[Jeondaegyu's 7 Jeon 8 Gi] Environmental Changes in the Dosan Incident

Since early 2020, COVID-19 has had a significant impact on many aspects of our lives. Not only self-employed individuals but also companies whose main focus is on people's movement, such as travel and accommodation, have suffered considerable damage. Due to the worsening economic situation, it was expected that individuals and companies would face financial difficulties in the future, and many would seek rehabilitation courts.

However, the reality is different. According to the Court Statistics Monthly Report (June 2021), compared to the previous year, individual bankruptcies have only slightly increased, while corporate rehabilitation, corporate bankruptcy, and individual rehabilitation have significantly decreased. Why is this the case?

Let’s look at the case of companies first. One reason is that companies themselves have become more adaptable. During the 1998 IMF crisis and the 2008 financial crisis, most insolvent companies were liquidated, and the surviving companies developed considerable resilience to economic downturns. Therefore, even with some external shocks, their business operations are not significantly affected. Larger companies, in particular, continue their business stably based on sufficient liquidity.

Next is the change in the audit environment. One reason companies attempt debt adjustment (rehabilitation procedures) through the court is to resolve contingent liability issues. Before the designated auditor system was implemented, companies chose their own auditors (accountants). As a result, auditors had to prepare audit reports according to the companies’ wishes to maintain ongoing audit contracts. It was also common to reduce audit fees below the set standards. Consequently, auditors had to minimize the time spent on audits.

For these reasons, the financial statements (such as balance sheets) prepared by auditors were less reliable. Contingent liabilities due to accounting fraud were latent. Under this audit environment, companies used court rehabilitation procedures as a way to resolve contingent liabilities. However, changes in the audit environment have occurred over the past three years.

The Financial Supervisory Service introduced the designated auditor system and the standard audit hours system (which mandates a minimum number of audit hours for auditors performing external audits). There is no longer a reason to maintain audit contracts with target companies, and sufficient audit time is secured. Additionally, cases have arisen where auditors who performed inadequate audits were held liable not only civilly but also criminally. As a result, auditors’ accounting audits have become stricter, eliminating the burden of contingent liabilities.

Lastly, market liquidity has increased due to low interest rates. With reliable corporate accounting data and easier access to funding, there is no longer a need for debt adjustment (rehabilitation procedures) through the courts. Companies are now attempting mergers and acquisitions in the capital market.

Looking at individuals, recent amendments to the “Debtor Rehabilitation and Bankruptcy Act” have expanded the range of individual debtors eligible for individual rehabilitation procedures. Nevertheless, the number of individual rehabilitation cases filed in courts has not increased but decreased. Although it may be too early for the effects of the legal amendment to appear, it seems unlikely that the numbers will increase significantly over time.

The main reason is that debt adjustment in individual rehabilitation procedures is limited to unsecured debts. Recently, most personal debts are secured loans for home purchases, with fewer unsecured loans. Credit card issuance has become stricter, so credit card debts are also not substantial. Debts from secured loans are not subject to debt adjustment in individual rehabilitation procedures. Consequently, the amount of debt subject to adjustment in courts is decreasing.

Although the prolonged COVID-19 pandemic is making it increasingly difficult for companies and individuals, there are limits to resolving these issues through the court’s debt adjustment system. This is not due to operational problems within the courts but stems from institutional aspects. The government and the National Assembly need to take an interest in establishing diverse and flexible restructuring systems to address household debt and corporate financial difficulties.

Jeon Dae-gyu, Chief Judge, Seoul Rehabilitation Court

This content was produced with the assistance of AI translation services.