Kim & Chang represented an investment company (the “Plaintiff”) and won a lawsuit in which the Plaintiff filed a partial claim against a game company (“Company A”) for KRW 100 billion in damages, alleging that Company A failed to pursue an initial public offering (“IPO”) as required under a convertible bond subscription agreement.

The Plaintiff and Company A entered into a convertible bond subscription agreement in 2017 (the “Convertible Bond Subscription Agreement”). The agreement contained a mandatory IPO covenant, stipulating that Company A must pursue an IPO if its net income for a fiscal year reaches or exceeds a certain amount (the “Threshold”). For fiscal year 2021 (“FY2021”), Company A’s net income comfortably surpassed the Threshold and cemented its obligation to pursue the IPO. Company A, however, did not proceed with an IPO, arguing that the IPO obligation became ineffective following its mid-process accounting standards transition from the Korea Generally Accepted Accounting Principles (“K-GAAP”) to the Korean International Financial Reporting Standards (“K-IFRS”), a structural change that rather resulted in a net loss for fiscal year 2022 (“FY2022”). The Plaintiff filed a lawsuit against Company A, seeking partial damages arising from the breach of its obligation to pursue an IPO.

Representing the Plaintiff, we successfully argued that Company A’s recognition of a net loss for FY2022 was entirely driven by classifying the investor’s conversion rights as a liability, which resulted in a huge valuation loss. We asserted that Company A’s pre-existing obligation to pursue an IPO could not be deemed extinguished simply because its financial statements—prepared under K-IFRS for FY2022—reflected a net loss. This argument was based on a holistic interpretation of the Convertible Bond Subscription Agreement and the principle of good faith prohibiting the unfair frustration of conditions, supported by the following grounds:
 

• Since Company A’s listing was effectively the Plaintiff’s sole means of investment exit, the obligation to pursue an IPO constitutes the most fundamental essence of the Convertible Bond Subscription Agreement.

• The Threshold for Company A’s IPO obligation under the Convertible Bond Subscription Agreement is properly understood as a financial metric reflecting the defendant’s corporate value, which served as the baseline for calculating the conversion price.

• Classifying the investor’s conversion rights as a liability and recognizing the resulting valuation loss had no bearing on Company A’s actual corporate value, and therefore posed no objective obstacle to pursuing an IPO.

• Under the K-GAAP, which Company A applied at the time of the Convertible Bond Subscription Agreement, conversion rights were classified as equity, meaning no valuation loss was recognized. Even under the K-IFRS, which Company A adopted during the IPO process, it was entirely feasible to classify conversion rights as equity and avoid recognizing a valuation loss based on an official interpretation by the Financial Supervisory Service (“FSS”) (Hoe-Je-I-00094).^[1] Furthermore, classifying conversion rights as equity was a standard accounting practice under the K-IFRS at the time the contract was executed.

• Interpreting the Convertible Bond Subscription Agreement such that Company A’s IPO obligation would dissolve due to a valuation loss from classifying conversion rights as a liability leads to various contradictory outcomes that the parties could not have anticipated or accepted at the time of contract.

• Beyond the liability classification of conversion rights, Company A engaged in various other highly unusual accounting practices for FY2022 to recognize substantial expenses and losses.
   

The court effectively accepted our firm’s arguments in their entirety, rendering a decision in favor of the Plaintiff. The court appropriately rejected Company A’s assertion that its IPO obligation had extinguished in FY2022. Company A had based its defense on its adoption of the K-IFRS and irregular accounting treatments, which led it to classify the investor’s conversion rights as liabilities and record massive, non-cash valuation losses, despite the fact that Company A’s actual corporate value had increased sharply in FY2022 compared to FY2021. Ultimately, the court’s judgment displayed both legal consistency and a commercially sound, equitable result.

We secured a complete victory by thoroughly reviewing and grasping the substance and essence of the Convertible Bond Subscription Agreement and K-IFRS accounting standards, carefully analyzing a wide range of evidence and executing a comprehensive, well-crafted defense strategy. This case is expected to serve as an important precedent in future disputes of a similar nature.

^[1]   Note on FSS Interpretation (Hoe-Je-I-00094): This refers to an administrative guidance issued by the FSS in the form of an inquiry reply concerning the accounting treatment of hybrid financial instruments (such as convertible bonds, bonds with warrants and redeemable convertible preferred shares). It was provided informally by the FSS to mitigate the artificial deterioration of corporate financial structures following the mandatory adoption of IFRS.

[Korean Version]