Suitability and the Duty to Explain for High-Risk Derivatives, and the Duty of Care in Financial Institutions' Loan Screening: Standards Set by Three Supreme Court Judgments

Question

This brief uses three judgments to set out how courts assess whether currency option derivative contracts are unfair or constitute standard terms and conditions, the scope of a bank's suitability principle and duty to explain, and, in project finance lending, a financial institution officer's duty of care of a good manager and the business judgment rule.

The first issue is the question addressed in 2013Da26746: "In selling KIKO currency options that caused heavy losses when exchange rates surged, did the bank breach the suitability principle and the duty to explain?" The second issue is the question addressed in 2012Da13637: "Is a KIKO currency option contract between an exporting company and a bank unfair, or does it breach the suitability principle?"

The third issue is the question addressed in 2009Da80521: "When a project finance loan is not recovered, is a financial institution officer relieved of liability by invoking business judgment?" All three judgments ask how the boundaries of the text and the substantive factors for decision are to be identified on the record.

Material to check

First (2013Da26746): this judgment addresses whether a KIKO currency option contract is unfair and whether it constitutes standard terms and conditions, the duty to disclose the price components of a zero-cost structure, rescission and termination on the ground of a change of circumstances, and the standards of suitability and the duty to explain as applied to companies seeking a currency hedge and to companies with an investment purpose. To examine unfairness and whether the contract constitutes standard terms and conditions, review in the currency option contract how "the specific terms of the contract, such as the contract amount and the strike exchange rate" came to be fixed through individual negotiation, and review the entire content of the contract as at the time of its conclusion. To examine suitability and the duty to explain, review the foreign exchange risk management rules, the records of the foreign exchange risk management team, and the materials on foreign currency inflows and trading experience to determine whether the bank ascertained in advance the company's "financial condition, including expected foreign currency inflows and the size of its assets and sales", and review the records of the explanation of risk factors.

Second (2012Da13637): this judgment addresses whether a KIKO currency option contract is unfair and whether it constitutes standard terms and conditions, the duty of disclosure for a zero-cost structure, rescission and termination on the ground of a change of circumstances, suitability as a hedge, the content and scope of the duty to protect customers and the duty to explain owed to companies seeking a currency hedge, and whether comparative negligence may be applied. To examine unfairness and whether the contract constitutes standard terms and conditions, review in the currency option contract how "the specific terms of the contract, such as the contract amount and the strike exchange rate" came to be fixed through individual negotiation, and, under the standard that the matter "must be determined as at the time of the juristic act", review the entire content of the contract as at its conclusion. To examine suitability and the duty to explain, review the materials on each company's foreign currency inflows and financial condition, the materials on its trading purpose and experience, and the records of the explanation of risk factors and potential losses, to determine whether the bank clearly explained "the structure and principal terms of the over-the-counter derivative contract in question".

Third (2009Da80521): this judgment addresses, in connection with project finance loans, whether a financial institution officer breached the duty of care of a good manager, whether a default may be presumed from the fact of non-recovery alone, and how far discretion in business judgment is permitted. To examine whether the duty of care was breached, review the loan screening materials to determine whether the officer comprehensively considered "various matters such as the conditions, content and size of the loan, the repayment plan, the existence and content of security, and the debtor's assets, business conditions and growth potential", and whether the officer followed "procedures such as obtaining sufficient materials and examining them closely". Review the records concerning the possibility of legal disputes over the project site and the assessment of the project's viability, and the materials reviewing the sources of repayment and cash flow, and check that liability was not imposed on the basis of non-recovery alone.

Possible readings

In 2013Da26746, the issues were whether the KIKO currency option contract constituted an unfair act, the point in time by reference to which it is determined whether a juristic act is unfair, and whether a contract becomes unfair merely because its structure may cause heavy losses to one party following a sharp change in the external environment after conclusion.

In 2012Da13637, the issues likewise were whether the KIKO currency option contract constituted an unfair act, the point in time by reference to which it is determined whether a juristic act is unfair, and whether a contract becomes unfair merely because its structure may cause heavy losses following a subsequent change in the environment.

In 2009Da80521, the issues were the standard for determining whether a financial institution officer breached the duty of care of a good manager in lending, whether neglect of duty is presumed merely from the result that a loss from unrecovered loans arose, and whether the project finance loans fell within the scope of discretion in business judgment.

What the decisions held

Supreme Court en banc Judgment 2013Da26746 rendered 26 September 2013 held: "Whether a juristic act constitutes an unfair juristic act must be determined as at the time of the juristic act." In this judgment, the Court takes the time of the juristic act as the reference point for unfairness. A contract does not become unfair merely because its structure causes one party's losses to grow following a sharp subsequent change in exchange rates. Where the contract amount and strike exchange rate fixed through individual negotiation are combined with the structure, the structure itself does not constitute standard terms and conditions, and, absent special circumstances, there is no duty to disclose the theoretical value and fees of a zero-cost product. Recommending a contract carrying excessive risk in light of its business conditions is prohibited in respect of a company seeking a currency hedge, but in respect of a company seeking foreign exchange gains it cannot be concluded that suitability was breached merely because the contract was concluded after the risks were disclosed. In this case, the plaintiff could be regarded as having had a foreign exchange risk management organisation and experience of numerous contracts and as having contracted for the purpose of currency speculation, and no deficiency in the explanation was apparent; the court below therefore erred in finding a breach of suitability and of the duty to explain.

