Supreme Court: "Illegal Stock Reading Contracts and Loss Compensation Agreements Are Legally Valid Under Private Law"

The Supreme Court has ruled that even if a contract for a 'stock leading room' concluded between a customer and an unregistered company that has not registered for financial investment business is prohibited under the Capital Markets Act, the civil validity of the contract itself remains effective.

The ruling holds that the prohibition of investment advisory business by unregistered companies under Article 17 of the Capital Markets Act cannot be regarded as a provision invalidating such acts, but should be seen as a regulatory provision. Furthermore, the Supreme Court maintained its previous stance that Article 55 of the same law, which prohibits loss compensation agreements by financial investment business operators, cannot be analogously applied to quasi-investment advisory businesses.

Supreme Court, Seocho-dong, Seoul.

According to the legal community on the 1st, the Supreme Court's First Division (Presiding Justice Seo Kyunghwan) overturned the second-instance ruling that dismissed the lawsuit for contract payment filed by securities information provider company A against former client B, and remanded the case to the Seoul Eastern District Court.

The court stated, "Assuming that Article 17 of the Capital Markets Act is a mandatory provision, the lower court's judgment that the contract in question is invalid for violating that provision, or that Article 55 of the Capital Markets Act can be analogously applied to quasi-investment advisory businesses and thus the contract has no civil effect, contradicts the Supreme Court's interpretation of the applicable law in specific cases as stipulated in Article 3, Clause 2 of the Small Claims Procedure Act, and this error affected the judgment result," explaining the reason for reversal and remand.

Company A, which only registered as a quasi-investment advisory business authorized to provide investment judgments or advice on the value of financial investment products to an unspecified number of people but did not register for financial investment business, entered into a 'Securities Information Provision VVIP Service Subscription Contract' with B in December 2021, receiving a subscription fee of 15 million KRW to provide stock information for one year.

The contract included special provisions stating that if the target cumulative return rate did not reach 700% after the service period, A would provide additional services for six months, and if it did not reach 200%, the entire subscription fee would be refunded.

B paid 15 million KRW by credit card, and A provided B with stock information such as which stocks to buy, quantities, and disposal timing via text messages.

However, when the expected profits did not materialize, B terminated the contract with A in March 2022. They then drafted a settlement agreement in which A agreed to refund 5.33 million KRW calculated according to the refund formula, and B agreed not to raise any objections to the refund amount in the future, with a penalty clause stipulating that if violated, B would pay double the refund amount as liquidated damages to A. A refunded the agreed amount to B.

The problem arose when B violated the agreement and requested a cancellation of payment for approximately 9.67 million KRW, excluding the 5.33 million KRW refunded by A, from the credit card company and received a refund.

Ultimately, A filed a lawsuit claiming 20.33 million KRW plus delayed interest, including the approximately 9.67 million KRW that B canceled and refunded, the liquidated damages amount stated in the settlement agreement, which is twice the refund amount of 5.33 million KRW, alleging breach of agreement by B.

Previously, the first and second instance courts ruled that since the settlement agreement was based on a contract violating the Capital Markets Act, B was not required to return the money.

In court, B argued that the investment advisory contract concluded with A, which was not registered for investment advisory business under the Capital Markets Act, was invalid as it violated the mandatory provision of Article 17 of the Capital Markets Act, and that the loss compensation agreement guaranteeing a 700% high return was also invalid under Article 55 of the same law; therefore, the settlement agreement based on such an invalid contract was also invalid.

The lower courts accepted B's argument.

The second-instance court concluded, "This contract involves the plaintiff, a quasi-investment advisory business not registered for financial investment business, providing advice on the value of stocks, which are financial investment products, or investment judgments to a specific person, and includes a promise to compensate all or part of the losses that the investor may incur in advance or to guarantee certain profits to the investor, thus violating the mandatory provisions of Articles 17 and 55 of the Capital Markets Act, making it invalid. The settlement agreement is also based on the validity of this contract and therefore cannot be recognized."

However, the Supreme Court's judgment differed.

The Supreme Court held that Article 17 of the Capital Markets Act prohibits investment advisory business by those not registered for financial investment business and criminally punishes violations under Article 445, Clause 1 of the same law, but it cannot be regarded as a provision invalidating the civil effect of investment advisory contracts concluded between private parties, and should be seen as a regulatory provision.

The court stated, "Article 17 of the Capital Markets Act, which prohibits investment discretionary and advisory business by unregistered companies, aims to protect investors as customers and foster sound financial investment business. However, contracts concluded in violation of this cannot be considered to possess such a degree of conspicuous antisociality or immorality that their civil effect must be denied, nor can it be said that denying their effect is the only way to achieve the legislative purpose," and added, "this provision is a regulatory provision, not an invalidating provision."

The court also stated, "Article 55 of the Capital Markets Act cannot be analogously applied to loss compensation or profit guarantee agreements concluded between private parties, not between financial investment business operators or their employees and customers, and there is little basis to deny the civil effect of such agreements. Furthermore, Article 55 cannot be analogously applied to contracts concluded by quasi-investment advisory businesses that are not financial investment business operators or their employees."