Effectiveness and Enforcement of Shareholders’ Agreements: Recent Case Law Analysis

1. Definition and Purpose of Shareholders’ Agreements

Shareholders’ Agreements are contracts between company shareholders to achieve specific objectives that cannot be easily accomplished through corporate law alone. They play a crucial role in joint ventures, venture capital investments, and governance structure stabilization. These agreements clarify shareholders’ rights and obligations regarding ownership, governance structure, share transfer restrictions, and decision-making processes.

Such agreements supplement the uniform regulations of corporate law. They provide tailored solutions that meet the specific needs of the parties. They promote investment and protect minority shareholders’ rights. When corporate disputes arise, these agreements clearly define the rights and obligations of the parties involved.

2. Case Law on Share Transfer Restrictions

Share transfer restrictions are common provisions in shareholders’ agreements. The Supreme Court of South Korea has taken clear positions on their effectiveness and legal consequences when violated.

The Supreme Court has recognized the obligation to pay damages for violating share transfer restrictions. However, it upheld a lower court’s decision to reduce excessive liquidated damages stipulated in the contract (Supreme Court Decision 2007Da14193, July 10, 2008). This shows that while damages are a valid remedy for contract violations, the amount must be reasonable.

Another notable case ruled that even when share transfer restrictions are violated, the transfer remains effective against the company. This means the company cannot refuse the transferee’s request to register the share transfer (Supreme Court Decision 99Da48429, September 26, 2000). This case involved shareholders of Shinsegi Telecom, the second mobile telecommunications operator in Korea, and demonstrates the limitations of shareholders’ agreements’ effects on corporate law.

These cases show that shareholders’ agreements are binding between parties but have limited external effect against the company. Practitioners should understand these limitations and consider them when drafting agreements.

3. Effectiveness of Control Provisions in Decision-Making

Shareholders’ agreements often include provisions controlling major company decisions. The effectiveness of such provisions can be confirmed through court decisions.

One notable lower court decision suspended the effectiveness of amended articles of incorporation that strengthened the requirements for director dismissal resolutions. The court ruled that such majority requirements are not permitted (Seoul Central District Court Decision 2008KaHap1167, June 2, 2008). This shows that even when shareholders’ agreement provisions are reflected in the articles of incorporation, they may be limited if they contradict mandatory provisions of corporate law.

There is also a Supreme Court decision interpreted as supporting the expansionist view that articles of incorporation can make self-dealing approval a matter for the shareholders’ meeting (Supreme Court Decision 2005Da4284, May 10, 2007). However, some interpret this ruling as limited to self-dealing approval, suggesting that not all shareholders’ agreement provisions can be incorporated into the articles to give them corporate law effect.

These cases show the complex legal issues that arise when shareholders’ agreement provisions are incorporated into articles of incorporation. When drafting agreements, careful consideration of mandatory corporate law provisions is essential.

4. Remedies for Breach of Shareholders’ Agreements

Cases Seeking Proxy Rights

Let’s examine the effectiveness of remedies for shareholders’ agreement breaches through actual cases.

In one case, a private equity firm acquired company shares and convertible bonds. When the respondents (the company and its representative director/shareholder) violated their agreement, the court recognized the breach and granted a request for voting rights proxy limited to a specific extraordinary shareholders’ meeting (Seoul Central District Court Decision 2011KaHap2785, November 24, 2011).

However, when shareholders changed, the court dismissed a provisional injunction application, ruling there was no basis to extend the agreement’s effect to new shareholders (Seoul Central District Court Decision 2011KaHap3134, February 9, 2012).

When another extraordinary shareholders’ meeting was convened, the court granted a request for voting rights proxy for the representative director’s shares. The court also issued an indirect enforcement decision (requiring payment of 20 million won for violation). However, requests against family members were dismissed (Seoul Central District Court Decision 2012KaHap324, February 21, 2012).

