What Should You Do When a Subcontractor Doesn’t Get Paid in South Korea? Corrective Orders & Settlement Agreements

1. What Is Subcontract Payment Under South Korean Law?

A subcontracting relationship arises when a prime contractor (original business operator) that has received work from a project owner delegates part or all of that work to another company (subcontractor). The compensation the subcontractor is entitled to receive from the prime contractor is called “subcontract payment” (hadogeup daegeum).

Why Does South Korea Have a Special Subcontracting Act?

In South Korean construction markets, prime contractors are typically larger and hold significantly greater bargaining power than subcontractors. Subcontractors often hesitate to raise payment issues for fear of losing future contracts. The Fair Transactions in Subcontracting Act (Hadogeup Georae Gongjeonghwa-e Gwanhan Beomnyul) was enacted precisely to address this structural imbalance.

Article 1 of the Act states that its purpose is to “establish fair subcontracting transaction practices so that original business operators and subcontractors may complement each other and develop in a balanced manner from an equal footing, thereby contributing to the sound development of the national economy.” The Act goes beyond ordinary civil contract enforcement by empowering the Korea Fair Trade Commission (KFTC) to directly intervene through corrective orders and surcharges.

What Is the Payment Deadline Under the Act?

Under Article 13(1) of the Act, the prime contractor must pay the subcontract price within 60 days from the date of receiving the finished goods or completed work. If payment is made by promissory note and the maturity date exceeds 60 days from receipt, the prime contractor must additionally pay discount fees for the excess period (Article 13(6)).

2. When Can (and Can’t) the KFTC Issue a Corrective Order?

The existence of a past violation does not automatically entitle the KFTC to issue a corrective order. The Supreme Court of Korea has drawn a clear line around the inherent limitations of such orders.

Corrective Orders Exist to Remedy “Currently Existing” Violations

In its Decision 2001Du3099 (November 26, 2002), the Supreme Court held that corrective orders under Article 25(1) of the Act are intended to “rectify unlawful outcomes that currently exist in reality as a result of the relevant violation.”

Put simply, a corrective order is not a finding that a law was broken in the past. It can only direct payment when unpaid amounts still remain outstanding at the time of the order.

What If the Debt Has Already Been Resolved?

If the subcontract payment obligation has been extinguished for any reason, whether through repayment, set-off, or settlement agreement, the KFTC has no remaining violation to correct. The Supreme Court explicitly confirmed this principle in the aforementioned decision.

Why Are Corrective Orders and Surcharges Treated Differently?

This distinction is critically important in practice. The Act operates corrective orders (Article 25(1)) and surcharges (Article 25-3(1)(iii)) as separate mechanisms. Surcharges penalize the act of violation itself, so subsequent repayment or settlement does not necessarily eliminate surcharge liability.

Additionally, Article 30(2)(iii) prescribes criminal penalties for failure to comply with a corrective order. Non-compliance with an order is itself a separate criminal offense under South Korean law.

What Is the Practical Takeaway for Subcontractors?

A corrective order is a powerful remedy, but the unpaid amount must actually remain outstanding at the time of the complaint. Even if the prime contractor rushes to settle after a complaint is filed, late interest and unpaid discount fees accrued prior to settlement may still be subject to a separate corrective order. In the case discussed above, the court upheld the corrective order for delayed payment of partial amounts and unpaid promissory note discount fees.

3. What Happens If the Prime Contractor Fails to Notify Inspection Results Within 10 Days?

If the prime contractor receives goods or completed work from the subcontractor and fails to notify the inspection results in writing within 10 days, the delivery is automatically deemed to have passed inspection. This is the core rule of Article 9(2) of the Act.

Article 9(2): The Deemed Acceptance Rule

Article 9(2) provides that the prime contractor must notify the subcontractor of inspection results in writing within 10 days from the date of receiving the goods (or, in the case of construction subcontracting, from the date of receiving notice of completion or progress). Absent notification within this period and without justifiable cause, the goods are deemed to have passed inspection.

Deemed Inspection Acceptance = Payment Obligation Arises

There was room for debate over whether this provision merely creates a presumption of inspection acceptance or also triggers the payment obligation. The Supreme Court provided a definitive answer.

In Decision 2001Du3099, the Court held that deemed inspection acceptance means, within the scope of the Act’s application, that the payment obligation also arises. In other words, deemed acceptance is not a mere procedural presumption; it carries the substantive legal effect of creating the payment obligation itself.

