[Jeondaegyu's 7Jeon8Gi] The Trap of Going Concern Value

Jeon Dae-gyu, Chief Judge of Seoul Bankruptcy Court

In an era where crises have become commonplace, rehabilitation procedures are a viable option for companies to choose in order to survive. The purpose of rehabilitation procedures is to allow financially distressed companies to continue their business while maintaining their going concern value. If the going concern value is greater than the liquidation value, the rehabilitation process benefits all parties involved. Creditors receive greater repayment based on the going concern value the company will acquire in the future, employees can continue working, and shareholders can preserve their investments.

The going concern value is one of the key concepts in rehabilitation procedures. To decide whether to continue the rehabilitation process, whether to draft the rehabilitation plan as a business continuation type (survival type) or liquidation type, and whether to submit the proposed rehabilitation plan to a creditors' meeting resolution, it is essential to calculate the going concern value. The going concern value refers to the economic value that can be obtained when a company continues to operate normally while remaining in existence. To proceed with the rehabilitation process and submit it to a creditors' meeting resolution, the going concern value must be greater than the liquidation value. The liquidation value refers to the sum of the values obtained by separately disposing of the individual assets that make up the company when the company is dissolved and liquidated. The going concern value forms the basic framework of the rehabilitation plan by presenting the future value of the company as the resource to be distributed to stakeholders, while the liquidation value represents the minimum guaranteed share for stakeholders. Therefore, accurate calculation of these two values is very important. In practice, the liquidation value rarely causes disputes or major issues. The going concern value is always the subject of disputes and problems.

The going concern value is calculated using the discounted cash flow method, which converts the company's future cash (revenue) flows into present value. The discounted cash flow method values the expected future cash flows by discounting them to the present value using an appropriate discount rate that reflects the company's risk level. For example, if a company is expected to generate 10 billion KRW in cash (revenue) annually for 10 years, these cash flows are discounted to their present value using an appropriate discount rate. In practice, the appropriate discount rate is the sum of the risk-free interest rate (basic discount rate) and a risk premium (recommended range is 2.5?6.5%, but it is often conservatively set at 6.5%).

The problem is that the appropriate discount rate used to discount future cash flows to present value is excessively high. When the risk-free interest rate and risk premium are combined, it generally reaches around 9?11%. This is too high as an appropriate discount rate in the current zero-interest-rate era. As a result, the going concern value of companies applying for rehabilitation procedures is calculated significantly lower, making it difficult to exceed the liquidation value. When a company's liquidation value exceeds its going concern value, it is common in practice to dismiss the application for rehabilitation or to terminate the rehabilitation procedure.

Comparatively, it is difficult to find examples in other jurisdictions where rehabilitation procedures are terminated simply because the liquidation value exceeds the going concern value. In the United States, the principle of liquidation value protection (the principle that the benefits obtained from rehabilitation must exceed those from liquidation) is stipulated as a requirement for approval of the rehabilitation plan, but exceeding the liquidation value is not a condition for continuing the procedure. Japan also does not require the going concern value to exceed the liquidation value as a condition for continuing the procedure, nor does it explicitly stipulate the liquidation value protection principle as a requirement for approval of the rehabilitation plan (court approval of the debtor's repayment plan).

Even if the going concern value does not reach the liquidation value, caution is needed when dismissing the application for rehabilitation or terminating the rehabilitation procedure. This is because the going concern value is only an anticipated future value and its realization cannot be determined with certainty due to its inherent limitations. There also needs to be reconsideration of the appropriate discount rate. Since companies are living entities, business performance can improve at any time, and considering that they are the livelihood of workers, a shift in perspective is required to prevent early exclusion from rehabilitation procedures.