Lawsuit for Invalidation of New Share Issuance: Legal Basis, Issues, and Corporate Response Strategies
- Concept of Lawsuit for Invalidation of New Share Issuance
- Legal Basis and Requirements
- Major Grounds for Invalidation of New Share Issuance
- Comparison Between Invalidation Lawsuit and Injunction
- Procedure for New Share Issuance Invalidation Lawsuit
- Practical Response Strategies for Corporations
- Checklist for Corporate Executives
- Conclusion
Related Contents
1. Concept of Lawsuit for Invalidation of New Share Issuance
A lawsuit for invalidation of new share issuance refers to legal action taken to nullify the effect of newly issued shares when there are legal defects in the issuance process. Since an increase in a company’s capital directly affects the ownership ratio of existing shareholders, the Commercial Act provides strict regulations regarding the procedures and methods for new share issuance.
When a new share issuance violates laws or articles of incorporation, or is conducted through grossly unfair methods, there may be a need to invalidate the issuance. However, since invalidating already issued shares may cause confusion in the company’s capital structure and shareholder composition, the Commercial Act restricts claims for invalidation of new share issuance to be made only through lawsuits.
2. Legal Basis and Requirements
The legal basis for a lawsuit for invalidation of new share issuance is Article 429 of the Commercial Act. According to this provision, the invalidation of a new share issuance can only be claimed through a lawsuit filed by a shareholder, director, or auditor within six months from the date of issuance.
Article 431 of the Commercial Act stipulates the effect of an invalidation judgment. The invalidation judgment has effect against third parties (erga omnes effect), but does not affect the rights and obligations between the company and third parties that arose before the judgment became final.
The requirements for filing a lawsuit for invalidation of new share issuance are as follows:
- Standing to Sue: Limited to shareholders, directors, or auditors.
- Filing Period: Must be filed within six months from the date of share issuance.
- Jurisdiction: Exclusive jurisdiction of the district court having jurisdiction over the location of the company’s principal office.
3. Major Grounds for Invalidation of New Share Issuance
The major grounds for a new share issuance to be recognized as invalid can be broadly categorized into violation of laws, violation of articles of incorporation, and issuance through grossly unfair methods.
3.1 Violation of Laws
Representative examples of law violations include:
- Absence of or defects in the board of directors’ resolution under Article 416 of the Commercial Act
- Infringement of shareholders’ pre-emptive rights under Article 418 of the Commercial Act
- Violation of public notice or notification obligations under Article 419 of the Commercial Act
3.2 Violation of Articles of Incorporation
When a company’s articles of incorporation contain special provisions regarding the issuance of new shares, violation of these provisions may constitute grounds for invalidation. For example:
- Exceeding the new share issuance limit set in the articles of incorporation
- Issuing a type of shares different from that specified in the articles of incorporation
- Failing to go through a shareholders’ meeting resolution when required by the articles of incorporation
3.3 Grossly Unfair Method
New share issuance through grossly unfair methods includes cases such as:
- Allocating new shares under favorable conditions only to specific shareholders
- Issuing new shares with the purpose of unfairly diluting the ownership of certain shareholders
- Issuing new shares at a significantly low price, harming the interests of the company or existing shareholders
- Unreasonably discriminating against shareholders with the same class of shares, violating the principle of shareholder equality
4. Comparison Between Invalidation Lawsuit and Injunction
There are significant differences in purpose and effect between a lawsuit for invalidation of new share issuance and an injunction against the effect of new share issuance.
| Classification | Lawsuit for Invalidation of New Share Issuance | Injunction Against the Effect of New Share Issuance |
|---|---|---|
| Nature | Main lawsuit | Preservative measure |
| Purpose | Confirmation of the invalidity of new share issuance | Temporary suspension of the effect of new share issuance until the result of the main lawsuit |
| Effective Timing | Takes effect only for the future after the judgment becomes final | Immediate suspension of effect upon grant of the application |
| Legal Basis | Article 429 of the Commercial Act | Article 300 of the Civil Execution Act |
| Matters for Review | Existence of grounds for invalidation of new share issuance | Protected right and necessity for preservation |
In practice, after a new share issuance has been made, it is common to file a lawsuit for invalidation of new share issuance as the main lawsuit while simultaneously applying for an injunction against the effect of new share issuance. However, since a judgment invalidating a new share issuance only has effect for the future once it becomes final (Article 431(1) of the Commercial Act), an injunction suspending the effect of a new share issuance results in exceeding the content of the final judgment in the main case, which violates the principle of supplementary nature of preservative measures, and is therefore generally not allowed.
