also be addressed by introducing a more conscise and a stricter priority rule.
Keywords: the Debtors Rehabilitation and Bankruptcy Law, Korean restructuring, APR, RPR,
priority rules, Imroving the Korean restructuring regime, enhancing creditors’ protection, Korean RPR.
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Chapter 1. Introduction
The Asian financial crisis in 1997 was a pivotal moment for economic restructuring in the financial and corporate sectors of Korea. The bankruptcy procedure reform, as a part of corporate sector reform in the economic program of the structural adjustment loan agreement between the World Bank and the Government of Korea, was one of the biggest legal reformations during that period. The Korean government needed to introduce a new bankruptcy law to satisfy two objectives, especially in corporate sector restructuring due to the urgency of the crisis. Firstly, the law had to be more efficient, market-based and it had to implement a more rapid procedure to facilitate both the financial and the corporate sector’s restructuring, and also the reallocation of assets to their best use. As for the second aspect, it had to ensure the creation of a reliable bankruptcy system which could reduce creditors’ uncertainty regarding the recoverability of their investments.1 As a result, the Debtors Rehabilitation and Bankruptcy Law (DRBL)2 was enacted on April 1, 2006. Although the law contributed to modernizing the corporate restructuring legal framework, the current practice and situation still lack the creditor protection mechanism, which can also be harmful in terms of the efficiency of restructuring.
1.1 Research question
Accordingly, the core research question of this paper is as follows: What are the creditors’ rights under the Korean restructuring regime, and is there any room for improvement of creditors' protection?
In accordance with all the above, this paper addresses different rules that influence the restructuring process in the DRBL. In particular, it takes a closer look at the Relative Priority Rule (RPR) that is considered as a default distributional rule in the DRBL. As it will be discussed in this paper, default distributional rules have substantial influence over the bargaining power of parties and protecting creditors. Additionally, a comparative study shall be conducted between the U.S. bankruptcy code, which adopted the Absolute Priority Rule (APR), and the RPR under the DRBL to see how these two different priority rules play in restructuring. Taking into account that the U.S. adopted the APR as the distribution standard of restructuring value as opposed to the DRBL, previous U.S. literature on the topic is considered as an appropriate source for the analysis of the priority rules in the Korean context
1 Report and Recommendation of The President of The International Bank for Reconstruction and Development to The Executive Directors on A Proposed
Structural Adjustment Loan in An Amount Equivalent to US $2.0 Billion to The Republic of Korea, March 19, 1998, The World Bank, 8, 15, 17.
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as comparative legal research, since these studies provide a large amount of research conducted on priority rules.
Moreover, this paper analyzes the priority rules in the recent EU Directives on Preventative Restructuring Frameworks (EU Directive)3 on one hand and the Korean law on the other, in order to propose a new framework applicable to the Korean context. The analysis of the Korean restructuring law faces a noticeable challenge: protecting creditors and rescuing businesses as a second chance to financially distressed debtors, and saving jobs at the same time. To provide a clearer working framework in relation to the topic, the following sub-question has been formulated: How is the priority rule in the U.S. law, namely the Absolute Priority Rule in
Chapter 114, different from the Korean law and can it be regarded as an alternative to the Korean law? To answer this question, the paper compares the Korean law to its U.S.
counterpart and analyzes the possibility of implementing the U.S. APR perspective as a replacement to the Korean priority rule. In this sense, the paper provides an analysis of the priority rules in different jurisdictions, which are the U.S. Bankruptcy Law and the new EU Directive, and it also offers a perspective on the impact of the priority rules on SMEs and bondholders as well as the whole economy. Additionally, the analysis of the priority rules provides insight into potential changes that could implement the APR in the Korean context for a better functionality.
This paper will also explain the topic from both a law and a finance perspective, by analyzing the legal framework and the financial mechanism behind restructuring. The supportive literature for this study includes sources in both English and Korean, with relevant legal rules and court cases. As a result, the paper is structured according to several topics, as following: Chapter 2 examines the tradeoff between creditor protection and the ex-ante effect, and the efficiency and flexibility with the assessment framework. Chapter 3 delves into the Korean law and practice, and provides an analysis of some Korean key court cases regarding this issue. Based on the sub-question presented above, Chapter 4 proceeds to encompass a comparative approach between the Korean DRBL and the U.S. Absolute Priority Rule (APR) on one hand, and the EU’s Relative Priority Rule (EU RPR) on the other, while analyzing possible impacts on stakeholders, such as bondholders and Small and Medium-sized Enterprises (SMEs). Lastly, Chapter 5 concludes the paper by providing the answer to the research question and suggesting
3 Directive (EU) 2019/1023 of the European Parliament and of the Council of 20 June 2019 on preventive restructuring frameworks, on discharge of debt and
disqualifications, and on measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt, and amending Directive (EU) 2017/1132 (Directive on restructuring and insolvency) (Text with EEA relevance.), the European Parliament and of the Council. Retrieved from https://eur-lex.europa.eu/eli/dir/2019/1023/oj
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an alternative framework to the current DRBL, as well as assessing the extent to which the proposal may result in the overall improvement of efficiency and creditor protection.
1.2 Background on Korean bankruptcy law
Before the enactment of the DRBL, the Korean restructuring rule was not only lengthy and costly in a way of ex-ante inefficiency, but it was also a major problem concerning corporate governance. Under the old regime, protecting public interests was somewhat predominant in comparison to creditor protection. ‘The established rule for trial on Corporate Reorganization Case No.5’ from the Supreme Court of Korea5 stated that a restructuring company should serve public interests with social values, and included several elements, such as the size of the company, years of business, employees and local economy, which had a negative influence on the company’s behavior about taking excessive risks, and also on monitoring incentives of lending banks as well as the government.
Furthermore, the existing restructuring legal framework of 1962 was divided into two different procedures, namely the Corporate Reorganization Law (CRL), and the Composition Law (CL). The main difference between these procedures was that the latter did not affect secured creditors and the shareholders. In fact, the CL resembles negotiating with unsecured creditors outside formal restructuring. There was another important difference between those two regimes, which is the discharge of incumbent managers in the CRL, whereas the directors of the company remain in the CL proceeding.6 As a result, debtors had no choice but to opt for one of the two. Additionally, ex-post costs would arise by switching from one procedure to the other. This is largely contributed by the characteristics of the CL and the CRL. Under the CL the shareholders were able to keep their control over the company, whereas during the CRL they lose their control over the company. Moreover, the CRL proceeding is cumbersome and strict, so debtors that should have chosen the CRL entered into the CL instead. Because of this, debtors would then spend even more time and an excessive amount of financial resources which could have been used for restructuring. The two-fold system was a burden for creditors as well: their claims were treated differently according to the applicable law, and the outcome would be unpredictable and inequitable.7
5 The established rule for trial No.5 (Song Min 92-5), The Supreme Court of Korea. Retrieved from https://glaw.scourt.go.kr/wsjo/gchick/sjo290.do#// 6 Ko, H. (2006). Korea's Newly Enacted Unified Bankruptcy Act: The Role Of The New Act In Facilitating (Or Discouraging) The Transfer Of Corporate
Control. UCLA Pac. Basin LJ, 24, 203, 204.
