| Melike ÖZYİĞİT Lawyer | Berru Ceren ZİYAGİL Lawyer |
ABSTRACT
It is a common occurrence for companies to encounter financial difficulties from time to time in their commercial activities. This situation may result in companies losing their capital or becoming over-indebted. In order to minimize the impact on the ordinary course of commercial life, the legislature has regulated the determination of capital loss and over-indebtedness situations in capital companies and the legal and financial measures to be taken against such situations within the framework of Article 376 of the Turkish Commercial Code No. 6102 (“TCC”) and the Communiqué on the Procedures and Principles Regarding the Implementation of Article 376 of the Turkish Commercial Code No. 6102 (“Communiqué”).
In this article, based on the principle of capital protection, the responsibilities of the board of directors and the general assembly in cases of over-indebtedness or capital loss will be examined, and the consequences of capital loss and over-indebtedness situations, measures that can be taken, and specific situations in merger processes will be discussed according to the provisions of the TCC and the Communiqué.
Keywords: Over-indebtedness, Capital Becoming Uncovered, Principle of Business Continuity, Completion of Capital.
INTRODUCTION
Capital companies are defined in the second paragraph of Article 124 of the TCC as joint stock companies, limited liability companies, and limited partnership companies with capital divided into shares. One of the most important principles adopted by the TCC for the relevant company types is the principle of business continuity and the protection of company assets. The principle of protection of company assets is primarily based on the consideration of protecting the interests of creditors.¹ Therefore, the legislature has deemed it necessary to regulate the fundamental responsibilities of the board of directors and the general assembly in order to prevent companies from directly falling into bankruptcy status when their financial situations do not always go as desired. For this reason, the calculation of capital loss and over-indebtedness situations is a very important issue in terms of the continuity of companies’ commercial life. The consequences of these situations for capital companies and the measures to be taken within the scope of the TCC will constitute the subject of this article.
1. CALCULATION OF OVER-INDEBTEDNESS AND CAPITAL LOSS
The framework regulation regarding measures that can be taken at the company level in cases of capital loss and over-indebtedness is made in Article 376 of the TCC titled “Loss of Capital, Situation of Being Over-indebted”.²
The existence of over-indebtedness or capital loss will be determined by examining the active and passive items of the company balance sheet. This determination should be made based on financial statements to be prepared by complying with and implementing the Turkish Accounting Standards, accounting principles within the conceptual framework, and interpretations that are an integral part thereof, published by the Public Oversight, Accounting and Auditing Standards Authority.³ Assets are the possessions of the company and consist of items such as fixed and current assets. Liabilities consist of the company’s short-term and long-term debts. When these liabilities are deducted from assets, the company’s equity is reached. The company’s equity is a source showing the investments made by the business owner or company shareholders to the business on the balance sheet date, paid-in capital, capital reserves, profit reserves, profits of previous years and losses of previous years, and net profit or loss of the period. Therefore, the loss of more than half of the equity or its becoming negative is an important indicator in the determination of over-indebtedness or capital loss.
Capital is the asset value established by the company shareholders to the company and stated in the company’s articles of association, and is the main material source of business activities. For the protection of this material source, the legislature has stipulated the necessity of allocating legal reserve funds in accordance with Article 519 of the TCC and Article 610, which envisages the application of this article to limited liability companies as well. In this context, in accordance with the principle of capital protection, the provisions of the TCC and the Communiqué envisage certain calculations and regulations regarding capital loss and over-indebtedness situations.
According to the provisions of the TCC and the Communiqué, different consequences are attached to the occurrence of capital loss in two ways. According to these provisions, capital loss occurs as follows:
- At least half of the sum of capital and legal reserve funds becoming uncovered due to loss: Equity ≤ (Capital + Legal Reserve Funds) / 2
- At least two-thirds of the sum of capital and legal reserve funds becoming uncovered due to loss: Equity ≤ (Capital + Legal Reserve Funds) × 2/3
When these situations occur, the measures to be taken by the general assembly and the board of directors will also differ.
Furthermore, the provisions of the TCC and the Communiqué define the state of over-indebtedness as the entire sum of capital and legal reserve funds becoming uncovered. In this case, over-indebtedness can be calculated as: Equity ≤ Capital + Legal Reserve Funds.