Supreme Court en banc Judgment 2012Da13637 rendered 26 September 2013 held: "In general, a seller of goods or services has no duty to inform the buyer of, or disclose, the components of the sale price of the goods or services it sells, such as their cost or the seller's profit." In this judgment, the Supreme Court held that unfairness is determined by looking at the entire content of the contract as at the time of its conclusion, and did not find the contract unfair merely because of a subsequent surge in exchange rates. Its view was that contract terms fixed through individual negotiation are individual agreements, that the contract structure itself is not standard terms and conditions, and that in principle there is no duty to disclose the theoretical value and fees of a zero-cost product. It held that exchange rate fluctuation is a risk presupposed by the contract, so that termination on the ground of a change of circumstances is in principle not recognised, and that a contract may be regarded as a hedge even if it reduces risk only within a certain range. A bank has a duty to ascertain a company's foreign currency inflows, financial condition and the like and then refrain from recommending excessive risk, and to explain the structure and the risk of loss clearly. Finding it difficult to accept the judgment below on the suitability of the contract dated 20 December 2007, the Court reversed only that part and remanded it to the court below for further hearing.

Supreme Court Judgment 2009Da80521 rendered 13 October 2011 held: "An officer of a financial institution owes the institution a duty of care of a good manager, and therefore can be said to have discharged his or her duties as an officer only when he or she has faithfully performed that duty. However, where a financial institution seeks to hold its officer liable for damages for non-performance on the ground of neglect of duty in connection with a loan, even if a loan made by the officer has ultimately become difficult or impossible to recover, that fact alone does not justify holding the officer who made the lending decision responsible for ensuring that no such result as a loss from unrecovered loans would occur at all, and thereby concluding that the officer's decision breached the duty of care of a good manager or the duty of loyalty." Under this judgment, an officer's obligation in performing his or her duties is not an obligation of result requiring that a certain outcome be prevented, but an obligation to exercise due care. The Court held that a decision falls within discretion where it was based on reasonable information, followed appropriate procedures, was made in the best interests of the institution and in good faith, and was not manifestly unreasonable. A breach of the duty of care cannot be concluded or presumed from the result of non-recovery alone. The Court held that because project finance loans depend on future cash flows, assessment of the project's viability is central. In this case, the Court upheld the judgment below that there was no breach of the duty of care with respect to the loans to Companies A, C and D, and reversed and remanded with respect to the loan to Company B because the dispute over the project site had not been sufficiently examined.

Practical checklist

First, in selling KIKO currency options that caused heavy losses when exchange rates surged, did the bank breach the suitability principle and the duty to explain? Whether the bank recommended excessive risk in light of the company's business conditions is examined through the records showing that it ascertained in advance the company's "financial condition, including expected foreign currency inflows and the size of its assets and sales" and through the circumstances of the contract's conclusion; whether the duty to explain was performed is checked against the records showing that the bank clearly explained "the principal information about the transaction, such as the risk factors inherent in the transaction and the key factors affecting potential losses".

Second, is a KIKO currency option contract between an exporting company and a bank unfair, or does it breach the suitability principle? Unfairness is examined, under the standard that it "must be determined as at the time of the juristic act", through the contract and the negotiation records reviewed for the entire content of the contract as at its conclusion; suitability and the duty to explain are checked against the records showing how the bank ascertained the company's business conditions and the records of the explanation of risk factors.

Third, when a project finance loan is not recovered, is a financial institution officer relieved of liability by invoking business judgment? Whether the decision was based on reasonable information and followed appropriate procedures is checked against the screening materials concerning "various matters such as the conditions, content and size of the loan, the repayment plan, the existence and content of security, and the debtor's assets, business conditions and growth potential" and the records showing that "procedures such as obtaining sufficient materials and examining them closely" were followed.

Glossary

Order of determining contract validity and bank duties in high-risk derivatives disputes (2013Da26746): The Court takes the time of the juristic act as the reference point for unfairness. A contract does not become unfair merely because its structure causes one party's losses to grow following a sharp subsequent change in exchange rates. Where the contract amount and strike exchange rate fixed through individual negotiation are combined with the structure, the structure itself does not constitute standard terms and conditions, and, absent special circumstances, there is no duty to disclose the theoretical value and fees of a zero-cost product. Recommending a contract carrying excessive risk in light of its business conditions is prohibited in respect of a company seeking a currency hedge, but in respect of a company seeking foreign exchange gains it cannot be concluded that suitability was breached merely because the contract was concluded after the risks were disclosed. In this case, the plaintiff could be regarded as having had a foreign exchange risk management organisation and experience of numerous contracts and as having contracted for the purpose of currency speculation, and no deficiency in the explanation was apparent; the court below therefore erred in finding a breach of suitability and of the duty to explain. The factors identified for decision include expected foreign currency inflows and financial condition, trading purpose and trading experience, and risk factors and potential losses.

