Background
In practice, when investing in a minority stake of a company, sophisticated investors often incorporate certain provisions into investment agreements or shareholders’ agreement, including: (i) requirements for prior consultation, notification, and consent regarding key management decisions of the company and its major shareholders, and (ii) investor remedies in the event of breaches of these obligations, such as claims for damages or a penalties clause. This article examines the Korean Supreme Court’s decision on the validity of such provisions and key takeaways.
Court Ruling
The plaintiff in this case is an investor, while defendant 1 is the Company, and defendant 2 is the CEO of the Company. The plaintiff entered into a subscription agreement with the Company and its CEO for an investment in RCPS of the Company. According to the Subscription Agreement, if the Company increases its capital by issuing new shares at a price lower than the plaintiff’s subscription price per share, such issuance requires the plaintiff’s prior written consent. In the event of a breach, the plaintiff would be entitled to exercise an early redemption right of the RCPS, claim liquidated damages, and demand compliance from the Company. Additionally, the Subscription Agreement provided that the CEO shall be jointly and severally liable, together with the Company.
However, the Company issued new shares at a price lower than the plaintiff’s subscription price per share without prior written consent of the plaintiff and the plaintiff brought a lawsuit to exercise an early redemption right as well as claim liquidated damages against both the Company and defendant 2.
The lower court ruled that an agreement granting a specific shareholder a prior consent right over key management decisions (in this case, issuance of new shares to a certain investor), a privilege not extended to other shareholders, along with penalties such as early repayment obligations and liquidated damages in case of violation, was invalid as it violated the principle of shareholder equality.
However, the Supreme Court (Supreme Court Decision 2021Da293213), overturned the appellate court’s decision and held that:
“an agreement granting preferential rights or benefits exclusively to certain shareholders in violation of the principle of shareholder equality is generally void. However, if the company grants preferential rights or benefits to certain shareholders, thereby treating them differently from others, such differential treatment may be permitted if it follows the legally prescribed procedures and methods or if special circumstances justify it.”
Also, the Supreme Court noted that:
“the issuance of new shares or paid-in capital increase of a corporation generally requires a resolution of the board of directors, rather than a resolution of the general meeting of shareholders, unless special circumstances exist. Therefore, even if certain shareholders hold pre-approval rights, it does not necessarily constitute a direct infringement of other shareholders’ voting rights.”
Since this specific precedent concerns the failure to obtain prior written consent before issuance of new shares and since it is usually resolved by the resolution of the board, the Supreme Court did not examine the case where a certain investor has a veto right to a shareholder resolution matter; therefore, it remains uncertain whether granting pre-approval rights to minority shareholders over matters requiring shareholder resolutions would be considered lawful and valid.
Special Circumstances
The Supreme Court noted that if the following special circumstances exist, it is likely that a minority shareholder’s right to consent to major management decisions and to seek remedies such as damages or penalties should be deemed valid:
(i) The funds contributed by the investor are essential for the company’s survival and growth.
(ii) The major shareholder, as a party to the agreement, has approved the contract.
(iii) There is no indication that other shareholders have objected to or raised concerns about the arrangement.
Key Takeaways
Therefore, investors seeking to secure pre-approval rights and remedies concerning shareholder meeting resolutions should:
▪ Ensure that their investment agreements align with the “special circumstances justifying differential treatment” as outlined by the Supreme Court:
(i) The funds contributed by the investor are essential for the company’s survival and growth;
(ii) The major shareholder, as a party to the agreement, has approved the contract; and
(iii) There is no indication that other shareholders have objected to or raised concerns about the arrangement.
▪ Obtain consent from existing shareholders at the time of investment and procure that future investors’ consents are obtained, and
▪ Closely monitor further development of court decisions such as pre-approval rights to minority shareholders requiring shareholder resolutions.