Turkey: Battle Of Collateral: The Share Pledge v. The Usufruct Right

The purpose of this article is to review current Turkish law that impacts shareholders' rights and usufruct rights. Turkish law provides shareholders of a joint stock corporation with certain, fairly typical rights as are found in virtually all corporate codes throughout Europe and North America. These include voting rights in general assembly of shareholders meetings, rights to collect dividends, pre-emptive rights, the right to subscribe for new shares, and the right to collect liquidation proceeds. While some of these rights are strictly attached (i.e. personal) to the shareholder, some of them are also available to pledges of shares or usufruct rights holders.

A share pledge is a form of pledge over movables, usually employed to secure a loan of some type. Under Turkish law, all shareholder rights, other than the collection of liquidation proceeds, remain with the pledgor until the share pledge is foreclosed. However, the parties may agree otherwise in the share pledge agreement. Therefore, the pledge agreement must specify who will be entitled to exercise the shareholder rights. The company must also be notified of such agreement.

Any liquidation proceeds that are to be distributed to the shareholders of the company are included within the scope of share pledge. Even if there is no specific provision under the share pledge agreement with respect to the right to collect liquidation proceeds, if the company whose shares are subject to the pledge goes into liquidation, the pledgee will be the beneficiary of the liquidation proceeds, since the proceeds will in effect substitute for the pledged shares.

As stated above, some rights attached to the shares of a company can only be exercised by the shareholder itself and cannot be exercised by the pledgee. For instance, the pre-emptive right to subscribe to new shares to be issued corresponding to the pledged shares, such as in the case of a capital increase in the company or the issuance of bonus shares, is vested with the pledgor/shareholder. It may be beneficial for the pledgee to oblige the pledgor under the share pledge agreement to subscribe to the new shares to be issued by the company to preserve the value of the pledged shares, thereby avoiding dilution of the pledged shares. Furthermore, the pledgor may also undertake to establish further pledges in favor of the pledgee on those newly subscribed shares.

In principle, the share pledge does not grant the pledgee any voting rights per se; thus, this right also remains with the shareholder. Nevertheless, contrary to the pre-emptive right of the shareholder mentioned above, the parties may enter into a voting agreement empowering the pledgee to attend the general assembly meetings and vote on behalf of the pledgor. In order to enable the pledgee to exercise voting rights, the pledgor must provide the pledgee with a separate proxy authorizing the pledgee to participate in each general assembly of shareholders on its behalf. Proxies cannot be irrevocable as a matter of Turkish law. However, revocation may contractually qualify as an event of default.

Although the holder of a share pledge cannot automatically benefit from most of the shareholder rights, the holder of the usufruct right would automatically benefit from most of the shareholder rights attached to the relevant shares, including voting rights and dividends. However; like the share pledge, the usufruct right does not provide the usufruct right holder with the pre-emptive right to subscribe for new shares to be issued by the company. As suggested above for the share pledge agreements, the usufruct agreement may also oblige the shareholder to prevent the dilution of the shares subject to a usufruct right.

A usufruct right is a type of an easement right, which merely provides the use of rights over the shares, rather than providing a security interest over the shares. Therefore, the holder of the usufruct right is not entitled to foreclose on the shares. In order to be entitled both to exercise the shareholder rights automatically, and to foreclose on the shares in the event of the borrower's default, it may be beneficial to simultaneously establish a usufruct right and pledge over the shares.

The use of shares of joint stock corporations is a popular means of securing debt obligations. Despite the apparently simple and straightforward approach of Turkish law on the subject, care must be taken when drafting security agreements and pledge agreements in order to appreciate the differences of the structures discussed in this article. An inadvertent mistake could result in the loan collateral not being worth the cost of the paper of the share certificate.

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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