The government will have to pull out all the stops to ensure its victory over Lone Star Funds in a looming legal battle, pundits said on Friday, as the case will set a critical precedent.

On Nov. 21, the Dallas-based private equity firm filed investor-state dispute, or ISD, arbitration claims at the International Centre for Settlement of Investment Disputes against the Korean government for damages of up to 2.4 trillion won over its delayed approval of prospective buyers for Korea Exchange Bank.

Lone Star alleged that due to Seoul’s unwillingness, it incurred unnecessary losses during the sales process. The equity firm also claimed that the government’s decision to impose capital gains taxes ran counter to a tax treaty between Korea and Belgium; Lone Star had invested in KEB through a Belgium-based arm.

“This is a case that the government must win at all costs because it’s bound to set precedent on what foreign investors can expect in the future and prevent similar such incidents,” said Sean Lim, an attorney at Lee & Co.

Financial authorities have formed a temporary task force, with officials from the Justice Ministry, the Foreign affairs and Trade Ministry, the Finance Ministry, the Financial Services Commission and the National Tax Service working together on the case.

Arnold and Porter, a Washington-based firm that has wide expertise in such disputes, will represent the Korean government.

“Everyone, from the task force and even those who had handled Lone Star and Korea Exchange Bank in the past should be enlisted for support,” Lim said.

Lone Star’s entry and exit scheme from Korea through what the equity firm had hoped to be a brief investment in a local bank had triggered outrage and protest from the public here.

Its latest decision to seek ISD arbitration drew renewed criticism, with the independent Solidarity for Economic Reform urging the government to “muster the willingness” to resolve the issue.

Kim Seok-dong, the head of the Financial Services Commission, meanwhile, has claimed he is more than 100 percent certain the case will end in favor of Korea.

The government also says it has been preparing for such a move from Lone Star as early as May this year.

The arbitration and ensuing ruling could take up to five years, according to both officials and legal experts.

It is the first time that the Korean government will undergo arbitration trials under the ISD mechanism to resolve the tax issue. Under the system, investors are allowed to file international arbitration against a government that they judge has incurred damages.

Lone Star bought a controlling stake in the local bank in 2003 but was delayed in selling the shares due to a prolonged dispute with the government over both the acquisition and sale price. Lone Star was later found guilty of stock manipulation.

By Kim Ji-hyun (jemmie@heraldcorp.com)