In general, share buybacks activity of companies is forbidden under the Turkish Commercial Code numbered 6762 ("TCC") except from certain exceptional cases. The Turkish Commercial Code numbered 6102 ("New TCC") introduces an important innovation enabling the companies to buy back their shares or to accept as a pledge thereon under certain conditions. Nevertheless, article 380 introduced prohibition on a company to provide an advance funding, loan or security to third persons, for the purchase of its own shares (briefly, the "prohibition of financial assistance"). This provision entering into force as of 1 July 2012 is of a significance with respect to the future and validity of company share sale and purchase transactions through benefiting from the company assets which frequently took place (leveraged buy-out). The prohibition of financial assistance, which concerns the companies and private equity investors, shall be analyzed in our newsletter article.
Share Buyback of Companies and the Prohibition of Financial Assistance
Article 329 of the TCC prohibits the share buybacks or acceptance of pledges on the shares by companies except from five exceptions specified under the article. The New TCC limits the scope of the current prohibition. Pursuant to article 379 and the following articles of the New TCC, joint stock companies may buy back their own shares (directly or indirectly through third persons). The possibility for the companies to buy back their shares is reviewed in another article in our newsletter.
New TCC sets out certain limitations and conditions to the share buyback. For instance, shares acquired pursuant to article 379 shall not exceed ten percent of the share capital of the company. The legislative intent of the code states that Article 380 has been introduced to prevent any bypassing of such limitations. Pursuant to this article, the provision of advance funding, loan or securities to third persons by target companies in order for such third persons to acquire shares of the company is prohibited. The justification of this article states that such transactions will be deemed as an indirect share buyback of companies.
The Reasons of Promulgating Article 380
The justification of the Article 380 of the New TCC imposing ban on financial assistance states that the Second Council Directive numbered 77/91 of the European Union1 with respect to companies ("Directive") has been taken as basis for this article. In England, numerous companies have declared bankruptcy during the financial crisis of 1920-21 after entering into leveraged buy-out transactions by using the funds of the target company after the First World War. As a result of these events, the financing of share purchases provided by the company for the acquisition of its shares has been considered dangerous and a rule prohibiting such financial assistances has been established in the British Company Act promulgated in 1929. The EU Law and EU member states adopted this rule, which is still in force in English Law.
Consequently, pursuant to the Directive prior to the amendment made on 2006, a company was not able to provide any advance funding, loans or security to third persons for purchasing its own shares. Nevertheless, facilities granted as part of the ordinary business activities of banks and other credit institutions; and advance funding, loans or security to the employees of the company (and subsidiaries) for their acquisition of company shares are not within the scope of this prohibition. Article 380 of the New TCC has adopted these provisions and stated that the transactions contradicting with this provision will be invalid.
Nevertheless, this ban has been criticized for limiting the possibilities of financing to an extent exceeding the pursued aims and objectives. Therefore the Directive has been amended with the directive numbered 2006/68/EEC2. As a result of this amendment, the European Union member states are provided a gateway to financial assistance as long as the conditions set forth in the Directive are satisfied. Pursuant to this amendment, the advance payment, loan or security provision transactions must be on an arm's length basis; a report about the transaction must be prepared by the management body and submitted to the company; the company shall approve this financial assistance transaction with the votes cast of two thirds of shareholders; the assets of the company shall not be less than the non-distributable reserves of the company after the granted financial assistance. Besides, equal amount of reserve shall be put aside and the benefits of the company shall be protected.
The New TCC did not adopt these amendments. Nevertheless it should be noted that the implementation of the amended Directive within member states of the European Union is left at the discretion of each member states, to either allow or prohibit financial assistance in their national law. Therefore, the New TCC has opted to adopt a criticized and inflexible system nevertheless the current text of article 380 does not constitute a violation of the acquis communautaire of the European Union.
The Financial Assistance Prohibition and Consequences of its Breach
The financial assistance transactions prohibited under article 380 of the New TCC are the provision of advance funding, loans or security to third persons to acquire the target company shares. Any type of transaction governing the provision of advance funding, loans or security is deemed to fall within the scope of the prohibition.
