Turkey: Enhanced Out Of Court Financial Restructuring Scheme

1. Introduction

Upon the Turkish Lira currency crisis of August 2018, the Turkish real sector encountered a liquidity shortage due to a considerable amount of foreign currency borrowings. To avoid the negative impacts of the liquidity shortage and bankruptcy of financially distressed businesses, the Banking Regulatory and Supervisory Agency ("BRSA") introduced an enhanced out-of-court financial restructuring ("FR") scheme with the Regulation on Restructuring of Debts Owed to the Financial Sector entered into force on 15 August 2018 ("Regulation")¹.

The Regulation authorised the Banks Association of Turkey ("BAT") for; (i) drafting the rules and procedures for FR; (ii) drafting a template financial restructuring framework agreement ("FRFA") to be executed by and between the financial market actors; and (iii) setting out the rules and procedures for financial restructuring agreements, to be executed by and between the debtor and its creditors on an individual basis ("FRAs").

The BAT classified FR in two categories, large-scale and small-scale, depending on the amount of the restructured debt, and correspondently prepared two separate template FRFAs for each category. Template FRFAs entered into force with the approval of BRSA. Execution of any of the FRFAs is optional and so far, more than 50 financial market actors executed the small and large-scale FRFAs.

Once an FRFA is executed, creditors, who are signatories to the FRFA, are obliged to take part in the FR and cannot take enforcement action against the debtor during the FR, unless there is a breach of the underlying FRA by the debtor. Another consequence of being a signatory of an FRFA is the binding effect of the FRA. Within this context, if an FRA is signed with necessary quorum, all FRFA signatories are obliged to restructure the debts of the respective debtor regardless of whether they were signatories to the FRA or not. These two elements represent the major differences between the FR and contractual out of court financial restructuring.

The FR, known in the market as "New Istanbul Approach", is akin to the Istanbul Approach, a financial restructuring scheme applied in Turkey during early 2000s upon two consecutive banking sector crises that occurred in November 2000 and February 2001. As a previously practiced and familiar method, the current scheme is widely accepted by the credit market, and many financially distressed debtors benefitted from the scheme so far. As per the Financial Restructuring Monthly Report of May 2022 published by the BAT, for the period between October 2019 and May 2022, the debts restructured amounted to approximately TRY 220 billion as 798 debtors executed financial restructuring agreements with their creditors under the enhanced out of court financial restructuring scheme.

2. Availability Period of the FR

The legal basis of the FRFAs is the provisional article 32 of the Banking Law numbered 5411 and dated 19 October 2005 ("Banking Law"). The provisional article 32 was published on 19 July 2019 with a validity of two years upon its publication, subject to a subsequent extension with the approval of the President of the Republic of Turkey for additional two years. Accordingly, the availability period has been extended to 19 July 2023 with the Presidential Decree numbered 4299².

3. Financial Restructuring Framework Agreements (FRFAs)

The FRFAs regulate the criteria for eligibility of debtors, the application procedures, and the general principles applicable to the FR and FRAs as well as dispute resolution mechanism, among others. The FRFAs are also akin to intercreditor agreements since they regulate the relationship between creditors and set out the rules for decision making processes.

The FRFAs may be executed by creditor institutions, foreign creditor institutions, international organizations as well as other creditors as defined under the FRFAs. Once executed, the signatories are considered to have accepted the relevant FRFA in the form and substance approved by the BRSA, and any reservations made to the FRFA by any signatory are invalid.

Any amendments to the FRFAs are subject to unanimous affirmative votes of the signatory creditor institutions and approval of the BRSA.

3.1. Requirements for Creditor Institutions

The Regulation and the FRFAs define creditor institutions as banks, including development, participation and investment banks, financial leasing, factoring and financing companies established in Turkey; all banks and other financial institutions established abroad provided that such foreign corporations made facilities available to the relevant debtors; multilateral banks and institutions having direct investments in Turkey; special purpose vehicles founded by the above-mentioned creditors for debt collection; and investment funds founded for debt collection as per the Capital Market Law numbered 6362 ("Creditor Institutions").

