Lending and taking security in South Korea: overview

A Q&A guide to Finance in South Korea. The Q&A gives a high level overview of the lending market, forms of security over assets, special purpose vehicles in secured lending, quasi-security, negative pledge clauses, guarantees, and loan agreements. It covers creation and registration requirements for security interests; problem assets over which security is difficult to grant; risk areas for lenders; structuring the priority of debt; debt trading and transfer mechanisms; agent and trust concepts; enforcement of security interests and borrower insolvency; cross-border issues on loans; taxes; and proposals for reform.

To compare answers across multiple jurisdictions, visit the Finance Country Q&A tool. This article is part of the global guide to finance. For a full list of contents visit www.practicallaw.com/finance-guide.

Contents

Overview of the lending market

1. What have been the main trends and important developments in the lending market in your jurisdiction in the last 12 months?

Due to the recent downturn of the real estate market, banks have adopted strict risk management measures to mitigate the losses they suffered in project financing transactions, and as a result became cautious when extending loans for project financing.

However, the total loan amount extended to corporations has steadily increased based on the efforts of banks to increase loans for corporate working funds and technology development and to fund restructuring companies. On the other hand, corporate financing in the form of direct finance (for example, corporate bonds and commercial paper) have maintained a steady level.

Furthermore, financial demands for funds and real estate investment trusts (REITs) for private rental housing projects are expected to increase in the future.

 

Forms of security over assets

Real estate

2. What is considered real estate in your jurisdiction? What are the most common forms of security granted over it? How are they created and perfected (that is, made valid and enforceable)?

Real estate

Real estate or immovable property (the legal term used) comprises:

  • Land, including any fixtures affixed to land.

  • Buildings, which are regarded as independent from the land on which they are built and which are subject to a separate registration system.

Common forms of security

The two most common forms of security created over immovable property are:

  • Mortgages. A mortgage gives the secured creditor a preferential right relating to the value of the mortgaged property and allows the mortgagee to receive payments from the proceeds of the mortgaged property ahead of unsecured creditors.

  • Kun-mortgages. A kun-mortgage is a type of mortgage, but the claims that it secures are not specified at the time of its creation.

Formalities

The creation of a mortgage is effective on:

  • An agreement between the borrower and lender(s).

  • Registration at the relevant property registry (this also perfects the mortgage).

A kun-mortgage is created and perfected in the same manner as a mortgage. However, the agreement creating a kun-mortgage must specify both the:

  • Scope, or type, of claims to be secured.

  • Maximum amount to which the kun-mortgagee has preferential rights.

 

Tangible movable property

3. What is considered tangible movable property in your jurisdiction? What are the most common forms of security granted over it? How are they created and perfected?

Tangible movable property

Any tangible thing or item, which is not immovable property, comprises movable property.

Movable property is given a different legal treatment depending on what type of movable property it is. Generally, the Civil Code provides that a mortgage cannot be created over most movable property. However, there are exceptions under statutes as follows:

  • Mortgages and kun-mortgages (see Question 2) can be created over the following movable properties:

    • construction machinery;

    • automobiles;

    • aircraft;

    • registered ships.

  • Security rights can be created over movable property under the Act On Security Over Movable Property and Claims (Security Act), which became effective on 11 June 2012 (section 2, Security Act).

A pool of movable properties is not recognised as a single movable property. Therefore, a single security cannot be established over a pool of movable properties (subject to limited exceptions).

However, the Supreme Court has recognised that a pool of movable properties can be subject to a single security interest if that pool can be identified as being separate from other of the security grantor's movable properties by specifying the type, location and quantity of the movable properties that are included in that pool. A single security right can also be created over a pool of movable properties (section 2, Security Act).

Common forms of security

The most common forms of security granted over movable property in secured lending transactions are:

  • Pledges.

  • Security assignments.

  • Mortgages (construction machinery, automobiles, aircraft and registered ships).

  • Security rights (dong-san-dam-bo-kwon) (section 2, Security Act).

Formalities

A pledge over movable property is created and granted by:

  • An agreement between the pledgee and the pledgor.

  • Delivery of the subject matter to the pledgee. Delivery includes:

    • actual delivery;

    • summary delivery (that is, if the pledgee is already in possession of the movable property under an existing lease agreement, delivery will be assumed to have taken place); and

    • transfer of possession by instruction.

However, it excludes constructive delivery. Constructive delivery occurs where the pledgor enters into a lease agreement, simultaneously with entering into a pledge agreement, and is allowed to be in continuous possession of the movable property under that lease agreement. In that case, the pledge would only acquire "notional" possession of the movable property.

A pledge over movable property is perfected by continuous possession of the subject matter of the pledge.

A security assignment of movables is created and granted through a granting contract and delivery. In contrast to a pledge (see above), delivery of the subject matter can take the form of constructive delivery. A security assignment over movable property is also perfected by continuous possession of the subject property.

