On July 14, 2016, the Supreme Court reversed the lower court's decision in the lawsuit brought by a consortium of investors led by Hanwha Chemical Corporation (such consortium, "Hanwha") against the Korea Development Bank ("KDB") and the Korea Asset Management Corporation ("KAMCO," and together with KDB, the "Sellers").
In its lawsuit, Hanwha sought the return of the performance guarantee deposit, which it delivered in connection with its attempted acquisition of DSME Co., Ltd. (the "Deposit"). Hanwha argued that despite the relevant agreement expressly providing that the Deposit constitutes a penalty in case of a breach of the agreement, the Deposit constitutes a liquidated damage in case of a breach of the agreement.
The Supreme Court's decision in this case is deemed exceptional, because despite the contractual language providing that the Deposit constitutes a penalty, the Supreme Court ruled that it constitutes liquidated damage, and accordingly, reduced the amount of such liquidated damage.
Details of the Decision – Long-standing Principles, Key Facts, Court's Discretionary Power:
In its decision, the Supreme Court reaffirmed the long-standing principles that:
- In determining whether certain down payment or performance guarantee deposit payable under an agreement and subject to forfeiture in case of a breach is deemed a penalty, or whether liquidated damage should be made, a court will take into account the intent of the parties and the totality of the facts and circumstances; and
- In case such down payment or performance guarantee deposit is forfeited upon a breach of the agreement, it is presumed that the forfeited amount constitutes liquidated damages rather than penalties. For such amount to be deemed a penalty, exceptional facts and circumstances are required to be shown.
Applying the principles above to this case, the Supreme Court held that the following facts indicate that the parties intended for the Deposit to be a means to enforce the execution of a definitive agreement, and cover all monetary compensation that may arise in the future. Thus, the Court reasoned, the Deposit should be deemed liquidated damage.
Key facts include:
- The memorandum of understanding between the parties (the "MOU") provides that all monetary damages should be covered and addressed through the forfeiture of the Deposit; and
- During the negotiation:
- Hanwha was not able to fully understand the risk of executing a definitive agreement without confirmatory due diligence; and
- Hanwha was not in a position to object to the performance guarantee deposit provision.
While a court cannot reduce the amount of penalties unless the imposition of such penalties is against public order and good morals, a court may – in its discretion – reduce the amount of unreasonably excessive liquidated damage.
Here, the Supreme Court reasoned that the amount of the Sellers' damages arising from the termination of the MOU should be limited to losses arising from the Sellers' reliance on the execution of the MOU. Therefore, the Court ruled that approximately KRW 315 billion of the Deposit forfeited is unreasonably excessive, and should be reduced.
Specifically, the Court stated that:
- The MOU does not provide any representation or warranty regarding the value of the DSME assets. The MOU only includes a performance guarantee deposit provision binding on Hanwha; and
- Hanwha did not have any opportunity to conduct confirmatory due diligence despite the sizable amount of the Deposit.
Impact of the Decision:
When entering into an agreement that includes performance guarantee deposit clauses providing for liquidated damages or penalties, it would be advisable for the parties to comprehensively take into account the relevant facts (e.g., the underlying facts for including such clauses in the agreement) and the intent of the parties to prevent potential disputes over the nature of such deposit.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.