Creditor Institutions will be able to take part in FRs and be bound by the provisions of the FRFAs for so long as the executed FRFA is in force. The foreign creditor institutions and international organizations, which are authorized in extending facilities under the jurisdiction of their operations and extended facilities to the debtor ("Foreign Creditor Institutions"), on the other hand, will be bound by the provisions of the FRFAs and take part in an FR by executing the relevant FRFA on an individual basis. In relation to the small-scale FR, Creditor Institutions who have not signed the small-scale FRFA, can only take part in the FR with the affirmative votes of at least two Creditor Institutions and the Creditor Institutions representing at least 2/3 of the total receivables ("Qualified Majority") provided that such Credit Institutions execute the small scale FRFA on an individual basis, as well.

Creditors, other than the Creditor Institutions, such as commercial creditors ("Other Creditors"), can also be parties to the FRFAs and take part in the FR by executing the relevant FRFA on an individual basis. In relation to the large-scale FR, Other Creditors must also obtain the approval of the other Creditor Institutions involved in FR, with the affirmative votes of the Qualified Majority.

Once a Foreign Credit Institution and Other Creditor take part in the FR, such creditor will have the same rights and obligations as the Creditor Institutions have under the relevant FRFA.

3.2. Consortium of Creditor Institutions (CCI)

CCI is the decision-making and coordinating body, established specific to each large-scale FR, comprising of the relevant Creditor Institutions, Foreign Creditor Institutions and Other Creditors taking part in the scheme. CCI decides on the matters with the affirmative votes of the Qualified Majority, unless otherwise stated under the large-scale FRFA. CCI must conclude discussion and decide on any matter within 10 business days from the commencement date of the discussions.

Several CCIs can be established for a debtor or a debtor group subject to a particular FR, if decided by the CCI. To accelerate the process, the CCI may decide to continue negotiations through a committee, which is led by the leader bank and comprises of a sufficient number of CCI members. Despite the establishment of such committees, voting rights will be practiced by all the members of the CCI.

The CCI members do not have to conduct physical meetings since the large-scale FRFA sets out the legal basis for conducting electronic communications and electronic voting in cases of necessity.

3.3. Requirements for Debtors

All companies established in Turkey, other than the institutions subject to the Banking Law, the Financial Leasing, Factoring and Financing Corporations Law numbered 6361, the Law on Payment and Securities Settlement Systems, Payment Services and Electronic Money Service Providers numbered 6493, and Article 35 of the Capital Markets Law numbered 6362, with the exception of investment partnerships, can be debtors under the FRFAs and benefit from the FR, provided that such debtors have defaulted on their payments or likely to have payment difficulties on due dates, and comply with other requirements, varying subject to the scale of the FRFA.

To benefit from the small-scale FR, total amount of debt to be restructured must be less than 100 million TL whereas to benefit from the large-scale FR total amount of debt to be restructured must be at least 100 million TL. The total amount of debt may be calculated as the whole or partial debts of a debtor or group of debtors, provided that each debtor in the group is in the same risk group. Regardless of the thresholds, any debtor or debtor group might be subject to the large-scale FR with the affirmative votes of the Qualified Majority.

Once it is determined that a debtor may benefit from the FR, the Creditor Institutions must express their affirmative opinions on the prospect of a successful rescue of such debtor. In relation to the large-scale FR, either independent audit firms or similar institutions appointed by the Qualified Majority or the Creditor Institutions themselves if accepted by the debtor, shall review the financial position, and assess the feasibility of an FR. In relation to small-scale FR, the Creditor Institution, which accepted debtors' FR application ("CIADA"), assesses the feasibility. However, in both small and large-scale FRs, affirmative opinion of the Qualified Majority on the prospect of a successful rescue of the debtor, is required after feasibility assessments.

If a judgment is rendered for the debtors' bankruptcy before the restructuring, such debtor cannot be subject to FR; and if a judgment is rendered for the debtors' bankruptcy during the FR, the FR will terminate.

3.4. Application Procedure, Leader Banks, and Duration of FRs

Small Scale FRs

In the small-scale FRFA, the debtors must submit their application to the Creditor Institution having the highest amount of receivables. The application must contain the Application Form and Letter of Undertaking, which are annexed to the FRFA, as well as other necessary documentation and information detailed therein, including but not limited to the list of all debt including cash and non-cash risks, and contact information of the creditors, list of all movable and immovable assets with encumbrances included therein, list of all pending lawsuits and execution proceedings, short, mid and long term action plans and business plans other than the FR, for the successful rescue of the debtors, the debtors' balance sheets and profit and loss statements for the last three years certified by the tax office, and the debtors' shareholding structure.

