Dentons Lee elicited a Supreme Court decision, quashing an original judgment that invalidated the execution of a stock pledge against unlisted shares upon valuating the per-share value at 0 won under the Inheritance Tax and Gift Tax Act, resulting in recognition of the validity of the stock acquisition in its effect.

1. Summary

The client acquired an NPL bond on a real estate developer through a public auction process, executed the pledge against all of the developer’s shares, and requested an extraordinary general meeting to replace the developer’s existing management. Then, the previous management countered by issuing new shares, and the client filed an action for nullification of issuance of new shares.

2. Trial and appellate judgment

Seoul High Court, the trial and the appellate court, dismissed the action and denied the client’s shareholder status by determining that the client’s stock acquisition is invalid because it exceeded the disposition limit under the pledge agreement. The court reasoned that the client executed the pledge by valuing the per-share value at 0 won under the Inheritance Tax and Gift Tax Act, which is contrary to the nature of the pledge governing the exchange value of the pledged object because it does not bring dissolution of the collateralized debt. The court further reasoned that the per-share valuation of 0 won under the stock valuation method according to the Inheritance Tax and Gift Tax Act was unreasonable.

3. Appeal strategy

We appealed to the Supreme Court and vigorously contested to realize the client’s rights because an action for nullification of issuance of new shares has a period limitation on the suit, making it difficult to bring additional suits once dismissed. Specifically, we proactively argued that (i) so-called the exchange value theory is only a theoretical tool explaining the preferential repayment of the collateral disposition proceeds, which has nothing to do with the preceding collateral disposition rights, (ii) in case of a commercial foreclosure agreement, the parties can freely decide on the disposition details, including 0 won execution, (iii) adopting the stock valuation method of the Inheritance Tax and Gift Tax Act to set the per-share value at 0 is not unreasonable against the former developer of an insolvent project when considering the general aspects of real estate PF loans and the interests of the parties involved in the NPL bond underwriting, and (iv) the technical explanation of allowing per-share valuation of 1 won and rejecting 0 won lack support while denying the validity of the pledge execution damages the pledgee’s predictability and is excessively unfavorable to the pledgee, even when a reasonable valuation of the pledged stock is necessary because valuation is only an issue of calculating the amount of extinguishing collateralized debt.

4. Decision of the Supreme Court

The Supreme Court accepted our claim and overturned the Seoul High Court’s judgment after 3 years and 11 months of hearing. The Court reasoned that when a concluded foreclosure agreement indicates that the pledgee can dispose and acquire unlisted shares at a reasonable price, and a specific valuation method is absent in the pledge agreement, selecting a generally accepted valuation method is sufficient to determine the disposition price. The Court further noted it could not deny the validity of the disposition, even when the determined price is not reasonable, because the determined price is only a settlement issue.

5. Implications of the Court’s decision

The Supreme Court previously decided that a reasonable stock valuation is necessary to execute a stock pledge on unlisted shares, and settlement obligation on the difference is recognized when the valuation is unreasonable (Supreme Court [S. Ct.], 2007Da11996, Mar. 14, 2008 (S. Kor.)). However, the Supreme Court never decided on the legality of a stock pledge execution and the validity of a share disposition when an unlisted share is valuated at 0 won per-share according to the net asset valuation under the Inheritance Tax and Gift Tax Act and the pledge is executed as a method of disposition and liquidation.

The outcome of this case, as a result of our vigorous contest, is significant because the Supreme Court decided for the first time that a share disposition is valid if the pledgee valuated the unlisted shares under generally accepted methods of valuation, even when the chosen method is the net asset valuation according to the Inheritance Tax and Gift Tax Act, or when the per-share value results in 0 won.

Previously, controversy existed surrounding the method of stock valuation and the validity of share acquisition a stock pledge is executed to take over the management of an unlisted corporation. This Supreme Court decision allows the purchaser of a NPL bond related to a development project to stably dispose of the developer’s shares while providing a more straightforward stock valuation method according to the Inheritance Tax and Gift Tax Act. Therefore, as an effect of this decision, stock pledge execution is expected to increase.