R&D Capitalization Liability in South Korea

A KOSDAQ-listed biotech company capitalized the research and development costs of seven drug pipelines that were still in Phase 1 or Phase 1/2a clinical trials. As a result, its 2017 semiannual and third-quarter reports stated that the company had generated operating profit. In March 2018, its auditor issued a qualified opinion and disclosed an operating loss of KRW 881,795,108 for 2017, which meant four consecutive fiscal years of operating losses.

The stock was designated as an administrative issue the next day, and the share price fell from KRW 33,850 to KRW 19,700 in a single session, a drop of more than 40 percent. Twelve investors sued. Nearly eight years later, in June 2026, the Supreme Court of Korea dismissed all appeals and the judgment became final. The message for management in South Korea is direct: when the accounting standard leaves room for judgment, that room is not unlimited discretion. Without contemporaneous objective evidence, an aggressive judgment call becomes a false statement, and liability reaches the chief executive officers and the disclosure officer personally.

1. Why does capitalizing R&D costs count as a false statement?

Because overstating assets beyond the reasonable and objective range permitted by accounting standards is treated the same as recording fictitious assets, and therefore constitutes a statement contrary to economic reality.

The Supreme Court of Korea has applied this standard for years. Recording assets in the financial statements of a business report at a value that exceeds the reasonable and objective range permitted by corporate accounting standards is equivalent to recording fictitious assets and amounts to a false statement inconsistent with economic facts (Supreme Court of Korea, October 11, 2012, 2010Da86709). The courts used the identical formulation here: the company overstated intangible assets beyond the reasonable and objective range permitted by K-IFRS.

The governing standard is K-IFRS No. 1038 (Intangible Assets), the Korean adoption of IAS 38. It divides the creation of an intangible asset into a research phase and a development phase. Expenditure in the research phase must be expensed as incurred. Even in the development phase, an intangible asset may be recognized only if all six of the following criteria are met:

• Technical feasibility of completing the asset for use or sale
• Intention to complete the asset and use or sell it
• Ability to use or sell the asset
• The manner in which the asset will generate probable future economic benefits
• Availability of adequate technical and financial resources to complete development and to use or sell the asset
• Ability to measure reliably the expenditure attributable to the asset during its development

If the research phase cannot be distinguished from the development phase, all expenditure is treated as incurred in the research phase. In other words, when in doubt, expense it.

Timing also matters. A “material fact” under Article 162(1) means a matter that may have a significant effect on a reasonable investor’s investment decision or on the value of the financial investment product, and whether a material fact was falsely stated or omitted is judged as of the time the statement or omission was made (Supreme Court of Korea, December 10, 2015, 2012Da16063).

2. What happened in Supreme Court case 2024Da300921?

A biotech issuer capitalized development costs for seven drug pipelines in Phase 1 or Phase 1/2a trials, reported operating profit, and was designated an administrative issue when the true operating loss emerged. Twelve investors sued the issuer and its officers.

The court of first instance (Seoul Central District Court, September 14, 2023, 2019Gahap529501, 2019Gahap582199 (consolidated)) held the company, two co-CEOs, and the disclosure officer liable, while dismissing the claims against one other director and the external auditor. The appellate court (Seoul High Court, September 26, 2024, 2023Na2052902, 2023Na2052919 (consolidated)) affirmed liability while recalculating damages and the limitation of liability, and the Supreme Court of Korea upheld that outcome.

For context, new drug development in South Korea follows the sequence of candidate discovery, preclinical testing, Phase 1, Phase 2 and Phase 3 clinical trials, government marketing approval, and commercial launch. The ultimate success rate is 1% at the preclinical stage, 10% at Phase 1, 15% at Phase 2, and 50% at Phase 3. That statistical reality underpinned the court’s conclusion that Phase 1 expenditure could not be treated as an asset.

