[Commercial Law Amendment Solution] ① The 'Duty of Loyalty of Directors' Debate Raised in Samsung Prosecution

Discussions on the amendment of Article 382-3 of the Commercial Act (Duty of Loyalty of Directors) are gaining momentum, centered around the National Assembly and the government. The current legal provision states that "a director shall faithfully perform his/her duties for the company." The key issue is whether to change this to "the company and shareholders." While the government and the National Assembly are actively pursuing the amendment, the actions of the Financial Supervisory Service (FSS) also draw attention. This is because Lee Bok-hyun, the head of the FSS, has stated that the provision on the "duty of loyalty of directors" should be amended. The Ministry of Justice is the department responsible for the Commercial Act.

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Within and outside the industry, there is an analysis that Lee’s experience investigating the Samsung Group case (the merger of Samsung C&T and Cheil Industries) played a role in this. At that time, the prosecution indicted Samsung Group Chairman Lee Jae-yong and former and current executives of Samsung C&T on charges of breach of fiduciary duty for violating the "duty of loyalty of directors." The court acquitted them. Previously, the Supreme Court left an important precedent related to the "duty of loyalty of directors." Due to this background, there is criticism that under the current Commercial Act system, it is difficult to hold directors accountable even if they make decisions unfavorable to shareholders. This is why both the National Assembly and the head of the FSS are voicing the need to amend the Commercial Act.

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The 2009 Supreme Court precedent has attracted attention from the business and academic communities. It concerns the Everland CB low-price issuance case related to Samsung’s illegal succession allegations.

In 1994, Chairman Lee received a gift of 6.14 billion KRW from his father, former Chairman Lee Kun-hee. Using these funds, he traded affiliate stocks to increase the capital size. In 1996, the Everland board of directors resolved to issue convertible bonds (CBs) at a low price. Although Everland, the holding company of Samsung Group, issued CBs at a low price, none of the Samsung affiliates subscribed to them. The Everland board eventually decided to allocate the remaining CBs to Chairman Lee’s siblings. As a result, the family’s shareholding ratio rose significantly from near zero to 6%.

Civic groups filed a complaint in 2000, accusing former Chairman Lee and Everland executives of breach of trust for causing losses to the company to facilitate Chairman Lee’s succession. The prosecution’s argument at the time was that because the low-priced Everland CBs were not subscribed to, shareholders’ stakes were diluted, and the resulting loss was a loss to the company. Although the duty of loyalty of directors is specified as being owed to the company, they pointed out that an expansive interpretation could include "shareholders" as well.

However, the Supreme Court ruled "not guilty" in 2009. The court stated, "This is merely a matter among existing shareholders and does not harm the company’s interests," and "Directors of a stock company (members of the board under the Commercial Act) are in charge of the company’s affairs, but they are not in charge of individual shareholders’ affairs."

Professor Lee Sang-hoon of Kyungpook National University School of Law said, "The 2009 Supreme Court ruling related to the Everland case is significant in that it explicitly stated that the duty of loyalty of directors is owed to the 'company,' not the shareholders," adding, "While the duty of loyalty can sometimes be interpreted to include shareholders, the Supreme Court precedent directly denied this."

He continued, "In common law systems, judges have relatively broad authority to interpret laws, so precedents can have the same status as laws. However, in Korea, influenced by civil law which values the separation of powers, judges do not actively interpret laws," and "In our legal system, which tends to rule conservatively based on legal provisions, the precedent that the duty of loyalty is not owed to shareholders makes it difficult to engage in legal battles in related lawsuits."

One argument against amending the Commercial Act is that "shareholders are included in the duty of loyalty of directors." However, since the Supreme Court precedent was established in the Everland CB lawsuit, it is pointed out that it is difficult to hold directors legally responsible for decisions unfavorable to shareholders.

Supreme Court
[Image source=Yonhap News]

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The legal dispute over the "duty of loyalty of directors" resumed in 2018 with the Samsung C&T and Cheil Industries merger case. The prosecution argued that Chairman Lee pushed the merger to secure management succession and that the merger ratio undervalued Samsung C&T’s stock, causing losses to shareholders.

One of the main charges applied by the prosecution was a violation of the Capital Markets Act. More than 15 allegations were pointed out in the indictment. After careful consideration, the prosecution indicted Chairman Lee and former and current Samsung C&T executives on charges of breach of fiduciary duty. The investigation team leader at the time was President Yoon Suk-yeol, and the prosecutor who wrote the indictment was Lee Bok-hyun. The indictment stated that "the duty to sufficiently review the business rationality of the merger to protect the interests of Samsung C&T and its shareholders was violated."

It also claimed, "When deciding the merger timing that determines the merger ratio, the interests of Samsung C&T and its shareholders were not considered at all, and the timing was chosen for the benefit of Chairman Lee, the largest shareholder of Cheil Industries." In other words, the management and board of directors did not fulfill their duty of care and loyalty to maximize the interests of the company and its shareholders, constituting breach of fiduciary duty. As a result, Samsung C&T and its shareholders suffered financial losses despite being entitled to a fair merger consideration.

However, the first trial court acquitted them. The court judged the merger between Samsung C&T and Cheil Industries as a "legitimate business activity driven by management needs." This point is important to remember because the "business judgment rule" of directors is presented as a key consensus in the current discussions on amending the Commercial Act.

The business community focuses on the above two lawsuits in relation to the Commercial Act amendment issue. This is because the prosecution indicted Chairman Lee and former and current executives on charges of breach of fiduciary duty based on the "duty of loyalty of directors" provision. In Korea, breach of fiduciary duty is subject to criminal punishment. Therefore, there are concerns that if "shareholders" are included as subjects of the duty of loyalty, there will be an increased possibility of frivolous lawsuits (criminal charges) against owners and CEOs registered as registered directors.

A capital markets law expert said, "Regarding the amendment of the Commercial Act, the business community argues that it 'shakes the foundation of company law' and opposes it by saying that expanding the duty of loyalty can be interpreted as including the company and shareholders, but the Everland CB precedent clarified that shareholders are not included in the duty of loyalty, so the basis is weak," adding, "The real reason is the concern that if 'shareholders' are explicitly included in the duty of loyalty, there is a higher possibility that registered directors could be detained on charges of breach of fiduciary duty depending on the situation."

A corporate litigation specialist lawyer said, "It is rare worldwide to criminally punish registered directors for breach of the duty of loyalty," and "The Samsung precedent actually reflects the prosecution’s failure to prove the case properly during the investigation, and expanding this into a legal issue to amend the Commercial Act is not appropriate."

In fact, Lee Bok-hyun is known to deeply sympathize with these concerns. At the Capital Market Value-Up International Forum on May 28, he said, "While expanding the duty of loyalty of directors to include shareholders, we must secure effectiveness by clarifying the business judgment rule through legislation," which aligns with this context.

Previously, the Supreme Court acquitted Chairman Lee and executives in the Samsung C&T and Cheil Industries merger lawsuit based on the "business judgment rule." This is interpreted as providing grounds to exclude breach of fiduciary duty if the duty of loyalty explicitly includes "shareholders" but the business judgment rule is observed.

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