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Appeals Court Finds KIKO Agreements Valid

October 2011 - Finance. Legal Developments by Yulchon.

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In its initial decision on the merits, the Seoul High Court has found that Knock-In, Knock-Out (KIKO) agreements are valid, despite plaintiffs' contention that such agreements should be declared null and void (Seoul High Court Decision No. 2010Na34519 dated May 31, 2011).

KIKO agreements are currency options designed to help companies hedge exchange rate risk associated with the appreciation of the Korean won beginning in the middle of the 2000's. However, when the won depreciated precipitously against the dollar during the global financial crisis in 2008, companies that had entered into KIKO agreements filed lawsuits against the banks, claiming that the KIKO agreements are null and void.

Nearly 140 cases Had been filed with the Seoul Central District Court regarding the KIKO issue, and the first courts decided that the KIKO agreements Were found to be neither unfair nor fraudulent. However, among 91 cases (involving 118 companies) decided on November 29, 2010, the court found that the banks failed to fully explain the KIKO agreements to customers and thus are partially responsible for the losses incurred by 19 companies who had filed claims.

Even after the Trial court's court decision, companies and legal scholars claimed that the banks not only failed to explain the agreements but also deceived the companies by describing the KIKO agreements as zero-cost products despite charging sizable fees for them. This claim was based on the German Federal Court of Justice's determination that banks were liable in CMS Spread Ladder Swaps, a kind of interest rate swap product.

However, the Seoul High Court decided that (i) the expected profit of the banks via option exchange was not unfairly large compared to that of the companies since the possibility that the actual exchange rate being outside the range of the knock out and knock in exchange rates was very low Based on the market exchange rate at the time of the execution of the KIKO agreements; (ii) the banks' fees in connection with the KIKO agreements were not excessive compared to other financial products; (iii) customers Did not have to pay extra premiums or fees as the call option Premium and put option Premium were the same; (iv) the banks were not obligated to explain Options' premium pricing methodology or fee scale; and (v) the plaintiff companies negotiated proper contract prices, had experience in forward exchange, foreign exchange risk insurance and other currency option agreements and were well aware of the risks associated with the KIKO agreements, and were actively involved in the negotiation of the execution time and contract terms with the banks, and in that regard the banks did not violate the suitability rule or its explanation obligation.

The significance of this decision is that the appeals court affirmed the trial court's decision that KIKO agreements are not null and void and that banks may be liable for a loss only where a violation of the suitability rule and explanation obligation is found (the appeals court for preliminary injunction proceedings regarding the KIKO lawsuits has made the same decision). In addition, the Seoul High Court's rejection of the companies' broad interpretation of the criteria for the banks' explanation obligation can be interpreted as confirmation of the Supreme Court's ruling on the banks' explanation obligation.

The Supreme Court has yet to rule on this case. This decision is expected to have a significant impact on over 100 KIKO cases pending at the Seoul High Court and other district courts.

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