Cash pooling is a cash management model which enables group of companies to minimize expenditure and optimize excess liquidity by way of having a central management of the cash and liquidity positions of their subsidiaries. Cash pooling system is growing more popular each day and widely used in many countries such as Germany, France, the Netherlands and England, however, in some countries, namely China, Argentina, Taiwan and Brazil, cash pooling system is prohibited.
Although it is not prohibited, cash pooling system is not regulated in Turkey. This memorandum aims to explain the purpose and different types of cash pooling mainly focusing on its advantages and risks in light of Turkish law. Although cash pooling mechanism has crucial tax implications under Turkish law that need to be carefully considered, this memorandum will not touch on such tax issues.
- The Purpose and Types of Cash Pooling
Under a cash pooling arrangement, the group of companies manage the balance of their accounts through a master account which is created based on a cash pooling agreement between the group of companies and the bank, in order to liquidate the cash deficiencies of the subsidiaries while minimizing the need for third party financing and lowering financial costs. Group of companies may decide that the master account is held by the parent company or they may also decide to establish another company for only this purpose or to have the system run by finance company. Within the cash pooling system, series of planned actions can be performed automatically between the accounts of the subsidiaries and the master account through a software developed by the bank, where clients can also intervene in real time.
There are two types of cash pooling depending on the type of agreement signed between the bank and the companies; namely physical and notional cash pooling. In physical cash pooling, the companies physically transfer their surplus cash to a master account (also called pooling account, leader account or header account) If there are companies in the group that are dealing with cash deficiencies, such shortfalls are liquidated from the master account and the remaining
amount will be charged interest at a rate which is agreed between the bank and group of companies. This type of cash pooling creates intra-group borrowings by nature.
Based on the cash pooling agreement, the companies either transfer their entire surplus cash (zero balancing) or cash exceeding a certain surplus level (target balancing) to the master account. However, in the event that the master account's balance is negative, all companies may be liable regardless of their contribution.
The second type of cash pooling, notional cash pooling, is rather different as the companies do not physically transfer their surplus cash yet the bank creates a shadow or notional position from all of the participant accounts reflecting the consolidated cash position on which interest is charged. Since there is no physical transfer of funds, there will be no creation of intra-group borrowings. However, in practice, it may be required for the participating companies to grant the banks cross-guaranties and security in order to maximize the available overdraft facilities. Notional cash pooling allows subsidiaries to independently manage their own credit lines. All such independently run accounts are then merged and taken into a single account as one account by the bank with respect to interest, without raising cash or paperwork.
It should be stressed that the cash pooling agreements should be drafted carefully considering the participating companies and their officers' liabilities and the parameters of the centralized management such as thresholds, pooling frequency, pre-determined parameters, etc.
- The Advantages and Risks of Cash Pooling
Cash pooling system owes its growing popularity to its advantages to the group of companies. However, it should also not be overlooked that the system also contains risks in itself.
Main advantages of cash pooling system may be counted as follows:
- As the cash deficiencies of a participating company are liquidated from the master account, such companies do not need external loan credits from banks and similar entities at high interest rates.
- Since it enables for the participating companies to benefit from the master account, each company does not keep idle capital within internal sources.
- Net balance kept in the master account would be in higher figures compared to the net balance of each participating company. Due to the nature of cash pooling agreements, higher interest rates will be charged by the banks; hence both group of companies and participating companies may benefit more.
- As the financial transactions are centralized, each company is not required to have relevant equipment and/or hire professionals in order to carry out financial transactions. Hence less expenses may be incurred.
- Parent company will have more efficient control over the participating companies and detect the possible financial difficulties more easily and in a timely fashion.
- The companies will be less dependent on outside financial sources and less affected by economic difficulties.
- As there will be less focus on financial transactions, the companies will have the opportunity to focus more on the main areas of activity which may result in more successful outcomes.
Various risks of cash pooling system may be counted as follows:
- A massive risk to be encountered by the companies in a physical cash pooling system is not being able to refund the cash transferred to the master account which might arise due to the financial difficulties faced by other participating companies. Transferring all cash to the master account will not be in compliance with risk diversification principle. As for notional cash pooling system, if a participating company fails to fulfil the obligations, remaining participating companies need to fulfil such obligations as the participating companies grants cross guarantees in notional cash pooling system.
