The Prohibition Against Financial Assistance under the New TCC
In general share buybacks activity -a corporate finance tool- of companies is forbidden under the Turkish Commercial Code numbered 6762 (the “TCC”) except from certain exceptional cases. The Turkish Commercial Code numbered 6102 (the “New TCC”) introduces an important innovation enabling the companies to buy back their shares or to accept as a pledge thereon under certain conditions. Nevertheless, article 380 introduced prohibition on a company that is the target of an acquisition to provide an advance funding, loan or security to third persons, for the purchase of its own shares (briefly, the “prohibition of financial assistance”). This provision entering into force as of 1 July 2012 is of a significance novelty with respect to the volume of future buyouts and validity of the private equity investment strategies for company share sale and purchase transactions through benefiting from the company assets (leveraged buy-out). The prohibition of financial assistance, which concerns the companies and private equity investors, shall be analyzed in our newsletter article.
Share Buyback of Companies and the Prohibition of Financial Assistance
Article 329 of the TCC prohibits the share buybacksor acceptance of pledges on the shares by companies except from five exceptions specified under the article. The New TCC has relaxed the current prohibition. Pursuant to article 379 and the following articles of the New TCC, joint stock companies may buy back their shares (directly or indirectly through third persons) provided that they do not exceed ten present of the share capital. The possibility for the companies to buy back their shares is reviewed in another article in our newsletter.
Although the share buyback is now a legitimate practice, New TCC sets out certain limitations and constraints to the share buyback program. For instance, shares acquired pursuant to article 379 shall not exceed ten percent of the share capital -equity capital- of the company. The legislative intent of the code states that Article 380 has been introduced to prevent any bypassing of such provisions. Pursuant to this article, the provision of advance funding, loan or securities to third persons by target companies in acquisition transactions to acquire its own shares is prohibited. The view that such transactions constitute an indirect share buyback of companies is the fundamental pillar, underpins the prohibition.
Necessities for the Promulgation of Article 380
The rationale behind the Article 380 of the New TCC imposing ban on financial assistance is explained by legislative intent and states that the Second Council Directive numbered 77/91 of the European Economic Community[i] with respect to companies (the “Directive”) has been taken as a legislative resources for this article. In England, numerous companies have declared bankruptcy during the financial crisis of 1920-21 after entering into leveraged buy-out transactions especially after the First World War. As a result of these events, the financing of share purchases provided by the company whose shares are acquired has been considered dangerous and the British Company Act promulgated in 1929 has introduced a rule prohibiting such financial assistances. The EU Law and some of EU member states adopted this rule, which is still in force for public companies but was abolished on 1 October 2008 with Companies Act 2006 in relation to private companies in the UK to promote economic growth by facilitating business activities.
Consequently, in the primitive Directive, a company was not able to provide any advance funding, loans or security to third persons for purchasing its own shares. Nevertheless, facilities extended as part of the ordinary business activities of banks and other credit institutions (private equity firms); and advance funding, loans or security to the employees for their acquisition of company shares are not within the scope of this prohibition. Article 380 of the New TCC has adopted these provisions and stated that to do otherwise would be unlawful.
Nevertheless, the policy of protecting shareholdersand creditors, which underpins the ban on financial assistance has been criticized as being out of line for limiting the acquisition financing possibilities to an extent exceeding the aims and objectives of company law. Therefore the Directive has been amended with relaxing provisions by virtue of whitewash procedure by the directive numbered 2006/68/EEC[ii] on banning financial assistance. As a result of this amendment, the corporate bodies across European Union member states are provided a gateway to financial assistance as long as whitewash procedures set forth in the Directive are satisfied. The conditions to meet whitewash procedure are: (i) the advance payment, loan or security provision transactions must be on an arm’s length basis; (ii) a detailed report about the transaction must be prepared and submitted by the directing body of the company; (iii) the General Assembly of the company shall approve this financial assistance transaction with the votes cast of two thirds of shareholders; (iv) The granted financial assistance shall not cause diminution of authorized share capital and non-distributable reserves of the company; (v) Equal amount of reserve to the financial assistance grant shall be put aside.
The New TCC has not adopted these amendments. Nevertheless it should be noted that the implementation of succeeding Directive within member states of the European Union rendered as voluntary and was left at the discretion of each member states, to either allow or prohibit financial assistance in their national law. Therefore, the New TCC has opted to adopt a criticized and inflexible system nevertheless the current text of article 380 does not constitute a violation of the acquis communautaire of the European Union.
