The National Assembly, during its plenary session on June 30, 2023, passed an amendment to the Fair Subcontracting Transactions Act (“FSTA”) that introduces a new variable subcontract price system (also referred to as the “variable supply price system”), which requires the adoption of arrangements within a subcontract agreement that automatically adjusts the subcontract price in response to significant changes in the cost of key raw materials during the contract term.
 
As a separate amendment introducing a similar system under the Act on Promotion of Mutual Growth and Cooperation between Large Enterprises and SMEs (“Mutual Growth Act”) is set to take effect on October 4, 2023, the FSTA amendment will also take effect on the same day to ensure a regulatory balance with the Mutual Growth Act.
 
Until then, the Korea Fair Trade Commission (“KFTC”) is expected to spend the next three months or so working on making necessary updates to the Enforcement Decree to the FSTA (e.g., drafting a proposed amendment and issuing an advance notice for public comment), creating model subcontract agreements that are based on variable subcontract price arrangements, and holding explanation sessions to help companies learn about the new system. In particular, as the proposed amendment to the Enforcement Decree will further specify regulations relating to the new system, and update other matters specific to the FSTA (e.g., provision of incentives, such as reducing penalty points for FSTA violations, if a company adopts a variable subcontract price arrangement), it will be necessary to carefully review the proposed amendment when it becomes available. Further, as the FSTA amendment allows the KFTC to designate agencies as “support headquarters” that will be in charge of supporting all working-level matters relating to the new system, it will also be necessary to monitor developments at agencies (e.g., the Korea Fair Trade Mediation Agency) that will likely be designated to carry out such an important role.
 
The new system has been a key policy objective of the current government, with the KFTC focusing on its implementation. Accordingly, once the KFTC goes through a round of informational activities (e.g., explanation sessions) to help the new system take root, it is expected to make proactive regulatory efforts (e.g., ex-officio investigations) to ensure implementation of the new system.
 
Going forward, therefore, it will be necessary for companies to continuously monitor developments relating to the introduction and implementation of the new system under the amended FSTA, and for each to prepare a customized response strategy for different stages and situations during the process of negotiating and executing subcontract agreements.
 
Key Details of the FSTA Amendment
 
According to the press release announcing the National Assembly’s approval, the FSTA amendment aims to foster a fair market economy by easing the burden of the changing cost of raw materials on subcontractors.
 
Recently, the surge in cost of raw materials (e.g., crude oil, iron ore, pulp) has been increasing the burden on SMEs that supply products to larger companies, and according to a survey conducted by the Korea Federation of SMEs, between 2020 and 2021, the average cost of raw materials nearly doubled (by 47.6%) while the increase in the supply price of products made using those raw materials was only 10.2% during that time, translating to an overall decrease in the subcontractors’ operating profit margin from 7% to 4.7%. While the current FSTA already allows for subcontractors to request for an adjustment in their subcontract price if such adjustment is necessary due to changes in the cost of raw materials, the conditions for making such requests are too strict, and there has been criticism that SMEs are reluctant to make such requests out of fear of losing their business.
 
The FSTA amendment will be promulgated after going through necessary procedures in the government, including approval by the Cabinet, and will take effect on October 4, 2023. Key details of the proposed are as follows:
 

[Korean Version]