When Is Reducing a Subcontract Price Lawful in South Korea?
Table of Contents
- 1. Is Reducing a Subcontract Price Permitted in South Korea?
- 2. What Types of Reductions Are Categorically Prohibited Under Article 11(2)?
- 3. How Do South Korean Courts Assess Voluntary Consent?
- 4. When Is a Raw-Material-Based Price Reduction Legitimate in South Korea?
- 5. How Have South Korean Courts Treated Exchange-Rate-Based Reductions?
- 6. What Procedural Obligations Apply Even When Legitimate Grounds Exist?
- 7. FAQ
Case Background: A South Korean automotive parts manufacturer reduced subcontract prices for 45 suppliers by a combined KRW 8 billion, citing raw material cost declines and exchange-rate movements. The Korea Fair Trade Commission (KFTC) found these reductions unlawful and imposed surcharges of approximately KRW 11.7 billion. The company challenged the KFTC in court — and lost on almost every count. What determined the outcome?
The KFTC’s Case vs. the Primary Contractor — What the Court Found
※ This analysis is based on Seoul High Court Case 2020Nu64561 (judgment rendered February 2, 2023). The names of the parties and subcontractors are anonymized in accordance with the court’s notation. Certain facts have been summarized for clarity.
Between June 2015 and August 2017, a manufacturer of automotive air-conditioning components carried out 106 lump-sum price reductions against 45 subcontractors. The company advanced multiple justifications — raw material price linkage, exchange-rate adjustments, productivity-sharing, new business awards, and investment cost recovery — but the Seoul High Court rejected nearly all of them after scrutinizing the company’s internal documents, emails, and negotiation records. The judgment provides a detailed, fact-specific roadmap of what “legitimate grounds” actually requires under South Korean subcontracting law, and it remains an important reference for both primary contractors managing supply chains and subcontractors evaluating whether a price reduction they accepted was, in fact, unlawful.
1. Is Reducing a Subcontract Price Permitted in South Korea?
As a general rule, no. Article 11(1) of the Fair Transactions in Subcontracting Act (Subcontracting Act) states: “A primary contractor shall not reduce the subcontract price determined at the time of the subcontracting order. However, if the primary contractor proves legitimate grounds, the subcontract price may be reduced.”
The Burden of Proof Rests with the Primary Contractor
The Seoul High Court in Case 2020Nu64561 confirmed that “in light of the legislative purpose, text, and structure of the Subcontracting Act, the ‘legitimate grounds’ referred to in the proviso of Article 11(1) must be proved by the primary contractor asserting them.” A primary contractor cannot simply assert a rationale; it must establish that rationale through objective evidence.
The court also clarified that Article 11 applies not only to reductions of amounts already payable, but also to reductions of amounts expected to become payable in the future. A primary contractor cannot escape the statute’s reach by framing a reduction as a “new unit price determination” for future orders when, in substance, it targets quantities whose delivery was already substantially fixed.
2. What Types of Reductions Are Categorically Prohibited Under Article 11(2)?
Article 11(2) of the Subcontracting Act lists nine categories of conduct that cannot constitute legitimate grounds, regardless of other circumstances. A reduction falling within any of these categories is unlawful without further analysis.
| Item | Prohibited Conduct |
|---|---|
| 1 | Reducing the price after the order is placed on the basis of cooperation requests, order cancellations, or economic conditions, where no reduction terms were disclosed at the time of the order |
| 2 | Retroactively applying a newly negotiated unit price to quantities already ordered |
| 3 | Making excessive deductions on the pretext of early payment or cash payment |
| 4 | Reducing the price for the subcontractor’s errors that had no material effect on the primary contractor’s losses |
| 5 | Deducting amounts exceeding the fair price for goods or equipment the primary contractor required the subcontractor to purchase or use |
| 6 | Reducing the price because commodity prices or material costs have declined between the delivery date and the payment date |
| 7 | Reducing the price on unreasonable grounds such as the primary contractor’s own operating losses or sales price cuts |
| 8 | Passing on to the subcontractor costs the primary contractor is legally required to bear, such as employment insurance premiums or industrial safety management costs |
| 9 | Other conduct equivalent to items 1 through 8, as prescribed by Presidential Decree |
3. How Do South Korean Courts Assess Voluntary Consent?
The existence of a signed agreement does not, by itself, establish that the subcontractor voluntarily consented to the reduction. The Supreme Court has held that voluntary consent must be assessed by examining all relevant circumstances, including the following factors (Supreme Court Decision 2010Da53457, January 27, 2011).
| Factor | Description |
|---|---|
| Degree of the primary contractor’s superior bargaining position | The primary contractor’s market dominance over the subcontractor |
| Subcontractor’s revenue dependence | The proportion of the subcontractor’s total revenue derived from the primary contractor |
| Continuity of the trading relationship | Duration and importance of the ongoing relationship to the subcontractor |
| Availability of alternative customers | Whether the subcontractor could realistically replace the primary contractor |
| Difference between the original and reduced price | The economic impact of the reduction on the subcontractor |
| Timing gap between delivery and the reduction demand | Whether the reduction was demanded after the goods had already been delivered |
| Circumstances of the reduction | How the negotiation was conducted and whether pressure was applied |
| Nature and extent of the subcontractor’s disadvantage | Actual financial harm caused by the reduction |
High Revenue Dependence Weighs Against Voluntary Consent
In Case 2020Nu64561, the court noted that most subcontractors derived approximately 60–80% of their total revenues from the primary contractor. Given this level of dependence, subcontractors faced a realistic risk of losing their entire business if they refused the primary contractor’s demands. The court therefore declined to treat their signatures as genuine consent and significantly discounted confirmation letters and witness testimony provided by subcontractor personnel after the KFTC investigation had commenced.
