Law firm's paper on SM: Trigger of SM Ent.'s management feud

On Jan. 19, SM Entertainment Co. founder and former Chief Producer Lee Soo-man received a 17-page document written by South Korea’s largest law firm Kim & Chang on behalf of local activist fund Align Partners Capital Management.

The letter, delivered by the entertainment agency, included a line that says: “If (SM) executives were found to have been involved in allegedly unfair business practices between SM and Like Production and faced charges in that regard, they could be sentenced to up to three years in jail, or up to a 200 million won ($160,000) fine."

Like Production is a boutique firm wholly owned by Lee. The document was titled "Review of the current issues in relation to Like Production." 

It was revealed after Align Partners filed proxy litigation against Lee and its seven former members of the board on Jan. 15.

SM Entertainment also shared two legal reports written by two other leading Korean law firms with Lee, which echoed Kim & Chang's warning, according to people familiar with the matter.

The producer of a string of globally popular groups such as H.O.T, S.E.S, Girls’ Generation and Aespa was irritated by the fact that Kim & Chang's paper was delivered directly by the company he established about three decades ago.

But what outraged him the most was that SM Entertainment’s Co-Chief Executives Lee Sung-soo and Tak Young-jun and two other board members, whom he had believed were supportive of him, were excluded from the final list of the accused.

They haven't been in contacdt with Lee since Align Partners lodged a lawsuit as a representative of the minority shareholders on Jan. 15

The lawsuit, addressed to Lee and seven ex-directors, made it clear that the K-pop pioneer's top management was no more on Lee's side and had shifted to Align Partners.

CATALYST FOR STANCE CHANGE
 
Kim & Chang's legal document was regarded as the catalyst that motivated SM's co-CEOs and two other directors to change their stance on the confrontation with Align Partners. It awakened them to a legal risk they might face if they stood by Lee, the sources said.

To put it simply, the warning contained in the 17-page document pulled the trigger on a management dispute between Lee and SM’s top management, instead of a battle between SM Entertainment-backed Lee and Align Partners.

The change eventually prompted Lee to sell most of his SM shares to HYBE Co., the label behind the boy band BTS, for 422.8 billion won last week.

The agreement ran contrary to SM management’s earlier decision, backed by Align Partners, to sell new SM shares to mobile giant Kakao Corp., or a 9.05% stake, for 217 billion won.
 

A complaint filed by Align Partners on Jan. 15 accused Lee and SM’s seven former directors of unfair business practices, under which Lee was entitled to receive as much as 80 billion won in additional royalties from SM through 2092.

The accusation was separate from the royalty agreement between the entertainment agency and Like Production, which was canceled last year as demanded by the activist fund.

The activist fund also claimed that SM’s business relationships with Like Production and SM Brand Marketing, both owned by Lee, as well as with a US food subsidiary, could constitute embezzlement and a violation of the requirements as top managers.

In response, Lee said he was open to criticism for the hefty loyalties Like Production had taken from SM. But he argued he was not liable for legal punishment.

It seems Lee had tried to avoid legal confrontations with Align Partners at least until mid-January. 

On Jan. 15, a few hours before the activist fund lodged the proxy lawsuit, he agreed to accept most of Align’s demands in relation to SM’s corporate governance.

The demands included having outside directors lead SM’s corporate governance reform; taking his hands off producing SM’s artists; and setting up a committee to monitor its internal transactions.

But he rejected two other options: naming an Align Partners executive as an outside director, or putting director candidates to a vote by an outside institution.

His decision had initially received backing from SM’s co-CEOs, until Align filed the litigation arguing that Lee was still determined to maintain his control over the company.

On Jan. 20, one day after the legal document was delivered to Lee, SM Entertainment's top management officially flipped its stance on its founder, without giving prior notice to Lee.

The company announced that it would accept all of Align Partners' demands aimed at its corporate governance reform. Lee was excluded from the decision-making process, too.

DECLARATION OF WAR

In a statement issued after Align Partners took legal action against him and ex-board members, Lee defined SM top management' decision to side with Align Partners as a declaration of war.

He also claimed that Align's series of moves were made under the table: the extension of the terms of incumbent board members; Align’s participation in SM’s management; and a recent share sale deal with Kakao.

Lee also took issue with SM co-CEOs and two other current directors’ involvement in previous decisions related to his boutique firms. 

Supporting Lee's argument, a former SM lawyer Cho Byung-kyu said in an internal memo that SM’s co-CEOs and two other board members were hiding behind Align Partners to avoid their responsibility in their allegedly unfair business practices with Lee's private firms.

Thus they have joined the activist fund in exaggerating SM’s problems in relation to Lee and are threatening the founder with legal action, Cho said.

Now that Lee and SM's top management have locked horns, they will likely enter a new round of confrontation for their separate share deals with HYBE and Kakao, which could be put to a vote at the March general meeting.

Write to Jun-Ho Cha at chacha@hankyung.com

Yeonhee Kim edited this article.