What If the Prime Contractor Claims the Goods Were Actually Defective?

Even after 10 days have passed, the prime contractor may want to argue that the delivered goods were defective. However, the burden of proof falls on the prime contractor: they must separately establish that the payment obligation did not arise. The Supreme Court noted that unless the prime contractor proves the debt never arose, the KFTC is entitled to issue corrective orders and impose surcharges.

When Does the 10-Day Period Start for Construction Subcontracting?

Under the parenthetical provision in Article 9(2), for construction subcontracting, the starting point is the date on which the subcontractor notifies completion or progress of work. It is therefore critical for subcontractors to document this notification in writing with a clear date. If the prime contractor fails to respond in writing within 10 days, deemed acceptance takes effect and the payment obligation begins to run from that point.

4. Does a Settlement Agreement Prevent Further Claims?

One of the most complex issues in South Korean subcontracting disputes is the binding force of settlement agreements. If the tax invoice states KRW 35 million but the parties later agreed to settle at KRW 16.5 million, which figure controls?

A Settlement Must Be Based on Verified Actual Progress

The Supreme Court addressed this issue head-on in Decision 2001Du3099. In that case, a director of the subcontractor had issued a tax invoice for KRW 35 million based on anticipated future work. However, the director abandoned the project mid-way, and actual progress fell far short of the invoiced amount. The parties then negotiated and agreed to settle the actual construction price at KRW 16.5 million (including VAT).

The Supreme Court held that, given the circumstances and content of this settlement, both parties had confirmed the actual progress at the time construction stopped and determined the price accordingly. Once such a settlement existed, any debt exceeding the agreed amount was deemed never to have arisen.

Paying VAT First Does Not Mean Accepting the Full Invoice Amount

The subcontractor argued that because the prime contractor had paid the KRW 3.5 million VAT portion in cash, it must have accepted the full KRW 35 million invoice. The Supreme Court rejected this argument, holding that paying the VAT component alone could not establish acceptance of the entire invoiced amount. This is a critically important ruling in practice.

What About Late Interest and Discount Fees Incurred Before the Settlement?

A key additional point from this case is that even though the settlement determined the scope of the main construction price, late payment interest and unpaid promissory note discount fees incurred prior to the settlement remain separate obligations. The court upheld the corrective order for these items, confirming that they survive independently of the main price settlement.

Why Subcontractors Should Not Rush Into Settlement Agreements

Subcontractors eager to receive at least partial payment, or worried about damaging the business relationship, sometimes sign settlement agreements at a significant discount. As this decision demonstrates, once a settlement agreement is signed, recovering amounts above the agreed figure becomes extremely difficult. Legal review before signing any settlement is essential.

5. How Are Promissory Note Discount Fees Calculated?

When a prime contractor pays subcontract fees by promissory note rather than cash, the subcontractor either has to wait until maturity or discount the note at a financial institution, absorbing the cost of early cash conversion. South Korean law requires the prime contractor to bear this cost.

Why Is a Promissory Note Payment Disadvantageous? — The Basics of Note Discounting

Suppose a subcontractor receives a KRW 5 million promissory note with a 3-month maturity. The subcontractor needs immediate cash for materials and labor, so it takes the note to a bank for discounting. The bank deducts interest for the 3-month period, paying out perhaps KRW 4.9 million. The KRW 100,000 difference is the “note discount fee.” The Act requires the prime contractor to compensate this fee.

Article 13(6): The Legal Basis for Discount Fee Claims

The main text of Article 13(6) requires that when the prime contractor pays by promissory note, discount fees for the period from the date of note delivery to the maturity date must be paid at the time the note is delivered. The proviso states that if the note is delivered within 60 days of receiving the goods, discount fees must be paid for the period from day 61 after receipt to the maturity date, payable within 60 days of receipt.

How Were Discount Fees Handled in This Case?

In the Supreme Court Decision 2001Du3099 case, the prime contractor delivered two promissory notes to the subcontractor. Both notes had maturity dates exceeding 60 days from the date of receiving the work. Under Article 13(6) proviso, the prime contractor should have paid discount fees for the period from day 61 to each maturity date. However, the prime contractor delivered the notes without paying any discount fees.

The court upheld the KFTC’s corrective order for these unpaid discount fees, confirming that discount fee obligations arise independently from the main construction price and are not extinguished by a settlement agreement on the principal amount.

