Shareholder agreements are essential tools for defining the rights and obligations of shareholders when multiple parties collaborate on a business or project. These agreements are commonly used in joint ventures and M&A transactions and are increasingly seen in investment contracts between financial investors and Korean startups.
In the entertainment industry, where collaboration between large labels and creative talents often forms the foundation of new ventures, shareholder agreements play a significant role in corporate governance. A recent dispute over ADOR, the label behind the K-Pop girl group New Jeans, highlights the legal implications of shareholder agreements, particularly voting rights agreements, in Korean joint ventures.
In the ADOR case, the Seoul Central District Court upheld the validity of the director appointment and voting restriction clauses outlined in the shareholder agreement and subsequently issued an injunction preventing the majority shareholder from the exercise of voting rights in an attempt to oust ADOR’s CEO.
This ruling serves as a key example of how shareholder agreements and voting agreements function in joint venture management disputes. It offers valuable insights not only for the entertainment industry but also for foreign companies engaged in joint ventures in Korea across various sectors.
Overview of the Dispute
ADOR (referred to as “A”) is a music label established by HYBE, a listed Korean entertainment company (referred to as “Y”). Initially, Y held 100% of A’s shares. X, a renowned producer, entered into a business agreement with Y, becoming A’s CEO and spearheading the success of New Jeans (referred to as “NJ”).
As part of the arrangement, X was granted stock options, and in March 2023, while X acquired 17.8% of A’s shares, X formalized a shareholder agreement with Y. This agreement included a clause stating that “Y must vote in favor of retaining X as CEO and director of A for five years, unless X violates laws or the company’s articles of incorporation.”
The Emergence of the Dispute
Following the successful debut of the girl group NJ, tensions arose. X raised issues regarding the non-compete clause and the exercise price of the put option stipulated in the shareholder agreement. Disputes intensified between X and Y over similarities between NJ and a new girl group produced by another label under Y, as well as whether X had breached its fiduciary duties.
The tension peaked when Y sought to dismiss X from the board of directors at the upcoming shareholder meeting scheduled for May 31, 2024. If X were removed from the board, she would automatically lose her position as CEO pursuant to Korean corporate law.
In response, X filed for an injunction with the Seoul Central District Court to prevent Y from exercising its voting rights in favor of X’s removal.
X’s Argument
X argued that the shareholder agreement required Y to support her retention as A’s CEO for five years unless specific legal violations occurred. Thus, X requested that the court prohibit Y from voting in favor of her removal and impose a 30 billion KRW penalty should Y violate this clause.
Y’s Argument
Y countered as followis:
- The provision in the shareholder agreement requiring Y to exercise its voting rights to maintain X’s position as CEO and director should be interpreted as obligating Y to support X’s reappointment only after the expiration of the three-year statutory term of a director, as set forth in the articles of incorporation, and not as a restriction on Y’s shareholder’s right to remove a director at a general meeting of A.
- Even if the above provision were interpreted as a voting restriction on X’s removal from the board, the shareholder agreement clearly provides an exception in cases where X engages in conduct that violates the articles of incorporation or laws, which constitutes grounds for removal under the Corporate Act. X, as a director of A, had breached her fiduciary duties by attempting to privatize NJ, a key asset of A, thereby causing significant harm to the company. As a result, Y is not bound by the voting restriction.
The Court’s Ruling
On May 30, 2024, the Seoul Central District Court ruled in favor of X, issuing an injunction preventing Y from voting in favor of X’s removal at the shareholders general meeting.
The court recognized the binding nature of the voting restriction clause in the shareholder agreement, stating that this clause which states ‘Y must exercise its voting rights at the shareholders’ meeting to ensure X maintains her position as a director for five years’ aimed to secure X’s tenure for five years unless legally valid reasons for her removal were presented.
The court also found that this voting agreement was valid and enforceable between X and Y, as there was no indication that it infringed on the rights of other shareholders or was otherwise unjust. The court further determined that given the clarity and specificity of the agreement’s terms, X was entitled to enforce Y’s obligations under the voting agreement.
The court dismissed Y’s argument that X had violated fiduciary duties under the Korean Commercial Act, which would exempt Y from the voting restriction, as Y failed to provide sufficient evidence to support this claim.
Ultimately, the court ordered Y not to vote in favor of X’s removal at A’s shareholders’ meeting. To ensure compliance, the court imposed a penalty of 20 billion KRW on Y, payable to X, should Y breach the injunction.
A shareholder agreement is a contract between the shareholders of a company to govern their mutual rights and obligations concerning the company’s management and operations.
In a corporation, control and management are carried out through the shareholders’ meeting and the board of directors, with the principle of majority rule typically governing, as outlined in the Commercial Act. As a result, shareholder agreements are vital in allowing minority shareholders to participate in management while also acting as a mechanism to limit the power of majority shareholders.
The structure and content of a shareholder agreement can vary depending on the number of shareholders involved, the investment objectives of each shareholder, and the company’s ownership structure. However, it typically includes key provisions concerning:
- Company’s governance structure
- Restrictions on the transfer of shares
- Composition of the board of directors and other corporate bodies
- Exercise of voting rights at shareholders’ meetings and board meetings
- Reporting and oversight of major management decisions
- Non-compete clauses, financing, and dividend policies
- Duration of the agreement, termination, and the effects of termination.
Among these, an agreement that pre-defines the content and manner of voting rights of each shareholder at the general meetings is referred to as a voting agreement.
