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Overview of foreign investment in Korea

Lawyers from Korean law firm Kim & Chang discuss the regulatory regimes and considerations for overseas investors in Korea. There are various structures available that should be considered before making any investment.

Businesses in Korea are classified in accordance with the Korean Standard Industrial Classification (KSIC) system, whereby each type of business falls under a particular KSIC number. Restrictions on direct foreign investment under the FIPL are tied to this classification system.

Korea uses a negative list system, which means that a business is open to foreign investment unless it is otherwise restricted. Under its liberalisation policy, the Korean government has gradually increased the number of businesses open to foreign investment, and almost all areas of business are now open to foreign investment.

There are still some limitations though. For example, a foreigner cannot own more than 49 per cent of the total shares in issue of a local periodical publication business, a telecommunications business or a power generation business operated by government invested institutions and, in any event, a foreign investor cannot be the largest shareholder.

Types of business organisations in Korea

The Commercial code recognizes four kinds of companies, but only two, the joint stock company (chushik hwesa), and a limited liability company similar to the German GmbH form (yuhan hwesa), are available as foreign-invested companies.

The great majority of foreign-invested companies in Korea are chushik hwesas, while the yuhan hwesa form is typically used by small family-owned businesses. The chushik hwesa form offers a greater variety of forms of investment, including common and preferred stock, bonds and debentures, and no restriction on the number of shareholders. The advantage of a yuhan hwesa, on the other hand, is that the corporate organisation is treated less formally and that share transfers may be restricted in the articles of incorporation.

Chushik hwesas with paid-in capital of KW500m or more must have a board of directors with at least three members. While the term of office for the directors cannot exceed three years, they may be re-elected for additional terms. The company is also required to have at least one statutory auditor or audit committee. In addition, the SEL and certain other laws (eg, laws governing financial industries) require a minimum number of outside directors and impose certain other corporate governance requirements to ensure transparent management.

Acquiring shares in a Korean corporation

There are two ways for a foreign investor to acquire local shares. The first route contemplates acquisition of newly issued shares directly from the Korean company, and the second route involves the acquisition of shares already issued from the existing shareholders of the Korean company.

FIPL requirements

A foreign investor's direct investment in the form of an acquisition of newly issued shares of a Korean company will normally be subject to a prior report/acceptance procedure under the FIPL. The procedures thereunder are fairly routine and are not time consuming. A foreigner's acquisition of newly issued shares which does not meet the qualification requirements for the FIPL investment can still be made, but under a different regime requiring clearance from the Bank of Korea or obtaining an investment ID from the Financial Supervisory Service and brokering by a domestic securities company.

To be more specific, in order to acquire shares in a Korean company that engages in an unrestricted business, the foreign investor must report such acquisition to the proper authorities. The MOCIE, which is in charge of accepting these reports, has delegated its authority to grant acceptance to certain authorized foreign exchange banks. These authorized foreign exchange banks are comprised of domestic banks and the Korean branches of foreign banks that the MOCIE has designated to perform certain tasks related to foreign investment. The foreign investor is required to submit a foreign investment report to any of these banks, and the report is normally accepted within one or two days.

After the foreign investment acceptance is issued, the foreign investor can subscribe for the new shares in the Korean company. Once the full amount of the investment has been completed, the Korean company can register with the government as a Foreign Invested Enterprise.

Commercial code requirements

The commercial code is the basic statute governing preemptive rights and conditions under which new shares may be issued to allow an outside third party's participation in the capital increase of a local company.

By law, the existing shareholders have a preemptive right to subscribe for newly issued shares in proportion to their shareholdings. If any shareholder waives or loses his preemptive rights by failing to exercise them, the board of directors may determine the allotment of such non-subscribed shares. Notwithstanding the above principle, the board may resolve to allot the new shares to an outside third party who does not have any existing shares (or to a certain shareholder(s) not in accordance with its shareholding ratio) if the company's articles of incorporation allows or a general meeting of shareholders approves it through a special resolution requiring supermajority approval. However, such allotment is subject to certain price regulations intended to protect other shareholders' interests.