What Rate Applies? — Calculating Discount Fees

Discount fees are calculated based on the rate prescribed by KFTC notice. Under the current Notice on Discount Rates for Subcontract Payment by Promissory Note (KFTC Notice No. 2015-15), the applicable discount rate is 7.5% per annum.

The formula is: Discount Fee = Note Amount × Annual Rate (7.5%) × Eligible Days / 365

For example, if a KRW 5 million note matures 90 days after receipt of goods, the discount fee covers the 30-day excess beyond the 60-day threshold: KRW 5,000,000 × 7.5% × 30 / 365 = approximately KRW 30,822. Larger note amounts and longer maturities produce proportionally higher fees. The applicable rate is subject to change by KFTC notice.

What Are the Penalties for Failing to Pay Discount Fees?

Failure to pay discount fees constitutes a violation of Article 13 of the Act. The KFTC may impose corrective orders (Article 25(1)) and surcharges (Article 25-3(1)(iii)). Criminal penalties are also possible under Article 30(1)(i).

Importantly, as confirmed in this decision, the corrective order for unpaid discount fees was upheld even though the main construction price had already been settled. This means that even if the prime contractor has fully paid the principal amount, non-payment of discount fees constitutes an independent and ongoing violation.

Practical Tips for Subcontractors

When receiving a promissory note, calculate immediately how many days the maturity extends beyond the date of delivery. If it exceeds 60 days from receipt, demand discount fee payment from the prime contractor right away. If discount fees are not paid upon note delivery, document the request in writing and include unpaid discount fees as a separate claim item in any subsequent KFTC complaint or civil lawsuit.

6. How Should You Respond to a Subcontract Payment Dispute in South Korea?

Subcontract payment disputes in South Korea involve a complex interplay of KFTC proceedings, civil litigation, and potential criminal prosecution. The choice and sequencing of legal strategies can dramatically affect the outcome.

Strategy for Subcontractors (the Unpaid Party)

First, document the date of your progress notification in writing. If the prime contractor fails to notify inspection results within 10 days, deemed acceptance takes effect automatically. Establishing this starting date clearly is critical evidence for calculating late interest and supporting a corrective order application.

Second, always obtain legal review before signing any settlement agreement. As this case demonstrates, a subcontractor’s ability to claim amounts beyond the settlement figure effectively disappears once the agreement is signed.

Third, consider pursuing KFTC complaints and civil litigation in parallel. A corrective order provides swift relief for currently outstanding amounts, while civil litigation enables recovery of late interest, damages, and other losses.

Strategy for Prime Contractors (the Paying Party)

First, always notify inspection results in writing within 10 days of receiving goods or work. Oral communications or informal emails may not qualify as “written notification” under the Act. Certified mail or electronically signed documents are the safest approach.

Second, accurately measure actual work progress and base settlement agreements on verified figures. If construction is interrupted or disputes arise, documented measurement records become crucial evidence.

Third, do not underestimate late interest and discount fee obligations. As the Supreme Court confirmed, these obligations are separate from the main construction price and can independently trigger corrective orders and surcharges. The current late payment interest rate under KFTC Notice No. 2018-21 is 15.5% per annum.

Essential Checklist for Subcontract Payment Disputes in South Korea

• Progress notification documented in writing (with clear date)
• 10-day inspection notice compliance verified
• 60-day payment deadline compliance checked
• Promissory note maturity within 60-day threshold confirmed
• Late interest and discount fees paid or properly claimed
• Settlement agreement reviewed by legal counsel before signing
• Outstanding unpaid amounts verified at time of KFTC complaint

Based on extensive experience handling subcontracting disputes, missing even one or two items on this checklist can result in differences of tens of millions of Korean won. Early-stage strategic planning is the single most important factor in determining the outcome of these disputes.

7. FAQ

Subcontract payment disputes in South Korea involve a complex interplay between KFTC administrative proceedings and civil litigation. Drawing on considerable experience with these matters, early evidence preservation and thorough review before signing any settlement agreement are the most decisive factors in determining the outcome.

* The legal information presented in this article is intended for general guidance purposes only. Legal outcomes may vary depending on the specific facts of each case. For advice on actual legal matters, please consult a qualified attorney.

atlaw.kr” target=”_blank” rel=”noopener noreferrer”>Visit Atlas Legal Website