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Passage of a Proposed Amendment to Corporate Governance Provisions of the Commercial Code

2020.12.21

How Do the Proposed Amendments to the Commercial Code Affect Corporate Governance and Management Rights Disputes? 
 
On December 9, 2020, a proposed amendment to the Commercial Code was passed in the National Assembly plenary session. The amendment will be effective immediately after a State Council meeting and a Presidential promulgation. The amended Commercial Code: (a) introduces a multi-level derivative lawsuit system (creating a cause of action for shareholders of a parent company to file a derivative claim against a director of the subsidiary); (b) strengthens minority shareholders’ rights (relaxing the requirements for exercising minority shareholders’ rights); and (c) adopts a separate election system for audit committee members. While civic organizations and vulture funds are also paying attention to the amendment to the Commercial Code, there is an increasing likelihood that various disputes affecting the exercise of the companies’ management rights will be actively raised. We introduce the key features of the amended Commercial Code for your reference in preparation for changes in the business environment.

I. Corporate Governance Improvement

1. Introduction of Multi-level Derivative Lawsuits

A. Key Features of the Amendment to the Commercial Code

1) Commercial Code Before the Amendment

If a director of a subsidiary causes harm to the subsidiary by neglecting his or her duties, the parent company and its shareholders are also affected. Prior to the amendment, the Commercial Code did not provide legal means by which the parent company's shareholders could hold the subsidiary's director accountable for causing harm to the parent company or its shareholders.

2) Commercial Code After the Amendment

The amended Commercial Code establishes a legal means for shareholders of a parent company who own more than a certain percentage of shares to file a shareholder derivative claim against a director of the subsidiary for causing damage to the subsidiary by neglecting his or her duties. In other words: (a) for non-listed companies, the parent company’s shareholders holding at least 1% of the total number of issued and outstanding shares; and (b) for listed companies, the parent company’s shareholders holding at least 0.5% of the total number of issued and outstanding shares continuously for 6 months or more may file a multi-level derivative claim against a director of each subsidiary to hold him or her accountable for damage suffered by the subsidiary as a result of his or her neglect of duties (in addition, a multi-level derivative claim may be filed against promoters, executive officers, auditors and liquidators of the subsidiary).

Once the multi-level derivative lawsuit system becomes effective, the directors of a subsidiary may be sued by the shareholders of the parent company, and such threat of being subject to a multi-level derivative claim in itself could significantly hinder the subsidiary's directors from performing their duties, potentially causing them to become passive or intimidated in performing their duties. Thus, in order to reduce the threat of a multi-level derivative lawsuit, it is necessary to strengthen the compliance procedures in advance and to inspect the works performed by the directors of the subsidiaries ex post facto in order to correct any potential problems.

B. Commercial Code Before and After the Amendment 
 
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2. Strengthening of the Regulations on Restriction of Voting Rights for the Appointment and Removal of Audit Committee Members

A. Key Features of the Amendment to the Commercial Code

1) Commercial Code Before the Amendment

Prior to the amendment, the Commercial Code, in connection with the appointment and removal of audit committee members, restricted: (a) the voting rights of shares exceeding 3% of the total number of issued and outstanding shares with voting rights (“3% cap rule”) by adding to the shares held by affiliated persons in the case of the largest shareholder when 'appointing or removing' an audit committee member who is not an outside director, and (b) the voting rights of shares exceeding 3% of the total number of issued and outstanding shares with voting rights per shareholder for all shareholders when 'appointing' an audit committee member who is an outside director.

2) Commercial Code After the Amendment

Regardless of the appointment and removal of audit committee members, the amendment to the Commercial Code restricts: (a) the voting rights of shares exceeding 3% of the total number of issued and outstanding shares with voting rights for audit committee members who are not outside directors: (1) in the case of the largest shareholder, by aggregating the total number of issued and outstanding shares with voting rights to the shares held by affiliated persons; and (2) in the case of the remaining shareholders, as to each shareholder; and (b) the voting rights of shares exceeding 3% of the total issued and outstanding shares with voting rights per shareholder for all shareholders (even in the case of the largest shareholder, not added with the shares held by affiliated persons) in the case of the audit committee members who are outside directors.

However, special regulations regarding the removal of audit committee members have been newly established. In other words, an audit committee member may be removed by a special resolution at the general shareholders' meeting (by at least 2/3 of the voting rights of the shareholders present at the meeting and at least 1/3 of the total number of issued and outstanding shares), and in this case, a person who is elected as a director to become an audit committee member pursuant to the separate election method (see Section 3 below) will lose the position of the audit committee member as well as director.

B. Commercial Code Before and After the Amendment 
 
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3. Adoption of Separate Election System of Audit Committee Members

A. Key Features of the Amendment to the Commercial Code

1) Commercial Code Before the Amendment

Under the Commercial Code prior to the amendment, listed companies1  had to appoint directors by a resolution of a general meeting of shareholders, then appoint members of the audit committee members from among the directors appointed by such resolutions (“collective election method”). As a result, all directors were collectively appointed without distinguishing those that would be appointed as audit committee members, and without there being restrictions to the voting rights of persons such as the largest shareholder. The voting rights of persons such as the largest shareholder were restricted only in cases such as when audit committee members were being appointed among them.