Validity of Voting Agreement
In Korea, the general view on the validity of shareholder agreements in joint ventures or other business relationship is that they are only effective between the shareholders involved and do not bind the company itself. This applies equally to voting agreements.
While the Supreme Court has yet to directly address this issue, multiple lower court rulings have taken the position that voting agreements are valid between the parties, as long as the agreement does not infringe on the rights of other shareholders or involve unfair practices.
For example, in a decision by the Anyang Branch of the Suwon District Court on May 29, 2018 (2018KaHap10007), the court upheld the validity and enforceability of a voting agreement in a strategic partnership agreement between a Japanese and a Korean company for the joint development and manufacture of medical medicines in Korea. The agreement stipulated that the Korean joint venture company would have four directors, with each partner designating two directors, and that the representative directors would be one appointed by the Japanese company and one by the Korean company. The court ruled that such a shreholder agreement and a voting agreement were both valid and enforceable.
Securing Enforceability of Voting Agreement
If a shareholder attempts to breach a voting agreement, can the other party seek an injunction to compel or prohibit the opposing shareholder from exercising their voting rights?
Although there are differing legal opinions, the prevailing trend in Korean courts tends to support this course of action.
It should be noted, however, that a court injunction does not go so far as to legally substitute the opposing shareholder’s exercise of voting rights. Rather, it is limited to imposing obligations to either act or refrain from acting, such as ‘you must vote in favor of the director’s appointment’ or ‘you must not vote in favor of the director’s removal.
Therefore, even if a court issues an injunction ordering the opposing shareholder to vote in favor of a director’s appointment, there are limitations. For instance, if the opposing shareholder simply does not attend the shareholders’ meeting, the objective of appointing the director cannot be achieved.
Moreover, if a resolution is passed at the shareholders’ meeting in violation of the injunction, the mere fact that it breaches the voting agreement between shareholders is not, by itself, sufficient grounds for nullifying the resolution, according to established case law.
Alternatively, the harmed shareholder can pursue a claim for damages against the opposing party for breach of contract. However, proving the amount of the damages suffered can be challenging.
Therefore,in practice, Korean voting agreements typically include penalty clauses to address breaches by either party. Additionally, when seeking an injunction, claimants often request indirect enforcement measures, stipulating that a specified sum be paid to the claimant if the respondent fails to comply with the injunction. Courts have generally recognized and upheld these requests.
In the ADOR case, the Seoul Central District Court, following established legal precedents, recognized the validity and enforceability of the voting agreement stipulated in the Korean shareholder agreement. The court ordered the opposing shareholder, Y, not to vote in favor of X’s dismissal at the shareholders’ meeting. Furthermore, the court issued an indirect enforcement order requiring Y to pay 20 billion KRW to X if Y exercised voting rights in violation of the injunction.
This ruling is a key example of how voting restriction clauses in shareholder agreements can operate in the context of a Korean corporate governance and management disputes, providing several practical insights.
By clearly defining how shareholders should exercise their voting rights in specific situations related to company operations, voting restriction clauses help protect management rights and minimize disputes. In the ADOR case, the court’s decision to prohibit majority shareholder Y from voting in favor of a resolution to dismiss minority shareholder-appointed director X highlights the significance of such provisions.
Therefore, it is essential that voting restriction clauses clearly define their scope (in this case, the appointment and removal of directors), as well as the conditions and procedures for exercising those rights.
In this ADOR case, the clause allowed Y to vote for X’s dismissal only if ‘X engaged in conduct that violated the articles of incorporation or laws’. This was advantageous to minority shareholder X, but unfavorable to majority shareholder Y with 80% of the shares. (Under the Korean Corporate Act, directors can be dismissed by resolution at a shareholders’ meeting. However, if a director with a fixed term is removed without just cause before their term expires, the company may be liable for damages to the director). From Y’s perspective as the majority shareholder, it would have been more beneficial to define the clause as ‘if X plans or is reasonably expected to engage in conduct that violates the articles of incorporation or laws.’ Had the clause been written this way, X’s application for an injunction to block Y’s voting rights could have been dismissed, because the court acknowledged that X, dissatisfied with the terms of the shareholder agreement, had explored ways to separate the girl group NJ from its exclusive contract with A to place the group under X’s private control.
Additionally, from the perspective of minority shareholders, it is advisable to include a penalty clause in case of a breach of the voting agreement. While the court may reduce the penalty amount, the clause can still serve as evidence that the parties recognized the binding nature of the agreement. At the injunction stage, the agreed-upon amount can also act as a reference point for setting the amount of the penalty, i.e. indirect enforcement payment.
As mentioned earlier, while voting agreements are generally upheld, there is a risk of invalidation if the agreement effectively forces shareholders to surrender their core voting rights. Under Korean case law, shareholder rights cannot be fully waived by mutual agreement. To mitigate this risk, it is advisable to clearly define the scope of the voting restriction and limit the duration of the agreement to a reasonable timeframe.
Conclusion
The ADOR case offers valuable lessons for foreign companies involved in joint ventures in Korea. As seen in this dispute, shareholder agreements can significantly influence corporate governance, especially in managing voting rights. Foreign companies should carefully draft these agreements, ensuring they reflect the nuances of Korean law and corporate practices.
If your company is navigating a joint venture or facing a governance dispute in Korea, understanding the legal landscape and having well-drafted agreements in place is essential. For further guidance, feel free to contact us for expert legal assistance tailored to your business needs.