Amid the AI boom, many companies have poured large sums into outsourced development of LLM-based chatbots and automation, only to receive buggy code that is unusable in practice. Such IT outsourcing disputes are surging in Korean courts. Buyers (the ordering party) have three legal cards: (i) terminate the contract for non-performance (delay or impossibility), (ii) demand full refund of service fees already paid, and (iii) seek damages for business losses caused by the disruption. The challenge is that all of this requires combined technical and legal expertise — winning hinges on how clearly AI and software defects are proven before a judge.

1. The Anatomy of "Garbage Delivery": The Gap Between "AI Solution Promises" and Reality

Recent IT outsourcing disputes in Korean courts typically begin the same way. At the contract stage, vendors promise cutting-edge technology — LLM-based chatbots, OCR automation, fully customized ERP — and collect contract deposits, kick-off payments, and milestone payments. But by the deadline, the deliverable fails to perform even basic functions or pass tests, and the buyer, lulled by "just a little more time," ends up losing hundreds of thousands of dollars.

(1) Software and AI Development Contracts Are Legally "Works for Hire (Dogeup)"

Korean courts consistently treat software development contracts as dogeup (works for hire) under the Civil Code, holding that "completion of the work" is a precondition for claiming the fee. A vendor must deliver completed deliverables before it can demand payment, so unfinished or defective deliverables generally cannot support a claim for the balance (Civil Act Articles 664 and 665).

(2) "Completion" Is Judged by Function Point (FP) Appraisal

Korean courts increasingly rely on expert appraisal of the work-in-progress ratio as the key criterion in software development disputes. The Seoul High Court held that an ERP system with an FP-based completion rate of only 60.98% "fell short of the performance socially required and thus cannot be regarded as completed" (Seoul High Court 2021Na2008369, Apr. 19, 2023). Even a system that is 77% complete may justify termination as "delay or incomplete performance" if it suffers repeated errors and incomplete integration tests (Seoul Central District Court 2021Gahap579417, Nov. 13, 2025).

(3) AI Solutions Face an Even Stricter "Working" and "Completion" Standard

AI solutions such as OCR or LLMs are not "complete" simply because they run. A Korean court ordered full refund of KRW 396 million in service fees, finding that "repeated scanning and classification errors made it impossible to achieve the purpose of the contract" (Seoul High Court 2024Na2003686, May 22, 2024). A vendor's defense that "the AI is running" does not, by itself, establish completion.

2. The Legal Framework You Need to Know

(1) Termination for Delay: Civil Act Article 544

If the deliverable is not produced by the deadline, the buyer may, after setting a reasonable period and demanding performance (choego), terminate the contract (Civil Act Article 544). The key is to lock in the three-step process — demand, cure period, lapse — by certified mail (naeyong jeungmyeong). Courts have upheld terminations that faithfully followed this procedure (Seoul High Court 2020Na2016875, Jun. 24, 2021).

(2) Where Defects Make the Contract Purpose Unattainable: Civil Act Article 668

Even if the deadline is met, if material defects in the deliverable make the contract purpose unattainable, the contract can be terminated immediately without prior demand (Civil Act Article 668). Courts apply this strictly where there are critical defects in core functions and re-development is effectively the only alternative (Seoul Central District Court 2023Gadan5184828, Jul. 9, 2025).

(3) Refund After Termination: Restitution Is the Default Rule

Once terminated, the buyer may claim restitution of contract deposits, kick-off payments, and milestone payments already paid (Civil Act Article 548). However, VAT must be excluded to the extent that input tax was deducted or refunded, so this should be factored into the claim amount (Seoul High Court 2020Na2016875, applying Supreme Court 2004Da16976).

(4) Offset of Work-in-Progress Fees: Portions Actually Used by the Buyer Are Excluded

Courts offset the value of portions of the deliverable actually used by the buyer, ordering refund only of the balance. In one case where the buyer actually operated franchise contract and order functions, the court recognized fees for 62.4% completion and ordered refund only of the balance after offset from the advance payment (Daegu District Court Gimcheon Branch 2021Gadan38436, Aug. 22, 2024). Partial use of the system may therefore preclude a full refund.

(5) Damages: Within the Reliance-Interest Cap, Proof Is Decisive

Damages on termination can include reliance interest (such as costs incurred to enter and perform the contract) on top of restitution. Reliance interest cannot exceed expectation interest, however, and where proof is difficult, the court may set the amount ex officio after considering the entire course of proceedings (Civil Procedure Act Article 202-2). Recovering business losses (lost profits) requires separate supporting evidence.

