Jong-Hyun Park and Joon B Kim, Kim & Chang
In 2018, 1,515 Korean M&A deals were announced, with a total deal value of US$72.8 billion. This represented an increase of 10.3 per cent and 5.3 per cent in announced deal volume and total deal value, respectively, as compared to 2017 (the foregoing is based on Bloomberg statistics). The increased M&A activity in 2018 was a welcome rebound after two consecutive years of declining activity since the market’s peak in 2015.
Halfway into 2019, we are seeing certain international and domestic factors weighing in on the Korean M&A market and anticipate such trends to continue throughout the remainder of the year. Internationally, uncertainty regarding North Korea relations, trade tensions between the US and China, the status of Brexit and China’s slowing economic growth are adversely affecting the Korean market, while domestically, increasing labour costs, higher borrowing costs and the stagnant automotive and semi-conductor sectors are tempering M&A activity. However, on the demand side, in addition to the continuing accumulation of dry powder on the part of private equity purchasers, we continue to expect technological innovation and the enthusiasm for “Fourth Industrial Revolution” assets to drive demand for M&A transactions. Korean conglomerates are looking primarily to the US and the EU to invest in proprietary technologies, with particular interest in smart-car / self-driving car technologies, artificial intelligence, IoT and big data. Moreover, in connection with the demand for these technologies and capabilities, we expect increased joint venture activity between companies in unrelated or adjacent sectors.
On the supply side, we expect to see a decent pipeline of potential targets coming on to the market. The continuing active enforcement of fair trade regulations by the Korea Fair Trade Commission (KFTC) should contribute to further conglomerate restructuring activity, which is likely to result in investment opportunities. Also, owners of small and medium-sized enterprises are opting to monetise their holdings instead of passing management control to their heirs due to inheritance tax considerations. Inheritance tax issues are affecting corporate transaction decisions of larger companies as well. Finally, as first and second-generation funds of domestic private equity firms near the end of their investment horizon, we expect more targets to become available.
In line with the global trend for rising shareholder activism, the Korean market has also seen high-profile activist campaigns by both activist hedge funds and institutional investors. In July 2018, the National Pension Service (NPS) of Korea, the third largest pension fund in the world, adopted a stewardship code. Recently, we have witnessed the NPS exercising a more proactive influence as a shareholder to bring about corporate governance reform. Between a proliferation of domestic and international activist hedge funds and increasingly vocal institutional investors, we believe that shareholder activism is here to stay, and will become an increasingly important aspect of the Korean corporate landscape. Finally, it is expected that the National Assembly will soon pass an amendment to private equity laws, which will integrate regulations governing private equity funds and hedge funds, allowing both to implement more flexible investment strategies between open market purchases and control transactions. This will also likely affect the M&A landscape.
Set forth below are our observations on a number of recent material developments.
Early this year, the Korean government announced its plans to amend the Act on Prevention of Leakage and Protection of Industrial Technology, to expand the scope of M&A targets for which a foreign buyer would be required to seek government clearance. This expanded scope would include Korean companies engaging in a designated national core technology (NCT), which have not received government funding for research and development. Further, the current administration will expand the NCT classifications to cover new subject matter areas such as artificial intelligence and new materials. The Korean government will also introduce more stringent penalties for divulgence of industrial technology, such as punitive damages and increased criminal liability.
In December 2018, a special law was enacted to protect small business owners whose livelihoods may be threatened by medium-sized to large enterprises entering the market. Under this law, certain business areas will be designated as those for which expansion or entry by medium-sized or large enterprises may be restricted. As of April 2019, applications for 14 business types – including book/magazine retail, used car sales and vending machine operation – have been identified for such designation, and it is expected that more applications will be made. Therefore, M&A transactions involving such designated (or potentially designated) business areas should be analysed carefully.
Further, in August 2018, the KFTC announced a bill to amend the Monopoly Regulation and Fair Trade Law (Comprehensive Amendment Bill) in its entirety. The Comprehensive Amendment Bill introduces more stringent regulations on unfair support of affiliates and holding companies. The current law prohibits a conglomerate company from providing unfair support to another company in which the conglomerate company’s owner-family holds an equity stake of at least 30 per cent (in case of a listed company) or 20 per cent (in case of an unlisted company). The Comprehensive Amendment Bill will unify the threshold to 20 per cent, regardless of whether the counterparty company is listed, and expand the scope of application to include subsidiaries in which such company, 20 per cent or more of which is thus owned, owns more than a 50 per cent equity interest. Although the Comprehensive Amendment Bill is subject to further revision during the course of review by the National Assembly, these proposed regulations are expected to result in conglomerates divesting affiliates or engaging in other restructuring activities involving such affiliates.
Navigating the regulatory requirements to consummate an M&A transaction in Korea is often a complex task, especially given the current trend toward increased regulatory oversight, and potential investors are advised to undertake a comprehensive review of regulatory trends, requirements and hurdles early in their investment process.
Anti-corruption is one of the top priorities of the current administration. We expect that enforcement authorities will continue to vigorously investigate suspected corruption in various forms (such as corruption in hiring) across various industries.
Another major area of focus for the current administration is on corporate reform, with specific emphasis on transparent corporate governance and compliance. Korean companies have taken various measures to follow this policy, such as encouraging boards to establish ethics committees or compliance committees, and conducting robust internal audits. The government also continues to strengthen regulations to protect citizens and consumers. These efforts are expected to continue in 2019, and – given this heightened societal and governmental scrutiny – investors in Korean companies are advised to pay greater attention to compliance due diligence.