7 Hong, S. (2007). Corporate rehabilitation process – by the practice of Seoul Central District Court. Human rights and Justice, the Korean bar association Vol.
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As a result, the DRBL was enacted on April 1, 2006. The birth of the DRBL is a tremendous improvement in the matter of both flexibility and creditor protection. The law contains new concepts such as the basic idea of ‘Debtor-in-possession’ and ‘comprehensive stay-order’8, giving incentives to managers of financially distressed firms for an early entry into restructuring. At the same time, the law also enhances creditor protection by reinforcing creditor committees’ functions and their power over monitoring debtors’ behavior and guaranteeing the liquidation value of their collateral as well as the corporate value of secured and unsecured creditors9.
However, the ongoing situation towards the corporate restructuring procedures is not as favorable as it was expected at the time the law was enacted fifteen years ago. The criticism that arose over the role of the DRBL is mainly related to calling for more expedite and efficient proceedings. The government recently introduced a series of procedures to enhance the law’s flexibility, whereas creditor protection measures have not arrived.
Chapter 2. Assessment Framework
2.1 Trade-off between creditors’ protection and flexibility
A proper starting point for the discussion on restructuring is to understand the reason why we need restructuring rather than liquidation. The simple answer is that restructuring, in theory, can be beneficial for all stakeholders, and also justified sometimes, either economically or socially. Shareholders could expect a second chance by keeping the legal entity alive, and creditors, such as employees, may be able to capture a higher value than with alternative proceedings. Debtors’ assets can be well kept in restructuring compared to a piecemeal dismantling because its going-concern value will not be lost. Also, in some cases, restructuring is a preferred alternative to a going concern sale: in restructuring, the legal entity remains intact, hence, a higher going-concern value (surplus value) can be captured due to the presence of soft assets such as permits, licenses and non-transferable contracts.10 Although restructuring is
economically desirable, it is not possible to achieve all the goals of restructuring because some of those are contradictory. For example, a proper restructuring process should not just have
8 Different from automatic stay order is comprehensive stay-order is not automatically granted, instead it is reviewed by the court and then granted. However,
this is a big improvement because debtors under the new law are now able to request a stay order on his assets all together.
9 Article 20-22 of the DRBL
10 de Weijs, R. J., Jonkers, A., & Malakotipour, M. (2019). The Imminent Distortion of European Insolvency Law: How the European Union Erodes the Basic
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outcomes with ex-post efficiency, but also give the right ex-ante incentive to shareholders and managers.11 The objective of 'Directive (EU) 2019/1023' is to save firms and jobs, giving a
second chance to honest insolvent businesses, as well as help maximize the total value to creditors which may conflict with the former goal.
If so, the fundamental question is whose interests restructuring should serve. A famous thinker Peter Drucker, who himself also lived through the great depression, argues that the going-concern of the corporation should be kept by society even with the sacrifices of individual rights of stakeholders.12 Also, a group of bankruptcy scholars insists that bankruptcy law should serve different policies and interests rather than maximizing creditors’ value, and, therefore, they argue that the restructuring process needs to be flexible for making the business viable even though the creditors will not receive what they are supposed to receive outside of the restructuring process.
Another group posits that the primary goal of restructuring should be creditors' protection over other concerns. This was derived from the agency theory, where the owners’ interests should be served. When a firm is financially distressed, its creditors become the owners of the firm. Then, it is reasonable that the creditors of the firm should be the owners, and the firm should maximize the value of the company for creditors, whether it is under restructuring or liquidation. This theory extends to recognize the interests of other stakeholders, such as employees, suppliers, and parties that are affected by restructuring, interests which are legally enforceable against creditors.13 However, creditors’ interests remain at the center of the
restructuring proceeding. Scholars such as Jackson argue for respecting pre-insolvency agreements to resolve the creditor-distribution questions regarding the creditors’ interest, otherwise the creditors will not agree with such a plan during the proceeding. 14 According to the creditors’ bargaining theory, the collective procedure of insolvency is a mere intention to enhance and realize creditors’ ex-ante rights with co-ordination, and not a limitation of the creditors’ rights.15 Acknowledging that, creditors’ non-bankruptcy rights might be a key
determinant for creditors’ protection. Whether creditors’ protection is the primary goal of restructuring or not, setting up the right primary goal of restructuring is essential not just for
11 Aghion, P., Hart, O., & Moore, J. (1994). Improving bankruptcy procedure. Wash. ULQ, 72, 852. 12 Drucker, P. F. (1993). Concept of the Corporation. Transaction Publishers. 21.
13 LoPucki, L. M. (2004). team production theory of bankruptcy reorganization. Vanderbilt Law Review, 57(3), 763-766.
14 Jackson, T. H. (1982). Bankruptcy, non-bankruptcy entitlements, and the creditors' bargain. The Yale Law Journal, 91(5), 857, 858.
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the proceeding but also for economic perspectives, due to the impact on various sectors including financial markets and the real economy.
2.2 Creditor protections and flexibility in restructuring
When a firm is in financial distress, besides the liquidation proceedings (i.e. piecemeal liquidation and going-concern sale), restructuring is a possible tool for debtors to restore its balance sheet through a collective procedure. They would expect some relief from the liabilities and seek to restructure their financial structures within the process that can bind dissenting creditors along with several debtor protection mechanisms, such as debtor-in-possession and an automatic stay.16
However, restructuring is also a favorable option for creditors if the process assures the protection of their rights. That is why creditor distribution is the main argument in a restructuring process. Outside of this collective procedure a going-concern value will not be kept well, as opposed to the case of insolvency proceedings where it is preserved better, and the value is destroyed by free-for-all behavior. Creditors would also reduce uncertainty from individual remedies which also help maintain the debtors’ assets for future cash flows, and increase its recovery rates.17
In this insolvency and common pool problem context, the main drivers of the proceeding are creditors. However, as we can see in the case of Korea prior to the DRBL, if restructuring cannot successfully address the main conflict between creditors and shareholders, neither creditors nor shareholders would agree during the proceeding, and the proceeding is likely to be lengthy and cumbersome, or even unsuccessful. The idea to provide flexibility pursues to prioritize the survival of a legal entity and saving jobs over giving the maximum value for the creditors. However, it is skeptical that flexibility actually brings those values in practice. Flexibility may result in uncertainty for the creditors and lead to holdout behavior of a certain group of creditors. Moreover, flexibility cannot regulate opportunistic behaviors of debtors. During the Asian Financial Crisis, Korean Chaelbols who had highly leveraged capital structures gained benefits from the restructuring framework merely because the primary focus of the restructuring regime was on saving the firms and jobs, which can also reduce the cost of
16 LoPucki, L. M., & Whitford, W. C. (1993). Corporate governance in the bankruptcy reorganization of large, publicly held companies. University of
Pennsylvania Law Review, 141(3), 677.