The Creditor Institution, to whom the application is made, may reject the FR application by informing the debtor with its reasons in writing. In such an event, the debtor has the right to submit another application to the second and third Creditor Institutions having the highest amounts of receivables, respectively. The CIADA, the Creditor Institution accepting the application, is responsible for managing and monitoring the FR until the execution of the FRA, as the leader bank. If none of the Creditor Institutions accept the application, the FR will be terminated. Once the process is terminated in such a way, the debtor can only reapply to the FR upon the expiry of a 6-month period.

The small-scale FR is aimed to be successfully completed with the execution of an FRA within a maximum of 65 business days upon the debtors' first application, if not terminated during the process.

Large Scale FRs

Debtors must submit their application to one of the three Creditor Institutions, having the highest amounts of receivables. The application must contain the Application Form and Letter of Undertaking, which are annexed to the FRFA, as well as other necessary documentation and information detailed therein, including but not limited to the list of all debt including cash and non-cash risks and contact information of the creditors, list of all movable and immovable assets with encumbrances included therein, list of all pending lawsuits and execution proceedings, short, mid and long term action plans and business plans other than the FR, for the successful rescue of the debtors, debtors' balance sheets and profit and loss statements for the last three years certified by the tax office, and list of all local and foreign subsidiaries.

If the Creditor Institution applied is of the opinion that the application must be denied on the ground that the application is made in bad faith, contrary to the banking practices, or that the application contains unacceptable conditions, Qualified Majority shall decide whether to terminate the FR or not.

The Creditor Institution having the highest amount of receivables shall be the leader bank who shall be responsible for managing and monitoring the FR until the execution of the FRA. Such leader bank has the right to assign its duties to the Creditor Institution having the second or third highest amount of receivables provided that such institution consents to such assignment. With the affirmative votes of the Qualified Majority, another leader bank may also be selected by the Creditor Institutions. In the event of such election, each Creditor Institution shall have voting rights proportionate to its receivables and candidate receiving the highest number of votes shall be elected as the leader bank.

The large scale FR is aimed to be successfully completed with the execution of an FRA within 90 days upon the debtors' application. Such period may be extended for a maximum of 90 more days, with the affirmative votes of the Qualified Majority. If an FRA cannot be executed within such 180 day period, the FR process shall terminate.

A debtor can apply to the large-scale FR for two times, regardless of the successful completion or failure of the first application.

3.5. Standstill Period

The Standstill Period is one of the primary consequences of the FR as the commencement of the FR prevents the Creditor Institutions, Foreign Creditor Institutions and Oher Creditors, who are creditors in the relevant FR, from taking legal action against the debtor to protect the existing legal status, security structure and existing assets of the debtor. During the Standstill Period, such creditors cannot initiate execution proceedings against the debtor, and can only continue with ongoing execution proceedings if the suspension of such ongoing proceedings would result in loss of rights considering statute of limitations, and cannot apply to other legal remedies in relation to their receivables which are subject to the FR.

In cases where any of the Creditor Institutions has commenced execution proceedings prior to the debtors' FR application, and (i) date for the sale has been determined upon seizure; or (ii) a legal action on cancellation of a tender is ongoing; or (iii) an executory commitment has been undertaken; or (iv) a case for cancellation of action is pending, such actions will not be suspended or otherwise affected from the FR, if not waived by the relevant Creditor Institution in its sole discretion. If such actions are ongoing and not waived, large-scale FRs may be terminated with the affirmative votes of the Qualified Majority; and small-scale FRs are deemed as terminated if such actions prevent the debtor from continuing its business operations.

In relation to large-scale FRs, the Standstill Period commences once an FR application is duly submitted by the debtors to the competent Creditor Institution, and the application is shared with other Creditor Institutions by such creditor. During the first CCI meeting, the continuation of the Standstill Period will be decided with the affirmative votes of the Qualified Majority. The creditors remaining silent in the first CCI meeting are deemed as expressing a positive opinion.

In relation to small-scale FRs, the Standstill Period commences once the debtors' FR application is accepted by the CIADA and shared with the other Creditor Institutions.

The Standstill Period shall continue after the execution of the FRA provided that the debtor complies with its obligations arising from the FRA.

The Standstill Period may be terminated with the affirmative votes of the Qualified Majority in large-scale FRs and by the CIADA in small-scale FRs, if the debtor does not comply with its obligations under the Application Form and Letter of Undertaking submitted during the application.

