Article 376 of the Turkish Commercial Code No. 6102 ('TCC") stipulates compulsory measures to be taken by certain organs of joint stock companies (i.e., the board of directors and the general assembly), regardless of whether or not they are public companies, in the event of a loss reaching or exceeding certain ratios in the sum of such companies' share capitals and legal reserves.

Briefly, (i) Article 376/1 addresses the cases in which one-half (1/2) of the sum of the share capital and legal reserves of a joint stock company (hereinafter referred to as simply "company/companies") remain uncovered as per the latest annual balance sheet, (ii) Article 376/2 addresses the cases where two-thirds (2/3) of the sum of a company's share capital and legal reserves remain uncovered as per the latest annual balance sheet, and (iii) Article 376/3 addresses the cases where a company's assets do not suffice to cover its debts (i.e., financial distress or technical bankruptcy).

On the other hand, the Capital Markets Board of Turkey has also set out certain clarifications and exceptions with respect to the implementation of Article 376 for public companies, in accordance with its decision dated April 10,2014, and numbered 11/352 ("CMB's Decision"). In this respect, public companies are subject to (and must comply with) the instructions put forth in the CMB's Decision.

Until very recently, it should be noted that, the implementation of Article 376 was a highly controversial topic for non-public companies, since there was no existing secondary legislation on the matter. In order to eliminate legal uncertainty and reconcile differing implementations in practice, the Ministry of Trade has introduced the Communiqué on the Procedures and Principles as to the Implementation of Article 376 of the Turkish Commercial Code ("Communiqué on Article 376") on September 15,2018, which entered into force on the same date.

While practitioners and commentators were still discussing the issue and deliberating on whether the Communiqué on Article 376 would also be applicable to public companies, the CMB made an important announcement on October 4,2018 which confirmed that the CMB's Decision and the provisions of the Communiqué on Article 376 should be taken into consideration and implemented jointly for public companies.

In light of these developments, the relevant rules, procedures and principles regarding implementation, which are collectively stipulated in Article 376 of the TCC, the Communiqué on Article 376, and the CMB's Decision, will be examined below as they relate to public companies:

I. In case one-half (1/2) of the Sum of Share Capital and Legal Reserves Remain Uncovered:

Article 376/1 of the TCC and Article 5/1 of the Communiqué on Article 376 stipulate that, if the latest annual balance sheet of a company affirms that one-half (1/2) of the sum of a company's share capital and legal reserves remain uncovered due to loss, the board of directors should immediately invite and convene the shareholders for a general assembly meeting, inform the shareholders regarding the financial situation, and provide the shareholders with a list of possible remedies that it sees fit in the relevant meeting. In such cases, the "early detection of risk committee" should also inform the board of directors, if it detects or notices this type of deterioration in the financial condition and circumstances of the company.

Article 5/1 of the Communiqué on Article 376 also stipulates that, if a company falls under the threshold of Article 376/1, this situation should, in any case, be discussed in the first general assembly meeting of the company, even if the agenda of the meeting comprises different topics.

As per Article 376/1 of the TCC and Article 6 of the Communiqué on Article 376, possible remedies are not numerus clausus (i.e., limited in number). They could include capital increases in cash or from internal sources (e.g., undistributed dividends), solutions such as closing or downsizing of certain divisions or branches, selling subsidiaries, adopting new and different marketing strategies, among many others.

In addition to the foregoing, according to the CMB's Decision, the following actions should be also taken:

  • The situation regarding the company's deteriorating finances should be communicated in the company's annual financial statements, which are subject to public disclosure rules in accordance with the Communiqué on the Principles of Financial Reporting in Capital Markets (II-14.1) ("Communiqué on Financial Reporting").
  • In the financial statements, the following formula should be used for the calculation of the amount of the loss: [((Share Capital + Legal Reserves) - Equity) / (Share Capital + Legal Reserves)]. For companies preparing consolidated financial statements, the total amount of the equity should be taken into consideration during the foregoing calculation.

II. In case two-thirds (2/3) of the Sum of Share Capital and Legal Reserves Remain Uncovered:

Article 376/2 of the TCC and Article 5/1 of the Communiqué on Article 376 stipulate that, if the latest annual balance sheet affirms that two-thirds (2/3) of the sum of a company's share capital and legal reserves remain uncovered due to loss, the board of directors should immediately invite and convene the shareholders for a general assembly meeting, and inform the shareholders about the financial situation of the company. The responsibility of the "early detection of risk committee" to inform the board of directors should be subject to the foregoing threshold as well, although this is not explicitly stated in the relevant legislation.

Article 376/2 of the TCC and Article 7 of the Communiqué on Article 376 stipulate and describe the resolutions that could be adopted by the shareholders during the subsequent general assembly meeting. Accordingly, the general assembly should adopt one of the following two resolutions: (i) to decrease share capital to an amount equal to one-third (1/3) of the original share capital, or (ii) to provide additional share capital to restore it to its original amount (i.e., share capital completion). In addition to the above, Article 7/1 of the Communiqué on Article 376 stipulates a third option, which involves a share capital increase that could be adopted and approved by the general assembly.

