ISD Dispute with Hedge Fund
About 30 South Korean government officials and legal representatives flew to The Hague for the final defense in the investor-state dispute (ISD) against Lone Star Funds (LSF). The final stage of the litigation takes place on June 2 and 3 (local time).
LSF acquired the Korea Exchange Bank (KEB) 13 years ago and the ISD against the South Korean government started four years ago. Nevertheless, specific issues of the litigation and the legal ground of LSF’s claim for US$4.6795 billion are still vague because the government has yet to make ISD documents public.
The first legal dispute between the South Korean government and LSF dates back to the IMF bailout in the late 1990s. The KEB, which had been established in 1967, took a serious hit at that time. It managed to deal with the crisis with the help of Commerzbank, but the German bank stepped out in the subsequent financial crisis in 2003 and the KEB fell back into a dire situation.
Then, LSF stepped in and purchased 51% of KEB shares with a 20% management control premium. The ongoing ISD is to determine whether the South Korean government responded appropriately when the private equity fund left the country after obtaining huge profits.
According to its arguments, LSF suffered a loss of 3.38 trillion won in total, two trillion won in opportunity cost plus interest, during its legitimate disposal of KEB shares due to the government’s procrastination in the authorization process. LSF bought 51.02% of the KEB at 1.3834 trillion won in October 2003. It failed to sell the shares to KB Kookmin Bank three years later, and then signed a share sale agreement with HSBC in September 2007 at 5.9376 trillion won. The Financial Supervisory Service, however, did not approve of it, saying that its approval would be available only after a court ruling on the legitimacy of the value of the KEB during the disposal in 2003.
Another financial crisis hit the global economy years later, and HSBC gave up on the KEB in September 2008. In the end, the KEB ended up in the hands of the Hana Financial Group in November 2010. LSF sold its shares at 3.9157 trillion won based on the government’s approval. Then, it filed the litigation in spite of the huge 2.5 trillion won profit in eight years. The government, in response, claimed that the delay at that time was not problematic at all because it was waiting for court rulings with regard to alleged malpractices related to the sale of the KEB and the merger between the KEB and KEB Card.
Another hot issue is whether the government’s taxation on the private equity fund was legit. The government imposed 85 billion won in tax on LSF with respect to its 4.6 trillion won profits derived from investment in real estates and the like in South Korea by its paper companies in Belgium. “The companies are tangible subsidiaries and the tax is supposed to be exempted in accordance with the bilateral investment treaty of South Korea and Belgium,” LSF said, adding, “We are to get back 1.7 trillion won, which includes the interest for the past period.”
LSF raised Lone Star Fund 4 and set up Star Holdings in Belgium. Then, in 2001, it bought the Star Tower located in Yeoksam-dong, Seoul, which is currently the Gangnam Finance Center. Later, it established LSF-KEB Holdings in Belgium and bought the KEB in 2003. In addition, its companies in Belgium purchased a series of South Korean assets such as the Tong Yang Securities, Far East Construction and SKC buildings. Then, it sold them to take profits and put up the treaty to avoid taxes. A serious controversy arose and the National Tax Service of South Korea collected 85 billion won in tax.
According to the South Korean government, in the meantime, the ISD itself is invalid let alone the two key issues brought up by LSF. Its arguments include that LSF’s investment in South Korea does not constitute a legitimate investment eligible for the arbitration request, the paper companies are not Belgian companies eligible for the arbitration request, and LSF’s arbitration request failed to comply with a filing period of five years. Furthermore, according to it, LSF intentionally omitted data for the examination of its eligibility as a major shareholder and tampered with the stock price of KEB Card during the purchase of the KEB, and thus cannot be protected by the treaty.