The New Turkish Code of Obligations will enter into force in July 2012 and will introduce many noteworthy changes to the suretyship (kefalet) institution, which is a widely used legal instrument of personal guarantee, perhaps most commonly invoked to secure loan agreements in Turkey.
The amendments introduce new limits to the extent of a surety's liability against the lender, and a more elaborate written form requirement that seems to be a reaction to the "just sign here" attitude that the current legislative scheme enabled. In this article, we have summarized various of the noteworthy provisions in the New Code of Obligations pertaining to suretyship contracts that either did not exist previously, or will significantly amend the current legislative scheme once the new law enters into force.
The most practical implication of the amendment is the new requisite written form for entering into a surety contract. The former regime required that an agreement giving rise to a suretyship obligation be in written form in order to create a valid and binding obligation. The New Code of Obligations goes one step further and requires that the following elements of the contract be handwritten by the person agreeing to act as surety for another person's debt or obligation: (i) the maximum amount of liability to be assumed by the surety; (ii) whether joint and several liability is assumed; and (iii) the date of the agreement. The prevailing banking practice in Turkey has been the "just sign here" attitude, whereby the surety contract was reduced to filling in printed forms, and the surety signed the signature block without the bank having to document the surety's signature or the aforementioned primary elements of a surety contract. The goal of this amendment appears to be to ensure that the person providing the surety considers, understands and actively consents to the subject matter, amount and duration of this undertaking. Any power of attorney issued to allow the attorney to take on the liability for the debt or obligations of a third party, resulting in the principal becoming a surety, is subject to the same formal requirement. Any amendments to an existing surety contract, such as an extension of term or a variation in the amount of liability must also be in writing, setting forth the aforementioned contractual elements in the handwriting of the person agreeing to act as provider of the surety.
The new legislation appears to be partly driven by social policy, as it requires the written consent of the spouse of a natural person agreeing to act as surety. Spousal consent is also sought where the amount or nature of the surety contract is being amended.
A general principle of the suretyship law is that the liability of the surety is secondary to that of the debtor, unless the surety assumes joint and several liability (acknowledging this in writing, as noted above). The New Code of Obligations does not result in the surety becoming primarily liable per se, even where joint and several suretyship is established by contract. The new legislation requires that the creditor first demand that the defaulting debtor pay off the outstanding amount, and allows the creditor to seek repayment from the surety's assets if and when the creditor fails to recover such amount from the debtor, or if the debtor is insolvent and it does not seem likely that any such debt recovery effort will be successful.
The obligation to first seek repayment from the original debtor enables the surety to delay the creditor in seizure of the surety's assets. In cases where the debtor is in default and fails to make payment despite having been notified of his/her obligation, or he/she is in apparent financial hardship, the creditor may seek to recover its debt from the jointly and severally liable surety provider. Another significant change that would comfort joint and several sureties is that the creditor is required to, firstly, accept pledged assets or receivables through which to recover its debt. If the debt is secured by a pledge on receivables or personal property, the creditor must first force a sale of the pledged property in order to satisfy the debt before proceeding to recover from the joint and several surety. There are also some exceptions to this provision. Should the court determine that the value of the pledged property does not suffice to satisfy the debt, or the debtor is bankrupt or enters into an arrangement with creditors, the creditors may then resort to the joint and several surety without having to resort to the aforementioned procedure.
The surety will not only be able to delay payments for reasons enumerated above, but will also be able to refrain indefinitely from payment should one of the causes identified in the New Code of Obligations emerge. To begin with, a surety will be liable only for those debts or obligations that came into existence after the formation of the surety contract, unless the contract expressly provides otherwise. The typical general loan agreement provision whereby the surety assumes responsibility for all kinds of debt and liability incurred, or that will be incurred, by the debtor against the bank will now have to be reconsidered. The person acting as surety may also object to payment should the debtor be rendered unable to make payment as a result of circumstances preventing his/her payment, e.g., restrictive foreign exchange controls. The debtor's waiver of a defense against the creditor (e.g., statute of limitations) will not preclude the surety from raising such defenses.
Finally, the liability of a natural person surety will expire at the end of ten years from the date of a surety contract. Should the contract provide for a period longer than ten years, the contract will still be enforceable for no longer than ten years, unless it is extended or renewed by duly observing the special written-form requirements identified above. The extension may again be for no longer than ten years, and it should be agreed to no earlier than one year prior to the expiration of the ten-year term of the initial surety contract.
The provisions of the New Code of Obligations pertaining to the special requirements in written form, eligibility for suretyship, and spousal consent will also apply to other forms of personal guarantees to be provided by natural persons. This provision is an attempt to prevent lenders from replacing sureties with guarantors in an effort to avoid the protective measures introduced to strengthen sureties against creditors.
Provisions 581 to 603 of the New Code of Obligations that address surety contracts, self-admittedly, aim to provide protection to sureties against economically superior lenders. These changes seem to restrict the freedom of contract as an instrument of social policy, most notably in the areas of the scope, enforceability and duration of the surety contract.
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.