In light of the foregoing, there may be three possible transaction structures under which an outside investor can subscribe to the newly issued shares of a local company:

• taking the new shares for which the existing shareholders waive or lose their subscription right;
• subscribing to the new shares in accordance with a supermajority resolution passed at a general meeting of shareholders; or
• causing the local company to amend the articles of incorporation to insert another exception clause by which the new investor may acquire newly issued shares without being subject to the preemptive rights of existing shareholders.

SEL requirements

When acquiring newly issued shares of a company whose shares are listed on the KSE or registered with Kosdaq, there are certain issue price restrictions in case of issues not based upon preemptive rights of existing shareholders. Although the SEL has a detailed formula to determine the minimum issuance price of new shares, investors many not be able to acquire such new shares at a price which in general reflects more than a 10 per cent discount from the prevailing market prices.

Under the SEL, issuance of new shares of a KSE-listed company or Kosdaq-registered company is generally deemed as a ‘public offering' and such company is required to file a registration statement with the FSC, even if the purchaser is only one person and such person is an institutional investor. In order to be exempted from the filing requirement, the purchaser must deposit the new shares with the Korea Securities Depository and agree not to dispose of such shares for one year.

Acquisition of outstanding shares

FIPL requirements

A foreign investor must file a report on the acquisition of shares with the foreign investment authorities pursuant to the FIPL in accordance with the relevant regulatory requirements similar to those for the acquisition of newly issued shares described above.

Commercial code requirements

After the FIPL share acquisition acceptance is issued, the foreign investor can acquire the contemplated outstanding shares in the Korean company. Under the Commercial Code, delivery of share certificates is required to effectuate a share transfer. Therefore, the Korean company should have issued share certificates to the existing Korean shareholders prior to the closing. However, if the Korean company has not issued share certificates and the company was established longer than six months ago, it may be possible to transfer shares through a deed of transfer of shares.

SEL requirements

Under the SEL, if any person who, together with any ‘specially related persons', which include ‘affiliated persons' and ‘persons acting in concert' as defined under the SEL, intends to acquire with consideration or purchase 5 per cent or more of the total issued and outstanding shares of a KSE-listed company or Kosdaq-registered company outside the KSE or the Kosdaq from 10 or more persons during a six-month period, such person is required to make a public tender offer. This so-called 5 per cent mandatory tender offer rule also applies to additional purchase of any number of shares by the person who already holds 5 per cent or more shares from 10 or more persons outside the Korea Stock Exchange or Kosdaq during a six-month period.

General SEL restrictions and reporting requirements

If the shares of the Korean company are, or in the near future will be, traded on the KSE or the Kosdaq market, there are certain other issues that must be considered. Furthermore, although many of the private equity fund investments are made in unlisted companies, the exit strategy for many of such investments is to assist the relevant company in listing or registering its shares on the KSE or Kosdaq, as the case may be.

If the Korean company plans to list is shares on the KSE or register them with Kosdaq, there are certain pre and post-listing lock-up restrictions. With respect to the KSE, the shareholding ratio of any shareholder owning 1 per cent or more of the total issued and outstanding shares of the company must not change during the one-year period prior to application for listing subject to certain exceptions. With respect to Kosdaq, the shareholding ratio of the largest shareholder of the company must not change during the six-month period prior to application for registration subject to certain exceptions. After the KSE listing or Kosdaq registration, the largest shareholder of the company and certain other shareholders are required to deposit their shares with the Korea Securities Depository and are not allowed to dispose of such shares until a certain period (generally three months to two years) have passed since the KSE listing or the Kosdaq registration.

Shares acquired pursuant to the FIPL can be sold by the foreign investor on or off the market at any time, but subject to the reporting requirement which is similar to that applied when the foreign investor acquired such shares. To the contrary, the shares acquired under the FETL for portfolio investment purposes can, in principle, be sold only on the market (i.e., through KSE or Kosdaq).

Also, as a separate procedural compliance matter in acquiring shares traded on the KSE or the Kosdaq, once the foreign investor comes to hold 5 per cent of the shares in said Korean company, the foreign investor would be required to file a report with the securities authorities within five business days. The 5 per cent shares would include the holding of any equity securities by other entities having a special relationship with the foreign investor. In addition, another report should be filed within five business days of any change of 1 per cent or more in such holdings.