A security right over movable property is created and granted by an agreement and registration but no delivery is required in that case (section 2, Security Act).

 

Financial instruments

4. What are the most common types of financial instrument over which security is granted in your jurisdiction? What are the most common forms of security granted over those instruments? How are they created and perfected?

Financial instruments

Financial investment instruments are classified as follows (section 1, Capital Markets Act):

  • Securities.

  • Derivatives.

  • Securities are further classified as one of the following:

    • debt securities;

    • equity securities;

    • beneficiary certificates;

    • investment contract securities;

    • derivatives-combined securities;

    • securities depositary receipts.

  • Derivatives are further classified as one of the following:

    • Exchange-traded derivatives;

    • Over-the-counter derivatives.

Common forms of security

There are four main methods of granting a security interest over the securities:

  • Unregistered pledge.

  • Registered pledge.

  • Unregistered security assignment (yang-do-dam-bo).

  • Registered security assignment.

However, the most common form of security over financial instruments is the pledge.

Formalities

The applicable formalities depend on the type of financial instrument, such as whether it involves a pledge over movable property (see Question 3) or a pledge over shares (see below).

Shares in unlisted companies

A registered pledge is created and perfected through the:

  • Execution of the pledge agreement.

  • Recording the pledgee's name on the back page of the share certificate.

  • Registration of the pledgee's name and address in the company's shareholders register.

  • Delivery of the share certificate and the copy of the company's shareholders register to the pledgee.

  • Continuous possession of the share certificate along with continued registration on the company's shareholders register.

An unregistered pledge is created and perfected through the:

  • Execution of a pledge agreement.

  • Delivery of the share certificate.

  • Continuous possession of the share certificate.

Shares in listed companies

A registered and unregistered pledge of shares in a listed company is created and perfected through the same procedure as shares in an unlisted company (see above, Shares in unlisted companies).

However, if the share certificates of the listed company are deposited with the Korea Securities Depository (KSD), a registered pledge over those shares is created and effective on the:

  • Execution of the pledge agreement.

  • Recording of the pledge and the pledgee in the investor's account book maintained by the investment broker or dealer (or depositor's account book maintained by KSD).

Bonds

This depends on whether bond certificates are issued for the bonds:

  • Bond certificates issued. Both a pledge and a security assignment over bonds are created by:

    • execution of the pledge/security assignment agreement;

    • delivery of the bond certificates;

    • continuous possession of the bond certificates.

  • For bearer bonds, there are no further steps required for perfection. However, for registered bonds, the assignee's name and address must be registered or recorded in the bond registry and the relevant bond certificates for unregistered security assignment (yang-do-dam-bo) perfection.

  • There are three conflicting views on what constitutes perfection in the case of a pledge of registered bonds:

    • notification of the creation of the pledge to the issuer;

    • registration of the name and address of the pledgee into the bond register; or

    • registration or endorsement of the name and address of the pledgee into both the bond register and the bond certificate.

  • The most common practice for perfection is registration or endorsement of the name and address of the pledgee into both the bond register and the bond certificate. However, there are not many cases where a security interest is established over bonds for which certificates representing those bonds are issued.

  • Bond certificates not issued. Bond certificates will not be issued for book-entry bonds. The issuer of public bonds can designate an institution that is responsible for registration of these bonds and that registration institution can register or record the pledgees or other interested parties in their registry. A pledge and security assignment of those bonds is created solely through a granting contract.

  • Perfection is achieved:

    • for bearer bonds, by registering the security interest in the account of the relevant registration institution;

    • for registered bonds, by registering the security interest in the account of the relevant registration institution and recording the security interest in the bond registry.

 

Claims and receivables

5. What are the most common types of claims and receivables over which security is granted in your jurisdiction? What are the most common forms of security granted over claims and receivables? How are they created and perfected?

Claims and receivables

There are no particular prescribed legal criteria for claims and receivables. In general, debts or rights under contracts (for example, accounts receivables) are bound by this category of security.

Common forms of security

The most common forms of security granted over claims and receivables in secured lending transactions are:

  • Pledges.

  • Security assignments.

  • Security rights (chae-gwon-dam-bo-kwon) (section 3, Security Act).

Formalities

A pledge over claims and receivables is created by a granting contract. However, creating a pledge over a claim represented by a claim instrument requires:

  • Delivery of the instrument.

  • The execution of the granting contract.

For a pledge over nominative claims, perfection is achieved (against the obligor of the claims (that is, the person obligated to pay the claims)) by giving notice to, or obtaining an acknowledgement from, each obligor.

Perfection against third parties, other than obligors of the claims, is achieved by giving notice to, or obtaining acknowledgement from, each obligor using an instrument bearing a fixed date stamp. A pledge over debts payable to order is perfected by an endorsement to this effect.

