An Analysis of The Communiqué on Article 376 of The Turkish Commercial Code
On November 11, The Ministry of Trade of Turkiye, has extended the enforcement of previous Communiqué dated as back as 2018, on regarding the Article 376 of the Turkish Commercial Code (TCC) until 01.01.2024.[1]
Preamble
Turkish Commercial Code (TCC) Art. 376 impose certain duties upon the Board and the shareholders where there is evidence that certain percentage of the capital of the company is lost. Due to the widespread capital losses that many companies had gone especially after 2018, the Ministry of Trade intend to provide additional rules in order to strengthen the capital position of the companies, albeit some of which may not have statuary legal base.
In this article we will try to explain some of the additions and perhaps deviations from Art. 376 that are introduced by the Communique.
1. The Communique in general repeats TCC 376. If the last annual balance sheet shows that at least ½ or 2/3 of the capital and the statutory reserves have been lost the BoD shall call a general meeting of shareholders (GA).
What is different from TCC?
A new exception to the “bindingness of the agenda” has been introduced. The Communique provides that even if the GA has been called with different agenda, these issues related to Art. 376, can be discussed and resolved by any of the first meeting available. This an exception to the “bindingness of the agenda” rule of the TCC. We know that so far, there were two exceptions, removal of Board as part of discussions of the financials, and for the listed companies, the Capital Market Board’s right to request addition of specific agenda items. We have now a third one.
Our Opinion: We think that this is a voluntary option for the BoD and cannot have a mandatory application since there is not statutory rule that would impose such deviation from “bindingness of the agenda”
2. Remedies introduced by the Communique
A. Capital Decrease, Increase or Simultaneously Both.
If the loss is equal to or greater than 2/3 of the capital, the GA may resolve for either of;
- capital reduction,
- completion of the capital
- capital increase
What is different from TCC 376?
Minimum Equity Threshold. Different provisions of the Communique confirm the same thing. Where the loss of capital is to be eliminated by way of any capital increase, capital reduction or both (“first decrease then increase”), then the payment to be made prior to registration shall at least be equal to an amount that would at least 1/2 of the new capital (to be registered) and ½ of the statutory reserve funds be present in the equity.
Our Opinion: Prior to 2018, since the TCC 376 would tolerate a loss up to 2/3 of the capital, therefore, at least presence of the 1/3 of the capital would be required before any capital increase. However, this has been now raised to ½ of the capital. This means that when the companies would apply to register the new capital, half of it will have to be present in the balance sheet.Also, as is known, normally in any capital increase, advance payment of ¼ is required so that the rest can paid least within 24 months. Therefore, the change will also affect the advance payment amount.[2] Although the new threshold lacks a statutory base, the registry will refrain from registration that do not comply with the threshold. This is an attempt to strengthen the equity of the companies which we believe that the courts may be inclined to give effect to the communique.
Simultaneous reduction and increase of capital. The Communique provides that an increase of the capital by the desired amount can be done in the same GA simultaneously with the reduction of the capital as a result of the loss is allowed.
Our Opinion: This a shortcut being an additional mechanism to the TCC capital increase introduced by the Communique and The Ministry deserves to be congratulated for having such provision. Under TCC normally each item is separate and can only be done after registry of a particular general meeting, but since the introduction of the Communique in 2018, Trade registries has been accepting this shortcut for some time. There seem to be no prohibiting TCC provisions and from a pragmatic point of view, we should welcome and opportunity that help companies saves cost and time.
Relief Against the Creditors: Where there is a capital decrease that meet the above condition, the BoD may refrain from calling creditors and from making payments to them or providing a collateral in their favor.
Our Opinion: We think that this is a fair approach. If the company operations can continue with lower registered capital and in fact it is able to its debts, it should not be forced to pay the creditors or give collateral on a hypothetical basis.
B. Completion of Capital introduced by the Communique
Obligation to make gratuitous payment: Completion of the capital is defined as “without the need to put back the lost statutory reserves but only the balance sheet deficits”. The Communique goes further to set the rule that as long as the GA resolves, each shareholder is obliged to compensate the losses with pro rata amount to his share. Not that all, also in the future such payments cannot claimed back from the company, that this is not a shareholder loan or a payment of capital, but a gratuitous payment and finally, cannot qualify as an advance for the future capital increases!
Payments made under this provision shall be recorded and tracked in the “capital completion fund account” within the equity. The fund can only be used against offsetting the losses.
Our Opinion: We believe that this provision does not have legal base in the TCC. It can only be complied with voluntarily. In other words, as long as all or some shareholders are willing to pay and the majority approve such resolution, this can be done. However, a shareholder who is not willing/or not able to make a gratuitous payment, cannot be obliged to compensate the losses of the company other than in a capital increase under TCC which is subject to his consent.
3. Failing to take the necessary measures
What is different from TCC 376?
Dissolution of the Company. The Communique provides that, if 2/3 of the sum of the capital and the statutory reserves are lost and the company had also failed to take one of the above measures, the company shall be deemed to have been dissolved. It then refers to the liquidation proceedings of the company that shall be carried out in accordance with Article 536 of TCC.
Our Opinion: As is known, in the absence of a formal resolution of the GA, no company can be forced to liquidation except for a bankruptcy mechanism under TCC. While Art. 536 of TCC, gives power to the BoD to carry out liquidation in case the GA fails to appoint a liquidation officer, we believe that still, a formal resolution of GA is necessary.
It can be argued that if the issue has never been on the agenda of the GA or if the GA has even not been called to a meeting in this regard, a liquidation issue will never take place. It must be remembered that during the old TTK period, the creditors were given the right to apply to the court for the dissolution of the company, whereas in the new TCC this has been removed. Within this new framework, we can assert that even in case of non-compliance with the provisions of TCC 376/2 and Article 7 of the Communiqué, the result of the dissolution may not automatically come to the agenda as long as the company is able pay its debts, and the creditors cannot demand the dissolution of the company unless the shareholders raise the issue.
