A. Introduction
One of the economic purposes of joint stock companies is to generate profits through their business activities and to distribute such profits among their shareholders in accordance with the rules stipulated by law and the articles of association. Accordingly, the right to dividends constitutes one of the most significant pecuniary rights arising from a shareholder's participation in a joint stock company.
Articles 507 et seq. of the Turkish Commercial Code No. 6102 (the "TCC") set out the fundamental principles governing the scope, calculation and distribution of dividends. However, the fact that a company closes a financial year with a profit does not automatically result in the distribution of all or part of such profit to the shareholders. In order for profits to be distributed, there must not only be a distributable source, but the statutory and contractual reserves must also be set aside and, as a rule, the general assembly must adopt a resolution regarding the manner in which the profit will be utilized.
In this context, particular importance attaches to the question of when the right to dividends becomes an enforceable receivable of the shareholder against the company, the extent of the general assembly's discretion as to whether or not profits should be distributed, and the consequences that may arise in terms of shareholders' rights where a company consistently refrains from distributing dividends.
B. The Right to Dividends and Its Legal Nature
Pursuant to Article 507/1 of TCC, each shareholder is entitled to participate, in proportion to its shareholding, in the net profit for the financial year that has been resolved to be distributed to shareholders in accordance with the law and the articles of association. Accordingly, the right to dividends is one of the fundamental financial rights attached to share ownership. Where certain shares have been granted dividend privileges under the articles of association, such privileges remain reserved.
Two distinct stages should be distinguished in relation to the right to dividends. A shareholder's general right arising from its status as a shareholder to participate in the profits generated by the company does not, merely upon the generation of such profits, become a specific monetary receivable. Once the competent corporate body has resolved to distribute the profit, however, the shareholder's right, as a rule, becomes a concrete receivable enforceable against the company.
Indeed, pursuant to Article 408/2-d of the TCC, resolving on the financial statements, the allocation of annual profits, the determination of dividends and profit shares, and the utilization of reserves are among the non-delegable duties and powers of the general assembly. Therefore, the existence of distributable profit in the company's financial statements is not, in itself, sufficient for a shareholder to directly claim a dividend receivable.
C. Calculation of Dividends and Determination of Distributable Profit
Pursuant to Article 508/2 of TCC, annual profit is determined on the basis of the annual balance sheet. Unless otherwise provided in the articles of association, dividends are calculated in proportion to the payments made by the shareholder to the company in respect of its capital contribution. Accordingly, the fact that a shareholder has not fully paid its capital contribution does not categorically mean that it is not entitled to dividends; however, the amount paid by the shareholder is taken into account in calculating the dividend.
However, the existence of profit on the balance sheet does not mean that the entirety of such amount may be distributed. Pursuant to Article 509/2 of the TCC, dividends may only be distributed out of net profit for the financial year and freely distributable reserves. This rule is a natural consequence of the principle of capital maintenance and is intended to prevent the company's share capital from being returned to shareholders under the guise of dividend payments.
The provisions governing reserves must also be taken into account when determining distributable profit. Pursuant to Article 519/1 of TCC, five per cent of the annual profit must be allocated to the general statutory reserve until such reserve reaches twenty per cent of the paid-in share capital. Article 519/2(c) further provides that, after a dividend of five per cent has been paid to shareholders, ten per cent of the aggregate amount to be distributed to persons entitled to a share in the profit must be added to the general statutory reserve.
Article 523/1 of the TCC also provides that the dividend to be distributed to shareholders may not be determined before the statutory reserves and the discretionary reserves provided for in the articles of association have been allocated. In addition, the general assembly may resolve to allocate reserves in excess of those required by law and the articles of association where such allocation is necessary for the replacement of assets or is justified, taking into account the interests of all shareholders, by the company's continued development and the objective of ensuring stable dividend distributions.
Accordingly, dividend distributions require consideration not only of shareholders' short-term interest in receiving dividends, but also of the company's financing needs, investment plans, liquidity position and continuity of its operations.
D. Is a Joint Stock Company Obliged to Distribute Dividends?
One of the most debated issues concerning joint stock companies is whether a company that has generated distributable profit is required to distribute a certain percentage of such profit to its shareholders each year.
