"Reduce Debt While Keeping Management Control"···What Are the Strategies for Successful Corporate Rehabilitation?

The concern that most worries the heads of small and mid-sized companies considering corporate rehabilitation is the loss of management control. There exists a vague fear that if a debt-to-equity conversion—turning debt into shares to obtain massive debt relief—takes place, creditors will become major shareholders and the existing owner will be ousted. However, the Debtor Rehabilitation and Bankruptcy Act, in principle, adopts the "existing manager as custodian appointment system," under which the existing representative director is appointed as the statutory custodian, barring serious disqualifying grounds such as embezzlement or breach of trust. In other words, corporate rehabilitation is not a deprivation of management control but a legal protective device that guarantees the management continuity of a company that has fallen into a temporary liquidity crisis.

The first hurdle to overcome in defending management control during the rehabilitation procedure is the "principle of guaranteeing liquidation value." One must prove to the court that the value of continuing the business (going-concern value) is objectively higher than the value of selling assets by bankrupting the company (liquidation value).

Looking at a case involving a certain company, this company faced a crisis due to an excessive investment in newly building an overseas plant and a deterioration of the external environment such as COVID-19 and the global interest-rate hikes, despite possessing excellent technological capabilities. However, through thorough financial investigation, it was able to secure the justification for rehabilitation by clearly proving—both legally and in accounting terms—that the company's going-concern value greatly exceeded its liquidation value. Thus, proving that it was a temporary crisis caused by the external environment rather than a management failure is the key starting point for approval of corporate rehabilitation.

Once going-concern value is recognized, the next step is designing an elaborate rehabilitation plan. For a rehabilitation plan to receive court approval, it must meet strict requirements: consent of three-quarters or more of secured rehabilitation creditors and two-thirds or more of rehabilitation creditors. The most effective strategy in practice is a "back-loaded" repayment schedule. In this structure, the repayment rate is minimized to around 2–4% in the early phase of rehabilitation so that the company can concentrate resources on normalizing operations, and repayment amounts are concentrated in the later phase when operating profits begin in earnest. This becomes a powerful weapon regarded by both the court and creditors as a realistic alternative with a high probability of repayment.

Attorney Kim Won-sang of Daeryun LLC (Limited) said, "The core legal principle for defending management control lies in the meticulous structuring of debt-to-equity conversion and capital reduction (share consolidation). Converting debt into shares inevitably swells the capital and rapidly increases creditors' shareholding ratio. To control this, a capital-reduction procedure that consolidates shares at a ratio of 10:1 or more must be designed into the plan," adding, "The company in the aforementioned case converted 55% of its rehabilitation claims into equity, yet through elaborate share-consolidation design defended the existing representative's shareholding ratio at over 7% and maintained management control. Thus, depending on how one designs the correlation between the debt-to-equity conversion ratio and share consolidation, the owner of the company after rehabilitation changes."

Attorney Kim said, "Also, an important issue that must not be overlooked in the corporate rehabilitation procedure is the protection of public-interest claims. Workers' wages and unpaid taxes are priority claims that must be repaid at any time regardless of the rehabilitation plan. To prevent the departure of skilled staff and continue smooth operations, the funding source for repaying public-interest claims must be thoroughly secured in advance. Corporate rehabilitation is not simply a procedure to plead for debt relief. It is a complex restructuring process that proves the company's continuation value and defends its governance structure. If you are experiencing a liquidity crisis, before the debt reaches its critical threshold, you must establish a meticulous strategy with the assistance of an expert from the early stage."

Enet News Reporter Park Jung-woo (woo@enetnews.co.kr)

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