Turkey: Loss Of Capital In Joint Stock Companies

Last Updated: 6 November 2015
Article by Tuna Çolgar

Introduction

Situation of the capital, namely, the effect of losses on a company's equity, carries vital importance in the deterioration of a joint stock company's financial structure. Worsening of the financial structure, losses due to incompetency, in other words, loss of equity, or superiority in the ratio of assets versus debts, may lead to over-indebtedness.

The essential objective underlying the provisions of Turkish Commercial Code numbered 6102 ("TCC" or "Law"), governing the precautions to be taken upon the loss of capital and over-indebtedness of joint stock companies, is to maintain the organization and protection of the company capital that constitutes the main assurance for creditors of joint stock companies.

TCC Art. 376/1 and TCC Art. 376/2 are two of the primarily debated, and most significant, provisions of the TCC, aiming to maintain protection of the capital until termination of the company. TCC Art. 376 regulates the precautions that are to be taken in the event of deterioration of the company's financial structure. Due to the fact that the first two paragraphs of such provision govern the duties of the board of directors in the event of capital loss, those two paragraphs pertain solely to the protection of the equity. The third paragraph, on the other hand, designates over-indebtedness of the company, namely, if a company's debts exceed its assets.

The actions to be performed in both the events of loss of capital and over-indebtedness have been designated as obligations of the board of directors. Moreover, the duty to notify the competent court in the event of over-indebtedness has been stipulated under the TCC as one of the non-transferable duties and authorities of the board of directors.

Precautions Regarding Protection of the Capital

As per TCC Art. 376/1[1], if it has been ascertained from the latest annual balance sheet that one-half of the total amount of legal reserve funds has remained uncovered due to losses, the board of directors is obliged to convene the general assembly, and provide the general assembly with appropriate remedial measures.

This paragraph merely requires the board of directors to inform the general assembly of the situation, and the general assembly to make a decision thereof. On the other hand, such provision does not necessitate a certain method to do so. The mentioned precautions may be exemplified as capital increase, reduction of outgoings, or shutoff of an ongoing investment, if the equity has not been fully paid, convocation for encashment of the remaining capital receivables, sale of assets, and other similar precautions[2]. The board of directors is responsible to undertake such precautions.

In accordance with TCC Art. 376/2[3], if it is determined from the company's balance sheet that two thirds of the total of the equity and legal reserve funds have become uncovered due to losses, then the board of directors is obliged to immediately convene the general assembly, and the general assembly must decide whether to replenish the capital or to continue operations with the remaining one thirds of the capital. If the general assembly refrains from making such decisions, then the company shall be deemed to be automatically terminated.

In summary, solely the lawmaker enables companies to lose an amount equal to, and at most, one-half of the sum of the capital and legal reserve funds, and requires additional precautions for losses that exceed half of such sum.

The TCC considers losses up to and exceeding one-half of the company capital to be significant matters requiring prompt notification to the general assembly and, thus, burdens the board of directors with the obligations to convene the general assembly for an extraordinary meeting, and to provide them with improvement projects that aim to reimburse the loss of equity. It is surely beyond doubt that the general assembly, solely, shall decide whether to take precautions or not, to accept or decline the suggestions of the board of directors, or to take precautions other than those that the board of directors suggests.[4]

The first precaution envisaged under Article 376/2 of the Law, which is the general assembly decision pertaining to continuation of the operations with the remaining one-third of the capital, is a capital decrease by means of reducing two-thirds of the capital. This may only be performed via extinguishing one-third of the capital, or reducing two-thirds of the nominal price of each share. Minimum capital and nominal prices envisaged in the TCC must be regarded during the implementation of both methods.

If the general assembly decides to continue operations with the remaining one-third of the capital, then Art. 474/2 of the TCC shall be instructive. Pertaining to such Article, the board of directors may relinquish convening the creditors and satisfying or securitizing them.[5]

The other precaution that the Law envisages for the loss of two-thirds of the equity, is replenishing the capital. As is mentioned in the preamble of Art. 376 of the TCC, replenishing may be performed via three methods. These are as follows:

  1. Decrease of capital, as much as the uncovered portion, and following, increase of the capital as much or more,
  2. Covering of adverse balances by all shareholders or some of the shareholders, and
  3. Some creditors' waiver of their receivables.

It should be stated that along with the option to increase the capital to an amount higher than the former capital, by complying with the capital increase and decrease procedures, the general assembly may also choose to replenish the capital of the company until registered share capital is reached, provided that this increment does not exceed the capital loss by two-thirds.

