A new price linkage system was introduced through amendments to the Enforcement Decrees to the Fair Transactions in Subcontracting Act (the “FTSA”) and the Act on the Promotion of Mutually Beneficial Cooperation Between Large Enterprises and Small and Medium Enterprises (the “Mutual Growth Act”),which are under the purview of the Korea Fair Trade Commission (the “KFTC”) and the Ministry of SMEs and Startups (the “MSS”), respectively. It went into effect on October 4, 2023, following presidential promulgation on September 26, 2023.
The new subcontract price linkage system requires automatic adjustment to the subcontract price that is “linked” to the difference between the actual change in the cost of a “key raw material” and the predetermined rate of change of such cost agreed between the contractor and subcontractor, which shall not be greater than 10%. (Article 2 (17) of the amended FTSA, and Article 2 (13) of the amended Mutual Growth Act)
The new system is created to further the current administration’s key policy objective to foster an environment that ensures payment of fair supply prices. It is expected to promote the “co-prosperity” of conglomerates and smaller companies as linked subcontract price arrangements become an integral part of the subcontracting culture.
Key details of the amendments to the Enforcement Decrees to the FTSA and the Mutual Growth Act are as follows:
| Amendment | Details in the FTSA/Mutual Growth Act Enforcement Decrees |
| Updated list of information that must be specified in writing in a subcontract agreement | Added matters relating to the new linkage system to the list of information that must be specified in writing in a subcontract agreement.
E.g., the names of products subject to price linkage, key raw materials, conditions for price adjustment, indices for key raw material prices, formulas for adjusting the subcontract price, the reference point and comparison point for calculating the rate of change in key raw material prices, the adjustment date, the adjustment cycle, and the date when the adjusted subcontract price applies (Article 3 (1) 2 of the amended Enforcement Decree to the FTSA; Article 14 (1) of the amended Enforcement Decree to the Mutual Growth Act). |
| Allowing the establishment of exemption criteria | Allowed the KFTC and the MSS to set exemption criteria for different transaction types based on the characteristics of each specific transaction within the boundaries set by the FTSA and the Mutual Growth Act (i.e., 90 days of contract term or transaction amount of less than KRW 100 million) (Articles 3 (2) and 3 (3) of the amended Enforcement Decree to the FTSA; Articles 14 (3) and 14 (4) of the amended Enforcement Decree to the Mutual Growth Act). |
| Specified criteria and process for designating Support Headquarters for the new system | Specified matters relating to the designation of Support Headquarters for the new system, including the designation method, designation criteria, requirements to submit application forms and performance results, and specific standards for suspending or cancelling such designation (Article 6-7 of the amended Enforcement Decree to the FTSA; Article 14-6 of the amended Enforcement Decree to the Mutual Growth Act).
The Support Headquarters aim to facilitate the expansion of the new system through various on-site support measures, such as promoting the new system, discovering exemplary cases, conducting performance analysis, providing support for analyzing production costs and developing indices for raw material prices.
The Korea Foundation for Cooperation of Large & Small Business, Rural Affairs was designated by the MSS as a Support Headquarters on July 31, 2023. The KFTC designated the Korea Fair Trade Mediation Agency (the “KOFAIR”) as a Support Headquarters on October 20, 2023, and initiated its trial operation on October 30, 2023. |
| Specified criteria for imposing penalty points relating to the new system | Required the KFTC to impose 5.1 penalty points against contractors that force subcontractors to agree not to adopt the new system, 3.1 points for other related major violations, and between 0.25 and 2 points for minor violations (e.g., failure to include certain required information in a written subcontract agreement, violation of the duty to consult with subcontractors in good faith, failure to specify the intent or reasons for agreeing not to adopt the new system) based on the current system of imposing penalty points (Attached Table 3 of the amended Enforcement Decree to the FTSA; Attached Table 3 of the amended Enforcement Decree to the Mutual Growth Act). |
| Specified criteria for imposing administrative fines relating to the new system | Required the KFTC to impose a fine of KRW 10 million for failure to specify matters relating to the new system in a written subcontract agreement, and for major violations, (i) a fine of KRW 30 million for the first violation, (ii) KRW 40 million for the second and (iii) KRW 50 million for the third. Allowed the KFTC to reduce a fine by up to 50% for first-time violators that are designated as “outstanding companies” in implementing the new system within three years from the imposition of the fine (Attached Table 5 of the amended Enforcement Decree to the FTSA; Attached Table 4 of the amended Enforcement Decree to the Mutual Growth Act). |
| Provided grace period for implementation | During the grace period for implementation, which lasted until December 31, 2023, the KFTC and MSS did not conduct ex officio investigations related to the new system and instead encouraged voluntary corrections when necessary. |
On September 11, 2023, prior to the enactment of the amended Enforcement Decrees, the KFTC and the MSS each distributed a model subcontract agreement incorporating the new linkage system, as well as a model opt-out agreement, along with a guidebook on how to implement the new model agreement in practice. On October 14, 2023, the KFTC and the MSS distributed a list of frequently asked questions (“FAQs”) relating to the new system.
The model subcontract agreement includes provisions specifying the following matters: (i) relevant indices for raw material prices, which determine fluctuations of raw material prices and whether the subcontract price should be adjusted, (ii) a list of key raw materials subject to linkage, (iii) procedures for creating a linkage chart, outlining the conditions and formula for price adjustment, (iv) procedures for price adjustment, (v) methods of adjusting the prices of materials that are not subject to linkage and (vi) prohibition of unlawful practices (in connection with implementing the subcontract price adjustment system).
As noted above, the KFTC and the MSS also distributed a separate opt-out agreement, where the contractor and subcontractor have agreed to opt out of the price linkage system. This includes provisions specifying the following matters: (i) a list of key raw materials that the parties have agreed to exempt from the linkage requirement, (ii) a summary of the parties’ agreement not to adjust subcontracting prices, including the date, method, names and position of the relevant personnel who participated in the agreement, (iii) reasons for opting out of the price linkage system and (iv) acknowledgement that it is unlawful to abuse one’s superior bargaining position to coerce a counterparty into agreeing not to adjust subcontract prices.
Meanwhile, the guidebook provides explanations of terms, along with detailed instructions and examples for these new standard agreements. Notably, for opt-out agreements where the parties decide not to link the subcontract price with the prices of key raw materials, the guidebook also outlines precautions and offers detailed drafting guidelines.
The list of FAQs, published on October 4, 2023, provides the KFTC and MSS’s answers to questions that companies have frequently asked about this new system. As it is expected to be updated on an ongoing basis, it will be a helpful resource to refer to.
Meanwhile, the KFTC and MSS are making various efforts to ensure the smooth operation of the new system. For example, on October 25, 2023, they held a joint meeting with the representatives of SMEs. Going forward, the KFTC and the MSS are expected to explore different means to ensure that the new system can take root in the market soon, while also proactively enforcing the new law.
Companies newly entering into, or amending an existing agreement with a subcontractor are advised to carefully review whether and how the new system applies to their transactions, and to discuss the implementation of the new system with the subcontractor.
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