Stock Pledge in South Korea: Documents Required, Creation & Enforcement

1. What Is a Stock Pledge?

Legal Nature of Stock Pledges

A stock pledge is a type of pledge over rights as stipulated in Article 345 of the Civil Act. Article 345 provides that “a pledge may have property rights as its object,” establishing the legal basis for creating pledges over property rights with economic value such as shares. However, the Commercial Act has separate provisions in Articles 338 through 340 considering the special characteristics of shares, so stock pledges have a dual regulatory structure where the basic principles of pledges over rights under the Civil Act form the foundation while the special provisions of the Commercial Act take precedence.

Application Areas of Stock Pledges

Stock pledges are utilized in various areas of modern finance. First, in M&A acquisition financing, the acquirer provides shares of the target company as collateral to raise acquisition funds. Second, in fund raising for major shareholders to maintain management control, they provide their shares as collateral to obtain personal funds. Third, in individual investors’ leveraged investments (credit financing), they provide their shares as collateral to raise additional investment funds. Fourth, in project financing, shares of special purpose companies (SPCs) are provided as collateral to secure project funds.

The Dual Nature of Shares and Legal Challenges

Unlike real estate or general movables, shares have a special nature where their value can fluctuate rapidly depending on the issuing company’s management performance and market conditions, and the content of the rights can be altered or extinguished through capital transactions such as redemption, consolidation, and division. Additionally, shares embody not only property value (dividend claims, residual asset distribution claims) but also public interest rights (voting rights) to participate in company management, so the process of a secured creditor enforcing security rights can cause changes in management control or significantly affect corporate governance structure.

Distinction Between Self-Interest Rights and Public Interest Rights

The prevailing view is that a stock pledge only affects self-interest rights (property rights such as dividend claims and residual asset distribution claims) and does not affect public interest rights (controlling rights such as voting rights). This is because a pledge is a security interest system designed to secure preferential repayment for creditors, not to transfer shareholder participation rights in company management. However, if the pledge agreement separately provides for delegation of voting rights, the pledgee can exercise voting rights as an agent.

2. What Is the Difference Between Simple Pledge and Registered Pledge?

Creation and Effect of Simple Pledge

A simple pledge is created by satisfying the requirement under Article 338(1) of the Commercial Act that “when shares are made the object of a pledge, the share certificates must be delivered to the pledgee.” It takes effect with just the pledge agreement and delivery of share certificates, without needing to record the pledgee in the shareholder registry. However, Article 338(2) provides that “the pledgee cannot assert the pledge against third parties unless they continuously possess the share certificates,” making continuous possession the perfection requirement against third parties.

A simple pledgee can assert rights against third parties but cannot assert rights against the company since they are not a shareholder, meaning they cannot directly control when the company pays dividends to shareholders or allocates new shares in a capital increase. Therefore, a simple pledgee carries procedural instability in that they must constantly monitor the company’s capital changes to exercise subrogation rights and must take attachment procedures before dividend payment dates.

Creation and Effect of Registered Pledge

A registered pledge requires, in addition to simple pledge requirements, that the company record the pledgee’s name and address in the shareholder registry upon request of the pledgor, and that the pledgee’s name be recorded on the share certificate, pursuant to Article 340 of the Commercial Act. A registered pledgee can directly receive dividends, residual asset distributions, and money through subrogation from the company and apply them to preferential repayment of their claim ahead of other creditors (Article 340(1) of the Commercial Act).

Paragraph 2 of the same article applies Article 353(3) of the Civil Act by analogy, granting registered pledgees direct claim rights. In particular, when the company proceeds with mergers, divisions, or capital reductions, it must notify the registered pledgee of such facts, so the pledgee can proactively respond to changes in collateral value.

Detailed Comparison of Simple Pledge and Registered Pledge

Why Simple Pledges Are Preferred in Practice

In practice, the majority of stock-secured loans are in the form of simple pledges. This is because the procedure of recording the pledgee in the shareholder registry is cumbersome, and shareholders (pledgors) are reluctant to have their debt disclosed to the company or other shareholders. Especially for listed companies, simple pledges are preferred even more due to disclosure issues such as large shareholding reports.

