Contribution in kind for defending managerial rights is illegal in violation of stockholders’ preemptive right to new stocks.
Even though there is a ruling by the Supreme Court suggesting that the preemptive right of stockholders to the issuance of new stocks is not applied to the issuance of new shares by contribution in kind, Shin & Kim successfully elicited a ruling that the issuance of new shares for contributions in kind is invalid on the grounds that such issuance is in violation of stockholders’ preemptive rights to new stock. This ruling is expected to serve as a key precedent sending a clear warning to acts of the surreptitious issuance of new stocks for contributions in kind for the purpose of defending managerial rights.
In a situation wherein a number of Group A affiliates became insolvent or were put under court receivership due to Group A’s deterioration in business management and liquidity crisis, from around December 2008, Company C, the largest stockholder of Company B (which was an affiliate of Group A), began the process of selling its shares and Group A was faced with the risk of losing its control rights in Company B to a third party.
The management of Company B then issued new stocks in a greater number than the total number of existing stocks then outstanding by secretly receiving contributions of bonds from other friendly Group A affiliates while completely excluding Company C (the creditor of the above company), and contributions of land reclaimed from public waters (reclamation rate: 46.83%) from Company D, another friendly affiliate of Group A. As a result, the Company C’s status in Company B as its largest-stockholder was reduced to a minority-stockholder status while Company D which was not even a stockholder of Company B before became Company B’s largest stockholder holding 41.15% of its total shares. That is, the governance structure of Company B was changed.
Company C, which later learned of this, filed a suit seeking to invalidate the issuance of new stocks for contribution in kind as above on the grounds that such issuance of new stocks infringed on its preemptive rights in violation of Article 418, Paragraph 2 of the Commercial Act because the issuance was made for the purpose of maintaining Group A’s control rights to Company B, not for meeting the company’s own managerial needs.
In the lawsuit, defendant Company B argued that the issuance of new stocks in this case did not constitute a violation of the stockholder’s preemptive rights as such issuance was made by contributions in kind and based its argument on the 88 Nu 8889 Decision by the Supreme Court on Mar. 14, 1989 which stated that “the stockholder’s preemptive right to new stocks is not applied to the issuance of new stocks by contributions in kind.”
However, Shin & Kim, representing the plaintiff, argued that the Supreme Court’s decision above was an inappropriate decision to be cited in a case in which the issuance of new stocks is suspected as an act performed for the purpose of defending control rights. We distinguished the decision above as it was a case regarding whether donation tax can be imposed on one stockholder of a company who acquired all the new shares of the company by contributions in kind when the company’s other shareholders waived their preemptive right with such waivers deemed as donations of new shares to the shareholder who made in-kind contribution. We emphasized that it is highly likely that the management of a company exploits contribution in kind as a tool to defend its control rights if the stockholder’s preemptive rights are not applied to the issuance of new stocks for contributions in kind. Thus, we argued, the requirement for justification for the purpose of excluding stockholder’s preemptive rightsArticle 418, Paragraph 2 of the Commercial Act should not apply. The court accepted the plaintiff’s arguments and ruled that the requirement for justification under Article 418, Paragraph 2 of the Commercial Act should also be applied to the issuance of new stocks for contributions in kind and rejected the defendant’s arguments which cited the Supreme Court’s decision as above.