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Introduction of Limited Liability Companies to the Korean Commercial Act

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Gy Yun Jung & Ina Chung*

I. INTRODUCTION

The Limited Liability Company (hereinafter LLC) newly introduced in the amended Korean Commercial Actwhich will be enforced from year 2012 is modeled after the LLC in American corporate law and the ‘joint corporation’ of Japan. However, as the joint corporation under Japanese corporate system is also a modified version of the American LLC, the American LLC can be seen as the origin of the newly adopted LLC in Korean Commercial Act. In general, LLC is a joint enterprise where all members bear limited liability but still can fully participate in management thus realizing a decentralized form of corporate governance.1 This is mixture of a corporation and an association resulting in form of joint enterprise that shows only the favorable characteristics of both forms. Moreover, LLC enjoys pass-through tax treatment under the American corporate law system which is a reason why it is vigorously employed in the industrial areas of information, chemicals, aerospace, semiconductor, and electronic engineering. This is the reason why various industrial sectors in Korea have also repeatedly

*

J.D. Candidates of Korea University Law School, Seoul, Korea.

1

Se Hwa Park, “The Legal Analysis on the System of Limited Liability Company,” Law Review, Vol. 48 No. 3, 2007 at 1107.

Table of Contents I. Introduction

II. The History and Definition of Limited Liability Company

III. Korean Commercial Act and Limited Liability Company as the Solution IV. Amendment of the Korean Commercial Act

V. Detailed Explanation on the Articles of the Amended Commercial Act Regarding Limited Liability Company

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requested the introduction of LLC as well and such efforts have come to fruition by the amendment of the Korean Commercial Act.

II. THE HISTORY AND DEFINITON OF LCC

A. History

In the United States, there used to three forms of joint enterprise: C Corporation, S Corporation and association in general. The C Corporation had the risk of double taxation and the S Corporation imposed severe restriction on the number and qualification of its shareholders, thus was not a suitable form of enterprise in an open society like nowadays. In an association, the members bear unlimited liability which is also a heavy burden.

Therefore, the LLC arose as a new form of enterprise that can avoid double taxation and only burdens its members with limited liability. LLC was first acknowledged by the State of Wyoming in 1977, but was not widely employed until the Internal Revenue Serviced decided not to subject LLC to double taxation and treat it equally with other corporations.2 Now more than 40 states in the United States accept LLC.

B. Definition

LLC is a company whose members bear limited liability towards the creditors that correspond to the investment they made for establishment. Although such aspect is similar to the Limited Liability Partnership, unlike Limited Partners, the members of the LLC are insured of active participation in the management of the company similar to the members of a Corporation. Nevertheless, most LLCs are classified as Partnership instead of Corporation and enjoy reduction in tax.3

2

Jae Yeon Lim, American Corporate Law 2nd ed., 2006 at 44-45.

3

Dong Seok Kim, “The Establishment and Characteristics of American Limited Liability Companies,”

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III. KOREAN COMMERCIAL ACT AND LCC AS THE

SOLUTION

A. Restriction on Company Types

The Korean Commercial Actallows only four types of company in Korea; General Partnership, Limited Partnership, Stock Company, and Private Company (Ltd.) (Art. 170).

A General Partnership is formed by two or more partners with unlimited liability. A Limited Partnership is comprised of one or more partner with unlimited liability and limited liability each. Both Stock Company and Private Company are composed only of members of limited liability. While large scale and disclosure describes a Stock Company, a Private Company is closed and managed by a few members.

Those who establishes a company in Korea is enforced to select one of these four types of companies. New types of companies that Korean Commercial Act does not enlist cannot be established.

B. Necessity of a New Type of Company

The rapidly changing economic conditions, however, demand for new types of companies. First, the current Korean Commercial Act excessively restrictingcompany types and thus underminescreative venture business activities. The four types cannot cover the new variety of modern companies. Professional service firms, high-tech firms, contents creation firms and all sorts of businesses that values human resources require a more flexible form of company.

Secondly, the Korean Commercial Act which provides only four types of companies in effect coerces small and medium enterprises to choose a company type far different from actual operations. Most small and medium enterprises are fit for General Partnership or Limited Partnership for these companies are owned, controlled and managed by a single person or a concentrated few. Yet small and medium enterprises tend to select Stock Company instead of General Partnership or Limited Partnership. This is because Limited Partnership restricts number of partners to fifty, bans securitization of shares and limits share transfer4. The

4

Kyoung Bong Ahn, “New Company Type and National Economy,” Review on the Major Issues of

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restrictions harden recovery of invested capital. On the other hand, if a company chooses Stock Company type, raising capital will be facile. Moreover, limited liability of a Stock Company lessens shareholder’s burdens making Corporation more attractive.

