On back foot after Lone Star threat, gov’t readies team

The government has set up a task force in case U.S. fund Lone Star proceeds with its threat to seek arbitration for what it sees as lost revenue resulting from Seoul’s interference in its sale of Korea Exchange Bank (KEB).

The unit has been established within the Prime Minister’s Office to deal with the potential legal dispute, which may emerge as the country’s first investor-state dispute (ISD) settlement case.

Officials said the team was convened last week as Lone Star seems intent on filing a claim after the government stepped in to obstruct its sale of the bank to several banks since 2006. It finally sold its controlling stake to Hana Financial Group early this year.

Lone Star’s aggressive move comes shortly after it was slapped with a huge tax bill by the government for the transaction.

The Texan buyout fund has garnered much bad press in the country for what its critics see as rampant profit-taking. In turn, it says the government has breached the rule of law by ignoring the fact that it bought KEB using a Belgium-based investment vehicle, which effectively lets it escape liability for the tax.

“Lone Star has requested discussions with the government in line with the ISD clause in a bilateral agreement between Korea and Belgium that is aimed at promoting and protecting foreign investments,” said a high-ranking official at the Financial Services Commission (FSC). “The appropriate government departments will join in the talks.”

The ISD clause has already become a controversial topic in Korea as protestors fought hard, but ultimately unsuccessfully, to have it removed from the Korea-U.S. Free Trade Agreement, which went into effect in March. It was not included in a similar pact with the EU that was implemented last summer.

The clause allows foreign companies and investors to file for arbitration in the event of a dispute with a company from the other country and is seen as a form of insurance against protectionist government policy.

If Lone Star fails to pound out an agreement with the government within six months, the fund has vowed to submit its claim to the International Court of Arbitration in November.

Lone Star released a statement on Monday notifying Seoul of its intentions.

“While we sincerely hope that the South Korean government will engage in good faith discussions to resolve these claims, if the dispute cannot be resolved amicably, Lone Star will file for arbitration. The claims will be heard in an international forum based in Washington, D.C., by an impartial panel of arbitrators whom we are confident will order Korea to compensate Lone Star for the damages its investors have suffered,” John Grayken, chairman of Lone Star, said in the statement.

The release followed a document it sent to the Korean Embassy in Belgium on May 22 that described the Korea’s National Tax Service (NTS)’s recent move as “arbitrary, unlawful and confiscatory.” The NTS has ordered Lone Star to pay withholding tax of 391.5 billion won for the sale.

The U.S. private equity fund, which entered Korea in 1998, claims that “public sentiment towards foreign investment in Korea soured” as the local economy strengthened after the Asian Financial Crisis of the late 1990s.

“Korean financial and tax regulators responded with a series of illegal actions that resulted in billions of euros of damages to Lone Star’s investors,” Grayken said.

Lone Star complained that Korea’s financial regulators were unwilling to approve a string of prospective buyers for its 51 percent KEB stake, which it purchased in 2003. It said this forced it to hold on to the asset for an unnecessarily long time, which ultimately resulted in a dramatic fall in the price of the stake.

It agreed deal with Hana Financial Group in November 2010 but the FSC delayed approving the sale until January of this year. The regulator waited until it could rule that Hana had sufficient financial strength for the acquisition.

Lone Star attempted to sell the same stake to Kookmin Bank in 2006, for $7.3 billion and to HSBC for $6.3 billion in 2008.

The fund claims it should be protected by its bilateral investment treaty with Belgium as its KEB stake was made via its Belgian subsidiary. But the NTS insists the subsidiary is just a paper company and the tax must be paid in full.

Lone Star reaped around 4 trillion won by selling its KEB share to Hana in February, shortly after the move was approved, and another 250 billion won through its sale of Star Tower in Yeoksam, southern Seoul, in 2004.

The tax office handed Lone Star a withholding tax bill of 100 billion won for the building sale, but the U.S. fund avoided this after winning a suit it filed in 2007. However, it still owes 1.6 billion won in corporate tax on the sale after the Supreme Court issued a verdict to this effect on May 23. This came after the government found Lone Star had not fully disclosed its profit on the property transaction.

By Song Su-hyun [ssh@joongang.co.kr]