[Invest&Law] Venture Investment 'Indirect Exit' Blocked... Automatic Termination Clause Halts Recovery

Attempt to Sell Shares Back to Management Instead of Direct Investment Contract

Lawsuit Filed After Management Sends "Termination" Notice

Court of First Instance: "Contract Automatically Terminates if Balance Not Paid"

A domestic venture investment association attempted an 'indirect agreement' to sell back its equity to the startup's management in order to exit its investment. However, due to an automatic termination clause in the contract, the court ruled against the recovery of the investment.

According to the legal community on March 25, the Civil Division 42 of the Seoul Central District Court (Presiding Judge Choi Nurim) recently ruled in a payment claim lawsuit filed by the GP (general partner, fund manager) of a domestic venture capital association against two startup executives. The court stated, "The executives are liable for the down payment and the penalty for breach, but they are not required to pay the remaining balance (the principal investment)." In effect, the compensation was limited to about 7% of the total claim.

‘Management Buyback’ Instead of Investment Contract...“Attempted Indirect Recovery”

Prior to this case, in August 2023, the fund manager invested approximately KRW 1.5 billion in a rubber product manufacturing startup, acquiring 18,645 redeemable convertible preferred shares (RCPS). Since other investors also held shares in the startup, a clause was included in the RCPS contract requiring prior consent from those shareholders in the event of any changes to shareholding.

The following year, the fund manager entered into a separate stock purchase agreement with the management. Under this agreement, the executives would purchase the shares from the fund manager. The purchase price matched the original investment at approximately KRW 1.5 billion, with a down payment of KRW 100 million to be paid by the end of September that year and the remaining KRW 1.4 billion by year-end. The contract also included a confidentiality clause prohibiting disclosure of the agreement to any third party.

However, on the day the down payment was due, the executives sent a message stating, “The stock purchase agreement conflicts with the pre-existing RCPS contract; therefore, we are terminating the agreement.” In response, the fund manager filed a lawsuit against each executive for approximately KRW 970 million, comprising the down payment, remaining balance, and penalty.

Court: “Recognizing Reservation of Termination Right Would Grant Unlimited ‘Indirect Investment Recovery’”

The court of first instance dismissed all claims for the remaining balance by the fund manager. The judgment was based on a clause in the stock purchase agreement stating, “The contract will be terminated if the remaining balance is not paid,” which was deemed an automatic termination provision.

The fund manager argued that the clause merely reserved the right to choose termination (reservation of termination right). However, the court found that the clause used the wording “will be terminated” rather than “may be terminated,” and given the circumstances of the contract, both parties had sufficient reason to intend automatic termination in the event of non-payment of the balance.

The court stated, “The stock purchase agreement, which included confidentiality clauses and other provisions, appears to have been entered into for the purpose of indirectly recovering the investment by circumventing the RCPS investment agreement. Accepting the fund manager’s position on the reservation of termination right would not only grant unlimited opportunities for indirect investment recovery but also risk excessive compensation, making it highly unfair.”

Accordingly, the court only recognized forfeiture of the KRW 50 million down payment and a penalty of KRW 15 million for each executive, and ordered the fund manager to bear 90% of the litigation costs.

This content was produced with the assistance of AI translation services.