A construction company, which was acquired by an investor during rehabilitation proceedings (the “Debtor Company”), received a claim for payment of billions of KRW brought by a company, which had been a specially-related entity (the “Creditor Company”) of the Debtor Company not long after the rehabilitation proceedings were terminated.
The Creditor Company asserted subrogation of the rights of a financial institution, which held receivables against the Debtor Company for certain beneficiary certificates in relation to a real estate investment trust business. Although the lower court recognized the Creditor Company’s claim and ordered the Debtor Company to make the payment, the Seoul High Court quashed the lower court’s decision and dismissed the claim in its entirety.
The Seoul High Court’s decision marks the first ruling that subrogation to the rights of the obligee as against the principal rehabilitation debtor is not permitted if the relevant right of reimbursement was extinguished under a rehabilitation plan. This has established a meaningful precedent for potential disputes that may arise between the debtor concluding a M&A deal in a rehabilitation proceeding and its former specially-related person or entity.
It is common in rehabilitation proceedings for a rehabilitation plan to release all rights of reimbursement held by a specially-related company against the rehabilitation debtor, which is what occurred in this case. Accordingly, neither the Debtor Company nor the investor acquiring it expected the Creditor Company, which was no longer entitled to any right of reimbursement, to file a claim for subrogation.
Article 482 (1) of the Korean Civil Code (“KCC”) provides that: “A person who has been subrogated to the rights of the obligee […] may exercise the claim and the right in respect to its security to the extent to which he may be reimbursed by virtue of his own right.” However, in a case where a creditor of a rehabilitation proceeding failed to report its right of reimbursement and thereby rendered the debtor concerned exempt from its liabilities pursuant to Article 251 of the Debtor Rehabilitation and Bankruptcy Act (the “Debtor Rehabilitation Act”), for example, the Supreme Court has held that: “While a creditor may not force the debtor to perform its obligations, the creditor’s right of reimbursement maintains full force and effect and therefore, there is no effect on the rehabilitation creditor being subrogated to the rights of the obligee and exercising the claim and the right regarding its security by virtue of subrogation under Articles 481 and 482(1) of the Korean Civil Code.”1
Various literature provide that the legal principle set out by the Supreme Court precedent applies not only when the debtor is exempt from its liabilities for rights to reimbursement that have not been reported, but also to rights for reimbursement that have been reported, but reduced or extinguished by a rehabilitation plan. Accordingly, the issue in this case was whether Article 482(1) of the KCC is also applicable if the rehabilitation creditor’s right of reimbursement was extinguished by the release of claims in accordance with a rehabilitation plan, or whether the provision was not applicable given the nature of a rehabilitation proceeding.
The Creditor Company also cited the above Supreme Court ruling, various literature and a decision rendered by the Supreme Court of Japan to support its claims for subrogation.
Kim & Chang successfully defended against these arguments by arguing that unlike the Supreme Court of Japan – which viewed subrogation as equivalent to a security interest and thus applied by analogy Article 177(2) of the Japanese Civil Rehabilitation Act, which stipulates that a rehabilitation plan shall not affect any security interests – there is no comparable provision for Korean rehabilitation procedures.
Our team also distinguished this case from the precedent case (ruling by the Supreme Court of Korea), whereby subrogation was recognized in rehabilitation proceedings where: (i) the right of reimbursement existed and only the debtor’s liability was extinguished; or (ii) the issue was the exercise of a right of reimbursement against a third party and not the rehabilitation creditor.
The Seoul High Court accepted these arguments and ruled that Article 482(1) of the KCC should also apply when the right of reimbursement is extinguished by the release of claims pursuant to a rehabilitation plan, revoking the lower court’s decision and dismissing all claims made by the Creditor Company.
Kim & Chang successfully represented the Debtor Company by carefully reviewing legal principles on subrogation in rehabilitation procedures in Korea and Japan. In particular, by questioning whether the exercise of the put option had been notified (a point which had not been disputed by counsel before the lower court), we were able to obtain the Seoul High Court’s judgment that the alleged receivables of the investor financial investment had not been accrued in the first place since the Debtor Company did not receive a notice on the exercise of the put option at issue.