For a security right over nominative claims, perfection against the obligor is achieved by either:

  • Giving notice with a certificate of registry issued by the Registration Office of the Supreme Court of Korea.

  • Obtaining an acknowledgement from each obligor.

Perfection against third parties is achieved by registration at the relevant registry under the Security Act (section 3, Security Act).

 

Cash deposits

6. What are the most common forms of security over cash deposits? How are they created and perfected?

Common forms of security

Under Korean law, cash is not recognised as an asset that can be the subject of a security.

The most common forms of security over cash deposits is a pledge over an account in which the cash is deposited (a pledge over account).

Formalities

See Question 5.

 

Intellectual property

7. What are the most common types of intellectual property over which security is granted in your jurisdiction? What are the most common forms of security granted over intellectual property? How are they created and perfected?

Intellectual property

Intellectual property is classified as follows:

  • Patents.

  • Utility models.

  • Trade marks.

  • Copyright.

  • Designs.

  • Right to a layout design for a semiconductor integrated circuit.

Common forms of security

The most common form of security granted over intellectual property is a pledge. Security assignments are, in practice, not widely used. A security right can also be created over intellectual property (section 5, Security Act).

Formalities

A pledge or mortgage over rights to patents, utility models, trade marks, copyrights and designs is created and perfected by the:

  • Execution of a granting contract.

  • Registration of the pledge or mortgage in the Korea Intellectual Property Office.

 

Problem assets

8. Are there types of assets over which security cannot be granted or can only be granted with difficulty? Which assets are difficult or problematic when security is granted over them?

Future assets

The Supreme Court has held that future assets (including contractual rights) can be subject to security provided that the following conditions are met:

  • It is possible to specify the:

    • current contractual right holder and obligor;

    • type of contractual right and the source of that contractual right or claim; and

    • terms of performance.

  • Therefore, the contractual right must be distinguishable from other contractual rights based on social convention (for example, a claim where the amount of the contractual right or claim is not specified at the time of entering into the contract, but the basis for calculating the amount of the contractual right or claim has been specified, will be viewed as being distinguished from other contractual rights, based on social convention).

  • There is a reasonable expectation that the future asset will be acquired, accrued, performed or generated in the near future.

If these conditions are met, security (in the form of a mortgage, pledge or security assignment) can be created and perfected over future assets in the same manner as existing current assets.

Future assets (including claims, receivables and movable properties) can be subject to security if these assets are sufficiently specified by indicating (Articles 3 and 34, Security Act):

  • Movable properties: type, place for storage, quantity of the properties.

  • Claims and receivables: type, cause of occurrence, the date of occurrence.

Fungible assets

Security can be granted over a pool of movable properties through a security assignment and that security can be perfected (see Question 3).

A pledge or a security right can also be granted over a pool of current and future claims (see above, Future assets) (Articles 3 and 34, Security Act).

Other assets

Security cannot be granted in relation to assets over which the creation of security is legally prohibited (for example, the right to receive pensions, subject to limited exceptions).

As security interests over non-transferable assets are not enforceable, it is thought that security interests cannot be granted over them.

Non-transferable assets can be classified into the following three categories:

  • Assets that are by their nature non-transferable (for example, a claim the performance of which is inherently only possible by a certain obligor, such as a claim against a painter to paint a portrait of the creditor).

  • Assets the transfer or disposition of which is legally prohibited, for example the right of an employee to claim compensation from his employer for industrial accidents and disasters.

  • Assets that the parties contractually agree not to transfer or otherwise dispose of.

 

Release of security over assets

9. How are common forms of security released? Are any formalities required?

For registered security (that is, a mortgage or a security right under the Security Act), a common form of releasing security is deregistration.

For non-registrable security (which does not require registration as security), common forms of releasing security is either to return the property (being subject to security) or to send a notice of termination of security.

 

Special purpose vehicles (SPVs) in secured lending

10. Is it common in your jurisdiction to take security over the shares of an SPV set up to hold certain of the borrower's assets, rather than to take direct security over those assets?

It is common in South Korea to take assets as security whose purchase is financed on the basis of limited-recourse or non-recourse loan, except in exceptional cases. Although it is basically the lender's discretion as to whether or not to take security over the shares of an SPV (which is set up to hold certain assets of the debtor), it is quite common to have security over the shares of an SPV as well as the borrower's assets.

 

Quasi-security

11. What types of quasi-security structures are common in your jurisdiction? Is there a risk of such structures being recharacterised as a security interest?

The following legal structures are used and function as quasi-security interests. The following transactions are distinguishable from security interests in that, from a legal perspective, the transactions contemplated by those legal structures would involve transfer of ownership rather than the creation of a security interest.

