Turkey: Financial Assistance Becoming More Cumbersome Under Turkish Law

Frequently foreign and local lenders and investors inquire whether financial assistance is valid and enforceable under Turkish law. Another layer of complication is added, when the entity providing financial assistance is a publicly held company, i.e., a Turkish company, whose shares are listed on the Istanbul Stock Exchange.

How to Respond to the Question on Financial Assistance?

The answer to this question depends on the changes that are being introduced by the new Turkish Commercial Code No. 6011 that will replace the existing commercial code upon its effective date of 1 July 2012 (the "New Code"). The very recent amendment introduced to the applicable capital markets legislation on 30 December 2011 further imposes on publicly held companies that are providing financial assistance the requirement to obtain proper corporate authorization in order for the security to be valid and binding.

The applicable capital markets legislation already imposes certain limitations on the circumstances under which publicly held companies may provide financial assistance. The existing commercial code governs all companies, including publicly held companies to the extent not governed by the capital markets legislation while, on the other hand, it does not stipulate financial assistance, neither does it prohibit it. The New Code, in contrast to the existing commercial code, introduces specific prohibitions directly applicable to the "financial assistance" provided by the affiliates to their parent companies by way of providing a surety, guarantee, aval and other types of security.

Thus, the response to this query will differ on a case-by-case basis and according to the timing of the financial assistance.

What is the Status under the Applicable Turkish Commercial Code?

Since the existing commercial code does not stipulate nor prohibit financial assistance, court precedents support that it is in the ordinary course of business life for commercial corporations to be entitled to provide security for each others' debts, particularly for the purpose of providing joint liability to the banks in order to obtain loans.

However, certain obstacles must always be taken into consideration even under the applicable commercial code.

Some of those issues are the fiduciary duties of the board of directors' members who are evaluated in relation to the benefits of the relevant company. The commercial code does not at all recognize the overall concepts of "group companies" or "group benefits." Therefore, each transaction must be considered and evaluated by the members of the board of directors of a company per se and be at arm's length. Any failure in the duty of care or duty of loyalty of the members of the board of directors may trigger the minority shareholders' right to sue the board for breach of its fiduciary duties. Minority shareholders may always try to cause nuisance by filing complaints with the Capital Markets Board as the capital markets regulator (the "CMB").

In addition to such issues, one other matter currently applicable under the existing commercial code is the relevant company's obligation to meet the ultra vires principle. The New Code abolishes the ultra vires principle. However, under the applicable commercial code, activities of a company are limited to the purpose and framework of each company as set out in its articles of association and the standalone agreement governing the relationship between the shareholders and the company. Transactions that are in violation of the ultra vires principle will automatically be considered null and void. The general principle and guiding rule in determination of the ultra vires principle is not only a review of the articles of association of such company, but also an evaluation of such transaction. As mentioned above, court precedents support that it is in the ordinary course of business life for commercial companies to provide security for each others' debts, particularly for the purpose of undertaking joint liability of the banks in order to obtain loans.

What is the Status under the New Code?

The New Code defines financial assistance as the abuse of dominant power of the parent company that causes loss to the affiliate.

Again, contrary to the applicable commercial code, the New Code defines the concept of the "parent company" and the "affiliate." The New Code prohibits financial assistance of a subsidiary to its parent company. A parent company cannot use its control over its affiliates to their detriment through forcing the affiliates to adopt certain resolutions, including resolutions related to financial assistance to the parent company by way of providing security.

If such financial assistance is given by the affiliate, the related losses of the affiliate must be covered/ adjusted by the parent company within the same financial year, or the method of covering such losses must be determined within the same financial year. Failure of the parent company to cover/adjust the losses of the affiliate will grant any shareholder of the affiliate the right to request the parent company and the directors of the parent company to cover its losses, but will not invalidate the financial assistance given.

Furthermore, the creditors of the affiliate will also have the right to request compensation of the affiliate's damages even if the affiliate does not enter into insolvency. Compensation will not be awarded where such conduct has been made, could be made, or could have been avoided by the board of directors' members acting in good faith and with a high level of duty of care under the same conditions.

What if the Financial Assistance was provided prior to the Enforcement Date of the New Code?

The enforcement of the provision introducing financial assistance has a specific regulation under the legislation regarding the transition period. Thus, if the company suffers any loss due to financial assistance given prior to 1 July 2012, this should be adjusted within 2 years from 1 July 2012. Upon the failure to make such adjustment, minority shareholders may seek recourse for their damages from the parent company, its members of the board of directors, or request that their shares be purchased by the parent company instead of being indemnified.