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legal procedures for the collection and uncertainty of the amount that they can recover under the proceeding.
Investor protection, both shareholders and creditors, is a focal point in the law and finance field, since this substantially influences firms’ behaviors and the development of financial markets. Creditors’ rights in restructuring are a crucial pillar of creditors’ protection, and this has been proved by many empirical researches. The reason that creditors’ protection is important in restructuring context is not only beneficial for themselves but also for debt markets which will be helpful for businesses and society.18 Firms are funded by both shareholders and creditors. When shareholders enjoy the unlimited upside profits, creditors only claim fixed returns. Moreover, the existence of non-adjusting creditors19 raises the doubt of a debtor-friendly plan. Creditors are not accountable for the firm’s failure. However, shareholders, management employees are the ones who are responsible at least more than creditors. Also, without creditors’ consent, the restructuring process cannot efficiently address the hold-out problem, and the value of the firm will be lost due to the delay of the proceeding. Even if the court can force them to accept such a plan, the problem will not fade away. The creditors are not willing to lend their money with the low cost and the cost of debt for the businesses will increase. The same goes for the unsecured creditors as well. They are afraid of losing their money during the proceeding, they have no choice but to raise the price or enforce stricter price terms for transactions. In the end, the whole economy will suffer from undermining creditors’ protection.
Flexibility is promoted to achieve ex-ante efficiency which reduces delays and costs. In a flexible restructuring regime, the debtor might be encouraged to enter into restructuring as early as possible. With less strict priority rule, there is a chance that the owners of the firm will retain some or full control. On the one hand, this can be an incentive for the debtors, but on the other hand, flexible or pro-debtor bankruptcy regimes may implicate ex-ante costs from highly-leveraged capital structures and engage in over-invest problem by shareholders who are less cautious due to less stringent restructuring rules. Also, ex-ante efficiency from flexibility does not mean that ex-post efficiency can be also improved. The longer negotiation period may
18 La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (2013). Law and finance after a decade of research. In Handbook of the Economics of Finance (Vol. 2, pp.
425-491). Elsevier. 442-443.
19 Non-adjusting creditors existence may be an argument for flexibility but also for the full priority of secured creditors. See Bebchuk, L. A., & Fried, J. M.
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impair the value of the firm, and sometimes the firm ended up proposing the plan which is not feasible just to get approvals from the creditors.20
2.3 Assessment Framework
Indicators of bankruptcy process assessment can be laws and procedures, restructuring time and costs, and the recovery rate.21 When an insolvency framework is lengthy and has barriers
to restructuring, then it may reduce recovery for creditors. As a result, banks or creditors are not willing to force debtors to the restructuring proceeding and instead they forbear on zombie firms, especially with this low-interest.22 Not only this is a loss of creditors as a result of that banks could evergreen loans to those underperformed firms to avoid incurring losses on their balance sheet and lose the opportunity for more profitable loans, but it also becomes even more dangerous when banks become unhealthy and spillover to the economy as a whole because of the weak restructuring legal framework. That is why the restructuring legal regimes take into account a creditors’ protection.
Saving jobs and businesses are fundamental to society. Massive job cuts hurt the economy and giving the businesses a second chance entices entrepreneurship in society. Especially after the financial crisis, bankruptcies grew a lot even in developed countries in the European Union. Those skills and intangible assets that they have acquired during its operation and removing obstacles for entrepreneurs' new starts are valuable in the recent economic situation. As a result of giving a fair and efficient second chance, both new or restructured firms can boost the economy, employment growth, and productivity in a competitive market. A restructuring system needs to recognize honest debtors systemically. Those honest debtors should be able to access to finance in restructuring. However, creditors or investors are not willing to fund if moral hazard is wide-spread.23 If the legal framework is designed to give more weight on
saving firms and jobs, negative effects on ex-ante monitoring to preclude firms’ opportunistic behaviors and prevent lending to a high probability of default. That is why the restructuring legal framework should yield the ex-post efficiency by maximizing creditors' value of the distressed with the cost-efficient and fast process of restructuring when so needed.24 All of these indicators of assessment cannot be accomplished without strict rules that uphold
20 Park, Y. S. (2008). Efficiency of Korean new rehabilitation proceeding. J. Korean L., 7, 254.
21 OECD/The European Commission/European Training Foundation (2014), “Efficient bankruptcy procedures and “second chance” for entrepreneurs”, in SME
Policy Index: The Mediterranean Middle East and North Africa 2014: Implementation of the Small Business Act for Europe, OECD Publishing, Paris. , 75 DOI: https://doi.org/10.1787/9789264218413-10-en
22 Andrews, D., & Petroulakis, F. (2019). Breaking the shackles: zombie firms, weak banks and depressed restructuring in Europe, ECB Working Paper No.
2240, 2.
23 European Commission. (2011). A Second Chance for Entrepreneurs. Prevention of Bankruptcy, Simplification of Bankruptcy Procedures and Support for a
Fresh Start, 11.
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creditors’ protection, and only flexibility alone cannot achieve designing a legal framework that benefits both creditors, businesses, and the economy as a whole.
Chapter 3. Korean bankruptcy law based on the law and practice
The DRBL consolidated two outdated restructuring laws and one bankruptcy law into a single legal framework, as a result of the reformation that came after the Asian financial crisis in 1997. Two main words used in the purpose of the DRBL law are ‘efficiency’ for debtors and ‘fairness’ for creditors.
