Prohibition on Loans by Companies to Their Shareholders Pursuant to the New Turkish Commercial Code

Att. Leyla Orak Celikboya, July 2012

Introduction

The Turkish Commercial Code numbered 6102 (the “New TCC”) has been enacted by the Grand Turkish National Assembly on 13 January 2011. Among other novelties, the New TCC prohibits grant of personal loan or any other advance funding to its directors and executive officers (broadly shareholders).The novelties introduced by the New TCC have attracted many criticisms between the date of enactment and the date of entry into force of the New TCC, which is 1 July 2012.Consequently, the New TCC has been amended initially by the Act numbered 6335 amending the Turkish Commercial Code and the Act on the Entry into Force and Application of the Turkish Commercial Code (the “Amendment Act”) which was enacted prior to the entry into force of the New TCC, and the Act numbered 6353 Amending Certain Laws and By-Laws enacted by the Grand Turkish National Assembly on 4 July 2012. The Amendment Act introduces provisions which minimize the scope of prohibition of indebtedness to the company to a great extent. This month’s article shall assess the provisions of the New TCC governing this prohibition on loans by the company and the changes introduced by the Amendment Act thereto. The changes introduced by the Amendment Act and related assessments shall be analyzed in another article of our Newsletter.

Prohibition on Loans to the shareholders by the company

While Article 358 of the New TCC makes it unlawful for shareholders to borrow any fund from the company, the Amendment Act, in certain circumstances, allows lending activity by the companies. Below, initially the prohibition of indebtedness of the shareholder to the company pursuant to the provisions of the New TCC ―prior to amendments introduced by the Amendment Act― shall be assessed and then changes brought by the Amendment Act shall follow.

The system introduced by the New TCC

For the first time in Turkish Company Law, The New TCC bans shareholders to obtain credit or loan from their company apart from their indebtedness arising from their capital subscription. Prior to the amendment introduced by the Amendment Act, the relevant article aimed at protecting other shareholders whom are not at executive level in the company and the creditors of the company. The justification of this provision stated that the practice prior to the entry into force of the New TCC whereby the shareholders could borrow from the company resulted in inconvenient situations (such as loss of share capital), thus the article aimed to prevent shareholders from using the capital of the company for their personal business.

Nevertheless, the relevant article permits the shareholder to borrow from the company as a result of certain business transactions executed by the shareholder. The article 358 does not prohibit bona fide business loans to the shareholders  resulting from transactions entered into with the company, which both fall within the scope of activities of the company and is necessary to be executed in relation to the commercial enterprise of the shareholder. This exception aims at preventing any problems arising from the rigid application of this provision.

Article 24 of the act numbered 6103 on the Entry into Force and Application of the Turkish Commercial Code (the “Application Act”) foresees an adaptation period for the shareholders who had already borrowed from their company prior to the entry into force of the New TCC. Such indebted shareholders are obliged to repay their debts in cash to the company within three years as of the date of entry into force of the New TCC. Non-compliance with this obligation shall result in the shareholder being faced with the sanction foreseen under the New TCC. The New TCC regulates that shareholders, acting contrary to the ban shall be faced with judiciary monetary fine of at least three hundred days.

The amendment introduced by the Amendment Act

The Amendment Act amended both the provision governing the prohibition on loans to shareholders by the company and the provision foreseeing the sanction for violation. Pursuant to amended article 358, the shareholders of the company may not be indebted to the company if (a) the shareholder does not fulfill its due obligations arising from capital subscription and (b) the company’s profit, including the free reserves is not sufficient to recoup the losses from previous years. The article of the Application Act governing the three year adaptation period is abrogated by the Amendment Act.

The justification for this amendment introduced by the Amendment Act states that the prohibition is not completely lifted. From now on, shareholders will be entitled to refer to the property of the company in the presence of urgent necessities.

The Amendment Act also amends the provision foreseeing the sanction in the event the prohibition on granting loans to shareholders by the company is violated. Accordingly, shareholders assuming debt in violation of this prohibition shall not be faced with any sanctions. Persons lending the property of the company to the shareholders in violation of this agreement shall be faced with judiciary monetary fine of at least three hundred days.

Even though the justification of the provision of the Amendment Act limiting the scope of prohibition states that the possibility provided thereunder shall be used only for the immediate and urgent needs of the shareholders and executive officers, we believe that the provision exceeds this purpose and may lead to the abuse of rule of law. Pursuant to the relevant article, shareholders who pay all their due capital subscription debts may be in a state of being indebted to companies whose income covers the loss from previous years, regardless of whether there is an urgent need or not. Notwithstanding however, the justification of the Amendment Act also states that shareholders and executive officers, using company property for long periods of time in large amounts may be deemed to have “emptied the company” which may constitute the crimes of abuse of confidence or fraudulent bankruptcy under the Turkish Penal Code.