- Due to the policies of group of companies, the participating companies need to transfer the surplus cash to the master account even otherwise is more beneficial for the company. This may result in missing out some investment opportunities.
- As the financial transactions are centralized, participating companies may lose their financial autonomy and their relations with banks and similar entities may weaken.
- In the event that the surplus cash cannot satisfy the cash needs, a loan may be borrowed. In such case, credit institutions may require for all participating companies to make commitments.
- Cash Pooling System in light of Turkish Law
As stated above, cash pooling system is not specifically regulated under Turkish law. Therefore, general principles of Turkish law should be taken into account when evaluating matters related to activities in connection with the cash pooling system. Moreover, as such system is rarely used in Turkey, it is not clear which rules under Turkish law would be applicable to the matters related to cash pooling system due to the lack of legal codification or judicial precedents.
That said, it should also be noted that implementation of cash pooling in Turkey will have various legal implications. Therefore, companies should consider the legal principles further explained below when entering into a cash pooling agreement.
3.1 Liabilities of Directors and Managers Under Turkish Law
Turkish Commercial Code ("TCC") regulates the types of companies which can be established under Turkish law and joint stock companies ("JSC") and limited liability companies ("LLC") are the most common types of companies established in Turkey. Due to being regulated separately, some differences may be observed when evaluating cash pooling system according to which type of company it is implemented in.
TCC provides that the JSCs are managed and represented by their Board of Directors (BoD) and members of the BoD must act prudently for the activities and duties related to the JSC or when delegating certain powers to professionals. Moreover, in the event that the JSCs, its shareholders or its creditors suffer damage due to the negligent actions of a member of BoD, the relevant member is required under the TCC, to compensate the damages incurred by the relevant party. Hence, if a cash pooling agreement causes damage to the JSCs, the members who signed such agreement may be held liable and obliged to compensate the damages incurred if such member is negligent in signing such agreement. However, if a member of BoD opposes to accepting such system and does not sign the agreement, the relevant member may not be held liable under the scope of differentiated liability principle which is provided in TCC and need not to compensate any damages incurred.
LLCs, on the other hand, are managed and represented by Manager(s) (at least one of whom must be a shareholder). The liability of managers towards to LLC in relation with the activities and duties related to LLC are the same as those of the members of BoD in JSCs. Therefore, the above-mentioned information regarding the liability of members of BoD will also be applicable for the managers of LLCs.
Therefore, to the extent possible, it is recommended that the consent of the shareholders of the company is obtained in a General Assembly resolution before implementing any cash pooling system.
3.2 Regulations Specific to Group of Companies
The TCC governs regulations specifically for group of companies which are affiliated with each other in respect of shareholding, management or audit and which are usually managed and administered from a top controlling entity according to predetermined policies.
According to the TCC, if a company, directly or indirectly, i) owns the majority of the voting rights in a legal entity; or ii) is entitled to vote on the appointment of sufficient number of members to establish the majority in the management of such legal entity; or iii) has the capacity to exercise majority of the voting rights in such legal entity on its own or with other shareholders arising out of a contractual relationship; or iv) controls such entity via a contract or in any other manner; such company qualifies as the parent/controlling company and the latter legal entity qualifies as the subsidiary/controlled company. In case a company holds the majority of the shares of another entity, it is automatically assumed to that such company has a control over the latter entity unless otherwise is proven, even if none of the abovementioned situations occur.
Under the TCC, parent companies and their controlled companies are restricted from entering into certain transactions. These, however, may differ based on whether the controlled company is wholly or partially owned by the parent company.