3. What Documents Are Required for Stock Pledge Creation?

Common Required Documents

Documents commonly required regardless of share type are as follows:

Additional Required Documents for Certificated Shares

For shares where certificates have been issued, the following additional documents are required:

Additional Required Documents for Non-Certificated Shares

For shares where certificates have not been issued, the Civil Act’s method for assignment of claims applies, requiring the following additional documents:

Required Documents for Electronically Registered Shares (Deposited Shares)

For shares electronically registered with the Korea Securities Depository, the following documents are required:

Essential Items in Pledge Agreement

The pledge agreement must include the following items:

First, identification of parties: clearly state the personal information of the pledgor (shareholder) and pledgee (creditor). Second, specification of secured claim: state the principal, interest, default interest, and default conditions. Third, specification of collateral: state the issuing company name, type of shares, quantity, par value, and share certificate numbers (if issued). Fourth, forfeiture agreement: for commercial pledges, specify the method of voluntary disposal or ownership acquisition upon default. Fifth, maintenance margin ratio and margin call conditions: specify the obligation to provide additional collateral when the collateral ratio falls and forced liquidation conditions. Sixth, agreement regarding voting right exercise: specify whether the pledgor exercises or delegates to the pledgee. Seventh, dividend handling method: specify whether dividends are applied to principal repayment or returned to the pledgor. Eighth, governing law and dispute resolution clause: particularly important for international transactions.

4. Creating and Enforcing Pledges on Certificated Shares

Procedure for Creating Simple Pledge on Certificated Shares

The procedure for creating a simple pledge on certificated shares is as follows:

A simple pledge is created at the time of share certificate delivery, and the pledgee can assert it against third parties as long as they maintain continuous possession. Under Article 338(2) of the Commercial Act, losing possession results in loss of third-party perfection, so the pledgee must safely store the share certificates. In practice, financial institution vaults or trust company custody services are often used.

Procedure for Creating Registered Pledge on Certificated Shares

The procedure for converting from a simple pledge to a registered pledge or creating a registered pledge from the outset is as follows:

Once a registered pledge is created, under Article 340 of the Commercial Act, the company must directly pay dividends, residual asset distributions, and merger consideration to the pledgee, and must notify the pledgee of capital changes.

Methods of Enforcing Pledges on Certificated Shares

Methods of enforcing the pledge upon default are as follows:

Enforcement Through Auction

Under Article 338(1) of the Civil Act, the pledgee can auction the pledged property. Under Article 273 of the Civil Execution Act, documents proving the existence of security rights (pledge agreement, copy of share certificates, etc.) are submitted to the enforcement court to apply for security right enforcement auction. However, the procedure is complex and time-consuming, and collateral value can rapidly decrease if share prices fall, so it is rarely used in practice.

Simplified Appropriation for Payment

Under Article 338(2) of the Civil Act, when there are justifiable grounds, the pledgee can request the court to appropriate the pledged property directly for repayment based on valuation by an appraiser. Examples of justifiable grounds include cases where the pledged property value is low making auction costs unreasonable, or unlisted shares where there is no market making it difficult to obtain fair value at auction. Prior notice to the debtor and pledgor is required for this procedure.

Voluntary Disposal Under Forfeiture Agreement (Commercial Pledge)

Under Article 59 of the Commercial Act, forfeiture agreements are permitted for pledges securing claims arising from commercial transactions. In this case, upon default, the pledgee can directly dispose of the shares without auction procedures (disposal-liquidation type) or acquire ownership (attribution-liquidation type). For listed shares, they are sold at market price on the securities exchange, and for unlisted shares, they are sold to third parties or acquired by the pledgee at fair value.

5. Creating and Enforcing Pledges on Non-Certificated Shares

Legal Basis for Pledge Creation on Non-Certificated Shares

Supreme Court Decision 2000. 8. 16. 99Geu1 presented important legal principles regarding pledge creation on non-certificated shares. In this decision, the Supreme Court held as follows:

“Transfer of shares before certificate issuance is also recognized, and since there is no legal provision prohibiting the provision of pre-issuance shares as security, pledge creation on pre-issuance shares is also possible. Since Article 338(1) of the Commercial Act should be interpreted as applying to registered shares where certificates have been issued, for pledging pre-issuance shares, we return to Article 346 of the Civil Act, the general principle for creating pledges over rights, and a pledge can be created by the method of transferring that right.”

Therefore, for pledges over non-certificated shares, Article 346 of the Civil Act applies along with Article 450 of the Civil Act regarding assignment of claims by analogy.