4. When Is a Raw-Material-Based Price Reduction Legitimate in South Korea?
The mere fact that raw material costs have fallen is not sufficient. Seoul High Court Case 2020Nu64561 held that for a raw-material-based reduction to be legitimate in South Korea, all of the following must be established.
- Prior Agreement — There must be a prior agreement between the primary contractor and the subcontractor to adjust the unit price in line with changes in raw material costs.
- History of Periodic Adjustments — The parties must have actually been making periodic unit price adjustments pursuant to that agreement.
- Bidirectional Adjustment — Critically, unit prices must have been raised when raw material costs increased. A mechanism that operates only in the primary contractor’s favor — lowering prices when costs fall but not raising them when costs rise — does not qualify.
- Rational Calculation — The reduction amount must not exceed the actual decrease in the subcontractor’s production costs attributable to the raw material price decline.
The One Case Where the Court Accepted Legitimate Grounds
Of the 106 reductions examined, the court accepted legitimate grounds for only three. One involved an aluminum (A3003) price adjustment (the case referred to in the judgment as “Line Item 71”). The company’s electronic records confirmed that between 2014 and 2017, unit prices for the relevant subcontractor had been adjusted ten times based on the aluminum price index, and six of those adjustments were price increases. An email exchange the day before the reduction also clearly identified the specific aluminum price decline and the corresponding cost savings calculation. The reduction amount matched that calculation. These features — a documented bidirectional history, a contemporaneous written explanation, and a traceable calculation — distinguished this item from the others.
5. How Have South Korean Courts Treated Exchange-Rate-Based Reductions?
South Korean courts apply the same rigorous standard to exchange-rate-based reductions as to raw-material-based ones. A primary contractor cannot justify a reduction simply by pointing to a favorable exchange-rate movement that has improved the subcontractor’s effective margins.
Why the Court Rejected All Exchange-Rate Reductions in This Case
For the reductions attributed to yen/won exchange-rate movements, the company’s own transaction records showed that after a period of rate-linked adjustments ending around 2009–2011, the unit prices for the relevant subcontractors were held constant for six to eight years — through substantial rate fluctuations in both directions — before the company demanded lump-sum reductions in 2016–2017. The court found several aspects of the company’s position difficult to accept.
First, the claim that rate-linked adjustments had been “accidentally omitted” for half a decade was inherently implausible. Second, even after making the first lump-sum reduction in July 2016, the company left the unit price unchanged and then made three additional lump-sum reductions for the same subcontractor — behavior inconsistent with a genuine correction of an oversight. Third, the LSP agreements for most of these transactions either contained no stated reason for the reduction, or stated a reason entirely different from exchange-rate movements (e.g., “productivity improvement”).
The conditions that would need to be satisfied for an exchange-rate-based reduction to be legitimate in South Korea are, in summary:
- A prior agreement to link unit prices to exchange-rate movements
- A continuous history of exchange-rate-based adjustments, including rate increases when the rate moved against the subcontractor
- A rationally calculated reduction amount that does not exceed the reduction in the subcontractor’s actual production costs
6. What Procedural Obligations Apply Even When Legitimate Grounds Exist?
Even where legitimate grounds can be demonstrated, a primary contractor in South Korea must follow prescribed procedures. Under Article 11(3) of the Subcontracting Act and Article 7-2 of the Enforcement Decree, the primary contractor is required to provide the subcontractor with a written notice containing all of the following information.
- The reason and basis for the reduction
- The quantity of goods or services subject to the reduction
- The reduction amount
- The method of deduction (e.g., offset against future invoices)
- Any other information substantiating the legitimacy of the reduction
The Evidentiary Importance of Contemporary Documentation
One of the most striking aspects of Case 2020Nu64561 was the extent to which contemporaneous internal documents and email records — rather than retrospectively assembled agreements — determined the outcome. The court found that several LSP agreements either contained no stated reason, stated a reason inconsistent with the company’s litigation position, or had been fabricated or materially altered after the KFTC’s on-site investigation. Multiple employees admitted to inserting language into historic documents to create paper evidence of justifications that, in the court’s assessment, had never actually existed. Experience from handling subcontracting disputes in South Korea confirms that real-time documentation of the negotiation rationale — maintained in the ordinary course of business — is decisive in these cases.
7. FAQ
Atlas Legal advises both primary contractors and subcontractors on supply-chain contract design, KFTC investigations, and administrative litigation in South Korea. The firm has handled numerous disputes involving unfair subcontracting practices, drawing on experience accumulated across a range of industries and transaction structures.
※ The information in this post is provided for general informational purposes only and does not constitute legal advice. The applicable legal analysis may differ depending on the specific facts of each case. Please consult a qualified attorney for advice on any particular matter.