“The purpose of this Act is to efficiently rehabilitate debtors facing distress due to financial difficulties, and their businesses through coordination of legal relations among interested persons, including creditors, shareholders and equity holders, etc. and to fairly realize and divide properties of debtors who are deemed difficult to rehabilitate.”25
The law encompasses both efficiency and creditor protection principles, shifting from the public interest theory from the past. However, this can be interpreted that the DRBL weighs efficiency in restructuring whereas fairness is pursued in liquidation. Thus, there has been a constant demand for strengthening creditor protections in a restructuring proceeding which eventually led to the failed reform attempt in 2008 to change its priority rule from relative priority rule to absolute priority rule. On the other side of the restructuring framework, the efficiency and flexibility of restructuring were also subject to fierce criticism, that the law is insufficient to rescue financially troubled firms in the form of restructuring. Many aspects contribute to this debate, and some of those come from the law itself and the way restructuring works in practice.
3.1. Initiation of the restructuring case in Article 34 and its effect 3.1.1. Initiation by debtors and creditors
Just as same as other court cases, a restructuring case is also started through a filing. Prior to discussing the initiation problems related to incentives for creditors and debtors, it is important to first point out which party initiates the proceeding. Article 34(1) of the DRBL stipulates that debtors may voluntarily file a reorganization proceeding when the firm is unable to repay its obligation, and article 34(2) gives creditors and non-controlling shareholders with a certain amount of shares the power to begin the proceeding in the brink of insolvency as a preventive measure. In this case, the stakeholders who initiate the restructuring process are asked to prove
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the need for restructuring, rather than the debtor. However, the law does not have a clear distinction of illiquidity and insolvency of the firm, which implies that the negative equity of the balance sheet is not the legal definition of the restructuring in the DRBL. Judging by this, the law does not formally adopt the balance sheet test as a definition of insolvency. This could be utilized as preventive restructuring before the firm’s financial situation gets worse regardless of its balance sheet. However, non-controlling shareholders that own a large portion after a controlling shareholder are easily able to abuse the initiation clause for taking a controlling interest. Thus, the DRBL should be more specific on the criteria for determining the need for restructuring to commence a proceeding.
3.1.2. Law and finance mechanism in the initiation
To make the restructuring framework more efficient, the law should prevent the destruction of the firm value, which will be available for distribution. Also, there should be incentives for a financially distressed company or for stakeholders, whether the incentives are for creditors or debtors. Article 34 states that both debtors and creditors can trigger restructuring; however, in many cases it relies upon the debtors’ managers. This is partly because, even though the restructuring legal framework is for the creditors as a whole and creditors can easily initiate the proceeding, individual creditors who are willing to trigger restructuring seem to be interested in a collective proceeding, and usually gain a little compared to individual debt collection under the proceeding. A reorganization bears considerable costs, and normally debtors share a large portion of these costs. Because of asymmetric information, the monitoring function of debtors hardly determines the financial condition of the firm for an initiation.26
Moreover, creditors monitoring activities tend to specialize in their interests. Secured creditors and trade creditors focus on different aspects of the debtor, and not on the debtor’s overall financial situation.27
Entrenched management and agency costs of debts are salient in the delay of restructuring. The entrenched managers of the firm are most likely to delay the restructuring proceeding, even when they acknowledge the need for restructuring due to financial distress. Financially distressed firms tend to overinvest in risk projects which result in risk-shifting and asset substitution. Shareholders can fully enjoy the benefits of the increased value of the firm by risk-shifting, because of limited liability at the expense of creditors. In this situation, creditors
26 Park, Y. S. (n 20) 269.
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are the ones who bear the loss from directors’ gambling for resurrection. Over-indebtedness of debtor firms brings the debt-overhang problem. Underinvestment occurs when the managers refuse to take a positive NPV that only benefits creditors. These effects incur the costs which decrease the assets available to creditors during the proceeding, primarily at the expense of creditors and especially unsecured creditors.28 A set of proper incentives should be given to debtors as well as creditors for restructuring efficiency.
3.1.3. Incentives for debtors in the DRBL
Although the condition of initiation has not been changed, the transition from the old system to the DRBL itself improved ex-ante efficiency by abolishing mandatory conversion from the CRL to liquidation, in case the debtor failed to pass so-called the ‘Economic Viability Test’ when the liquidation value is higher than the going concern value.29 This plays as an incentive for incumbent managers who used to be afraid to file for restructuring in the early stage due to the compulsory liquidation resulted from the failure of the going concern test under the old regime. During the legislative procedures, a minority opinion from the Legislation and Judiciary Committee of the Congress opposed to the abolishment of the conversion, because debtors can abuse the restructuring to delay the liquidation process while the value of the assets is diminished.30 In the end, the improvement of ex-ante efficiency was thought to be greater than the delay costs by abusive behaviors of the debtors in bad faith. Also, the fact that the court’s discretionary bankruptcy declaration prevents such acts contributed to the abolishment of mandatory conversion.
3.1.4. Debtors-in-possession (DIP)
The pursuit of self-interest by entrenched management can be mitigated, to some extent, by debtor-in-possession. Before the DRBL, the incumbent manager was dismissed, and an outside third-party candidate was appointed by the court practice in the CRL. The DRBL addresses two issues of the absence of debtor in possession concept. The former is an incentive for the debtor to initiate the proceeding, and the other is to preserve knowledge from the management to prevent the loss of a going concern value for maximizing distribution available to creditors while achieving the efficiency of the proceeding.
28 Moon, B. S. (2017). Prevention of delay of filing for insolvency proceeding and creditor protection (Doctoral dissertation). Seoul National University, 4-13. 29 Park, Y. S. (n 20) 253, 254.
30 Legislation & Judiciary Committee, The National Assembly of The Republic of Korea, (2005). Public hearing on enactment of the Debtor Rehabilitation and
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As Choi observed in his research on the effect of the DIP on the Business Performances of restructuring firms, Table 1 shows the rate of incumbent managers serving as trustees in the corporate reorganization proceedings for the first ten years of the DRBL, from 2006 to 2016. Approximately 85 percent of reorganization firms are operated under the debtor-in-possession, showing that the debtor-in-possession approach is settled in the DRBL regime.31 The achievement of the purpose of the legislation is supported by the court as well. The court points out that the number of SMEs which have entered into restructuring is higher than prior to the DRBL because the debtor-in-possession rule reduced the loss of control, which was a significant concern to SMEs under the old regime (Kim, 2010).32 Table 2 supports this analysis by showing that the number of SMEs with DIP is higher than that of big enterprises with DIP. The DRBL’s debtor-in-possession rule is distinct from the one that U.S. Bankruptcy code stands for. In Chapter 11 of the U.S. Bankruptcy Code33, a debtor can serve as trustee in a case, meaning that the debtor is permitted to still possess the estate under the proceeding and use its assets in the “ordinary course of business” without court permission or creditors intervention.34
In the DRBL a trustee is a different legal person from the director of the firm and has more restrictions than in the case of the U.S. debtor-in-possession rule. However, this does not apply to SMEs, since SMEs that enter into reorganization can be trustees and represent themselves in the proceeding.