However, that is not a %100 percent solution. In our view, there is still a danger of creditors seeking "determination of insolvency" decision by the commercial court, which can be seen as an alternative mechanism to a direct insolvency lawsuit. It must be remembered that such “declaratory decision” is not enforceable against the company but still may open the path for trade registry to consider the status of the company “under liquidation”. Credibility and reputational risks are other aspects that is worth consideration.
In order to avoid unnecessary risks and facing a "determination of insolvency" request by creditors or a shareholder under 376/2 in the future, it is advisable for BoD’s to take the matter seriously[3] especially where the loss of 2/3 or more is the case, there is benefit in being cautious as to bring the issue to the agenda of the GA and activate one of the three mandatory alternatives in the Communiqué. Here again, it seems more correct to determine an attitude by taking into account the complexity of shareholder structure, whether the company is a listed companies or is subject to other strict regulations etc.
4. Provisional Article on losses due to exchange rates of foreign currency
What is different from TCC 376?
Until 1/1/2024, when the companies are making calculations regarding the loss of capital or indebtednesswithin the scope ofArticle 376ofTCC,
a) Full loss amounts resulting from exchange rate difference of foreign currency obligations that have not yet been performed yet,
b) Half of the lease expenses, depreciation and personnel expenses accrued in 2020 and 2021 may not be taken into account.
In determining these amounts, the calculation shall be made in such a way that there is no duplication. No record shall be included in thefinancial statements, this shall only be included in thefootnotes.
Our Opinion: This is a relief to the companies by allowing them to disregard losses that arise due to foreign exchange rates. Therefore, it would not be wrong to assert that in general, the intention is to prevent insolvency filings due to devaluation of Turkish Currency. Under IFRS a loss would normally be recorded as a loss when it occurs. However, here we see that foreign currency obligations that have not yet been performed yet are to be recorded as loss. It is assumed that at the time of performance of the contract, the exchange rates may change. The Communique is also very cautious by providing that “the losses shall only be shown in footnotes” a protective solution in order to avoid future accountancy complications.
5. Frequently Asked Questions
- Is the new technical bankruptcy formula introduced by the Communique is based on comparison with the "loss", instead of "equity"? In other words, when applying the TCC 376, are still able to consider funds and accounts under equity items such as real estate, machinery valuation fund, company's own share purchases, goodwill incurred during acquisition of a subsidiary under common control?
+ The formula introduced by the Communiqué on the loss of capital does not seem to introduce different result from the formula we have applied before. Companies can continue to apply the calculation method that they have adopted in the past period (that is, the calculation we made based on the relationship between equity and basic capital + statutory reserves.)
- Can still the companies consider value added by trademarks evaluation in TCC 376 calculation?
+ In terms of technical bankruptcy/indebtedness, the Communiqué does not bring any change. The changes are limited to definitions as to what we call "loss of capital, i.e., to put it more precisely, 1/2 or 2/3 (and more) of capital remains unpaid. In contrast, there was no change to the definition or provisions of "indebtedness." under TCC 376/3 The definition of indebtedness is still as described as "the inability of the company's assets to meet its debts" has also been preserved.
If the suspicion of indebtedness of the company has arisen, a balance sheet will be drawn up both on the basis of the continuity of the enterprise and on the possible sales prices of the assets, and if even one of them shows that there is no indebtedness, we believe there will be no need to file technical bankruptcy.
- Companies used to analyse the technical insolvency situation by comparing the total equity with the balance of capital + legal reserves. It seems that in the new regulation, the sum of "loss" and "capital + legal reserves" would be comparative. A question may arise as to whether the definition of loss should be considered as the total amount of "past year loss + period loss - past year profits and extraordinary profit reserves".
+ This would be a correct assumption. As is known there are different definitions of “capital loss” and in fact, with the Communiqué, one of them was preferred. However, in order for the adopted definition to give the right result, all accumulated profits and free reserves must be subtracted from the balance sheet loss (last year losses + period loss). In other words, only (accumulated profits and losses) that cannot be covered by free reserves can be considered as capital losses.
- What are the alternatives for the BoD’s who suspect that the capital loss is so severe?
+ Article 6 of the Communiqué is a provision that has existed since the period of the previous Turkish Commercial Code Art. 324. Since then, the BoD is expected to inform the GA in the event of the loss of 1/2 of the capital. Likewise, the new TK 376 stipulates that the BoD should present its proposals for remedial measures at this meeting. However, there is no sanction for non-compliance with this provision alone; that is, even if the BoD a company in this situation does not offer remedial measures, as long as the company is able to pay its debts, no severe complication would arise from a creditor point of view (accept where the creditors are financial institutions) Even the company may get rid of the capital loss situation in the natural activity process. However, where there is an increasing the damage due to the refraining from taking these measures, the responsibility of the BoD may arise especially where he BoD members are not the controlling shareholders or where they are under strict liability due to the company operating in strictly regulated business. Needless to assert, that the safest way is to fulfil the Law and Communiqué regulation to the letter; in this sense, it would be appropriate to prepare an alternative report on remedial measures.
[1] The communique is a continuation of the first Communique dated 14.09.2018 which has gone major changes on 26.12.2020 which were due to expire as of 01.01.2023.
[2] Please note that no company will be able to make any capital increase unless the prior capital has been paid in full.
[3] Please note that the BoD can be held accountable against creditors in such cases. The BoD has a duty to protect the interest of creditors and other stake holders. Remember that where the delay cause greater harm so the BoD may be held accountable for not mitigating the losses, even if it cannot be held liable for the insolvency itself.