Turkey: Capital Inadequacy Under Turkish Commercial Code

1. General Rule

Article 376 of the Turkish Commercial Code ("TCC") regulates specific cases of capital inadequacy in joint stock and limited liability companies and requires certain corporate actions to be taken in each case.

1^stCase: If it is clear in the last annual balance sheet that 1/2 of the sum of the capital and statutory reserves (including items listed under Article 519 of the TCC) is unsecured due to loss, the Board of Directors ("Board") in a joint stock company (or manager(s) in a limited liability company) must immediately convoke the General Assembly and present remedial measures they consider appropriate, such as capital increase, close of certain part of business, sale of affiliates, etc. The Board (or manager(s)) must present this issue to the General Assembly in a thorough and transparent manner, otherwise they may be held liable under the TCC for failing to fulfill their duties.

2^nd Case: In case, - according to the last annual balance sheet - it is clear that 2/3 of the sum of the capital and statutory reserves is unsecured due to loss; unless the General Assembly either i) decides to fully supplement the capital or ii) decides that the company will continue to operate with 1/3 capital (by decreasing the capital, provided that the minimum capital requirements under the TCC and any other applicable legislation are satisfied), the company will be deemed automatically terminated.

In order to determine whether the company falls under one of the above-mentioned situations, the Board (or manager(s)) must compare i) the shareholders' equity (which equals to: assets - liabilities) in the company with ii) the total of capital and legal reserves of the company.

3^rd Case: If suspicions are raised that the company's liabilities exceed its assets, the Board (or manager(s)) must have an interim balance sheet prepared based on both the going concern value and on liquidation value of the assets. If it is clear in the said report that the assets of the company are not sufficient to cover the receivables of creditors, the managers must notify the court at the location of the company's headquarters, of this situation and must file a claim for bankruptcy.

In such case, the company will be declared bankrupt unless, before adjudication of bankruptcy, the company's creditors representing an amount sufficient to cover the company's deficit and to eliminate the indebtedness of the company accept in writing that they will be ranked after all other creditors and that the legitimacy, authenticity and validity of this situation is verified by experts assigned by the court.

In addition, according to Article 377 of the TCC, the Board (or manager(s)) or any of the creditors may request bankruptcy adjournment also by submitting a serious, credible recovery plan to the court indicating the resources and measures that can be taken to the overcome the bankruptcy situation. In such case, Article 179 of the Execution and Bankruptcy Law ("EBL") will be applied.

2. Criminal Liability

On the other hand, according to Article 345/a of the EBL, the representatives (e.g. Board members or managers) of a company who fail to fulfill their obligation to file for bankruptcy of the company according to Article 179 of the EBL, may be sentenced to imprisonment from 10 days to 3 months, upon complaint by a creditor.

3. Remedies to Supplement the Capital

3.1. Capital Subscription (in Cash or in Rem)

Capital increase is the most common remedial measure in the event that any of the three circumstances under Article 376 of the TCC occur. According to the TCC, capital can be increased through capital subscription or from internal sources (from reserves (emanated from profits) or funds allowed by law).

The capital cannot be increased unless the consideration of the existing shares is fully paid in. However, unpaid shares which do not constitute a substantial portion of the capital do not prevent the capital increase.

%25 of the increased capital must be paid prior to the registration of the capital increase with the Trade Registry (as mentioned below), and the remaining must be paid within 24 months following the registration.

In order to increase the capital, the General Assembly must adopt a resolution (have it notarized by a public notary) and submit the resolution to the Trade Registry along with the other required documents (such as a petition, public accountant/certified public accountant report with the good standing certificate of such accountant and a document evidencing %25 of the increased capital is paid, etc.), for the registration. As an important note, the representative of the Ministry of Customs and Trade must also sit in the General Assembly meetings held to increase the capital. The capital increase only takes effect upon registration.

Within the context of application to the Trade Registry, as mentioned above, the company must submit a public accountant/certified public accountant (YMM or SMMM) report indicating whether the previous capital has been fully paid-in by the shareholders, whether circumstances under Article 376 have occurred, whether the capital is increased in cash or from the internal resources (in such case with certification that such internal resources actually exist). This report must also include the required calculations of the company's equity.

In case of contribution of capital in-rem (which are transferrable movable or immovable properties or rights which have a monetary value and which can be added to the balance sheet as asset), valuation report prepared by an expert appointed by the relevant court must also be submitted to the Trade Registry.

3.2. Addition of Shareholders' Mature Receivables to the Capital

Turkish law also allows for addition of mature (due) debts owned by the company to its own shareholders, to the capital of the company, by way of capital increase.

This process is subject to the same rules and procedures applied to the capital increase. While making an application to the Trade Registry, the certified public account report must also include that the capital increase is supplied from the receivables of the shareholders to be collected from the company, either in cash or in rem. In case the receivables are in rem, valuation report prepared by an expert appointed by the relevant court must also be submitted to the Trade Registry.

3.3 Postponement of due dates of payables to shareholders

Another solution to avoid falling under Article 376 of the TCC, as may be practiced by the companies in Turkey, is to postpone the due dates of the company's payables to its shareholders, if any, without the need for a capital increase, by way of entering into an agreement between the relevant shareholder and the company.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.