2. CONSEQUENCES OF CAPITAL LOSS IN TERMS OF TCC AND COMMUNIQUÉ
a. Responsibility of the Board of Directors
According to the aforementioned Article 376 of the TCC, in joint stock companies, the board of directors, and in limited liability companies, since Article 633 of the TCC envisages the application of provisions regarding capital loss and over-indebtedness to limited liability companies by analogy, the board of managers must urgently convene the general assembly and present the improvement measures it deems appropriate. The provisions of the Communiqué provide details regarding the duties of the management body and the decisions that the general assembly can make.
b. General Assembly in Case At Least Half of the Sum of Capital and Legal Reserve Funds Becomes Uncovered Due to Loss
According to the provisions of the Communiqué, in case at least half of the sum of capital and legal reserve funds becomes uncovered due to loss, in the general assembly convened urgently, the management body of the company presents the latest balance sheet to the general assembly and explains the financial situation of the company in all clarity and in a manner that each shareholder can understand. A report may also be submitted to the general assembly on this matter. The management body presents to the same general assembly, as alternatives and comparatively, improvement measures it deems appropriate to eliminate the deterioration in the company’s financial situation or at least to mitigate its effects, such as completion of capital, capital increase, closure or reduction of certain production units or departments, sale of affiliates, or change of the marketing system. The general assembly may accept the presented improvement measures as they are, or may accept them with changes, or may decide to apply a measure other than the presented measures.
c. General Assembly in Case At Least Two-Thirds of the Sum of Capital and Legal Reserve Funds Becomes Uncovered Due to Loss
In case at least two-thirds of the sum of capital and legal reserve funds becomes uncovered due to loss, the following decisions must be taken by the general assembly convened:
i. Capital reduction to be made within the scope of the TCC,
ii. Completion of capital,
iii. Increase of capital.
In case capital reduction is made, the company may reduce the capital down to the minimum capital amount, provided that the sum of capital and legal reserve funds is protected within equity, according to Articles 473 to 475 of the TCC. According to the provisions of the Communiqué, in capital reduction to be made within the scope of this article, the company management body has the opportunity to waive calling creditors and paying their claims or securing them.
The decision by the general assembly to complete the capital means that the deficits causing capital loss in the balance sheet are closed by some or all of the shareholders. In this case, there is no need to complete the legal reserve funds. Although it is not possible for the shareholders to take back the payments they have made, these payments are without consideration and cannot be evaluated as an advance in a capital increase to be made in the future. Each shareholder who wishes to complete the capital may participate in proportion to their shares. Payments made for the purpose of closing the balance sheet loss will be collected within equity under the “capital completion fund” account and will be tracked in this account. This fund can only be used by offsetting losses.
In case the general assembly decides to increase the capital, subject to the capital markets legislation which is of a special nature for publicly traded joint stock companies, this capital increase can be realized in different ways. As follows:
- Capital can be increased in the desired amount simultaneously with reducing the capital by the amount of loss arising from the damage. In such a capital increase, in joint stock companies, at least 25% of the nominal values of shares committed in cash must be paid before registration according to Article 344 of the TCC, whereas this requirement is not applied to limited liability companies according to Article 585 of the TCC.
- Capital increase can be decided without resorting to reducing the capital by the amount of loss arising from the damage. In such a capital increase, the amount that will ensure that at least half of the sum of capital to be registered and legal reserve funds is protected within equity must be paid before the registration of the capital increase.
- In the same general assembly meeting, it can be decided to increase the capital to the desired level and then reduce it by fully paying the prices. As a result of transactions realized in this way, it is mandatory that at least half of the sum of capital to be registered and legal reserve funds is protected within equity.
In case the company general assembly does not decide on one of the measures of capital reduction or increase and completion of capital, the company will terminate automatically. The provisions of the TCC regarding liquidation apply to companies terminated in this way.
3. CONSEQUENCES OF OVER-INDEBTEDNESS IN TERMS OF TCC AND COMMUNIQUÉ
The state of a company being over-indebted is a situation where the company’s assets cannot cover its debts, and this situation can emerge from the company’s annual and interim financial statements, audit reports in companies subject to audit, reports of the early detection committee, and determinations of the management body. In this case, if there are signs that raise suspicion that the company is over-indebted, the management body must prepare an interim balance sheet of assets both according to the principle of business continuity and over possible sales prices. If it is understood from the balance sheet prepared according to these principles that the assets are not sufficient to cover the company’s receivables, and if the general assembly does not take one of the measures of capital reduction or increase and completion of capital mentioned in the previous section of our article, the company’s bankruptcy will be applied for to the court by the board of directors.
