The Woongjin Group crisis is roiling financial markets. The second-tier chaebol, which ranked 31st among Korea’s big business groups, sent a shockwave through the business community last week by filing for court protection for two key bankrupt companies ― Woongjin Holdings and Kukdong Engineering & Construction.

The group’s aggregate debt was estimated at some 10 trillion won (about $9 billion), including 4.3 trillion won in borrowings from financial companies. A substantial part of it would become unrepayable, inflicting losses on the group’s creditor banks, investors in its bonds and commercial paper, and partner companies.

In particular, the 1,200 subcontractors of Kukdong E&C could fall like dominoes unless they collect 300 billion won in overdue payments for their work.

The builder’s collapse is likely to worsen the credit crunch plaguing the domestic construction industry. Many builders have been experiencing severe funding problems amid a prolonged slump of the property market. Those with low crediting ratings will find it more difficult to get loans or to sell bonds or CP.

Before Kukdong went belly up, 20 of the nation’s top 100 builders have already been placed under either a debt-workout program or court receivership due to their financial difficulties stemming largely from unsold homes.

The builder’s failure has sent local banks scrambling to reduce their exposure to financially shaky companies as they might also file for court protection without consultation with their creditor banks.

Banks have to curb the growth of nonperforming loans as the financial regulator has told them to reduce their NPL ratio to an industry average of 1.3 percent by the end of this year.

The Woongjin debacle is also driving corporations into crisis mode. A growing number of companies are ratcheting up efforts to secure cash to avoid falling prey to the continuing global recession.

Companies facing liquidity problems are making more desperate belt-tightening efforts to stay afloat. Some have already downsized their workforce through early retirement programs.

Under these circumstances, the financial regulator needs to make sure that financial markets do not seize up due to the Woongjin crisis. It should encourage banks to provide liquidity support to Kukdong’s subcontractors to avert chain bankruptcies.

It also needs to press banks to launch a preemptive restructuring drive for companies that have liquidity or solvency problems. The importance of such a proactive move cannot be overemphasized, especially in times of growing uncertainty.

The Woongjin case has also highlighted loopholes in the current bankruptcy system. The regulator should address them to prevent moral hazard among failed businessmen.

According to reports, Woongjin Holdings paid back 53 billion won to two group affiliates a day before applying for court protection. The company bolstered the balance sheets of the two subsidiaries at the expense of its creditor banks.

Furthermore, Woongjin chairman Yoon Seok-kum’s wife and one of his relatives disposed of a large chunk of their stakes in group companies before Woongjin Holdings and Kukdong E&C went bankrupt.

Yoon also drew fire by registering himself as the CEO of Woongjin Holdings right before seeking court protection. His move was aimed at maintaining his managerial control of the company during the restructuring process.

Under the current bankruptcy act, when a distressed company applies for court receivership, the court allows the person running the business to remain in control of its assets and day-to-day operations.

This makes court receivership more attractive to failed businessmen than debt-workout, a process that is less cumbersome but is carried out under tight oversight of creditor banks.

Hence the 10-fold surge in court receivership filings between 2006 and 2011, after the bankruptcy law was revised to introduce the debtor-in-possession concept.

The concept is based on the assumption that the task of reorganizing a bankrupt company can be done most efficiently by its incumbent CEO because he knows it better than anyone else.

This may be true but it is also clear that the current law encourages moral hazard among failed businessmen. The financial regulator needs to plug the loopholes.