Table 1
DIP vs Non-DIP in the DRBL
Total restructuring firmsa DIP vs Non-DIP
With a DIP Non-DIP
1,496 (100%) 1,277 (85.36%) 219 (14.64%)
Note. The data on DIP are taken from “The Effect of the DIP on the Business Performances of
Rehabilitated Corporates (in Korean)”, by Choi, Y. J., 2017, Working paper of the Bank of Korea, No. 2017-34, pp.7. aThe number of total firms is as of October 31, 2016. The source of DIP is retrieved from
the registry of the Supreme Court of Korea.
31 Choi, Y. J. (2017). The Effect of the DIP on the Business Performances of Rehabilitated Corporates (in Korean), Bank of Korea Working Paper No. 2017-34,
7.
32 Kim, J. H. (2010, April 1). 85% of restructuring custodians evaluate positively for the DIP adoption. Law Times. Retrieved June 18, 2020, from
https://www.lawtimes.co.kr/Legal-News/Legal-News-View?serial=51856
33 11 U.S. Code § 1107, 1108
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Table 2 shows the lower numbers of DIPs for big enterprises. The reason is although the trend has changed since 2011, the court usually appoints either an outsider third-party or co-trustees with the incumbent manager in practice as punitive measures. This arises from a unique corporate ownership structure of Korean chaebols, which rarely separated from ownership from control in the past.35
Table 2
The size of the firms in the DIP (Large enterprises vs SMEs)
Total restructuring firmsb
DIP
Applied Not Applied
Large Enterprises 92 (7.1%) 70 (76.1%) 22 (23.9%) SMEs 1,212 (92.9%) 1,038 (85.6%) 174 (14.4%) Total 1,304 (100%) 1,108 (85.0%) 196 (15.0%)
Note. The data on DIP are taken from “The Effect of the DIP on the Business Performances of
Rehabilitated Corporates (in Korean)”, by Choi, Y. J., 2017, Working paper of the Bank of Korea, No. 2017-34, pp.7. b192 firms out of total 1,496 firms are excluded in the table since the size of those firms
is reported. The source of DIP is retrieved from the registry of the Supreme Court of Korea.
There is an ongoing debate about the characteristic of the DIP in the DRBL. The distinction between the U.S. Bankruptcy Code and the Korean DRBL in terms of debtor-in-possession is that a trustee in the DRBL is a different legal person from the director of the company. The court rules that a trustee who was the director of the firm should serve as the administrator for public interest while representing different stakeholders in the proceeding including creditors and shareholders36, even though the director of the firm is appointed to the trustee of the case. However, another court case argues that a trustee can qualify as both the trustee and the debtor simultaneously.37 In light of these, it is hard to say that those two debtor-in-possession situations share the same legal characteristic, and this can cause differences in certain
35 Choi, H. J. (2011) The current practice and the plan for improvement of corporate restructuring (Analysis on the SsangYong Motors case, Spring Academic
Seminar collection of Korea Insolvency Law Association (May 21, 2011), 469.
36 The Supreme Court of Korea, March 28, 2013, 2010Da63836 Decision [Judgment in claims of Secured Creditors under a rehabilitation case] 37 The Supreme Court of Korea, August 22, 2012, 2010Da68279 Decision [Indemnification]
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circumstances. However, from an economic perspective, the debtor-in-possession rule of the DRBL has improved ex-ante efficiency.
3.2. Filing of a proposed plan 3.2.1. Who can draft a plan?
Article 220 of the DRBL mandates a custodian, either a debtor-in-possession or a court-appointed receiver, to prepare a proposed reorganization plan within the period determined by the law. Following article 221, it is also allowed for the debtor, creditors, and shareholders to prepare their own plan. In this case, two plans are subject to approval and compete with each other to be adopted as the restructuring plan. Any creditors that hold or obtain consents from other creditors more than half of the debtor’s liabilities may submit a reorganization plan before the commencement of the restructuring proceeding.38 This provision was introduced for the pre-packaged plan in 2016. The proposed plan should meet the criteria under article 243(1) in order to be authorized by the court and to comply with the law.
On the contrary, in chapter 11 of the U.S bankruptcy law, the debtor has an exclusive right to file a plan within 120 days.39 After the exclusivity period, or extended period if any, has expired, a creditor or the case trustee may file a competing plan as well. In both cases, the creditors’ right to file a proposed plan to compete against the debtor’s plays an important role, giving the debtor the right to negotiate with the creditors and ensure the reflection of the interests of creditors in the plan. The difference here is that the debtor has an exclusive period to prepare the plan. Debtors are not provided with an exclusive period to draft the restructuring plan under the DRBL. As a result, creditors have greater bargaining power over debtors, because they can propose their own plan without any consultation with the debtor. At a glance, creditors in Korean law have an advantage over the procedure mentioned in Chapter 11. However, it is difficult to say that the DRBL protects creditor rights because creditors are exposed to unfavorable outcomes under the RPR, in comparison to the situation stipulated in Chapter 11. Also, according to the survey of receivers conducted by the court, the plan is very rarely proposed by creditors in practice.40 The reason that the plan is proposed mostly by the
creditors is uncertain and this practice has not been changed under the DRBL. Yet, the point here is there is a little incentive for creditors to propose a plan by themselves. Several factors may explain this such as asymmetric information, costs bearing, and difficulties of bargaining
38 Article 223 of the DRBL 39 11 U.S.C. § 1121(b)
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among other creditors. Of all the things, under the DRBL, the creditors' consultative council has supportive roles, whereas creditors’ creditors in Chapter 11 play a major role in formulating a plan. Although an individual creditor can file a plan, it is hard to expect that individual creditors actively deal with all the other creditors. In that sense, granting the power to the council to file a plan will improve this situation for the creditors.
3.2.2. Elements of a plan
The custodian should assess whether the proposed plan satisfies the following three conditions before they file the plan to the court.41 First, the plan should meet the qualification for the contents that the law42 requires. Mandatory contents must include how the claims for each class of creditors will be treated and other things such as the way of finance in the future and administrative expenses. When there is any change in the situation, those should also be stated in the plan. If the contents meet the requirement, the plan should be evaluated whether it has the future viability of the debtor and the fair and equitable standard. Feasibility of the reorganization in this process is not important because if the going concern value is less than liquidation value, the commencement of the case is not possible. However, the receiver must validate the feasibility of the plan with the cash flow and income statement forecast. One of the important elements here is “the best interest of creditors” test. Unless a creditor agrees otherwise, the creditor must receive at least as much under the plan as it would in a (hypothetical) liquidation scenario43. Thus, any creditor should not be worse off as compared to liquidation.44 Under the CRL regime, the court did not adopt the best interest of creditors test, so creditors were worse off in restructuring than the liquidation process45. This precedent
is now obsolete by the DRBL and the law prevents the situation that creditors received less than the amount that such holder would so receive or retain if the debtor were liquidated. Lastly, the plan is expected to be accepted in the voting. This element underpins the needs of full consultation between debtors and creditors before the plan is drafted. There is no hard rule for the possibility of acceptance. However, an unrealistic plan cannot pass this assessment before the plan is available for voting.