If a joint stock company is over-indebted, the board of directors must notify the over-indebtedness situation to the court of first instance for commercial cases where the company headquarters is located and request the company’s bankruptcy. Otherwise, the members of the board of directors may be subject to criminal sanctions upon the complaint of a creditor according to paragraph (a) of Article 345 of the Enforcement and Bankruptcy Law and other article provisions, and additionally, they may also be punished within the framework of Article 162 of the Turkish Penal Code.⁴ However, the legislature has envisaged a tool to prevent the company’s bankruptcy in the continuation of the third paragraph of Article 376 of the TCC. From this perspective, the third paragraph of Article 376 of the TCC brings a new opportunity to Turkish law that exempts the board of directors of an over-indebted company from making a bankruptcy request. It can be said with a general approach that subordination in our law means that some company creditors, whose claim amounts are at least enough to eliminate the over-indebtedness situation, agree to demand and collect their claims after all other company creditors in case of the debtor company’s bankruptcy, that is, to accept that their claim will be paid only after the claims of other company creditors are fully paid.⁵
4. PARTICIPATION IN MERGER IN CASE OF CAPITAL LOSS AND OVER-INDEBTEDNESS
A company in a state of capital loss or over-indebtedness may sometimes prefer to merge with another company in order to continue its activities and protect its assets. In this context, the procedures to be applied show similar characteristics with an ordinary merger transaction. However, the legislature has envisaged some additional obligations and conditions in Article 139 of the TCC and Article 14 of the Communiqué in order to ensure that the interests of the merging companies are protected in case of merger in capital loss and over-indebtedness situations. In the first paragraph of Article 139 of the TCC, it is envisaged that a company whose half of the sum of its capital and legal reserve funds is lost due to losses or which is in an over-indebted state may merge with a company that has freely disposable equity in an amount that can cover the lost capital or, if necessary, the over-indebtedness situation. In the second paragraph of Article 139 of the TCC, it has been made mandatory to submit the documents proving this situation to the Trade Registry Directorates, and what these documents are has been clarified in the second paragraph of Article 14 of the Communiqué. According to the said article provision, it is necessary to reveal with a sworn financial advisor or independent accountant financial advisor report that the other company party to the merger has freely disposable equity in an amount to cover the lost capital or over-indebtedness situation, and that the amounts related to this are verified by showing the calculation method, or that the stated situations do not exist. Additionally, in case the transferred companies are subject to independent audit, this report may also be prepared by the auditor of the company subject to audit.
As a result, the restructuring of companies in capital loss or over-indebtedness situations through merger stands out as an important legal solution in terms of both protecting company assets and ensuring the sustainability of commercial activities. These additional obligations and conditions in the provisions of the TCC and the Communiqué, while ensuring that the merger is realized in a fair and transparent manner for the parties of the merger, also contribute to the realization of merger transactions in accordance with law and market dynamics.
CONCLUSION
Capital loss and over-indebtedness is one of the important problems that may be encountered in the financial structure of capital companies. Effective management of these situations is of great importance in terms of the company’s ability to continue its existence. The provisions of the TCC and the Communiqué, by clearly regulating the measures to be taken and the processes to be followed when companies face such financial problems, protect both the interests of creditors and the company. In this way, the continuity of companies, as well as the sustainability of commerce and the increase of market confidence, are also ensured.
¹ Hasan PULAŞLI, “Şirketler Hukuku Şerhi”, Adalet Yayınevi, Ankara 2018, p.717
² “(1) If it is understood from the latest annual balance sheet that half of the sum of capital and legal reserve funds has become uncovered due to loss, the board of directors immediately convenes the general assembly and presents the improvement measures it deems appropriate to this general assembly.
(3) If it is understood according to the latest annual balance sheet that two-thirds of the sum of capital and legal reserve funds has become uncovered due to loss, the company terminates automatically if the general assembly convened immediately does not decide to be content with one-third of the capital or to complete the capital.
(4) If there are signs that raise suspicion that the company is in an over-indebted state, the board of directors prepares an interim balance sheet of assets both according to the principle of business continuity and over possible sales prices. In case it is understood from this balance sheet that the assets are not sufficient to cover the claims of the company’s creditors, the board of directors notifies this situation to the court of first instance for commercial cases where the company headquarters is located and requests the company’s bankruptcy. Unless the creditors of the company debts in the amount that will cover the company’s deficit and eliminate the over-indebtedness situation before the bankruptcy decision is given have accepted in writing that the order of their claims be placed in a subsequent order after the order of all other creditors, and the appropriateness, reality and validity of this declaration or contract have been verified by experts appointed by the court to which the bankruptcy request will be notified by the board of directors. Otherwise, the application made to the court for expert examination is accepted as a bankruptcy notification.”
³ Emek Deniz ŞİMŞEK & Zülküf DEMİR, “Karşılıksız Sermaye & Borca Batık Bilanço, Türk Ticaret Kanunu 376. Maddesi Kapsamında Yapılacak Sermaye Artırımı ve Azaltımı”, MDERGI, March 2021
⁴ Selçuk ÖZTEK, “Borca Batık Anonim Şirketlerde İflası Önleyen Yeni Bir Araç Olarak Sırada Sona Yerleştirme (Sıradan Vazgeçme)”, Dokuz Eylül Üniversitesi Hukuk Fakültesi Dergisi, No.2321 ⁵ ÖZTEK, op.cit., No.2323