Procedure for Creating Pledges on Non-Certificated Shares

Distinction Between Creation Requirements and Perfection Requirements

For pledges over non-certificated shares, creation requirements and perfection requirements must be distinguished:

Methods of Securing Fixed Date

Practical methods of securing a fixed date for third-party perfection are as follows:

First, notice by content-certified mail. Send content-certified mail in the pledgor’s name notifying the company of the pledge creation, and obtain delivery certification. The mailing date of the content-certified mail serves as the fixed date. This is the most common method.

Second, notarization. Have the pledge creation notice or company acknowledgment certified by a notary. The notarization date becomes the fixed date.

Third, fixed date stamp from court. Submit the acknowledgment to the competent court and receive a fixed date stamp. In practice, the content-certified mail method is most frequently used.

Methods of Enforcing Pledges on Non-Certificated Shares

Voluntary Disposal for Commercial Pledges

Under Article 59 of the Commercial Act, for pledges securing commercial transaction claims, upon default the pledgee can voluntarily dispose of or acquire the shares under the forfeiture agreement. Upon disposal, they either request the company to register a name change to the pledgee, or sell to a third party and receive preferential repayment from the proceeds.

Name Registration Request Procedure

When acquiring shares through pledge enforcement, under Article 337 of the Commercial Act, a name registration request must be made in the shareholder registry to exercise shareholder rights against the company. For non-certificated shares, name registration is in principle requested jointly by the transferor and transferee, but if the transferor does not cooperate, a judgment can be obtained for a unilateral request.

Auction Under the Civil Execution Act

Security right enforcement auction can be applied for under Article 273 of the Civil Execution Act. However, since normal auction procedures are difficult for unlisted shares, special sale methods (bidding, price calling, negotiated sale, etc.) are often used.

6. Creating and Enforcing Pledges on Deposited Shares (Electronically Registered Shares)

Introduction of Electronic Securities System and Paradigm Shift

With the enforcement of the Act on Electronic Registration of Stocks and Bonds in September 2019, physical certificate issuance was prohibited for most corporate shares including listed shares, and rights arise by registration in the account books of the electronic registration institution (Korea Securities Depository). This fundamentally changed the creation requirements for stock pledges. In the past, possession of share certificates was the core of pledges, but now registration in the account books has taken its place.

Electronic Registration as Validity Requirement

Article 35(3) of the Act on Electronic Registration of Stocks explicitly provides that “when electronically registered stocks are made the object of a pledge, pledge creation electronic registration under Article 31 must be made for the pledge to take effect.” Therefore, electronic registration is a validity requirement for the pledge. Without electronic registration, the pledge is not created, and a contract between parties alone has no effect.

Procedure for Creating Pledges on Electronically Registered Shares

Structure of Electronic Registration Account Book

The electronic registration account book is broadly divided into customer account books and account management institution proprietary account books. Customer account books record individual investors’ shareholdings and pledge creation details. When a pledge is created, the pledgee information and secured claim information are recorded in the pledge creation column for those shares.

Recognition of Good Faith Acquisition

The electronic registration book has strong public credibility as an official ledger. Under Article 35(5) of the Act on Electronic Registration of Stocks, a person registered as pledgee in the electronic registration account book in good faith and without gross negligence, trusting the entries in the electronic registration account book, validly acquires the pledge even if the pledgor was a person without rights. This is an essential measure to protect transaction safety and liquidity in capital markets.

Deemed Registered Pledge

Under the electronic securities system, it is impossible to separately write the pledgee’s name on share certificates. Article 35(4) of the Act on Electronic Registration of Stocks provides that “a person registered as pledgee in the electronic registration account book is deemed to have the pledgee’s name recorded on the share certificate under Article 340 of the Commercial Act,” opening the way for electronically registered pledges to naturally have the effect of registered pledges.

Methods of Enforcing Pledges on Electronically Registered Shares

Forced Liquidation (Most Common)

The most frequently occurring form of enforcement in securities company credit financing or stock-secured loans is forced liquidation. When the maintenance margin ratio falls short, additional collateral is requested through margin calls, and if not resolved within the deadline, immediate sale occurs on the securities market.

Block Deal

For large shareholdings, direct sale on the market can significantly impact share prices, so block deal methods of bulk sale to institutional investors off-market are used. Typically, transactions occur at a certain discount from the current market price.

Name Registration After Pledge Cancellation

When the pledgee acquires share ownership, they apply to the electronic registration institution for pledge cancellation and simultaneous ownership transfer registration to the pledgee’s name.

Special Issues with Electronically Registered Share Pledges

Dividend Receipt

Since electronic registration pledges are deemed registered pledges, the pledgee can directly receive dividends and apply them to repayment. In practice, when dividends are deposited into the securities company account, they are automatically applied to loan repayment.