During the Standstill Period, the debtor, its shareholders, and its affiliates must refrain from taking any action that may result in an unequal treatment among the Creditor Institutions.

3.6. Restructuring Methods

The FRFAs set out sample restructuring methods such as (i) redetermination of maturity; (ii) extension of additional funds for capital expenditures or investments; (iii) liquidation of subsidiary business activities of the debtors; (iv) increasing debtors' capital, changing its management and/or shareholding structure, conducting initial public offerings, selling debtor's assets and/or subsidiaries; (v) establishing pledges and usufruct rights on the shares of the debtor in favour of the Credit Institutions; and (vi) establishing securities on the assets of the debtor's shareholders as well as their first degree relatives. Any other method the Creditor Institutions may deem necessary for the successful rescue of the debtor can also be applied to the relevant FR by the decision of the Creditor Institutions.

In relation to large-scale FRs, the restructuring methods, which are subject to the affirmative votes of all Credit Institutions, are as follows: (i) waiver from the principal amount, accrued interest, default interest, default penalty, or any other amount arising from the loan relationship in part or in full; (ii) release of the securities in part or in full; (iii) transfer or assignment of all receivables arising from the debtor's principal amount or interest payment obligations to special purpose vehicles or investment funds established as per Capital Markets Law numbered 6362 against a remuneration in kind or cash or subject to condition of collection; (iv) liquidation, sales or otherwise removal from the balance sheet of receivables arising from the debtor's principal amount or interest rate payment obligations in part or in full against remuneration in kind. Unless otherwise decided by the Credit Institutions, any amount waived thuswise will be deducted pro rata from the receivables of the Credit Institutions.

3.7. Interest Rate Applicable to the Restructured Debt

In large-scale FR, as a principle, the interest rate applicable to the restructured debt is decided with the affirmative votes of the Qualified Majority. However, an interest rate lower than 75% of the TRY reference interest rate can only be applied with the affirmative votes of at least two Creditor Institutions representing 90% of the total receivables

In small-scale application, a TRY reference interest rate-based floating interest rate depending on the maturity is applicable.

3.8. Repayment Plan of the Restructured Debt

As a principle, the repayment plan shall be applicable to the restructured debt as a whole, in both large and small-scale FRs. However, separate repayment plans can be agreed for Credit Institutions having receivables below the threshold determined by the Qualified Majority provided that (i) the feasibility report anticipates such structure; (ii) the Qualified Majority consents; and (iii) the Leader Bank or CIADA, as applicable, makes such a proposal.

3.9. Additional Financing under the FR

In relation to small-scale FRs, providing additional financing to the debtors is arbitrary, and each Credit Institution may extend additional funds to the debtor at its sole discretion. In case of additional financing, any amounts recovered from the enforcement of the secured assets will be primarily applied to the repayment of the additional funds extended.

In relation to large-scale FRs, all banks, which are signatories to the FRA, must extend additional funds, pro rata to their receivables, to the debtor by the decision of minimum two CCI member banks representing at least 90 % of the total receivables of the CCI member banks. Furthermore, any Credit Institution may extend additional funds to the debtor with the affirmative votes of the Qualified Majority. In case of additional financing, any amounts recovered from the foreclosure of the secured assets will be primarily applied to the repayment of the additional funds extended.

Borrowings from third parties, other than the CCI members, is also available under the large-scale FR with the affirmative votes of the Qualified Majority.

3.10. Securities under the FR

The protection of the existing securities of the Creditor Institutions is an essential principle of the FR. FRAs must contain provisions on the seniority and protection of the existing securities and collection and realization of the secured debts and assets. As per the FRFAs, any amounts recovered from the enforcement of the senior secured assets will be deducted from each instalment amount equally so that the number of instalments and maturity of the senior secured debt remains unchanged.

Without prejudice to the principle of protection of the existing securities, any security to be established under the FR will be established on a pro-rata basis and any prior encumbrances attached to such secured assets, other than existing senior securities, will be removed with the establishment of the securities. In large-scale FR, Creditor Institutions might deviate from the principle of establishment of securities on a pro-rata basis with their unanimous decision.

4. Termination of the FR

The FR is or may be terminated if (i) a judgement is rendered for the debtors' bankruptcy; (ii) the FR application of the debtor is not accepted; (iii) the FR period expires before the execution of an FRA; or (iv) the ongoing execution proceedings are not waived by the relevant Credit Institutions.