The Scope of the Financial Assistance Prohibition and Consequences of its Breach
The financial assistance transactions prohibited under article 380 of the New TCC are the provision of advance funding, loans or security to third persons to acquire the target company shares. Any type of transaction governing the provision of advance funding, loans or security is deemed to fall within the scope of the prohibition.
Either granting interests directly to the third persons acquiring company shares or providing financial assistance through indirect means to such persons may fall within the scope of this article. Bearing the costs of legal and financial due diligence, audit and consultation received for the share purchase transaction, repayment of a facility extended for the payment of the share price by using another facility extended as a result of providing company assets as collateral, and financial assistance transactions by the intermediary of various companies are considered to fall within the scope of the prohibition of financial assistance in the practice of European Union member states[iii].
Article 380, further states the consequences of acting contrary to financial assistance prohibition is sanctioned as being null and void. For the legal sanction to be applicableit is not necessary to establish the incurrence of any losses to the target company. Therefore any financing or assistance, in the absence of which would cause the assisted person to not enter into the purchase transaction, is subject to the prohibition under article 380 and is null and void.
Where a financial assistance is concerned, there are two transactions, one being “the transfer of shares” and the other being the “financial assistance for the payment of theshare price”. In Article 380 it has only foreseen the acquisition financing transaction shall be null and void, and had an oversight to elaborate further as to any consequences governing the share transfer transaction. Therefore, we are of the opinion that the share purchase transaction carried out for acquisition transaction shall continue to be valid and binding. Furthermore, Article 385 of the New TCC foresees the obligation of disposing of shares purchased in violation of articles 379. 380 and 381 governing company share buybacks, rather than rendering such transactions invalid (void). It is not evident what is meant with this wording but inclines that the share purchases in violation of article 380 may be realized. Therefore the only transaction that is invalid is the financing transaction.
Exceptions to the Prohibition of Financial Assistance
Article 380 regulates two exceptions to the prohibition of financial assistance. The first exception governs the transactions normally undertaken banks’ or other credit and financial institutions’ usual business. The second exception governs the transactions in which shares are acquired by or for employees of the company or its subsidiaries. Such transactions shall not however decrease the reserves of the company, and shall comply with articles 519 and 520 governing the deposit and usage of reserves. The justification for article 380 states that the financing should be provided from the available assets of the company. The transactions falling within the scope of these exceptions are allowed and are not null.
The exception governing the credit and financial institutions (private equity firms) has been introduced by adopting the provisions in the Directive; nevertheless the scope of this exception is disputed. Certain scholars interpret this exception as permitting the banks to extent a facility to third persons for the acquisition of the shares of a company, with the company providing collateral to the bank for this transaction. Nevertheless, bearing in mind both the purpose and the justification of article 380, and the practice in the European Union, it must be stated that the dominant scholar opinion regards this exception to be limited to the banks providing facility and financing to third persons in order for such persons to acquire their own (the bank’s) shares.
Conclusion
Article 380 of the New TCC has a material impact to the future of the private equity operations using leveraged buy-out technique. In general the financial assistance by a company for acquisition of its own shares has been prohibited, save for the financing provided to third persons by banks for them to acquire the bank’s shares and the financing provided to company employees for them to acquire the company’s shares. Any transaction of providing advance funding, loan or security (financing) to third persons for the acquisition of its own shares, other than the aforementioned exceptions, are deemed null and void.
This provision creates a material obstacle with respect to facilitate acquisition financing via share purchase transactions. The Directive has been amended in the year 2006 to enable such financing under certain conditions in order to circumvent this obstacle and promote economic growth. Nevertheless, the New TCC has not adopted this amendment.
In the light of this provision, The Company Law of Turkey do not let companies to use their assets or resources or present them as collateral for the sale and purchase of their own shares.
[i] Second Council Directive 77/91/EEC dated 13 December 1976.
[ii] Directive 2006/68/EC of the European Parliament and of the Council dated 6 September 2006.
[iii] Gül Okutan Nilsson, Anonim Şirketlerin Kendi Hisselerini İktisabı Bağlamında Finansal Yardım Yasağı, Anonim Şirketler ve Sermaye Piyasası Hukukunda Güncel Gelişmeler Türk – Alman Uluslararası Sempozyumu (25-26 Haziran 2010), p. 96-97.
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