41 Seoul Bankruptcy Court. (2018). The manual of the Custodial Committee, Judicial Development Foundation. 155-157. 42 Article 193 of the DRBL
43 Article 243(1)(4) of the DRBL 44 Hong, S. (n7) 109.
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3.3. The classification of creditors and rules regarding voting and cramdown 3.3.1. Creditors classification
The DRBL categorizes three different voting classes; secured creditors, unsecured creditors and shareholders, respectively.46 Within these three classes, those unsecured creditors and shareholders groups may be categorized and treated differently if they have preferential rights or the special circumstances on the nature of the rights or relationship over other unsecured creditors or shareholders according to article 236(2)-(5). However, the court has discretion on the classification of creditors, as long as the three groups, namely secured, unsecured creditors and shareholders, are categorized separately by article 236(1). The court rules affirmed that unless there is a factual circumstance that prevents the court to do so, the court has the discretion of for the classification of creditors in the proceeding47. The law does not explicitly
provide treatment of junior debt and subordinated loans. According to article 218, the principle of equality among persons who hold rights of the same nature is a key determinant of junior class claims and subordinated loans. The first part of the article supports the idea that junior claims should be treated differently in unsecured creditors class if the consent is obtained from the creditor, those claims do not need to be equally treated. Those junior class creditors already entered into the contracts that their rights are treated differently from other unsecured creditors. The second part of the articles regulates the loans that should be subordinated even though the loans were not originally subordinated by the contracts. Related party transaction is one example of the subordinated loans that the law regulates. In practice, unsecured creditors classify into many classes according to their characteristics so that they treat differently in terms of recovery rates. Hence, preferred or subordinated claims are ranked as followed by its original priority or subordination regulations.
3.3.2. Rules regarding voting and cramdown
Under article 237, the court should confirm if the plan is accepted by secured creditors that hold at least three-fourths in amount, four-fifths in case of the proposed plan by the creditors, more than two-thirds in amount of the unsecured creditor class and at least a half of the shareholders class by number. However, the shareholders' class usually does not have the right to vote because the firm is already likely to have negative equity on its balance sheet. If the requisite majority is not reached in a class, there is still a possibility to enforce the
non-46 Article 236(1) of the DRBL
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consensual plan though a cross-class cram-down mechanism, applied by courts. Article 244 ‘Authorization in Cases of Group in Disagreement’48 is in place to prevent possible creditor
hold-out problems that cause anti-commons situations in restructuring.
Under the DRBL, the court may amend the proposed plan with a protection clause for the right of the dissenting class by preserving the substantial value of claims and equity in the subparagraph of article 244(1).49 The main idea of protection is preserving the security rights of the secured creditors and ensuring liquidation value to the creditors and shareholders. Although there is no clause, the plan should be accepted by at least one class if the court confirms the plan with article 244 according to the ruling of the supreme court of Korea.50 The requirement for cramdown in the DRBL is not objective compared to the eleven subdivisions of section 1129(a) in the U.S. Bankruptcy Code.
The principle of assurance of liquidation value in article 244 raises a few issues. First, the valuation method and the concrete meaning of liquidation value does not meet the goal of restructuring since a going concern sale value is not considered as a liquidation value and only a piecemeal liquidation is used for the best interest of creditors test. Before the DRBL, the court kept the interpretation of a piecemeal valuation of the debtor’s assets by calculating the value of assets which assume to be sold on a piecemeal basis as fair value.51 Under the DRBL, there is no clause for either the definition of liquidation value or the method of valuation for cramdown, one can assume that from pursuant to the court the administrative rules of the court52 for the valuation for liquidation and the method in a general term of a reorganization
case. The rule inherited the doctrine from the old regime. In addition, they added the method of valuation which is book value of the assets except for the value of fixed assets which is derived from the average court sale price of the asset. Book value as a value indicator of appraisal may mean something on certain assets, but normally discrepancy between book value market value is significant. This will be magnified with what kind of discount rate they use for distribution. Also, off-balance-sheet assets are hard to include in the valuation. Second, a question arises whether the piecemeal liquidation value as the floor of minimum protection in the reorganization is a proper way to rescue a financially distressed firm.53 If the plan with a going concern value expects a better result than the liquidation value, there is no reason that
48 Equivalent to Section 1129(b) of Chapter 11 of the U.S. Bankruptcy Code
49 Oh, S., & Song, H. (2008). Priority in insolvency proceedings. Journal of Korean Law, 7(2), 317 50 The Supreme Court of Korea, May 18, 2018, 2016Ma5352 Decision [Rehabilitation]
51 The Supreme Court of Korea, December 10, 2004, 2002Gue121 Decision [Corporate Insolvency]
52 Article 9 of the established rule for trial on Corporate Reorganization Case of 2017 (Jae Min 2006-5), the Supreme Court of Korea. 53 Oh, S., & Song, H. (n49) 314.
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the court retains the principle. The best interest creditors test serves for creditors ensuring that creditors receive more than they are supposed to get in liquidation. However, this test is solely for distribution perspective, not the matter of how the receiver or debtor sells its assets for the best result. If they can sell the business as a whole or they have a reason to keep the entire assets, and if these maximize creditors’ recovery, then the court should adopt the appropriate approach.
In practice, a court-appointed appraiser, usually accounting firms, adjusts the book value according to the due diligence result. In this stage, the appraiser will deduct expenses of the sale of assets and reevaluate the assets in which fair value can be measured differently during the due diligence.54 Regarding the discount rate for distribution, the court accepts two different discount rates for future cash flows and distribution to creditors. For its discounted cash flows, Capital Asset Pricing Model (CAPM)55 is used, and for the present value of distribution calculation, it adopts current market interest rates determined by bank loans to a firm with an average risk profile.
Because the requirement is left to the discretion of the court, it is extremely hard to expect whether a cramdown will be imposed or not and how the protection clause will be implemented in the case. The Supreme Court of Korea ruled that whether the court performs cramdown or not depends on the judgment in the light of interests of stakeholders and the need for restructuring at the discretion of the court.56 In this case, debtors and creditors including
shareholders cannot argue with the court decision of not to cramdown, it can only appeal if the protection clause is not enough to preserve the rights of the dissenting class or the plan itself is not fair and equitable.57 To explain the principle of fair and equitable in the DRBL, the priority rule should be considered.