In relation to large-scale FRs, the FR might also be terminated with the affirmative votes of the Qualified Majority of the CCI members if execution proceedings, amounting more than 25 % of the total debt subject to the FR, are initiated by the entities who are not parties to the FRFA during the FR process and such execution proceedings are not eliminated within a cure period of 30 days. In any case, such cure period cannot exceed the large-scale FR maximum duration which is 180 days.

5. Financial Restructuring Agreements (FRAs)

FRAs are the final products of the FR, setting out the negotiated terms and conditions of the relevant restructuring. An FRA must contain provisions on (i) the amount of receivables of each Creditor Institution; (ii) amount to be repaid and the repayment schedule; (iii) the acts constituting breaches and the consequences of such breaches; (iv) the pricing (e.g. interest rate, commissions and other fees); (v) the criteria for monitoring and auditing the debtor; (vi) the authority to review the accounts and documents of the debtor; (vii) the security structure; (viii) other obligations of the parties; and (ix) any other matter deemed appropriate by the Credit Institutions and agreed between the parties including grace periods, interest periods, representations and warranties, events of default, acceleration etc.

Small-scale FRAs and large-scale FRAs differ from one another on the application of the principle of freedom of contract. While large-scale FRAs provide more freedom and flexibility to parties, small-scale FRAs must be prepared in line with the sample FRA, drafted by the BAT. In addition, commercial terms applicable to small-scale FRAs are also restricted under the provisions of restructuring parameters of the small-scale FRFA. The restructuring parameters, as detailed under the small-scale FRFA, restrict significant commercial terms such as maximum length of maturity and grace periods, minimum annual repayment obligations, frequencies of instalments and minimum repayment requirements, applicable floating interest rates and their calculations, amount of the restructuring commission, compulsory currency of the restructured debt and the repayment schedule amendments. To eliminate the application of the restructuring parameters, the Creditor Institutions may decide on the application of the large-scale FR with the affirmative votes of the Qualified Majority.

Most important aspect of the FRAs is that once the Creditor Institutions representing 2/3 of the total receivables execute the FRA, all Creditor Institutions are obliged to restructure the relevant debt in line with the provisions of such FRA.

6. Dispute Resolution

The Regulation refers, any dispute arising from non-compliance with the FRFA, to arbitration. As per the Regulation and the FRFAs, an arbitral tribunal, comprising of three arbitrators, must be established by BAT and such tribunal will issue awards by simple majority. If deemed necessary, the tribunal may be established on an ad hoc basis. The details of the rules and procedures applicable to the tribunals are annexed to the FRFAs.

The arbitral tribunal shall issue the arbitral award within 5 business days from the receipt of application. Arbitral awards are final and binding for all Creditor Institutions who are parties to the FRFA.

The FRAs, on the other hand, shall be subject to Turkish law, and any dispute arising out of the FRAs may be resolved by the Turkish courts.

7. Conclusion

Enhanced financial restructuring schemes, as out-of-court contractual debt restructuring arrangements supported by legislation, are commonly practiced schemes during times of economic difficulty, and are available for a temporary period. Such financial restructuring schemes have objectives of macro-economic importance such as safeguarding the continuity of employment, restoring the growth of the real sector, and indirectly keeping currency depreciation and inflation under control.

The FR, as an enhanced financial restructuring scheme entered into force with similar objectives and aims to create real value in the Turkish economy by reassuring the companies in financial difficulties to continue their business. The FRFAs are designed 29658

to expedite the FR process and simplify the FRA negotiations by setting out the exemplary contractual workouts, maximum durations of negotiations, and the framework of the relationship between creditors including decision-making mechanisms.

Although the FRFAs restrict the freedom of contract and oblige market actors, who are signatories to (i) take part in the FRs; (ii) refrain from taking certain actions against the debtors during the Standstill Period; and (iii) take part in the restructuring once the conditions of the FRAs are accepted by the Creditor Institutions representing 2/3 of the total receivables, it is not compulsory for all credit market actors to execute the FRFAs. Any market actor who is of the opinion that such enhanced restructuring scheme is not in line with its commercial purposes does not have to execute the FRFA and may initiate regular insolvency proceedings or commence other out-of-court restructuring methods even if the debtor applies for FR.

Footnotes

1. The Official Gazette dated 15.08.2018 and numbered 30510

2. The Official Gazette dated 15 July 2021 and numbered 31542.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.