▲ Attorney Bomi Seo, LIN LLC

Investing in venture companies based on innovative ideas inherently carries the nature of high risk and high return. Conversely, the potential for significant losses is also high, so appealing conditions such as promises of investment recovery are often presented. However, such promises may jeopardize the foundational capital of the company, infringe on the equality of shareholders, and even trigger legal disputes.
In particular, the “principle of shareholder equality” under the Commercial Act is the key criterion for determining the validity of agreements that grant preferential rights or profits only to specific shareholders. Notwithstanding the principle of shareholder equality, an agreement may be deemed valid if it is seen as consistent with the overall interests of the shareholders and the company as a whole. However, an investment return agreement in an investment contract is highly likely to be deemed void as it contravenes the principle of shareholder equality.


■ The Validity of Investment Return Agreements: The Hot Topic in the PE/VC Market

In this context, the Supreme Court ruling delivered on July 7, 2023 (Supreme Court Ruling 2022Da290778) is important. This ruling is evaluated to have set forth important legal principles concerning the validity of investment return stipulations executed as part of corporate investment and the scope of application of the principle of shareholder equality. The ruling concurrently set forth criteria for determining (1) whether an agreement by which the company guarantees the full recovery of investment to a specific shareholder violates the principle of shareholder equality, and (2) the scope of application of this principle not only to the relationship between the company and its shareholders but also to legal relationships with individuals such as other shareholders or directors.
In the case at issue, the company being sued (Defendant 1) had issued preference shares to investors (Plaintiffs). The agreement included a clause that if a specific R&D product that the defendant company had under research and development was not registered with a government agency within a certain period, the new share subscription agreement would become void, and the defendant company, its CEO (Defendant 2), along with the head of R&D (Defendant 3), etc., would be obligated to return the full investment amount. The CEO (Defendant 2) participated in the investment agreement as the company's representative and also largest shareholder. Defendant 3 participated as a shareholder and head of R&D, acting as a surety for the joint obligation of Defendant 2 and the company. Subsequently, the defendant company failed to complete the product registration by the agreed deadline, leading the plaintiffs to file a lawsuit seeking the full return of the investment from all three defendants based on the investment return agreement.


■ “We Will Return the Investment,” Is it Unlawful? …Supreme Court Reaffirms the Principle of Shareholder Equality.

The core issues of this case were twofold. First, whether the investment return agreement violates the principle of shareholder equality and is therefore void. Second, if the agreement is void in the relationship with the company, whether the principle of shareholder equality also applies to the relationships with the individuals—including Defendant 2, who is both the largest shareholder and the CEO, and Defendant 3, who is both a shareholder and head of R&D—rendering the agreement void even with them.

The Supreme Court reaffirmed the principle of shareholder equality, which dictates that “a shareholder must be treated equally according to the number of shares they hold.” The Court ruled that any agreement violating this principle, which grants preferential rights or profits only to certain shareholders, is void, absent special circumstances.
Specifically, the Court concluded that an agreement like the one in this case—where the company guarantees the full return of the new share subscription payment to the new shareholder—constitutes a separate profit payment not recognized for other shareholders outside of legal dividends. This was deemed void as it "absolutely guarantees the recovery of invested capital solely to the relevant shareholder, granting a preferential right not recognized for other shareholders," thereby violating the principle of shareholder equality.
Furthermore, the Supreme Court ruled that even with consent from all shareholders, such an agreement violates mandatory rules of law, such as the Commercial Act, by jeopardizing the company’s foundational capital and nullifying the essential responsibility of shareholders. Therefore, the agreement was deemed void in the relationship with the company, upholding the lower court’s judgment. 


■ Shareholder Equality Does Not “Directly Apply” to Individuals

The Court also clarified that principle of shareholder equality only applies within the relationship between shareholders and the company — not to legal relationships between individuals (other shareholders or directors). 
The investment agreement in this case must be separated into the contract between the plaintiffs and the defendant company, and the contract between the plaintiffs and Defendants 2 and 3. Even if the agreement is void in the relationship with the company for violating the shareholder equality principle, it is not automatically void in the relationship with the individuals.

Therefore, the lower court should have examined whether the investment repayment obligation borne by Defendant 2 was a subordinate joint guarantee to the company's debt or an independent joint liability, and the validity of the obligations of Defendants 2 and 3. However, the lower court denied the effect of the agreement under the pretext that the principle of shareholder equality also applies directly to the relationship between individuals. Consequently, the Supreme Court remanded the case to the lower court for re-examination of this part.


■ Common Ground with the Supreme Court Ruling on Investor's Prior Consent Rights

Another Supreme Court precedent (Supreme Court Ruling 2021Da293213, rendered July 13, 2023) related to the principle of shareholder equality concerned the validity of the investor’s prior consent rights regarding major corporate management matters under an investment agreement. This ruling held that even if differential rights are granted to a specific shareholder, the provision may be deemed valid despite the principle of shareholder equality if there is a special reason that justifies it.
This stance confirmed a common legal principle, similar to the aforementioned investment return agreement case, that a monetary payment stipulation which absolutely guarantees the recovery of capital is void for violating mandatory rules of law. This acts as an important principle for the integrity of company capital and the protection of other shareholders' rights. Even with the consent of all shareholders, such an agreement cannot be legally recognized if it jeopardizes the foundational capital of the company and nullifies the essential responsibility of shareholders.


■ Even if the Agreement is Broken, Does Liability Remain?…The Personal Liability of the Representative Must Be Examined
 
The ruling clarified that an agreement whereby the company guarantees the absolute recovery of invested capital to a shareholder is void as it violates the principle of shareholder equality and mandatory rules of law. This demonstrates a commitment to protecting the soundness of company capital and maintaining fair treatment among shareholders.
Furthermore, by limiting the scope of application of the principle of shareholder equality to the relationship between the company and its shareholders, the Court made it clear that the principle does not apply to agreements with individuals (representatives or other shareholders) other than the company. This leaves open the possibility for investors to secure investment recovery from individuals.
These two rulings emphasize the necessity of clarity regarding the contracting parties and the specific terms of the agreement when drafting an investment contract. The investor must clearly stipulate who, besides the company, is a party to the contract, and under what conditions and how much can be recovered. It is also necessary to design the contract structure to avoid contravening the principle of shareholder equality or mandatory rules of law. This is important for preventing unnecessary disputes and preventing situations where liability is pursued by limited partners (LPs) against the general partner (GP). From the perspective of the company receiving the investment, it is necessary to execute investment contracts that promote the soundness of capital and thereby establish a stable foundation for growth.


■ Now begins the “era of investment contract design”… anticipating fewer PE/VC disputes

The accumulation of these precedents is expected to contribute to enhancing legal predictability in the PE/VC market. This can help foster a sound investment environment by encouraging investors and companies to enter into agreements that adjust their interests more clearly and rationally. Of course, this Supreme Court ruling did not deem all agreements possessing the nature of investment return to be uniformly void. The judgment of validity may vary depending on the specific contract details, the class of shares issued, the terms and method of investment recovery, and the company's financial status, etc. Therefore, there is a need to scrutinize the specific facts of each case, and the necessity of consulting a legal expert before executing investment contracts to carefully structure the agreements has increased significantly. 


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Hankyung Law&Biz
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