According to Article 202 of the TCC, in case the parent company does not wholly own the controlled company, the parent company is prohibited from exercising its control in a way that would make the controlled company incur a loss. In particular it cannot direct the controlled company to carry out legal transactions such as the transfer of business, asset, fund, staff, receivables and debt; to decrease or transfer its profit; to restrict its assets with real or personal rights; to undertake liabilities such as providing surety, guarantee and bill guarantee; to make payments; to adopt decisions or take measures which negatively affect its efficiency and activity
such as not renovating its facilities, limiting, suspending its investments without reasonable grounds; to refrain from taking measures that will ensure its development.
However, such steps may be taken if;
- Any loss incurred is remedied by the parent company within the same fiscal year,
- A right to claim of equivalent compensation is granted to the controlled company no later than the end of that financial year, with a specific explanation of how and when this loss will be recovered.
On the other hand, if the controlled company is wholly owned by the parent company, the parent company may give instructions concerning the direction and management of the controlled company even if it is of a nature which can cause results that could lead to a loss, provided that it is a requirement of the pre-specified and concrete policies of the group of companies. However, no instruction can be given which clearly exceeds the controlled company's solvency and that can endanger its existence or can cause significant assets loss.
Failure to comply with the restrictions provided above would have the following consequences: If the controlled company is partially owned:
- Each shareholder of the controlled company can claim the loss incurred from the parent company and its board members, who caused the loss.
- Creditors can also request that the company's loss to be compensated.
- The shareholders of the controlled company may request that the parent company purchase the shares held by the said shareholders in the controlled company.
- Managers of controlled company can request from the parent company to undertake through a contract all legal consequences of responsibilities that can arise against the shareholders and the creditors.
If the controlled company is wholly owned, the creditors who have incurred loss can take an action for compensation against the parent company and its board members responsible for the loss.
On the other hand, shareholders of the controlled company, who oppose (having it recorded in the meeting minute) General Assembly or Board of Directors/Board of Managers resolutions regarding transactions such as merger, division, conversion, termination, issuing securities and material amendments to the articles of association, which are obtained through application of control of the controlling company and without any clear and reasonable justified reason in respect of the controlled company, can request (within a maximum period of 2 years following the publication of the relevant resolution) from the court:
- Payment of compensation for their damages by the controlling company, or
- Purchase of their shares by the controlling company at their stock exchange value or at their real value.
If any auditor, special auditor, early risk identifier and management committee ever delivers an opinion pointing out the existence of an act of fraud and conspiracy in the controlled company's relationship with the controlling company or with another controlled company, any shareholder of the controlled company can request assignment of a special auditor from the commercial court of first instance at the location of the company's headquarters for the purpose of clarifying such matter.
In light of the foregoing, cash pooling system has direct implications in respect of the provisions of the TCC relating to the group of companies. Therefore, it is in fact still not clear as to whether these provisions shall be applicable for cash pooling systems adopted in Turkey. However, it would be prudent to take into account such restrictions and consequences when entering into a cash pooling agreement.
3.3 Liability Arising from Loans Granted to Shareholders
As the parties (JSCs and LLCs) to a cash pooling mechanism shall generally be considered as granting loans to each other, Turkish legislation regarding loans granted to shareholders should also be taken into consideration when entering into cash pooling agreements.
As per Article 358, a shareholder must not take out a loan from an affiliated company unless that shareholder has
- Already paid its due share capital; and
- The profit of the affiliated company along with its freely usable capital reserves are sufficient to cover any losses incurred by the said company over the previous years.
In this regard, an affiliated company could face monetary fines under Article 562 of the TCC if it transfers funds to the master account where
- The direct shareholder of such affiliate has not yet deposited the respective share capital into the accounts of the affiliate; or
- The capital reserves of the affiliated company are not sufficient to cover losses (if any) incurred in previous years.
Hence, when adopting cash pooling system and entering into a cash pooling agreement, these provisions should also be considered in order not to avoid non-compliance with such provisions.
3.4 Liability Arising from Principle of Capital Adequacy
Article 376 of the TCC regulates specific cases of capital inadequacy in joint stock and limited liability companies and requires certain corporate actions to be taken in each case:
1stCase: If it is clear in the last annual balance sheet that 1/2 of the sum of the capital and statutory reserves (including items listed under Article 519 of the TCC) is unsecured due to loss, the Board of Directors ("Board") in a joint stock company (or manager(s) in a limited liability company) must immediately convoke the General Assembly and present remedial measures they consider appropriate, such as capital increase, close of certain part of business, sale of affiliates, etc. The Board (or manager(s)) must present this issue to the General Assembly in a thorough and transparent manner, otherwise they may be held liable under the TCC for failing to fulfill their duties.