Preemptive Rights in Capital Increases

When a capital increase is implemented for electronically registered shares, preemptive rights in principle belong to the shareholder (pledgor). However, this follows any separate provisions in the pledge agreement. The pledge effect extends by subrogation to new shares acquired through exercise of preemptive rights.

Stock Splits, Consolidations, and Redemptions

During stock splits, consolidations, and redemptions, the electronic registration institution automatically adjusts the pledge creation details. If the number of shares increases due to a split, the pledge extends to all increased shares, and if consideration is received due to redemption, the pledge effect extends by subrogation to that consideration.

7. Why Are Forfeiture Agreements Only Permitted for Commercial Pledges?

Principle of Prohibition of Forfeiture Agreements Under the Civil Act

Article 339 of the Civil Act provides that “the pledgor cannot agree before the debt maturity date to have the pledgee acquire ownership of the pledged property in lieu of repayment, or to dispose of the pledged property other than by methods prescribed by law,” prohibiting forfeiture agreements.

The legislative intent of this provision is as follows. First, debtor protection: to prevent usurious acts where economically stronger creditors lend money to debtors in difficult circumstances and seize collateral worth far more than the debt amount at low prices. Second, fair security enforcement: to realize fair value of collateral through court auction procedures and return any surplus to the debtor. Third, prevention of private enforcement: to prevent creditors from unilaterally disposing of collateral and ensure fairness of legal procedures.

This provision is mandatory, so agreements violating it are void.

Special Provision of Article 59 of the Commercial Act

However, Article 59 of the Commercial Act provides an exception: “Article 339 of the Civil Act does not apply to pledges created to secure claims arising from commercial transactions.” These are called commercial pledges.

The reasons for permitting forfeiture agreements in commercial pledges are as follows. First, transaction speed: in commercial transactions, capital turnover is vital, so rapid debt recovery is needed upon default. Auction procedures are time-consuming and costly, hindering commercial transaction efficiency. Second, rationality of merchants: it is presumed that merchants, as rational economic actors, fully recognize the risk of their collateral being disposed of when entering contracts. Third, collateral value volatility: for collateral with rapidly changing values like shares, rapid disposal is necessary since value can plummet during auction procedures, disadvantaging both creditors and debtors.

Expansive Interpretation in Supreme Court Decision 2017Da207499

The issue is how broadly to interpret “claims arising from commercial transactions.” In particular, whether forfeiture agreements are valid when banks or securities companies make stock-secured loans to ordinary individuals (non-merchants) became a point of contention.

Supreme Court Decision 2017. 7. 18. 2017Da207499 provided clear criteria on this issue.

First, recognition of unilateral commercial acts: for a forfeiture agreement to be valid, it is sufficient that the secured claim arose from a commercial transaction, and the pledgor need not be a merchant.

Second, application of Article 3 of the Commercial Act: Article 3 of the Commercial Act provides that “for obligations arising from acts that are commercial transactions for one of the parties, this Act applies.” Therefore, when a financial institution (merchant) executes a loan to an individual as a business activity, this is a commercial transaction for the financial institution, so Article 59 of the Commercial Act applies.

Third, confirmation of forfeiture agreement validity: in stock pledge agreements concluded between financial institutions and individual investors, forfeiture clauses stating “may dispose at will upon default” are valid.

This legal interpretation provides strong legal grounds for financial institutions to immediately sell shares on the market (forced liquidation) without complex auction procedures upon default.

Enforcement Standards for Unlisted Share Forfeiture Agreements

Supreme Court Decision 2021. 11. 25. 2018Da304007 presented important standards regarding enforcement of forfeiture agreements for unlisted shares:

“If the pledge agreement does not specify the price or pricing method for pledged unlisted shares and there is no objectively formed market price or it is difficult to confirm, as long as the creditor adopts one of the generally permitted unlisted share pricing methods to calculate the disposal price when enforcing the pledge through disposal-liquidation, even if that price is later found to be unreasonable, the creditor’s disposal act itself does not become void absent other special circumstances.”

However, this decision presupposes the existence of a liquidation duty. If the collateral value exceeds the secured claim, the difference must be returned to the pledgor, and failure to do so may result in separate damages liability.