Sale and leaseback

Sale and leaseback transactions have long been extensively used because of the advantages of off-balance sheet treatment, and the possible enhancement of the debtor's liquidity. Assets for which sale and leaseback structures have been commonly used include:

  • Aircraft.

  • Office buildings owned and occupied by companies.

  • Machinery and facilities.

  • High value medical equipment.

Factoring

Factoring has been used for a long time. In a typical factoring transaction, the seller will transfer to a factor its receivables that are receivable from a debtor, and the factor will replace the seller by acquiring all rights relating to the collection of the transferred receivables.

However, there is a risk that a factoring transaction will be viewed as a loan secured by a purchased claim if it has a structure where the seller:

  • Repays the factor the amount equivalent to the sales price of the claim purchased from the factor.

  • Must repurchase the claim on the debtor's default.

Hire purchase

Hire purchase is widely used in the sale of consumer products (such as cameras and automobiles). The seller usually retains the ownership of the subject matter unless and until full repayment is achieved.

Retention of title

Retention of title is often used in sales of automobiles and other similar equipment. The seller retains a right to terminate the sale agreement and demand the return of the subject matter, based on the title retained, in case of the buyer's default.

Other structures

Other structures include:

  • Repurchase arrangements. Repurchase arrangements can be created over most assets, including but not limited to:

    • immovable property;

    • movable property;

    • contractual rights; and

    • intellectual property.

  • Repurchase arrangements are arrangements where the seller specifically reserves its right to repurchase the purchased asset at the time of entry into the sale and purchase agreement. After a specified period of time, the seller may exercise its right to repurchase by returning the purchase consideration (including any purchase costs borne by the purchaser) to the purchaser and repurchasing the asset from the purchaser.

  • Finance leases and trusts. Other secured transactions include finance leases and trusts for security purposes. Generally, these transactions are deemed to be security interest arrangements under insolvency proceedings as well as, in certain circumstances, other laws.

 

Guarantees

12. Are guarantees commonly used in your jurisdiction? How are they created?

Guarantees are commonly used in South Korea. A guarantee becomes effective by entering into a contract by a guarantor in favour of lender(s). In many loan transactions, a typical guarantee that imposes joint and several obligations against the guarantor (together with the obligor (that is, borrower)) is used.

 

Risk areas for lenders

13. Do any laws affect the validity of a loan, security or guarantee (or the terms on which they are made or agreed)?

Financial assistance

There are no financial assistance rules in South Korea. However, if a director grants security over the company's asset to a creditor without any benefit to the company in return, that director may be in breach of his fiduciary duty and liable to the company for any damages that it sustains. The director can also be prosecuted for misappropriation.

In principle, a company is prohibited from acquiring its own shares or the shares of its parent company (although there are certain limited exceptions). In practice, breach of a target company director's fiduciary duty can become an issue from time to time in leveraged finance transactions.

Corporate benefit

It is not illegal for a subsidiary to grant to its parent a security in connection with a loan whether or not extended by a third party. In addition, there are no provisions in the Korean Commercial Code relating to corporate benefit rules. However, if a subsidiary's director provides security over the subsidiary's asset to a creditor of its parent, with no benefit to that subsidiary in return, that director may be in breach of his fiduciary duty and liable for damages to the subsidiary.

However, a listed company cannot grant security for a loan to its parent company unless there is an exceptional case in which such grant of security for its major shareholders is required for its business purpose (Article 542-9, Korean Commercial Code).

Meanwhile, any company belonging to an enterprise group subject to the limitations on debt guarantees cannot grant security in connection with loans received by a domestic affiliated company from a specific financial institution (certain exceptions apply). Yet, securities directly granted only between enterprises and not involving a financial institution are not prohibited, and in practice, the Fair Trade Commission has interpreted that mortgages are also exempt from prohibition (Article 10-2, Monopoly Regulation and Fair Trade Act).

Loans to directors

To avoid conflict of interest, prior approval of a proposed trade or transaction is required from the company's board of directors (two out of three of the directors must approve (Article 398, Korean Commercial Code) if a company enters into a trade or transaction (including a loan transaction) with, among others, either:

  • A director of such company.

  • A major shareholder (holding at least 10% of total shares).

  • Another company or its subsidiary that is at least 50% owned by either of the above.

The terms of the trade or transaction and the procedures related to the transaction must be fair, and any breach will render that trade or transaction null and void between the company and its related party (however, this does not apply against innocent third parties).

Usury

Licensed money lending businesses, when making loans to individuals or small businesses under the Framework Act on Small and Medium Enterprises, cannot impose an interest exceeding 27.9% per year (Article 8, Money Lending Business Act and Article 5, Presidential Decree, Money Lending Business Act). Article 8 of the Money Lending Business Act prescribes that such interest shall not exceed 27.9% per year, and this provision is expected to be effective until December 31, 2018. Article 5 of the Presidential Decree for the Money Lending Business Act has not so far been amended in accordance with Article 8 of the Money Lending Business Act. However, Article 5 is expected to be amended in the future.