In 2018, there was a notable Supreme Court case that heightened the level of duty required of data controllers in relation to protection of user data. The case involved a civil claim brought by users against an internet portal/social networking website following a hacking incident, whereby personal information of more than 30 million users was leaked. In eventually ruling that the website operator was not liable to such users, the Supreme Court deviated from past decisions and held that even if a company implemented the technical and administrative protective measures stipulated in relevant laws and guidelines, a company would still be required to take “protective measures that can be easily expected in general for businesses to comply with based on social norms”, and that a failure to comply with such additional protective measures may lead to civil liability for damages.
This means that, in order to avoid civil liability for potential hacking incidents, all data controllers will need to consider additional security measures that may be expected to be easily implemented, based on social norms. This may pose challenges for data controllers in terms of keeping pace with recent trends in data protection, as the “social norm” standard will continue to change as technology evolves.
Further, concerns that excessive privacy regulations are hindering innovation have led to discussions of deregulation among lawmakers so as to permit use of anonymised/pseudonymised data in the big data sector. Korean M&A participants are advised to thoroughly monitor, review and assess risks and exposure associated with Korean regulatory trends and developments.
Robust enforcement of employment and labour laws by the Ministry of Employment and Labour (MOEL) –particularly in the areas of wages, working hours, unfair labour practices and workplace safety – increases the complexity of executing an M&A transaction in Korea. Further, expansion of union activities in terms of recruitment of new members, as well as a more aggressive advancement of traditional union agenda items, warrants advance preparation.
The increased frequency and scope of labour audits will require greater attention by companies, particularly due to recent legislation mandating shorter working hours and strict compliance with employers’ obligations to pay overtime allowance and minimum wage. Due to significant changes in the law governing working hours and wage, businesses will not only face heavier compliance responsibilities but also a higher incidence of disputes with employees. These challenges are “must-check” items from a legal due diligence perspective.
In terms of disputes with employees, the ongoing debate over minimum wage is increasingly becoming a source of tension. The Korean government raised the hourly minimum wage from 7,530 won in 2018 to 8,350 won in 2019, representing a 10.9 per cent increase year-on-year. Many businesses have been seeking to change their wage regimes to address the significant increase in labour costs, and such attempts by management have been met with strong resistance from employees and, in many cases, the unions. By way of illustration, many large companies that paid fixed bonuses are now trying to change the payment cycle from bimonthly (the customary practice for many companies) to monthly, because the new regulatory regime permits monthly bonus to be factored when computing minimum wage.
According to December 2018 data published by the MOEL, the unionisation rate in Korea is increasing, attributed in large part to growing union membership at large companies. In parallel, union-led disputes have increased in many key sectors of the Korean economy, with unions vigorously contesting management’s efforts to implement restructuring initiatives by, among other things, raising legal challenges, such as claims of violation of collective bargaining agreements.
The current administration is focused on securing more tax revenue by, among other things, increasing the tax rate and decreasing available tax exemptions for the purposes of expanding welfare and income redistribution. Further, the administration is closely monitoring global tax trends, including BEPS and OECD guidelines to keep Korean tax laws in line with other OECD countries. In this connection, there have been several changes to the tax laws in 2018, as summarised below.
To provide more certainty on whether an entity would be deemed as the beneficial owner or an overseas investment vehicle (OIV) of Korean-sourced income, Korean tax laws were amended in 2018 (effective on January 1, 2020). First, the amendment eliminated “separate legal capacity” as a criterion that would result in classification as a foreign corporation, so that a “look-through” approach may be warranted in taxing Korean source income received by an OIV. Prior to the amendment, an OIV, although not a corporation in the country of its jurisdiction, could be classified as a foreign corporation for Korean tax purposes if it directly assumed rights and obligations as an entity (eg, the entity owned assets independently from its members, and has legal capacity for legal actions). Second, the amendment further clarifies that Korean-sourced income earned by an OIV that is not classified as a foreign corporation is subject to “member taxation”, under which the OIV is treated as a pass-through entity, with its investors becoming taxpayers according to the underlying income classification (to the extent that its investors are identified). Finally, the law specifies very limited circumstances in which the OIV itself, and not the investors of the OIV, may be deemed the beneficial owner of the Korean-sourced income.
The 2018 tax law amendment closely resembles BEPS Action 7 of the OECD guidelines, and thus the permanent establishment (PE) rules in Korea have become stricter. Applicable to taxable years commencing on or after 1 January 2019, a fixed place of business currently not deemed as a PE may need to proactively demonstrate that the “preparatory or auxiliary character” requirement is satisfied at the place of business. Even if the activities carried out at a specific location are of a preparatory or auxiliary character, a PE may exist if the overall activity, resulting from the combination of all activities undertaken by related parties, is not of a preparatory or auxiliary character. Furthermore, the definition of dependent agent has been expanded so that a person – even one that does not have the authority to conclude contracts – will be deemed as a dependent agent if both of the following conditions are met:
The acquisition tax exemption for qualified mergers, spin-offs, and in-kind contributions that was scheduled to expire at the end of 2018 has been further extended to the end of 2021. However, the applicable exemption rate will be reduced from 100 per cent (effectively an 85 per cent exemption due to the minimum tax payment system) to:
Exemptions for the comprehensive transfer of assets expired at the end of 2018 as scheduled.