Due to Art. 480/1 of the TCC that prohibits the general assembly resolution from forcing the shareholders to make additional payments, such general assembly resolution regarding the method mentioned above under subparagraph (ii), which covers adverse balances by shareholders, must be unanimously taken. However, if unanimity is not able to be provided, there are no restrictions inhibiting the shareholders to cover the adverse balances by submitting cash at their own discretions. This submission denotes neither a shareholder loan, nor an advance payment for capital increase. This submission of cash solely signifies the shareholders' sacrifice in order to save their company from the current situation without expecting something in return, or claiming a right in return. The amount of shares that the shareholders hold shall not change after the completion of this capital replenishment.

Although loss of capital is detected principally from the annual balance sheet, it may also be identified from the interim balance sheet issued for any reason. For instance, if the interim balance sheet that has been issued upon the suspicion of over-indebtedness and implies that the company is not over-indebted, yet it has lost 1/2 or 2/3 of its capital, the precautions stipulated under Art. 376/1 and 376/2 of the TCC should be taken.[6]

The debates regarding the implementation of Art. 376 of the Law revolves around the detection and determination of loss of equity. Both of the aforementioned paragraphs of the Article include the expression of "total of the capital and the legal reserve funds." The first issue to clarify here is the definition of capital and the legal reserve funds.

According to the first view, the preamble of Art. 376 of the TCC, it includes the explanation of "By the term of capital, the law maker aims to predicate the registered capital found under the capital item of the balance sheet." This means that the registered capital shall be the total amount undertaken by the shareholders, which are designated under the articles of association, and registered, accordingly. Revaluation fund is not included in this amount. Moreover, legal reserve funds are stipulated under Art. 519 of the TCC. This Article has been regulated in view of the numerus clausus principle, and the items other than the ones stipulated therein shall not be considered in calculation of legal reserve funds.[7] Due to the fact that such provision explicitly indicates that the premium of newly issued shares shall be added to the legal reserve fund, premiums on issued capital shall be regarded in calculating the legal reserve funds. By virtue of the fact that inflation correction differences are not listed under Art. 519, they shall not be taken into consideration in calculation of legal reserve funds.[8]

In accordance with the opposing view, in order for the precautions on the loss of capital to be taken, the equity that is equal to the residual of the difference between the assets and the liabilities of the company should be less than half or one-third of the total amount of capital and legal reserve funds. As per such view, due to the fact that all assets and liabilities of the company shall be regarded in determination of the equity of the company, all resources that constitute the assets of the company, such as the capital, undistributed profit, legal, contractual, mandatory and voluntary reserve funds, revaluation funds should be considered in the event of capital loss.

Conclusion

Currently, in commercial life, no uniform implementation of the effects and consequences of Art. 376 of the TCC have been adopted thus far. The distinctness of two such opposing views induces significant distinctions in the determination of the financial position of companies; therefore, legal precedents should also be borne in mind while deciding on the financial future of companies.

Footnotes

[1] TCC Article 376/1: If it is detected from the last annual balance sheet that one-half of the total amount of the capital and legal reserve funds remains uncovered due to losses, the board of directors shall immediately convene the general assembly and provide them with appropriate remedial measures.

[2] Prof. Dr. TEKİNALP Unal, Sermaye Ortaklıklarının Yeni Hukuku, Degistirilmis ve Duzenlemelerle Guncellestirilmis 3. Basi, Vedat Kitapcilik 2013, P:244.

[3] TCC Article 376/2: If it is detected from the last annual balance sheet that one-half of the total amount of the capital and legal reserve funds remains uncovered due to losses, the immediately convened general assembly shall decide as to whether or not to continue operations with the remaining one-third of the capital, or to replenish the capital; otherwise the company shall automatically be terminated.

[4] Prof. Dr. KAYAR Ismail, Yeni TTT'ya Gore Anonim Sirkette Sermaye Kaybi ve Borca Batıkligin Tespiti ve Sonucları Tebligi.

[5] Prof. Dr. TEKINALP Unal, Sermaye Ortakliklarinin Yeni Hukuku, Degiştirilmis ve Duzenlemelerle Guncellestirilmis 3. Basi, Vedat Kitapcilik 2013, P:245.

[6] Prof. Dr. KAYAR Ismail, Yeni TTT'ya Gore Anonim Sirkette Sermaye Kaybi ve Borca Batıkligin Tespiti ve Sonucları Tebligi.

[7] Sermaye Ortakliklarinin Yeni Hukuku, Degiştirilmis ve Duzenlemelerle Guncellestirilmis 3. Basi, Vedat Kitapcilik 2013, P:244.

[8] Prof Dr. PULASLI Hasan, Yeni Sirketler Hukuku Genel Esaslar, Guncellenmis 2. Basi Ankara 2013, p. 467.

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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