JIPYONG LLC

Jipyong News|KOREA LEGAL INSIGHT

Set-off in Korean Rehabilitation Proceedings: Limits and Practical Risks for Foreign Creditors

2026.01.19

Introduction
<div> 
Set-off is recognized under Korean civil law as a mechanism that allows parties with mutual obligations of the same nature to extinguish their respective debts to the extent they overlap.  In ordinary commercial transactions, set-off is widely used as a credit-risk management tool and is frequently incorporated into contractual arrangements governing long-term supply, service, or financing relationships. 
 
The legal treatment of set-off, however, changes significantly once rehabilitation proceedings are commenced against a counterparty in Korea.  From that point, the exercise of set-off rights is no longer governed solely by the Civil Act, but is also subject to the Debtor Rehabilitation and Bankruptcy Act (the “DRBA”), which imposes specific statutory restrictions to preserve equality among creditors and safeguard the debtor’s estate. 
 
In practice, creditors often underestimate these insolvency-specific limitations.  A failure to properly assess the permissibility of a set-off under the DRBA results in its invalidation, the loss of procedural and voting rights, or even the exclusion of the relevant claims from the rehabilitation process. </div>
 
 
1. Set-off in Rehabilitation Proceedings: A Restricted Mechanism

<div> 
Outside of insolvency, set-off generally operates as a relatively straightforward mechanism.  Where two parties owe obligations of the same nature to one another, either party may offset its obligation once the relevant maturity requirements are satisfied.  In the context of rehabilitation proceedings, however, this commercial logic is significantly constrained. 
 
Under the DRBA, set-off is no longer an automatic or freely exercisable right.  Only creditors holding rehabilitation or secured rehabilitation claims may assert a set-off, and only if all statutory requirements are met.  These requirements pertain to the timing of claim accrual, the maturity of the obligations, and compliance with procedural steps, including filing a formal declaration of set-off with the court-appointed receiver within the prescribed period. 
 
For foreign creditors, this framework reflects a material risk reallocation.  Set-off provisions that appear effective and enforceable in ordinary commercial transactions may offer limited or no protection once rehabilitation proceedings commence.  Failure to satisfy even a single statutory requirement may render an attempted set-off legally ineffective. </div>
 
 
2. Prohibited Set-off and Structural Policy Concerns

<div> 
Beyond conditioning the availability of set-off, the DRBA expressly prohibits set-off in defined circumstances.  These prohibitions are grounded in insolvency policy rather than contractual fairness.  Where set-off would undermine creditor equality or diminish the debtor’s estate, it is categorically disallowed. 
 
Common high-risk situations include:

<ul>
	<li>obligations incurred after the commencement of rehabilitation proceedings;</li>
	<li>obligations assumed with awareness of a payment suspension or pending insolvency filings; and</li>
	<li>strategic acquisition of claims once insolvency risk has become apparent.</li>
</ul>
 
In such cases, Korean law presumes that permitting set-off would allow certain creditors to achieve preferential recovery at the expense of the collective restructuring process, and hence, is prohibited.</div>
 
 
3. Procedural Risk, Retroactive Invalidity, and the Importance of Claim Filing

<div> 
A particularly challenging feature of Korean rehabilitation law is the retroactive invalidation of set-offs.  Korean courts have affirmed that even a set-off declared before proceedings commenced may be nullified if statutory grounds for prohibition exist when the proceedings start.  Consequently, pre-filing timing alone does not shield a set-off from post-filing judicial review. 
 
This framework creates significant procedural risk for creditors.  For example, a supplier or financier may reasonably believe its exposure is neutralized by a pre-filing set-off, only to discover after proceedings commence that the set-off has been invalidated, leaving the supplier as an unsecured rehabilitation creditor. 
 
A common mistake is assuming that delivering a set-off declaration to the court-appointed receiver extinguishes the corresponding obligations.  Under the DRBA, this is not guaranteed.  If a set-off is later found to be impermissible, the declaration takes no legal effect.  A creditor who failed to file a rehabilitation claim in reliance on the set-off may then face both the loss of the claim and procedural disadvantages. </div>
 
 
Conclusion

<div> 
For foreign creditors and investors, the central lesson is that set-off in Korean rehabilitation proceedings is not a routine contractual remedy but a tightly regulated insolvency mechanism.  Once rehabilitation proceedings commence, set-off must be reassessed through the lens of the DRBA, with careful attention to claim classification, timing, and procedural compliance. 
 
Given the mandatory nature of set-off prohibitions, the risk of retroactive invalidation, and the serious consequences of non-filing, conservative strategies are often warranted.  Where there is uncertainty, filing a rehabilitation claim while separately evaluating the feasibility of set-off is crucial to preserving both economic value and governance rights in the restructuring process. 
 
Foreign companies dealing with financially distressed Korean counterparties should therefore integrate set-off considerations into a broader insolvency response strategy, not treat it as a standalone remedy.  Seeking early legal assessment is essential to avoid the unintended forfeiture of rights.</div>

</div>

News JIPYONG Established Jipyong IP 2024.11.25

KOREA LEGAL INSIGHT 2025 in Review & 2026 Outlook 2026.01.05

Back to List

JIPYONG LLC

Related Practices

Professionals

Related Practices

Professionals

SHARE

Disclaimer

Limited Liabilities