Hello, this is attorney Eom Sang-yoon of Cheongchul Law Firm.

There have been repeated cases in which large shipbuilders or construction companies operating in-house subcontractors were sanctioned for violating the Subcontracting Act (하도급법) after handling the documentation of entrusted work, the method of determining subcontract payments, and the procedures for cancelling or modifying orders according to established business practices. Against this backdrop, in a recent appeal concerning the Korea Fair Trade Commission's surcharge order against shipbuilder A, the Supreme Court (i) squarely confirmed the requirements for establishing three types of violations, and (ii) held that imposing a fixed-rate surcharge for a violation of the written contract issuance duty, where the violation amount is difficult to calculate, may constitute a deviation from or abuse of discretion if it loses balance with the fixed-amount surcharge system introduced by the amended Enforcement Decree of the Subcontracting Act (하도급법 시행령).

Today, I will summarize the facts of the case and the Supreme Court's holdings on the three types of violations, and then look at how the gap between fixed-rate and fixed-amount surcharges is emerging as a new axis of discretionary control.

Overview of the Case

The subject of the disposition was large shipbuilder A. On February 8, 2021, the Korea Fair Trade Commission issued a corrective order together with a surcharge payment order of KRW 15.294 billion. While the litigation was pending, the Commission, reflecting the purport of a final judgment in a similar case (Supreme Court Decision 2024Du35125, November 28, 2024), applied a higher reduction rate and revoked KRW 5.127 billion on its own initiative, so that the final surcharge was changed to KRW 10.167 billion.

Three types of violations were in dispute. First, the violation of the written contract issuance duty concerned 6,168 cases of modification and additional work, in which the plaintiff entrusted tasks closely tied to the shipbuilding process, such as scaffolding installation, transport, and operation, to in-house subcontractors, and the work proceeded after the plaintiff had sent the outsourcing construction contract through the electronic contract system but before both parties had completed their electronic signatures. Second, the unilateral determination of subcontract payments at a low unit price concerned the practice, in modification and additional work, of carrying out the work first under a so-called 'work first, sign later' arrangement and then having the plaintiff determine the modified and additional man-hours through internal procedures alone to calculate the subcontract payment. Third, the unfair cancellation and modification of orders concerned a substantial portion of the 111,500 transactions entrusted by the plaintiff to in-house subcontractors, which were cancelled or modified without substantive consultation.

The Supreme Court's Holdings: Establishment of Violations and the 'Low Unit Price' Exception

The Supreme Court upheld the lower court's findings of violations for all three types. The criteria confirmed for each type are as follows.

Criteria for Violation of the Written Contract Issuance Duty

First, regarding the violation of the written contract issuance duty, the Supreme Court held that the date of issuance of the written contract means the date on which the plaintiff and the in-house subcontractor both completed their electronic signatures on the outsourcing construction contract in the electronic contract system, and that the plaintiff's mere preparation and transmission of the outsourcing construction contract to the subcontractor cannot be deemed to satisfy the written contract issuance requirement under the Subcontracting Act. Furthermore, the Court reaffirmed the principle of Supreme Court Decision 2021Du49208 (November 28, 2024) that the burden of proving a justifiable reason for failing to issue a written contract lies with the prime contractor asserting it, and that this determination must be stricter than that for a justifiable reason concerning the omission of certain items from an issued written contract.

Unilateral Low Unit Price and the Exceptional Manufacturing Cost Standard

Next, regarding the requirement of 'unilaterally without agreement' under Subcontracting Act Article 4(2)(v) (하도급법 제4조 제2항 제5호), the Supreme Court reaffirmed its prior position that the following must be considered comprehensively: (i) the prime contractor's superior bargaining position in the transaction, (ii) the subcontractor's degree of dependence on the transaction, (iii) whether and to what extent a continuous business relationship exists, (iv) whether the subcontractor's autonomy to negotiate was restricted in the process of determining the subcontract payment, and (v) the disadvantage to the subcontractor resulting from the determined payment (see Supreme Court Decision 2016Du35540, December 7, 2017; Supreme Court Decision 2016Du59430, March 13, 2018). In this case, the decisive circumstances recognized were that the in-house subcontractors were highly dependent on the plaintiff and in a precarious position facing the possibility of termination, that the modification and additional work proceeded on a 'work first, sign later' basis without the subcontract payment being fixed, and that the determination of the modified and additional man-hours, the core of calculating the subcontract payment, was made solely through the plaintiff's internal procedures, leaving the in-house subcontractors with no channel to provide information, express opinions, or raise objections.

