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[Legal Issues in Anbyeon]
The direction of the 3rd revision of the Commercial Act and the discussion on mandatory stock cancellation
The revisions to the Commercial Act currently being pursued by the Lee Jae-myung administration are all centered around the transparency of corporate governance and strengthening shareholder rights. In particular, the third revision of the Commercial Act is likely to significantly strengthen regulations regarding treasury stocks. The amendments currently pending in the National Assembly mandate that listed companies cancel their treasury stocks within a certain period of time after acquiring them. They also restrict long-term holding of treasury stocks, except for specific purposes such as stock-based compensation or exercising rights under convertible bonds or bonds with warrants issued through public offerings.
Currently, it appears that a total of four amendment bills have been proposed. What's interesting is that all four differ in the method and provisions of the amendment to the Commercial Act, as well as in the content and scope of application (whether it applies to listed or unlisted companies). Representative Kim Nam-geun's bill creates a new Article 542-14 (Acquisition and Disposal of Treasury Stock) of the Commercial Act to apply only to listed companies. Representative Kim Hyun-jung's bill creates a new Article 542-14 (Acquisition and Cancellation of Treasury Stock, etc.) of the Commercial Act to apply only to listed companies. Representative Min Byeong-deok's bill creates a new Article 341-4 (Cancellation of Treasury Stock) of the Commercial Act to apply to both listed and unlisted companies. Representative Cha Gyu-geun's bill revises Article 342 (Disposal of Treasury Stock) to apply this too to both listed and unlisted companies.
Representative Kim Nam-geun's bill requires the cancellation of new and existing treasury shares within one year of acquisition, while Representative Kim Hyun-jung's bill requires the cancellation of new treasury shares immediately upon acquisition and existing treasury shares within six months. Furthermore, Representative Min Byeong-beop's bill requires the cancellation of both new and existing treasury shares within one year, while Representative Cha Gyu-geun's bill requires the cancellation of new treasury shares within six months and existing treasury shares within five years. Furthermore, all four amendments allow for the continued retention of treasury shares as an exception for reasons such as employee stock compensation approved by the general shareholders' meeting. These amendments aim to correct the practice of management using treasury shares for stock price management, management rights defense, and hostile takeovers, and to more clearly institutionalize shareholder returns.
Conflicts over the Legal Nature of Treasury Stock: The Asset Theory and the Unissued Share Theory
The debate over the legal nature of treasury stock has long been divided between the asset theory and the unissued stock theory. The asset theory holds that when a company acquires treasury stock, the stock becomes part of the company's assets. In other words, acquisition and disposal are considered ordinary asset disposals, and the board of directors can freely decide within the scope of their business judgment. Conversely, the unissued stock theory interprets treasury stock as having effectively lost its inherent substance. Therefore, holding or disposing of treasury stock should not be viewed as a simple disposal of assets, but rather should follow procedures and methods similar to those used for issuing new shares or capital transactions.
Case law generally tends to adhere to the asset theory. The Supreme Court has held that the sale of treasury stock constitutes a disposal of assets, and that the legality of such disposals should be determined by the business judgment principle. In other words, if the board of directors acquires, holds, and disposes of treasury stock for a reasonable purpose and in accordance with reasonable procedures, such business judgment is respected. In fact, this Supreme Court ruling is widely criticized as a minority view in academia, with many corporate law scholars arguing that the unissued stock theory should be followed.
However, from an accounting perspective, the unissued stock theory is more persuasive. Specifically, treasury stock acquired by a corporation is accounted for as a capital adjustment, with the acquisition cost included as the treasury stock item. While in the past, treasury stock was sometimes treated as an asset based on the asset theory, it is now explicitly accounted for as a capital adjustment, with a negative number recorded on the balance sheet (the amount of treasury stock acquired is directly deducted from total equity). Consequently, a normative discrepancy exists between the asset theory followed by the courts and the unissued stock theory in accounting. This discrepancy, coupled with the discussion of the third amendment to the Commercial Act, calls for a new balance. While the court's asset theory will remain in place unless Supreme Court precedent changes, it is highly likely that some restrictions will be placed on the freedom to dispose of treasury stock to prevent misuse for the purpose of protecting management and to promote shareholder equality and market order in the public interest.
The impact of mandatory stock cancellation on the RSU system among stock compensation systems
As explained above, even if the Commercial Act is revised in the future, it appears that the disposal of treasury stock will not require approval at the general shareholders' meeting for employee stock compensation. However, if the Commercial Act is revised in this direction, it will directly affect Restricted Stock (RS), Restricted Stock Units (RSU), and Restricted Stock Awards (RSA). RS, also known as Restricted Stock Units, are stocks that the company awards to employees who have met performance criteria, such as length of service and sales, but with restrictions on the timing of transfer. They are a type of employee stock compensation. RSUs are a performance-based compensation system that allows the transfer of company stocks if certain conditions are met in the future, such as after a certain period of service and contribution to the company. RSAs are a performance-based compensation system that grants stocks immediately but restricts the timing of transfer so that they can be definitively transferred if certain conditions are met in the future, such as after a certain period of service and contribution to the company. RS is a collective term for both RSUs and RSAs.
Since both RSUs and RSAs essentially involve the disposal of treasury stock, they can be granted to employees and others with a board of directors' resolution under the current Commercial Act. However, the third amendment to the Commercial Act requires general shareholders' approval for employee stock compensation. This is particularly true for listed companies, which must be mindful of shareholder sentiment. While RSUs and RSAs, which were once highly beneficial when granted solely through a board of directors' resolution, have now significantly diminished their utility. Granting RSUs without general shareholders' approval is highly likely to be invalidated for violation of the Commercial Act. Furthermore, under the first amendment to the Commercial Act, which is already in effect, directors have a duty of loyalty to shareholders. Therefore, when granting RSUs or RSAs to employees and others, the board must thoroughly review whether they are being faithful to all shareholders and whether they are not unfairly granting benefits to specific shareholders. Consequently, companies operating stock-based compensation programs such as RSUs and RSAs need to completely reorganize their compensation policies.
Inquiry for information
Attorney Heechul Ahn 010-9135-4773 / heechul.an@dlglaw.co.kr
Simharu, Senior Manager, PR Marketing Team 010-9458-6068 / ru.sim@dlglaw.co.kr
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