[Jeondaegyu's 7 Attempts and 8 Failures] The Not-So-Simple Simplified Rehabilitation Procedure

Jeon Dae-gyu, Chief Judge of Seoul Bankruptcy Court

The novel coronavirus infection (COVID-19) has struck the world, and its impact is immediately affecting small and medium-sized enterprises (SMEs). Since SME bankruptcy filings are a lagging economic indicator, the number of rehabilitation and bankruptcy cases filed in courts has not surged as much as perceived externally. However, a visible increase in cases is expected soon, possibly in the second half of the year. The issue is whether courts and insolvency practitioners are preparing debt adjustment procedures suitable for SMEs in response to the worsening economic conditions.

Currently, there is a simplified rehabilitation procedure for SMEs. The conventional rehabilitation procedure is designed for large companies and has been criticized for being costly and time-consuming, which led to the introduction of the simplified procedure in 2014. Compared to the United States, which established a separate procedure for SMEs last year and implemented it this year, Korea adopted it relatively early. However, the current simplified rehabilitation procedure and the court’s practical operation have several shortcomings as debt adjustment procedures for SMEs in the post-COVID era.

First, the SMEs eligible to use the procedure are limited. Currently, SMEs can only use the simplified rehabilitation procedure if their total debt is 3 billion KRW or less at the time of application. If the total debt exceeds 3 billion KRW, debt adjustment must be done through the conventional rehabilitation procedure. While the limitation aims to protect creditors and ensure procedural speed, considering the scale of Korea’s economy, the debt threshold feels low. It is somewhat fortunate that the Ministry of Justice has recently announced a legislative amendment to raise the debt limit to 5 billion KRW.

Second, the repayment period is long. Currently, the practice is to set the repayment period in the rehabilitation plan at 10 years, the same as the conventional rehabilitation procedure. Compared to the U.S. federal bankruptcy law, which sets the rehabilitation plan period for SMEs between 3 and 5 years, this is excessively long. Whether to set it at 10 years or 5 years does not require a legal amendment. We hope for a progressive change in court practice.

Third, the simplified investigation report is not simple. The simplified investigation report is a document prepared by the simplified investigation committee that investigates the debtor company’s assets and liabilities, the appropriateness of proceeding with the simplified rehabilitation procedure, and the feasibility of executing the rehabilitation plan. In the conventional rehabilitation procedure, the investigation period is long and accounting data is extensive, often resulting in reports exceeding 100 pages. However, in the simplified rehabilitation procedure, to expedite the process, the report is supposed to be prepared briefly based on document reviews and debtor interviews. The investigators are mainly court clerks or individual accountants.

Given the purpose of introducing the simplified rehabilitation procedure and the investigation method of the simplified investigation report, a brief report should be submitted. In reality, however, reports of the same length as those submitted in the conventional rehabilitation procedure are submitted. Both companies and simplified investigation committee members are dissatisfied. Many SMEs do not have well-maintained accounting systems. Accounting data is often minimal or poor, and many are not subject to external audits, so they lack proper accounting systems. Nevertheless, simplified investigation committee members request a considerable amount of data, which inevitably causes hesitation. Non-court clerk investigators are also dissatisfied. To reduce costs, the simplified rehabilitation procedure pays about 3 to 5 million KRW for investigation fees. Considering the investigation period and report length by individual accountants, this amount is low. Therefore, when I was the head of the bankruptcy division at Suwon District Court, I required submission of simplified investigation reports of about 10 pages.

The simplified rehabilitation procedure was introduced to simplify the process, but its practical operation is far from simple. The main reason is that the current law does not adequately keep pace with changes in economic conditions. However, the courts applying the law also bear significant responsibility. They can operate the system more flexibly without exceeding the limits of legal interpretation. Recently, the Korea Small Business Institute has advocated introducing a third-party-centered SME debt adjustment procedure, based on Japanese practice, which does not involve creditors, debtors, or courts. This arises because the court’s practical operation of the simplified rehabilitation procedure does not meet SMEs’ demands in terms of speed and procedural progress. It is something to deeply reflect upon.