3.4. Priority rule in the DRBL
3.4.1. Fair and equitable in the DRBL context
Priority waterfall in rehabilitation cases of the DRBL is much more complex than liquidation proceeding or normal compulsory execution according to civil code and commercial code. When a firm is in stable condition, the conflict of priority structure does not occur among
54 Seoul Central District Court. (2009). “The review on the method for liquidation value” from the Roundtable of the inspection commissioners, Seoul Central
District Court Bankruptcy Division, 110-114.
55 Rf+βi (ERm−Rf) where Risk-free rate is 3-year Korean government bond yield, risk premium, beta is market beta in the same industry and the expected return
of the market is the average stock market return of the same industry in 20 years.
56 The Supreme Court of Korea, 11 October, 2007, 2007Ma919 Decision [Commencement of a Rehabilitation case] 57 Rim,C. H., Baek, C. H. (2002). Corporate Insolvency Law (II), Korea Judiciary Administrative Publishers Ltd, 328.
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creditors as long as the firm is capable of satisfying its liabilities to creditors. However, when the firm is financially distressed so that the firm is unable to pay its obligations, priority rule among creditors becomes critical in the stage. Restructuring is one example of a creditors’ collective process where the aggregate value of the debtor’s assets is more valuable than the individual assets.58 By this procedure, the assets can be kept better as collective assets which mean bigger distribution to the creditors, creditors will be beneficial as compared to individual claims on the debtors' assets and reduce the cost of creditors because they do not need to bring legal procedures against other creditors over the debtors' assets. However, a problem arises for rehabilitation cases because the goal of restructuring is not only liquidating current assets to creditors but also keep the assets for future earnings to also creditors.
The priority rule in the DRBL lies in article 217 ‘fair and equal differentiation’. A relative priority rule has been maintained since prior to the DRBL under the CRL. Although the plan takes into account the ranking order of rights in subparagraphs of article 217(1), this does not mean that higher position creditors paid in full or paid in before lower position creditors according to the order but rather that this is ensured by to treat creditors at least as favorably as any other class of the same rank and more favorably than any junior class. The law leaves room for a possibility that creditors in the same class can be treated differently as long as it is equitable which here is the assurance of liquidation value.59
The fair and equitable treatment is relevant to not just to a dissenting class when a cramdown is imposed. In the DRBL, the proposed plan should treat creditors and shareholders fairly and equitably which applies to the acceptance of the plan in a non-cramdown case. Assuming the case that secured creditors will receive three-fourths of their claims in the 5 years, trade creditors of unsecured creditors will receive two-thirds of their claims in 2 years, unsecured part of banks’ claims will receive two-thirds of their claims in 3 years and subordinated loan holders will get half of their claims in 2 years. This plan will be deemed as the plan is fair and equitable in the DRBL context, and it can get to cramdown because the secured creditors will have a higher percentage in their claims than unsecured creditors. Also, those two different unsecured creditor groups in the same class which treat differently are also equitable because it is fair to say the claims of subordinated bondholders are clearly treated differently outside of
58 de Weijs, R. J. (2018). Harmonization of European Insolvency Law: Preventing Insolvency Law from Turning against Creditors by Upholding the Debt–
Equity Divide. European Company and Financial Law Review, 15(2), 412.
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the restructuring process or liquidation process and no reason subordinated bondholders need to be treated better than other unsecured creditors.
In the DRBL, the plan can be approved even if the dissenting voting classes are treated less favorably than other classes of the same rank. There is no rigid rule on how the court measures fairness except for the assurance of liquidation value. In practice, the court only compares the present value of repayment of each group to see whether there is reasonable differentiation among those groups. For example, the court intervenes and will not approve the plan for voting if the amount that secured creditors give up is more than an unsecured creditor class.60 However, even in this case, the method and schedule of repayment are not considered as factors of the principle of fair and equitable. Priority rule in the DRBL is, thus, flexible which makes negotiation among relevant parties are very important to draft the proposed plan.
3.4.2. Shareholders in the RPR of the DRBL
Of all three classes in the DRBL, unsecured creditors and shareholders are the main problems in restructuring proceeding. In practice, receivers are instructed secured creditors receive in full before unsecured creditors except for those who have super-priority over secured creditors such as small claims creditors under a certain amount 61or tax authorities62. On the contrary, there is no guideline on the distribution between shareholders and unsecured creditors. Concerning shareholders' rights and distributional rights, there are two clauses in the DRBL. First of all, article 146 rules that no voting rights on the proposed plan when their obligation amounts exceed its assets. Because of this clause, shareholders will not exercise their voting rights during the voting since financially distressed firms are insolvent. If the proposed plan is favorable to shareholders, none of the classes agree with the plan. The second clause is article 205 ‘Capital reduction’. According to article 205(4) and 205(5), the shares of controlling shareholders and its related party shareholders' equity such as the family of the controlling shareholders or affiliated firms of a group company should be reduced more than two-thirds or retired more than one-third. Those shareholders cannot participate in the new share issuance under the DRBL.63
The latter is a very important part of the DRBL, because of the compulsory capital reduction of controlling shareholders, financially distressed firms would be discouraged to enter the
60 Working Research Group, Bankruptcy Division of the Seoul Central District Court. (2008). Restructuring cases in practice (2nd Ed.). Park Young Sa, 59. 61 Article 132(1) of the DRBL
62 Article 140 of the DRBL
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proceeding. After the compulsory capital reduction, shareholders usually lose their control over the firm and hold minority shares of the firm. On the other hand, some researchers argue that compulsory capital reduction helps promote acquisition by a third party since controlling shareholders lose their control during the proceeding. At the same time, they proposed to open for the possibility of debtors’ new equity investments within non-controlling shares.64 However, it is hard to expect that the incumbent controlling shareholders or management who failed to fund capital before the commence will invest in the same company with new capital if they cannot be controlling shareholders. Whether it incentivizes a firm’s revitalization through being acquired during the case is not been proven yet due to a lack of statistics from the bankruptcy court. Also, many other factors can contribute to this. However, it is easy to tell that this clause is a discouragement for debtors to get into the proceeding in the DRBL. Article 205(3) was originally referred to the compulsory share reduction of non-controlling shareholders, this was deleted in 2014 because they are not the ones who managed the company and have little monitoring incentives on the company. They will also not affect anything on the negotiation process or voting since they do not have bargain powers or their benefits are negligible for them to be actively involved with the process. With the above-mentioned mechanism, in practice, the court instructed receivers to draft a plan for the debt-equity swap structure that shareholders equity will be lower than creditors' shares.65 The focal point is
shareholders cannot opportunistically enjoy the maximum recovery to themselves, but there is no specific instruction on the topic.