2nd Case: In case, - according to the last annual balance sheet - it is clear that 2/3 of the sum of the capital and statutory reserves is unsecured due to loss; unless the General Assembly either i) decides to fully supplement the capital or ii) decides that the company will continue to operate with 1/3 capital (by decreasing the capital, provided that the minimum capital requirements under the TCC and any other applicable legislation are satisfied), the company will be deemed automatically terminated.
In order to determine whether the company falls under one of the above-mentioned situations, the Board (or manager(s)) must compare i) the shareholders' equity (which equals to: assets - liabilities) in the company with ii) the total of capital and legal reserves of the company.
3rd Case: If suspicions are raised that the company's liabilities exceed its assets, the Board (or manager(s)) must have an interim balance sheet prepared based on both the going concern value and on liquidation value of the assets. If it is clear in the said report that the assets of the company are not sufficient to cover the receivables of creditors, the managers must notify the court at the location of the company's headquarters, of this situation and must file a claim for bankruptcy.
In such case, the company will be declared bankrupt unless, before adjudication of bankruptcy, the company's creditors representing an amount sufficient to cover the company's deficit and to eliminate the indebtedness of the company accept in writing that they will be ranked after all other creditors and that the legitimacy, authenticity and validity of this situation is verified by experts assigned by the court.
In addition, according to Article 377 of the TCC, the Board (or manager(s)) or any of the creditors may request bankruptcy adjournment also by submitting a serious, credible recovery plan to the court indicating the resources and measures that can be taken to the overcome the bankruptcy situation. In such case, Article 179 of the Execution and Bankruptcy Law ("EBL") will be applied.
On the other hand, according to Article 345/a of the EBL, the representatives (e.g. Board members or managers) of a company who fail to fulfill their obligation to file for bankruptcy of the company according to Article 179 of the EBL, may be sentenced to imprisonment from 10 days to 3 months, upon complaint by a creditor.
Turkish law provides that the shareholders, in principle, cannot request for the refund of the share capital they deposited in a JSC or an LLC in accordance with the "protection of share capital principle". In case such transaction takes place, the same will be considered void and the affiliated company, other shareholders of the affiliated company or the creditors may challenge.
Therefore, the share capital of the JSCs and LLCs must be maintained at all times. In the event of any loss of the share capital, it will be required for the general assembly of the company to convene and decide on any remedies to compensate the loss according to the foregoing provisions.
Hence, cash pooling system must not result in losing share capital of affiliated companies or re- payment of share capital deposited by the parent company.
3.5 Corporate and Other Regulatory Restrictions
When entering into a cash pooling agreement, statutory documents of the relevant company should also be taken into account. In some instances, articles of incorporation may directly or indirectly prohibit for the companies to adopt such system or it may be required to receive approval from the BoD or General Assembly. Therefore, a company may enter into a cash pooling agreement if there are no restrictions imposed by the statutory documents of the company.
In addition, under Turkish Banking Law, only banks and certain financial institutions may lend money to the third parties. As explained above, in cash pooling system, participating companies are to lend money to the other participating companies in need of cash. Therefore, even though it is not clear if such lending activities could create a breach of Turkish Banking Law as cash pooling system can be rarely seen in Turkey, the companies entering into such agreement should consider such regulations.
Finally, implanting a cash pooling system along the group of companies may give way to claims regarding piercing the corporate veil, which means that companies' legal entity, which is separate from the shareholders, acts like an invisible shield when it comes to the liability of the shareholders. In practice, sometimes shareholders benefit from forming a company in order to escape from personal liability. This brings – in certain occasions – the necessity of exercising "piercing the corporate veil" theory according to which shareholders and/or directors/managers of a company can be held personally liable for the accounts or debts of the company.
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.