3. Can a company rely on the absence of regulatory guidance at the time?

No. The Financial Supervisory Service (FSS) supervisory guideline of September 19, 2018 merely elaborated on a principles-based accounting standard. It did not create or tighten the recognition criteria for intangible assets.

The company argued that no clear regulatory standard on R&D capitalization existed when the reports were filed, and that a later advisory guideline could not retroactively render those filings false. The courts rejected the argument on two grounds.

First, the Korea Accounting Institute confirmed to the court that the September 22, 2022 guideline only clarified points left ambiguous in the 2018 guideline rather than relaxing them, and that a supervisory guideline cannot relax an accounting standard in any event. Second, domestic practice already pointed the same way. Korean pharmaceutical companies had treated the recognition criteria as satisfied only upon reaching Phase 3 clinical trials, even under the previous Korean generally accepted accounting principles (K-GAAP), whose recognition criteria were identical.

It is true that in December 2011, ahead of the adoption of K-IFRS, the FSS stated that a company could change its accounting treatment on reasonable grounds. The courts read that statement narrowly. It presupposed the existing domestic practice of capitalizing from Phase 3 and meant only that Korean issuers need not follow the more conservative global practice of capitalizing from marketing approval. It did not confer unlimited discretion.

The 2018 guideline itself did not help the company. For new drugs, technical feasibility is presumed from approval to commence Phase 3 clinical trials; for biosimilars, from approval to commence Phase 1. Capitalization at an earlier stage requires objective proof of technical feasibility. The 2022 guideline provision permitting capitalization before Phase 1 approval applies to biosimilars, not to new drugs.

4. Does an internal accounting policy provide a defense?

No. The courts characterized the company’s internal policy as a subjective standard with no evidence that it was generally accepted in the industry.

The company had adopted an internal policy of recognizing as intangible assets any expenditure on drug candidates that had cleared preclinical testing and had a high likelihood of commercialization. On that basis, it capitalized costs for seven pipelines then in Phase 1 or Phase 1/2a trials.

The court’s reasoning reduces to three findings. The internal policy was merely subjective. There was no evidence that it was widely used in the industry. And even if the policy was satisfied, that did not establish satisfaction of the six recognition criteria under the accounting standard. Decisively, during the FSS thematic review the company failed to produce objective evidence of technical feasibility, acknowledged the error, restated its financial statements, and filed corrected disclosures.

Each specific justification advanced by the company also failed. The possibility of conditional marketing approval after Phase 2 does not establish technical feasibility, because safety and efficacy are first confirmed through Phase 1 and Phase 2 and the conditional approval decision itself rests on the Phase 2 results. The prospect of a technology license was too uncertain, and the accounting treatment would vary with the contract terms. Most instructive is the treatment of license agreements actually executed in 2023 for two of the pipelines. Because falsity is judged as of the time of the statement, and no agreement existed then, the later contracts could not validate the earlier accounting. The court added that the pipelines were still at Phase 1/2 even when the agreements were signed, so the agreements did not show that technical feasibility had been equivalent earlier. A good outcome does not retroactively justify the accounting.

5. Are directors personally liable, or only the company?

Both. Here the company, two co-CEOs, and a disclosure officer who was an employee rather than a director were jointly liable.

Article 162(1) of the Financial Investment Services and Capital Markets Act imposes liability on the filer of the report, the directors in office at the time of filing, and any person who executed the preparation of the report in the name of a director. The disclosure officer in this case was not a director, but he executed the preparation of the reports in a director’s name and was held liable on that basis.

The statutory defense is demanding. A defendant must prove that despite exercising due care he could not have known of the false statement. Proving “could not have known despite due care” means proving that after conducting the investigation reasonably expected of a person in that position, he had reasonable grounds to believe there was no false statement and in fact so believed (Supreme Court of Korea, July 28, 2022, 2019Da202146).