Such preference resulted 95% of companies in Korea to exist as Stock Companies. Private Companies take up 3.6%, with General Partnership and Limited Partnership 1.3%5. 98% of the Stock Companies are small and medium enterprises with assets less than a billion won. These small and medium enterprises chose Stock Company even though General Partnership or Limited Partnership is more suitable existence for them.

Above facts and statistics clearly demonstrate a need unsatisfied by the contemporary Korean Commercial Act. New types of companies reflecting the need of small and medium enterprises should be introduced.

Lastly, tax base can hinder small and medium enterprises from choosing more suitable forms. The Tax Law collects corporate income tax from companies and income tax from natural persons. The companies other than Stock Companies enjoy no different treatment because of the Tax Law’s dichotomy6. General Partnership and Limited Partnership are classified as company and pays corporate income tax, while the owner must pay income tax separately. The double taxation ruins General and Limited Partnership’s attraction. Small and medium enterprises evade General and Limited Partnership and choose Stock Company which has other favorable aspects.

C. LLC as the New Type of Company

As the rigidity of company types hinder diverse and small size companies, introduction of LLC arose as a solution. LLC is the combinations of strong points of Corporation and Partnership. On the outside it is a Corporation, but on the inside it is a partnership. Members hold limited liability and share transfer is liberal compared to Limited Partnership in a LLC. Such characteristics allow small and medium enterprises flexible and liberal usage. Additionally, merits of limited liability are preserved that individual safety is guaranteed. With these advantages understood the amended Commercial Act introduced LLC.

5

Statistical Yearbook of National Tax, 2007.

6

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IV. AMENDMENT OF THE KOREAN COMMERCIAL ACT

AND INTRODUCTION OF LCC

A. Purpose of Introduction

The report presented to the Legislation-Judiciary Committee by the government outlined the purpose of introduction of LLC as follows7;

1) Importance of human resources has been rising recently, and demand for a company type that embraces and accommodates human resources by taking partnership form on the inside and limited liability on the outside is rising.

2) By founding LLC that acknowledges limited liability but allows broad autonomy,

3) It is expected that private equity fund, ventures and variety of new types of companies will utilize the LLC form.

The amended Korean Commercial Act (hereinafter ‘Amendment’) aims at development of Korean Civil and Commercial Act to the global standard and enhancement of company autonomy. The Amendment consults the recent change in both Japanese and American corporate laws, relaxing strict restrictions8. On concrete level, the Amendment comprehends that economic conditions and new industries require more than the current four types of companies and introduces two new types of companies. One of the two is LLC.

B. Characteristics

LLC is provided in the Korean Commercial Act, corporation part, articles 287-2 to 287-287-45. The provisions are based on Uniform Limited Liability Act 1996 of the United States and Japanese corporate law9. The inside relations are based on

7

Report by the government presented to the Legislation and Judiciary Committee, on October 21, 2008, on the Commercial Act Amendment Bill, Corporate Part. Available at http://likms. assembly.go.kr/bill/jsp/BillDetail_backup20100621.jsp?bill_id=ARC_J0E8G1I0T2J1U1B8C1X0N 1F3H7R9G4v (last visited on May 2011).

8

Jae Moon Kim, “A Study on the Bill of Commercial Act Amendment on the Introduction of New Company Type,” Management Law, Vol 18, No. 1, 2007 at 201.

9

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General Partnership provisions while the outside relations are provided reflecting corporate aspects.

IV. DETAILED EXPLANATION ON THE ARTICLES OF THE

AMENDED COMMERCIAL ACT REGARDING LCC

A. Paragraph One: The Establishment (Arts.287-2~287-6)

1. Explanation

In order to establish an LLC certain aspects of the LLC that are specified in the new Amendment must be included in the memorandum of incorporation (Arts. 287-2, 287-3) and registration of incorporation is required as well (Art. 287-5). Establishment takes effect only after registration of incorporation. These are the only requirements for establishment. The respect of autonomy shown in these provisions is the vestiges of the Uniform Limited Liability Act. LLC can be established by a single person and anyone can become a member be it a natural person or a juristic person.

