Compensation to Directors Upon Removal

by Brendon Carr

Under Korea’s Labor Standards Act, it’s very difficult to dismiss an employee without “just cause”, a concept that ties the hands of employers and only permits termination in cases of well-documented misconduct. Simple loss of confidence, or a realization that the employee is incompetent or just plain stupid, is the employer’s problem.

But the definitions of “employer” and “employee” under the Labor Standards Act exclude—in all but a few exceptional cases—the directors of the company from protection as employees. Directors are ownership, not labor.

The Korean Commercial Code, Art. 385, para. (1) provides that a director may be removed from office at any time by an Art. 434 supermajority resolution at a general meeting of the shareholders (such resolutions require 2/3 of the votes in attendance at the meeting, provided that such majority must constitute at least 1/3 of the total issued and outstanding voting rights). Simple, right? The director serves at the pleasure of the shareholders and can be disposed of without consequence.

Not exactly. In cases where the director is removed without good cause, the director shall be entitled to compensation—defined by case precedents as generally meaning all cash-based salary compensation he would ordinarily have earned—for the balance of his appointed term (see Commercial Code, Art. 385, para. (1) in its entirety). Note that this compensation is a statutory entitlement, and not the same as any “golden parachute” which might be agreed.

(For a discussion of a recent case concerning a company’s severance agreement with a dismissed director, see this blurb at Sigong Law’s KoreaLaw.com site.)

Most foreign-invested companies’ Articles of Incorporation provide that directors’ terms shall be three years, because that’s the longest possible term of appointment allowed under the Commercial Code (Art. 383, para. (2)). A three-year term seems very convenient for the company, since it reduces the overhead of the annual shareholders’ meeting.

However, it’s a mistake and possibly a trap. Imagine the situation where a company loses confidence in its Representative Director—let’s say they discover he’s a compulsive gambler and sex addict—and wants to remove the guy before he causes damage to the reputation or finances of the company. And his contract doesn’t specifically address the off-duty aspects of his life, because nobody thought this could happen. And they discover this six months after renewing the Representative Director’s appointment to a second three-year term.

Basically, the Representative Director has to go because of a loss of confidence in him, rather than any specific misconduct. A common enough situtation, for sure.

In that case, based on the no-cause removal provision of Art. 385, the Representative Director has a claim against the company for 30 months of compensation. That claim could be reduced or avoided altogether by the company simply understanding the Art. 385 entitlement, and responding by amendment of the Articles of Incorporation to appoint directors and statutory auditors to a standard one-year term.

How does your company treat this issue? Are you stuck with a three-year term of appointment for directors and auditors, without having thought about the business consequences? Think it over again, and tune up your Articles of Incorporation to avoid unnecessary liabilities.

October 31, 2007 | Filed Under Company and Commercial Law, Corporate Governance, Employment Law

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