That same judgment sets out what is expected of a chief executive officer. A CEO must build an internal control system capable of preventing accounting irregularities in advance and detecting and correcting them afterward, and must make efforts to ensure it functions. A CEO who makes no such effort, or who deliberately ignores the duty to supervise through such a system, has breached the duty of oversight. Whether the system was reasonably designed and actually operated cannot be established merely by pointing to the existence of a policy or a position such as chief financial officer; the director seeking to escape liability bears the burden of proving that it functioned in practice.

In this case the courts found that the two co-CEOs and the disclosure officer were in a position to know, or could have known, whether the pipelines satisfied the recognition criteria, and that they capitalized the expenditure without objective supporting evidence or a reasonable basis. The due care defense failed.

6. Why were one director and the audit firm released from liability?

The director had not signed the reports at issue and other inside and outside directors were in office. The audit firm was released because the plaintiffs did not prove that they relied on its reports.

There were six defendants at first instance.

Director D prevailed for two reasons. When the semiannual and quarterly reports were prepared, the company also had one other inside director and two outside directors, and D did not sign those reports. On that basis the court accepted that D could not have known of the false statement despite exercising due care. What D had actually prepared was the 2015 annual business report, and, as explained below, the false statements in the 2015 and 2016 annual reports were held not to have caused the investors’ losses.

The audit firm prevailed on different grounds. The 2017 semiannual report was found to have been prepared and filed by the company alone without the auditor’s involvement, so it was not proven that the auditor had certified and signed the financial statements as true and accurate. While the audit and review reports were found to contain false statements, the plaintiffs failed to prove that they relied on those reports in purchasing the shares. The statutory basis and the defense structure differ between directors and auditors.

7. How are damages calculated, and why only 30%?

Damages are presumed to be the acquisition price less the disposal price or the normal share price, and the court then applied a 30% limitation of liability under the principle of fairness.

Presumed damages and the normal share price

Article 162(3) presumes damages to be the difference between the price actually paid to acquire the security and its market price at the close of oral argument, or the disposal price if sold earlier. However, once the false statement has been revealed, the shock has subsided, and the inflated component has been fully removed so that a normal share price forms, later price movements are unrelated to the false statement. Damages are then the purchase price less the share price on the date the normal price formed (Supreme Court of Korea, October 25, 2007, 2006Da16758, 16765; Supreme Court of Korea, October 11, 2012, 2010Da86709).

Here a court expert used an event study to determine a normal share price of KRW 20,900 as of October 10, 2018, excluding the effect of the administrative issue designation. The defendants argued that the expert should have used comparable companies rather than the KOSDAQ composite index as the independent variable and that the estimation window was inappropriate. The courts held that the choice of independent variable is a matter for the expert’s judgment and that a three-year window ending before the designation date was not so remote as to undermine the regression, and accepted the expert opinion.

Where causation failed

Not every false statement produced compensable loss. The courts found no proximate causation for the 2015 and 2016 annual business reports. Those reports understated the amount of the operating loss, but the existence of an operating loss was already disclosed, so they did not drive the administrative issue designation based on four consecutive years of losses or the resulting price collapse.

The semiannual and quarterly reports were different. The defendants argued that interim reports do not determine full-year results and that the price movement merely tracked a sector-wide surge and correction following the government announcement. The courts held that when both the semiannual and third-quarter reports show operating profit, investors may reasonably expect full-year operating profit absent an unusual fourth-quarter development. Proving that the cooling of speculative interest may have contributed to the decline amounts only to proof that the cause of the decline is unclear, which does not rebut the statutory presumption (Supreme Court of Korea, December 15, 2016, 2015Da243163).

