Korean M&A industry may reconsider leveraged buyouts

South Korea’s M&A market may reconsider leveraged buyouts due to the Supreme Court’s remanding of the case involving Sun Jong-koo, the former chairman of electronics retailer Lotte Himart Co. on Oct. 15.

Sun, the founder and chief executive officer of Himart before it was acquired by Lotte Corporation in 2012, faces charges of embezzlement and breach of duty for incurring 240 billion won ($211 million) worth of damages for Himart in the process of selling it to Hong Kong-based private equity firm Affinity Equity Partners in 2005.

The deal was considered a leveraged buyout, whereby Affinity used Himart’s assets as collateral to borrow money for acquisition financing. The Supreme Court did not convict former CEO Sun nor designate the leveraged buyout strategy as illegal, but stated that the deal classifies as a collateral-type leveraged buyout instead of a merger-type since Himart included the SPC – Himart Holdings Co. – debt as part of its collateral. 

In Korea, two types of leveraged buyouts are commonly used in M&A transactions and the legality of asset collateral-backed deals has been debated many times. In general, it is collateral-backed agreements that are brought to the court for breach of fiduciary duty whereas mergers are relatively free from such accusations. 

Asset collateral-type agreements are when the acquirer uses assets of the company being acquired as collateral for loans to pay for the transaction. Mergers are when the acquirer sets up a special purpose company for loans and then merges the SPC with the company being acquired and pays off the debt. Mergers are rarely brought to the court because shareholders can avoid risk by using their appraisal rights.

Former Chairman Sun combined both methods in the process of selling Himart. He set up Himart Holdings Co. as an SPC to take out loans and also offered Himart assets as collateral on grounds that Himart would pay off the debt after merging with the SPC.

Former chairman Sun was not found guilty during the first and second trials as the court ruled that Himart’s shareholders made a voluntary choice and that the leveraged buyout did not intend to inflict damage on Himart. The court ruled that the secured debt was confined to Himart, and not to the SPC.

The recent Supreme Court decision, however, leaves room for debate. The Supreme Court concluded that the former chairman violated his responsibility by putting up Himart’s assets as collateral given that Himart would have to take on the risk if the SPC was unable to pay off the debt.

"The core message here appears to be that the Supreme Court determined that Himart Holdings' acquisition-financing debt is included in Himart's collateral. It does not mean that merger-type leveraged buyouts will be banned, and it remains that each case will be examined on a case-by-case basis," said an industry lawyer.

Other industry lawyers stated that the Supreme Court's action indicates that merger-type leveraged buyouts could become an issue, meaning that more caution will be required as it could affect future M&A strategy for PE firms.


Write to Jeong-min Nam and Ri-ahn Kim at peux@hankyung.com
Danbee Lee edited this article.