Amendments to the South Korean Commercial Act: Refinements of Directors’ Duties to drive Governance Improvements

Serving as a board director has become an increasingly demanding role—standards have risen, expectations evolved, and the scope of director responsibilities has continued to expand. The pressure only intensifies when companies hit a rough patch, as the board of directors often bears the brunt of the blame.

In South Korea, efforts to reform corporate governance have actively sought to enhance the roles of board directors. Among various movements, one has been gaining momentum over the past few months - the proposed revisions of the Commercial Act ("the Act") to refine their duties to shareholders.

DUTY OF LOYALTY

Earlier this year, the South Korean government announced its plan to strengthen board accountability by amending the Commercial Act, emphasizing the importance of integrating governance principles into the legal framework. In June, a number of amendment proposals were submitted at the 22nd National Assembly, which included suggestions to explicitly add “interests of shareholders” to the director’s “duty of loyalty” (under the existing Article 382 -3 of the Act).

The current provision stipulates that “directors shall perform their duties in good faith for the interest of the company in accordance with statutes, and the articles of incorporation.”

The objective of the current law is for “the company” to refer to its stakeholder groups, including all shareholders. However, in cases such as capital allocations or transactions, the interests of the company or a few major shareholders may occasionally conflict with those of ordinary shareholders.

In South Korea, this has been at the heart of many legal disputes. The absence of explicit mention of “shareholders’ interests” in the current provision has led the Supreme Court to make a clear distinction between the two. As a result, the Court has sided with the board if their decisions were made for the “company's interests,” often to favor a few controlling shareholders, even at the expense of minority shareholders.

Proponents of the amendments argue that such precedents established market standards that perpetuate directors' prioritization of the interests of major shareholders, often chaebol owners.

By adding “the interest of shareholders” into the clause, the amendment proposals share a common goal: to broaden the scope of directors’ duties beyond the traditional focus on the company or major shareholders and to include consideration of the general or minority shareholders.

If passed, directors could be held legally accountable for decisions deemed to be harmful specifically to shareholder value, even if the company’s overall interests remain unaffected.

Another distinctive aspect of South Korea’s legislative framework is its enforcement of criminal law for both general and business-related breaches of trust by directors. In addition to special breaches under company law, there’s also a breach of trust under the Act on the Aggravated Punishment, Etc. of Specific Economic Crimes. Consequently, the abolition of these laws is also being proposed in conjunction to shift the director’s liability from criminal to civil. 

Despite the government backing, these suggestions have faced strong resistance from the business sector. They fear the changes will expose boards and directors to excessive civil liability and increase judicial risks, thereby stifling business activities and impeding innovative decision-making. Detractors also emphasize that the distinction between the interests of the company and its shareholders is often unclear, which could allow hostile activists to exploit this ambiguity to gain control.

DUTY OF FAIRNESS

To ease these concerns, another proposal was submitted on August 5, which took a slightly different approach. It suggests no change to be made to the existing clause on the duty of loyalty for directors (Article 382 – 3), and instead adding two sub-provisions to the Act: 1) Article 382 – 3. 2 "Duty of Fairness”, requiring directors to treat all shareholders fairly in their duties; and 2) Article 382 – 3 .3 to add a specification of what constitutes “fair”.

The third sub-provision (3.3) outlines the resolutions approved by the general shareholders without the major shareholders or the related parties exercising voting rights - will be deemed to be “fairly” made decisions. In connection to those decisions, the directors will be considered to have fulfilled their obligations to be fair. Under this, major shareholders are liable for damages alongside the directors if they violate their duty of fairness.

In spite of these modifications, the market pushback has remained strong, as the detractors are still uncertain whether these changes effectively address the concerns raised. New doubts have surfaced around the practical implications of the provisions, given the ambiguity of the term “fair.” Additionally, there is a debate regarding the appropriateness of leaving important business strategic decisions solely to the discretion of minority shareholders.

The Value-Up Program

Korea has long recognized the need to enhance regulations regarding director duties and their liabilities, but the catalyst for this recent effort has been the roll out of the Corporate Value-Up Program, announced in February this year. This government-led initiative aims to tackle the perennial ‘Korea Discount’ in the stock market: the tendency for Korean companies to be valued lower than their global peers attributing to factors such as outdated governance practices, low dividend payouts, and the dominance of opaque conglomerate structures which are the hallmark of the dominant chaebols. By quantifying the discount and incentivizing improvements, the Program encourages companies’ voluntary participation to help them achieve higher valuations and improve governance.

Although the initial announcement of the Program did not explicitly specify the enhancement of the director’s role as a core focus, the lack of emphasis on shareholder rights has been well-recognized as one of the primary causes of the ‘Korea Discount.’ Consequently, the refinement of directors’ duties to strengthen shareholder interests has emerged as the next step in this initiative to effectively eliminate structural unfairness and factors of inequality that hinder the Korean stock market’s advancement.

Supporters of the revisions, including Financial Supervisory Service Governor Lee Bok-hyun, assert that amending the Act will ensure that directors consider all shareholders’ interests fairly and comprehensively as part of their duty to protect. Even in cases where interests of minority and majority shareholders come into conflict. Lee believes that “resolving the ‘Korea Discount’ hinges on equally protecting the interests of controlling and minority shareholders” and emphasizes that the proposed revision will support the market in achieving this goal.

Our Perspective

While the proposals’ shared objective of protecting shareholder interests is much to be lauded, the inherent risks and potential gaps present a substantial threat to the board’s effectiveness.

Policymakers’ efforts to create benchmarks for “global best practices” are also fraught with challenges. Such comparisons are not always straightforward, and there’s no universal standard that ensures the same functionality across all regions. For instance, some foreign jurisdictions, such as Australia, the UK, Hong Kong, and Singapore, have specific “headcount” tests (which require approval from a majority in number of individual shareholders rather than just a majority of shares) as a tool to safeguard the interests of minority shareholders when approving significant transactions. In contrast, the USA lacks a direct equivalent but employs various voting requirements, such as Majority Voting, Supermajority, and Class voting, to ensure broad shareholder support for transactions.

Regardless of the advancements seen in the referenced markets, it is crucial to consider the unique context of the specific countries that the policy is meant for—including their regulatory environment, corporate structures, historical and cultural factors, and social expectations. Without careful consideration, implementing corporate governance reforms or adopting policies from other markets in South Korea could backfire, leading to unforeseen consequences.