Keun-mortgage on real property
Keun-mortgage is registered with the relevant Registry Office of the Supreme Court of Korea.
Keun-mortgage on concession right
In relation to a private investment project under the Act on Public-Private Partnerships in Infrastructure (the PPP Act), by way of execution of a concession agreement between the government and the concessionaire, the concessionaire completes construction of the facilities and transfers its ownership to the government, and the concessionaire is granted the concession right.
As the government retains the ownership, lenders cannot establish a mortgage on the relevant properties and this is an obstacle to obtaining successful project financing. To prevent this, the concessionaire is granted a concession right. The PPP Act treats the concession right as real property right under the Civil Act, and the government maintains a register for the concession right granted, which is equivalent to the Registry Office’s keeping of the registry. The lenders are able to establish a Keun-mortgage on the concession right and the Keun-mortgage is registered with the government’s register.
Keun-mortgage on factory assets
Various assets, including real estate, movables, lease rights and intellectual property rights, among other rights, may be attached together as a collective ‘factory asset’, and a new ownership right can be initially established in relation to the factory asset (registration of the ownership right of the factory asset) and, thereafter, a Keun-mortgage can be established on this ownership right. Various assets can be jointly mortgaged and, as such, creditors may find this convenient.
Power plants, terminals and waste management facilities are also recognised as factories and the concept of the factory asset may be also used in such projects. To preserve the ownership right, registration is required in advance with respect to a factory asset. In relation to a registration officer’s acceptance of the application for registration for preservation of ownership right, a public notice that requests a person entitled to the movables constituting the factory asset or a creditor under attachment or injunction procedure such as provisional attachment to report its rights, must be published in the Official Gazette. The reporting period is generally between one and three months (two months on average). The public notice is required since a new ownership right (the ownership right over the factory asset) is being created by attaching various assets.
Once the ownership right over the factory asset is created, a Keun-mortgage on the factory asset may be registered with the Registry Office of the Supreme Court of Korea.
Real estate mortgage trust
The ownership right is registered under the name of the trustee for the purpose of entrustment of the collateral.
The original trust agreement is filed with the registry and as such, the lenders are listed in the registry as a preferred security holder.
Yangdo-dambo in relation to movables
A transfer of possession is required to establish a security (in the form of a pledge) with respect to a movable. However, no physical delivery is necessary if a yangdo-dambo is being established on a movable. For example, the yangdo-dambo method is used with respect to a movable property, such as a wind turbine, which is not recognised as a building. Accordingly, a Keun-mortgage cannot be established over a wind turbine as it is not real property. However, the yangdo-dambo method is useful in this context as the borrower must continue to operate it and, accordingly, the lender cannot take its possession.
To establish a yangdo-dambo over a movable, the disclosure procedure known as ‘recognition method’ must be used to notify the public that a yangdo-dambo has been established. In practice, this notice is printed, laminated and attached to the movable.
Keun-pledge in relation to the shares
Possession of the shares is transferred to the lenders. In practice, the security agent retains the share certificates.
The name of each pledgee (as opposed to the security agent) is recorded on the back of the share certificate.
The pledgee’s name and address are recorded in the shareholders’ registry maintained by the issuer of the shares.
Keun-pledge in relation to bank account
Establishment of a Keun-pledge on the account is notified to the account bank and the account bank must provide its consent with a fixed date stamp.
The account passbook is retained by the lenders. In practice, the account passbook is held by the security agent.
Keun-pledge in relation to insurance
Establishment of a Keun-pledge on the insurance is notified to the insurance company and the insurance company must provide its consent affixed with a fixed date stamp.
The insurance policy is retained by the lenders. In practice, the insurance policy is held by the security agent.
It is recorded in the insurance policy that Keun-pledge has been established on the insurance and the name of each pledgee (as opposed to the security agent) is also recorded.
Assignment of contractual right must be notified to the counterparty to the contract (eg, a construction company under an engineering, procurement and construction (EPC) contract or a government authority under concession agreement) and the other party must provide consent affixed with a fixed date stamp.
The counterparty will consent to the lenders replacing the role of the borrower if a default is triggered and the lenders have enforced the assignment of contractual right. On an additional note, the consenting party may defer its exercise of termination right after an event of default has been triggered to allow the lenders to cure the default. In particular, if a cause of termination set forth in the relevant contract subject to the assignment of contractual right (eg, EPC contract) has been triggered, the consenting party may notify the security agent that a cause of termination has been triggered, but nevertheless refrain from terminating the contract for, say, three months, and allow the lenders a remedy period of three months. In this instance, the lenders will pledge that they will jointly undertake the project company’s obligations.
