SM Entertainment’s counsel at a court hearing today (22nd) with respect to the request for an injunction against the proposed issuance of new stocks and convertible bonds

2023. 02. 22

The following is a full text of the verbal statement made by SM Entertainment’s counsel at a court hearing today (22nd) with respect to the request for an injunction against the proposed issuance of new stocks and convertible bonds (CBs).

[Full Text]

Good Morning, Your Honour. I am Daju Jung, a counsel from the law firm Lee & Ko. I would like to address you on the validity of the issuance of new stocks and convertible bonds with regard to this case.

The applicant of injunction contends that a dispute over managerial rights is at the heart of the case. As I will elaborate further in the later part of my statement, however, I believe that this case is very unique in that the relevant arguments are in direct opposition to what you would find in similar cases. Thus in order to fully understand this case, we have to take a close look at how the current situation came about. As you can see, the debtor company has been faced with two major managerial issues so far.

One of them was its declining competitiveness in the so-called IP distribution. For entities in the entertainment industry these days, competitive advantage in online environments is more crucial than ever. These circumstances prompted competitors to partner with platform providers and allowed them to get ahead, but the debtor company lagged seriously behind since it was late in trying to form such an alliance.

Another grave and chronic issue faced by the debtor company had to do with IP production. As I will explain in more detail later, the creditor had long been improperly receiving a significant part of the company’s operating profit through an unjustifiable production system where a single person called all the shots, which was the cause of repeated trouble with the National Tax Service, institutional investors, and the National Assembly, among others. Above all, this was about loss of productivity and thus required prompt action.

In response, the debtor company developed a new strategy for IP creation and content production. Dubbed SM 3.0, the strategy was announced recently.

At first, the creditor was cooperative as the debtor company strived to improve its business. For example, the creditor agreed to an early termination of the agreement with Like Planning, which was at the core of the issue at hand, or in other words, an entity that had been used by the creditor as a conduit for receiving operating income improperly.

However, as the agreement was about to be terminated, the creditor abruptly changed their position and wanted to maintain the unjustifiable system in any way they could. When the debtor company announced a strategy to improve its business structure and decided to issue new stocks that concern this case to achieve the goal, the creditor filed the injunction request of this case the next day, citing a dispute over managerial rights. And almost at the same time, the creditor signed an agreement to sell all their stocks to HYBE, the debtor company’s competitor, and this move has led to the current situation.

The creditor argues that the current situation is one of a dispute over managerial rights that merits an evaluation of whether the decision to issue new stocks is justifiable, but I’d like to respectfully disagree.

If you look closely, you can understand that the current situation was indeed “created deliberately” by the creditor. All this row was caused and intended by the creditor and the competitor, since they signed a deal to sell stocks after they learned about the debtor company’s decision to issue new stocks.

It goes without saying that the timing of the decision to issue new stocks must be used as an important criterion when determining the justifiability of the decision. Then in this case, any situation that was deliberately made and created after the decision must definitely be excluded and ruled out as a criterion for judgement and must not be allowed to mislead anyone.

A cursory look at objective situations clearly reveals the contention that the current situation is one of a dispute over managerial rights is actually groundless. As you can see, the incumbent management, who the creditor sees as the counterparty of the so-called dispute, will step down at the time of the upcoming regular shareholders’ meeting in March as their term expires. They have even expressed their intention not to seek another term. Their combined stocks amounts to a mere 0.33% of the total shares issued, which means they have no influence whatsoever.

In addition, as you are well aware, Kakao, the counterparty for the new stock issuance, will not be a shareholder until March 6 of this year. Since voting rights are granted to those registered as shareholders as of December 31 of last year, Kakao is unable to exercise any voting rights at the upcoming regular shareholder’s meeting. In other words, the company could not help the incumbent management maintain their control over the debtor company even if they wanted to. Another important point to note is that the incumbent management, Kakao, and Align cannot be regarded as a team.

The creditor is trying to label the current situation, with no clear grounds, as one of a dispute over managerial rights, but such an argument requires evidence to back it up. They should at least prove that objective situations justify the contention. It is totally unreasonable to request that the debtor prove something that does not exist in the first place. If you take into account several points I have just made, you will realize that the creditor’s argument is based on preposterous assumptions.

Now, let me move on to the most crucial issue. The term “dispute over managerial rights” speaks for itself. It is a war over managerial rights. In a fundamental sense, the issue is not about who controls the company, Mr. Suman Lee or the incumbent management.

Although this case is seen as a conflict between certain individuals just because it concerns the hidden problems of an entertainment company that the entire country is interested in and curious about, the core issue here is a difference in opinion about business decisions. It is about whether to stick to the wrong decision that only protects the personal rights of major shareholders or to uphold the right decision that was made by taking into account the interests of all shareholders. It is not about forcing a certain individual out of office. A business decision to shift away from an unreasonable production system geared toward a single person to an advanced and competitive production system should not be unjustly labeled as an attempt to rule out a certain person. A difference in opinion about business decisions is one thing, and a dispute over managerial rights is another. It is unjustifiable to label such a difference as a dispute, and it is even dangerous from the perspective of sound business practices.

In other cases, when new stocks were unjustly issued to protect managerial rights, an injunction request was justly filed to prevent such an issuance.

On the contrary, this case involves a situation where a justifiable issuance of new stocks for business purposes has been labeled as a cause for a dispute over managerial rights and has been the subject of unjust opposition simply because it gets in the way of pursuing personal interests, which I believe is quite unusual.