The maximum interest rate for transactions between private individuals is 25% per year (Article 2, Interest Limitation Act). Any contract in breach of these restrictions is null and void.

Others

A lender must return any surplus or residual value (between the secured property and the amount of outstanding loan) to a borrower even if the contract contains a provision to transfer the ownership of the secured property to the lender in the event of default (Articles 607 and 608, Korean Civil Code).

 
14. Can a lender be liable under environmental laws for the actions of a borrower, security provider or guarantor?

A lender is not liable under environmental laws for the actions of a borrower, security provider or guarantor. However, in certain cases, a lender can be subject to liability for environmental pollution. If the lender, in exercising his security right, acquires the borrower’s land on which soil contamination has occurred, the lender may be subject to liability under the Soil Environment Conservation Act if he is found to have acted with malicious intent or negligence (Article 10-4, Soil Environment Conservation Act).

 

Structuring the priority of debts

15. What methods of subordination are there?

Contractual subordination

A subordination clause is often used in structured finance to create senior and junior subordination in relation to distributions from cash flow generated by securitised assets. This subordination clause is often included in:

  • Intercreditor agreements for syndicated loans.

  • Waterfall provisions under trust agreements (priority-based formulas to determine distributions between debt holders).

  • Conditions of bonds in securitisations.

When an obligor is operating under normal circumstances, a subordination clause operates as it was originally intended and therefore will not pose any particular problems. However, it is not clear whether that subordination provision will be valid according to its original intention if the obligor is bankrupt. The Debtor Rehabilitation and Bankruptcy Act (DBRA) provides that, in principle, a claim that has been agreed to be subordinated to another claim in the event of bankruptcy will be subordinated to that claim when insolvency occurs (section 446, Clause 2).

There are no other statutes, regulations or precedents that provide guidance on this issue.

Structural subordination

Structural subordination can be effected in South Korea, but it is not yet common.

Intercreditor arrangements

Intercreditor arrangements include provisions relating to:

  • Subordination.

  • Order of payments.

  • Enforcement of rights.

  • Foreclosure of security.

  • The agent's responsibilities, duties, rights, authorities, obligations and liabilities.

  • Voting procedures for deciding key issues in relation to the facility.

 

Debt trading and transfer mechanisms

16. Is debt traded in your jurisdiction and what transfer mechanisms are used? How do buyers ensure that they obtain the benefit of the security and guarantees associated with the transferred debt?

Secured loans from banks and other financial institutions are traded and transferred, but less frequently than in the US or Europe. If a secured loan is transferred, security interests relating to the loan are generally automatically transferred to the assignee with the secured loan. However, there are cases where the transfer of security interests needs to be separately perfected. For example:

  • If a security interest requires registration, the security interest will be transferred only on the completion of the transfer registration.

  • If a security interest requires notification, or the consent of the obligor, the security interest will only be perfected on the notification, or the consent of the obligor, of the transfer.

 

Agent and trust concepts

17. Is the agent concept (such as a facility agent under a syndicated loan) recognised in your jurisdiction?

The agent concept is recognised and is commonly used in syndicated loans. Depending on the provisions of the respective facility and intercreditor agreements, an agent can enforce rights on behalf of other lenders. Typically, agent banks possess the right to collect the principal and interest of loans from the borrower and distribute such principal and interest to the lenders. Agent banks also possess security rights as security agents and if a borrower forfeits the benefit of time, the agent bank can exercise its security rights, collect funds and distribute such funds to the lenders.

 
18. Is the trust concept recognised in your jurisdiction?

A trust is created under the Trust Act. A trust is a legal relationship where, under a special relationship, a settler (Article 2, Trust Act):

  • Transfers a specific piece of property (including part of a business or an intellectual property right), establishes a security right or makes any other disposition.

  • Authorises the trustee to manage, dispose of, operate, or develop such property or engage in other necessary conduct, for either:

    • the benefit of the beneficiary; or

    • a specified purpose.

Although the Trust Act does not deal with foreign trusts, foreign trusts are recognised in numerous cases. However, there is no clear precedent on this issue.

   

Enforcement of security interests and borrower insolvency

19. What are the circumstances in which a lender can enforce its loan, guarantee or security interest? What requirements must the lender comply with?

A secured creditor can enforce security:

  • In circumstances specifically agreed between the parties. In such a case, depending on the terms of the specific agreement being made, it may be necessary for the creditor to make a request to the debtor to perform its obligations before the creditor is able to enforce the security.

  • If the obligor has:

    • damaged, diminished or extinguished the secured asset;

    • failed to perform its obligation to create security in favour of the creditor; or

    • been declared insolvent.

