Turkey: The Impact Of The New Turkish Commercial Code’s Multi-Corporate Enterprise Concept On Securities Provided By Subsidiaries

The new Turkish Commercial Code1 (the "New TCC") that was ratified by Parliament in January 2011 and will enter into force on 1 July 2012, will replace the current Turkish Commercial Code2 (the "current TCC"). The New TCC introduces the multi-corporate enterprise concept and controlling company in this context,3 and includes certain principles applicable to assistance that subsidiary companies provide to their controlling companies for the purposes of facilitating transactions undertaken by such controlling companies ("Subsidiary Assistance").

Subsidiary Assistance under the Current TCC

The current TCC does not include any specific provisions on Subsidiary Assistance, and due to the absence of any specific provisions, Subsidiary Assistance is subject to the general provisions under Turkish law governing the so-called concept of "undertaking the performance of a third party." Hence, today, there are no rules prohibiting subsidiaries from providing Subsidiary Assistance, including giving loans and/or securities for debts of their parent companies. However, certain principles under the current TCC have an effect on Subsidiary Assistance. For instance, fiduciary duties of the members of the Board of Directors (the "Board Members") require Board Members to ensure that the transactions of the company are always conducted at arm's length. Also, rules relating to the duty of care of Board Members require Board Members to act as prudent company executives while performing their duties. Hence, any decision by Board Members to provide Subsidiary Assistance will be subject to evaluation by the subsidiary's shareholders and creditors as to whether the Board Members were prudent in making such decision.

Subsidiary Assistance under the New TCC

The New TCC aims to preserve subsidiaries from any kind of loss due to the actions of the controlling company. Under the New TCC, the relations between the subsidiary and controlling company are devised for the sake of transparency, accountability, and balance of interests for the first time. Therefore, unlike the current TCC, the New TCC provides specific prohibitions for Subsidiary Assistance.

(i) Subsidiary Assistance Provided by Controlled Subsidiaries

Article 202 of the New TCC indirectly restricts subsidiaries from providing Subsidiary Assistance to controlling companies. As per this Article, controlling companies may not use their voting power to force their subsidiaries to (i) carry out transactions such as transferring their businesses, assets, funds, employees, claims or profits (fully or partially) to third parties; (ii) undertake liabilities as surety, guarantor or otherwise; (iii) make payments to third parties; or (iv) adopt certain resolutions for the purposes of transactions undertaken by their controlling companies and causing the subsidiaries to incur a loss, by decreasing the subsidiaries' productivity and by negatively affecting their activities.4

That being said, Article 202 of the New TCC also provides a relaxation procedure as an exception to its prohibition on providing Subsidiary Assistance. According to the relaxation procedure, the controlling company will not be deemed liable if it compensates for the loss of the subsidiary or provides equivalent claim rights within the same financial calendar year. Any of the subsidiary's shareholders have the right to request compensation for damages if the controlling company does not cover the loss of the subsidiary, or does not provide an equivalent form of compensation within the same financial calendar year. In that instance, the controlling company's board of directors will be liable together with the controlling company. Furthermore, creditors of the subsidiary also have the right to request compensation for the subsidiary's damages. Creditors may also bring legal action to claim damages from the controlling company and its shareholders if the controlling company fails to cover Subsidiary Assistance-related losses of the subsidiary or to determine the method of covering such losses within the same financial year. Under the New TCC, compensation will not be awarded where any Board Members acting in good faith and with a high level of duty of care under the same conditions could have engaged in such conduct (i.e. Subsidiary Assistance).

(ii) Subsidiary Assistance Provided by Wholly Owned Subsidiaries

Despite the restriction applicable to controlled subsidiaries, the New TCC sets forth a different regime for wholly owned subsidiaries. According to Article 203 of the New TCC, the Board of Directors of the controlling company – as long as its specified and factual policies require – is entitled to issue instructions regarding the management and direction of its subsidiary provided that it holds, directly or indirectly, 100% of the shares and voting rights of its subsidiary. In this case, even if such instructions might result in loss for the subsidiary, the management and other bodies of the subsidiary must comply with such instructions. However, as an exception, Article 204 of the New TCC provides that instructions that are of a nature which clearly exceed the subsidiary's solvency, jeopardizes its existence, or results in the loss of significant assets of the subsidiary, may not be given.

Article 205 of the New TCC provides that the subsidiary's Board Members, managers and other related persons may not be held liable toward the subsidiary or the controlling company for complying with the instructions in Articles 203 and 204 of the New TCC. Furthermore, since the controlling company's management may instruct its wholly owned subsidiary to provide Subsidiary Assistance, it is possible to say that the New TCC enables wholly owned subsidiaries to provide Subsidiary Assistance to their controlling companies. Nevertheless, the controlling company and its managers will still be responsible for damages incurred by the subsidiary's creditors. According to Article 206, if the controlling company fails to cover the subsidiary's loss incurred as a result of the instructions given by the controlling company or its management, or to determine the method of covering such losses within one financial year, the creditors of the subsidiary will be able to bring legal action to claim their damages from the controlling company or its managers who are responsible for the loss.

Effect on Security

In general, providing security on behalf of the controlling company is a commonly used method of Subsidiary Assistance. The regime applicable to providing Subsidiary Assistance under the New TCC differs depending on whether the controlling company partially or wholly owns the subsidiary.

When the controlling company enjoys Subsidiary Assistance provided by its partially owned subsidiary, the material point to be cautious about is the loss that may be incurred by the subsidiary. As mentioned above, the controlling company shall not be held liable, provided that it compensates for the loss of the subsidiary or provides equivalent claim rights within one financial calendar year. To that extent, if, through effective financial planning, the controlling company ensures that benefit to the subsidiary is not jeopardized, the subsidiary may provide security on behalf of the controlling company. Under the New TCC, unless the controlling company wholly owns the subsidiary, it will need to assume more than its parental obligations and, now, must also be a "brother's keeper" if it requests Subsidiary Assistance.

However, if the controlling company wholly owns the subsidiary, such controlling company will be able to instruct its subsidiary to provide securities on its behalf, even if providing such securities may result in loss for the subsidiary. The controlling company, in this case, is still not entitled to give instructions to its wholly owned subsidiary to provide security that may jeopardize its existence or cause significant loss of its assets. Nevertheless, as we mentioned above, the wholly controlling company and its managers will still be held liable for the damages of its subsidiary's creditors.

Footnotes

1. Law No. 6102, published in the Official Gazette dated 14 February 2011and numbered 27846.

2. Law No. 6762, published in the Official Gazette dated 9 July 1956 and numbered 9353.

3. The new TCC introduces a concept defined as a controlling company under the section of multi-corporate enterprise. As per Article 195 of the New TCC, if a company, directly or indirectly, (i) controls the majority of voting rights; (ii) is entitled to vote on the appointment of a sufficient number of members to establish a majority in the management body; (iii) has the capacity to exercise majority voting rights on its own or with other shareholders arising out of a contractual relationship entered into with the same; or (iv) controls another corporation via a contract or in any other manner, it qualifies as a controlling company.

4. This is a non-exhaustive list under the new TCC, and similar acts will be considered within the scope of the said Article's prohibition.

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.

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