Prohibition on Company Loans to Directors and Executive Officers (“Board Members”)

Article 395 of the New TCC governs, for the first time in Turkish Law, the prohibition on loans to directors and executive officers to enter into transaction with the company. The enacted article prohibits board members from being indebted to the company in cash or any other non-cash benefit. The Amendment Act, ―together with the amendment to the prohibition on loans to shareholders by the company―, minimizes the scope of this prohibition. Below, the prohibition on borrowing of board members from the company prior to the amendment shall be analyzed and then the amendment introduced by the Amendment Act shall be assessed.

The system introduced by the New TCC

With a provision similar to the provision governing prohibition imposed on shareholders to borrow from their company, the New TCC prohibits board members, and their associates (i.e., persons within lineal kinship to the board members, spouses and relatives to third degree (third degree included) of the board members) to borrow from the company. The extension of ban covers the private unlimited companies of those in which they are partners and/or they hold at least twenty percent of the share capital of a company. The scope of the prohibition with respect to associates concerned is very broad. These persons may not borrow from the company in cash or get any non-cash benefit, moreover, the company may not provide any surety, guarantee, collateral for these people, assume any obligations or their debts for such persons. The article regulates one exception to the prohibition stating that companies which are member of a group of companies may become sureties or guarantors for one another. Nevertheless, the provisions governing group of companies are reserved.

There is a double punishment foreseen for the violation of this prohibition. In the event the persons ―mentioned in the article― borrows from the company (or the company assumed any of the obligations stated above) in violation of the prohibition, the creditors of the company may initiate proceedings to obtain their receivables from the company for the lent amount.  Furthermore, persons, who violate this rule, shall be faced with a judicial monetary sanction of at least three hundred days.

The amendment introduced by the Amendment Act

The Amendment Act narrows the scope of prohibition with respect to the related persons. The prohibition shall not be applicable to the board members and their relatives specified in the article, who are shareholders in the company. Furthermore, reference to unlimited companies and capital companies, to which the board members and their relatives are members, has been completely abrogated. Therefore, only the board members and their relatives who are not shareholders in the company are prohibited from borrowing the company and the company may not provide guarantee, suretyship or other collateral, assume obligations or debts for such persons.

The Amendment Act does not amend the provision on granting the creditors of the company the authority to pursue persons indebted to the company in violation of the prohibition. Nonetheless, the provision of the New TCC, granting authority to pursue caused criticism, since the Enforcement and Bankruptcy Code already grants the creditors to claim from company debtors to pay their debts within the scope of execution up to the receivable amount. The New TCC only reaffirms this possibility and, being a statutory provision entering into force at a later date; it may even result in the provision of the Enforcement and Bankruptcy Code no longer being applicable.

The sanction of judicial monetary fine of at least three hundred days for persons violating this article is not amended either. It is apparent that, board members and their relatives who are shareholders in the company may be indebted to the company in compliance with article 358 analyzed hereinabove, and the failure to comply shall result in the application of sanctions.

Conclusion

The New TCC, as enacted, includes provisions, which prohibit companies to grant any personal loan to the shareholders, board members and relatives of board members as well as unlimited and capital companies in which the board members and their relatives are partners.  Persons violating such prohibitions shall be faced with judicial monetary fines of at least three hundred days. These provisions were severely criticized due to not allowing indebtedness even in the presence of urgent needs. The Amendment Act narrows the scope of this prohibition to a great extent.

Shareholders are now granted the right to borrow from the company whereby shareholders having paid their due capital subscription obligations may assume debts to companies whose interest is sufficient to cover its loss. In the event of violation of these conditions, the persons loaning the debt (instead of the shareholder) shall be faced with judicial monetary fines of at least three hundred days. Although the amendment aims only to enable borrowings in the presence of urgent needs, we are of the opinion that the shareholders will be able to become indebted to companies as long as it does not constitute crimes of abuse of confidence or fraudulent bankruptcy, regardless of whether the necessities are urgent or not.

Furthermore, the Amendment Act narrows the scope of persons related to the prohibition on loans to board members and their relatives. As per the amended provision, board members and their relatives who are shareholders in the company may borrow from the company as long as the conditions set forth hereinabove are satisfied. The provision including the unlimited and capital companies to which the board members and their relatives are partners within the scope of the prohibition is abrogated. Only the board members and their relatives who are not shareholders in the company are prohibited from being indebted to the company.