Either granting interests directly to the third persons acquiring company shares or providing financial assistance through indirect means to such persons may fall within the scope of this article. Bearing the costs of legal and financial due diligence, audit and consultation received for the share purchase transaction, repayment of a facility extended for the payment of the share price by using another facility extended by providing company assets as collateral, and financial assistance transactions by the intervention of other companies are considered to fall within the scope of the prohibition of financial assistance in the practice of European Union member states3.
Article 380, further states the consequences of acting contrary to financial assistance prohibition is sanctioned as being null and void. For the invalidity of financial assistance transaction, it is not necessary for the company to have incurred of any losses. Therefore any financing or assistance of the target company, in the absence of which would cause the assisted person to not enter into the purchase transaction, is subject to the prohibition under article 380 and is null and void.
Where a financial assistance is concerned, there are two transactions, one being the transfer of shares and the other being the financial assistance for the payment of the share price. Article 380 only foresees that the financing transaction shall be null and void, and didoes not regulate any consequences to the share transfer. Therefore, we are of the opinion that the share transfer transaction carried out with the financial assistance transaction which will be deemed invalid, shall continue to be valid and binding. Furthermore, Article 385 of the New TCC foresees the obligation to dispose of shares purchased in violation of articles 379. 380 and 381 governing company share buybacks, rather than rendering such transactions invalid (void). From this expression, it is understood that the share purchases in violation of article 380 may be realized. Therefore the only transaction that is invalid is the financing transaction.
Exceptions to the Prohibition of Financial Assistance
Article 380 regulates two exceptions to the prohibition of financial assistance. The first exception governs the transactions normally executed by the credit and financial institutions' as a part of their field of operation. The second exception governs the advance payment, loan or security provision transactions in which shares are acquired by or for employees of the company or its subsidiaries. Such transactions shall not however decrease the reserves of the company, and shall comply with articles 519 and 520 governing the deposit and usage of reserves. The justification for article 380 states that the financing should be provided from the available assets of the company with even where financial assistance is permitted. The transactions falling within the scope of these exceptions are allowed and are not null.
The exception governing the credit and financial institutions has been introduced by adopting the provisions in the Directive; nevertheless the scope of this exception is disputed. Some views in the doctrine declare that the banks may grant a facility to third persons for the acquisition of the shares of a company, with the company providing collateral to the bank for this transaction. Nevertheless, bearing in mind both the purpose and the justification of article 380, and the practice in the European Union, it must be stated that the dominant opinion in the doctrine regarding this exception to be limited to the banks providing facility and financing to third persons in order for such persons to acquire their own (the bank's) shares.
Article 380 of the New TCC has a material impact to the future of the leveraged buy-out transactions. In general the financial assistance by a company for acquisition of its own shares has been prohibited, save for the financing provided to third persons by banks for them to acquire the bank's shares and the financing provided to company employees for them to acquire the company's shares. Any transaction of the company providing advance funding, loan or security (the financing transaction) to third persons for the acquisition of its own shares, other than the aforementioned exceptions, are deemed null and void.
This provision creates a material obstacle with respect to financing of share purchase transactions. The Directive has been amended in the year 2006 to enable such financing under certain conditions in order to circumvent this obstacle. Nevertheless, the New TCC has not adopted this amendment.
In the light of this provision, the assets or resources of the company may not be used or presented as collateral for the sale and purchase of its own shares.
1. Second Council Directive 77/91/EEC dated 13 December 1976.
2. Directive 2006/68/EC of the European Parliament and of the Council dated 6 September 2006.
3. Gül Okutan Nilsson, Anonim Şirketlerin Kendi Hisselerini İktisabı Bağlamında Finansal Yardım Yasağı, Anonim Şirketler ve Sermaye Piyasası Hukukunda Güncel Gelişmeler Türk - Alman Uluslararası Sempozyumu (25-26 Haziran 2010), p. 96-97.
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.