The purpose of the LLC must be commercial (Art. 169, present Commercial Act Art. 169). A member is required to invest capital or something with a tangible economic value. Credit, service or any other intangible assets cannot be invested. Cash and assets must be paid before the registration of incorporation (Art. 278-4). The capital of LLC is constituted of cash and the value of other assets that are invested by its members (Art. 287-35), it must be stipulated in the memorandum of incorporation (Art. 287-3 3 ho) and it must be registered in the register of incorporation as well (Art. 287-5 3 ho). Such rigorous regulations on investment are stipulated to protect creditors as all members only bear limited responsibility.

The number of members is not restricted. Establishment with a single member is possible, just like Corporation. All LLC shall use the letters Limited Liability Company in its trade name (Art. 19).

2. Comparing with Other Forms of Company

Unlike articles of warranty liability for payment or warranty liability for subscription stipulated on Stock Company and article of full compensation of the members stipulated on Limited Liability Company, there are no such penalizing articles that insure the substantiality of capital in the case of LLC. Regarding the

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litigation nullifying or cancelling the establishment of LLC, the articles on Unlimited Partnership Company is applied mutandis mutandi. Still, non-member executives as well as members have locus standi in LLC, whereas in Unlimited Partnership Company only the latter enjoys such status.

3. Suggestions

The investment provisions provoke worries that the Amendment’s purpose may be hindered. The Amendment was introduced to promote company autonomy and to easily attract capital and assets, but rigorous regulations are setback to the purpose. Considering that LLC was to give liberty to small and medium enterprises and venture companies, a various types of investment should be allowed. Like the Uniform Limited Liability Act, investment with intangible values should be allowed10. Service, Credit and contents investment will contribute to the diversifying of companies.

B. Paragraph Two: Internal Relationship

1.Members (287-8 ~ 287-10)

A member’s liability is similar with Uniform Limited Liability Act. A member is liable to the company’s debt within the limit of his or her investment (Art. 287-7). Individual member’s own assets are untouchable by the company’s creditors. Thus a member holds limited and indirect liability. This facilitates procuring capital finance.

On the transfer of shares, however, the amendment differentiates itself from the Uniform Limited Liability Act. Under Uniform Limited Liability Act members may freely transfer and acquire economic rights but the shares are not transferred11. The Amendment, however, silences on whether it is only economic rights or the share itself transferred when it states “transfer of shares”. The Amendment just restricts transfer of shares by requiring consent of other members (Art. 287-8 (1)). The restriction is alleviated in parts for the company may eliminate the restriction by articles of incorporation and a member who is not a managing partner may transfer his shares when all managing partners agree (Art. 287-8 (2)). Yet it is still true that the Amendment intended to restrict transfer of

10

Jin Ee Choi, “A study on the Introduction of Limited Liability Company,” Corporate Law Study, Vol. 22, No. 2, 2008 at 79.

11

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shares in a way similar with general partnership.

The problem of investment recovery is solved by allowing members to resign (Art. 287-24). To protect creditors the company may not acquire its own shares.

There are dissatisfactions to the fact that the amendment is not clear on whether economic rights are transferred just like the Uniform Limited Liability Act or the shares themselves are transferred. To reduce confusion precise and definite provision is essential.

2. Management (287-11 ~ 287-22)

General partnership is the basic and core of LLC’s management provisions. The power of representation and execution are principally given to the members, but can also be awarded to a third party12. Big difference between Limited Partnership and LLC is that in the latter the members may directly manage the company.

The managing partner is decided during establishment and must be recorded in the articles of incorporation (Art. 287-12 (1), (2)). The managing partner, or the executive, has the power of representation and power to execute in and out of court. If several members are made executive all members must consent to allow a single executive to execute by himself. Unlike general partnership, there is no provision resolving a delay situation. If the Amendment adds provisions concerning a delay in unanimous consent when there is an urgent situation the legislation gap will be filled13.

If the executive damages a third party while performing his duty, he has a joint obligation with the company to compensate (Art. 287-20). In other cases the executive has no liability with his individual assets. Like the stockholders of a corporation, members of LLC may demand the company to sue the executive (Art. 287-22 (1)).

C. Paragraph Three: External Relationship

1. Explanation

The executive and representative of LLC can be a third party who is not a member and may be a juristic person as well as a natural person (Art. 287-12 (1),

12

Kim, supra note 8.