As per Article 9 of the Communiqué on Article 376, the completion of share capital could be realized by way of cash injection(s) by shareholders on a complimentary basis. In such a case, the injected cash amount would be unreciprocated {i.e., it would be given without receiving any equivalent consideration and/or shares in return). It should be noted that the general assembly cannot force the shareholders to inject cash into the company without a unanimous decision; however, some of the shareholders may choose (of their own accord) to deliberately inject cash into company on a complimentary basis.

Also, as per Article 10 of the Communiqué on Article 376, a share capital increase could be carried out by way of: (i) decreasing share capital by an amount equal to the loss and simultaneously increasing share capital by the desired amount, or (ii) injecting cash in return for newly issued shares. If option (i) is chosen, at least one-fourth (1/4) of the increased share capital must be paid at the time of the concurrent share capital increase. Similarly, if option (ii) is selected, at least one-half (1/2) of the share capital must be paid prior to the registration of the general assembly resolution with the trade registry.

According to Article 376/2 of the TCC and Article 11 of the Communiqué on Article 376, the company shall cease to exist if (i) the shareholders do not convene, or (ii) the shareholders do convene, but fail to adopt any of the aforementioned three resolutions at the general assembly.

According to the CMB's Decision, the following actions should be taken in addition to the foregoing:

  • The financial situation of the company should be stated in the company's annual financial statements, which are subject to certain public disclosure requirements in accordance with the Communiqué on Financial Reporting.
  • In the financial statements, the following formula should be utilized for the calculation of the loss amount: [((Share Capital + Legal Reserves) - Equity) / (Share Capital + Legal Reserves)]. For companies that are preparing consolidated financial statements, the total amount of the equity should be taken into consideration for the foregoing calculation.
  • If the latest annual balance sheet of the company affirms that two-thirds (2/3) of the sum of share capital and legal reserves remain uncovered due to loss, the board of directors should also conduct an analysis with respect to the situation and the financial distress of the company.

III. In Case of Financial Distress (Technical Bankruptcy):

Article 376/3 of the TCC and Article 12 of the Communiqué on Article 376 stipulate cases in which a company's liabilities exceed its assets. Accordingly, if there are any indications that the liabilities of a company exceed its assets, the obligation imposed on the board of directors is to initially prepare an interim balance sheet. This interim balance sheet should be prepared in compliance with the principles of both: (i) going concern concept ("Balance Sheet of Going Concern Concept"), and (ii) possible purchase price of assets ("Balance Sheet of Article 376").

As per Article 12/4 of the Communiqué on Article 376, if a company falls under the threshold of Article 376/3, it could implement one of the remedies explained in detail under Section (II) above. However, if the interim balance sheet affirms that the liabilities of the company exceed its assets (i.e., the assets are not sufficient to meet creditors' receivables), then the board of directors should inform the relevant commercial court of first instance of the situation and file for bankruptcy.

According to the CMB's Decision, some of the actions that should be taken (in addition to the foregoing) can be summarized as follows:

  • For companies that are subject to the requirement to prepare interim financial statements in accordance with the Communiqué on Financial Reporting;
  • For the Balance Sheet of Going Concern Concept, periodical financial statements are taken into consideration within the scope of the Communiqué on Financial Reporting.
  • The Balance Sheet of Article 376 is not subject to the provisions of the Communiqué on Financial Reporting. However, this interim balance sheet should be prepared within thirty (30) days, as of the date on which suspicions arise concerning the company's technical bankruptcy, and this interim balance sheet will have the same date as the Balance Sheet of Going Concern Concept.
  • For companies that are not subject to the requirement to prepare interim financial statements in accordance with the Communiqué on Financial Reporting, the Balance Sheet of Going Concern Concept should be prepared in accordance with the principles of the Communiqué on Financial Reporting.

In light of the applicable Turkish corporate law doctrine and the CMB's Decision, it should be highlighted that all procedures that are already conducted (or are to be conducted) within the scope of Article 376, and consequently the provisions of the Communiqué, are the responsibility of the board of directors. In accordance with Article 375, this liability cannot be transferred to other executives of the company.

IV. Other Significant Points

As per Article 14 of the Communiqué on Article 376, a public company that has lost its share capital or is in technical bankruptcy could merge with another company by being absorbed by that company, as long as the merger is conducted in line with the CMB's further requirements regarding such transactions. In this respect, the company that absorbs the public company which has suffered a capital loss should have disposable equity that is sufficient to cover the loss in share capital (and legal reserves).

Furthermore, according to Provisional Article 1 of the Communiqué on Article 376, until January 1, 2023, damages arising from fluctuations of non-performed debts in foreign currencies may not be taken into consideration for the calculations relating to the financial position of a company, in terms of the application of Article 376.



This article was first published in Legal Insights Quarterly by ELIG Gürkaynak Attorneys-at-Law in December 2018. A link to the full Legal Insight Quarterly may be found here.

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