    In these cases, before the creditor enforces its security, it must make a request to the debtor to perform its obligations (or make good any damage).

  • When the secured loan has matured (that is, repayment dates have passed).

 

Methods of enforcement

20. How are the main types of security interest usually enforced? What requirements must a lender comply with?

The main types of security interest are usually enforced as follows:

  • Registered security interests. A registered security interest (for example, a mortgage over immovable property and pledge of intellectual property) is enforced through a court-supervised auction process. To start the auction process, a creditor must submit to either the courts or an enforcement agency documents evidencing the existence of the security interest.

  • Pledges of movable properties. A pledge of movable properties can be enforced through a court auction process. If there are justifiable reasons (for example, if the value of the movable property concerned is insignificant and therefore inappropriate for an auction), it is also possible to apply to the courts for a direct sale and discharge following a valuation by an appraiser.

  • Pledges of shares. A pledge of shares can be enforced through:

    • a court auction process; or

    • a sale applying a market value on the date of that sale, where the shares concerned have a market value.

  • The method agreed in the pledge agreement, where the pledge has been created to the parties under a commercial agreement and:

    • the creditor has appropriated the pledged asset; or

    • the parties have agreed to another method to dispose of the pledged asset on enforcement.

 

Rescue, reorganisation and insolvency

21. Are company rescue or reorganisation procedures (outside of insolvency proceedings) available in your jurisdiction? How do they affect a lender's rights to enforce its loan, guarantee or security?

Corporate Restructuring Promotion Act (CRPA)

During the 1997 Asian financial crisis, South Korean financial institutions entered into an accord for voluntary workouts with financially troubled companies. This accord was later codified into the Corporate Restructuring Promotion Act (CRPA). The CRPA was originally enacted in 2001 and was only to be effective until 2005 (with a sunset clause). However, CRPA was amended and extended on several occasions. It will continue to be effective until 30 June 2018.

The CRPA applies to certain South Korean financial institutions (including the South Korean branch of foreign financial institutions) which are defined in the CRPA (Applicable Financial Institutions). It does not apply to foreign financial institutions. It provides workout programmes to companies to whom Applicable Financial Institutions have granted credit of at least KRW50 billion.

If a debtor company applies for a workout programme under the CRPA, the Applicable Financial Institutions that have extended credit to that debtor company, will, in most cases, become members of a commission (Commission). The Commission will decide on and administer the workout programme for the debtor company.

On applying for a workout programme under the CRPA, the Governor of the Financial Supervisory Service of Korea may request Applicable Financial Institutions not to exercise their rights against the debtor company until the first meeting of the Commission is convened. The Commission may decide that the Applicable Financial Institutions should stay any exercise of their rights against the debtor company for up to four months. Thereafter, the Commission enters into a restructuring agreement with the debtor company. The restructuring agreement will provide:

  • How the debtor company will recover from its financial difficulties (Restructuring Plan).

  • How the terms and conditions of any credit agreements will be adjusted (Credit Restructuring). The Credit Restructuring may include debt-to-equity swaps.

If the Commission fails to decide for a stay, or the restructuring agreement is not finalised during the stay, the workout programme is deemed to be discontinued.

The restructuring agreement can also provide for injection of new funds. Newly injected funds rank immediately behind the security interest held by the secured creditors but ahead of other unsecured claims of the Applicable Financial Institutions.

The Commission can decide on most issues related to the restructuring, including whether to start the workout programme, or to approve the restructuring plan and/or the credit restructuring. All decisions must be made on the basis of votes in favour from the Applicable Financial Institutions representing at least 75% of the aggregate amount of the credit extensions made to the debtor company.

An additional affirmative vote of 75% of the secured claims of the Applicable Financial Institutions is required for a Credit Restructuring.

Under a workout programme, the Applicable Financial Institutions can take over control of the debtor company through debt-to-equity swaps, and so on.

Voluntary workout agreements

South Korean financial institutions have prepared various workout agreements that are similar to the CRPA.

 
22. How does the start of insolvency procedures affect a lender's rights to enforce its loan, guarantee or security?

The Debtor Rehabilitation and Bankruptcy Act (DRBA) is the main legislation relating to a company's insolvency proceedings. Under the DRBA, a financially troubled company can choose to apply for a court decision in relation to either:

  • A rehabilitation proceeding. In this proceeding, a lender can enforce its guarantee but secured creditor cannot enforce its loan or security interest on the debtor company once the proceeding has started and, unless the court grants an exemption, its claims can be only be satisfied by the rehabilitation plan.

  • An insolvency (liquidation) proceeding. In this proceeding, a lender cannot enforce its loan and will have to wait for distributions. However, a lender will be free to enforce its guarantee or security interest.