What is Different under the Capital Markets Legislation?

In 1998, the CMB allowed publicly held companies to provide pledges and mortgages or guarantees in order to secure third parties' debts, provided that necessary disclosure as required under the applicable legislation is made. However, in 2009, the CMB limited the instances whereby a publicly held company may provide pledges, mortgages or guarantees. As a result, since 2009, those companies are allowed to provide financial assistance either in the name and on behalf of their own legal entities, or for the benefit of companies that have been fully consolidated in their financial statements, or for the benefit of third parties, in order to conduct ordinary commercial activities.

On the other hand, 31 December 2014 is to be the date upon which all of the collateral that has been provided on behalf of any person who does not fall into the above-listed cases is unwound.

Is it Clear as to How to proceed in the Financial Assistance of a Publicly Held Company?

This procedure has certainly become clearer than before. Despite the fact that the CMB legislation and the decisions of the CMB have favoured financial assistance by publicly held companies, the CMB's Guide on the Principles of Corporate Governance that was issued in 2003 and amended in 2005 (the "Guide") has encouraged publicly held companies to resolve issues that cause changes in equity, management or assets of companies, and to provide guarantees and collateral in the meetings of the general assembly of shareholders of such companies. However, it has remained unclear whether such principle must have been complied with since the Guide itself was not itself binding, but was more advisory in nature.

The CMB adopted two new steps to have the corporate governance principles that were initially introduced under the Guide be adopted by, and be binding on, publicly held companies. The first novelty was introduced in October 2011 upon the issuance of Communiqué Serial IV, No. 54 regarding Determination and Implementation of the Corporate Governance Principles that obliged the Istanbul Stock Exchange 30 Index (IMKB 30 Endeksi) of publicly held companies to fulfill certain provisions of the amended corporate governance principles. Assuming that in response to the reactions of the Communiqué issued in October 2011, and which was in line with the global economic approach, the CMB, abolished this Communiqué and replaced it with one that was issued on 30 December 2011 - Communiqué Serial IV, No.56 - on Determination and Implementation of the Corporate Governance Principles (the "New Communiqué").

The provision regarding the financial assistance under the New Communiqué is slightly different than the version that was issued in October, 2011 and is a mandatory provision applicable to all publicly held companies trading on the Istanbul Stock Exchange (the "ISE Companies"). Similar to the former one, the New Communiqué includes, on its face, a very broad provision regarding financial assistance; however, this time it focuses more on related party transactions and the collateral given to third parties rather than changes in equity, management or assets of companies.

Under the New Communiqué, the related party transactions or provision of security, pledges or mortgages in favor of third parties of an ISE Company requires a board resolution that must be approved by the affirmative votes of the majority of the independent directors. If the majority of the independent directors do not approve such a decision, this is to be disclosed to the public and the transaction will be subject to the approval of the general assembly of shareholders. While no meeting quorum is required in such general assembly of shareholders meeting, the decision will be subject to the simple majority of the shareholders entitled to vote in such meeting. ISE Companies are also obliged to amend their articles of associations in line with such new provision imposed by the CMB. Any board resolution or general assembly of shareholders resolution adopted in violation of such provision will be null and void.

Differing from the classification under the Communiqué of October, 2011, the New Communiqué classifies ISE Companies in three main categories based on the systemic risks of the average of the market value of the relevant company and the market value of the shares that are actually in trading.1: Under this categorization, while the companies in the first category are obliged to fulfill all the mandatory provisions of the New Communiqué, the other two category companies benefit from certain exemptions.

It appears that the New Communiqué attracts the importance of the corporate governance rules and places certain importance on the financial assistance decisions of the ISE Companies; therefore, it does not provide any exemptions to any of the ISE Companies. The wording of the relevant provision covers all types of securities for "third parties" and does not carve out affiliates. However, similar to the other regulations in place, we may observe certain distinctions in the implementation of the relevant provision in line with the necessities of daily practice.


1 Categorization of ISE Companies under the New Communiqué are as follows:

  1. Category I: ISE Companies with a market value exceeding TL 3,000,000,000 and a free-fl oating value exceeding TL 750,000,000;
  2. Category II: ISE Companies with market value exceeding TL 1,000,000,000 and free fl oat value exceeding TL 250,000,000, and,
  3. Category III: All other ISE Companies that do not fall under (i) and (ii) above.

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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