As a follow-up measure to the “Real Estate Project Financing (“PF”) System Enhancement Plan” jointly announced by the Ministry of Land, Infrastructure and Transport (the “MOLIT”) and other relevant ministries on November 14, 2024, the Korea Financial Investment Association (the “KOFIA”) has established the “Best Practice Guidelines for Completion Guarantee Land Management Trusts” (the “Best Practice Guidelines”), which became effective as of January 31, 2025.

The Best Practice Guidelines clearly set forth the criteria and procedures that trust companies must adhere to when conducting a feasibility review of a project to issue a completion guarantee. Additionally, the Best Practice Guidelines clearly define the scope of liability for trust companies in the event of non-performance of their completion guarantee obligations and require that project costs must be secured in advance.

The scale of land management trusts has grown rapidly over the past few years as trust companies have actively taken on their roles as trustees for land management trust works, leading to a significant increase in the proportion of land management trust portfolios within the trust companies’ financial structures. Completion guarantees have been actively utilized as a means to mitigate completion risks in PF projects involving small and medium-sized contractors with low credit ratings or lower selection priority as the general contractor. However, since the second half of 2022, rising interest rates and increased construction costs have led to an increase in cases where contractors failed to fulfill their completion guarantee obligations. Recently, due to the downturn in the real estate market, difficulties in the lenders’ collection of loans through pre-sales have led to instances where the lenders claim damages from trust companies based on trust companies’ completion guarantees.

Amidst the recent surge in legal disputes related to trust companies’ completion guarantees, the Best Practice Guidelines aim to reinforce the completion guarantee system by establishing detailed procedures regarding completion guarantees and the criteria for risk allocation. The key provisions of the Best Practice Guidelines are as follows:
 

• Securing Required Project Costs for Completion: When entering into a completion guarantee land management trust agreement, trust companies must, during the feasibility review study, verify whether or not the required project costs for completion (i.e., project costs necessary for completing the development of buildings even if the pre-sale rate is 0%) have been secured by way of the trustor’s own capital, loans or other means.

• Limitation of Liability: The scope of a trust company’s liability for damages will be limited to the actual damages directly incurred by the lending financial institution due to delays in the collection of loan principal and interest resulting from the trust company’s failure to fulfill its obligation of responsible completion.

• Making Completion Guarantee Performance Period Reasonable: (i) The completion guarantee performance period for a trust company must be extended by whichever is longer among (a) a period of six months and (b) a period corresponding to 20% of the contractor’s scheduled construction period, beyond the contractor’s completion guarantee performance period; (ii) if delays occur due to faults not attributable to the trust company or the contractor, the completion guarantee performance period is to be adjusted through mutual agreement of the lending institution and the trust company; and (iii) if the contractor’s completion guarantee performance period is extended, the trust company’s completion guarantee performance period will also be extended accordingly.

• Right to Change Contractor: To facilitate and enable a trust company to change a contractor during the performance of its completion guarantee obligations, certain terms and conditions, such as the contractor’s covenant to assign and transfer the project and waive its right to claim a mechanics lien, are now required to be specified in the trust agreement.

• Adjustment of Pre-Sale Price: The trust agreement is now required to include provisions specifying that the lending institution and trust company will mutually agree upon and determine the pre-sale price in case an adjustment to the pre-sale price is deemed necessary during the trust company’s performance of its completion guarantee obligations.

• Feasibility Review Procedure: Trust companies are now required to establish internal business feasibility review guidelines and policies specifically designed for completion guarantee management land trusts, separate from general land trusts, and implement them accordingly.
   

The Best Practice Guidelines on its own may not have a binding effect on financial institutions, but they appear to have actual and meaningful influence considering the following. First, financial institutions are obligated to establish and manage internal control standards pursuant to the Act on Corporate Governance of Financial Companies. Second, in practice, financial institutions often incorporate the content of the Best Practice Guidelines into their internal control standards to comply with the aforementioned obligations. Third, if the officers of the financial institutions violate their duties to inspect and oversee compliance, the financial authorities impose sanctions on the relevant financial institutions and their responsible officers. Considering these factors, it appears that the Best Practice Guidelines are likely to have de facto binding effect on the financial institutions.

If the Best Practice Guidelines are enforced, trust companies’ burden in relation to the completion guarantee will be reduced. On the other hand, the use of the completion guarantee may also dramatically decrease as a result of increased loan collection risk. It appears that demand for completion guarantee may still continue for development projects carried out by small-to-medium sized contractors to a certain extent but, even in such cases, it would be advisable to keep track of the utilization of land management trusts. Regulatory authorities will also oversee the real estate market after the Best Practice Guidelines are enforced, because interest rates and fees related to loans are expected to rise as well.

[Korean Version]