Efficiency of Korean New Rehabilitation Proceeding

Abstract

The rehabilitation proceeding under the reformed Debtor Rehabilitation and Bankruptcy Law

(DRBL), effective as of April 1, 2006, unified two old rehabilitation procedures used for the

recovery of financially distressed firms for more than forty years in Korea. However, two key

elements of the previous procedures survived in the unified rehabilitation scheme with some

modifications to achieve efficiency of the new rehabilitation proceeding, i.e., receiver instead of

debtor-in-possession and relative priority rule (RPR) for distribution of corporate value

according to a rehabilitation plan. Under the new rehabilitation proceeding, the representative of

the debtor company can be appointed as receiver of the debtor company unless it is liable for the

commission of material mismanagement causing insolvency thereof. In some special cases, the

representative can operate the debtor company without an appointed receiver. The RPR is revised

in a way to guarantee secured and unsecured creditors at least the liquidation value of their

collaterals and the corporate value. Do those modifications maximize the ex post revenue and

reduce the ex ante costs, such as overinvestment effects and delay effects, of financially distressed

firms? Generally speaking, the ownership and management are not separated even in large and

publicly-held corporations in Korea. In such economic and legal environments, the

overinvestment effects and the delay effects to experiment overinvestment become great before

filing for bankruptcy. It is very important to reduce such ax ante inefficiency so as to ensure that

more value of the debtor company can be distributed to its creditors. To minimize the ex ante

costs, the rehabilitation proceeding should be more lenient to shareholders of the debtor company.

Based on the foregoing considerations, the legislators were set to grant the shareholders incentives

to file for rehabilitation proceedings at the right time through the 2006 reform, but the reform still

leaves much uncertainty as to the efficiency of the united scheme to debtors and creditors.