Of particular practical significance is the exception concerning the determination of a 'low unit price'. The Supreme Court confirmed the principle that whether a unit price is low must, as a rule, be judged by reference to the terms of prior transactions or the price level formed in comparable transactions, and that a low unit price cannot be found on the basis of the subcontractor's manufacturing cost merely because proof of prior or comparable transactions is difficult. However, the Court held that where (i) it is practically impossible to identify prior or comparable transactions, (ii) the prime contractor determines the subcontract payment only after receiving delivery of the entrusted object from the subcontractor, and (iii) it is established that the prime contractor unilaterally determined the unit price without substantive consultation by exploiting the subcontractor's weakened bargaining power, a low unit price may exceptionally be found on the basis of the subcontractor's manufacturing cost (see Supreme Court Decision 2024Du35125, November 28, 2024). This exception was applied in this case because the 'work first, sign later' practice in modification and additional work itself has the nature of structurally weakening the subcontractor's bargaining power.

Unfair Cancellation and Modification of Orders

Finally, regarding the unfair cancellation and modification of orders, the Supreme Court upheld the lower court's determination that, among the 111,500 orders entrusted by the plaintiff to in-house subcontractors, 33,229 cases were excluded from the finding of unfairness, namely (i) cases cancelled before contract conclusion, (ii) cases cancelled or modified due to the subcontractor's fault, and (iii) cases in which substantive consultation took place, while the remaining 78,271 cases were cancelled or modified without substantive consultation and therefore constituted unfair cancellation and modification of orders.

The Gap Between Fixed-Rate and Fixed-Amount Surcharges and the Finding of Deviation from or Abuse of Discretion

The most noteworthy point of this judgment is the Supreme Court's holding on deviation from or abuse of discretion in surcharge determination. Although the plaintiff's grounds for appeal were ultimately rejected, this was not because the plaintiff's substantive argument was unfounded, but because the lower court had already revoked the entire surcharge for the relevant part, so that the plaintiff's grounds for appeal did not affect the conclusion of the judgment. In other words, the Supreme Court substantively accepted the plaintiff's claim of deviation from or abuse of discretion while dismissing the appeal on procedural grounds.

The Gap Between Fixed-Rate and Fixed-Amount Surcharges

The basis on which the Supreme Court found a deviation from or abuse of discretion was the extreme gap between the fixed-rate surcharge and the fixed-amount surcharge. While the relevant subcontract payments differed by a factor of 1.4 and the number of violations by a factor of 1.5, the surcharges differed by more than 20 times.

Holding on the Limits of Discretion in Surcharge Calculation

The Supreme Court explained the reasons for this extreme gap as follows.

(i) A violation of the written contract issuance duty is a type of violation with no violation amount, making it difficult to ascertain the scale of the benefit obtained by the prime contractor, yet a fixed-rate surcharge is calculated in proportion to the total subcontract payments and may therefore become excessive regardless of the substance of the violation; (ii) after the amended Enforcement Decree of the Subcontracting Act rationalized the imposition standards by introducing a method of multiplying the violation amount ratio and a fixed-amount surcharge so that the surcharge would be proportionate to the degree of the prime contractor's unlawful gain, that purport needed to be reflected at the stage of determining the surcharge to be imposed; and (iii) no matter how many cases a violation of the written contract issuance duty may span in an individual matter, as long as the nature of the violation is not linked to the acquisition of gain, its sanction should focus on deterrence rather than on the recovery of unjust enrichment. From this perspective, the Supreme Court assessed that even with a 50% reduction, the surcharge still exceeded the scope necessary to achieve the purpose of recovering unjust enrichment and was excessive, with its punitive character overly emphasized.

In other words, the Supreme Court reaffirmed that even though the Fair Trade Commission is granted broad discretion in calculating surcharges, a calculation that is not proportionate to the relevant statutes and the illegality of the violation may be unlawful as a deviation from or abuse of discretion.

Implications for Prime Contractors

From the practical standpoint of prime contractors, businesses operating an in-house subcontractor structure, such as large shipbuilders and construction companies, need to pay close attention to the following points. ① Since the issuance of a written contract is measured by the completion of both parties' electronic signatures, not by preparation or transmission, the operating processes of the electronic contract system must be reorganized accordingly. ② In work involving frequent post-hoc settlement, such as modification and additional work or design changes, the 'work first, sign later' practice itself carries a high risk of leading to an unfair determination of subcontract payments, so practices must be reformed to document provisional payment determinations and settlement procedures before work commences. ③ Cancellations and modifications of orders must be accompanied by documented records of substantive consultation in order to avoid a finding of unfairness. ④ Where a fixed-rate surcharge has been imposed in a large-scale violation case, this judgment has clarified the basis for arguing a deviation from or abuse of discretion by reference to the gap with the fixed-amount surcharge system under the amended Enforcement Decree of the Subcontracting Act, so there is room to make use of this holding after the fact.

This judgment shows that while the regulation of prime contractors under the Subcontracting Act continues to follow existing legal principles in determining whether a violation has been established, the principle of discretionary control, which requires that the surcharge calculation be proportionate to the substance of the violation and the scale of the gain, operates alongside it. With the government's recent amendments to the surcharge notification substantially raising the imposition standards themselves, the extent to which such ex post control will be recognized, and in which cases, is expected to be refined further through subsequent case law and the Fair Trade Commission's adjudication practice.