13

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287-5 (4) -5). This article which allows juristic person to manage and represent LLC must be noted for the fact that it was stipulated amidst the controversy on whether juristic person can become the representative director or not.14 The executive has the authority regarding all judicial and non-judicial acts (Art. 287-19 (1) 5 ho, present Commercial Act Art. 209). If there are two or more executives, then one person may be selected as the representative executive or all of the executive can act as co-executives by stipulating it in the memorandum of incorporation or by gaining the approval of all of the members (Art. 287-19 (2), (3)).

2. Comparing with Other Forms of Company

The responsibility of the executive towards the LLC is the same with that of the representative director of a Stock Company. Therefore, if the executive of LLC cause damage against another person during the execution of his duty, the LLC bears joint liability with the executive (Art. 287-20). And in a litigation between the LLC and a member (same applies to the litigation with a non-member executive), if there is not one to represent the LLC, then a representative shall be appointed through a resolution by the majority members (Art. 297-12). Also, a member may request the LLC to institute litigationagainst the executive on account of his duty towards the LLC.

The members of LLC do not bear any direct responsibility towards the creditors of the LLC, and only bear direct and limited responsibility towards the LLC corresponding to the investment he made. Thus articles on the external relationship of a Stock Company are applied mutandis mutandi to that of the LLC.

IV. CONCLUSION

The introduction of LLC in Korean economy brings hope that a more business friendly environment will prosper. The fact that the law is on the path of liberalization is a good news to newborn and diverse enterprises that suffer from tedious regulations. Now the small and medium enterprises will have more room to act freely. Yet the introduction of LLC sparked small controversies concerning legislation blanks. Hereunder are some suggestions for possible improvement of the Amendment.

14

Hyung Kyoo Lee, “Research Report on the Newly Amended Commercial Law,” Amended Commercial Law Research Committee of Korean Commercial Law Colloquium, 2005 at 156.

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First of all, with 95% of companies existing as Stock Companies there is doubt that the new LLC type wouldn’t be used as much as expected. Critics argue that before introducing LLC, the original four types should be amended so that LLC has sharp attraction to certain types of companies. Furthermore, with LLC introduced, whether Private Company has enough value to be classifiedindependently is another issue.15Since LLC needs no organs, may issue debentures, and thus guarantees company autonomy, lesser companies will select Private Company. The Japanese corporate law classified Private Company as a type of Stock Company giving LLC an independent difference. Classifying each type of company clearly specifying their differences is a work the Amendment has yet failed to do. Without this work done companies will still be confused on which type to choose.

Lastly, LLC is a company and therefore will have to pay corporate income tax like other companies. The constant complaint of small and medium enterprises has not been solved through the introduction of LLC. Taxation problem will probably cause companies to hesitate when selecting LLC. Since tax is a key to vitalizing LLC, related tax laws should be revised if LLC is to be used as purposed16.

Even without the aforementioned missing pieces the Amendment and introduction of LLC opens are way to developing Korean corporate law to the global standard. If the above suggestions are applied LLC will be frequently used by the small and diverse companies and become a central part of Korean corporate system.

15

Ahn, supra note 4.

16

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REFERNECES

Ahn, Kyoung Bong, “New Company Type and National Economy,” Review on the Major Issues of the Commercial Act : Focusing on the Bill of Commercial Act Amendment, 2007.

Choi, Jin Ee, “A study on the Introduction of Limited Liability Company,” Corporate Law Study, Vol. 22, No. 2, 2008.

Kim, Dong Seok, “The Establishment and Characteristics of American Limited Liability Companies,” Research on Commercial Law, Vol. 20 No. 3, 2001. Kim, Jae Moon, “A Study on the Bill of Commercial Act Amendment on the

Introduction of New Company Type,” Management Law, Vol 18, No. 1, 2007.

Lee, Hyung Kyoo, “Research Report on the Newly Amended Commercial Law,” Amended Commercial Act Research Committee of Korean Commercial Act Colloquium, 2005.

Lim, Jae Yeon, American Corporate Law 2nd ed., Parkyoung Co., 2006. National Tax Service, Statistical Yearbook of National Tax, 2007.

Park, Se Hwa, “The Legal Analysis on the System of Limited Liability Company,” Law Review, Vol. 48 No. 3, 2007.

Report by the government presented to the Legislation and Judiciary Committee, on October 21, 2008, on the Commercial Act Amendment Bill, Corporate Part (available at http://likms.assembly.go.kr/bill/jsp/BillDetail_backup 20100621.jsp?bill_id=ARC_J0E8G1I0T2J1U1B8C1X0N1F3H7R9G4v).

References

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