Why 30%

Even where the statute presumes damages and shifts the burden of proof, the fundamental principle of fair allocation of loss still applies, so comparative negligence and limitation of liability on equitable grounds remain available (Supreme Court of Korea, October 25, 2007, 2006Da16758, 16765). The courts relied on the following factors:

• Other factors, including general conditions in the securities market and the pharmaceutical and biotech sector, likely contributed to the decline, and their effect cannot be separated in practice
• The company had already reported three consecutive years of operating losses before 2017, which investors could have known
• The stock surged on stem cell speculation after the November 30, 2017 deregulation announcement and was designated an investment warning issue on January 9, 2018; the plaintiffs began buying around that period
• No clear regulatory guideline on R&D capitalization existed at the time of the filings
• The FSS did not treat the matter as serious enough for criminal referral and issued only a warning

The plaintiffs argued that intentional accounting fraud should preclude any limitation. The courts held that even for intentional torts, limitation remains available unless it would allow the wrongdoer to retain the benefit of the wrong in a manner contrary to equity or good faith, and that the evidence did not establish intentional fraud. The per-plaintiff damages found by the appellate court total approximately KRW 3.98 billion, of which 30% was awarded together with delay interest.

8. What is the filing deadline for these claims?

One year from the date the claimant learns of the relevant fact, and three years from the filing of the business report. The trigger is not the day the price collapsed but the day the specific report and the specific misstatement can be identified.

Article 162(5) sets a short exclusion period, so the start date often decides the case. The defendants argued that one plaintiff knew of the misstatement by the designation date of March 23, 2018, or at the latest by March 30, 2018, when emergency management measures were discussed at the annual shareholders meeting, making a suit filed more than a year later inadmissible.

The courts disagreed. Knowing the relevant fact means actually recognizing the false statement or omission in a business report. Because a claimant must identify the specific report containing the misstatement and the directors involved in preparing it, actual recognition occurs only when the claimant knows, or an ordinary person could know, which report is at issue (Supreme Court of Korea, August 29, 2024, 2022Da228407).

Applying that test, as of March 2018 the market knew only that the auditor had applied a stricter standard and restated the 2017 operating loss at roughly KRW 880 million. Which report misstated which line item, and by how much, was not identifiable. That became apparent from an ordinary investor’s perspective only when the corrected audit report was disclosed on August 14, 2018. A suit filed on April 30, 2019, less than a year later, was therefore timely, and the Supreme Court of Korea confirmed that this analysis involved no error of law.

9. What does this mean for foreign-invested companies in South Korea?

Foreign-invested issuers listed in South Korea face the same exposure, and the practical burden falls on contemporaneous documentation rather than on the reasonableness of the accounting judgment in hindsight.

Many research-intensive companies in the Incheon Free Economic Zone (IFEZ), which comprises Songdo International Business District, Cheongna International City, and Yeongjong International City, carry large development pipelines on their balance sheets. Three points deserve attention.

First, a group accounting policy set at headquarters does not displace K-IFRS as applied in South Korea. The company here lost precisely because its internal policy was not anchored in the six recognition criteria. Second, liability under Article 162(1) attaches to individuals. Both representative directors and the employee who executed the filing were held personally liable, and the due care defense requires affirmative proof that an internal control system existed and functioned. For a Korean subsidiary, that means board minutes, technical assessments, and auditor correspondence retained as of the filing date, not reconstructed later. Third, the one-year exclusion period runs from the date the misstatement becomes identifiable, so a corrective disclosure restarts the practical exposure window rather than closing it.

Frequently Asked Questions

This article is a general explanation based on published judgments and the law currently in force in South Korea. Whether the capitalization of research and development costs is lawful, and the scope of any resulting damages, depends on the clinical stage of each pipeline, the quality of contemporaneous internal documentation, and market conditions at the time of disclosure, so it cannot be applied directly to an individual matter.

About the Author

Taejin Kim | Managing Partner

Corporate Counseling, Corporate Disputes, White-Collar Crime

Former Public Prosecutor | Judicial Research and Training Institute, 33rd Class

Korea University LL.B. & LL.M. (Criminal Law), University of California, Davis LL.M.

Atlas Legal | Incheon Songdo, South Korea

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