Standards for the fairness of derivative contracts, whether they constitute standard terms and conditions, and banks' duty to protect customers (2012Da13637): The Supreme Court held that unfairness is determined by looking at the entire content of the contract as at the time of its conclusion, and did not find the contract unfair merely because of a subsequent surge in exchange rates. Its view was that contract terms fixed through individual negotiation are individual agreements, that the contract structure itself is not standard terms and conditions, and that in principle there is no duty to disclose the theoretical value and fees of a zero-cost product. It held that exchange rate fluctuation is a risk presupposed by the contract, so that termination on the ground of a change of circumstances is in principle not recognised, and that a contract may be regarded as a hedge even if it reduces risk only within a certain range. A bank has a duty to ascertain a company's foreign currency inflows, financial condition and the like and then refrain from recommending excessive risk, and to explain the structure and the risk of loss clearly. Finding it difficult to accept the judgment below on the suitability of the contract dated 20 December 2007, the Court reversed only that part and remanded it to the court below for further hearing. The factors identified for decision include expected foreign currency inflows and financial condition, the contract structure and risk-of-loss factors, and the hedged range and transaction terms.

Standards for financial institution officers' duty of care in loan screening and business judgment (2009Da80521): An officer's obligation in performing his or her duties is not an obligation of result requiring that a certain outcome be prevented, but an obligation to exercise due care. The Court held that a decision falls within discretion where it was based on reasonable information, followed appropriate procedures, was made in the best interests of the institution and in good faith, and was not manifestly unreasonable. A breach of the duty of care cannot be concluded or presumed from the result of non-recovery alone. The Court held that because project finance loans depend on future cash flows, assessment of the project's viability is central. In this case, the Court upheld the judgment below that there was no breach of the duty of care with respect to the loans to Companies A, C and D, and reversed and remanded with respect to the loan to Company B because the dispute over the project site had not been sufficiently examined. The factors identified for decision include the loan conditions and repayment plan, the existence and content of security, and the debtor's assets and business conditions.

Sources and limitations

This brief is based solely on the texts of Articles 104, 109, 681 and 750 of the Civil Act, Articles 2(1), 3 and 6 of the Act on the Regulation of Terms and Conditions, and Articles 382(2) and 399(1) of the Commercial Act, as published on the National Law Information Center, and on Supreme Court Judgment 2013Da26746 rendered 26 September 2013, Supreme Court Judgment 2012Da13637 rendered 26 September 2013 and Supreme Court Judgment 2009Da80521 rendered 13 October 2011.

This is academic research material setting out general legal principles and standards for reviewing records; it is not legal advice on any individual case or an opinion for submission to a court.

Points left open

2013Da26746: Even after this judgment, where does the line between a hedging purpose and a speculative purpose lie?

2012Da13637: At what point should recommending currency options exceeding the volume of exports be regarded as a breach of the suitability principle?

2009Da80521: Where a large loan is made with knowledge of a dispute over the project site, how far does the duty to gather information extend?

When to reconsider

2013Da26746: The conclusion may be revisited if records are found showing that the bank actively recommended a contract carrying excessive risk to a company with a hedging purpose and did not explain material risks.

2012Da13637: The conclusion will be revisited if the recommendation process for the contract dated 20 December 2007 and the export forecast materials are heard again.

2009Da80521: The conclusion will be revisited if further screening records come to light concerning the legal dispute over the project site, the borrower's financial capacity and the security. Management records at the time of extension are material for the assessment of negligence.

Statutes referred to

• 민법 제104조, 제109조, 제681조, 제750조
• 약관의 규제에 관한 법률 제2조 제1항, 제3조, 제6조
• 상법 제382조 제2항, 제399조 제1항

Decisions referred to

• 대법원 2013. 9. 26. 선고 2013다26746 전원합의체 판결 · Decision ledger
• 대법원 2013. 9. 26. 선고 2012다13637 전원합의체 판결 · Decision ledger
• 대법원 2011. 10. 13. 선고 2009다80521 판결 · Decision ledger

Verification status

The cited provisions (Articles 104, 109, 681 and 750 of the Civil Act; Articles 2(1), 3 and 6 of the Act on the Regulation of Terms and Conditions; Articles 382(2) and 399(1) of the Commercial Act) and the judgments discussed (Supreme Court Judgment 2013Da26746 rendered 26 September 2013; Supreme Court Judgment 2012Da13637 rendered 26 September 2013; Supreme Court Judgment 2009Da80521 rendered 13 October 2011) were checked against the current statutes on the National Law Information Center and the original texts of the Supreme Court judgments as at 15 October 2026. This brief cites only the three judgments listed among the judgments discussed.