Korean Investment: Acquiring Convertible Bonds (CB) as a Foreign Investor

**Foreign Investors and Convertible Bonds in Korea: Acquisition, Purchase, and Transfer**

Foreign investors looking to invest in Korean businesses have several options, one of which is acquiring convertible bonds (CB). Convertible bonds offer both the security of bonds and the opportunity to convert into equity, providing benefits to both investors and companies.

In this article, we will explain how foreign investors can seize opportunities through convertible bonds and discuss the step-by-step process involved.

### What is a Convertible Bond?

A convertible bond (CB) is a unique form of bond that gives the bondholder the right to convert the bond into the issuing company's stock after a predetermined period.

Convertible bonds offer two major advantages for investors. First, they provide stable interest income as a bond. Second, if the company performs well, the investor can convert the bond into equity to gain higher returns. Therefore, convertible bonds are popular among investors who want to minimize risks while sharing in a company's growth potential.

For companies, convertible bonds serve as more than just a funding tool; they are a way to build trust with investors. Issuing convertible bonds allows companies to quickly secure funds that can be used to expand and grow. The conversion into equity shows that investors have confidence in the company's long-term growth, sending positive signals to both the company and its stakeholders.

### Case Study 1: Japanese Company Investing in a Korean Startup via Convertible Bonds

A Japanese company decided to invest in a Korean startup that combined IT and traditional services. This startup targeted a fast-growing market and showcased excellent technology. Since the Japanese investor had similar business operations in Japan, they also saw an opportunity to expand and create synergy between the two markets.

While there are many ways for foreign investors to invest in Korean businesses, such as acquiring shares or establishing a joint venture (JV), the Japanese investor opted to invest through convertible bonds due to the stable interest income and the growth potential brought by the conversion into equity.

After the initial subscription to convertible bonds, the Japanese company decided to convert them into shares if the Korean company achieved stable growth, which was specified in the convertible bond subscription agreement. Later, as the Korean company needed additional funding, some of the convertible bonds were converted into shares, and additional bonds were subscribed to.

### Key Considerations When Acquiring Convertible Bonds

1. When signing a convertible bond subscription agreement, foreign investors should carefully examine the following items and specify them clearly in the contract:

  **(1) Conversion Terms:** Clearly outline conversion prices, ratios, and periods, and verify the appropriateness of conversion price adjustment clauses (repricing).

  **(2) Interest Rate and Maturity:** Confirm whether the interest rate is reasonable and whether the maturity aligns with the investment objectives.

  **(3) Collateral and Guarantee:** Include collateral or guarantee provisions if necessary.

  **(4) Early Redemption Conditions:** To protect investors, early redemption conditions (Put Option) may be included.

  **(5) Coping with Changes in Control:** To manage changes in control post-conversion, clauses like Right of First Refusal and Tag-along Rights should be prepared.

  **(6) Other Special Provisions:** Include special provisions that help achieve the purpose of the convertible bond issuance.

### Convertible Bond Subscription Agreement for Foreign Investors

To achieve their investment goals, foreign investors must draft a convertible bond subscription agreement and, if necessary, sign supplementary agreements. From the issuer's standpoint, overly demanding requirements from investors may lead to the inclusion of harsh terms, so it is crucial to carefully coordinate and ensure that the contract is balanced and fair.

### Additional Important Considerations

1. **Legitimacy of Issuance Purpose**: When issuing convertible bonds to third parties, the purpose must comply with Korean corporate law. For instance, issuance should aim to introduce new technology or improve financial structure. Issuing convertible bonds solely to secure management control may pose legal problems.

2. **Legality of Issuance Procedures**: When issuing convertible bonds via a third-party allocation method, the articles of association must have relevant provisions, or a special resolution from the shareholders' meeting is required. Failure to follow these procedures may result in invalid issuance. The company must review its internal regulations and ensure that all shareholders understand and agree to the issuance procedures.

3. **Fairness of Conversion Price**: The conversion price must be fair. Setting it too low may infringe on existing shareholders' rights and could be considered a breach of duty. Fair conversion prices are crucial for all stakeholders to cooperate under reasonable conditions.