3.4.3. Fast-track and pre-packaged plan
Recently, the legislation body approached with a different solution to deal with an efficiency problem in restructuring. Fast-track and Prepackaged plan are the answers from the court to address the problem. Fast-track is adopted in 2011 as an administrative procedure to shorten the length of the restructuring process for less than six months. The court allows receivers to merge different steps in the law so that separate stages of procedures can be held together. This only applies to debtors with the total credit over 50 billion Korean Won which is approximately 37.5 million euros worth of bank loans and there must be some sort of pre-negotiation of the rehabilitation plan with their creditors. Recent empirical research from the Bank of Korea looks into the effect on the track procedure in restructuring proceedings. The result of the fast-track procedure was limited mainly due to bankruptcy stigma and cost disadvantage effects
64 Oh, S. (2009). A way to improve Bankruptcy Law, Business Finance Law Vol. 34, Center for Financial Law, Seoul National University, 15-16. 65 Seoul Bankruptcy Court. (2018). The manual of the Custodial Committee, Judicial Development Foundation, 157.
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which are caused by a lower credit rating and high-risk premium.66 The result also shows that
simply reduced and merged steps in the proceeding cannot achieve the goal of restructuring. Shortly afterward pre-packaged plan was implemented to the DRBL in 2016. By article 223(1), debtors or creditors hold claims at least half of the debtor’s obligation may submit a prearranged rehabilitation plan to the court. The pre-packaged plan under the DRBL was adopted to mitigate holdout problems in a workout procedure outside of the court and to provide financing from the creditors by giving the new financing a priority over secured creditors. It is too early to say whether the new pre-packaged plan will be successful.67 Although the pre-packaged plan contributes to lower ex-post costs to some extent, this only works when the majority of creditors and the debtor agreed upon a certain plan. If this works, then shareholders will file for rehabilitation proceeding at the earlier stage. If they fail to produce a prearranged plan, then the outcome is the same as normal rehabilitation proceeding or even worse because they already spent time on pre-negotiation.
3.5. The analysis of the DRBL and the objective that needs to be prioritized
The DRBL is considered as debtor-friendly, or at least creditors are not happy with their positions in the DRBL. The main reason is their opinions are often ignored during the proceeding. Unlike Chapter 11 where creditors' committees can play a major role, the bankruptcy court is the main decision-maker under the DRBL because of the lack of power of the creditors' consultative council and debtor-in-possession. The role of the creditors’ consultative council is not suitable for the expression of their opinions when there is asymmetric information. Instead of being an important safeguard to the proper management of the debtor in possession by investigating its operation and participating in drafting a plan, the council is only provided a limited amount of information from the debtor-in-possession, and it has no actual decision making or influence during the proceeding. This is even worse with the absence of DIP financing availability. Notwithstanding a few disadvantages in the DRBL,68
the law generally recognizes a priority for new funding over other reorganization claims. Because these two important bodies, namely a debtor in possession and a creditors’ committee, are weak, the role of the court is greater than in other jurisdictions. The court actively engages
66 Choi, Y. J. (2017). The Effect of the Fast-Track Corporate Rehabilitation Program on the Interest Coverage Ratio of the Companies Under Court
Receivership, Bank of Korea Working Paper No. 2017-20, 26.
67 Paik, J. H., & Lee, S. J. (2017). Practical issues of prepackaged plan in Korean Bankruptcy proceedings, Korean Journal of Insolvency Law, Vol. 7, No. 2,
Insolvency Law Institute of Korea, 143.
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from the usual operation of business to the review and the approval of drafting plans to the monitoring after the authorization.69
Another reason is that the directors of a financially distressed firm have no legal duty to file a restructuring petition in the DRBL. Whether the directors are responsible for the loss of creditors from debtors’ delay of restructuring filing is open for debate but many agreed that the current DRBL and the Commercial law of Korea are unfavorable for creditors who seek compensation from the directors who had breach fiduciary duties to creditors by not filing for a restructuring proceeding.70 In theory, creditors can file a restructuring case instead of the debtor. However, there is less incentive for creditors to start the proceeding and it is also very difficult for them to monitor its debtors when accounting standards and transparency of Korea are questionable. Hence, creditors are worse off since they cannot argue with the fiduciary duty of directors in case of late filing of restructuring.
However, the biggest problem of the DRBL cannot address the tension between shareholders and creditors. This is the main reason why court rehabilitation cases are lengthy and costly. Recent research from Seymour and Schwarcz illustrates that weak priority rules usually turn to produce lengthier and costly restructuring proceedings with the high recovery rates for shareholders at the expense of creditors.71 Not stringent priority rule in the DRBL exacerbates the viability of restructuring because the debtors cannot tap into the new funding during the restructuring proceeding. The DIP financing is not commonly used during restructuring proceedings under the DRBL, not because of the regulation but because of that financial creditors are not willing to supply fresh funding to the restructuring firms after their opinions were not counted in the plan.72 Creditors’ protection and the participation in restructuring proceedings are important not only for the creditors but also for debtors to access credit. It is clear that creditors who feel that they are protected will lend more and lower the cost of lending which ease access to finance for businesses.73 In sum, creditor protection should be the primary goal of restructuring to answer the main problem that the DRBL has, at least in the Korean context. Then, how does the DRBL address the creditors' protection, the efficiency of restructuring, and easier access to lenders? The Priority rules are important in this respect. For
69 Kang, I. (2019). The Problems and Improvement Directions of the Creditor's Consultative Council System. Journal of Legislation Research Vol.55, Korean
Legislation Research Institute, 240-241.
70 Han, M. (2015). Directors’ Obligations in the Period Approaching Insolvency. Advanced Commercial Law Research Vol. 70. Ministry of Justice, Republic of
Korea, 4.
71 Seymour, J., & Schwarcz, S. L. (2019). Corporate Restructuring under Relative and Absolute Priority Default Rules: A Comparative Assessment. Available at
SSRN 3498611, 39.
72 Kang, I. (2018), The creditor's point of view for the improvement of the corporate rehabilitation system, Law Times. Retrieved June 26, 2020, from
https://m.lawtimes.co.kr/Content/Opinion?serial=142927
73 Koch-Saldarriagaraman, K. Maroz. R & Dannaoui, N. (2019, June 19). Giving creditors a voice for a better insolvency process. [Blog post]. Retrieved June
