Minority Shareholders | A Supreme Court Judgment Holding That a Representative Director or Director Cannot Escape the Duty of Oversight Through a Defense of "I Did Not Know"

The lower court determined the following with respect to this matter.

As to the representative director (Defendant 2), the court determined that, because the creation of off-the-books funds and the remittance of political funds within the CR Division had never been reported to the representative director or the board of directors, and because there were insufficient grounds to find that the representative director had any particular reason to suspect the illegality, it was difficult to recognize liability for breach of the duty of oversight.

As to the director (Defendant 13), the court partly recognized the direct remittances and a breach of the duty of oversight for a certain period thereafter, but it limited the scope of liability for damages by finding that the damage had been made good through return, repayment, and the like, or by denying any causal relationship with the U.S. sanctions payment.

The Supreme Court confirmed the premise that a director who, intentionally or negligently, violates statutes or the articles of incorporation or neglects his or her duties bears joint liability to the company, and that the representative director bears a company-wide duty of oversight. It then held that the duty of oversight is not exempted even in a large-scale, division-of-labor organization.

The court went on to summarize that the key point is whether a reasonable information and reporting system and an internal control system have been established and are functioning.

In particular, the court found that, taking the following circumstances together in this case, there was a substantial possibility that Defendant 2 (the representative director) and Defendant 13 (a director) had neglected their duty of oversight in connection with the creation of off-the-books funds and the remittance of political funds during their terms in office.

• The scale of the off-the-books funds was large, at approximately 1.1 billion won, and was created over a long period, with the remittance of political funds occurring repeatedly and in numerous instances.
• By their nature, off-the-books funds carry a high inducement to be used for unlawful purposes, and in fact a substantial amount was remitted as political funds, resulting in numerous final criminal convictions.
• There were indications that officers outside the CR Division were also involved in the remittances under their names, and yet internal restraint and checks did not operate.
• Abstract mechanisms alone, such as an internal accounting management system and ethical management guidelines, can hardly be regarded as effective internal controls that prevent or detect the creation of off-the-books funds and the remittance of political funds.

In the end, the Supreme Court determined that it is difficult to confine the period of the representative director's and director's breach of the duty of oversight as narrowly as the lower court did, and that further review is needed as to whether an internal control system was actually established and operated.

The Supreme Court held the following with respect to the standard for assessing the duty of oversight.

• Division of labor and specialization does not exempt the duty of oversight

Even in a large company, the duty of oversight is a basic duty, so liability does not disappear.

• The key is the "effectiveness" of the internal control system

The mere existence of a system on paper is insufficient; what matters is whether it operated in a form capable of detecting, reporting, and correcting signs of a violation.

• High-risk areas require stricter oversight

Where there has been neglect in areas of high legal risk, such as off-the-books funds and government-relations or political funds, the assessment of liability may be reinforced.

With respect to the determination of the scope of damages against Defendant 13, the Supreme Court found it difficult to accept the lower court's having limited the damage solely to the amount of remitted political funds and having readily denied a causal relationship even as to the U.S. sanctions payment.

The key points are as follows.

• The damage is not limited solely to the "amount of remitted political funds"

The money remitted as political funds out of the off-the-books funds was only a portion.

If the remaining amounts likewise represented company funds that were abnormally diverted or used, they may be assessed as damage (with returns and reimbursements deductible).

• The U.S. sanctions payment (collection of equivalent value and penalty surcharges) is not excluded from the causal relationship either

If the conduct of creating off-the-books funds is included among the grounds for the sanctions, it is, in principle, difficult to deny the causal relationship between the officers' breach of duty that made the creation of off-the-books funds possible and the damage of paying the sanctions.

However, because other causes frequently concur, identifying the amount of damage may be difficult, so that portion must be further reviewed.

In other words, rather than concluding that "there is no causal relationship," the Supreme Court indicated the direction that the scope must be determined by reviewing to what extent the damage bears a causal relationship.

In a case where minority shareholders pursue the officers' liability through a shareholder derivative suit, merely listing the unlawful acts is insufficient; one must structure, in accordance with the legal principles, (1) the structure of the internal control failure, (2) the timing and scope of the breach of the duty of oversight, and (3) the identification of the damage and the causal relationship.

Drawing on its experience in corporate governance and Commercial Act disputes, Daeryun Law Firm LLP reconstructs, on a case-by-case basis, the structure of the breach of the duty of oversight by the board of directors, the representative director, and the directors in charge of operations.

It also designs the direction for gathering and organizing evidence centered on whether the internal control system was effective, and at the same time it pursues a strategy of organizing the scope of damage and the causal relationship into a provable form, including the relationships among off-the-books funds, sanctions, returns, and repayments.

The success or failure of a minority shareholder's exercise of rights turns on how precisely the structure of liability and the structure of damage are proven.

If a related dispute is anticipated or proceedings are already underway, you are welcome to seek a legal assessment and develop a response strategy from the early stages.