3. The Later You Send the Termination Notice, the Weaker the Buyer's Position

The instinct to "wait just a little longer" weakens the buyer's legal standing. As the vendor stalls, implied acceptances accumulate, providing a basis for a court to find the buyer "partly responsible."

Late termination raises two specific problems. First, even if restitution of paid amounts is otherwise straightforward, the scope of work-in-progress offsets widens as more functions are actually used or operated. Second, proving business losses requires a clear starting point for when the disruption began; a late termination notice blurs that reference date.

A termination notice should be sent by certified mail and include (i) specific defects and instances of delay, (ii) a demand for performance with a reasonable cure period (for delay cases), and (iii) advance notice that, if not cured within the period, the contract will be terminated and refund of service fees and damages will be sought.

4. Going Beyond "Refund of Paid Amounts" to Recover "Business Losses"

The buyer's real loss is often not the paid amount itself. The real damage lies in business losses from disrupted plans premised on the AI solution, the cost of re-procuring development from a substitute vendor, and wasted personnel costs during the system gap.

To recover these in court, three lines of proof are required.

(1) Concrete Proof of Technical Defects

Saying "it doesn't work" is not enough. An expert appraiser should calculate the work-in-progress ratio using the FP (function point) method and produce a report specifying which functions fall short and to what extent. Courts use appraisal results as the principal basis for recognizing work-in-progress and computing damages.

(2) Proving Causation for Business Losses (Lost Profits)

To recover business losses caused by project delays, the buyer must concretely prove the gap between "the revenue that would have arisen if the system had been completed on time" and "the actual disrupted revenue." Where proof is difficult, the court may set the amount ex officio under Civil Procedure Act Article 202-2 (recognizing KRW 20 million in Seoul Central District Court 2023Gadan5184828), but the stronger the proof, the larger the recovery.

(3) Leveraging the Performance Bond

If the contract provides for a performance bond, it can be claimed as liquidated damages without separate proof of loss. Korean courts have recognized damages equal to the performance bond in an "OCR solution defect" case (Seoul High Court 2024Na2003686, May 22, 2024).

5. Once a Dispute Erupts: Engineering the Technical Appraisal Decides the Case

The most common pattern in IT outsourcing litigation is the vendor's defense that "the buyer kept changing the requirements." Courts take this defense seriously, and if frequent requirement changes by the buyer are recognized, the vendor's fee claim may instead be granted (Seoul High Court 2023Na2043663, Jun. 20, 2025).

Litigation strategy therefore needs two axes.

First, marshal the contract, requirements specification (RFP), delivery history, emails, and KakaoTalk chats to prove through technical appraisal "what functions were originally promised" and "how far the actual delivery falls short."

Second, even if the buyer made requirement changes, examine whether the changes fell within the contract's scope or were the subject of a separate supplemental contract to defeat the defense. Even where the contract conditions payment on "acceptance," Korean courts construe this as a deadline rather than a condition (Suwon High Court 2023Na11206, Oct. 31, 2024), enabling counter-strategies against payment delay through acceptance refusal.

6. Practical Checkpoints

• From the contracting stage, have you confirmed that the software or AI development contract includes (i) deadlines, (ii) acceptance standards, (iii) functional specifications (RFP), (iv) a performance bond, and (v) a liquidated damages clause for delay? (Without them, evidentiary burden in a dispute spikes.)

• When the vendor stalls with "almost done," are you locking in specific completion standards and a final deadline by certified mail to build the conditions for termination? (Civil Act Articles 544 and 668)

• If parts of the system have actually been used or operated, have you designed the claim amount to account for those portions being subject to work-in-progress offsets? (Daegu District Court Gimcheon Branch 2021Gadan38436)

• If you intend to claim business losses (lost profits), have you organized in advance your business plan, sales forecasts, and the record of disruption caused by the system gap? (Without sufficient proof, courts award only modest amounts at their discretion.)

• Have you preemptively had an expert appraiser calculate the work-in-progress ratio using the FP method to prepare for negotiation and litigation? (If the appraisal comes in below 60%, refund claims for work-in-progress are nearly always fully granted.)

• If a performance bond is in place, have you considered claiming it first as liquidated damages? (Seoul High Court 2024Na2003686)

---

IT dispute litigation turns on how clearly technical (AI, software) defects can be explained and proven to a judge. You need a lawyer who can translate "the code doesn't work" into legal language and engineer everything from FP appraisal to proof of business losses on both the technical and legal sides.

Our firm handles IT and AI outsourcing disputes on a one-stop basis, from termination notices through technical appraisal design, service-fee refund litigation, and business-loss damages claims.