2) Commercial Code After the Amendment

The amendment contains a new provision that requires at least 1 person (provided, that 2 or more are also possible if provided as such in the articles of incorporation) be appointed as an audit committee member at the general meeting of shareholders and that such person be separated from the other directors from the appointment stage on. As such, the Commercial Code has been amended to require at least 1 person among the directors to be appointed as an audit committee member to be appointed by a resolution of a general meeting of shareholders where the voting rights of persons such as the largest shareholder are restricted from the director appointment stage on.

B. Commercial Code Before and After the Amendment 
 
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II. Clarification of Vague or Unreasonable Provisions

1. Reform of the Provisions on Minority Shareholders’ Rights

A. Key Features of the Amendment to the Commercial Code

1) Commercial Code Before the Amendment

Regarding the exercise of minority shareholders’ rights, the Commercial Code contains special provisions for listed companies that are separate from the general provisions. While shareholders of listed companies are subject to a more relaxed shareholding ratio requirement for exercising minority shareholders’ rights, they are required to have continuously held such shares for a 6-month period preceding exercise of their rights. As the Commercial Code prior to the amendment did not have express provisions on whether it was possible for a shareholder of a listed company to exercise his or her minority shareholders’ rights if he or she held shares in excess of the shareholding ratio under the general provisions for a period less than 6 months, there has been a debate as to the interpretation of the law and there was also a divergence among the lower courts’ decisions on this very issue. 
 
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* Listed companies determined by the Presidential Decree (listed companies whose amount of capital is at least KRW 100 billion as of the end of the last business year).

2) Commercial Code After the Amendment

The amendment to the Commercial Code resolved such ambiguity through legislative means. By expressly setting forth that exercise of minority shareholders’ rights provided by other sections of this Chapter remains unaffected despite special provisions for listed companies, the amendment allowed the minority shareholders’ rights to be exercised as long as the requirements of either the general provisions or the special provisions are met, subject to each of such requirements.

B. Commercial Code Before and After the Amendment 
 
<img alt="" height="295" src="http://www.jipyong.com/uploads/editor/image/2020/12/20201218154323_5.gif" width="713" />

2. Relaxed Requirements in Adopting a Resolution of General Meeting of Shareholders via Electronic Voting to Appoint Auditors (or Audit Committee Members)

A. Key Features of the Amendment to the Commercial Code

1) Commercial Code Before the Amendment

The appointment of an auditor pursuant to the Commercial Code before the amendment required a resolution of general meeting of shareholders adopted by affirmative votes of a majority of the voting rights of the shareholders present, which represent at least a quarter of the total number of issued and outstanding shares (Article 368(1)). However, the abolishment of the shadow voting system2 in 2017 and the strengthening of the 3% voting right cap rule for appointing auditors have given rise to difficulties in satisfying the quorum of resolutions for the appointment of auditors, shedding light on the need for reform.

2) Commercial Code After the Amendment

The amendment to the Commercial Code relaxed requirements by allowing a resolution of general meeting of shareholders via electronic voting by doing away with the requirement of affirmative votes representing a quarter of the total number of issued and outstanding shares and by simply providing that a resolution to appoint auditors and audit committee members can be adopted with a majority of the voting rights of the shareholders present at the general meeting of shareholders.

B. Commercial Code Before and After the Amendment 
 
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3. Reform of the Provisions Relating to Dividend Record Dates

A. Key features of the Amendment to the Commercial Code

1) Commercial Code Before the Amendment

Before the amendment to the Commercial Code, in the event that new shares were issued (including conversion of convertible shares or bonds, issuance of new shares following the exercise of stock options and increases in paid-in capital), it was possible for companies to deem such shares as having been issued at the end of the business year prior to the business year the issuance date fell under. As it was understood to be necessary to put newly issued shares on equal footing with existing shares in relation to payment of dividends, it was thus the norm to deem the end of the business year as the dividend record date. Accordingly, most companies set their base dates by having their articles of incorporation provide that dividends shall be distributed to the shareholders listed on the register of shareholders as of the end of each business year. Thus, there was a concentration of general meetings of shareholders being held in late March as the ordinary general meeting of shareholders must be held within 3 months of coming into effect of the dividend record date (see Commercial Code Article 354(2)).

2) Commercial Code After the Amendment

The amendment to the Commercial Code has done away with provisions that assume the dividend record date to be the end of the business year and thus allows companies to set other dates as the dividend record date. Accordingly, it is anticipated that companies amending their articles of incorporation may set dates other than the end of the business year (or fiscal year) as the dividend record date and this will in turn spread out the schedules of ordinary general meetings of shareholders. However, the holding of general meetings of shareholders after late March necessitates the consideration of many factors such as the articles of incorporation provisions relating to the base date of the exercise of voting rights during an ordinary general meeting of shareholders and the submission date of the business report under the current Financial Investment Services and Capital Markets Act.

B. Commercial Code Before and After the Amendment

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1. Listed companies with total asset amount of at least KRW 2 trillion, or listed companies with total asset amount of at least KRW 100 billion that has installed an audit committee. 
 
2. A form of proxy voting system which prevents the dissolution of the general meeting of shareholders due to lack of quorum by allowing the exercise of the voting rights of absent shareholders. The absent shareholder expresses his or her approval and disapproval by dividing his or her voting rights according to the proportion of the approval and disapproval votes of the shareholders present.
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