Turkey: Escrow Agreement In Turkish Law And Its Application In Mergers & Acquisitions

Last Updated: 22 September 2016
Article by Sezi Demirçark

Introduction

Escrow1 mechanism is a common practice in mergers and acquisitions aiming to secure the performance of the obligation at a later time if immediate performance is impossible or not preferred. This is a practice whereby the obligations of the parties to the underlying agreements in mergers and acquisitions are entrusted with a third party named as the escrow agent in an effort to secure the performance of the obligations (i.e. transfer of the purchase price and/or shares) arising therefrom. In this respect, the parties to merger and/or acquisition transactions and a trustee (escrow agent) enter into an escrow agreement setting forth the terms and conditions for returning the sale shares and/or consideration.

It is intended with this article to provide the reader an insight regarding escrow mechanisim and its implementation to mergers and acquisitions under Turkish Law.

Relationship between Escrow Agreement and Merger & Acquisition Agreements

The aim of the escrow agreement is to secure the performance of the obligations arising from the merger and/or acquisition agreement.

An escrow agreement is based on the agreement of the merger or acquisition transaction. Within this context, there are two separate agreements having different parties with varying rights and obligations. Thus, one part of the escrow agreement is the parties to the merger and/or acquisition agreement, while the other part thereto is a third person not being a party to the underlying agreement (escrow agent). Escrow agreements are preferred as a security mechanism also in case of asset and business transactions. What characterizes the escrow agreement in this instance is that the right of disposition over the assets being the subject matter of the escrow agreement is assigned to the escrow agent until the certain terms and conditions of the underlying agreement are fulfilled.

The underlying agreement may explicitly set forth that an escrow agreement shall be executed, or even incorporate full text or principal terms and conditions of such an escrow agreement.

Accordingly, it is essential for the escrow agreement to be executed by and between the escrow agent and the parties to the merger and/or acquisition agreement to include the following particulars2:

  • Information on the transaction being the basis for the escrow relationship,
  • Detailed information on the assets entrusted with the escrow agent (for instance, if the assigned asset is a share, the number, type, distinctive features of the sale shares; and if the assigned asset is the purchase price, then the amount and type of the consideration),
  • Relevant obligations of the escrow agent,
  • Detailed information under which conditions the assigned asset (i.e. share or consideration) shall be returned to the parties to the underlying agreement, and about the procedure to be followed upon occurrence of such conditions (for instance, joint instruction to be sent by the purchaser and seller to the escrow agent, or a unilateral statement of will to be sent by either the purchaser or seller to the escrow agent),
  • Consequences of the rights and obligations related to the assigned asset during the escrow period (for instance, who shall be entitled to profit shares, dividends accrued on the sale shares, or interest accrued on the purchase price),
  • terms and conditions for returning the assigned assets in the event where none of the conditions requiring the return thereof has occurred,
  • Fee payable to the escrow agent,
  • Information about the applicable law and jurisdiction to be applied to the conflicts likely to arise from the escrow agreement.

During the contract negotiations, it may not be possible to verify the representations and warranties made by the seller to the purchaser with respect to the shares or assets. In such cases, the purchaser shall be willing to pay the consideration only after the fulfillment of the relevant representations and warranties that are the subject matter of the underlying agreement. On the other hand, it is apparent that the seller will also be willing to transfer the transferred company or assets only after the full payment of the consideration. In such cases, as a mechanism securing the risk for both parties, the escrow creates a security also for the said representations and warranties.

One of the methods employed in practice is that the purchaser and seller being the parties to the underlying agreement require that a bank account (escrow account) be opened in favor of the escrow agent as the impartial third party. The consideration held in the escrow account is paid to the parties only after certain condition(s) is/are fulfilled as envisaged under the underlying agreement. Here, the seller or purchaser has no right of release by their own initiative on the escrow account; such right can only be exercised by the escrow agent and/or by the parties, together with the escrow agent.

Legal Nature of Escrow Agreement

As a contract originating from Anglo-Saxon law, the escrow agreement has not been regulated under the Code of Obligations or any other specific law. Pursuant to the freedom of contact principle, the parties are free to execute an agreement in the form and substance as they so elect, subject to the limitations envisaged under the law (Article 26 of the Code of Obligations). Unlike generic or typical agreements regulated under the Code of Obligations or other laws, escrow agreements can be qualified as atypical or innominate agreements.

While the constituents of escrow agreements do not meet any agreement types regulated under the Code of Obligations, it can, nevertheless, be compared to bailment contracts (bailment agreement and sequestration contracts) and contracts of mandate, which have been covered in detail in the Code of Obligations. As a matter of fact, the essence of the contract of bailment is safekeeping, and the bailor is obliged to return the chattel at any time upon request of the bailee (Article 564 of the Code of Obligations). Even if one of the components of the escrow agreement is the obligation to keep it safe, the obligation to return, as envisaged in the contract of bailment, does not coincide with the structure of the escrow agreement, because the obligation to return as envisaged in the escrow agreement is intended for the performance of the obligations arising from the underlying contractual relationship. In the event of sequestration as a kind of contract of bailment, it is essential that if the legal status of the parties to the underlying agreement is unclear or disputed, the contractual asset is entrusted to a third party (Article 569 of the Code of Obligations). Here, again, it is also intended to prevent any disposition over the asset entrusted to the third party and, in this respect, it has a purpose similar to that of the escrow agreement. However, the point that differs this contract from the escrow agreement is that the legal status is unclear or disputed. A contract of mandate is an agreement where the mandatory undertakes to perform a particular business or transaction for the mandator (Article 502 of the Code of Obligations). Here, too, the escrow agent in the escrow agreement is also obliged to act prudently and loyally just like the contract of mandate. However, the basic point in the contract of mandate is that the mandator is entitled at any time to terminate the contract and to dismiss the mandatory, unilaterally (Article 512 of the Code of Obligations). This unilateral power does not comply with the structure of the escrow agreement3.

In light of the foregoing, while the escrow agreement contains the particulars related to the types of agreements regulated under the Code of Obligations, it is rather an innominate contract (mixed/sui generis contract) with distinct conditions.

Conclusion

If the mutual performance of the obligations arising from merger and/or acquisition agreement is not readily possible and contingent on certain conditions, securing such performance is satisfied by the escrow agreement. The escrow agreement serves as a substantial security tool. In the light of the foregoing explanation, it would be beneficial to make revisions in the relevant legislation to set out the escrow mechanism.

Footnotes

[1] Since the Turkish translation for the word "escrow" cannot fully correspond, and it may cause confusion or ambiguity, the word has been used in English.

[2] Kırca Ismail, Banka ve Ticaret Hukuku Dergisi, Vol. XIX, Issue 1, Ankara 1997: p 46-47.

[3] Kırca Ismail, Banka ve Ticaret Hukuku Dergisi, Vol. XIX, Issue 1, Ankara 1997: p.53-56.

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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