Turkey: Affiliation Reports In A Corporate Group

Introduction

The Turkish Commercial Code No. 6102 ("TCC") introduces provisions on group companies on the basis of the concept of dominance between companies. Pursuant to these provisions, where a company directly or indirectly (a) holds the majority of voting rights in another company, (b) has a right in another company to appoint the number of members of its managing organ having the majority to adopt board resolutions, (c) owns the majority of voting rights in another company solely or together with other shareholders based on an agreement; or where a company controls another company through a dominance agreement or through other means, the first company is in a dominant position. The parent company and the subsidiaries under its control, which are party to a dominance relationship, constitute a group of companies (a corporate group). The Trade Registry Regulation1 Art. 105/1 on the other hand stipulates that for a corporate group to exist pursuant to TCC Art. 195/4, there must be one parent company and at least two subsidiaries.

In order to prevent negative influences of the parent company over the subsidiaries as a result of the dominance, the TCC stipulates some obligations for both the parent company and the subsidiaries. The main obligation of the parent company is to not exercise control illegally. In the event the parent company exercises its control illegally over its subsidiary, resulting in the subsidiary facing losses, the parent company shall compensate the losses of the subsidiary. The purpose of such obligation is to prevent the shareholders and the creditors of the subsidiaries from incurring losses. In the event the parent company does not compensate the losses, the shareholders of the subsidiary may request compensation of damages and the creditors of the subsidiaries may request compensation of the losses to be paid to the company.

Affiliation Report

Article 199 of the TCC stipulates that the subsidiaries will annually prepare an "affiliation report" in order to both render the above explained mechanism effective and to ensure that the shareholders and creditors of the subsidiaries are informed of the relationship between the subsidiary and other group companies. This report shall assess the relationship between the subsidiary and other subsidiaries and the parent company of the corporate group, and the consequences arising therefrom.

Due to the nature of the information included therein, the affiliation report shall also constitute a basis for the exercise of certain rights granted to shareholders and creditors under the TCC. For instance, the issues determined in the affiliation report are of great importance with regards to the rights of the shareholders to information and to conduct examinations. Additionally, this information may also form the basis for compensation lawsuits to be filed in case the parent company does not make the necessary compensations where compensation shall be made under the law. For these reasons, TCC Art. 199/2 stipulates that the affiliation report shall be prepared in accordance with the true and fair view principle.

The Companies Obliged to Prepare an Affiliation Report

As mentioned above, all of the subsidiaries that are under control of a parent company are obliged to prepare affiliation reports. The fact that the subsidiary is a parent company of other affiliates or subsidiaries does not eliminate its obligation to prepare the affiliation report. The determining factor is whether the company is under the control of another company through any means. It is not necessary that the subsidiary be a joint stock company in order to prepare an affiliation report.

The Content of the Affiliation Report

Article 199 of the TCC which governs the preparation of the affiliation report also determines the information which shall be included therein. Pursuant to this article, in general, the relationship between the company and the parent company and other subsidiaries of that parent company shall be stated in the affiliation report. Within that scope, (i) the obligations of the subsidiary and the counter obligations, (ii) the measures to prevent the losses of the subsidiaries which the parent company adopted or refrained from providing, together with the reasons of such measures and the interest and damages that the company may incur due to such measures and (iii) whether compensation was made where some losses were incurred and the information with regards to such compensation shall be included to the affiliation report.

In short, the matters to be mentioned in the affiliation report may be classified into three groups: the legal transactions with the other companies of the corporate group, the measures omitted or provided in favor of such companies, and the compensation made for the losses incurred.

The text of the article regarding measures to be provided and compensation is quite clear. However, the scope of the legal transactions to be included in the affiliation report must be carefully and diligently determined; as the wording of the article may result in differences of interpretation.

The wording of the article with regard to legal transactions is as follows: "... the legal transactions made with the parent company or a subsidiary of the parent company, or made in favor of the parent company or one of its subsidiaries upon the direction of the parent company". As can be seen, the interpretation of the phrase "upon the direction of the parent company" is not sufficiently clear; neither does the justification of the article offer any explanation to that end.

In our opinion, all of the transactions made with the parent company and the subsidiaries shall be included in the affiliation report without being subject to any other condition. However, certain transactions that are not made with the parent company or one of its subsidiaries may also be included to the report provided that such transactions are made in favor of the parent company or one of its subsidiaries, and that the transactions have been made upon the direction of the parent company. Therefore, three groups of transactions shall be included in the report: (i) all of the transactions made with the parent company, (ii) all of the transactions made with the subsidiaries of the parent company and (iii) the transactions made with third parties upon the direction of the parent company in favor of the parent company or one of its subsidiaries2.