The debate primarily arises from the wording of Article 519/2(c) of the TCC, which refers to the amount remaining "after a dividend of five per cent has been paid" to shareholders. Whether this wording imposes an obligation on joint stock companies to distribute dividends of at least five per cent each year has been the subject of differing views in legal doctrine.
According to one view in legal doctrine, TCC does not contain a general provision expressly requiring a joint stock company to distribute a specific portion of the profits it generates under all circumstances. Article 519 of the TCC primarily concerns the calculation of statutory reserves, and the wording used therein should not, by itself, be interpreted as imposing a mandatory minimum annual dividend distribution requirement.
This approach continues to be supported in contemporary legal doctrine. It is argued that the phrase "after ... has been paid" in Article 519 of the TCC cannot be interpreted as requiring privately held joint stock companies to distribute dividends every year, and that the company's financing requirements and long-term interests must also be taken into consideration.
However, this does not mean that the general assembly has unlimited discretion to refrain from distributing profits. The general assembly's discretion is limited by the law, the articles of association, the principle of equal treatment, the company's interests and the principle of good faith.
E. Legal Remedies Available to Shareholders Against a Resolution Not to Distribute Dividends
The fact that the general assembly has resolved not to distribute dividends does not necessarily mean that such resolution is lawful in all circumstances.
Pursuant to Article 445 of the TCC, general assembly resolutions that are contrary to the law, the articles of association and, in particular, the principle of good faith may, where the statutory conditions are satisfied, be challenged by way of an action for annulment within three months from the date of the resolution. Accordingly, where a company has a strong financial position and consistently generates distributable profits, but the majority systematically refrains from distributing dividends with the intention of economically excluding minority shareholders from the company, the relevant general assembly resolution may, depending on the circumstances of the specific case, be subject to review from the perspective of the principle of good faith.
A prolonged failure to distribute dividends may also become relevant in the context of dissolution of a joint stock company for just cause under Article 531 of the TCC, particularly where it is accompanied by infringements of other shareholder rights. However, the mere failure to distribute dividends for one or several years does not automatically constitute just cause for dissolution. The company's financial condition, investment and financing requirements, the duration of the non-distribution policy, conflicts of interest between the majority and minority shareholders, and whether other shareholder rights can effectively be exercised must be assessed together.
Accordingly, the protection of dividend rights requires a balance to be struck between the interests of the company and the economic interests of its shareholders.
F. Advance Dividend
The TCC also permits the distribution of advance dividends, subject to certain conditions, before the end of the annual accounting period. Pursuant to Article 509/3 of the TCC, advance dividends in companies that are not subject to the Capital Markets Law are governed by a communiqué issued by the relevant Ministry.
Under the Communiqué on the Distribution of Advance Dividends dated 9 August 2012, in order for an advance dividend to be distributed, among other requirements, the general assembly must resolve to distribute an advance dividend and the company must have generated a profit according to its interim financial statements for the relevant three-, six- or nine-month period of the relevant financial year.
With respect to publicly held joint stock companies, specific provisions are set out under Capital Markets Law No. 6362 and the Capital Markets Board's Communiqué on Dividends No. II-19.1. Accordingly, dividend distributions by publicly held joint stock companies must additionally be assessed within the framework of capital markets legislation.
G. Conclusion
The right to dividends is one of the fundamental financial rights of a shareholder in a joint stock company. However, the fact that a company closes a financial year with a profit does not automatically result in the shareholder acquiring a due and payable receivable in respect of such profit. In determining whether dividends may be distributed, the company's annual financial statements, the existence of distributable resources, statutory and contractual reserves, and the relevant resolution of the general assembly must be considered together.
TCC does not contain a general provision expressly requiring privately held joint stock companies to distribute a specific percentage of profit in each financial year. The general assembly may resolve to retain profits within the company, taking into account the company's financing requirements, investment plans and long-term development. However, this discretion is not unlimited. Where a resolution not to distribute dividends is contrary to the law, the articles of association or the principle of good faith, the annulment of such resolution may be sought. A systematic and abusive policy of withholding dividends may, when combined with infringements of other shareholder rights, also give rise to the assessment of more severe remedies under corporate law.
Therefore, dividend distribution in joint stock companies is not merely an accounting matter concerning whether or not the company has generated a profit. Rather, it is a corporate law matter that must be assessed by taking into account, collectively, the protection of capital, the continuity of the company, the balance of interests between majority and minority shareholders, and the protection of shareholders' rights.
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.