 
23. What transactions involving loans, guarantees, or security interests can be made void if the borrower, guarantor or security provider becomes insolvent?

In principle, the trustee of a rehabilitation proceeding or an insolvency proceeding can void the following transactions:

  • Any action that the debtor takes with the knowledge that it will prejudice or cause harm to its creditors, provided, however, that this is limited to when the individual benefitting from the action knew that the action will prejudice or cause harm to the creditors.

  • Any action that the debtor takes following a triggering event (see below) that:

    • creates a security interest in the debtor's assets;

    • discharges any obligation of the debtor; or

    • is otherwise prejudicial to creditors.

    Please note that the above is limited to when the individual benefitting from the action knew at the time of the action that there were suspensions of payments, or that such action would prejudice or cause harm to the creditors.

  • A triggering event can be:

    • an application for the start of a rehabilitation or insolvency proceeding;

    • a suspension of payment (that is, where the debtor explicitly or implicitly indicates that it is not able to make payments for its debts generally and continuously when they become due).

  • Any action taken by the debtor after or within 60 days prior to a triggering event (one year in the case of related party transactions) that creates a security interest in the debtor or discharges any obligation of its debtor, where the debtor is under no obligation to do so. In this respect, "related party transactions" mean transactions with certain parties that are related by blood or affinity and/or are affiliated by equity investment, directorship or other control. In case of a related party transaction, the bad faith of the benefitting party will be inferred.

  • Any gratuitous act taken by the debtor after or within six months (one year in the case of related party transactions) prior to a triggering event.

However, these actions cannot be invalidated after the earlier of:

  • Two years from the start of a rehabilitation or the date of declaring bankruptcy.

  • Ten years from the date of the action.

 
24. In what order are creditors paid on the borrower's insolvency?

Rehabilitation proceedings

Generally, claims incurred before the start of the rehabilitation proceedings, whether secured or not, must be repaid only through the rehabilitation plan, which must be approved by all the classes of interested parties having voting rights.

Typically, there are three classes of interested parties:

  • Secured creditors.

  • Unsecured creditors.

  • Shareholders (who are usually not entitled to vote).

The court has discretion to approve the rehabilitation plan, even if not all the classes consented, with certain modifications designed to give "fair and equitable protections" to the dissenting class(es), provided that at least one class approved the submitted rehabilitation plan.

The court applies a relative priority rule (as opposed to an absolute priority rule). Under a relative priority rule, secured creditors, unsecured creditors and shareholders are treated based on "fairness and equity" (Article 217, Debtor Rehabilitation and Bankruptcy Act (DBRA)). For example, unsecured creditors may receive some distributions even if secured creditors are not paid in full. However, typically:

  • The repayment ratio applicable to the secured creditors would be higher compared to that of the unsecured creditors.

  • The proceeds from the sale of the property securing claims would be first paid to satisfy the claims secured by the property.

Under the DRBA, however, the highest priority is given to certain claims for expenses and costs necessary for implementing the rehabilitation proceedings (statutory claims). Most statutory claims arise after the commencement of the rehabilitation proceedings and, in principle, are paid without any restriction under the rehabilitation proceedings.

Insolvency proceedings

In insolvency proceedings, the claims are paid in the order of:

  • Estate claims (similar to statutory claims under a rehabilitation proceeding (see above, Rehabilitation proceedings)).

  • Bankruptcy claims with priority.

  • Ordinary bankruptcy claims.

  • Subordinated bankruptcy claims.

Secured claims (which are not included among these claims) are not subject to the insolvency proceedings and can be enforced independently and separately. Estate claims, like statutory claims, are paid without any restriction under the insolvency proceeding. In principle, all three types of bankruptcy claims listed above are claims arising before commencement of the insolvency proceedings.

In principle, the rankings of security interests on real property (such as mortgages and kun-mortgages) are determined by the order of application for registration.

For security interests on movables and claims, in principle, priority is determined by the order of perfection.

A security interest holder will be treated as an unsecured creditor if its security interest has not been validly perfected.

 

Cross-border issues on loans

25. Are there restrictions on the making of loans by foreign lenders or granting security (over all forms of property) or guarantees to foreign lenders?

If a resident receives a loan from a non-resident, enters into a security agreement with a non-resident or provides a security to a non-resident, such resident shall report the foregoing (with relevant documents attached) in advance to the minister of the Ministry of Strategy and Finance (MOSF), the governor of the Bank of Korea or the head of a designated foreign exchange bank unless it falls under an exception explicitly provided under the Regulations on Foreign Exchange Transactions.

 
26. Are there exchange controls that restrict payments to a foreign lender under a security document, guarantee or loan agreement?

Foreign currency loans

A resident must make a prior report to its designated foreign exchange bank if the resident seeks to borrow foreign currency from a non-resident, including the issue of:

  • Foreign currency denominated securities.