The types of the transactions to be mentioned in the affiliation report are not limited under the TCC. For instance, all sale, rental or service agreements etc. between the corporate group companies, or provision of securities in favor of the group companies may be cited as transactions to be mentioned in the affiliation report. Additionally, the cases stated in Art. 202, which result in liability of the companies, may be used to determine the matters which shall be included in the affiliation report.

It should also be determined whether the subsidiary, where it is the parent company of other companies, shall state the transactions conducted with its own subsidiaries. In fact, such an obligation is not stipulated for the affiliation report which shall be prepared in accordance with TCC Art. 199/1-3; and in practice, this shall not be necessary. The subsidiaries of a company that are also under the control of another parent company, and therefore in the position of a subsidiary, shall state those transactions in the affiliation reports that they will prepare. For instance, in the event joint stock company (A) is a parent company and joint stock companies (B), (C), and (D) are its subsidiaries, (B), (C) and (D) shall each prepare an affiliation report regarding their relations with (A). If (B) controls joint stock companies (V), (Y) and (Z), (B) shall not mention its relationship with (V), (Y), and (Z) in the affiliation report that it shall prepare. (V), (Y), and (Z) shall mention such relationships in the affiliation reports that they shall prepare.

The parent companies on the other hand are obliged to mention such information in the "control report" that they will prepare upon request, in accordance with TCC Art. 199/4. For the example above, (A) shall prepare a control report for its relationship with (B), (C) and (D); whereas (B) shall prepare a control report for its relations with (V), (Y), and (Z).

The Relation between the Affiliation Report and the Activity Report

The purposes of the affiliation report and the activity report are similar with regards to informing the shareholders and the creditors of a company's activities. Aside from this similarity, they are quite different regarding their contents. Nevertheless, TCC Art. 199/3 stipulates that some of the information in the affiliation report must also be included in the activity report. The article reads as follows: "At the end of the report, the board of directors shall explain whether or not the company, in the circumstances and conditions known to the board at the time the company conducted the legal transaction or took or refrained from taking the measure, undertook the appropriate counter measure in relation to each legal transaction and whether or not the company suffered losses due to taking or refraining from taking the measures. In the event the company incurred losses, the board of directors shall also specify whether or not the losses were compensated. This explanation shall only be included in the annual activity report."

As seen, the article states that the affiliation report shall have a conclusion section and it also determines the content of this section. However, in line with the principle that the affiliation report shall not be disclosed to the shareholders in its entirety, all of the information in the affiliation report shall not be included in the activity report, and only its conclusion section shall be cited in the activity report3.

In addition to the above explanations, another passage of the article, which may result in material controversies in practice, should also be mentioned. As seen above in the article, the board of directors shall evaluate the information "in accordance with the circumstances and conditions known to the board". Therefore, it may be concluded that the cases that are not known, but should be known to the board of directors will not be taken as basis for such evaluation. However, the justification of the article states that, "Whether or not the circumstances and conditions which should have been known to the board of directors shall be taken into consideration with regard to the liability of the board of directors necessitates determination to be made by academics and jurisprudence". Therefore, the board of directors may be held liable for assessments it will make in preparation of the affiliation report regarding the circumstances and conditions it should have known in addition to those of which it had knowledge. Taking into consideration the practice of the Turkish Commercial Code No. 6762, it is highly probable that the phrase "known" shall be interpreted as "should have been known" by academics and the courts. Therefore, it will be prudent to make the evaluation in accordance with the circumstances and conditions that the board of directors should have known.

Conclusion

In conclusion, subsidiaries are obliged to prepare an affiliation report pursuant to Art. 199 of the TCC. In this report, the subsidiary shall cite all of the transactions made with the parent company and the subsidiaries of the same parent company, the transactions made with third parties upon the direction of the parent company in favor of the parent company or its subsidiaries, the measures taken and not taken in favor of those companies and the losses incurred resulting from the corporate group relationship and it compensation of those losses.

The conclusion section of the affiliation report shall be disclosed to the shareholders through citation in the activity report.

Parent companies shall prepare a control report pursuant to Art. 199/4 upon request with regard to their relationship with their subsidiaries.

Footnotes

1. Official Gazette, 27.01.2013, No. 28541.

2. It is also argued that, for the transactions that are not made with the parent company or its subsidiary to be included to the affiliation report, it is not necessary that the conditions of the transaction being in favor of the parent company or its subsidiaries and the transaction being made upon the direction of the parent company are cumulative. According to this opinion, the transactions in favor of the parent company or its subsidiaries and the transactions made upon the direction of the parent company shall be separately considered and included in the affiliation report.

3. During the preparation of the TCC, the sub-commission discussed the disclosure of the affiliation report to the shareholders in its entirety and it was decided that it is not necessary. Accordingly, the word "only" is added to the article emphasizing that only the conclusion part of the affiliation report shall be included in the activity report.

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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