April 2019 – The new Turkish Commercial Code, which comes largely into effect on 1 July 2012, introduces for the first time into Turkish company law a financial assistance prohibition in the context of share acquisitions. This will prohibit a company from providing financial assistance to a third party for the purpose of enabling the third party to acquire shares in the company.
This prohibition is likely to introduce a great deal of uncertainty and risk in the context of share acquisitions financed by a purchaser through debt. This alert focuses on the implications in the context of leveraged buy outs, whereby a purchaser acquires a company's shares through acquisition financing relying on the target company to provide loans or security as a means to secure repayment of the acquisition financing.
Tax consequences of a leveraged buy-out are not covered by this memorandum.
The current position
The current Turkish Commercial Code does not at present have a financial assistance prohibition.
A company can currently in principle provide loans, guarantees or security to a purchaser in the context of an acquisition of its shares. There are general corporate law principles which would require the board of a company to consider whether the provision of such assistance is within the scope of the company's business (the ultra vires principles) and whether the transaction can be deemed an unlawful buy back of shares or distribution of capital (maintenance of capital principle). However, the flexibility of the current approach has enabled leveraged buy outs to occur in Turkey without the level of difficulty experienced in various other jurisdictions.
The new financial assistance prohibition
Article 380 of the new Turkish Commercial Code introduces an explicit prohibition on financial assistance for the first time into Turkish law. It prohibits the provision of an advance, loan or security by a joint stock company for the purpose of the acquisition of its own shares by a third party. The financial assistance prohibition applies to all joint stock companies, irrespective of whether they are public or private companies, but does not apply to other corporate forms such as limited liability companies (limited şirket).
The prohibition covers the provision of financial assistance to a third party purchaser both before and after the acquisition of the company's shares.
The wording of the prohibition is taken almost word for word from Article 23 of the Second Company Law Directive of the European Union (77/91/EEC) as originally drafted. This prohibition applied solely to public companies. The purpose of the prohibition is broadly to protect a company's creditors from a depletion of the assets of a company for a third party share purchaser's benefit and has therefore been traditionally viewed as part of the maintenance of capital principle.
This prohibition was recently relaxed for implementation in 2008 by an amendment to the Second Company Law Directive to permit financial assistance where broadly it is provided on fair market terms, it has been approved by shareholder assembly and the net assets of the company are not reduced below the shareholder capital and statutory reserves, as a result of the financial assistance.
Many European jurisdictions do not apply the prohibition in the context of private companies or, if they do, relax the prohibition. In particular, the UK no longer has a financial assistance regime applying to private companies following the Companies Act 2006 and previously had a "whitewash" procedure to enable a process to approve financial assistance subject to certain conditions being met in particular the solvency position of the company being maintained.
The new Turkish Commercial Code has therefore taken the opposite approach introducing a strict form of prohibition by contrast at a time of relaxation in other jurisdictions.
Exceptions to the prohibition
There are two specific but narrow exceptions to the financial assistance prohibition in Article 380 of the new Commercial Code:
Any financial assistance provided under either of these exceptions must be out of free assets and must not result in a reduction of the statutory reserves of the company that are required to be set aside under the relevant provisions of the Commercial Code or the company's articles of association. Both these exceptions broadly follow the same exceptions permitted under the Second Company Law Directive.
Consequences of breach
The provision of unlawful financial assistance by a company results in the financial assistance being null and void. The new Code envisages that court decisions will determine whether the actual share acquisition itself will also be null and void as well.
Clearly in practice a lending institution will not advance loans under an acquisition facility where there is a risk to the validity of a debt push down to a target company.
Impact on structuring leveraged buy outs
The financial assistance prohibition will have a major impact on the ability of purchasers planning to acquire Turkish joint stock companies through debt financing. Part of the common package for such financing structures is to push down the acquisition debt to the target company's assets and income stream since the purchasing vehicle particularly in a private equity context will be a special purpose vehicle with no right of recourse to the private equity fund's assets.
Accordingly leveraged buy outs will need to be structured very carefully in the future given the wide financial assistance prohibition. Practice and discussion should focus on the following possibilities and issues:
Indirect financial assistance – the financial assistance prohibition relates to the provision by a company of financial assistance for the purpose of acquiring its shares. Therefore there is a question mark over whether an operating subsidiary can provide financial assistance in relation to the purchase of its parent company's shares. Sub-section (2) of the same Article 380 of the new Commercial Code refers to the prohibion of indirect acquisitions of a company's shares in the context of a share buy back of the company's shares. The Turkish courts may use this provision to determine that the provision of indirect financial assistance is also prohibited.
Upstream merger – an upstream merger whereby a target company is merged into the purchaser vehicle may be an alternative solution. Here the purchaser vehicle takes on the acquisition debt and provides security for repayment. The target company is merged into the purchaser vehicle and therefore the target's assets and income streams become available to repay the loan and widen the asset and income pool of the merged entity for the security package. This model is used in certain European jurisdictions already where there is a similar wide financial assistance prohibition. The new Commercial Code sets out a regime for such mergers. However, it is possible that such mergers may be challenged if the only basis for the merger is to circumvent the financial assistance prohibition. From a transaction execution perspective, the process and risks associated with an upstream merger will need to be taken into account.
Limited company conversion – the financial assistance prohibition applies only to joint stock companies. Whether companies will seek to convert to limited companies prior to the provision of financial assistance will be an interesting development.
These issues would need to be considered together with tax structuring advice.
The new Turkish Commercial Code has introduced a wide financial assistance prohibition on all joint stock companies. This is at a time when other European jurisdictions have relaxed those prohibitions by introducing exceptions or restricting the prohibition to public companies only. It will be interesting to see whether the legislature will seek to relax the prohibition in the future if it impedes substantial investment into Turkey or whether structuring solutions are successfully implemented by practitioners.