What is the creditor trying to achieve by preventing the issuance? They are trying to maintain a system of protecting unjust personal interests, which has long been around and tantamount to forcing others to pay what could have been avoided without the presence of the system. So far, the creditor has taken more than a third of the debtor company’s operating income, using the unreasonable production system as a pretext. The compensation is more than seven times higher than that of head producers at competitor companies. If this continues, the company cannot grow any more. In addition, the system seriously undermines the interests of the entire shareholder body. It also caused the company to be subject to tax audits and pay more than KRW 10 billion in penalties. An entertainment company whose survival depends on reputation was criticized repeatedly by the media and at congressional hearings, and this has not changed. Despite these circumstances, the creditor filed an injunction request in this case just to keep the system intact.

So this case has presented us with a critical point to think about. In the so-called Hanjin KAL case, the court ruled that a dispute over managerial rights alone cannot invalidate the issuance of new stocks. This case goes a step further and requires us to determine whether a simple claim that there is a dispute over managerial rights can be interpreted to mean such a dispute really exists. It also requires precise judgement and ruling as to what kind of dispute over managerial rights should be taken into account when determining the justifiability of new stock issuance. In other words, we have to decide how to deal with a fabricated situation where a party claims the presence of a dispute over managerial rights, makes argument that is not backed up by objective situations, and the party does not fulfill their burden of proof.

Let me now talk about why the new stock issuance is so critical to the debtor company.

The company’s industry ranking has dropped from first place to second place to the current third place. Whereas the traditional business model of the entertainment industry is to sell music albums, hold concerts, and land commercials, the new business environment requires those involved in the industry to promote the fan community, distribute online concerts on platforms, and utilize metaverse and NFT. However, the debtor company is lagging behind on these fronts, and it desperately needs an alliance with a platform provider.

Alliance with platforms is not just a matter of needs. Without getting ahead by forming such an alliance like your life depends on it, your whole business model will fall apart. In most cases, alliance with a platform takes the form of capital alliance. YG Entertainment has formed a capital alliance with Naver, and HYBE has partnered with Dunamu in a KRW 700 billion capital alliance. This is a natural course of action aimed at maximizing the effect through a close long-term relationship.

Financing is desperately needed for another reason. Due to the unreasonable system of one-man production, as you can see, the productivity of the debtor company lags far behind. While competitors debut one or two groups of artists every year, the debtor company debuts only one every two to three years. Whereas the operating income of competitors has grown ten times over the years, the debtor company has seen its operating income remain unchanged. What’s even more serious is the fact that as you can see on the right, the company has a far greater fan base, consumers of their products, but its productivity is half that of its competitors. This is holding back the company’s growth, which is quite ridiculous and frustrating.

To address this issue, the company should emulate its competitors by establishing multiple production centers, operating a variety of labels, and creating a system in which a number of producers and directors make independent decisions and unleash their full creative potential. But this requires financing of at least KRW 500 billion. This is of course a hefty amount of money. However, the debtor company is confident that it will be money well spent and it needs the money right now.

Then isn’t there any option other than allotment to third parties? A little thought will make you realize easily that allotment to shareholders or simple borrowing cannot meet the business needs of the debtor company in any way. I believe you are well aware that other options such as allotment to shareholders are not even closely viable when it comes to alliance with a platform provider and financing of a massive amount of money.

Moreover, the debtor company has no other option than Kakao. Naver is already collaborating with HYBE and YG Entertainment, and an attempt to form a business alliance between Naver and the debtor company was suspended in the past due to unfortunate reasons. There had been a series of discussions with Kakao, the company’s only option, for a long period of time, and the company made the decision to offer convertible bonds to Kakao since they believed that the circumstances were ripe.

The proposed new stock issuance would not have significant implications for the managerial structure of the company. The creditor would remain a major shareholder regardless of the issuance. Only 1.67% of their shares would be diluted, and Kakao wouldn’t have sufficient stake to gain any business interests or control over the company. The debtor company also conducted intensive reviews to minimize the impact on existing shareholders.

As I explained earlier, the incumbent management will step down at the upcoming general shareholders’ meeting, and Kakao cannot exercise any voting rights.

In addition, Align and Kakao cannot be seen as one team with the incumbent management. The activist fund Align only makes moves according to their own beliefs and principles, and Kakao just makes investments and seek profits based on their interests. If there is one thing that the incumbent management and Align have in common, it would be the fact that both of them prioritize the interests of the entire shareholder body. There is no possibility that Align or Kakao will serve as a knight in shining armor for the incumbent management.

Lastly, since the creditor has agreed to sell their shares and lose their position as a major shareholder soon, it is questionable whether there is a need to continue this case. In addition, their claim of a dispute over managerial rights is not backed up by objective factual evidence, and this is yet another reason that it is hard to recognize the necessity of this case.

Let me give you the conclusion. Please make a distinction between the difference in opinion about business decisions and the presence of a dispute over managerial rights. It is not right to label a decision for sound business management as a dispute over managerial rights and try to nullify it by citing factual information that was hastily fabricated after the decision was made. The proposed new stock issuance was a desperate and unavoidable move for the debtor company. The decision was legitimately made based on justifiable reasons in terms of purpose and means.

We are witnessing an unreasonable attempt to use a hostile takeover to nullify a sound business decision aimed at correcting the wrong business structure of the past and to have a monopolistic scheme entrenched in the promising K-Pop industry. I respectfully request that the case be denied.

Thank you for your attention.