8. What Rights Can the Pledgee Exercise?

Right of Preferential Repayment

The most essential effect of a pledge is the right of preferential repayment. Article 329 of the Civil Act provides that “the pledgee may exercise their rights over all of the pledged property until they receive full repayment of the claim.” The pledgee can receive repayment from the proceeds of the collateral shares ahead of other general creditors. Pledges have indivisibility, so even if part of the claim is repaid, the pledge is maintained over all of the collateral.

Right of Subrogation

The right of subrogation is based on Article 342 of the Civil Act, and Article 339 of the Commercial Act provides special provisions for shares. Article 339 of the Commercial Act provides that “when there is redemption, consolidation, division, or conversion of shares, the pledge over the original shares may also be exercised over money or shares that the former shareholder receives as a result.”

Objects subject to subrogation include: first, refund money from capital reduction when the company implements paid-in capital reduction and pays money to shareholders; second, merger consideration when the company dissolves through merger and pays merger consideration to shareholders; third, new shares acquired through stock splits where the pledge extends to all increased shares when share count increases; fourth, shares acquired through conversion from convertible bonds or convertible preferred shares; fifth, residual asset distribution when the company distributes residual assets during dissolution and liquidation.

Principle of Pre-Payment Attachment

To exercise the right of subrogation, the relevant money or property must be “attached before payment or delivery” to the shareholder (proviso to Article 342 of the Civil Act). This is to prevent the pledged property from losing specificity by mixing with the general assets of the shareholder (pledgor).

Dividend Receipt Right (Registered Pledgee)

Dividend receipt rights are only recognized for registered pledgees. Article 340(1) of the Commercial Act provides that registered pledgees can “receive dividends, residual asset distributions, or money under Article 339 from the company and apply them to preferential repayment of their claim ahead of other creditors.”

Paragraph 2 of the same article applies Article 353(3) of the Civil Act by analogy, granting registered pledgees direct claim rights. Accordingly, registered pledgees can directly claim dividend payment from the company, and if the company pays the pledgee, the debt to the shareholder is also extinguished to that extent.

Right to Collect Fruits

The pledgee can collect fruits (dividends) arising from the pledged property and apply them to repayment ahead of other creditors (Article 323 of the Civil Act). However, simple pledgees cannot assert rights against the company, so to receive dividends, they must separately obtain attachment and collection orders or obtain the pledgor’s cooperation.

9. What Are the Rights and Obligations of the Pledgor?

Rights of the Pledgor

The pledgor as shareholder maintains their shareholder status even after pledge creation. This is because a pledge is a security interest that captures exchange value only, not depriving all shareholder rights.

Rights the pledgor retains include: first, voting rights—can exercise voting rights at shareholders’ meetings (unless otherwise agreed); second, preemptive rights—has the right to subscribe for new shares in capital increases; third, right to attend shareholders’ meetings and ask questions; fourth, right to inspect accounting books (Article 466 of the Commercial Act); fifth, various litigation rights including shareholder resolution cancellation suits, director dismissal suits, and derivative action rights; sixth, right to receive surplus dividends—has the right to receive any dividends exceeding the secured claim; seventh, right to request pledge extinction—can repay the secured claim and request extinction of the pledge.

Obligations of the Pledgor

Conversely, the pledgor bears a duty to preserve the pledged property. Article 352 of the Civil Act provides that “the pledgor cannot, without the pledgee’s consent, extinguish the rights that are the object of the pledge or make changes that harm the pledgee’s interests.”

Specific obligation contents include: first, prohibition of pledge extinction acts—cannot transfer or abandon shares or take other actions that extinguish the pledge without the pledgee’s consent; second, prohibition of collateral value impairment—voting in favor of indiscriminate disposal of company assets or other acts that significantly reduce share value may be grounds for damages liability to the pledgee; third, collateral supplementation obligation—must provide additional collateral when the maintenance margin ratio specified in the pledge agreement falls below requirements; fourth, information provision obligation—contractual duties to notify the pledgee of important company management information or capital changes may be imposed.

Collateral Value Impairment and Damages

If the pledgor intentionally or negligently impairs the value of the pledged shares, they may be liable for damages to the pledgee as breach of contract or tort. For example, voting in favor of selling major company assets at low prices or voting for excessive dividends that deteriorate the company’s financial condition may be applicable.

However, this does not restrict legitimate shareholder rights exercise. Even if business decisions within the scope of business judgment result in share price decline, this alone does not immediately give rise to damages liability.