Should the holdings reach 10 per cent or more, the other report should be filed within 10 days and any change in shareholding (even if it involves one share) would be required to be reported on a monthly basis (by the 10th day of the subsequent month). A shareholder holding 10 per cent or more of a company would be considered a ‘major shareholder' and as such would be subject to, among others, the short swing profit disgorgement rule.

FTC filing

Under certain circumstances, investments in Korea may trigger fair trade law filing requirements and scrutiny. The FTL regulates various types of mergers and acquisitions, including the acquisition of shares or a business.

In general, the anti-trust clearance filing should be filed, among other things, under the following circumstances:

• The acquisition of all or a major portion of the business or assets of a target company, if the acquirer or the target company has assets or revenues (including those of the affiliates prescribed by the FTL) which are equal to or exceed KW100 billion. A major portion of the business is deemed to be acquired if the purchase price is not less than either 10 per cent of the target company's total assets as stated in the financial statement of the most recent fiscal year or KW5 billion, whichever is lower;
• The purchase of the existing or new shares of an existing company, if the acquirer company or the target company has assets or revenues (including those of the affiliates prescribed by the FTL) which are equal to or exceed KW100 billion and the acquirer intends to effect a transaction as a result of which the acquirer becomes a shareholder holding 20 per cent (15 per cent if a KSE-listed or Kosdaq-registered company) or more of the voting shares of another company; and
• A merger between companies one of which has assets or revenues (including those of the affiliates prescribed by the FTL) which are equal to or exceed KW100 billion.

Significantly, if the FTC finds that the investment will substantially restrain competition in the relevant market, it has the authority to stop the investment or, if the investment has already completed, force the acquirer to dispose of the shares, business or assets it has acquired.

Under certain circumstances a presumption of anti-competitive effect arises and the burden of proof shifts to the parties in question to show that the investment will not have significant anti-competitive effects on the relevant market. Once established, it is quite difficult to overcome such presumption.

Alien land acquisition law

Foreign investors acquiring outstanding shares of a Korean company should be mindful of the implications of the Alien Land Acquisition Law (ALAL). Under the ALAL, a foreigner who acquires 50 per cent or more shares of a Korean company must file a report of its deemed acquisition of the land owned by such company with the relevant local authority within six months of such acquisition.

Other matters

Many of the private equity fund investments require various selling restrictions and put/call options in connection with their acquisition of shares in a Korean company. For example, many foreign investors want to enter into shareholders agreements with the major Korean shareholders, which include tag-along rights; drag-along rights and put/call option arrangements. Since the Bank of Korea considers such contractual arrangements as a type of derivative transaction under the Foreign Exchange Transaction Regulations, such arrangements should be described in a report that should be filed with, and accepted by, the Bank of Korea prior to the consummation of the share acquisition. Depending upon the specifics of the actual arrangements the foregoing Bank of Korea report may be filed and accepted within as little as a week or as long as a month.

Also, with respect to put option arrangements, foreign investors should note that for a Korean company to repurchase its own shares in general, the most typical method of accomplishing such a repurchase is through a capital reduction process that is very time consuming and requires one month's notice to creditors, among other procedures and requirements. Therefore, one typical solution to avoid the complications and uncertainties associated with a capital reduction is to find an appropriate third party to be the counter-party to the put option.

Although this article only discusses the regulatory regimes and considerations in connection with investments by foreigners through a sale and purchase of common shares, we note that there are various other structures that may be possible. For example, certain investors prefer to make their investments by purchasing convertible bonds, bonds with warrants, exchangeable bonds and/or preferred shares. The actual investment structure selected will depend on the specific needs of both the foreign investor and the Korean company, as well as the tax implications of the various structures.

Kim & Chang, Seyang Building, 23 Naeja-Dong, Chongro-Ku, Seoul, Korea, 822 3703 1100/1114, www.kimchang.com

© Copyright IFLR 2002

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