Binding Force of Shareholder Agreements on Directors who are Shareholders

Analysis of Supreme Court Decision 2012da80996, Decided on September 13, 2013

1. What is the Binding Force of Shareholder Agreements on Directors who are Shareholders?

A “director who is also a shareholder” refers to an individual who simultaneously holds both positions within a company. This dual role is common in many small and medium-sized enterprises or closed corporations in South Korea. The legal issue arises when determining whether shareholder agreements can bind these individuals when they act in their capacity as directors.

2. Key Legal Issues in this Case

This case represents the first Supreme Court decision in South Korea to address the binding force of shareholder agreements on directors who are also shareholders. The central question was whether a shareholder agreement could extend its binding effect to the actions taken by a signatory in their capacity as a director.

3. Case Background

3.1 Context

This case originated from a management dispute at Company X, which operated a golf course. The plaintiffs and defendants were all family members or relatives of Company X’s founder, collectively holding 52.5% of the company’s shares:

• Plaintiff A: 28,000 shares (17.5%)
• Plaintiff B: 28,000 shares (17.5%)
• Defendant C: 16,023 shares (10%)
• Defendant D: 11,977 shares (7.5%)

3.2 The Shareholder Agreement

On January 19, 2006, these parties entered into a shareholder agreement to secure stable joint management control during a management dispute with other shareholders, including Mars Fund.

3.3 Key Provisions of the Agreement

1. Share Transfer Restrictions: Any transfer of shares to third parties required written consent from all other parties to the agreement
2. Joint Exercise of Voting Rights: The parties agreed to jointly exercise voting rights at shareholders’ meetings on matters such as the appointment of directors and auditors
3. Decision-making Process: Decisions would be made according to the wishes of those holding a majority of shares among the agreement parties
4. Penalty Clause: A penalty of 10 million KRW per share would be imposed for violations of the agreement

3.4 The Dispute

At a special shareholders’ meeting on July 29, 2010, three directors representing the agreement parties were elected, giving them a majority (3 out of 5) on the board of directors. However, cooperation among the agreement parties subsequently broke down.

Defendant C took the following actions:

1. As a director, opposed the appointment of Plaintiff B as CEO, siding with the Mars Fund
2. As a director, exercised voting rights at board meetings against the wishes of the plaintiffs
3. As the CEO, rejected the plaintiffs’ requests to convene a special shareholders’ meeting

4. Arguments by the Parties

4.1 Plaintiffs’ Arguments

• The defendants had violated the shareholder agreement, triggering their obligation to pay the penalty
• Defendant C’s exercise of voting rights at board meetings against the majority view of the agreement parties constituted a breach of the agreement

4.2 Defendants’ Arguments

• The agreement only affected the parties’ rights and obligations as shareholders
• The agreement did not apply to actions not predicated on shareholder status
• The binding force of the shareholder agreement did not extend to actions taken as a director

5. Court Decisions

5.1 Trial Court

The trial court ruled in favor of the plaintiffs.

5.2 Seoul High Court (Appellate Court)

The Seoul High Court overturned the trial court’s decision, ruling:

• The authority of a shareholder and that of a director are clearly distinguishable
• If a shareholder agreement were to restrict a director’s authority, it could potentially harm the interests of shareholders not party to the agreement and the company itself
• Such restrictions could significantly conflict with a director’s duty of loyalty and duty of care
• The agreement in question only restricted the parties’ rights as shareholders and did not restrict their authority as directors

5.3 Supreme Court of South Korea

The Supreme Court upheld the High Court’s decision, dismissing all appeals:

• The agreement only had the effect of restricting the parties’ rights as shareholders and could not be interpreted as restricting their authority as directors
• This principle applies even when the parties simultaneously hold both shareholder and director positions

6. Significance of the Case

6.1 Clarification of the Scope of Shareholder Agreements

This case clearly established that shareholder agreements only affect the rights and obligations of parties in their capacity as shareholders, not in their capacity as directors.

6.2 Distinction Between Shareholder and Director Positions

The decision confirmed the principle that even when the same individual holds both shareholder and director positions, the rights and obligations associated with each position must be clearly distinguished.

6.3 Respect for Corporate Governance Structure

The case emphasized that shareholder agreements cannot be used to circumvent the corporate governance structure by restricting directors’ authority.

7. Practical Implications

7.1 Considerations When Drafting Shareholder Agreements

1. Clearly recognize the limited scope of shareholder agreements
2. Distinguish between matters for shareholders’ meetings and board meetings when drafting agreements
3. Understand that directors’ business judgment cannot be restricted by shareholder agreements

7.2 Appointment of Officers

If parties wish to have the shareholders’ meeting determine the appointment of officers such as the CEO, this must be explicitly stipulated in the company’s articles of incorporation.

7.3 Management Stability in Closed Corporations

Since shareholder agreements alone have limitations in stabilizing management control, they should be combined with other methods such as amending the articles of incorporation.

8. Conclusion

This case established the principle that shareholder agreements only have binding force on the rights of parties as shareholders, and this binding force does not extend to actions taken in a director capacity, even when the same individual holds both positions. This is a significant case that protects the corporate governance structure and directors’ independent business judgment, and must be considered when drafting shareholder agreements in practice.

K&P Law Firm has recently achieved successful outcomes in shareholder agreement disputes between companies, and possesses extensive experience in drafting shareholder agreements and resolving disputes, particularly for closed corporations where individuals often hold dual positions as shareholders and directors in South Korea.