Hello, I am Kim Kwang-sik, attorney at Cheongchul Law Firm.

When investors suffer losses in private equity fund (PEF) investments, the first question that arises is "what responsibility does the general partner (GP) managing the fund owe to the investors?" Particularly in buyout structures where a fund acquires a specific company, disputes often originate from whether the core value or risk factors of the target company were accurately conveyed at the time of investment solicitation.

Recently, the Korean Supreme Court provided important standards regarding the content and stages of the duty of care owed by the general partner of a private equity fund that acquired a cosmetics OEM company to investors (limited partners), and the scope of damages for breach. As the trial court, appellate court, and Supreme Court reached different conclusions at each stage, this case carries significant practical implications.

Today, we examine this judgment to clarify how the general partner's duty to protect investors is recognized structurally.

[Question]

When a general partner managing the acquisition of a company through a private equity fund (PEF) misrepresents information about the target company, to what extent may investors claim damages against the general partner?

[Answer]

1. Case Structure — Private Equity Fund Acquiring a Cosmetics OEM Company

In this case, the fund managers solicited investors to acquire all shares of a cosmetics company through a PEF and a special purpose company (SPC). Through investment proposals, the managers explained that the target company was an ODM (Original Design Manufacturer) that developed cosmetics directly and held recipe rights (trade secrets including ingredients, content, and manufacturing process) for those cosmetics.

However, around the closing of the transaction, a distributor who handled the cosmetics asserted that "the recipe rights belong to us, and the target company is merely an OEM provider," and around the same time, it emerged that the distributor planned to build its own factory to produce cosmetics. Consequently, the target company's revenue, which was overwhelmingly dependent on this distributor, plummeted, and the investors were unable to recover their investment.

The investors (limited partners) sued the general partners managing the fund for damages based on breach of fiduciary duty.

2. Key Issue — Distinction Between Investment Solicitation Stage and Investment Operation Stage

The duty that a PEF general partner owes to investors differs in nature depending on the timing. Courts distinguish between the 'investment solicitation stage,' where investors are asked to decide on participation before the fund is established, and the 'investment operation stage,' where the general partner manages the fund's assets after establishment.

At the solicitation stage, it is difficult to view the general partner as bearing the same general investor protection duties (such as suitability principles and disclosure obligations) that financial investment business operators bear under the Capital Markets Act. However, the Supreme Court has held that those who establish and operate private equity funds bear a 'duty of care to generate accurate information and provide it to investors' regarding important matters such as investment targets, investment methods, and investment recovery structure, and that if such breach influences the investor's judgment and causes harm, tort liability is established (Supreme Court Decision 2015Da216796, etc.).

On the other hand, at the operation stage, the general partner bears the duty to manage fund assets with the care of a good manager, and as long as operational judgments were made within reasonable bounds, mere occurrence of losses does not automatically constitute a breach of duty.

3. Conflicting Judgments at the Trial and Appellate Courts

The trial court (Seoul Central District Court) divided the general partner's duties into solicitation and operation stages and, finding no breach of duty at either stage, dismissed all the investors' claims. The bases were that materials supporting belief that the target company held the recipe rights existed (such as legal due diligence reports and the seller's representations and warranties), and that the investors were PEF investors with a certain level of expertise.

However, the appellate court (Seoul High Court) reversed, finding that the general partner had breached the 'pre-closing duty of care.' That is, before the closing, materials indicating dispute potential already existed (such as emails showing the distributor's assertion of recipe rights and circumstances of factory construction), yet the manager closed the transaction without properly notifying investors or sufficiently investigating these matters. The appellate court limited liability and ordered damages.

4. Supreme Court's Judgment — Breach of Duty Affirmed, but Damages Calculation Reversed

The Supreme Court (2023Da226170) held that the appellate court's conclusion recognizing the general partner's breach of duty of care was correct. That is, if the manager provided information to investors without accurately investigating important matters about the target company, thereby influencing their investment judgment, liability for breach of duty of care arises.

However, the Supreme Court reversed on the 'calculation of damages.' The key point is that the loss suffered by the investor due to the general partner's breach should be calculated not as the 'full investment amount' but as the 'unrecoverable amount' — the investment minus what has been or could be recovered. The lower court treated the full investment (KRW 2 billion) as damages merely because the investor had not recovered the investment by the close of arguments, but the Supreme Court ruled that damages must be calculated after deducting the recoverable portion, considering the residual value of the target company shares held by the fund.

5. Unjust Enrichment Restitution and Damages Are Different Structures — The Meaning of Damages

Investors might easily think "since I invested based on incorrect information, I should get the full investment back." However, the manager's liability for breach of duty is 'liability for damages,' not 'liability for investment restitution.' In damages, only losses with proximate causation to the wrongful act are compensable, and such losses are measured by the portion that has actually become unrecoverable.

Therefore, if the fund's acquired company still retains some value in its shares, that residual value must be deducted from damages. This ruling clarifies that in PEF disputes, damages cannot be simplified as the 'full investment amount,' but recovery possibility and residual value must be specifically examined.

This judgment carries implications for both PEF general partners and investors. From the manager's perspective, not only at the solicitation stage but also right up to closing, they must independently investigate and review the target's core value (such as intangible rights like the recipe rights in this case) and risk factors, and if dispute potential is identified, they bear a duty to notify investors.

From the investor's perspective, the mere fact of loss does not automatically allow recovery of the full investment; one must specifically prove and calculate which duty the manager breached, whether there is proximate causation between the breach and the loss, and how much residual value remains recoverable.

Whether a PEF general partner has breached duty must be examined together with the stage distinction of the duty, causation, calculation of unrecoverable amount, and limitation of liability (comparative negligence) for an accurate judgment.

Cheongchul Law Firm provides expert legal counsel on PEF and financial investment product disputes, drawing on advisory experience for both investor and manager sides, covering whether the general partner breached duty of care, adequacy of information provision, scope of damages, and overall litigation strategy. If you require legal review related to PEF investment losses, we recommend systematically analyzing contracts, due diligence materials, and notice documents from the initial stage to design a response strategy.