The Court decided on a preliminary injunction filed by a group of shareholders against the Company to prohibit the exercise of voting rights vested in holders of Exchangeable Bonds under the Exchangeable Bond Subscription Agreement
Dong-A Pharmaceutical Co., Ltd. (the “Company”) was notified in April 2007 by the Seoul District Office of the National Tax Service that it owed and needed to pay approximately KRW 35 billion in additional income tax by June 30, 2007. The Company also needed approximately KRW 80 billion to repay long- and short-term debt due in 2007, plus additional funds for the re-arrangement of plants, purchase of development sites, and construction of new branches and expanded research institutes.
To raise these funds, the Company sold 748,440 shares of treasury stock (approximately 7.45% of total issued and outstanding shares)(the “Shares”) to special purpose companies in Labuan, Malaysia (the “Overseas SPCs”) on July 5, 2007. The Overseas SPCs in turn issued exchangeable bonds worth USD 44,800,000 and USD 35,000,000 in face value, respectively, using the Shares as underlying assets (the “Exchangeable Bonds”). The Company guaranteed the repayment of the bond principal and interest payable by the Overseas SPCs to the exchangeable bondholders (the “Payment Guarantee”) (Sale of Shares, issuance of the Exchangeable Bonds, and Payment Guarantee collectively referred to as the “Transaction”). The Exchangeable Bonds Subscription Agreement provides that any instruction exercising the voting rights attached to the Shares should do so by exchangeable bondholders, and if no instruction is made, then the Overseas SPCs should conduct shadow voting.
Under the circumstances, some shareholders (“Plaintiff”) applied for a preliminary injunction against the Company (“Defendant”) to prohibit the exercise of these voting rights, arguing that the Transaction constituted a breach of trust for the current management’s continued control of the Company by way of reviving the voting rights of the Shares.
Provisions on the Issuance of New Shares Are Not Extended by Analogy to the Disposal of Treasury Stock for the Issuance of Exchangeable Bonds (lex stricta)
Plaintiff’s Argument: Based on the precedents set forth below, Plaintiff argued for invalidity as to the disposal of the Shares to the Overseas SPCs, which would allegedly affect any change in shareholding control over the Company and hence undermine the interests of existing shareholders to an extent hard to ignore.
Precedent 1) The Supreme Court ruled that if any issuance of convertible bonds is held to be unfair by extending by analogy provisions relating to procedures for the issuance of new shares or complaints regarding the invalidation of the issuance thereof, then such an issuance of convertible bonds is invalid (Supreme Court, June 25, 2004,2000da37326).
Precedent 2) A lower court ruled that provisions relating to procedures for the issuance of new shares, or complaints for the invalidation of the issuance thereof, may be extended by analogy to any sale of treasury stock by a company to existing shareholders, which then may be invalidated. (Seoul Western District Court,June 29, 2006, 2005gahap8262)
Defendant’s Argument: Defendant countered that provisions with respect to the issue of shares are not extended by analogy to the disposal of treasury stock for the following reasons: (i) unlike the issue of new shares, the Transaction does not affect capital stock since it involves the disposal of Shares that were already issued and outstanding; (ii) the issue of new shares is a legal action under collective law, whereas the disposal of treasury stock is not a legal action under collective law since it deals in shares already issued and outstanding; and (iii) it would be consistent to the provisions and intent of legislators of the Commercial Act and the Securities and Exchange Act to understand that both laws have no provision on their respective procedures for the issuance of new shares to be applicable to the disposal of treasury stock, taking into consideration the difference set forth in (ii); and (iv) the application of provisions on the issuance of new shares to the disposal of treasury stock without an explicit legal basis may undermine legal stability.
Court Decision: The court ruled in favor of the Company and held that provisions for the issuance of new shares are not extendable by analogy to the disposal of treasury stock, unlike the case with convertible bonds.
Disposal of Shares is not a Abuse of a Defense Mechanism for Control of the Company
Plaintiff’s Argument: Plaintiff argued that the disposal of Shares amid a dispute over control over the Company is a breach of trust aimed to help certain shareholders, including chairman Kang Shin Ho and the company’s current management, maintain control of the Company, and hence should be held invalid.
Defendant’s Argument: Defendant justified the Transaction by taking into consideration the following factors: (i) the Transaction was executed to raise funds required by the Company; (ii) prior to the execution of the Transaction, the Company compared the advantages and disadvantages of the Transaction and other financing options, and determined that the Transaction would be relatively more beneficial to the Company than any other financing method; and (iii) the Transaction did not incur any substantial costs or loss of property to the Company.
Court Decision: The court ruled that with respect to disputes arising from a Board of Directors’ decision for defense of control of a company, while it is fair for the alleging party to point out the defects of such a decision, where a defending party proves the legitimacy of such a decision, the material submitted by the Plaintiff was insufficient to prove that the Transaction constituted a breach of trust or was aimed to keep the current management in control of the Company. The court also ruled that even if the Transaction had been executed so as to continue the management’s control of the Company, the Transaction should still be treated as legitimate and would not constitute a breach of trust.
Whether Voting Rights Attached to Shares are Separately Assigned
Plaintiff’s Argument: Plaintiff argued that the Overseas SPCs’ obligation to exercise its voting rights at the instruction of exchangeable bondholders under the Exchangeable Bonds Subscription Agreement means that the right to control the exercise of voting rights is separate from the ownership of the Shares, and thus a violation of the principle under the Commercial Act that shares and voting rights may not be separately assigned. Therefore, the agreement on the right to direct the voting of shares included in the Exchangeable Bonds Subscription Agreement (“Instruction Right Agreement”) is invalid. This also affects the validity of the Transaction, in its entirety, given the invalid provision.
Defendant’s Argument: Defendant argued against the invalidity of the Instruction Right Agreement, for the following reasons. First, unlike an assignment of voting rights, which takes place by assigning voting rights to a third party, the Instruction Right Agreement is a legally binding agreement on claims that provides that shareholders should exercise their voting rights as the owner provided that they do so at the instruction of a third party as agreed between shareholders and the third party. Second, the Securities and Exchange Act assumes that shareholders may assign the right to instruct the use of voting rights to a third party as set out in a contract, agreement or promise between shareholders and a third party. Third, shareholders are free to determine in advance how to exercise their voting rights. Thus, the Instruction Right Agreement put forward at the discretion of shareholders cannot be held as invalid. Fourth, where the Instruction Right Agreement is executed as accompanied with an Exchangeable Bonds Subscription Agreement, exchangeable bondholders need to have the means to protect themselves with respect to resolutions at a shareholders’ meeting, which may negatively affect such exchangeable bondholders, before they become shareholders, by exercising the option to exchange the relevant bonds into shares.
Court Decision: The court acknowledged the defendant’s argument and ruled in favor of the Company, i.e., that the Instruction Right Agreement as included in the Exchangeable Bonds Subscription Agreement is valid, and hence the Transaction itself is also valid.