5. Procedure for New Share Issuance Invalidation Lawsuit
A lawsuit for invalidation of new share issuance proceeds through the following procedure:
- Filing of Complaint: The plaintiff (shareholder, director, or auditor) files a complaint with the district court having jurisdiction over the location of the company’s principal office.
- Preparatory Proceedings: The court organizes the parties’ claims and evidence through preparatory proceedings.
- Pleadings: The plaintiff and defendant (company) present their arguments and submit evidence in court.
- Judgment: The court pronounces judgment after determining whether there are grounds for invalidation of the new share issuance.
- Finalization of Judgment: The judgment becomes final after the appeal period has elapsed or after a judgment from a higher court.
- Registration: If an invalidation judgment becomes final, the company must register the invalidation at the registry offices of its principal office and branches within one month (Article 432 of the Commercial Act).
6. Practical Response Strategies for Corporations
The following are strategies for corporations to effectively respond when faced with a lawsuit for invalidation of new share issuance:
6.1 Preventive Strategies
- Ensure the legality of the board of directors’ resolution procedure (quorum, convocation procedure, voting method, etc.).
- Clearly document justified reasons when restriction of pre-emptive rights is necessary.
- Prepare materials that can objectively prove the fairness of new share issuance conditions.
- Thoroughly fulfill public notice and notification obligations to shareholders.
- Strictly adhere to the procedure for payment of share prices.
6.2 Litigation Response Strategies
- Check whether the filing period has elapsed (six months from the date of share issuance).
- Review whether the plaintiff has standing to sue.
- Systematically organize materials that can prove the legality of the new share issuance procedure.
- Assert legitimacy based on the business judgment rule.
- For an injunction application filed simultaneously with the lawsuit, argue violation of the principle of supplementary nature of preservative measures.
7. Checklist for Corporate Executives
Items that corporate executives should check to prevent legal disputes when issuing new shares:
7.1 Legality of Share Issuance Resolution Procedure
- Has the board of directors’ convocation procedure been conducted legally?
- Has the quorum for board of directors’ resolution been met?
- Is the content of the resolution clear and specific?
- Have all necessary matters been recorded in the minutes?
7.2 Protection of Pre-emptive Rights
- Have existing shareholders’ pre-emptive rights been protected?
- If pre-emptive rights are restricted, is there a justified reason?
- In case of third-party allocation, can the necessity and fairness be proven?
7.3 Fulfillment of Public Notice and Notification Obligations
- Have the obligations of notification or public notice to shareholders been fulfilled?
- Has the subscription form been prepared in accordance with the law?
- Has the procedure for payment of share prices been legally adhered to?
7.4 Fairness of Share Issuance
- Has the issuance price been determined fairly?
- Are there no unfavorable conditions for specific shareholders?
- Is the purpose of new share issuance legitimate and in line with the company’s interests?
8. Conclusion
Legal issues related to new share issuance have a significant impact on a company’s governance structure and capital raising, making professional and experienced legal counsel essential. It is important to prevent potential disputes through thorough legal review from the planning stage of a company’s new share issuance.
K&P Law Firm has recently succeeded in representing an Incheon-based company in a case involving an injunction against the effect of new share issuance. In this case, our firm successfully argued, based on Article 431(1) of the Commercial Act, that a judgment invalidating a new share issuance only has effect for the future once it becomes final, leading to the dismissal of the injunction application that would have exceeded the content of the final judgment in the main case. With this professional response, our client company was able to maintain the effect of its new share issuance and continue its management activities smoothly.