10. Who Exercises Voting Rights and Preemptive Rights?

Principle of Voting Rights Exercise

The most sensitive issue when creating a stock pledge is “who exercises voting rights.” This is because voting rights at shareholders’ meetings are core rights that determine company management control.

According to prevailing views and case law, even if a pledge is created over shares, shareholder rights, particularly voting rights, still belong to the shareholder (pledgor). This is because a pledge is a right that captures exchange value only, not comprehensively depriving use, profit, or management/disposal rights. Since Article 369(1) of the Commercial Act provides that “shareholders” exercise voting rights, pledgees cannot directly exercise voting rights as they are not shareholders.

Therefore, even if a major shareholder pledges shares as collateral, they can still exercise voting rights to appoint representative directors or amend articles of incorporation.

Voting Rights Delegation by Special Agreement

However, creditors (especially private equity funds or large lender groups) may want voting rights control to prevent management decisions that impair company value. If the pledge agreement delegates voting rights exercise to the pledgee or grants power of attorney, the pledgee can exercise them as an agent.

Types of voting rights delegation agreements include: first, full delegation—delegate all voting rights exercise to the pledgee; second, conditional delegation—the pledgee can exercise voting rights only upon Event of Default (EOD), which is most common; third, specific agenda delegation—the pledgee exercises voting rights only for specific agendas such as articles of incorporation amendments or director appointments; fourth, consultation obligation—impose prior consultation obligations with the pledgee for important agendas.

In M&A acquisition financing, it is customary to obtain blank powers of attorney in advance so that lender groups can immediately exercise voting rights upon borrower default.

Exercise of Preemptive Rights

Preemptive rights, as inherent shareholder rights, are also in principle exercised by the pledgor. Under Article 418 of the Commercial Act, shareholders have the right to receive allocation of new shares according to the number of shares they hold, and this right is not deprived by pledge creation.

However, the prevailing view is that the pledge effect extends by subrogation to new shares acquired through exercise of preemptive rights (see Article 339 of the Commercial Act). Therefore, if the pledgor exercises preemptive rights and acquires new shares, the effect of the existing pledge extends to those new shares.

Exercise of Other Shareholder Rights

Conversion rights, redemption claim rights, and other shareholder rights are likewise exercised by the pledgor, with the pledge effect extending by subrogation to shares or money acquired as a result.

11. What Are the Maintenance Margin Ratio (LTV) and Margin Calls?

Concept of Maintenance Margin Ratio

The maintenance margin ratio (LTV, Loan to Value) is the ratio of the appraised value of pledged shares to the loan amount. For example, if the loan is 100 million won and the pledged share value is 150 million won, the maintenance margin ratio is 150%. Financial institutions require maintaining a certain level of maintenance margin ratio to prepare for collateral value decline risk.

Maintenance margin ratios vary depending on the financial product and nature of pledged shares:

Occurrence of Margin Calls

When the maintenance margin ratio falls below the standard due to share price decline, a margin call occurs. A margin call is a notice from the financial institution to the borrower requesting provision of additional collateral or partial loan repayment.

Borrower options upon margin call include: first, cash deposit—deposit cash equivalent to the collateral shortfall; second, additional collateral provision—provide additional shares or other collateral; third, partial loan repayment—repay part of the loan to restore the collateral ratio; fourth, take no action—in this case, forced liquidation is executed.

Forced Liquidation Process

If the collateral shortfall is not resolved within the specified period after a margin call, the financial institution executes forced liquidation. This is a legitimate exercise of rights based on the commercial forfeiture agreement under Article 59 of the Commercial Act.

Market Impact of Forced Liquidation

Large-scale forced liquidation can significantly shock share prices. When large volumes of forced liquidation selling pour out, share prices can plummet further, which in turn can trigger margin calls on other collateral loan accounts, causing a vicious cycle (chain forced liquidation).

In fact, during sharp price decline phases, news of major shareholder stock-secured loan forced liquidation often triggers additional share price decline. This is because it suggests the major shareholder’s financial difficulties and management control instability to the market.

12. How Do You Enforce a Stock Pledge?

Concept of Pledge Enforcement

Pledge enforcement refers to the pledgee converting the pledged shares to money to satisfy the claim when default occurs. Pledge enforcement methods include auction under the Civil Execution Act, simplified appropriation for payment, and voluntary disposal under forfeiture agreement.

Auction Under the Civil Execution Act

Under Article 338(1) of the Civil Act, the pledgee can auction the pledged property. Under Article 273 of the Civil Execution Act, documents proving security right existence are submitted to the enforcement court to apply for security right enforcement auction.