These sequential decisions recognized contract violations but were reluctant to grant sufficient legal remedies. They show limitations where disputes can be repeatedly renewed. Practitioners should recognize these limitations and specify more effective remedies in agreements.

Cases Seeking Specific Voting Directions

Can specific voting directions promised in shareholders’ agreements be enforced? Two interesting cases provide insight.

In the first case, parties agreed to vote in a specific way when forming a joint venture. When the respondent tried to vote contrary to the agreement, the applicant sought an injunction to enforce the agreed voting direction. The court dismissed the application, ruling that such a request is a type of injunction ordering an expression of intent, which contradicts the purpose of Civil Code Article 389(2) and Civil Execution Act Article 263(1) (Seoul Central District Court Decision 2007KaHap2556, February 25, 2008). This suggests that voting agreements may be difficult to legally enforce.

The second case shows a different approach. When a Korean company and a foreign company established a joint venture with provisions on director appointment ratios, the foreign company proposed articles of incorporation amendments following changes in equity ratios. The Korean company sought an injunction to force specific voting directions.

The court defined the joint venture agreement as an innominate contract similar to a partnership agreement. It ruled that such agreements are valid between parties if they don’t harm other shareholders’ rights or contain unfair provisions (Seoul Central District Court Decision 2012KaHap1487, July 2, 2012). The court also recognized the obligation to vote for director candidates nominated by the counterparty. Although this case was dismissed based on interpretation of the joint venture agreement, it’s notable that the court recognized voting obligations in obiter dictum.

However, Korean legal doctrine and lower court precedent (Mokpo Branch of Gwangju District Court Decision 2011GaHap257, October 4, 2011) hold that violations of voting constraint agreements don’t constitute defects in resolutions. This limits the effect of shareholders’ agreement violations on the validity of shareholders’ meeting resolutions.

5. Practical Strategies for Shareholders’ Agreements

Let’s examine strategies for effectively utilizing shareholders’ agreements in practice.

1. Party Design: Shareholders’ agreements affect only the contracting parties. Consider including the company as a party or reflecting provisions in the articles of incorporation.
2. Specify Concrete Remedies: Clearly specify various remedies for contract violations, such as damages, penalties, and share purchase rights.
3. Connection with Articles of Incorporation: Reflect key provisions in the articles where possible, but avoid contradicting mandatory corporate law provisions.
4. Share Transfer Restriction Mechanisms: Share transfer restriction provisions have limited effect against the company. Introduce mechanisms like right of first refusal and tag-along rights to complement them.
5. Secure Voting Agreement Effectiveness: Direct enforcement of voting agreements is difficult. Consider alternatives like voting trusts and advance proxy procurement.
6. Dispute Resolution Clauses: Pre-agree on efficient dispute resolution procedures through arbitration clauses and exclusive jurisdiction clauses.

These strategies can maximize the effectiveness and enforcement of shareholders’ agreements.

6. Conclusion and Implications

Shareholders’ agreements are formed to achieve specific objectives difficult to accomplish through corporate law alone. They serve the important function of promoting investment. Unless there are specific grounds for invalidity, their legal effect should be recognized. In principle, not only damages but also specific performance should be recognized for violations.

Recent cases acknowledge the effectiveness of shareholders’ agreements while showing their limitations. The principle of “distinction between personal law and organizational law” should not be mechanically applied to closed corporations. Legal theories should develop in the direction of respecting the intentions of contracting parties.

In practice, it’s important to understand case trends and establish various legal devices to complement the limitations of shareholders’ agreements when drafting contracts. Provisions on corporate governance structure, share transfer restrictions, and decision-making processes should be designed with careful examination of their relationship to mandatory corporate law provisions.

K&P Law Firm has extensive successful litigation experience in shareholders’ agreement disputes for companies in Songdo, Incheon, South Korea. We have particular expertise in designing shareholders’ agreements and resolving disputes for companies with complex governance structures, such as joint ventures and venture capital investments.