  • Korean Won-linked foreign currency securities.

If the amount of the proposed loan exceeds US$30 million (including any amounts that have been borrowed in one year prior to the date of that reporting), the resident must make a report to the Ministry of Strategy and Finance (MOSF) through its designated foreign exchange bank (instead of making a report to its designated foreign exchange bank). In addition, a party seeking to either collect or pay an amount exceeding US$2,000 (per collection or payment) under the loan agreement, must submit to a foreign exchange bank, documents evidencing the reason for and amounts of the payment or collection.

MOSF orders

The MOSF can, in the event of a natural disaster, war, armed conflict, material and sudden changes to the domestic or international economy or other events that have a similar effect, order:

  • A temporary suspension of payments or collections of the whole or part of a loan.

  • The deposit or sale at or to a government institution of the proceeds of that payment or collection.

In addition, the MOSF can order the partial deposit of the proceeds of foreign currency payments at a Korean bank, a financial company, or into a foreign exchange stabilisation fund or require the prior approval of any foreign currency transaction if there are concerns that there are either:

  • Severe difficulties or possibilities of severe difficulties in relation to international balance of payments and international finance.

  • Severe adverse effects on the MOSF executing macroeconomic policies (such as exchange rate or currency policies) caused by an outflow of capital from South Korea.

 

Taxes and fees on loans, guarantees and security interests

27. Are taxes or fees paid on the granting and enforcement of a loan, guarantee or security interest?

Documentary taxes

Stamp duty is levied on a person who prepares a certifying document that establishes his or her rights to property in South Korea. Loan agreements entered into with financial institutions and guarantee deeds issued by Korean financial institutions are treated as taxable documents. Stamp duty for loan agreements is progressively taxed. The maximum tax rate for loans over KRW1 billion is KRW350,000. A guarantee deed is taxed at a fixed rate of KRW10,000. No stamp duty is payable at the time of execution and enforcement of the relevant security agreement.

Registration fees

A registration-licence tax is imposed for the acquirer of secured loans such as a mortgage or a kun-mortgage (see Question 2). The registration-license tax rate is 0.24% (including local education tax) of the secured loan amount.

Notaries' fees

When notarising an English-language version of the loan agreement, a notaries' fees (maximum KRW1 million) may be incurred. A registration fee (calculated as 0.24% of the secured amount or the maximum secured amount plus other costs) is payable for a mortgage or a kun-mortgage (see Question 2). It is common practice to create a kun-mortgage with a maximum secured amount of 130% of the total principal amount of the loan (which would then include those other costs).

The registration fee for other types of security (for example, pledges or security assignments) is nominal. No stamp duty is payable at the time of execution and enforcement of the relevant security agreement. There are no notaries' fees.

 
28. Are there strategies to minimise the costs of taxes and fees on the granting and enforcement of a loan, guarantee or security interest?

As the registration fee may be significant for a mortgage or kun-mortgage over immovable property, parties often consider entering into a real estate security trust scheme.

Under this scheme, the borrower entrusts the immovable properties with a South Korean real estate security trustee (duly licensed as a real estate trustee in South Korea) who then:

  • Issues beneficial certificates to the lenders.

  • Manages and disposes of the entrusted assets.

Registration fees are nominal but the security trustee's fees account for the main costs. The main advantage is that no additional registration costs are incurred on a change of lender.

 

Reform

29. Are there any proposals for reform?

There are currently no proposals for reform regarding lending and taking security in South Korea.

 

Online resources

Supreme Court of Korea

W http://glaw.scourt.go.kr

Description. Official, up-to-date.

Financial Supervisory Service

W http://english.fss.or.kr/fss/en/main.jsp

Description. Official, up-to-date. The translations are for guidance only.

South Korea Legislation Research Institute

W http://elaw.klri.re.kr/kor_service/main.do

Description. Unofficial, potentially out-of-date, the translations are for guidance only.


Contributor profiles

Soonghee Lee

Yoon & Yang

T +822 6003 7507
F +822 6003 7025
E shlee@yoonyang.com
W www.yoonyang.com

Professional qualifications. South Korea, 1990; New York, (US), 2001

Areas of practice. Banking and finance; capital markets; financial regulations and compliance; corporate governance disputes; insurance.

Sung Woon Kang

Yoon & Yang

T +822 6003 7591
F +822 6003 7011
E swkang@yoonyang.com
W www.yoonyang.com

Professional qualifications. South Korea, 2005

Areas of practice. Banking and finance; capital markets; financial regulations and compliance; IPO; M&A.

Dong Seon Kim

Yoon & Yang

T +822 6003 7057
F +822 6003 7025
E kds@yoonyang.com
W www.yoonyang.com

Professional qualifications. South Korea, 2007

Areas of practice. Banking and finance; project finance; structured finance; construction and real estate.


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