However, auction procedures are time-consuming (months to over a year), costly, and exposed to share price fluctuation risk. Especially for unlisted shares, it is difficult to find buyers through normal auction methods, often requiring special sales (negotiated sale, etc.). For these reasons, the auction method is rarely used in practice.

Simplified Appropriation for Payment

Under Article 338(2) of the Civil Act, “when there are justifiable grounds, the pledgee can request the court to appropriate the pledged property directly for repayment based on valuation by an appraiser.”

Examples of justifiable grounds include: cases where the pledged property value is low making auction costs unreasonable; unlisted shares where there is no market making it difficult to obtain fair value at auction; cases where share prices are plummeting and collateral value is expected to decline further during auction procedures.

This procedure requires prior notice to the debtor and pledgor and valuation by a court-appointed appraiser. Upon court permission, the pledgee acquires the pledged property at the appraised price and offsets it against the claim. However, this method also has low utilization because it requires court permission and is time-consuming and costly.

Voluntary Disposal Under Forfeiture Agreement (Commercial Pledge)

Under Article 59 of the Commercial Act, forfeiture agreements are permitted for pledges securing claims arising from commercial transactions. In this case, upon default, the pledgee can directly dispose of the shares or acquire ownership without auction procedures.

Disposal-Liquidation Type

The pledgee sells the shares to a third party, receives repayment of the secured claim from the sale proceeds, and returns the balance to the pledgor. For listed shares, they are sold at market price on the securities exchange; for unlisted shares, they are sold through negotiated sale to third parties.

Attribution-Liquidation Type

The pledgee directly acquires ownership of the shares and pays the difference (liquidation amount) to the pledgor if the share value exceeds the secured claim. This method is mainly used for unlisted shares.

Liquidation Duty

Even in disposal under forfeiture agreements, there is a liquidation duty. According to Supreme Court Decision 2018Da304007, if the collateral value exceeds the secured claim, the difference must be returned to the pledgor. Failure to pay the liquidation amount may result in separate damages liability.

Forced Liquidation of Listed Shares

The most frequently occurring form of enforcement in securities company credit financing or stock-secured loans is forced liquidation. After margin calls when the maintenance margin ratio falls short, immediate sale occurs on the securities market. Forced liquidation typically involves sell orders at the lower limit price in the next day’s opening call auction, selling only the quantity needed for loan repayment.

13. How Do You Release and Cancel a Pledge?

Grounds for Pledge Release

A pledge is released on the following grounds: first, repayment of the secured claim—the pledge naturally extinguishes when the debt is fully repaid (dependency principle); second, abandonment of the pledge—the pledge extinguishes if the pledgee abandons it; third, destruction of the pledged property—however, if there is substitute property, subrogation is recognized; fourth, confusion—the pledge extinguishes if the pledgee acquires ownership of the pledged property; fifth, consensual release—the parties can release the pledge agreement by mutual agreement.

Release Procedure for Certificated Share Pledges

Release Procedure for Non-Certificated Share Pledges

For non-certificated shares, since there are no share certificates to return, issuance of the pledge release confirmation and notice of pledge release to the company are key.

Cancellation Procedure for Electronically Registered Share Pledges

For electronically registered shares, the pledge notation must be cancelled in the electronic registration institution’s account books.

Items to Include in Pledge Release Confirmation

The pledge release confirmation must include the following: first, party identification—personal information of the pledgor and pledgee; second, identification of original pledge agreement—contract date, contract number, etc.; third, identification of collateral—issuing company name, type of shares, quantity, etc.; fourth, release grounds—debt repayment, consensual release, etc.; fifth, release date; sixth, share certificate return confirmation (if applicable); seventh, signatures and seals of the parties.

14. Comparison of Stock Pledges with Other Security Instruments

Types of Security Instruments

In addition to pledges, there are various instruments for using shares as security, including assignment for security, security trust, and mortgages. A comparison of the advantages and disadvantages of each security instrument is as follows:

Advantages of Stock Pledges

Stock pledges have the following advantages: first, simple creation procedure—for simple pledges, it is created by share certificate delivery alone, making the procedure simple; second, low cost—no trust fees as with security trusts; third, ownership maintained—unlike assignment for security, ownership is not transferred so pledgor rights are protected; fourth, shareholder rights maintained—the pledgor can continue to exercise shareholder rights such as voting rights.

