Skip Navigation

Recent Developments in Derivative Actions and Director’s Obligations and Liabilities


The public’s interest in minority shareholders’ rights has recently increased and the possibility of the National Pension Service’s (the “NPS”) taking derivative actions has garnered attention.  Given this context, it is noteworthy that, in a recent derivative action case, the Supreme Court rendered a decision that broadly interprets directors’ obligations and responsibilities.

The Korean Commercial Code (the “KCC”) has a derivative action system under which a shareholder holding 1% or more of the total issued and outstanding shares of a company (and in the case of a listed company, a shareholder continuously holding 0.01% or more of the total issued and outstanding shares of such listed company for at least six months) may file a suit against the company’s director on behalf of the company upon meeting the requirements for filing such lawsuit (Articles 403 and 542-6 (6) of the KCC).  In addition, Article 406-2 of the KCC, which was amended and became effective in December 2020, provides the basis for a “multilayer derivative action,” in which shareholders holding 1% or more of the total issued and outstanding shares of the “parent” company (and in the case of a listed company, shareholders continuously holding 0.5% or more of the total issued and outstanding shares of the parent company for at least six months) may try to hold directors of the “subsidiary” accountable through such multilayer derivative action. 

While shareholder derivative actions were not actively utilized in the past, concerns have been raised recently that managing officers should be held liable for various incidents and accidents that occur in the course of business, including large-scale embezzlements or misappropriation within listed companies, human casualties, conflicts of interest between major shareholders and minority shareholders during business restructuring of listed companies, and indiscriminate exercise of stock options by officers and employees of listed companies.  Shareholder derivative actions are considered as effective means to address such issues.

1.   Supreme Court Decision Broadly Recognizes Directors’ Duty to Monitor

In a recent derivative action against a representative director seeking damages from the company, the Supreme Court ruled that even if a director has not actively instructed or engaged in an illegal act, a director may be held liable for the breach of his or her duty to monitor and supervise if the director did not establish or make an effort to establish a reasonable internal control system to prevent such illegal act.

In the above case, a shareholder of Company B, which was merged into Company A, filed a derivative action against the then representative director of Company B, seeking damages of an amount equal to the surcharge imposed on Company B (which was subsequently merged into Company A) for its market collusion activities.  The lower court refused to accept the plaintiff’s claim on the grounds that “there is no evidence to prove that the representative director was involved in the collusion or neglected to perform his duty to monitor despite knowing that the act was illegal.” 

However, the Supreme Court, while acknowledging that there is insufficient evidence for the defendant’s instruction or direct involvement in the collusion, ruled that “if the defendant, the representative director of Company B, was unaware of the continuous and systematic collusive activities, which is a serious illegal act, and could not prevent them or take corrective measures immediately upon the occurrence of such activities, this may be regarded as a result of the defendant's failure to make any effort to establish an internal control system to control the risks that may arise from serious illegal and unfair acts in the course of the company’s business, or intentional avoidance from performing the defendant’s duty to monitor and supervise the overall business of the company through such system.” 

The court also ruled that “the internal accounting management system allegedly established by the defendant as an internal control system was generally limited to purposes of accounting, as it was established for the preparation and disclosure of accounting information under the Act on External Audit of Stock Companies.  Furthermore, the code of ethics adopted in 2003 is simply an abstract and overarching guideline on the performance of duties by officers and employees.  Thus, it is difficult to deem that the appointment and operation of outside directors and auditors, decision-making through the board of directors, etc. brought up by the defendant functioned as mechanisms to prevent illegal acts such as price-fixing, collect and report information on suspected or confirmed illegal acts, and control such illegal acts.” 

Therefore, the Supreme Court reversed the lower court’s decision, which did not acknowledge the representative director’s liability, and stated that “the defendant, as the representative director, cannot be exonerated from liability solely on the grounds that he was not aware of the details of the illegal activities and did not directly instruct such activities.  If the defendant's continuous neglect of his duty to monitor, which should have been duly performed by him as the representative director, caused damage to the company, the defendant should be deemed liable for such damages.” 

As such, in line with the trend of court decisions that recognize a broader scope of a directors’ duty to monitor, the likelihood that directors will be held liable in the event of damage to the company will increase, thereby incentivizing shareholders to utilize derivative actions more actively. 

2.   Trends in Representative Lawsuits Filed by the National Pension Service

In addition, the NPS’s recent activities have attracted the attention of various fields, as they seem to display the NPS’s intentions to actively file derivative actions going forward. 

In July 2018, the NPS, in line with the introduction of the “Principle on Trustee Liability (Stewardship Code),” adopted the “Guideline on Activities of Trustee of the NPS” (the “Trustee Guideline”) and provided the requirements and standards for derivative actions.  However, since then, the NPS has not filed any derivative action against its investment companies, which elicited opinions that the pension fund should more actively exercise its shareholder’s rights.  In December 2021, however, the NPS apparently sent confidential letters to about 20 to 30 companies to inquire about the factual background of events that were believed to have undermined shareholders’ rights within the respective companies.  In the same month, the NPS proposed to the National Pension Service Fund Management Committee an amendment to the Trustee Guideline that changed the decision-making authority for derivative actions.  Consequently, the NPS is now expected to file derivative actions and exercise its shareholder rights more actively than before.

The Proposed Amendment to the Trustee Guideline incorporates the multilayer derivative litigation system introduced by the amendment to the KCC.  Further, while the Fund Management Division of the NPS (investment committee) used to decide whether to file a derivative action (provided that if it is difficult to make a decision or if at least one-third (1/3) of the members of the Special Committee on Trustee Responsibility (the “Special Committee”) requests that NPS refer the case to the Special Committee, the Special Committee will decide whether to file a derivative action), pursuant to the amendment, the Special Committee is now in charge of deciding whether to file a derivative action while the Fund Management Division is in charge of the practical matters related to litigation. 

Regarding the proposed amendment, the Ministry of Health and Welfare issued a press release stating that the amendment to the Trustee Guideline aims to establish a timely and consistent decision-making system and plans to prevent the abuse of derivative actions through rigorous procedures such as prior review by the Fund Management Division.  With various stakeholders raising different arguments with regards to the amendment, the Fund Management Committee did not reach a resolution on the amendment at its meetings held in December 2021 and February 25, but it has decided to revisit it after organizing a separate subcommittee to further discuss the issue.  Accordingly, continued monitoring of the process is necessary.

As such, in light of recent trends where general shareholders and the public request the active exercise of shareholders’ rights, derivative actions against companies and their management may increase.  Therefore, it will be necessary to monitor the plans and movements of pension funds including the NPS, institutional investors, and civic groups in connection with derivative actions. 

Furthermore, when a derivative action is filed, it may be difficult to find, solely based on the establishment of an internal accounting management system, that the relevant directors have fulfilled their duty to monitor and supervise to prevent illegal acts by the company’s officers and employees.  Therefore, more concrete and systematic information reporting systems and internal control systems should be established to fulfill the management's duties and responsibilities.