[Invest&Law] Court: "Failure to obtain a clean audit opinion disrupts IPO"...Major shareholder held liable under put option

IPO failure materializes after audit "disclaimer of opinion"
"Grounds for put option arose at the company...can still be claimed against interested parties"

After a startup received a "disclaimer of opinion" in its external audit, making an initial public offering (IPO) difficult, the general partner (GP) of a venture investment partnership and the company’s largest shareholder became embroiled in a dispute over whether to exercise a put option, with the GP winning in part at the first trial. The court held that even if the grounds arise within the company, a put option can be claimed against an interested party in accordance with the wording of the contract.

According to the legal community on February 4, the Civil Division 22 of the Seoul Central District Court (Presiding Judge Choi Ukjin) recently ruled in the first-instance lawsuit filed by a venture investment partnership GP against Company A, a pharmaceutical company that is the largest shareholder of a bio startup, for payment of the purchase price, that "Company A must pay about 5.3 billion won to the GP (the acquisition price plus 10% annual compound interest)."

"Disclaimer of opinion is a serious obstacle to pursuing an IPO"

Previously, in December 2020, the investment partnership acquired 800,000 new shares (worth about 3.5 billion won) of a bio startup that had been spun off from Company A. The investment agreement stipulated that if certain events occurred to the company or its interested parties, the investor could exercise a put option. A put option is the right, once specified conditions are met, for the investor to resell shares in a predetermined manner.

The startup’s CEO and Company A, as the largest shareholder, participated in the contract as interested parties, and the contract specifically listed as one of the grounds for exercising the put option "a case where a serious obstacle to an initial public offering (IPO) arises due to a non-unqualified audit opinion (including a disclaimer of opinion)."

The startup’s business conditions subsequently deteriorated sharply. In November 2023, the company informed its shareholders that "our remaining cash assets are about 200 million won, and we will need at least 1 billion won in short-term funds over the next three months," adding, "We will need 40 billion won in funding over three years, but we failed to secure 5 billion won in investment during the process of raising a 10 billion won Series B follow-on round."

Ultimately, the investment partnership exercised its put option, arguing that "it has become virtually impossible to pursue an IPO," and when Company A, the largest shareholder, refused to comply, it filed a lawsuit demanding payment of the share purchase price.

Court: "Under the contract wording, interested parties are also put-option counterparties"

The court of first instance sided with the investor. It first focused on the fact that the startup received a "disclaimer of opinion" in the external audit of its financial statements for the 2024 fiscal year. A disclaimer of opinion means that the accounting firm either could not obtain sufficient audit evidence or there was such great uncertainty that it was difficult to express any opinion at all on whether the financial statements were presented fairly. Citing listing rules that require a "clean (unqualified)" opinion on the audit of the most recent fiscal year as a formal condition, the court found that a disclaimer of opinion can constitute a serious obstacle to pursuing an IPO.

During the proceedings, Company A argued, "The audit opinion issue is a circumstance that arose at the startup, so can the investor claim a put option against Company A?" and contended that "to hold an interested party liable, there must be fault such as intent or gross negligence."

However, the court held that, under the wording of the contract, the put-option clause separates the "party in which the grounds arise" from the "counterparty against whom the option is exercised." In other words, even if the obstacle arises at the company, the investor can choose an interested party as the counterparty and make a claim against that party.

In addition, the court found it difficult to interpret the separate clause requiring "intent or gross negligence" as a restrictive condition imported into the put-option clause. It reasoned in particular that when the company’s finances have deteriorated due to a non-unqualified audit opinion, it is difficult for the company itself to buy back the shares, which could render the put option ineffective; and if, even in such circumstances, the investor could not claim the put option against the major shareholder, the clause itself would lose its practical effect.

However, the court dismissed the claim for 15% annual default interest, holding that "it cannot be viewed that Company A delayed its payment obligation." Both parties appealed after the first-instance judgment.

※This article is based on content supplied by Law Times.

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