[Venture, Litigation Alert] ① Startup Failure Becomes a Lifelong Shackle... Founders Ordered to Pay Billions Personally

Investors File Lawsuits as Startups Enter Rehabilitation
Founders Held Liable as 'Interested Parties'
Joint Liability Banned for Venture Capital, but
Technology Finance Companies and Accelerators Remain in a Regulatory Blind Spot

Editor's NoteIn leading venture nations such as the United States and Israel, failure in entrepreneurship is often recognized as valuable experience, serving as a stepping stone for future attempts. However, in Korea, failure still acts as a stigma for founders, and even the path to a comeback is often blocked. In particular, lawsuits that require founders to take personal responsibility for corporate debts due to investment contracts pose a critical risk. This three-part series analyzes recent domestic lawsuits between startups and investors, as well as strategies to avoid toxic clauses in contracts.

It has been about two years since the prohibition on requiring joint guarantees in venture investments was fully implemented, yet cases continue to emerge where startup founders give up on their dreams of a comeback after becoming embroiled in lawsuits with investors following business failure. With the prolonged downturn in venture investments, many startups have entered rehabilitation proceedings, and investors are presenting founders with hefty claims based on various contract clauses.

The Shackles of 'Sinking Fund' and 'Put Option' Return to Founders

There are multiple cases where founders are required to pay large sums to investors in lawsuits related to company failure. On July 4, the Civil Division 17 of the Seoul Central District Court ruled against the founder and CEO of Startup A in the first trial of a repayment claim lawsuit filed by a domestic mid-sized new technology finance company on behalf of its investment association.

The key issue in this case was the 'sinking fund' clause in a 3 billion won convertible bond (CB) investment contract signed in 2020. A sinking fund refers to a reserve that a company must set aside monthly to prepare for principal repayment. This condition is commonly used as a safeguard in traditional financial loan contracts but is rare in venture capital contracts, which are intended to support startup growth.

Startup A was required to reserve about 300 million won each month for six months starting February 2021, but failed to do so as its financial situation worsened. Last year, the company entered rehabilitation proceedings. The investment association claimed loss of benefit of time and demanded the principal and interest from the founder and others. Although the contract had not yet matured, they argued that a violation of certain conditions triggered immediate repayment obligations. The founder responded that the failure to reserve funds was due to unavoidable financial deterioration and denied any personal fault.

The court, based on the contract clauses, ruled that not only Startup A but also the founder and CEO, who signed as 'interested parties,' were jointly liable for the debt. The court stated, "The defendants, as the CEO and largest shareholder, were obligated to supervise and control the sinking fund reserves," and found that a significant breach of contract had occurred, acknowledging personal intent or negligence on the part of the founder and others. As a result, the founder was ordered to pay a total of approximately 3.517 billion won, including 2.2 billion won in unpaid principal and about 1.3 billion won in interest, and ultimately gave up on appealing the decision.

Kim Sunghoon, managing attorney at Law Firm Mission, commented, "The sinking fund clause had not previously appeared in startup investment contracts," and added, "Given the nature of venture capital, investment losses are inevitable, but due to high interest rates and reduced funding, investors are increasingly including legal provisions in contracts that strongly hold founders personally accountable."

Attorney Kim further noted, "Korea's venture investment market has largely been shaped by government funds such as the Korea Fund of Funds," and added, "Perhaps for this reason, some investors see themselves as operators of government-supported projects or even as a type of lender."

On July 16, a first-instance verdict was also reached in a repayment claim lawsuit filed by Shinhan Capital against Mr. B, CEO of the construction platform company Urbanbase. The Civil Division 46 of the Seoul Central District Court ruled that "Mr. B must pay approximately 1.25 billion won, including the investment principal and interest."

Shinhan Capital invested in redeemable convertible preferred shares (RCPS) of Urbanbase in 2017, including a put option clause that allowed the investor to demand repayment of the investment at any time. When Urbanbase entered rehabilitation proceedings at the end of 2023, Shinhan Capital exercised the put option. Mr. B argued during the trial that it was excessive to hold the founder personally responsible for management failure.

In this lawsuit over the scope of contractual liability, the court focused primarily on the put option clause in the contract. The court stated, "Mr. B signed the contract as an interested party, and it is difficult to see that the investor abused its superior position," thus ruling in favor of Shinhan Capital. Although there was no explicit joint guarantee clause, the put option effectively resulted in the founder being personally liable for a large sum, producing a similar outcome.

A lawyer specializing in startup investment contracts, who requested anonymity, said, "There have been rulings in favor of founders, stating that they cannot be held liable for minor breaches, but as seen in the Shinhan Capital case, literal interpretation of the contract is also common," adding, "Startup-friendly contracts are rarely used in practice, and the courts are increasingly prioritizing the literal wording of contracts over promises or customary practices."

The System Has Changed, But Blind Spots Remain

Joint guarantees by founders were first prohibited in 2018 for investments and loans from policy financial institutions. In 2022, the Enforcement Decree of the Venture Investment Promotion Act was revised to fully ban joint guarantee requirements by venture investment associations as well.

However, this does not apply to new technology finance companies licensed under the Specialized Credit Finance Business Act, which is overseen by the Financial Services Commission, rather than venture capital firms subject to the Venture Investment Promotion Act under the Ministry of SMEs and Startups. Accelerators, which typically make very early-stage investments, were also not previously subject to this regulation. The Venture Investment Promotion Act itself contains exceptions: joint liability can be recognized for founders in cases of intentional or gross negligence, such as making false statements during IR (investment attraction activities), misappropriating investment funds, or selling shares in violation of the contract.

Recently, the Ministry of SMEs and Startups announced an amendment to expand the prohibition of joint guarantees to include accelerators and individual investment associations where they act as general partners. At a field meeting last month, Minister Han Sung-sook reiterated the ministry's commitment to improving the system, stating, "Re-entrepreneurship is not simply a repetition of closure and new business, but a process of expanding the asset of 'experience' accumulated by our society into a new 'growth engine.'" However, since new technology finance companies fall under the jurisdiction of the Financial Services Commission, which would need to amend the Specialized Credit Finance Business Act, coordination among relevant ministries and legislative revisions are necessary for comprehensive reform of venture investment regulations.

An industry insider in venture investment commented, "In the absence of robust legislation, investors who can circumvent the system may freely demand joint guarantees through contracts," and added, "While the new rules for accelerators will likely take effect by early next year, much discussion is still needed regarding new technology finance companies. Since startups cannot simply choose which source of funding to accept, meticulous institutional improvements are required."