4. **Limit on Call Option Exercise for Major Shareholders**: As of December 1, 2021, if a listed company grants a call option on convertible bonds to major shareholders and their special related persons, the exercise limit must not exceed the shareholder's stake at the time of issuance. This rule aims to prevent major shareholders from acquiring excessive stakes and infringing on existing shareholders' rights.

5. **Restrictions on Repricing Mechanisms**: For private issuances, if the conversion price is adjusted downward due to falling stock prices, it must be readjusted back to the original conversion price if the stock price rises again. This regulation provides fair conditions for both investors and companies, ensuring market balance. Companies need to clearly define how price adjustments will be made and be prepared for market fluctuations.

6. **Disclosure Obligations**: Major matters such as the exercise of call options for convertible bonds are subject to disclosure obligations under the Capital Markets Act. Failure to fulfill disclosure obligations may lead to legal penalties and have negative effects on corporate credibility.

7. **Potential for Invalid Issuance of Convertible Bonds**: If convertible bond issuance violates laws or articles of association or is carried out unfairly, a lawsuit for invalid issuance may be filed. This can occur when basic principles of a corporation are violated or existing shareholders' rights are severely infringed upon. Therefore, companies must carefully confirm the issuance procedures, purpose, and impact on shareholder rights.

8. **Simulate Changes in Shareholding Structure**: It is essential to simulate how the shareholding structure will change if all convertible bonds are converted into shares. By assessing how much existing shareholders’ stakes will be diluted, companies can foresee and prepare for potential problems.

### Foreign Investors: Key Procedures When Acquiring Convertible Bonds in Korea

Foreign investors acquiring convertible bonds in Korean companies must carefully confirm multiple legal requirements and procedures. According to Korean corporate law, when issuing to third parties, the purpose must be aligned with business goals, such as new technology adoption or financial improvement. If these requirements are not met, the issuance may be invalid. When non-resident foreign investors acquire convertible bonds over-the-counter, they must file a securities acquisition report with the Bank of Korea, along with the necessary documents.

If the foreign currency securities issuance exceeds USD 50 million (recently raised from USD 30 million), it must also be reported to the Ministry of Economy and Finance.

- **Documents Required**:
  - Two copies of the Securities Acquisition Report
  - Statement of Reasons
  - Identification documents for the applicant and the counterparty
  - Draft of the Securities Acquisition Agreement
  - Power of Attorney (if applying through an agent)
  - Declaration Form
  - Other necessary documents

### Case Study 2: U.S. Investment Company Becomes a Major Shareholder

A U.S. investment company acquired convertible bonds issued by a Korean company from an existing Korean investor and converted them into shares, thereby becoming a major shareholder. Although the company had strong technological capabilities and stable clients, it faced a declining stock price due to several adverse factors. The U.S. investor converted the convertible bonds into shares to stabilize management and influence key decisions. This action represented a strategic move aimed at contributing to the company's long-term growth beyond simple equity conversion.

If more than 10% of the shares are acquired through conversion, it requires a foreign investment notification according to the Foreign Investment Promotion Act. For acquisitions below 10%, a securities acquisition report must be filed with a foreign exchange bank, following the Foreign Exchange Transaction Regulations. As of August 1, 2023, foreign investment standards have been relaxed, recognizing acquisitions of less than 10% as foreign direct investments if they include rights to appoint directors.

### Conclusion

For Further Assistance:

Siwoo Law Firm International Investment and Transaction Team
Ryu Seungho, South Korean Attorney
Email: [ryu@siwoo-law.com](mailto:ryu@siwoo-law.com)

Convertible bonds are an attractive investment option that combines stable interest income with potential growth through equity conversion. For foreign investors considering Korean companies with growth potential, convertible bonds can be an effective strategy. However, it is crucial to strictly adhere to legal requirements and procedures when acquiring convertible bonds, including verifying the legitimacy of issuance purposes, conversion conditions, and notification obligations.

For successful investment outcomes, foreign investors are advised to seek professional assistance and conduct comprehensive legal due diligence, ensuring compliance with Korean regulatory frameworks.