With respect to the consent noted above, if the counterparty refuses to provide such consent despite the borrower making reasonable efforts to obtain consent (if, for example, the Korea Gas Corporation (KOGAS) is the off-taker under a gas purchase agreement for a liquified natural gas (LNG)-fired power plant, KOGAS often declines to provide such consent), if the underlying contract does not have any restriction on the granting of a security or assignment, in practice only notice of the creation of the assignment over contractual rights needs to be provided.
A Keun-mortgage that is established is registered in the register maintained by the Registry of the Supreme Court of Korea and the registration expense includes registration and licence tax, municipal education tax and purchase of the national housing bonds. Such expense is determined based on the maximum amount of the secured obligation. The registration expense cannot be deferred or reduced. However, national housing bonds are generally purchased and immediately sold off at a discount. If the maximum amount of the secured obligation is large, a real estate mortgage trust is often used. However, it should be noted that the trust scheme still incurs fees for the trustee, though it is generally cheaper than the costs involved in establishing a Keun-mortgage. Generally speaking, lenders prefer a Keun-mortgage over a trust scheme.
Yangdo-dambos and Keun-pledges are not registered and do not incur any expenses.
How is its priority established?
A subordinated lender may have a subordinated security right (eg, a second priority Keun-mortgage). A real estate mortgage trust may also have such subordinated security right (eg, a second priority beneficial interest). A second priority keun-pledge may be established in favour of a subordinated lender over the borrower’s right to request the return of share certificates, deposit certificate (passbook) or insurance policy. In the case of yangdo-dambo, a second priority security right can be established so that a security manager treats a senior lender and a subordinated lender with a different level of priority.
Subordination by contract is a frequently used mechanism. If there is a senior loan and a subordinated loan, a separate intercreditor agreement may be executed or creditors make an agreement on common terms. This intercreditor agreement or agreement on common terms is honoured by a rehabilitation or bankruptcy court under the Debtor Rehabilitation and Bankruptcy Act.
One of the major issues relating to an intercreditor agreement is whether subordinated creditors would be permitted to participate in the decision-making process of creditors. The creditors’ agreement also includes provisions relating to:
- the order of application of amounts repaid by borrower or proceeds from foreclosure or insurance;
- declaration of acceleration by a subordinated creditor; and
- conditions on amending a subordinated loan agreement, etc.
Structural subordination is a frequently used M&A financing transaction in Korea although it is not used often in project financing transactions. In most Korean project financing transactions, the borrower is the project company, and does not comprise numerous entities. That said, a structural subordination is possible for project financing and can be enforced by a court. For instance, if a lender provided a loan to a parent company and another lender provided a loan to a subsidiary of the parent company, a creditor of the subsidiary would have priority over any of its shareholders (ie, the parent company) with respect to the operating income of the subsidiary. Therefore, the parent company would be subordinated to the creditor of the subsidiary with respect to the operating income of the subsidiary, meaning that the rights of the lender of parent company would be structurally subordinated to those of the lender of the subsidiary.
One of the principles underlining the Civil Act is that of ‘subordinate nature’. According to these principles, a security right may only exist subject to the existence of the relevant secured obligations, and a creditor must be the secured party and any creation of a security right in favour of a third party that is not a creditor is invalid. Accordingly, it is not permissible to create a security right in favour of an agent or trustee that is not a lender.
While security agents are always involved in project finance transactions in Korea, the security agent does not become a secured party because of the above principles, and secured parties are always the same as the lenders. For example, for the creation of a Keun-mortgage, if there are 10 lenders, and all of the 10 lenders must be registered as creditors and secured parties in the Keun-mortgage register. The security agent conducts only administrative tasks, etc, relating to security management, execution of security and the distribution of the proceeds acquired through the enforcement of security.
For a real estate mortgage trust, the ownership of the mortgaged property will be transferred to the trustee for the purpose of establishing the security interest, and a lender will become a beneficiary of the mortgage trust. In the mortgage register, the trustee will be described as the owner of the mortgaged property and a lender will not be described as a creditor or a secured party in the register, although it will be specified as a preferred beneficiary as the trust ledger for mortgage trust is described together in the register. Importantly, as the real estate mortgage trust is not registered as a right granted by way of security but as a transfer of ownership, the principle of subordinate nature is irrelevant. However, because the trust ledger for a mortgage trust must be specified in the mortgage register, registration of a modification is required each time a preferred beneficiary is changed, meaning that it is difficult to enjoy the benefit of parallel debts. This is another reason why in practice lenders prefer a traditional Keun-mortgage over a real estate mortgage trust.
In the event:
- a security agent becomes a creditor owing to an assignment of receivables by a lender to the security agent and a security right is established in favour of the security agent;
- an acceleration event occurs; and
- the security agent enforces the security right and distributes the proceeds to the lenders, benefits similar to that of a parallel debt structure can be enjoyed.
In such instance, the lenders would only have rights to receivables against the security agent without any security rights. Accordingly, lenders rarely adopt the aforementioned parallel debt structure through the creation of rights to receivables against a security agent.
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