Turkey: Financial Assistance Regime –
A Well-Known Concept in a New Jurisdiction
→ Ece Çağil
→ Tomurcuk Eroğlu
The authors discuss the financial assistance prohibition introduced by the Turkish Commercial Code, enacted in 2012, and its implications on M&A financing.
New wine in old bottles
In an effort to modernise its laws and be in line with EU regulations, the Turkish Commercial Code (TCC) entered into force on 1 July 2012. The TCC introduced the financial assistance prohibition and incorporated many modifications, including an important alteration on capital maintenance.
In recent years, Turkey has witnessed a sharp increase in M&A transactions, mainly in the form of joint ventures and buyouts. A common way for the purchasers to structure a share deal is through a leveraged buyout transaction (LBO).
The key for a share deal is the “leveraging” of a limited amount of equity by using a large amount of external capital, usually bank debt. The lender should find sufficient security for the loan. An SPV, which is usually established and serves as the borrower of the loan and as the buyer of the shares of the target company (Target), generally provides only a limited amount of the capital. Therefore, the acquisition debt of the SPV is secured by using the shares, assets, and cash flow of the Target.
Such backing of a company to a third party to purchase its own shares (financial assistance) was, until the enactment of the TCC, allowed in Turkey, making an LBO transaction a preferred method of acquisition.
What are “financial assistance restrictions”
Under Article 380 of the TCC, applicable only to joint stock corporations (anonim şirket), both public and private, a company may not advance funds, make loans, or provide security with a view to acquire its shares through a third party. Such a transaction is considered null and void. There are two exemptions: (i) transactions performed by banks or financial institutions, if performed in the normal course of business; and (ii) advances, loans, and security, if to the company’s employees, or its parent or sister company’s employees, in order to acquire the shares of the company. But even those exceptional transactions are null and void if they have the effect of reducing the statutory legal reserves of the company.
The legal community is currently considering and discussing many aspects of the prohibition and how it will be implemented by the courts. Currently, there is no secondary legislation and the new provision has not been tested before the courts. In view of the current strict regime, new ways of structuring may be needed.
Conversion to a limited liability company
One solution is converting a joint stock corporation to a limited liability company. In practice it is believed that the financial assistance restriction should not be extended to transactions of other types of companies.
Post-acquisition upstream merger
Another alternative is a post-acquisition upstream merger (merger LBO). But it could be argued that a merger is an unlawful circumvention of Article 380 of the TCC.
Against such a view one may argue that in a merger, the minority shareholders and the creditors are afforded sufficient legal protection, leaving application of Article 380 of the TCC outdated. The TCC also accepts that a company may, by way of universal succession, acquire its own shares. Using the same reasoning, it could be concluded that in Turkey, as well, a merger as a means of restructuring a company should be allowed. However, there is still a risk that a merger LBO will be considered a breach of the financial assistance restriction.
The third alternative is domination or profit and loss transfer agreements. These were introduced to create mechanisms to protect shareholders and creditors, and to prevent the abuse of the controlling company. The TCC’s approach is based on three elements: (i) the prohibition to exercise abusive control over a subsidiary; (ii) an exception to the prohibition in the case of compensation of losses; and (iii) the liability of the dominant company and its board members for non–compensation. Article 202 of the TCC enumerates examples of disadvantageous transactions, including the transfer of funds and the provision of guarantees.
It is, however, questionable whether domination by agreement as legally foreseen under Article 198 (3) of the TCC also leads to the effect that the upstream of funds from the controlled company to the controlling company can be covered by these provisions.
For the time being, the only applicable solution in Turkey seems to be a merger of the SPV and the Target, or a conversion of the Target Company into a limited liability company. As discussed above, it is open whether these solutions present an unlawful circumvention of Article 380 of the TCC. Further, tax considerations will also be decisive.
It remains to be seen, from the Turkish legislator’s point of view, or by interpretation of the courts applying the new law, whether there are ways to implement the law without disregarding the fact that these types of structured transactions are necessary in today’s business and investment climate. Meanwhile, private equity funds and banks, as well as their advisors, will need to carefully consider how to structure upcoming deals.