Disadvantages of Stock Pledges

Conversely, stock pledges have the following disadvantages: first, weak bankruptcy remote effect—protection upon pledgor bankruptcy is weaker than security trusts; second, limitations of simple pledges—cannot assert against the company so direct dividend receipt is difficult; third, difficult information access—simple pledgees have difficulty obtaining company capital change information; fourth, limited management control—voting rights cannot be exercised in principle so management control is difficult.

Security Instrument Selection Criteria

Selection of security instruments requires comprehensive consideration of transaction nature, party needs, costs, and legal stability. Simple pledges are suitable for general short-term loans due to simple procedures, and security trusts are suitable for large-scale long-term financing or transactions where bankruptcy remote is important. In M&A acquisition financing, assignment for security or pledges with voting rights delegation agreements are used as management control is necessary.

15. Practical Considerations and Dispute Prevention

Items to Verify Before Pledge Creation

Items that must be verified before stock pledge creation are as follows:

First, whether share certificates have been issued. Request a certificate non-issuance confirmation from the company to verify whether certificates have actually been issued. If certificates have not been issued, the pledge must be created using the Civil Act’s method for assignment of claims.

Second, whether Article 335(3) of the Commercial Act is satisfied. Transfer (and pledge creation) of shares before certificate issuance is only possible after 6 months have elapsed since company establishment. However, an exception is recognized for claims arising before company establishment.

Third, share transfer restrictions in the articles of incorporation. Unlisted companies can restrict share transfers in their articles of incorporation to require board of directors or shareholders’ meeting approval (proviso to Article 335(1) of Commercial Act). Review is needed on whether this provision applies to pledge creation.

Fourth, existence of prior security. Verify whether other pledges or security have already been created on the relevant shares. If there is senior security, the junior pledgee’s rights are limited.

Fifth, status of shareholder rights. Verify whether the shareholder lawfully holds the shares and whether there are provisional attachments or disposition prohibition provisional dispositions.

Importance of Satisfying Perfection Requirements

Satisfying perfection requirements is very important for stock pledges. Without perfection requirements, the pledge cannot be asserted against third parties, so the pledgee is not protected if other creditors of the pledgor attach the shares or if the pledgor transfers the shares to third parties.

Special Issues with Unlisted Share Collateral

When using unlisted shares as collateral, the following special issues require attention:

First, difficulty in valuation. There is no objective market price, making valuation difficult. It is advisable to specify valuation methods in the pledge agreement in advance (e.g., supplementary valuation method under the Inheritance Tax and Gift Tax Act, net asset value method, discounted cash flow method, etc.).

Second, difficulty in conversion. Unlisted shares lack liquidity and are difficult to sell. Finding buyers may be difficult during pledge enforcement, so it is advisable to specify buyer designation methods or attribution-liquidation methods in the pledge agreement.

Third, information asymmetry. Unlisted companies have no disclosure obligations so financial information access is difficult. It is necessary to impose periodic financial information provision obligations in the pledge agreement.

Contract Drafting for Dispute Prevention

To prevent stock pledge-related disputes, the following matters must be clearly specified in the contract:

First, maintenance margin ratio and margin call conditions—clearly specify collateral ratio calculation method, valuation timing, margin call notification method, and additional collateral provision deadline. Second, specific contents of forfeiture agreement—specify whether disposal-liquidation type or attribution-liquidation type, disposal method, pricing method, and liquidation amount payment method. Third, matters regarding voting rights exercise—specify who exercises voting rights, whether conditional delegation, and consultation obligations for specific agendas. Fourth, dividend handling method—specify whether dividends are applied to principal repayment or returned to the pledgor. Fifth, information provision obligation—specify the scope and frequency of information the pledgor must provide to the pledgee. Sixth, acceleration events—clearly specify what events other than collateral ratio decline cause acceleration. Seventh, dispute resolution clause—specify competent court, arbitration clause, etc.

16. FAQ

Atlas Legal provides legal services in corporate advisory, corporate disputes, corporate counseling, and corporate crime (fraud, breach of trust, embezzlement, tax law, customs law) in Songdo, Incheon. We have professional advisory and litigation experience in complex corporate finance legal issues including stock pledge creation, security right enforcement, management control disputes, and M&A acquisition financing. We protect client rights by accurately applying the latest case law on stock pledge provisions under Articles 338 through 340 of the Commercial Act and pledge creation under the Act on Electronic Registration of Stocks.

※ Cases introduced in this article are based on actual experience but have been modified for illustration purposes, and client confidentiality has been protected.